A new approach: the intersection of US tax reform and global tax reform

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Alan Winston Granwell
Holland & Knight, Washington, DC
[email protected]

Joshua David Odintz
Holland & Knight, Washington, DC
[email protected]

Introduction

The Biden Administration has recently announced domestic tax reform proposals alongside a more multilateral approach to global tax issues, which may not only change the US tax code but also the taxation regimes of other countries.

With President Biden's American Jobs Plan, a US$2tn package to modernise the nation's infrastructure, came the vehicle that will pay for it: the Made in America Tax Plan. One of the underlying principles and key constituent elements of this Tax Plan is to end 'the race to the bottom around the world' (as the Administration puts it) on corporate tax rates by encouraging other countries to adopt robust minimum taxes on corporations similar to that being adopted by the US.

In conjunction with this domestic tax reform agenda, the US has actively re-engaged with the G20 and the Organization for Economic Cooperation and Development's (OECD) Inclusive Framework to reach an agreement with other countries on the Framework's Pillar 1 and Pillar 2 initiatives, which are viewed by the Administration as essential elements in its tax reform initiative.

These two events, while significant on their own, in combination may represent the first time that a US tax reform proposal has involved reaching out to other countries to change their tax laws.

In this note, we provide some additional detail and commentary about these events.

The Made in America tax plan

The headline proposal in the Made in America Tax Plan is to increase the federal corporate income tax rate from 21 per cent to 28 per cent in order to to garner more tax from the corporate sector. Opponents of the tax increase argue that it will make the US uncompetitive, with the Tax Foundation observing: 'An increase in the federal corporate tax rate to 28 percent would raise the US federal-state combined tax rate to 32.34 percent, highest in the OECD and among Group of Seven … countries, harming US economic competitiveness and increasing the cost of investment in America.'[1]

In addition, and particularly relevant to these discussions, the Made in American Tax Plan would increase the rate that the US taxes the foreign profits of US multinationals under the Global Intangible Low Taxed Income (GILTI) regime from 10.5 per cent to 21 per cent. This is three-quarters of the proposed new 28 per cent corporate tax rate, compared to one-half of the current 21 per cent rate.

The reason underlying the increase in the GILTI tax rate (as well as associated proposals to disallow deductions for the offshoring of production and instituting stronger guardrails against corporate inversions) is to reduce the current US tax regime's preferences for foreign relative to domestic profits, thereby seeking to create a more level playing field between domestic and foreign activity. The Plan would also make certain other changes: eliminating the 10 per cent tax-free return on qualified business investment assets (QBAI) and applying a country-by-country approach, rather than an aggregate methodology to compute GILTI.

In formulating its proposal to encourage foreign countries to adopt robust minimum taxes, worldwide[2], the US has recognised that such a step may not be an attractive proposition to all countries - for instance, Hungary has a nine per cent corporate tax rate, Ireland has a 12.5 per cent corporate tax rate - and that these and other countries might need additional inducement to increase their rates.

There are two parts to that inducement: first, the repeal of the unpopular (and, in the view of the Biden Administration, ineffective) Base Erosion and Anti-Abuse Tax, which should be well received by other countries. Second, a new anti-base erosion provision, the Stop Harmful Inversions and Ending Low-tax Developments (SHIELD) provision, to bring reluctant jurisdictions to the bargaining table. The idea behind SHIELD is that it would deny multinational corporations US tax deductions by reference to related party payments subject to a low effective rate of tax. If the payment is taxed in the foreign jurisdiction at a low rate, then the deduction is denied in the US. The low rate of tax would be determined by reference to the rate agreed upon in the Pillar 2 multilateral agreement. However, if SHIELD comes into effect before the multilateral Framework agreement is in force, the default rate trigger would be the tax rate on the GILTI income (21 per cent)[3], as it will be under the Made in America Tax Plan. It is worth noting that if the corporate rate were reduced from 28 per cent to a lower rate, then the 21 per cent rate would most likely be reduced proportionately. It is unclear whether SHIELD overrides or is compliant with current US tax treaties.

Multilateral engagement

The drafters of the Made in America Tax Plan recognised that a minimum tax on US multinational corporations is insufficient to end the race to the bottom because if other countries do not adopt similar robust minimum taxes, then foreign corporations with US operations could structure their affairs so as to engage in base erosion and US corporations could potentially invert. To that end, through various statements, letters, speeches and op-eds, the US Treasury Secretary, Janet Yellen, and other officials of the US Treasury Department have reached out to the G20 and the OECD to encourage multilateral adoption of a global minimum tax.

In addition, the Biden Administration has made clear that until there is a resolution of the Pillar 1 allocation and nexus rules, which have the aim of stabilising the overall architecture of international tax rules, it may not be possible to reach a consensus on the Pillar 2 global minimum tax. To seek to resolve the current complex, opaque and uncertain Pillar 1 proposals, and to end the unilateral adoption of digital services taxes, it has been reported that the US has proposed a simplified profit allocation and nexus approach to the Inclusive Framework. Under this new approach, only the most successful global multinational groups, based on a revenue and profit-margin threshold, and without regard to industry, would be subject to the new regime. The objective of the US proposal is to reboot the Pillar 1 discussions with clear, principled, administrable rules that provide tax certainty and are not discriminatory to US taxpayers.

While the US approach is commendable, in order to reach a resolution, numerous issues would have to be resolved.

Conclusion

Time will tell whether the Made in American Tax Plan is passed by Congress and whether the Inclusive Framework is able to reach a consensus on the Pillar 1 and Pillar 2 initiatives. Irrespective of outcome, however, as a matter of international tax policy, the approach of the US linking its domestic tax reform with a multilateral approach working towards collectively revising global tax systems reflects the reality of a new borderless virtual economy.

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