The Most Interesting International Tax Proposals in Biden's FY 2023 Budget

This Holland & Knight alert discusses the intersection of President Joe Biden's proposed changes to the U.S. tax code, as announced in connection with his fiscal year (FY) 2023 budget, and work underway on the global stage before the Organization of Economic Cooperation and Development (OECD), of which the U.S. is a party. As discussed below, countries party to the OECD had the aspirational goal of developing an agreed-upon manner under which to tax multinational corporations to ensure a minimum level of tax is paid, referred to as "Pillar Two," by 2023.

Background

In 2021, the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting agreed to a two-pillar solution to address the tax challenges arising from the digitalization of the economy. Under Pillar Two, approximately 140 countries agreed in theory to a minimum tax rate of 15 percent on foreign earnings, determined on a per-country basis, for those with a global revenue of 750 million euros or more. Referred to collectively as the Global Anti-Base Erosion (GloBE) Rules, there are two main components – the Income Inclusion Rule (IIR) and Undertaxed Payment Rule (UTPR).

Oversimplified, the IIR is a top-up tax. If the country in which the Ultimate Parent Entity (UPE) of the corporate group is based has a qualifying IIR, then the IIR of the UPE country applies ensuring a minimum of 15 percent is paid. For those countries where the effective tax rate (ETR) is below 15 percent, the UPE country collects the top-up tax on earnings, if any were made, in that foreign jurisdiction. The ETR in a particular country is based on consolidated financial statements.

The UTPR is a backstop to the IIR – it incentivizes all countries to adopt an IIR. Low-taxed countries (those with an ETR below 15 percent) are identified in the same manner as the IIR, based on adjusted consolidated financial statements. The UTPR applies to those low-taxed countries if they do not have an IIR. Countries that participate in Pillar Two (known was Qualified UTPR jurisdictions) are entitled to an allocation of additional tax. The allocation that a particular Qualified UTPR is entitled to is based employee headcount and tangible assets. For example a Qualified UTPR allocation ratio considers headcount in the Qualified UTPR as it compares to total headcount worldwide. As a proxy to match the allocation to which it is entitled, each Qualified UTPR jurisdiction denies deductions or other payments that would otherwise be allowable under its domestic tax code, in an amount equivalent to its entitled allocation.

In addition to the UTPR and IIR, there is a third component that was recently revealed referred to as the Qualified Domestic Minimum Top up Tax (QDMTT). Low-taxed countries that don't want to let other countries get an allocation can apply a QDMTT to top up their ETR to the minimum 15 percent. The QDMTT effectively ensures the low-taxed country can collect the top-up tax, rather than having the allocated amounts go to a country with a UTPR.

In December 2021, the OECD released Model Rules for Pillar Two – a detailed template for moving forward that provided scope and details. As relevant to the discussion below that, the Model Rules stated that for purposes of determining whether a country has an ETR of below 15 percent and is thus a low-taxed country, qualified refundable tax credits do not decrease the ETR, while nonrefundable credits negatively impact the ETR.¹ Stated another way, a taxpayer who has significant nonrefundable tax credits may be subject to the UTPR by reason of the domestic investment.

FY 2023 Green Book

While negotiations continue on the global stage, the U.S. continues to contemplate changes to its domestic tax code. Every year, except under former President Donald Trump, the president releases a "Green Book" alongside the proposed budget.² The Green Book is officially published by the U.S. Department of the Treasury and catalogs changes to the tax code that are embraced by the Administration in support of the budget.

As it relates to the work at the OECD, the FY 2023 Green Book begins with a seminal note: It is assumed that the House-passed version of the Build Back Better Act (BBA) becomes law. Relevant provisions of the BBA include significant changes to the global intangible low taxed income (GILTI) and Base Erosion and Anti-Abuse Tax (BEAT). Under the BBA, GILTI is modified to a country-by-country calculation and set at a rate of 15.8 percent. The proposed changes to BEAT include potential denial of deductions capitalized under section 263A, anti-conduit authority for Treasury to address base erosion payments, and a carve-out for payments made to jurisdictions with an ETR of 15 percent or greater. If BBA becomes law, it would move the U.S. tax system in the direction under consideration at the OECD.

The most interesting international tax proposal in the Green Book is the repeal of the BEAT and proposed adoption of the UTPR beginning in 2024. In the reasons for change, Treasury notes the historic deal reached by nearly 140 countries at the OECD and a desire to improve alignment between the U.S. and the international tax system as proposed by Pillar Two. Treasury also notes that the UTPR is preferable to the BEAT because "the BEAT does not apply comprehensively to cost of goods sold, or COGS, of manufacturing companies in the same manner that it applies to deductions incurred by services firms."³

The UTPR proposal as set forth in the Green Book would adopt the OECD Model Rules as they relate to scope, computation and allocation. The close conformance to the Model Rules, specifically the rules around the treatment of tax credits to determine ETR, caused concern in the U.S. business community. This concern stems from the fact that virtually all U.S. tax credits are not refundable, driving down the ETR of the U.S. This in turn could open U.S.-parented businesses to UTPR to another country based on its U.S. activities, such as hiring specified classes of workers or investing in low-income housing.

In response to this anticipated criticism, the Green Book states that, "[w]hen another jurisdiction adopts the UTPR, the proposal would also ensure that taxpayers continue to benefit from tax credits and other tax incentives that promote U.S. jobs and investment."⁴ It is unclear, however, how Treasury intends to fulfill the promise and ensure domestic tax credits are protected from the UTPR.

If foreign earnings are subject to the UTPR, then the U.S. would collect its share of the UTPR by a pro rata disallowance of allowable deductions. The UTPR applies after all other deduction disallowance provisions in the Internal Revenue Code.

The scope of the UTPR applies to financial reporting groups that have global annual revenue of at least $850 million, with several exceptions. First, if a group has a three-year revenue average of less than $11.5 million and three-year profit average of less than $1.5 million, then the UTPR does not apply to that jurisdiction. There is also a five-year delay for small groups (operations in five or fewer jurisdictions with tangible assets in those jurisdictions of less than $57 million).

Treasury also proposes adopting a QDMTT on U.S. profits as contemplated under the Pillar Two Model Rules. The QDMTT appears to be in addition to the book alternative minimum tax as proposed in the BBA, which applies to the global profits of a U.S. group or the profits of the U.S. operations and its foreign subsidiaries for a foreign-parented group. The Green Book addresses the interaction of the two taxes.

Treasury estimates the repeal of the BEAT and adoption of the various provisions in the UTPR proposal will raise approximately $240 billion over 10 years. This score assumes a corporate tax rate of 28 percent. If the U.S. adopts the UTPR proposal, it is very unlikely the U.S. will receive revenue from topping off low-taxed jurisdictions because other countries will likely implement their own QDMTTs and collect the revenue. If the U.S. receives any revenue from the UTPR, it will likely come from the QDMTT, which will top off US corporations.

To add insult to injury, Treasury proposes increasing the GILTI rate from 15.8 percent to 20 percent (plus a 5 percent haircut for foreign tax credits). This increase means that foreign-headquartered companies with U.S. operations and controlled foreign corporations under the U.S. will be subject to the UPE's IIR at 15 percent and GILTI at 20 percent. The BBA would provide a credit for IIR taxes paid by a UPE to offset GILTI, but the U.S. refuses to turn off GILTI, despite the top-down approach of the IIR. Query whether other countries will complain that the U.S. is applying an IIR in excess of 15 percent, contrary to the Inclusive Framework agreement from summer 2021.

Concluding Thoughts

The president's tax proposals as included in the Green Book are aspirational and require Congress to turn proposals into legislative language and pass them. However, the UTPR proposal as contained in the Green Book demonstrates how Treasury would incorporate Pillar Two into domestic law. Significant questions remain about what will happen domestically and in the global arena, and companies should engage with U.S. policymakers and the OECD to raise technical and policy issues.

Notes

¹ Congress made this error with the base erosion and anti-abuse tax (BEAT). Domestic tax credits (other than specified credits) increase BEAT liability.

² Under Republican presidents, the description of revenue provisions is referred to as the "Blue Book" and contains a blue cover.

³ FY 2023 Green Book at 6.

⁴ FY 2023 Green Book at 8.

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