The Biden administration has proposed to significantly increase the tax burden on foreign income through a policy known as Global Intangible Low-Tax Income (GILTI). While the administration’s rhetoric focuses on doubling the tax rate on GILTI from 10.5 percent to 21 percent, this is less than half the story.
The rate on GILTI is going up, but to a higher rate than suggested by the Biden administration. Additionally, the tax base will be broadened. Together, the higher rate and broader base means that companies will face a tax hike on their foreign earnings resulting in $532 billion in additional federal tax revenue (over and above tax increases resulting from the proposed 28 percent corporate tax rate). It is likely that companies will face a total tax burden on GILTI that exceeds Biden’s proposed 28 percent corporate tax rate.
GILTI was intended to work as a backstop to the corporate tax system by subjecting some foreign earnings of U.S. companies to a minimum level of tax. Under current law, GILTI is defined as net foreign income after a deduction for 10 percent of the value of foreign tangible assets. Half of GILTI is taxed at the U.S. corporate rate of 21 percent, which means the basic rate on GILTI is 10.5 percent.
If a company pays foreign taxes, it can claim 80 percent of the value of those taxes as a credit against GILTI liability. Taking this foreign tax credit policy into account means the tax rate on GILTI moves up to 13.125 percent.
Companies can face an even higher tax rate on GILTI for various reasons, and a recent report by the Joint Committee on Taxation suggests the average total tax rate on GILTI in 2018 was 16 percent among 81 companies.
The Biden administration is proposing several changes that impact GILTI’s rate and base.
On the tax rate, their proposed corporate tax rate of 28 percent directly impacts the GILTI rate. When the corporate tax rate rises, the tax rate on GILTI automatically increases.
Additionally, they are proposing to increase the amount of GILTI that is subject to tax. Instead of only half of GILTI being taxed, 75 percent would face additional U.S. tax liability. This means that the basic tax rate on GILTI would increase to 21 percent, the number that the Biden administration focuses on.
However, the administration has not proposed changes to the 80 percent limit on foreign tax credits. So, the tax rate on GILTI would start at 26.25 percent for companies that already pay foreign taxes.
Under Biden’s proposals, the current law range of GILTI rates from 10.5 to 13.125 percent would double to a range of 21 to 26.25 percent.
Then would come the changes to the tax base.
The 10 percent deduction for foreign tangible assets would be repealed, increasing the tax liability of U.S. companies with foreign factories and other infrastructure that are serving foreign markets.
The calculation for GILTI would also be changed from net foreign income to net income calculated on a country-by-country basis. This creates an issue because GILTI does not provide loss carryforwards or carryforwards of excess tax credits under current law and the Biden administration is not proposing to change that. Without those policies, the switch to country-by-country calculations means that GILTI will ignore timing differences between start-up phases and profitable phases and artificially inflate GILTI liability over time.
They are also proposing to expand the tax base to include foreign income from oil and gas extraction.
Moreover, the Biden administration has proposed disallowing some deductions for expenses related to GILTI under Section 265 of the tax code. Current law restricts companies from deducting expenses for income that would be exempt. This is most relevant for tax-exempt bonds. If the proceeds from a bond are not going to be taxed, then the interest expenses for the bond should not be deductible.
The Biden administration wants to treat 25 percent of GILTI as tax-exempt and disallow deductions in line with that deemed exemption. Interest deductions are already limited by another policy in current law, so the administration’s proposal to further limit deductions is just another tax hike by way of further limits on deductions.
Current law also provides an exclusion from GILTI for income that faces high levels of foreign tax. If a company’s foreign income is already taxed at 90 percent of the U.S. rate (currently 18.9 percent), then that income can be excluded from the GILTI calculation. This policy was meant to limit the unintended impact of GILTI on income that already faces high tax levels elsewhere.
However, the Biden administration would repeal that high-tax exclusion and increase the scope of GILTI.
If you take all these policies together, the rate hikes and the tax base changes, it is not difficult to arrive at an effective tax rate on GILTI that would exceed Biden’s proposed 28 percent statutory corporate tax rate. It would also far exceed the 15 percent global minimum tax the administration is negotiating with some 139 other countries.
There are four key factors that contribute to this outcome, and they do so because they result in double taxation of foreign income. The first three are problems under current law that would be exacerbated under the Biden approach. These are the 80 percent limit on foreign tax credits, the requirement to apportion some domestic expenses to foreign income, and the lack of carryforwards for losses or excess foreign tax credits. If GILTI were to work as intended (as a minimum tax on foreign income), each of these problems would need to be fixed.
However, instead of proposing to fix those issues, the administration is proposing a fourth complication that leads to double taxation by denying additional deductions related to GILTI.
Though GILTI was adopted as a backstop to the new international tax system put in place in 2017, the Biden administration’s proposals would turn the policy into an exceedingly high burden on cross-border investment. This would put U.S. companies at a relative disadvantage when competing in foreign markets against foreign companies.
Companies that currently owe additional U.S. tax liability on GILTI would see their tax costs go up, and companies that currently are out of scope for GILTI’s impact would be caught.
Instead of complicating and layering on new tax burdens through GILTI, policymakers should focus on rationalizing the U.S. international tax rules and ensuring that GILTI does not leave U.S. companies at a disadvantage in foreign markets.