Pleading GILTI

For the first time in a while, the Biden administration is riding high. Inflation is slightly down, the president’s approval is slightly up, and the Democrats finally passed the Inflation Reduction Act, likely to be one of President Biden’s signature accomplishments.

In the international tax sphere, however, things are gloomier.

Sen. Joe Manchin (D-WV) nixed the international tax proposals that were in both Biden’s initial wishlist as well as the House-passed reconciliation legislation. The final bill did include a corporate minimum tax–but not the right one, at least to follow the new guidelines set by the Organization for Economic Cooperation and Development following last year’s announcement of a 15% global minimum tax agreement.

“It is unfortunate that the United States was unable to lead in adopting the global minimum tax after U.S. Treasury Secretary Janet Yellen’s crucial leadership in forging this transformative agreement,” wrote Kimberly Clausing, a UCLA tax professor who left Treasury earlier this year after working on these issues as a deputy assistant secretary.

Former Treasury Secretary Larry Summers said that implementing the OECD agreement was “the most important, urgent unfinished business after this bill.”

Amid all of this doom and gloom, one might forget that the U.S. does actually have a global minimum tax–the 10.5% tax on global intangible low-taxed income, enacted by the 2017 Tax Cuts and Jobs Act. Indeed, most of the changes Biden proposed were alterations to GILTI that left the fundamental concept intact.

But blasting GILTI as loophole-ridden and toothless has been a Democratic talking point since before the TCJA was even passed. Chief among these claims is that because GILTI is calculated on a worldwide basis, not country-by-country, it still allows profit-shifting to occur. Reversing this has been part of the Dems’ agenda, including Biden’s 2020 presidential campaign platform, long before the OECD agreement. Even late-night comedian John Oliver got in on the GILTI-bashing a few years ago.

If I were to go out and ask strangers on the street, I’d doubt that 1 out of 100 would guess that the Trump tax cuts included a rule against offshore tax avoidance that, however flawed, is likely the strongest passed by Congress in 50 years. And not just because most people aren’t steeped in tax policy, and would probably be annoyed if a stranger came up to bother them about it.

That the TCJA, mostly known to Americans as a corporate tax break, included anti-abuse rules goes so far against the public narrative, it’s like trying to tell people that 2 + 2 = fish. You can blame Democrats for this, who’ve attacked the TCJA from day one–but former President Trump and his fellow Republicans have also been inexplicably wary of touting that side of the bill.

Now both the U.S. and the OECD will have to deal with GILTI as it is, not as they’d like it to be. Since the country-by-country/aggregate issue is likely the biggest difference between the OECD standards and current U.S. law, it’s worth revisiting the central debate, and how GILTI ended up the way it is.

Both GILTI and the OECD global minimum tax are meant to target intangible income in low-tax jurisdictions, such as profit from valuable intellectual property. That’s what’s most often used in complex crossborder structures meant to reduce taxes. GILTI’s appeal is that it’s a somewhat blunt instrument, using a formulaic proxy rather than trying to identify the intangible assets themselves. If companies have income taxed abroad at lower than 13.125%, it’s taxed immediately at 10.5%, after removing a 10% return on depreciable, tangible assets. (The slight difference in effective tax rates is due to a slim reduction on the foreign tax credits that a company can use against GILTI.)

The complication comes in with how to calculate these figures. Aside from the foreign tax credit limitation–that’s a whole other discussion–there’s no restriction on how a company can claim foreign tax credits, it all goes into one big bucket. Credits from a high-tax jurisdiction can help cover the GILTI tax liability arising from a low-tax jurisdiction.

The depreciable, tangible asset calculation is aggregated, too–although it can only apply for subsidiaries which are showing a profit in a given year. (While GILTI can be aggregated across jurisdictions, it can’t be aggregated across years, a significant tradeoff. The OECD’s tax takes into account net operating losses and foreign tax credit carryforwards, while GILTI doesn’t.)

Defenders of GILTI say that an aggregated approach is most reasonable–it still captures intangible income, while avoiding scores of administrative headaches. Of course, a country-by-country approach would be a bonanza for international tax lawyers and accountants, increasing the amount of cross-border income management exponentially. Companies will have a whole new reason to scrutinize their income in every jurisdiction they operate in.

Critics say that while the administrative concerns are valid, they’re manageable, and worth bearing to ensure that all income-shifting is being captured. Given all of the tools for tax planning at a corporation’s disposal, to allow more cross-jurisdictional flexibility enables more tax avoidance, they claim.

Is GILTI working? That’s the $600 billion question without a satisfactory answer.

While the TCJA is five years old, one of those years was spent in transition, and another (2020) was spent in full chaos. The IRS country-by-country tax data, one of the best sources of information on U.S. subsidiaries, only goes up to 2019 so far. That leaves just a few data points, which can be used to support either side of the argument.

Two different papers have shown that acquisitions of entities in low-tax jurisdictions have slowed since 2017, seemingly confirming that GILTI has discouraged activity there. But there’s evidence that income-shifting is continuing and the tax havens are still full of income from U.S. companies.

What I’ve heard anecdotally is that GILTI has shut down many opportunities for future tax planning, but the disincentives aren’t strong enough for companies to overlook their wariness about fully unwinding current overseas tax structures and repatriating valuable intellectual property, or the earnings that come with it. (Although many companies have.) This doesn’t necessarily contradict the studies above. But as everyone knows, the plural of anecdote is not data.

George Callas and Mark Prater, two former Congressional staffers who worked extensively on different versions of what became the TCJA, wrote a 2020 Tax Notes piece defending GILTI’s current structure, noting that lawmakers found that dis-aggregated approaches were “too onerous.” They also cited a 2013 analysis by Harry Grubert, then with Treasury, and Rutgers Professor Roseanne Altshuler, which determined that an aggregate global minimum tax was a “serious” option.

“While it is not as successful as the per-country minimum tax in targeting tax haven income, it is a substantial move in that direction and is much simpler,” they wrote.

The debate became that eternal question, is the juice worth the squeeze?

"The question becomes, what are you achieving through this huge administrative burden?" Callas told me for a 2019 Law360 article. "We thought it was not Congress' job to put American companies at a disadvantage around the world to protect foreign tax bases."

The advantage of a country-by-country system is that it catches all of the intangible income that might be involved in profit-shifting–but that’s also a potential weakness. Not only does it capture incidental income that may not be true base erosion, but it also captures profit-shifting from non-U.S. countries. If it encourages a company to reverse that shifting, it will increase other countries' revenues, not our own. Should that be a goal of U.S. policy, and if so how much collateral cost is it worth?

This is another version of a debate that has been swirling around international tax policy for decades–at least since the 1962 enactment of Subpart F, and likely earlier. That law declared that interest, rents and royalties earned abroad are automatically U.S. taxable income, regardless of where the payments are from or where they are going. The principle stayed mostly intact until the Clinton administration in the 90s released check-the-box regulations, which made it much easier for corporations to shield foreign-to-foreign transactions from U.S. taxation.

When the administration realized this and prepared new rules to close that apparent loophole, Congressional Republicans revolted and claimed that Treasury was trying to become the global tax policeman. The department eventually backed off, and check-the-box was here to stay. For the next few decades, Treasury decided that it’s not really their business if U.S. companies shift income out of other countries, they just focused on what happens over the U.S. border.

The experience of check-the-box seems to show that we should care about foreign-to-foreign profit-shifting by U.S. companies, at least a little. The offshore cost-sharing arrangements which garnered attention and infamy in the years that followed were only possible because of those rules. Profit-shifting is apparently contagious–income in low-tax jurisdictions enabled by foreign-to-foreign shifting became an overwhelming incentive for erosion from the U.S. base, which our own rules were unable to withstand.

This issue is one reason why estimates of global profit-shifting are all over the place. Determining tax avoidance can be subjective–it always reminds me of Justice Potter Stewart’s famous definition of pornography, “I know it when I see it,”--but narrowing it does to U.S. tax avoidance is even more tricky.

This still doesn’t answer the key question with GILTI. It also points to a central irony: the more that other countries enact their own Pillar 2/global minimum tax rules, the less the country-by-country issue matters. If all high-tax countries would enact rules similar to GILTI, we could just close the book on this issue and call it a day.

But it’s getting from here to there that’s the hard part.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

OTHER NEWS OF THE WEEK

Some more summer beach reading just dropped--the OECD released comments on its Progress Report for Amount A of Pillar One, the new source-based income allocation system that is paired with the 15% global minimum tax. I admit, I've slacked a bit on trying to understand this--with only so many hours in the day and only so much my brain can handle, it's too tempting to skip over a policy which seems so far away from implementation. But this is, no doubt, a mistake on my part. Tax policy can follow a winding, uncertain road, and you never know how stalled ideas may be resurrected or applied. Just ask Congress!

Sen. Ron Wyden (D-Ore.) is continuing his crusade against offshore tax avoidance and evasion--but now he's focused on what he claims is a loophole in the Foreign Account Tax Compliance Act system. An August 24 report claims that "shell banks" can exploit an exception in information-trading agreements with Switzerland, Bermuda, the Caymans, and other reputed tax havens.

Speaking of information-sharing, the OECD released peer review reports on the transparency and exchange of information standards for eight countries. This is part of the Common Reporting Standard--sort of the global version of FATCA, although the U.S. doesn't participate. These reports are always interesting to scan for tidbits--for instance, the OECD dings Ecuador for gaps in its financial reporting system. It also downgrades Finland from "compliant" to "largely compliant," for failing to adopt all of the post-Panama Papers standards on information transparency. Hopefully their prime minister can find time in her busy social schedule to address this.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

The American Crusader, created by Max Plaisted for Thrilling Comics in 1941. A mild-mannered astronomy professor who gained superpowers such as invulnerability and flight after he was blasted by atomic radiation from a colleague's experiment. He used his superhero identity to fight crime as well as Nazis on the European front, assisted by Mickey Martin, an American student stranded in occupied France.