Rebuilding the U.S. Global Minimum Tax on Better Considerations

The Build Back Better legislative package includes both tax hikes and tax cuts, which contain two contrasting tax policy narratives. Tax hikes include corporate tax increases on foreign income and a new national minimum tax of 15%, and green energy tax incentives offer a tax reduction. Policymakers have also sought to protect some pre-existing tax incentives from the cancellation of the national minimum tax and the Base Erosion and Anti-Abuse (BEAT) tax. However, the new global minimum tax casts doubt on the US approach to tax incentives.

In the coming days, US policymakers may have to choose between changing their approach to tax incentives or allowing US companies to face higher tax bills in other countries. Whether or not Build Back Better succeeds, some domestic tax benefits will simply mean increased taxes abroad.

While U.S. lawmakers have aligned some elements of Build Back Better with the global minimum tax (albeit with some remaining differences), tax incentives built into the U.S. tax code would create an opening for foreign jurisdictions to charge higher taxes. to American companies.

The global agreement sets a minimum effective tax rate of 15% which applies to multinational companies with a turnover of more than 750 million euros (about 847 billion US dollars). Countries are not required to implement the rules, but the European Union has already started its legislative process with the aim of implementing the minimum tax by 2023. The global minimum tax has also been touted by the Treasury Secretary Janet Yellen, who worked through 2021 to secure the deal.

The minimum tax undermines tax incentives such as tax exemptions and tax credits in two ways. First, foreign-income businesses that benefit from low tax rates elsewhere will face a minimum effective tax rate of at least 15% imposed by the “income inclusion rule”. Second, for multinational companies whose national income is taxed below 15%, foreign governments could charge additional taxes through an “undertaxed payment rule”.

Although policymakers are not required to change their tax incentives to comply with the global minimum tax, the value of these incentives will be directly eroded.

Recently, I sketched out a framework for policymakers to consider in light of the global tax agreement. Policies facing a “red light” are primarily those that offer a zero effective tax rate. Yellow light policies offer reduced effective tax rates below 15%, but not zero. Green light policies are those that reduce the cost of investing without triggering the minimum tax, unless the general corporate tax rate is very low.

Many US tax incentives are in the “Yellow Light” zone. These policies include the Low-Income Housing Tax Credit, Job Opportunities Tax Credit, Green Energy Preferences, and Research and Development Tax Credit. The Foreign Derived Intangible Income Policy, which offers a lower effective rate to exporters using U.S.-based intellectual property, is also in the “Yellow Light” zone.

So how do these incentives relate to the global minimum tax? Suppose a US company operates in Japan and Germany, and both countries apply the global minimum tax. In the United States, the company faces a statutory tax rate of 21% on its profits, but it also benefits from the R&D credit and several other tax advantages linked to its investments in climate-friendly projects. These tax benefits could reduce the effective tax rate on its US profits to 10%, below the global minimum rate of 15%.

The U.S. will tax this company’s low-taxed foreign earnings under Global Intangible Low Tax Income (GILTI), the type of U.S. version of an income inclusion rule. However, low-taxed domestic profits could be targeted by Germany and Japan with the undertaxed payments rule.

Using a new formula in the Model Rules for the Global Minimum Tax, Germany and Japan would share the ability to collect additional tax from the U.S. corporation based on their share of that corporation’s employees and assets. So while the company would benefit from tax credits for R&D and green investments, thereby reducing its tax bill for the US Treasury, these benefits would be swallowed up by higher taxes elsewhere. This removes the attraction of making these investments in the United States

This result may be true whether or not Build Back Better is adopted and becomes law. So far, legislators have specifically chosen to shield many tax credits from the impact of the 15% accounting minimum tax (a separate policy from the overall foreign income minimum tax) and the BEAT.

Even when trying to generate revenue for other Build Back Better priorities, members of Congress are often less concerned with the fiscal cost of these policies than with influencing corporate investment behavior through incentives. tax.

Tax incentives themselves are not policy-neutral, and Congress may choose to conduct a major review and overhaul of tax preferences in preparation for the global minimum tax. A more neutral tax code vis-à-vis business decisions would be much preferred (and less complex) than the current situation. If policymakers want to seize it, this is an opportunity to broaden the corporate tax base and channel their efforts into broad reforms that support the growth of the tax code.

Taxable grants and credits above the line would fare better with the overall minimum tax than the way many US tax credits are structured. Policymakers might choose to switch to a combination of tax incentives that include these features.

On a narrower front, Sen. Ron Wyden (D-OR) has proposed an overhaul of energy tax preferences. Although Wyden’s proposal is flawed, it goes in the direction of simplification. Even this package, however, could open large US corporations to a tax cut at home that would be offset by tax hikes abroad.

Focusing US tax policy on simplicity and neutrality (alongside stability and transparency) will take a lot of work. But reforming the various tax incentives throughout the tax code would help even if the overall minimum tax were to leave those credits alone.

Members of Congress could also participate in ongoing work on minimum tax rules. This work is not yet complete, particularly because many governments have yet to begin the legislative process to implement the rules. The U.S. isn’t alone in having a variety of tax preferences that will be affected by the global minimum tax, but it’s unclear whether the U.S. Treasury appreciates the contrast between the legislator’s approach in Build Back Better. and the impact of the model rules on US taxation. incentives.

Either way, the current prospect of a global minimum tax requires the attention of US lawmakers. Otherwise, a tax advantage in the country will simply mean an increase in taxes abroad.

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