Taxes

Gift or Lump of Coal: U.S. Cross-border Tax Changes Won’t Be Home for Christmas

As 2021 comes to a close, countries are moving toward harmonizing tax rules for multinationals, but stalled talks on the Build Back Better Act (BBBA) in the United States means new uncertainties for a global agreement and for taxpayers.

Despite the 2017 U.S. tax reform serving as inspiration for current discussions of a global minimum tax, the policy being discussed at the international level is different from the minimum tax in the U.S. tax code. The BBBA would have made substantial changes to the U.S. minimum tax with a goal of setting rules that mirror the template agreed upon by nearly 140 jurisdictions in October. Since the prospects of the BBBA becoming law have dimmed, it is worth exploring what that means for U.S. companies that might be caught between the different rules.

The 2017 tax reform in the U.S. brought in a first-of-its-kind minimum tax on the foreign earnings of U.S. companies. The policy known as GILTI (for Global Intangible Low-taxed Income) applies a rate of at least 10.5 percent on foreign profits. However, after accounting for foreign taxes paid and other GILTI complexities, U.S. companies can end up paying a combined rate much higher than 10.5 percent on their foreign earnings.

When using GILTI as the template for a global minimum tax became a possibility, the U.S. Treasury department (during President Trump’s tenure) argued that if other countries define harmonized rules, then GILTI should be treated as an approved minimum tax regime.

Following the 2020 election, the Biden administration desired to change GILTI and support a broader global minimum tax. Over the last year the administration has pushed for what has recently become the BBBA version of GILTI while departing from the Trump position in international conversations that GILTI should be approved as it is in current law.

The global minimum tax which has emerged recently from discussions at the Organisation for Economic Co-operation and Development (OECD) draws inspiration from GILTI, but it differs in some key respects. First, the rate of the global minimum tax is 15 percent. Second, the minimum tax would be calculated using financial accounting standards (with some adjustments). Third, the tax would be determined for each country where a company has profits, rather than pooling foreign subsidiaries across countries.

There are other differences as well, but those capture some critical gaps between GILTI and the global minimum tax.

The BBBA included changes to GILTI to reflect a roughly 15 percent minimum tax applied to each country where a U.S. company has profits. The rate could rise to 15.8 percent depending on how exposed a company is to foreign taxes.

This would have made the U.S. GILTI rules more reflective of the global minimum tax than in current U.S. law.

These differences matter because a U.S. company that is complying with GILTI as it is currently constituted (assuming BBBA does not get enacted) may have its foreign subsidiaries caught both by GILTI and the global minimum tax rules when they are put in place around the world.

Think about a U.S. company that pays an average of 18 percent on its foreign earnings. That average reflects some earnings that face just a 5 percent effective tax rate in one jurisdiction, 10 percent in another, and yet other earnings in a higher tax jurisdiction at an effective rate of 28 percent.

Under current GILTI rules, that company may not have to pay any additional tax to the U.S. government. But if the global minimum tax rules are put in place, the company would have to pay a top-up tax in both jurisdictions where it is currently paying less than a 15 percent effective tax rate.

This gets to the question of whether GILTI will be deemed a “qualified income inclusion rule” as defined in the global minimum tax model rules. The definition looks at whether the outcomes of a minimum tax policy are like those of the global minimum tax. Separately, an FAQ document suggests that the coexistence of GILTI (either as current law or as envisioned in the BBBA) will be discussed in 2022.

What this means for U.S. companies is uncertain. If GILTI (as it is currently constituted) is treated as qualified, then U.S. multinationals would not be caught in between the two sets of rules. However, if GILTI is not deemed qualified, then a U.S. company that complies with GILTI may also have to comply with a foreign application of minimum tax rules.

This would result in a U.S. company having to calculate its liability under both GILTI and the global minimum tax.

Compliance with U.S. law would be straightforward given that GILTI has already been in effect for four years. However, compliance with the global minimum tax rules would require companies to track earnings based on financial accounting rules (with adjustments) for every country where they have earnings. This is not something that U.S. companies currently are required to do and would greatly expand the work necessary to comply.

The global minimum tax rules are expected to be in place by the end of 2022, so the clock is ticking on determining whether GILTI is qualified.

Lots of questions remain, but three are critical. Will the U.S. Treasury change course and argue that GILTI in current law should be treated as a qualified minimum tax? Will the “qualified” label apply to GILTI in a dynamic way (allowing for future changes to also be “qualified”) or will it be static? How will other countries respond?

A pivot from the Treasury department would reflect the current challenges of getting the BBBA signed into law and show they are concerned about the looming tax uncertainty. A dynamic approval of GILTI could create issues, though, particularly for other countries that might also want to veer from the model rules. If the U.S. gets an exception, why shouldn’t others?

The global tax deal to-do list for 2022 was already large but ironing out these issues will be critical. It seems that this Christmas brings fresh complexity and uncertainty to an already murky area of tax policy. Here’s hoping for more clarity in 2022.

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