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Tax Bill, Supreme Court of the US, Washington DC

June 02, 2021

Biden Administration Releases Green Book Offering Further Detail on Corporate and International Tax Proposals

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BIDEN ADMINISTRATION RELEASES GREEN BOOK OFFERING FURTHER DETAIL ON CORPORATE AND INTERNATIONAL TAX PROPOSALS

On May 28, 2021, the U.S. Department of Treasury (“Treasury”) released its explanation of the Biden Administration’s fiscal year 2022 revenue proposals (the “Green Book). The Green Book provides further details on the proposals set forth in the “Made in America tax plan (the “Tax Plan”) that the Biden administration unveiled on March 31, 2021. This publication summarizes the proposed changes to key corporate and international tax provisions of the Internal Revenue Code of 1986, as amended (the “Code”),[1] that are contained in the Green Book.

As summarized in more detail below, the significant changes to the corporate and international tax provisions proposed by the Green Book include:

  • Increasing the statutory corporate income tax rate from 21 percent to 28 percent;
  • Repealing the deduction for foreign-derived intangible income (FDII);
  • Increasing the tax rate and making other changes to convert the global intangible low-taxed income (GILTI) provisions to a regime more closely resembling a global minimum tax;
  • Eliminating a tax deduction for expenses attributable to income that is not subject to U.S. federal income tax or that is subject to U.S. federal income tax at a reduced rate;
  • Replacing the base erosion and anti-abuse tax (the BEAT) with the Stopping Harmful Inversions and Ending Low-Tax Developments (the SHIELD) rule;
  • Expanding the scope of the anti-inversion rules under Section 7874;
  • Limiting the foreign tax credits arising from sales of hybrid entities;
  • Limiting interest deductions for disproportionate borrowing in the United States;
  • Imposing a 15 percent minimum tax on large corporations’ book income; and
  • Providing tax incentives to onshoring businesses and denying deductions incurred in connection with offshoring businesses.

We would expect that the scope and details of the corporate and the international tax proposals set forth in the Green Book will ultimately be modified during the legislative process, and it is unclear whether any of such proposals would be enacted. In addition, the progress this year by the Organisation for Economic Co-operation and Development (OECD) toward advocating the Inclusive Framework Pillar Two (“Pillar Two”) could also materially impact the final form of these proposals. [2] In the interim, taxpayers are encouraged to monitor these proposals and to begin considering their impact.

Corporate Tax Rates

The Green Book proposes increasing the corporate income tax rate to 28 percent for taxable years beginning after December 31, 2021. For taxable years of non-calendar year taxpayers beginning after January 1, 2021, the tax rate would be equal to the sum of (i) 21 percent and (ii) the product of seven percent and the portion of the taxpayer’s taxable year that falls within 2022.

FDII

The Green Book proposes repealing the deduction allowed for FDII for taxable years beginning after December 31, 2021.

GILTI and Subpart F Regime

The Green Book proposes reducing the deduction allowable to U.S. corporations for GILTI from 50 percent to 25 percent. Based on the Biden Administration’s proposed 28 percent corporate income tax rate, this would result in an effective GILTI tax rate of 21 percent (before the use of foreign tax credits). Further, the Green Book proposes eliminating the exemption from GILTI of the “net deemed tangible income return” (equal to 10 percent of a U.S. shareholder’s share of the tax basis of a relevant controlled foreign corporation (CFC) in certain tangible property). The Green Book also proposes eliminating the high tax exemption to subpart F income and GILTI. Despite the increase in the GILTI effective tax rate, the Green Book does not suggest that the amount of foreign tax credit that taxpayers may use to offset GILTI would be changed from the current level of 80 percent.

In addition, the Green Book proposes calculating a U.S. shareholder’s GILTI inclusion and foreign tax credit limitation on a jurisdiction-by-jurisdiction basis (rather than on an aggregate basis). A similar jurisdiction-by-jurisdiction approach would also apply with respect to a domestic corporation’s foreign branch income. Therefore, foreign income taxes paid to a high-tax foreign jurisdiction (generating excess foreign tax credits) would no longer be able to be used to reduce the U.S. federal income tax liability with respect to GILTI (or branch income) earned in lower-tax jurisdictions.

Foreign parented groups with U.S. subsidiaries that in turn own stock in CFCs would pay a global minimum tax at the foreign parent level under Pillar Two if it is adopted. The GILTI tax owed by such U.S. subsidiaries with respect to their CFCs would be adjusted to take into account foreign taxes paid by the foreign parent if Pillar Two is adopted.

The Green Book would also propose repealing the exemption from GILTI for foreign oil and gas extraction income.

The Green Book proposes making the changes to the GILTI rules described above effective for taxable years beginning after December 31, 2021.

Deductions Allocable to Exempt Income

Section 265 generally disallows a deduction for any amount that is allocable to certain classes of income that are wholly exempt from U.S. federal income tax.

The Green Book proposes expanding the application of Section 265 to wholly or partially disallow deductions that are allocable to classes of foreign gross income that are either exempt from U.S. federal income tax or subject to U.S. federal income tax at a preferential rate as a result of a deduction (e.g., the deductions under Sections 245A and 250). Although it is not entirely clear from the Green Book, it is possible that this rule would be applied by allocating expenses among various assets in the same manner as provided by Section 861. Special rules would apply for determining the amount of disallowed deductions when only a partial deduction is allowed. This rule may make holding foreign operations in branch form (rather than through CFCs) more advantageous for taxpayers with high interest expense that would otherwise be disallowed.

The Green Book also proposes the repeal of Section 904(b)(4), which for purposes of the foreign tax credit limitation disregards deductions that are attributable to income from the stock of foreign corporations, other than GILTI and subpart F inclusions.

These proposals would be effective for taxable years beginning after December 31, 2021.

Anti-Inversion Rules

Under current law, Section 7874 applies to certain transactions in which a domestic corporation or domestic partnership is acquired by a “foreign acquiring corporation” in a transaction where:

  • substantially all of the assets held directly or indirectly by the domestic corporation or substantially all of the properties constituting a trade or business of a domestic partnership are acquired directly or indirectly by the foreign acquiring corporation;
  • the former shareholders of the domestic corporation or former partners of the domestic partnership, as the case may be, hold at least a 60 percent ownership interest in the foreign acquiring corporation by reason of the acquisition; and
  • the foreign acquiring corporation, together with its expanded affiliated group (the EAG), does not conduct substantial business activities in the country in which the foreign acquiring corporation is created or organized (a “Section 7874 Acquisition”).

If, following a Section 7874 Acquisition, the continuing former shareholder (or partner) ownership of the foreign acquiring corporation is at least 80 percent (by vote or value), the foreign acquiring corporation is treated as a domestic corporation for all U.S. federal income tax purposes (the “80% Test”). Use of certain U.S. federal income tax attributes may also be disallowed, in addition to other potential adverse tax consequences, if following a Section 7874 Acquisition, the continuing former shareholder (or partner) ownership of the foreign acquiring corporation is at least 60 percent but less than 80 percent (by vote or value) (the “60% Test”).

The Green Book proposes modifying the 80% Test such that a 50 percent threshold applies and would eliminate the 60% Test. Thus, under the proposals set forth in the Green Book, a foreign acquiring corporation would be treated as a domestic corporation if, after a Section 7874 Acquisition, the former shareholders of the domestic corporation own 50 percent or more of the stock of the foreign acquiring corporation.

The Green Book also proposes a “control and management test” under which a foreign acquiring corporation would be treated as a domestic corporation after a Section 7874 Acquisition regardless of the amount of stock of the foreign acquiring corporation owned by the former domestic corporation shareholders if:

  • immediately prior to the acquisition, the fair market value of the domestic corporation is greater than the fair market value of the foreign acquiring corporation;
  • after the acquisition, the EAG of the foreign acquiring corporation is primarily managed and controlled in the United States; and
  • the EAG does not conduct substantial business activities in the country in which the foreign acquiring corporation is organized.

Finally, the Green Book proposes expanding Section 7874 to include acquisitions of substantially all of the assets constituting a trade or business of a domestic corporation, substantially all of the assets of a domestic partnership or the U.S. trade or business assets of a foreign partnership. Section 7874 would also apply to a distribution of the stock of a foreign corporation by a domestic corporation or a partnership that represents substantially all of the assets of the distributing corporation or partnership.

The proposed changes to Section 7874 would apply to transactions completed after the date of enactment.

Replacement of BEAT with SHIELD

The Green Book proposes replacing the BEAT with the SHIELD. The SHIELD would apply to financial reporting groups with greater than $500 million in global annual revenues reflected on the group’s financial statements. The SHIELD would disallow deductions to domestic corporations or branches for gross payments made to a “low-taxed member.” Payments made by a domestic corporation or branch that are otherwise deductible under the Code would be disallowed in their entirety, and payments for other deductibles of costs such as cost of goods sold would be disallowed up to the amount of the payment.

For these purposes:

  • A “low-taxed member” is any member of a financial reporting group whose income is subject to an effective tax rate (ETR) that is below a “designated minimum tax rate.”
  • A “financial reporting group” is a group of business entities that prepares consolidated financial statements and that includes at least one domestic corporation, domestic partnership, or foreign entity with a U.S. trade or business.
  • The “designated minimum tax rate” will be the rate agreed to under Pillar Two. If SHIELD is in effect before the OECD reaches an agreement on Pillar Two, the designated minimum tax rate will be the effective GILTI rate currently proposed to be set at 21 percent.
  • The ETR of a financial reporting group member would be determined based on the income earned and taxes paid or accrued with respect to the income earned in that jurisdiction by financial reporting group members, as determined based on the members’ separate financial statements or the financial reporting group’s consolidated financial statements, as disaggregated on a jurisdiction by jurisdiction basis. The Green Book provides that special rules will be enacted to account for net operating losses and distortions that may arise due to differences between the applicable income tax rules and the financial accounting rules.

Payments made to financial reporting group members that are not low-tax members would be partially subject to the SHIELD to the extent that other financial reporting group members were subject to an ETR of less than the designated minimum tax rate in any jurisdiction. In such case, the domestic corporation or branch would effectively be treated as having paid a portion of its related party amounts to low-taxed members of the financial reporting group based on the aggregate ratio of the financial reporting group’s low-taxed profits to its total profits, as reflected on the financial reporting group’s consolidated financial statements. This rule appears to create an incentive for low-taxed countries to raise their corporate income tax rates or face a potential exodus of multinationals.

Lastly, the Green Book proposes providing Treasury with the authority to exempt from the SHIELD payments to domestic and foreign members that are investment funds, pension funds, international organizations or non-profit entities, and to take into account payments by partnerships.

The proposal to replace the BEAT with the SHIELD would be effective for taxable years beginning after December 31, 2022.

Disposition of Hybrid Entities

Section 338(h)(16) provides generally that the deemed asset sale resulting from a Section 338 election is generally ignored in determining the source or character of any item for purposes of applying the foreign tax credit rules to the seller. Instead, for this purpose, any gain recognized by the seller is treated as gain from the sale of the stock of the target corporation.

Solely for foreign tax credit purposes, the Green Book proposes extending the principles of Section 338(h)(16) to determine the source and character of an item recognized in connection with (i) the disposition of an interest in an entity that is treated as a corporation for foreign tax purposes but that is a partnership or disregarded entity for U.S. federal income tax purposes (a “specified hybrid entity”) and (ii) to a change in the classification of a specified hybrid entity that is not recognized for foreign tax purposes (for example, due to an entity classification under Treasury Regulation Section 301.7701-3).

Accordingly, for foreign tax credit purposes, the source and character of any item resulting from the disposition of an interest in a specified hybrid entity or an election to change a specified hybrid entity’s U.S. federal income tax classification would be determined based on the source and character of the gain or loss that would have been recognized by the applicable seller had the seller sold stock disregarding Section 1248 for this purpose.

This proposal would likely limit the amount of foreign tax credits that are available to offset income recognized on the sale of a specified hybrid entity. In particular, under this proposal, a domestic corporation’s direct sale of a specified hybrid entity would appear to generate U.S.-source passive category income and a CFC’s sale of a specified hybrid entity would appear to generate foreign-source passive category income.

This proposal would be effective for transactions occurring after the date of enactment.

Limitations for Interest Deductions for Excessive US Borrowing

The Green Book proposes limiting the deduction for interest expense available to members of financial reporting groups to the extent that any such member’s net interest expense for financial reporting purposes on a separate company basis exceeds such member’s proportionate share of the financial reporting group’s net interest expense. Excess limitations and disallowed interest expense can be carried forward.

A financial reporting group member’s proportionate share of the financial reporting group’s net interest expense would be determined based on the member’s proportionate share of the group’s earnings reflected in the financial reporting group’s consolidated financial statements.

If a financial reporting group member fails to substantiate its proportionate share of the group’s net interest expense for financial reporting purposes, or a member so elects, the member’s interest deduction would be limited to its interest income plus 10 percent of the group member’s adjusted taxable income as determined under Section 163(j).

A member of a financial reporting group that is subject to this rule would continue to be subject to the application of Section 163(j). Thus, the amount of interest expense disallowed for a taxable year of a taxpayer that is subject to both this rule and Section 163(j) would be determined based on whichever of the two rules imposes the lower limitation.

This proposal would not apply to financial services entities.

This proposal would be effective for taxable years beginning after December 31, 2021.

Minimum Tax on Book Income

The Green Book proposes a 15 percent minimum tax on worldwide book income for corporations with book income in excess of $2 billion. Under the proposal, a taxpayer would calculate their “book tentative minimum tax,” which would equal 15 percent of its worldwide pre-tax book income less book net operating loss deductions. In computing its book tentative minimum tax, a taxpayer would be allowed a credit for general business credits and foreign tax credits. The tax due under this proposal would equal the excess, if any, of the book tentative minimum tax over regular the federal income tax due.

This proposal would be effective for taxable years beginning after December 31, 2021.

Tax Incentives for Onshoring Businesses & Disallowance of Deduction for Offshoring Businesses

The Green Book proposes a tax credit for 10 percent of certain expenses paid or incurred in connection with onshoring a U.S. trade or business that results in an increase in U.S. jobs. If such expenses are incurred by a foreign affiliate of the domestic corporation, the tax credit would be claimed by the domestic corporation.

In addition, the Green Book proposes disallowing a deduction for certain expenses incurred in connection with offshoring a U.S. trade or business that results in a loss of U.S. jobs.

The expenses covered by these proposals would be limited solely to expenses associated with the relocation of the trade or business and would not include capital expenditures or costs for severance pay or other assistance to displaced workers.

These proposals would be effective for expenses paid after the date of enactment.

Expanded Information Reporting, Including With Respect to Crypto Asset Exchanges

The Green Book focuses on expanding comprehensive information reporting to narrow the “tax gap” with respect to business income (outside of large corporations). The Green Book proposes to create a comprehensive financial account information reporting regime. Financial institutions would report data on financial accounts in an information return that would report annually gross inflows and outflows with a breakdown for physical cash, transactions with a foreign account and transfers to and from another account with the same owner. This requirement would apply to all business and personal accounts from financial institutions, including bank, loan and investment accounts, with the exception of accounts below a low de minimis gross flow threshold of $600 or fair market value of $600. Reporting requirements also would apply to other similar accounts, such as payment settlement entities, and crypto-asset exchanges and custodians. Separately, reporting requirements would apply in situations in which taxpayers buy crypto assets from one broker and then transfer the crypto assets to another broker. Businesses that receive crypto assets in transactions with a fair market value of more than $10,000 would be required to report such transactions. This proposal would be effective for tax years beginning after December 31, 2022.

Another Green Book proposal would expand broker information reporting with respect to crypto assets. This proposal would allow the United States to share such information on an automatic basis with appropriate partner jurisdictions, in order to reciprocally receive information on U.S. taxpayers that directly or through passive entities engage in crypto-asset transactions outside the United States pursuant to a global automatic exchange of information framework. The proposal would require brokers, including entities such as U.S. crypto-asset exchanges and hosted wallet providers, to report information relating to certain passive entities and their substantial foreign owners when reporting with respect to crypto assets held by those entities in an account with the broker. If adopted, the proposal would require a broker to report gross proceeds and such other information as the Secretary may require with respect to sales of crypto assets with respect to customers, and in the case of certain passive entities, their substantial foreign owners.

The proposal would be effective for returns required to be filed after December 31, 2022.

Footnotes

[1]  Unless otherwise indicated, all “Section” references contained herein are to sections of the Code.
[2]  In general, Pillar Two is intended to provide for a global minimum tax regime and a minimum level of taxation on certain related party payments.

Authors and Contributors

Ryan Bray

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Larry Crouch

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