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News Analysis: Post-Midterms: A Progressive Tax Agenda?

Posted on Dec. 10, 2018

In January Democrats retake the House and Republicans remain in control of the Senate, making it unlikely that major tax legislation will be passed in the next two years. President Trump has said he would like to see a middle-income tax reduction passed, but it’s unclear whether his policy goals will align with those of House Democrats, some of whom might want more relief for low-income workers, and many of whom successfully campaigned on providing relief from the rollback of the state and local tax deduction in the Tax Cuts and Jobs Act (P.L. 115-97).

On the international and business side, the bigger questions are whether the corporate rate cut will hold, whether any of the TCJA’s more pro-business measures will be scaled back, and whether some of the problems businesses face under the more radical parts of the TCJA can be fixed. Those questions must be addressed in a challenging fiscal climate with a Democratic chair of the House Ways and Means Committee and a more progressive wing of the Democratic party that wants to make itself heard.

A Democratic House

The likely incoming chair of the Ways and Means Committee is Richard E. Neal, a Democrat from Massachusetts who has a reputation as a moderate with a strong interest in retirement reform and working in a bipartisan fashion. His comments to date don’t suggest that he wants to radically overhaul the TCJA.

At the same time, the partisan nature of the TCJA’s passage means there’s strong Democratic interest in revisiting that process and the resulting law (probably with a focus on its mistakes and perceived inequities). Neal has said he will hold hearings that would include testimony on the law, likely on areas in which progressives have argued that it increases inequality and favors corporate interests and the wealthy.

But moderate Democrats won’t necessarily hold sway. Progressives might have greater influence in the next Congress. And the ranking minority member of the Ways and Means Tax Policy Subcommittee in the 115th Congress was Lloyd Doggett, D-Texas. The tax bills Doggett has introduced reveal a much stronger progressive streak, with an emphasis on getting companies to pay more taxes. His policy agenda suggests that Democrats see plenty of opportunity to scale back international reforms in ways that could affect corporate tax rates.

The Corporate Rate

One TCJA provision that has been repeatedly emphasized as unsustainable over the longer term is the 21 percent corporate tax rate. At a November 29 Urban-Brookings Tax Policy Center event to discuss tax policy after the midterms, panelist Sandra Salstrom, legislative representative for the American Federation of Government Employees, said the next Congress will likely revise the corporate rate. As the midterm elections showed, much of the public views the TCJA’s corporate rate reduction — in concert with little in the way of individual tax relief — as a giveaway to businesses and high-income earners.

At the Tax Policy Center event, Mark Prater, formerly on the Republican staff of the Senate Finance Committee and now at PwC, argued that the TCJA simply brought the corporate rate down to the OECD average (representing the federal rate combined with the average state rate) and that increasing the U.S. rate above that average puts pressure on the global tax system, thereby increasing incentives for U.S. multinationals to engage in the type of tax planning that erodes the U.S. tax base.

A complex international dynamic necessitates the lower rate and has nothing to do with corporate giveaways, but an argument for a low corporate rate based on a fragile global tax ecosystem is fairly sophisticated — and it’s unclear that either the public or House Democrats will be swayed by it.

The Disconnect

In their earnings calls, many businesses have characterized the TCJA’s international changes as harming effective tax rates. After all, as a result of the global intangible low-taxed income rules, U.S. multinationals’ foreign earnings are mostly subject to immediate U.S. tax (albeit at half the corporate rate). The base erosion and antiabuse tax provision has also had negative and unexpected effects on companies’ effective rates. Anti-hybrid rules and an expanded interest expense limitation round out the provisions that are making some companies realize that the reforms were less a golden egg than simply a trade of one set of complex rules for another.

The big TCJA benefit on the international side was supposed to be the 100 percent dividends received deduction on the repatriation of foreign earnings by way of a dividend. But given GILTI’s bite, that benefit is less than many expected, and historically, many companies have been able to access those earnings essentially tax free anyway.

Although businesses haven’t necessarily been viewing the TCJA’s international changes that favorably, progressive groups still describe many of them as corporate giveaways that create incentives for companies to move operations and profits offshore and have called for more stringent changes.

A Progressive Agenda

The nonprofit Institute on Taxation and Economic Policy has published a report, “Understanding and Fixing the New International Corporate Tax System,” detailing its platform for addressing the TCJA’s problems — and it’s not the same as the corporate agenda. According to ITEP, the international tax provisions are one of the best places to start reforming the code for progressive change.

ITEP argues that real reform of the international tax system means moving to a regime that raises more revenue and eliminates the incentive to shift profits offshore. It says the TCJA does neither, and instead gives away more revenue to multinationals and introduces “a significant new tax incentive” for profit shifting.

QBAI

One aspect of the TCJA that ITEP finds especially problematic is the exclusion from GILTI of a 10 percent return on tangible assets. It says that exemption allows companies to pay nothing on offshore profits as long as those profits are lower than 10 percent of tangible offshore assets and creates a substantial incentive for companies to move tangible assets offshore to increase the 10 percent base not subject to GILTI taxation. It also says the 10 percent rate is well above that needed to exempt a normal rate of return.

Companies that generate profits of less than 10 percent on their basis in their tangible assets probably aren’t the ones the TCJA — or the OECD, for that matter — were focused on as bad actors engaged in profit shifting. For one thing, if all of a business’s profits are generated from tangible assets, it’s not that easy to shift the profits from one jurisdiction to another. Most of the companies held up as culprits of aggressive tax planning are earning a return over 10 percent on assets, largely generated from intangibles, either in the form of technology, patents, or marketing intangibles. But whether ITEP’s arguments are logical or not, the claim that this aspect of the law unnecessarily provides multinationals with an overly favorable benefit may be readily accepted by lawmakers who want to dial back terms of the TCJA that are viewed as too generous to business; an added bonus is that doing so could generate revenue.

The exemption for qualified business asset investment (QBAI) may be particularly vulnerable to repeal because of another point raised by ITEP: An exemption for a return on tangible assets held overseas could encourage businesses to move those assets offshore. The magnitude of a shift like that is probably small, and only on the margins. But again, a provision that gives businesses limited benefits and has poor optics might well be overturned, or at least scaled back.

Blended FTC and GILTI Rate

Unlike some previous foreign minimum tax proposals, which prescribed a per-country calculation for the foreign tax credit, the TCJA allows GILTI to be offset by FTCs with the limitation calculated on a blended worldwide basis. That the FTC limitation is still calculated that way means companies might be able to cross-credit taxes paid in a high-tax jurisdiction against profits generated in a low-tax one. And GILTI, while imposing an immediate tax on most companies’ foreign profits, does so at half the corporate rate.

According to ITEP, the global FTC limitation means that “despite being portrayed as a minimum tax of 10.5 percent, the combination of the application of foreign tax credits and the 10 percent base of offshore tangible assets guarantees that many companies will end up paying much lower rates or even nothing on their offshore earnings.” ITEP claims that companies can end up paying less than half the U.S. rate of 21 percent on domestic profits, which it says “creates a significant tax incentive for companies to shift their profits, on paper at least, offshore.” It also says the reduced rate on offshore income encourages companies to move real jobs and operations offshore to obtain that lower rate.

ITEP’s characterization of the worldwide FTC limitation as creating major tax planning opportunities for businesses is somewhat at odds with how companies have been describing the constraints imposed by the interaction of the FTC limitation, expense allocation rules, and the separate GILTI basket (with no carryover allowed) for FTC credits. But raising concerns about incentives the TCJA created to shift profits offshore could encourage lawmakers — who might otherwise have been eager to scale back the TCJA’s business benefits — to either raise the GILTI rate (by reducing the section 250 deduction beyond what’s already written into the law) or further limit companies’ ability to claim credits against U.S. tax on GILTI.

FDII Calculation

ITEP also decries the foreign-derived intangible income (FDII) regime, intended to entice companies to bring valuable intangible assets back onshore. It says that because of how the FDII benefit is calculated, “having more tangible assets in the United States means a smaller tax break, [so] this provision further exacerbates the incentive for companies to move their tangible assets offshore to lower their taxes.” Here, ITEP singles out for criticism the differentiation between the tax rate on GILTI, which is 50 percent of the standard corporate rate, and the lesser tax benefit of FDII, which is only a 37.5 percent deduction from the corporate rate. According to ITEP, that smaller benefit won’t be enough to encourage companies to move intangibles back to the United States, and “foreign companies still have an even greater incentive to locate their intangible assets in tax haven countries where they can pay single-digit tax rates or nothing at all on their intangible income.”

ITEP also points to flaws in how the benefit was drafted, saying companies could try to expand its scope beyond the TCJA’s original intent by selling their products to separate foreign distributors that then sell them back into the United States, thereby turning domestic income into export income. All in all, ITEP characterizes FDII as “a windfall to those export-oriented domestic companies and multinationals that have held intangibles domestically and conducted operations in the United States for years.”

The BEAT

Finally, ITEP faults the BEAT, a provision drafted specifically to combat base erosion. It says the BEAT appears to invite various tax-minimization strategies that could sharply limit its effectiveness. The organization doesn’t like that the tax applies only to companies with average gross receipts over $500 million or whose tax benefits from base erosion exceed 3 percent of their overall deductions. And it says the BEAT exception for cost of goods sold “could allow companies to package their royalties with cost of goods sold and avoid triggering BEAT liability.”

Proposed Reforms

To address those problems in the TCJA, and to end what it calls “rampant international tax avoidance,” ITEP proposes changes that embrace three broad policies:

  • equalizing the rates paid by U.S. multinationals on foreign and domestic earnings (in other words, eliminating the section 250 deduction on GILTI and the QBAI exemption and applying the FTC limitation on a per-country basis);

  • eliminating inversions (replacing the corporate incorporation test for residency with a management and control test, eliminating the BEAT cost of goods sold exception, and expanding section 163(j) so that it’s more like section 163(n) as proposed by the House); and

  • creating transparency (public disclosure of country-by-country tax return information).

Advocacy and Bills

ITEP’s agenda isn’t falling on deaf ears, and circumstances are such that advocates of scaling back the TCJA’s benefits might be successful. In a November 29 letter, 27 national groups opposed a 300-page tax bill recently introduced by Ways and Means Committee Chair Kevin Brady, R-Texas, that included technical corrections to the TCJA. They argued that “any new tax legislation should get rid of the tax incentives that encourage corporations to outsource jobs and factories to low-wage countries, like General Motors is doing in Mexico.” Like ITEP, the groups called for repeal of the section 250 deduction, saying that “by taxing foreign profits at about half the rate of domestic ones, the Trump-GOP tax law entices U.S. corporations to shift profits and send production and jobs offshore.”

ITEP’s proposals are also consistent with bills introduced by Democratic lawmakers. In February Doggett introduced the No Tax Breaks for Outsourcing Act (H.R. 5108) (introduced in the Senate by Finance Committee member Sheldon Whitehouse, D-R.I. (S. 2459)). The bill, which has 77 cosponsors, includes many of the reforms recommended by ITEP, such as eliminating the QBAI exemption, the section 250 deduction for GILTI income, and the FDII deduction. It also would tighten the definition of a foreign corporation and restrict the deductibility of excess interest payments.

A bill introduced by Rep. Rosa L. DeLauro, D-Conn., the Close Tax Loopholes That Outsource American Jobs Act, would eliminate the section 250 deduction on GILTI income. Meanwhile, the Per-Country Minimum Act (H.R. 6105), introduced by Rep. Peter A. DeFazio, D-Ore., would apply the GILTI FTC limitation on a per-country basis, eliminate the QBAI exemption, and reduce the GILTI deduction.

Aside from the technical fixes to the TCJA that would generally expand U.S. taxation of U.S. companies’ foreign earned income, there’s a separate push among Democrats for public CbC reporting. The Stop Tax Haven Abuse Act (H.R. 1932), originally sponsored by Whitehouse and Doggett in 2017, includes public CbC disclosure as one of its many provisions meant to stop tax avoidance under the pre-TCJA international tax regime. The Tax Fairness and Transparency Act (H.R. 2057), introduced by Rep. Mark Pocan, D-Wis., would also require public CbC reporting.

While the odds of any of those bills becoming law may be slim, the level of public support the bills receive is an important indicator of what progressives think are the pressure points on the TCJA’s international provisions. Especially for public CbC reporting, the pressure is coming not just from the legislative side, but also from the regulatory side.

Obama Budget

For some perspective on ITEP’s agenda and the tax bills introduced by Democratic lawmakers, it’s helpful to compare the proposals with President Obama’s international tax reform ideas in his administration’s framework for business tax reform that was reissued in 2016.

Obama repeatedly proposed cutting the corporate tax rate (albeit not to 21 percent), with the 2016 budget offering a 28 percent rate, and suggested a lower rate on manufacturing income of just 25 percent. Likewise, while Obama similarly proposed ending deferral with a minimum tax on foreign earnings, he didn’t propose equalizing rates — his proposed minimum tax was 19 percent, approximately two-thirds that of the proposed general corporate rate. And like the TCJA, the Obama proposal for a minimum tax allowed for an exemption for a fixed rate of return on foreign investment, deemed the allowance for corporate equity. According to the Obama budget, that allowance would have provided a risk-free return on equity of the controlled foreign corporation invested in active assets, which would provide an even playing field for U.S. companies operating abroad relative to their foreign competitors.

The Obama proposal for a minimum tax was designed as a per-country tax, which could have reduced the ability to cross-credit foreign taxes. But it was more favorable to taxpayers than the TCJA provisions are in that it would have allowed the FTC as an 85 percent credit. The Obama budget was also similar to the ITEP proposal in containing a managed and controlled test for inverted companies.

Treasury’s Role

Treasury has broad leeway in issuing guidance to make the TCJA’s international provisions more or less taxpayer- or business-friendly, or more or less progressive. So far it seems to be taking a fairly evenhanded approach — interpreting the law in a manner highly beneficial to taxpayers in some instances, such as in the recently proposed section 956 regulations (REG-114540-18), but declining to agree with the most taxpayer-favorable interpretations of the law in others, such as in the recently proposed regulations applying expense allocation rules to GILTI income (REG-105600-18). (For prior analysis of the section 956 regs, see Tax Notes , Nov. 12, 2018, p. 809. Prior coverage of the FTC regs.)

A Glimpse of 2020?

A progressive agenda that includes dialing back many of the international law changes that made elimination of deferral more palatable to multinationals — including the section 250 deduction, the blended FTC limitation, and the exemption for a fixed return — might have little chance of success in the next two years. But 2020 brings many great unknowns. When combined with uncertainties over how other countries might respond to, adopt, or attempt to counter the more competitive U.S. international tax rules introduced by the TCJA, some of those changes may be up for revision in a way that forces multinationals to pay more U.S. tax.

Mindy Herzfeld is professor of tax practice at University of Florida Levin College of Law, director of its International Tax LLM program, and a contributor to Tax Notes International. Email: herzfeld@law.ufl.edu

Follow Mindy Herzfeld (@InternationlTax) on Twitter.

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