On 28 May 2021, the United States (US) Treasury released its FY 2022 explanation of the Biden Administration's revenue proposals (the Green Book), offering new details on the various proposals included in the President's "Made in America" tax plan.
The Made in America tax plan was first released in March (see EY Global Tax Alert, Report on recent US international tax developments – 2 April 2021) and followed by a Treasury report detailing the Administration's corporate tax proposals, including increasing the corporate tax rate from 21% to 28% and significant changes to international tax provisions (see EY Global Tax Alert, US Treasury releases President’s plan to overhaul corporate tax system, dated 7 April 2021). The significant international tax proposals include:
Increased tax rates and other changes to the regime for global intangible low-taxed income (GILTI)
Country-by-country limitations on foreign tax credits
Repeal of the deduction for foreign-derived intangible income (FDII)
Replacement of the base erosion and anti-abuse tax (BEAT) with a newly proposed "SHIELD" (Stopping Harmful Inversions and Ending Low-tax Developments)
Expanded rules targeting inversions
A new minimum tax on book income
Limits on interest deductions for disproportionate borrowing in the US
Treatment of dispositions of "specified hybrid entities" as stock sales for certain purposes
Most of the proposals would be effective for tax years beginning after 31 December 2021, though several are proposed to be effective for transactions completed after the date of enactment. The proposal to repeal BEAT and introduce SHIELD would be effective for tax years beginning after 31 December 2022.
In this Alert, EY shares its first impressions of the Green Book proposal.
The Made in America tax plan would increase the tax rate on GILTI from 10.5% to 21% by reducing the Internal Revenue Code1 Section 250 deduction to 25% from 50%. Furthermore, the plan would eliminate the exemption from GILTI of a net deemed tangible income return (qualified business asset investment), currently equal to 10% of a US shareholder's share of controlled foreign corporation (CFC) adjusted basis in qualified business asset investments.
The Green Book would repeal the high tax exception for both GILTI and subpart F. It would also repeal Section 904(b)(4) (which affects the treatment of deductions allocated to income exempted under Section 245A for purposes of the foreign tax credit (FTC) limitation). Instead, it would expand Section 265 to disallow deductions allocable to foreign gross income that is exempt from tax (such as income eligible for a dividends-received deduction under Section 245A) or foreign gross income subject to a lower rate through a deduction (such as a Section 250 deduction on GILTI).
Country-by-country FTC limitation
The Green Book would determine a US shareholder's GILTI inclusion and FTC limitation on a country-by-country basis, thus preventing excess FTCs from high-tax jurisdictions from being credited against GILTI inclusions from low-tax jurisdictions. The Green Book would also expand the country-by-country limitation to branch income.
For a foreign parented controlled group, the Green Book would allow US shareholders to take into account taxes paid by a foreign parent under an income inclusion rule that is consistent with an Organisation for Economic Co-operation and Development (OECD)/Inclusive Framework Pillar Two agreement if a consensus is reached at the OECD. It is unclear whether the foreign parent's taxes would be taken into account as deemed paid credits, or whether the income subject to foreign-parent taxation would be excluded from tested income.
FDII and Jobs incentives
The Green Book would repeal the FDII deduction and replace it with tax-based incentives for research and development (R&D) in the US. No details are provided on how domestic R&D would be incentivized under the Green Book proposal, though the budget scoring indicates new incentives would match the revenue raised by eliminating FDII.
In lieu of FDII, the Green Book proposes to create a new 10% general business credit for eligible expenses incurred in connection with onshoring to the US a trade or business that is currently conducted outside the US. Conversely, the Green Book would disallow deductions for expenses paid or incurred at the US or CFC level in connection with offshoring a US trade or business if the offshoring would result in a loss of US jobs.
Replacement of BEAT with SHIELD
The Made in America tax plan would repeal the BEAT and replace it with SHIELD. SHIELD would deny deductions "by reference to all gross payments that are made (or deemed made)" to related entities whose income is subject to a low effective rate of tax (ETR). The threshold rate of tax for disallowance would be the GILTI rate of 21% until the adoption of a multilateral agreement on global minimum tax rates under the OECD's BEPS initiative. According to press reports, Treasury proposed on 20 May that the global minimum tax rate should be at least 15% and that discussions should continue to push that rate higher. The Green Book provides these additional details on SHIELD:
SHIELD would apply to financial reporting groups with greater than US$500 million in global annual revenues, although Treasury could exempt payments to domestic and foreign members that are investment funds, pension funds, international organizations, or non-profit entities, and take into account payments by partnerships.
The Green Book proposal would modify current inversion rules by generally treating a foreign acquiring corporation as a US company based on a reduced 50% continuing ownership threshold (instead of 80%).
The Green Book proposal would also expand the inversion rules to apply regardless of the level of shareholder continuity if:
The proposal would expand the scope of acquisitions covered by the inversion rules and also cover certain distributions of foreign corporation stock by a domestic corporation or a partnership. The expansion of the inversion rules would be effective for transactions that are completed after the date of enactment.
Minimum book tax
The Made in America tax plan would introduce a minimum book tax on certain large multinational corporations. According to the Green Book, a 15% minimum tax would apply to the company's book income that is generally reported to investors. In-scope companies, those with a calculated base in excess of US$2 billion, would make an additional payment to the Internal Revenue Service for the excess of up to 15% on their book income over their regular tax liability. Companies would be given credit for taxes paid above the minimum book-tax threshold in prior years, for book net operating loss deductions, for general business tax credits (including research, clean energy, and housing tax credits) and for FTCs.
Interest limitation for disproportionate borrowing in the US
The Green Book introduces a new limitation on interest deductions that would apply to an entity that is a member of a multinational group preparing consolidated financial statements in accordance with US Generally Accepted Accounting Principles or International Financial Reporting Standards. The provision is similar to Section 163(n), which was proposed, but never enacted, in the run-up to the Tax Cuts and Jobs Act of 2017.
A member's interest deduction would be limited if the member's net interest expense for financial reporting purposes is greater than the member's proportionate share of the financial reporting group's net interest expense reported on the group's consolidated financial statements.
A member of a financial reporting group must first compute its proportionate share of the group net interest expense as reported on the group consolidated financial statements, as follows:
Member book EBITDA x Group book net interest = Member share of group book net interest
Group book EBITDA
After determining its proportionate share, a member determines its excess financial statement net interest expense, if any, as follows (all amounts are with respect to a group member):
Book net interest – Share of group book net interest = Excess book net interest
Finally, the amount of the member's interest expense that is disallowed and carried forward for US federal income tax purposes is the member's "excess net interest expense," computed as follows (all amounts are with respect to a group member):
Tax net interest x Excess book net interest = Excess tax net interest
Book net interest
Dispositions of specified hybrid entities
The Green Book would extend the principles of Section 338(h)(16) to the disposition of entities treated as corporations under foreign tax law but as partnerships or disregarded entities for US tax purposes (specified hybrid entities). Consequently, the source and character of any item resulting from a specified hybrid entity disposition would be determined for FTC purposes as if the seller had sold or exchanged stock (determined without regard to Section 1248).
With a closely divided House and an evenly split Senate, the details of the international tax provisions in the Green Book are likely to change during the legislative process, making the prospects for enactment unclear. Nevertheless, the Green Book demonstrates that the Biden Administration is committed to fundamental changes to the international tax rules and to aligning key proposals such as SHIELD to the OECD Pillar Two proposals. By using the key new details in the Green Book, taxpayers can better model the potential impact of the international tax proposals on their planning and operations, although many key design features of these proposals still need to be clarified.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (United States), International Tax and Transaction Services