A number of the sweeping international tax budget reconciliation proposals contained in draft legislation released by the House Ways and Means Committee on Sept. 13, 2021, included amendments to, among other things, the global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), base erosion and anti-abuse tax (BEAT) and foreign tax credit rules (the “Draft House Legislation” or “Chairman’s Mark”). This alert also discusses a number of other new and modified international tax provisions including the proposed interest expense limitation rule. Unless otherwise indicated, these changes are expected (if enacted) to be effective for tax years beginning after Dec. 31, 2021.
Key takeaways
If enacted as drafted, the Draft House Legislation would:
Generally bring U.S. international tax principles more in line with analogous Organization for Economic Cooperation and Development base erosion and profit shifting (BEPS) global minimum tax proposals
Apply a top marginal corporate tax rate to GILTI of 16.56% (17.43% inclusive of a foreign tax credit haircut which reduced from 20% to 5% of allowable credits) and to FDII of 20.7%, and eliminate limitation based on taxable income allowing for full section 250 deduction (at reduced 37.5% and 21.875% for GILTI and FDII, respectively) and a resulting NOL carry forward
Apply the GILTI calculation on a country-by-country basis, and now allow for tested losses (and certain tested foreign income taxes of tested loss “taxable units”) to carry forward to subsequent periods to help ameliorate the negative effects of timing differences and the change from a single aggregate calculation
Reduce qualified business asset investment (QBAI) to 5% (10% in U.S. territories) for purposes of calculating GILTI inclusion amounts
Repeal the carryback of excess foreign tax credits and limit the carryforward period (including newly available excess foreign tax credits for GILTI) to five years
Require application of the foreign tax credit calculation and limitation provisions in all baskets on a country-by-country basis (with a repeal of the separate foreign branch limitation category), while eliminating section 861 expense apportionment (e.g., interest and stewardship) to the GILTI basket
Substantially modify the BEAT to include treating components of cost-of-goods sold as base erosion payments in broadening the application of the BEAT, phasing out the separate 3% (2% for certain financial services taxpayers) base erosion percentage safe harbor in determining an “applicable taxpayer” for BEAT (leaving more taxpayers potentially subject under a $ 500 million average annual gross receipts threshold alone), narrowing BEAT’s application in now generally excluding from base erosion payments any amounts subject to a sufficient minimum level of tax (i.e., not less than the BEAT rate, or 15% on a fully phased-in basis), and allowing for full credits in reduction of regular tax liability and corresponding base erosion minimum tax amounts
Retroactively reinstate the prohibition of downward attribution from foreign persons under former section 958(b)(4) to determine controlled foreign corporation (CFC) status and enact new section 951B to address perceived abuses the repeal of downward attribution was intended to prevent
Enact new section 163(n) which more broadly limits the deduction of interest expense of certain U.S. corporations in financial groups with non-U.S. corporate members to a share of reported net interest expense on an applicable financial statement of the financial group in proportion to the U.S. corporation’s relative share of book earnings before interest, tax, depreciation and amortization (EBITDA) of the overall group, with excess interest expense limited to a five-year carryforward
Provide a host of other ad hoc changes including the following: – Restriction in eligibility for a section 245A participation exemption to certain qualifying dividends received by U.S. domestic C corporation 10% shareholders which are from foreign corporations having CFC status; – Repeal of one-month deferral under section 898(c) requiring CFCs to adopt the U.S. tax year of its majority shareholder in necessitating stub period Form 5471 filings, expansion of GILTI reporting, etc., for a cutover to same; – Change in definition of disqualifying persons for portfolio interest exemption purposes to include persons who are 10% or more owners of an issuing corporation on a vote or value basis (previously vote only); – Change in operative rules for the determination of a U.S. shareholder’s pro rata share of deemed inclusion amounts (e.g., Subpart F, GILTI) from a CFC; – Narrowing the application of the foreign base company sales and services income rules under Subpart F to CFC transactions with U.S. related parties; – Providing for a more complete basis adjustment in lower-tier CFC shares for related deemed inclusion amounts attributed to U.S. shareholders of those CFCs and not just for the more limited purpose of providing relief in determination of Subpart F at an upper-tier CFC; – Deferring deductibility of losses realized in certain controlled group liquidations as might implicate considered Granite Trust/“check-the-box” planning pertaining to foreign subsidiaries; – Deferring application of a change from current expensing to capitalization and amortization of section 174 expenses from tax years beginning after Dec. 31, 2021, to tax years beginning after Dec. 31, 2025, which of particular benefit to taxpayers conducting research and development activities outside the U.S. for which a longer 15-year amortization period otherwise applies; and – Providing for a later in time codification for treatment of IC-DISC dividends (gain realized on disposition of IC-DISC shares) to a foreign shareholder as U.S. effectively connected income taxed on a net basis at applicable U.S. tax rates.
Taxpayers should talk with their advisors about whether they should consider modelling, including potential transfer pricing policy adjustments, as it is a critical element for preparedness related to these proposed changes.
Proposed GILTI and GILTI foreign tax credit amendments
Rate of tax
The Draft House Legislation would subject GILTI inclusions (and any section 78 gross-ups) to a tax rate of 16.56% by reducing the GILTI section 250 deduction to 37.5% and increasing the corporate rate to a maximum of 26.5%. The effective GILTI tax rate would increase to 17.43% for taxpayers who used GILTI-related foreign taxes as foreign tax credits due to the proposed 5% haircut (discussed below). If enacted, the transition rule would apply a blended GILTI tax rate to fiscal-year taxpayers (i.e., those with tax year-ends other than Dec. 31, 2021).
GILTI section 250 deduction
If enacted as drafted, the Chairman’s Mark would accelerate decreasing the GILTI section 250 deduction to 37.5% starting in 2022 (which is scheduled to be reduced from 50% under the current rules for taxable years beginning after Dec. 31, 2025). That said, taxpayers will be pleased to learn that the GILTI section 250 deduction would no longer be limited to taxable income (meaning that any amount in excess of taxable income would create or increase a net operating loss).
Application of GILTI on a country-by-country basis
The Draft House Legislation would amend the GILTI rules to require that GILTI items such as tested income, net deemed tangible income return, QBAI and interest expense be determined on a country-by-country basis. The mechanism contemplated to achieve this result would be by applying the rules to “Taxable Unit(s)” of CFCs in a country. Broadly, Taxable Units include CFCs themselves, pass-through entities and taxable branches resident in a country other than where the taxpayer is resident. Transfer pricing policies should be reviewed in detail within and among Taxable Units to mitigate potential increased GILTI cost to taxpayers.
Other proposed GILTI changes
If enacted, net CFC tested losses by country would be potentially eligible for carryforward to succeeding tax years. Separately, QBAI would be reduced to 5% from 10% and applied on a country-by-country basis, and foreign oil and gas extraction income (FOGEI) (which would be expanded to include income from oil shale and tar sands activity) would be included in determining tested income and tested loss of a CFC.
Proposed GILTI foreign tax credit modifications
The foreign tax credit rules applicable to GILTI income would also be amended to apply on a country-by-country basis vis-à-vis a Taxable Unit framework. There are a number of taxpayer-favorable proposed changes to the GILTI foreign tax credit rules. For example, GILTI foreign tax credits: (1) would be carried forward five years (no carryforward is currently available); (2) would only be subject to a 5% “haircut” (there is a 20% haircut under the current rules) if paid or accrued to foreign countries other than U.S. territories (no haircut would apply if the taxes were paid or accrued to U.S. territories); (3) would only have section 250 deductions applied for GILTI foreign tax credit limitation purposes (e.g., no longer any section 861 apportionment of interest and stewardship expenses); (4) would be available for CFCs with net tested losses ; and (5) be subject to loss limitation rules on a country-by-country basis (with separate loss limitation and overall foreign loss amounts no longer allocable to the GILTI basket).
Proposed FDII modifications
Rate of tax and section 250 deduction
The Chairman’s Mark would subject FDII to a tax rate of 20.7% by accelerating the decrease of the FDII section 250 deduction to taxable years starting in 2022 (the rate is currently scheduled to be reduced from 37.5% under the current rules for taxable years beginning after Dec. 31, 2025) in combination with the proposed 26.5% corporate rate. Similar to the proposed GILTI section 250 deduction, the FDII section 250 deduction would no longer be limited to taxable income.
Proposed retroactive modifications to FDII
For taxable years beginning after Dec. 31, 2017, deduction eligible income may not include income from passive foreign investment companies for which a U.S. shareholder has made a qualified electing fund election and income of a type that is similar to foreign personal holding company income as defined in section 954(c). While there is uncertainty as to how this rule may be applied, the latter could include royalties and gains from the disposition of property that could give rise to royalty income.
Proposed BEAT modifications
Rate of tax
The BEAT tax rate increase to 12.5% from 10% would be accelerated to tax years beginning after 2023. Additionally, the BEAT tax rate would increase to 15% for tax years beginning after 2025.
Other BEAT modifications
In what appears to be an attempt to bring the current BEAT regime more in line with the OECD’s BEPS global minimum tax proposals in the so-called Pillar 2 initiative, a number of other amendments to the BEAT regime are being proposed such as: (1) payments made to a related party that are subject to U.S. tax (e.g., Subpart F, GILTI, sufficient U.S. withholding taxes) or foreign taxes equal to or greater than the applicable BEAT tax rate (described above) would not be considered base erosion payments; (2) certain components of cost-of-goods sold (such as indirect section 263A costs capitalized into inventory and certain base erosion component amount of inventory purchases from foreign related parties) would be base erosion payments; and (3) the base erosion percentage safe harbor would be repealed starting with taxable year 2024.
Additionally, in what should be a welcome change, the base erosion minimum tax amount is to be determined taking into account all tax credits (including foreign tax credits). Separately, taxpayers will be required to calculate and track BEAT net operating losses, which can be used to offset modified taxable income.
Other foreign tax credit amendments
Application of foreign tax credit baskets on a country-by-country basis
Perhaps the largest modification to the foreign tax credit rules would be the determination of foreign tax credits (including overall foreign loss/separate limitation loss rules) on a country-by-country basis by income category (including the general and passive baskets). If enacted, foreign tax credit computations in all baskets would require assigning each item of income and loss to a Taxable Unit (as described above but also including the taxpayer) resident in a country. Transfer pricing modelling is recommended so taxpayers may potentially be positioned for the most efficient utilization of foreign tax credits on a per country basis.
Repeal of foreign branch income category
The Draft House Legislation would repeal the foreign branch income basket. This would require a number of conforming amendments to the Internal Revenue Code including the definition of FDII and transition rules on reassigning foreign branch taxes to another basket.
Repeal of excess foreign tax credit carryback and reduction of carryforward period
If enacted as currently drafted, excess foreign tax credits from foreign taxes paid or accrued in taxable years beginning after Dec. 31, 2021, could not be carried back and would be limited to a five-year carryforward. As noted above, the rules would also apply to excess foreign GILTI tax credits (which currently cannot be carried back or forward).
Miscellaneous international tax proposals
New section 163(n) interest limitation proposals
The Chairman’s Mark includes new section 163(n) which would, broadly, limit the deduction of interest expense of certain U.S. corporate taxpayers (excluding regulated investment companies, real estate investment trusts, S corporations and entities that meet the small business exemption of section 163(j)) that are members of an “International Financial Reporting Group” included in consolidated financial statements to a certain percentage of net interest expense based on the U.S. taxpayer’s relative contribution to the group’s book earnings. An International Financial Reporting Group generally would consist of a U.S. corporation or corporations (the “U.S. Group”) and a foreign corporation or corporations (collectively the “Overall Group”) or a foreign corporation engaged in a U.S. trade or business.
The interest expense limitation would be calculated by using the International Financial Reporting Group’s applicable financial statements to determine the U.S. Group’s portion of EBITDA (determined using the applicable financial statements) compared to the Overall Group’s EBITDA. This ratio is multiplied by the Overall Group’s net interest expense and then dividend by the U.S. Group’s net interest expense. The result is then multiplied by the U.S. Group’s deduction for interest expense (determined under U.S. federal tax rules) and, again, multiplied by 110% to determine the interest expense limitation.
The section 163(n) interest limitation would not apply to U.S. corporations that do not have an average of $ 12 million or more of net interest expense over a three-year period. However, section 163(n) would apply to both U.S. inbound and outbound taxpayers.
Separately, section 163(n) would apply in tandem with the interest expense limitation under current section 163(j) (both of which would apply at the partner level). Assuming that both provisions are applicable during the taxable year, the smaller amount of interest expense deduction allowance of the two would apply. Additionally, under new section 163(o) any disallowed interest expense under either section 163(j) or section 163(n) can only be carried forward for five years (section 163(j) currently provides for an unlimited carryforward period) and would be subject to a section 382 limitation (should such event occur). It is not expected that interest limited under section 163(j) in pre-2022 tax years would be subject to the five-year carryforward rules and interest will be treated as allowed as a deduction on a first-in, first-out basis. Finally, section 163(n) does not allow for the carryforward of any excess limitation.
Retroactive reinstatement of prohibition of downward attribution from foreign entities
The Draft House Legislation would reinstate, retroactively to Jan. 1, 2018, section 958(b)(4) which prohibited downward attribution to determine CFC status. Instead, new section 951B would be enacted to subject certain foreign-controlled U.S. shareholders of foreign CFCs to Subpart F and GILTI (with some exceptions). This provision was originally included in the Tax Technical and Clerical Corrections Act issued in early 2019, under former House Ways and Means Chair Kevin Brady, R-Texas.
Portfolio interest
The 10% shareholder ownership threshold in the issuing corporation included in the portfolio interest withholding tax exception rules would be revised to apply by vote or value. The proposed changes would apply to obligations issued after date of enactment.
Proposed changes to Subpart F income rules
The Chairman’s Mark would amend the current Subpart F rules related to foreign base company sales and foreign base company services income to apply only where a related U.S. tax resident person is part of the sales or services transaction. As such, it is not expected that foreign-to-foreign transactions that would otherwise give rise to Subpart F under the current rules will be treated as foreign base company sales and foreign base company services income.
Separately, the one-month deferral of CFCs with fiscal year-ends under section 898 would be repealed (and such CFCs would be required to conform to the U.S. Shareholder’s tax year). This more typically is expected to require a one-month “stub” return for CFCs with November taxable year-ends that must be conformed to the U.S. parent’s calendar taxable year.
Additionally, section 961(c) dealing with basis adjustments to stock held by foreign corporations would be updated to apply for all U.S. federal income tax purposes (as opposed to only applying for the purposes of determining the amount included in the gross income of a U.S Shareholder under section 951). Finally, the Draft House Legislation would revise the definition of the pro rata share rules retroactively.
Proposed amendments to section 245A dividends-received deduction
The Draft House Legislation would limit the dividends-received deduction to foreign-source dividends received by U.S. corporations from CFCs (as opposed to such dividends received by U.S. corporations from specified 10% owned foreign corporations). It is expected this provision would be effective for distributions made after the date of enactment.
What’s next?
The Draft House Legislation is anticipated to be included in the budget reconciliation bill and released to the House Rules Committee, which may suggest additional or different amendments. Further, if the House does pass a reconciliation bill, it would likely be sent to the Senate for consideration and reconciliation.
We encourage you to connect with your Baker Tilly advisor regarding how any of the above may affect your tax situation.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
