‘Future Tax Traps’ Lurk for Multinationals in Senate's ProposalBy
Tax increases would kick in if tax bill raised federal deficit
Spring-loaded levies would target offshore profit-shifting
Senate Republicans tucked some multibillion-dollar tax increases for corporations into the 515-page tax bill they released this week -- spring-loaded hikes that would begin after 2024 if the economy doesn’t grow as fast as GOP lawmakers have promised.
Some of the taxes in question aim squarely at companies like Apple Inc. and Alphabet Inc., which rely on intellectual property, also known as “intangibles,” that they’ve transferred to overseas subsidiaries, tax experts say. Spokesmen for the two tech giants didn’t respond to requests for comment Tuesday.
“These so-called ‘sunrise’ provisions essentially are future tax traps for unsuspecting multinationals,” said David Sites, a partner in Grant Thornton LLP’s National Tax Office in Washington. In all, changes made by the Senate Finance Committee last week would boost revenue from international provisions aimed at such companies by about $55.6 billion over a decade, to $154.6 billion; most of the increase would come in 2026 and 2027.
Senate Republicans want permanent changes that will make American companies more competitive globally -- while erecting guardrails to shore up the U.S. tax base.
But they’re also under pressure to produce a bill that won’t increase the long-term federal deficit -- a standard that would allow them to fast-track their tax legislation over Democrat objections that would otherwise stymie their bill. They’ve argued that their tax cuts would lead to economic growth, making up any lost revenue. Analysts have questioned that claim.
According to the Joint Committee on Taxation, one of Congress’s official fiscal scorekeepers, the Senate’s bill would boost the deficit by $1.4 trillion over 10 years. But -- with the help of the latter-year tax increases -- it would actually reduce the deficit by $30.6 billion in 2027, the JCT found. On its very last page, the Senate bill sets a revenue trigger designed to keep any revenue losses below the $1.5 trillion level that Congress agreed to in its 2018 budget.
The full Senate is scheduled to vote as soon as Nov. 30 on the bill, which -- in addition to making several temporary tax cuts for individuals -- would cut the corporate tax rate in 2019 to 20 percent from 35 percent, the highest in the industrialized world. The bill would also move the U.S. toward a “territorial” system for corporate taxes that would focus on companies’ earnings from domestic activities.
But the measure also contains three new taxes aimed at preventing companies from sending taxable income overseas to affiliates in jurisdictions with even lower tax rates:
- A new levy on “global intangible low-taxed income,” or GILTI, would make any such income received by a U.S. company’s offshore unit immediately subject to the new 20 percent tax rate. Companies would be entitled to a 50 percent deduction on that income, resulting in an effective tax rate of 10 percent. After 2025, though, the deduction would be set to shrink, taking the effective rate to 12.5 percent.
- Another change would create a separate 12.5 percent tax rate on “foreign derived” income from intangibles that comes specifically from trade or business in the U.S., not from overseas sales. After 2025, that rate would be set to grow to 15.625 percent. That rate is designed to give companies an incentive to locate valuable IP in the U.S., tax experts say.
- And a third new provision, called the “base erosion and anti-abuse tax,” or BEAT, would apply to other payments companies make to their overseas units, such as loan payments. That rate would begin at 10 percent and be set to grow to 12.5 percent in 2026.
“Base erosion” is a term that refers to international tax-avoidance strategies in which companies shift their profit out of the U.S., often through deductible payments to foreign affiliates that don’t pay tax in the countries where they’re based. The BEAT tax wouldn’t apply to cross-border purchases of inventory that are considered costs of goods sold. It’d function as a kind of minimum tax, capturing profit the other taxes don’t.
Still, the BEAT would only apply to companies with average annual gross receipts of more than $500 million over three years -- a threshold that could allow smaller and mid-sized companies to escape it.
“If base erosion is a systematic problem, then the provision should be more widely applicable,” said Bret Wells, a tax law professor at the University of Houston.
Companies would have to pay foreign taxes at rates of at least 12.5 percent -- or, with the spike, 15.625 percent -- to avoid the Senate bill’s levies, said Robert Kovacev, a tax partner at Steptoe & Johnson LLP.
The Senate bill’s provisions on international taxes differ from those in a bill that cleared the full House last week. The House legislation would impose a 20 percent excise tax on certain payments -- including royalties but not interest -- that U.S. companies make to their foreign affiliates.
The effect of that tax was sharply curtailed by changes that House Ways and Means Chairman Kevin Brady made to the bill, allowing companies to cut their tax bills by using credits for 80 percent of the foreign taxes they’d paid. That revision served to “significantly water down the tax,” said the University of Houston’s Wells.
To use the foreign tax credits, a company would effectively have to open the books of its overseas affiliates to the Internal Revenue Service. But in essence, the ability to use the credits would mean that the excise tax “would almost never be applied,” said Michael Mundaca, co-director of the national tax department at Ernst & Young LLP.
After the change, the JCT reduced its estimate of the revenue that the House provision would raise to $87.6 billion over 10 years, down from $154.5 billion originally.
The House bill would also impose a 10 percent tax on the foreign “high returns” of U.S. corporations’ foreign subsidiaries.
If the Senate approves its legislation next week, lawmakers will have to reconcile the differences between the two bills before any bill could go to President Donald Trump’s desk. So there’s still time for changes.
“We believe that any imperfections” in the bills “can be addressed as the legislative process continues,” said a letter that the U.S. Chamber of Commerce sent to senators on Tuesday.
And even if the Senate’s time-delayed tax increases get approved, that won’t necessarily settle the question, said Stephen Stanley, the chief economist at Amherst Pierpont Securities, a broker-dealer.
Multinationals “will get a chance in seven or eight years to lobby for extending the breaks,” he said.
— With assistance by Erik Wasson