Today’s is not the economy of years past. Gone are the days when tried-and-true manufacturing and a steady, patriotic gusto were enough to ensure an American company’s success; to thrive in the modern market, large companies must maintain a well-organized, nearly prescient process of tax structuring and avoidance. Enter the global scale, and the process intensifies: foreign revenue codes, altered demand, and shifting geopolitical winds make it impossible for a company to survive without a finely tuned tax strategy that captures every last cent of profit.
So what happens when another country decides to lure American companies to its shores with more favorable corporate tax rates? Will national pride keep companies at home, or will the mighty dollar drive companies to foreign shores in search of a better bottom line? Unfortunately for the home team, profit usually rules the day.
Faced with this bitter reality, legislators in the 2017 Tax Cuts and Jobs Act (TCJA) implemented a new form of international tax to prevent U.S.-based multinationals from shifting profits to more favorable jurisdictions. To do this, a tax would be levied against corporations’ foreign-held intangible assets—assets producing what is known as global intangible low-taxed income. It was a necessary move, but one that has proven difficult to enforce.
GILTI: What it is and Why it Matters
Global intangible low-taxed income, or GILTI, is foreign income earned through moveable, intangible assets such as copyrights, patents, and trademarks. In a rapidly digitizing economy, such assets are easily scaled and relocated, and their corresponding income forms a significant chunk of corporate profits. As a result, companies have begun shifting more and more intangibles overseas in an effort to reduce their overall tax burden.
The benefits of such a shift can be substantial. Before the TCJA, American businesses paid taxes on their worldwide income at the U.S. rate of about 35%. The TCJA lopped 14% off that rate, but even that number failed to compete with the rates in certain “tax-haven” countries. These countries offer lower, sometimes non-existent corporate rates that lure profit-minded companies offshore in search of tax avoidance—a major problem for America’s corporate tax base.
Enter the GILTI tax—a special levy against U.S.-controlled foreign corporations (CFCs) to ensure they pay a minimum level of tax on foreign-earned income. GILTI’s aim is straightforward: keep the tax base from eroding by discouraging American multinationals from locating income-producing assets abroad. To do this, it places a higher tax burden (between 10.5% and 13.125%) on foreign profits that might otherwise be located overseas. Put simply, if a company wants to shift profits to a foreign jurisdiction, it must pay for it.
Problems with the GILTI and the TCJA
But things did not go as planned. One of the TCJA’s main goals was to reduce profit shifting and increase domestic investment through recognition and taxation of global intangible assets. US multinationals, the theory went, would prefer to locate profits at home once they realized foreign-owned intangibles could no longer avoid being taxed. But reality proved sobering. Post-enactment data revealed that GILTI had curtailed international profit shifting only slightly, and any boost in repatriated profits led, not to new investment, but to increased share repurchases. By the end of 2019, the U.S. was collecting only one percent of GDP in corporate tax revenue—less than its neighbors in Canada and Mexico. Something, it seemed, needed to be done to level the playing field.
THE OECD and Its Release of Pillar Two
The major proponent for a level international playing field in terms of foreign-profits taxation is the Organisation for Economic Co-operation and Development (OECD), a coalition of 38 member countries aimed at developing a set of evidence-based international standards that promote social, economic, and environmental well-being.
For some time, the OECD has championed the idea of a global minimum tax as a solution to the challenges of taxing a digital economy. In December 2022, the OECD officially released its “Pillar Two” Model Rules for implementation of a 15% minimum tax. Designed to ensure large multinationals pay a minimum level of tax on foreign income, the rules provide a template that each jurisdiction can translate into its own domestic law.
Build Back Better’s Proposed Adoption of Pillar Two
In response to OECD guidance, the House-passed Build Back Better Act (BBBA) proposed changes to the U.S. international-tax regime meant to bring GILTI into conformity with Pillar Two’s Model Rules. In fact, in a number of regards, BBBA would actually have made the U.S. regime more stringent than that of the Model Rules. By taking the lead in enforcing a global minimum tax, the idea was that the U.S. would spearhead an environment of international cooperation which would allow other OECD-member countries to follow suit. But not everyone agreed.
In a letter addressed to Treasury Secretary Janet Yellen, the Alliance for Competitive taxation—a group whose members include the likes of Coca Cola, Disney, and 3M—urged against the BBBA’s adoption of Pillar Two. Full-scale adoption, it warned, would clash with existing U.S. tax laws and have deleterious effects on U.S. multinationals.
Their concern appeared justified; for in addition to its other recommendations, Pillar Two contains an Under-Taxed Payment Rule (UTPR) that penalizes companies that achieve an effective tax rate under the 15% minimum. These “top-up” penalty payments are made, not to the parent corporations’ home county, but to its foreign affiliates’ homejurisdictions (i.e., the jurisdiction in which the affiliate is actually located). The downstream effects of this provision are two-fold:
First, Pillar Two’s adoption, at least in current form, would discourage corporations from making investments that benefit society as a whole. Unlike other OECD member countries, the U.S. has enacted a host of tax credits that incentivize certain activities in US-based enterprises. Through dedicated research and development, investment in low-income housing, carbon sequestration, and a slew of other socially beneficial activities, a company receives tax breaks which reduce its effective tax rate. But under the Model Rules, a multinational that succeeds in reducing its effective rate below the 15% Pillar Two minimum opens itself up to additional tax penalties by way of the UTPR. Such a company, forced to make “top-up” penalty payments to cover the difference between 15% and the company’s effective incentive-reduced rate, is unlikely to shoulder the burden of seeking such credits in the first place. Far from incentivizing socially desirable domestic investments, Pillar two’s framework would discourage them.
Not only that, but top-up taxed income would be distributed abroad, rather than at home, allowing foreign governments to capture profits that would otherwise benefit U.S. taxpayers. Because the U.S. tax regime does not include a qualified Income Inclusion Rule (IIR), foreign companies playing home to multinational subsidiaries would be able to claim the proceeds of the UTPR tax from parent-companies. Stated another way, foreign countries would reap the benefit of congressionally approved tax breaks intended for domestic benefit. Congress—its tax credits useless to incentivize domestic innovation, job creation, and targeted investment—might as well be casting its pearls.
The Inflation Recovery Act and Current Proposals to Change GILTI
Despite BBB’s failure to pass in the Senate, there was widespread belief that much of its legislation, including its tax aims, would be resurrected in other bills. That belief was well placed. On Wednesday, July 27, 2022, Senate majority Leader Chuck Schumer and Senator Joe Manchin announced their agreement to move forward with a reconciliation package known as the Inflation Reduction Act (IRA).
Stemming from the BBBA’s negotiations, the Inflation Reduction Act aims to stifle inflation by dampening demand. To do that, it touts among other things a 15% global minimum tax on U.S. CFCs. But notably absent from the Act is any attempt to raise the GILTI rate. The IRA thus fails to address the inconsistencies that raised concern over the original proposal in the BBBA. Rather than craft a solution to the problem, the Act sidesteps it altogether, leaving the GILTI tax rate—along with its problems—right where it began.
The Problem with Congress’s Approach
Congress has now made two attempts at reforming GILTI: one has already failed, the other is destined to do so.
Under BBB, the U.S. does not have a qualified Income Inclusion Rule, despite arguments by the Treasurer and a few members of the OECD to the contrary. As a result, companies who succeed in lowering their effective tax rate via congressionally incentivized tax breaks are penalized through the UTPR.
The IRA, meanwhile, fails to even attempt a qualified Income Inclusion Rule and allows countries that have adopted the UTPR to enforce the Pillar Two minimum tax against U.S. multinationals via their subsidiaries. Not only does this hamper U.S. multinationals, but it actually lines the pockets of foreign jurisdictions that are already mauling the corporate-tax base. For all the talk, both the BBBA and the IRA do little more than place the ball right back where it began.
Sam Hampton Sturgis is a current Tax LL.M. candidate at the University of Florida Levin College of Law, where he serves as a Graduate Editor of the Florida Tax Review.