The Senate Finance Committee recently released a draft of proposed changes to the international tax rules adopted under the Tax Cuts and Jobs Act (TCJA) of 2017. The legislation would amend three taxes created under TCJA: (1) the global intangible low-taxed income (GILTI) tax, (2) the foreign-derived intangible income (FDII) provision and (3) the base erosion and anti-abuse tax (BEAT).
Senate Finance Chair Ron Wyden (D-Oregon) said that, “The Finance Committee is making steady progress in developing our proposals for the reconciliation bill, and overhauling the international tax code is central to our efforts to restore fairness and fund critical investments like the paid leave and the expanded Child Tax Credit—Social Security for our children.” 1
Proposed changes to GILTI
The three proposed changes to GILTI are:
- Repealing the tax exemption that incentivizes shipping jobs overseas to foreign factories.
- Raising the GILTI rate.
- Preventing multinational corporations from shielding income from U.S. tax in tax havens by switching to a country-by-country system.
The draft legislation also adjusts how research and development expenses and headquarters’ costs are treated to prevent companies from paying higher taxes under GILTI when they invest in the United States.
The current GILTI provisions impose a minimum tax on certain low-taxed income of foreign corporations but allow U.S. corporate shareholders to reduce such income with a deduction. The deduction amount is currently 50% of GILTI. U.S. taxpayers can also take an 80% foreign tax credit. This means that, generally, the GILTI tax should apply only to foreign income with an effective tax rate below 13.125% (50% x 21% corporate tax rate/80% foreign tax credit).
For example, if a foreign corporation generates $100 of GILTI, a U.S. corporate shareholder is eligible for a $50 GILTI deduction. The $50 of net income will be subject to the U.S. tax rate of 21% for a total tax of $10.50. If the foreign tax rate is $15, there will be a $12 foreign tax credit (80% of $15) against the $10.50 of GILTI tax. Thus, the U.S. tax liability after applying the credit is $0 ($12 foreign tax credit exceeds the $10.50 of GILTI tax).
The draft legislation would make changes to the foreign tax credit and other aspects of the current statute to curb perceived abuse by multinational corporations.
Proposed changes to FDII
The three proposed changes to FDII are as follows:
- Ending the incentive to move manufacturing facilities and other assets offshore.
- Equalizing the FDII and GILTI rates.
- Replacing offshoring incentives with a new provision to reward current year innovation-spurring activities, such as research and development, in the United States.
The FDII deduction was implemented to further incentivize companies to keep their operations in the United States. The deduction is available to U.S. companies deriving income from sales to foreign markets. The FDII deduction allows export income to be subject to a 13.125% U.S. tax rate instead of the standard corporate rate of 21%, if such income is tied to an intangible asset held in the United States.
Note that foreign sales are not limited to U.S.-manufactured products. Foreign sales include sales of property to a foreign person for foreign use. Foreign use means that the property:
- Is not used domestically for three years, OR
- Incurs further manufacturing abroad before being returned to the United States.
Manufacturing abroad of the exported property may result in either (1) a physical or material change to the property, or (2) the property constituting no more than 20% of the fair market value of any product in which the foreign buyer incorporates the property.
The draft legislation would modify deductions related to tested income and modify the definition of “deemed intangible income” to address perceived weaknesses in how the provision currently operates.
Proposed changes to BEAT
The proposed changes to BEAT focus on the following three areas:
- Restoring the full value of tax credits for domestic investment.
- Creating a higher, second tax bracket for income associated with base erosion.
- Using revenue from the additional tax bracket to support companies investing in the United States.
BEAT applies to large corporations with at least $500 million in gross receipts. The tax is effective for taxable years beginning after Dec. 31, 2017, and is currently calculated by taking 10% of modified taxable income. The rate is 5% for years beginning in 2018 and increases to 12.5% for years beginning after 2025. Deductible payments to related foreign persons are added back to taxable income to arrive at modified taxable income.
BEAT does not apply to individuals, S corporations, regulated investment companies or real estate investment trusts. The proposed legislation also includes a de minimis exception for companies whose foreign related party payments are low relative to overall deductions.
The draft legislation imposes a second tax bracket for income associated with base erosion to target the biggest offenders and tax their income at a higher rate.
The proposed changes to GILTI, FDII and BEAT would mean higher effective tax rates for international taxpayers, although what those tax rates will be remains to be determined.
- U.S. Senate Committee on Finance. “Wyden, Brown, Warner Unveil International Taxation Overhaul Discussion Draft.” Senate.gov, 6 Aug. 2021. https://www.finance.senate.gov/chairmans-news/wyden-brown-warner-unveil-international-taxation-overhaul-discussion-draft.
Tara Fisher has been practicing tax for over 20 years. Her professional background includes working for the U.S. Congress Joint Committee on Taxation, the national tax practice of PricewaterhouseCoopers, the University of Pittsburgh and American University in Washington, D.C. She is a licensed CPA and holds both undergraduate and graduate degrees in accounting from the University of Virginia.
The content contained in this article is for informational purposes only and is not tax advice. You should consult a tax advisor for advice applicable to your situation.
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