Treasury’s Green Book, Part 3: Waves of Change for International Tax

HOST: Welcome to the Cherry Bekaert Tax Beat, a conversation about tax that matters.

BROOKS: Good afternoon. Welcome to this edition of the Cherry Bekaert Tax Beat podcast. Today is July 27, 2021. Today's topics are the international tax issues surrounding the current tax proposals from the Biden administration, as well as developments in the global tax framework.

BROOKS: First, let me introduce the colleagues joining me on today's call. Sarah.

SARAH MCGREGOR: Hi. This is Sarah McGregor. I'm calling in from Greenville, South Carolina.

BRIAN DILL: Yes. I'm Brian Dill, international tax partner based in Atlanta.

MIKE CORNETTE: Hi. I'm Mike Cornette. I'm a director in the international tax group based in Atlanta, but I work out of St. Louis.

BROOKS: All right. I'm Brooks, sitting here in Richmond, Virginia today. Sarah McGregor, how's life treating you?

SARAH MCGREGOR: Life is good. I'm glad we're talking about international issues this week when the Olympics have just gotten started. It keeps me up late at night watching these wonderful athletes accomplish great things.

BROOKS: There have been a lot of surprises in the Olympics so far. I enjoy watching the alternate channels where you see some sports you don't always see. I liked watching fast-paced women's field hockey on those surfaces.

SARAH MCGREGOR: I think I would drown if I had to play water polo.

BROOKS: You got that right. You talk about some serious stamina. All right. Let's move away from international sports and into the more consequential topic of international tax.

BROOKS: In general, we'll talk about the proposed changes to the tax law that came in through the American Jobs Plan and then further explained by the Treasury Green Book. I'll run down those proposals and then discuss where we are in congressional passage. We'll also briefly touch on G7 and G20 discussions.

BROOKS: March 31, the White House released the American Jobs Plan fact sheet, which was the first formal introduction of their tax proposals related to international provisions.

BROOKS: Then, approximately May 28, the Treasury released the General Explanations of the Administration's Fiscal Year Revenue Proposals, commonly called the Green Book. In that Green Book, there are numerous important international tax proposals that could be deeply impactful.

BROOKS: The first was a proposed global minimum tax of 21 percent. The proposal to reach that 21 percent minimum involved modifications to how you tax GILTI, Global Intangible Low-Taxed Income. These are several technical modifications to get to an overall 21 percent rate. That was proposed in conjunction with a proposed U.S. federal corporate rate increase to 28 percent.

BROOKS: Second was limitations on the ability to expatriate income, with many nuances. Third was repeal of FDII, Foreign-Derived Intangible Income. Fourth was replacing BEAT, the Base Erosion and Anti-abuse Tax, with SHIELD, Stopping Harmful Inversions and Ending Low-Taxed Developments.

BROOKS: There were also proposals for foreign tax credit modifications, changes to Section 163(j) interest expense limitations, and eliminating the deduction for shipping jobs overseas, among other items.

BROOKS: Two themes recur throughout the administration's literature: avoiding the "race to the bottom" and avoiding incentives to move operations, profits, property, and jobs offshore.

BROOKS: As of today, we are still in negotiations at the congressional level on how these proposals, accompanied by many other tax and spending proposals, will proceed. There is a tentative bipartisan compromise for roughly $600 to $800 billion of spending, seemingly without tax provisions attached. Parallel to that is a $3.5 trillion expenditure package likely to proceed through reconciliation.

BROOKS: Off to the side, the G7 and G20 are discussing whether they can agree on a global minimum tax rate of 15 percent. That number is getting a lot of attention. Smaller countries and tax-favored jurisdictions are not universally happy about it.

BROOKS: I'll turn it over to Brian. Give us your professional view of what all this means for global tax.

BRIAN DILL: For the last several decades, jurisdictions have competed to attract jobs, facilities, and research and development. Tax policy has been part of that competition. Most jurisdictions migrated to a territorial tax system, taxing only profits associated with earnings in that country, whereas profits earned offshore were not taxed.

BRIAN DILL: The United States historically took a different approach, and U.S. businesses argued that put them at a competitive disadvantage. The 2017 Tax Act introduced elements of a territorial system but also introduced GILTI. Political winds shifted, and we're now again seeing proposals for a minimum tax on global earnings for U.S. companies and an effort to lead the world toward a global minimum tax.

BRIAN DILL: Implementing a global minimum tax is a huge undertaking. Countries like Ireland, with a 12.5 percent rate, have been politically savvy in addressing this. Those smaller, open economies are tied to competitiveness and attracting investment, which complicates global implementation.

BROOKS: When you do something like this to some of those countries, it will mean a loss of business and jobs at some point. Does the end result net to zero? I'm not sure it does for some smaller countries.

BRIAN DILL: In the 1990s, Treasury took an interest in capital export neutrality to avoid adversely harming developing jurisdictions. That policy does not appear to be a priority in current messaging.

SARAH MCGREGOR: Michael, let's bring you in to talk about the proposals from the American Jobs Plan and the Green Book. The repeal of FDII and the changes proposed to GILTI are getting the most attention. Your thoughts?

MIKE CORNETTE: FDII was enacted as part of the Tax Cuts and Jobs Act to encourage investment in the United States and help bring jobs back to the U.S. It provided a low rate on qualifying income and was criticized by the OECD as an export subsidy.

MIKE CORNETTE: The Biden administration feels FDII has not achieved its goals and has proposed repealing the FDII regime. That would remove a tax incentive for exports. There is still the possibility of using an Interest Charge Domestic International Sales Corporation, IC-DISC, for certain taxpayers, but FDII repeal would be a shift from the last four years where FDII existed.

MIKE CORNETTE: Regarding GILTI, the regime would remain but be modified. The Green Book proposed reducing the 50 percent haircut to 25 percent to drive up the effective tax rate on GILTI income toward that 21 percent range. The proposals would also remove the 10 percent tangible asset return, which the administration views as encouraging offshore investment in tangible assets.

MIKE CORNETTE: The changes would increase the amount of income subject to GILTI inclusion and move the system away from a territorial approach. There are other proposed changes, such as moving from a group basis to a country-by-country basis for GILTI computation and possible shifts in foreign tax credit treatment.

MIKE CORNETTE: U.S. manufacturers and others have pushed back, arguing FDII helps competitiveness. If reconciliation includes tax changes, FDII could disappear. GILTI will likely persist in some form, but the scope of changes depends on legislative negotiation.

SARAH MCGREGOR: Brian, this anti-inversion proposal under SHIELD seems like it could catch many taxpayers by surprise. Can you comment?

BRIAN DILL: If you've watched business networks, there is some acceptance of higher corporate tax rates. But corporate America is highly concerned about foreign earnings and changes to GILTI. Early modeling suggests the proposed changes could put U.S. multinationals at a competitive disadvantage.

BRIAN DILL: SHIELD—Stopping Harmful Inversions and Ending Low-Taxed Developments—would penalize deductions for payments to related parties in low-tax jurisdictions. For example, if Ireland taxes at 12.5 percent and the threshold is 15 percent, payments to related parties could become non-deductible in the U.S.

BRIAN DILL: Existing anti-inversion rules, such as Section 7874, already catch some transactions unexpectedly. SHIELD could tighten these rules and create unintended consequences for middle-market clients who do not intend to invert but may fall within the rules due to new structures or foreign investors.

BROOKS: The 15 percent global minimum tax seems to be the headline item. Mike, what should U.S. companies be thinking about regarding a 15 percent global minimum tax proposal?

MIKE CORNETTE: U.S. companies setting up operations offshore need to be sensitive to the potential for a minimum tax. Countries like Ireland, at 12.5 percent, may be forced to conform or face top-up taxes under a global minimum. Some low-tax jurisdictions, such as Hungary, have raised concerns about losing competitiveness.

MIKE CORNETTE: SHIELD includes a threshold for applicability, which is currently fairly high, but thresholds can be adjusted when policymakers need revenue. If other countries adopt a 15 percent minimum while the U.S. adopts a higher rate for GILTI, there will be tensions: the U.S. proposal in the Green Book targeted 21 percent for GILTI, while the OECD discussions center on 15 percent.

MIKE CORNETTE: SHIELD also targets cost of goods sold. A company purchasing goods from a related party in a low-tax jurisdiction might lose a deduction for that cost if the counterparty's tax is insufficient. That could raise the cost of goods sold and potentially increase prices downstream.

BROOKS: That cost is likely to be passed on, which we see with other tax rate differences. Mike, can you discuss allocation of income, transfer pricing, and Pillar 1 and Pillar 2 concepts?

MIKE CORNETTE: The OECD has been working on allocation frameworks for years. Pillar 1 focuses on profit allocation to jurisdictions and attempts to reduce subjectivity in transfer pricing, partly driven by digital commerce where companies allocate risk and profit to low-tax jurisdictions while selling in higher-tax markets.

MIKE CORNETTE: Pillar 2 focuses on a global minimum tax, proposing a 15 percent floor. The two pillars are complementary: allocate profit fairly, then ensure a minimum tax is paid. These proposals are initially targeted at large multinationals with revenue thresholds, but once adopted, countries may extend rules more broadly.

MIKE CORNETTE: Transfer pricing remains necessary because businesses differ in risk and economic profiles. Any global allocation method will struggle to fully account for business-specific differences.

BROOKS: Brian, any final comments on the 15 percent proposal?

BRIAN DILL: The affiliated rules and interpretations will matter greatly. The 15 percent applies on the foreign side, while the U.S. mechanism through GILTI is intended to bring U.S. taxpayers to the minimum. The effective GILTI rate under the Green Book proposals may be higher than 15 percent.

MIKE CORNETTE: From a competitive standpoint, companies worry the rest of the world might be at 15 percent while the U.S. taxes them at 21 percent or higher depending on the corporate rate discussion. That differential raises competitiveness concerns and fuels interest in inversion planning.

SARAH MCGREGOR: We still need all countries that agreed in principle to a minimum tax to enact actual legislation. That could take considerable time.

BROOKS: Let's move to the economic and supply chain implications. Brian, what do you see happening with global supply chains as a result of these tax proposals?

BRIAN DILL: The hope is that jobs and manufacturing would move back to the United States for competitive reasons. But if other countries rise to 15 percent, they may still be competitive. The regional supply chain structure may shift.

BRIAN DILL: Jurisdictions like Mexico and Honduras, with maquiladora and outsourcing operations, will be relevant. Private equity and private companies will evaluate how to use IC-DISCs for exports if FDII disappears.

BRIAN DILL: Compliance and accounting systems will need updates. If a global minimum tax uses a book-income concept, companies will need to calculate effective tax rates based on financial statement earnings. That compliance complexity could be significant.

MIKE CORNETTE: The U.S. began pushing transparency years ago, and many foreign countries have followed. With enhanced reporting and withholding emphasis, companies must ensure proper documentation and withholding, especially if the IRS receives increased funding for enforcement.

SARAH MCGREGOR: Brian, you've mentioned IC-DISC a couple of times. Why is that still a good choice for companies to consider?

BRIAN DILL: An IC-DISC allows certain U.S. exporters, particularly private companies, to exempt certain profits from corporate-level tax and tax them at the shareholder level instead. It's a rate arbitrage and the primary export incentive remaining if FDII is repealed.

BRIAN DILL: The critical issue is timing. You must establish and elect an IC-DISC before you can use it. If FDII disappears, IC-DISC may be the only export regime available, so consider setting one up sooner rather than later.

SARAH MCGREGOR: In light of proposed GILTI changes, what should companies do now?

BRIAN DILL: Be conservative and plan for higher effective foreign tax rates. Evaluate whether corporate blocker structures should migrate to flow-through entities, such as partnerships, to optimize foreign tax credits and overall competitiveness.

MIKE CORNETTE: Quantitative modeling and analysis are essential. Modeling will help determine whether credits apply and how changes affect deal economics and operational decisions.

BROOKS: Any final comments? Brian?

BRIAN DILL: Political winds favor higher taxes. While headlines focus on rates, international provisions could have more substantive impact on multinational businesses. Modeling will be critical.

BROOKS: Sarah?

SARAH MCGREGOR: Companies need flexibility. Moving operations and people is difficult, but planning must begin now because implementation takes time.

MIKE CORNETTE: Consider acceleration. If you're contemplating an acquisition or inversion, consider completing transactions sooner rather than later because rule changes could alter deal economics.

BROOKS: From my perspective, this underscores tax planning. Global tax structure planning could be turned upside down if even half of these proposals pass. Companies need to plan now and be ready to move. This could be game changing and a substantive tax increase in many cases. It plays well politically to tax foreign income more, so we'll keep monitoring.

BROOKS: Thank you, Brian, Mike, and Sarah. Thank you to our listeners for spending your time with us. Quick disclaimer: We're not providing tax advice on this podcast. Please consult with your tax advisor, preferably at Cherry Bekaert, to discuss information from today's podcast.

BROOKS: Check our firm's website at CBH.com for the latest guidance and materials on this and other tax and business topics. We have previous podcasts on the Green Book and the American Jobs Plan for background.

BROOKS: This concludes today's podcast. Thank you again. Go forth in peace.