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Design Choices for Unilateral and Multilateral Foreign Minimum Taxes

Posted on Sep. 2, 2019

Aaron Junge is an international tax director with PwC. Karl Edward Russo is a director and Peter R. Merrill is a consultant in the national economics and statistics group in PwC’s Washington National Tax Services.

The authors thank Will Morris, Drew Lyon, Pat Brown, and Jeremiah Coder of PwC for their insights and comments in developing this report.

In this article, the authors examine the legal and economic issues surrounding a foreign minimum tax, setting out the consequences and administrative details of various design options.

Copyright 2019 PwC. All rights reserved.

Table of Contents
  1. I. Executive Summary
    1. A. Overview
      1. 1. Minimum Tax Design Issues
      2. 2. Economic Issues
    2. B. Conclusion
  2. II. Introduction
  3. III. Obama Minimum Tax Proposal
    1. A. Overview
    2. B. Minimum Tax Rate
    3. C. Country-by-Country Rate
    4. D. Country-by-Country Base
    5. E. Hybrid Arrangements
    6. F. Foreign Branches
    7. G. Subpart F and Section 956 Rules
    8. H. Sale of CFC Stock
    9. I. Comparison of FMT With GILTI Regime
  4. IV. Designing a Unilateral FMT
    1. A. Introduction
    2. B. Measuring the Minimum Tax Base
      1. 1. Per Country or Overall
      2. 2. Applicable Laws
      3. 3. Routine Returns
      4. 4. Affiliates
        1. a. Consolidation Regimes
        2. b. Participation Exemptions
      5. 5. Timing Differences
    3. C. Determining the Residual Tax Imposed
      1. 1. Types of Taxes Taken Into Account
      2. 2. Multiple Layers of Foreign Taxes
      3. 3. Imposing Residual Tax
      4. 4. Excess Foreign Taxes
    4. D. Coordinating With Anti-Base-Erosion Regimes
      1. 1. Limitations on Deductible Payments
        1. a. Interest Limitations
        2. b. Anti-Hybrid Rules
      2. 2. CFC Rules
  5. V. Coordination of a Multilateral FMT
    1. A. Introduction
    2. B. Concurrent Application of Multiple FMTs
      1. 1. Ultimate Shareholder Approach
      2. 2. Immediate Shareholder Approach
      3. 3. Credit Approach
    3. C. Common Elements of Coordinated FMTs
    4. D. Residency Changes
    5. E. Administrative Issues
  6. VI. Efficiency and Rationale for an FMT
    1. A. In General
    2. B. Rate Differentials and Efficiency
    3. C. Benefit Principle and Efficiency
    4. D. Domestic and Foreign Complementarity
      1. 1. Domestic Investment and Foreign Sales
      2. 2. Domestic and Foreign Investment and Employment
      3. 3. Rationale for Minimum Tax
  7. VII. Per-Country vs. Overall FMTs
    1. A. Multilateral vs. Unilateral FMTs
    2. B. Corporate Behavioral Responses
      1. 1. Foreign Tax Reduction
      2. 2. Location of Deductible Expenses
      3. 3. Ownership of Low-Tax Subsidiaries
    3. C. Governmental Behavioral Responses
      1. 1. Soak-Up Taxes
      2. 2. Proliferation of Nontax Incentives
    4. D. Revenue Effects
    5. E. Treatment of Losses
    6. F. Simplicity
  8. VIII. Excluding Routine Returns
    1. A. Rationale
    2. B. Incentive Effects
      1. 1. Incentives for Companies
      2. 2. Incentives for Countries
  9. IX. Other Issues
    1. A. International Equity
    2. B. Dual System Coordination

I. Executive Summary

A. Overview

International interest in implementing foreign minimum tax regimes has accelerated recently, as a result of the U.S. adoption of the global intangible low-taxed income regime as part of the Tax Cuts and Jobs Act, and ongoing discussions within the G-20 and OECD inclusive framework on base erosion and profit shifting. With the possible role of a foreign minimum tax as a global standard, it is critical to understand the legal and economic issues that arise from the various design choices. This report discusses these design choices for both a unilateral and a multilateral foreign minimum tax.

Three main policy rationales for adopting a foreign minimum tax are preventing multinational companies from shifting profits abroad for tax reasons, counteracting perceived harmful tax competition, and increasing corporate tax collections. The design choices for a foreign minimum tax will reflect the relative priority given to these policy goals.

1. Minimum Tax Design Issues

Any foreign minimum tax has three fundamental design elements: (1) measuring the minimum tax base; (2) determining the residual tax imposed; and (3) coordinating with other anti-base-erosion regimes, including foreign minimum taxes imposed by other countries.

A critical decision is whether to apply the minimum tax on a per-country or an overall basis. A per-country approach aims to prevent a tax incentive for a multinational company to shift profits to a no- or low-tax country in which the average tax rate is below the minimum tax rate. This approach requires assigning income and expense items to countries, including rules to deal with taxation of the same income by more than one country or by no country.

By contrast, an overall minimum tax aims to prevent a tax incentive for a multinational company to shift profits to no- or low-tax countries to the extent this would result in an overall average foreign tax rate below the minimum tax rate. An overall approach is administratively simpler, more consistent with the integrated nature of modern global supply chains, and less vulnerable to distortions in measuring the minimum tax base. However, for a given tax rate, a per-country approach may raise more tax revenue, much of which may accrue to low-tax countries if they raise their corporate tax rates to the minimum tax rate.

A per-country foreign minimum tax was included in the Obama administration’s fiscal 2016 and 2017 budget proposals. Ultimately, the TCJA adopted the GILTI regime, which is determined on an overall, rather than a per-country, basis.

To measure the minimum tax base, a jurisdiction can look to the home country’s law, the host country’s law, or a commonly accepted accounting standard. Differences between home and host country tax bases may arise because of permanent or timing differences.

The minimum tax base may include or exclude routine returns. Routine returns may be excluded by formula (for example, subtracting a specified rate of return on capital) or, in present value, by allowing first-year capital cost recovery (that is, expensing).

In determining the minimum tax base of affiliates within the same country, a choice needs to be made whether to respect local law consolidation rules, which affect the use of losses, among other items.

There also are numerous issues involved in the determination of the foreign tax rate, including which types of taxes to take into account, the treatment of dual-capacity taxpayers, refunds, audit adjustments, noncompulsory payments, soak-up taxes, subsidies, and the imposition of tax by more than one country on the same item of income.

The minimum tax may be imposed as a “top-up” tax — that is, at a rate equal to the excess of the minimum tax rate over the foreign effective tax rate (either on a per-country or an overall basis) or by taxing the minimum tax base at the minimum tax rate with a credit for foreign taxes. Under the credit approach, variations in the foreign tax rate over time can be averaged by allowing a carryover of excess foreign tax credits to other tax years. Under the top-up approach, foreign tax rate variations can be smoothed by measuring the foreign tax as a multiyear moving average (for example, a five-year average as under the Obama administration proposal).

A foreign minimum tax regime must be coordinated with other anti-base-erosion mechanisms, such as limitations on deductible payments and controlled foreign corporation rules. This coordination is particularly important in light of the anti-base-erosion provisions that are included in the 2015 BEPS package and have been adopted by many countries.

Although all the design elements of a unilateral minimum tax system are equally applicable in a multilateral context, there are additional considerations that arise in a multilateral setting. Coordinating rules are necessary to ensure that a multilateral minimum tax framework avoids economic double taxation and minimizes overlapping application of foreign minimum taxes. Common elements among different countries’ foreign minimum taxes would facilitate coordination, including issues arising from shareholder ownership levels and tax residency changes. Moreover, a high degree of global uniformity in minimum tax systems is important to lessen harmful tax competition, minimize double taxation, and ease compliance costs. One solution for determining equivalence among jurisdictions’ foreign minimum tax regimes could be reliance on white lists (or other commonly accepted criteria) subject to peer review.

2. Economic Issues

For multinational companies, an overall minimum tax creates an incentive to reduce foreign taxes when the global tax rate is higher than the home country’s minimum tax rate; this gives companies an incentive to locate deductible expenses in the jurisdiction with the highest effective marginal tax rate. A per-country regime would likely reduce the incentive for companies to allocate more (foreign) expenses away from low-tax countries (relative to a world without a minimum tax), while in an overall regime the preference for allocation depends on whether the company’s rate is above or below the minimum tax threshold.

Under a multilateral per-country minimum tax, there is a strong incentive for host countries to raise domestic tax rates on foreign-headquartered companies to soak up the minimum tax differential. One response by the home country might be to limit FTCs to less than 100 percent. A multilateral overall minimum tax creates less of an incentive to enact soak-up taxes than a per-country minimum tax. If countries compete less on the basis of low tax rates, there may be an increased use of nontax or discretionary incentives. Discretionary incentives may be less desirable than tax incentives because they may have higher administrative costs associated with evaluating potential beneficiaries, higher misclassification errors for marginal and inframarginal investments, and less transparency.

When a minimum tax reduces profit shifting and leads to greater home country investment, it is likely to increase the revenue raised by the home country; in fact, high-tax countries in general should benefit when profits are shifted out of low-tax jurisdictions. If foreign countries do not respond, an overall minimum tax may result in less revenue in the home country than a per-country system for a given tax rate. By contrast, if a per-country minimum tax causes host countries to raise their tax rates to the minimum rate, the revenue gain to the home country is reduced. An overall minimum tax may allow faster use of net operating losses, deferring government revenue. Of course, systematic adoption of a per-country or overall minimum tax may increase the cost of capital, leading to a decrease in revenue-generating economic activities.

A minimum tax may exclude routine returns to maintain international competitiveness, allowing investors to receive the same after-tax rate of return for investments that earn a normal return regardless of residency. Depending on how it is accomplished, exclusion of routine returns may lead companies to engage in various types of structuring. For example, if routine returns are measured as a percentage of tangible capital, there would be an incentive to locate low-return tangible capital alongside high-return investments to shield some of the high return from minimum tax. Likewise, countries may seek to attract routine return tangible capital investment by offering generous depreciation allowances.

B. Conclusion

Ultimately, the global effect of any minimum tax depends on which countries adopt it and on the distribution of cross-border investment; multilateral adoption of a minimum tax is likely to have a concentrated effect on the countries with the largest outbound investment. Although more beneficial in terms of certainty and ease of compliance, a uniform multilateral approach requires consensus of jurisdictions with different economic interests, which may be difficult to achieve.

II. Introduction

In early 2019 the OECD released a public consultation document addressing the tax challenges of the digitalization of the economy.1 That document describes proposals discussed by the OECD’s inclusive framework on BEPS.

One set of those proposals is designed to address the continued risk of profit shifting to entities subject to no or very low taxation through the development of two interrelated rules: an income inclusion rule and a tax on base-eroding payments. The income inclusion rule would operate as a foreign minimum tax and might draw on aspects of the U.S. regime for taxing GILTI,2 enacted as part of the TCJA at the end of 2017. The OECD has since built on this proposal in a subsequent work program,3 which sets forth in greater detail a global anti-base-erosion (GLOBE) proposal.

At a high level, a foreign minimum tax is a tax imposed by the country where a shareholder is a tax resident (the home country) on the foreign earnings of the shareholder’s foreign subsidiaries and branches if subject to a low effective tax rate by the host countries. No country uses a true foreign minimum tax, although some countries condition the application of CFC rules or participation exemptions for foreign dividends based on the level of tax to which a foreign subsidiary is subject.

Some view the recently enacted GILTI regime as akin to an income inclusion rule, and the base erosion and antiabuse tax as a type of base-eroding payments tax. The OECD’s GLOBE proposal, however, is a foreign minimum tax (with both an income inclusion and base-eroding payment rule) that is intended to be implemented on a coordinated multilateral basis.

This report identifies legal and economic issues relevant to the design and implementation of a multilateral foreign minimum tax.4 This report begins with an overview of the most detailed foreign minimum tax proposal to date: the Obama administration’s fiscal 2016 and 2017 budget proposal. It then summarizes considerations for designing a unilateral foreign minimum tax. It then discusses the coordination of a multilateral foreign minimum tax. Next, the report describes the economic rationale for a minimum tax, then compares a per-country to an overall foreign minimum tax, and finally discusses economic considerations regarding the exclusion of routine returns and other issues.

III. Obama Minimum Tax Proposal

Before the United States adopted a participation exemption (territorial) tax system along with the GILTI regime in the TCJA, the Obama administration’s fiscal 2016 and 2017 budgets included a proposal to adopt a territorial tax system with a 19 percent per-country minimum tax on some foreign income earned by U.S. corporations directly or through CFCs. The Obama proposal appears to be the most detailed description of the mechanics of a per-country foreign minimum tax and thus is a useful reference point in considering the legal and economic issues that arise under such a tax. At the end of this section, the Obama administration proposal is compared with the GILTI regime, which is determined on an overall rather than a per-country basis.

A. Overview

The Obama administration foreign minimum tax proposal was a 19 percent, per-country minimum tax. It would have applied to U.S. corporate shareholders of CFCs and to foreign income earned by U.S. corporations through foreign branches or from the performance of services abroad. The foreign minimum tax would have applied regardless of whether foreign income was repatriated. It would have been an addition to the existing tax imposed on U.S. shareholders for some passive and mobile income earned by CFCs (subpart F income).

The foreign minimum tax would have been the final U.S. tax on the income to which it applied, so that a subsequent repatriation of foreign income would have been exempt from U.S. tax and no credit would have been allowed for foreign taxes imposed on that repatriated income. The tax would have been imposed on U.S. corporations regardless of whether the ultimate parent corporation was a U.S. resident; consequently, a U.S. corporate subsidiary of a foreign corporation would have been subject to the foreign minimum tax for its foreign income.

B. Minimum Tax Rate

The minimum tax rate applicable to foreign income would have been determined as a residual, on a per-country basis, as the excess, if any, of 19 percent over 85 percent of the per-country foreign effective tax rate. The foreign effective tax rate would have been determined by taking into account all foreign taxes and foreign income assigned to a country and measured over a 60-month period.5 By accounting for only 85 percent of the foreign effective tax rate in determining the minimum tax rate, the proposal would have created an incentive for companies to reduce foreign taxes below 19 percent (because the companies would have kept 15 percent of the foreign tax savings).

The rolling 60-month period for determining the foreign effective tax rate was intended to smooth fluctuations in the effective tax rate resulting from timing differences between U.S. and foreign income tax base determinations. This would have been in lieu of a carryforward of excess foreign taxes as was allowed under the prior-law corporate alternative minimum tax.

The foreign taxes taken into account would have been the same as those that would have been creditable absent the proposal. Foreign income generally would have been measured under U.S. tax principles, but would have included otherwise disregarded payments deductible elsewhere, and would have excluded dividends from related parties (to ensure that foreign income was not subject to the foreign minimum tax more than once).

C. Country-by-Country Rate

Under the proposal, when a CFC had earnings subject to tax in different countries, the earnings and taxes could be assigned to multiple countries. When the same income of a CFC was taxed by more than one country, the earnings and all the associated foreign taxes would have been assigned to the country with the highest effective tax rate.6 A CFC that was not considered a tax resident of any foreign country would have been subject to the full 19 percent minimum tax rate.

D. Country-by-Country Base

The tax base of the foreign minimum tax for any country would have been the earnings assigned to that country reduced by an allowance for corporate equity. That adjustment would have been equal to the risk-free rate of return on equity invested in active assets in the country.7 Active assets are those that do not generate foreign personal holding company income (that is, generally passive income) determined without regard to the look-through rules of section 954(c)(6). Equity in active assets presumably would have been determined using the U.S. tax basis of foreign assets with a reduction for the allocable share of any associated foreign debt. The risk-free rate of return was not specified in the proposal, but it was understood that Treasury staff were contemplating the use of the applicable federal rate for 10-year Treasury bonds.

E. Hybrid Arrangements

Special rules would have applied to hybrid arrangements to prevent the shifting of income from low- to high-tax countries for U.S. tax purposes without triggering tax in the high-tax jurisdiction. Thus, no deduction would have been recognized for a hybrid dividend that was deductible by the payer in a low-tax country (that is, treated as an interest payment) and excluded from tax in the high-tax country of the shareholder (that is, treated as an exempt dividend). For this purpose, “high tax” presumably would have meant a foreign effective tax rate of 19 percent or more.8

F. Foreign Branches

A foreign branch of a U.S. corporation would have been treated like a CFC — that is, the U.S. shareholder would have been subject to the foreign minimum tax on the branch’s foreign earnings as if they were earned through a CFC. By contrast, under current law, foreign branch income is included in the U.S. owner’s taxable income and taxed at the regular corporate tax rate, with a credit for associated foreign income taxes. To the extent the foreign branch used intangibles of the U.S. owner, it would be deemed to pay an arm’s-length royalty that would be included in the U.S. owner’s taxable income. The proposal did not specify whether for tax purposes there would be a deemed outbound transfer of branch assets to a CFC as part of the transition to the foreign minimum tax.

G. Subpart F and Section 956 Rules

The subpart F rules would have continued to apply, and income that was taxable to a U.S. shareholder under subpart F would not have been included in the tax base of the foreign minimum tax. Subpart F income would have been taxable at the regular corporate tax rate, and a credit would have been allowed for associated foreign taxes. The section 954(c)(6) look-through rules would have been made permanent so that inter-CFC payments qualifying for look-through treatment under then-current law would be subject to the minimum tax (and not taxed as subpart F income). As a result, first-tier and lower-tier CFCs would have been taxed in an equivalent manner. The high-tax exception from subpart F would have been made mandatory; however, it is unclear whether high-taxed subpart F-type income would have been included in the minimum tax base or treated as exempt income (without an FTC) for U.S. tax purposes. Further, the section 956 rules that treat some investments of foreign income in U.S. property as deemed dividends would have been repealed.

H. Sale of CFC Stock

Gain on the sale of CFC stock by a U.S. shareholder would have been treated as a dividend (that is, exempt from U.S. corporate tax) to the extent attributable to earnings that were subject to tax under the foreign minimum tax or subpart F; gain exceeding that amount would have been included in the base of the foreign minimum tax (that is, treated in the same manner as future earnings). Gain on the sale of CFC stock by a CFC presumably would have been excluded from tax to the extent attributable to income previously subject to tax under the foreign minimum tax or subpart F rules; however, gain exceeding that amount apparently would have been treated as subpart F income and been taxable at the regular corporate tax rate.9 The foreign minimum tax proposal would have directed Treasury to issue regulations addressing the taxation of undistributed earnings when there was a change in status of a CFC or a non-CFC.

I. Comparison of FMT With GILTI Regime

The GILTI regime enacted in the TCJA differs in several important respects from the Obama administration’s foreign minimum tax proposal. Some of the key differences are noted below.

First, under GILTI, the foreign effective tax rate is determined on an overall rather than a per-country basis. This avoids the need to assign foreign earnings and associated foreign taxes to individual countries or to recharacterize hybrid transactions between CFCs in high- and low-tax jurisdictions. As a result, the administrative and compliance burdens under GILTI are less than would have been the case under the Obama foreign minimum tax. The overall calculation in GILTI also provides an additional incentive for companies to reduce foreign taxes in low-tax jurisdictions (rather than merely high-tax jurisdictions) for U.S. shareholders with excess FTCs in the GILTI basket.

Second, the effective GILTI tax rate is 10.5 percent (after the 50 percent deduction under section 250), and a credit is allowed for 80 percent of foreign taxes imposed on GILTI (determined within a new separate FTC limitation category). Consequently, leaving aside expense allocation, no GILTI tax is due on foreign income subject to an overall tax rate of 13.125 percent or more (because 10.5 percent equals 80 percent of 13.125 percent). By contrast, the residual Obama foreign minimum tax rate would have been 19 percent less 85 percent of the foreign tax rate, so no foreign minimum tax would have been due for any country when the country’s effective tax rate was 22.35 percent or more (because 19 percent equals 85 percent of 22.35 percent).

Third, although the GILTI tax rate is lower than the Obama foreign minimum tax rate, no carryforward of excess FTCs is allowed under GILTI, so foreign taxes paid at a rate above 13.125 percent in one year are not considered in a future year when foreign taxes may be less than 13.125 percent. By contrast, the 60-month averaging period used for determining the foreign effective tax rate under the Obama foreign minimum tax would have effectively allowed a five-year carryforward.

Fourth, because of the taxable income limitation, the inability to carry forward excess section 250 deductions, and the ordering of NOL carryforwards before the section 250 deduction, taxpayers with NOLs lose some or all of the benefit of the section 250 deduction. By contrast, the 19 percent foreign minimum tax rate would not have depended on the taxable income of the U.S. shareholder.

Fifth, despite its name, the tax on global intangible low-taxed income applies to income subject to high foreign tax rates because of the allocation and apportionment of domestic interest, research, and stewardship expenses in determining the FTC limitation. Consequently, taxpayers subject to high foreign tax rates, even well exceeding the 21 percent U.S. corporate tax rate, are still subject to tax by reason of GILTI because domestic expenses reduce otherwise allowable FTCs (in general, each $100 of domestic expense allocated to GILTI increases U.S. tax by $21 for a taxpayer with excess FTCs in the GILTI basket).

By contrast, under the Obama foreign minimum tax, domestic interest expense allocated and apportioned to the foreign minimum tax base of a country would have been deductible only at the lesser of the foreign effective tax rate or the U.S. corporate tax rate. For countries with tax rates below the U.S. corporate rate, the Obama foreign minimum tax would have been tantamount to a partial denial of deduction of allocable interest expense. Under GILTI, the deduction for domestic interest, research, and stewardship expenses effectively is fully denied to the extent allocable to GILTI (if the U.S. taxpayer has excess FTCs in the GILTI basket).

Sixth, unlike the Obama foreign minimum tax, the GILTI tax base excludes foreign oil and gas extraction income. Further, in computing GILTI, a deduction is allowed for 10 percent of tangible depreciable property (for CFCs with positive tested income) reduced by specified interest expense. By contrast, the foreign minimum tax base would have allowed a deduction for a risk-free rate of return on the equity-funded portion of active foreign assets of CFCs.

Seventh, GILTI applies to noncorporate U.S. shareholders in CFCs at regular tax rates because there is no section 250 deduction. Moreover, noncorporate taxpayers are not entitled to the credit for 80 percent of foreign taxes imposed on GILTI. An election exists, however, to provide greater parity.

Eighth, foreign branches are not treated as CFCs and are not subject to the GILTI regime. Instead, foreign branch income is taxed at full corporate rates with a credit for foreign taxes imposed on this income determined within a new separate FTC limitation category.

Ninth, the high-tax exception from subpart F is not mandatory under the TCJA; however, high-tax subpart F income is excluded from GILTI, and if the high-tax exception is elected, this income effectively is exempt from U.S. tax (without an FTC). Unlike under the Obama foreign minimum tax proposal, section 956 is not repealed by the TCJA.

Tenth, gain on the sale of CFC stock exceeding previously taxed earnings is taxable at the full U.S. corporate tax rate rather than, as under the Obama foreign minimum tax, the minimum tax rate. Moreover, under the TCJA, loss on the sale of CFC stock is deductible only to the extent that it exceeds the post-TCJA dividends received from the CFC for which the section 245A dividends received deduction was allowed.

IV. Designing a Unilateral FMT

A. Introduction

A foreign minimum tax can be viewed as striking a balance between capital import neutrality (CIN) and capital export neutrality (CEN).

Under CIN, the after-tax rate of return to investors in a host country is the same regardless of the home country of the investor. This can be achieved if all countries exempt earnings from foreign investments under territorial tax systems. Under CIN, corporate income taxes do not affect the nationality of the ownership of assets, because cross-border mergers (or so-called inversion transactions) do not affect the amount of tax on the income generated by these assets. However, under CIN, investors have a tax incentive to locate investment and profits in host countries with tax rates below the home country rate.

Under CEN, the after-tax rate of return to home country investors is the same regardless of where the investment is made. This can be achieved if the host country taxes the foreign income of its investors — earned directly or through foreign affiliates — on a current basis with an unlimited credit for foreign taxes. Under CEN, corporate income taxes do not affect the international location of investment or profits, because the net amount of tax (after FTCs) is the same regardless of location. However, unless all countries impose tax at the same rate, there is an incentive for home country multinationals to be acquired by companies located in countries with territorial tax systems (or with low corporate tax rates).

In practice, most countries have hybrid international systems that generally exempt foreign earnings of foreign subsidiaries, with exceptions, in some cases, for passive or highly mobile income or active income earned in tax havens.

The adoption of a foreign minimum tax has the effect of moving a territorial (or hybrid) tax system closer to a CEN regime. If the minimum tax is set at the regular corporate tax rate, the system moves all the way to CEN and, indeed, is harsher than a pure CEN system unless the FTC is unlimited.

There are three main policy rationales for adopting a foreign minimum tax. The first reason is to address concerns that home country multinationals are locating excessive amounts of real investment or profits abroad for tax reasons, notwithstanding existing transfer pricing rules and other measures designed to prevent BEPS (for example, CFC rules, thin capitalization rules, anti-hybrid rules, anti-treaty-shopping rules, country-by-country reporting, and switch-over rules that restrict the scope of territorial tax systems). The second reason is to counteract what is viewed as excessive tax competition by jurisdictions that set low or zero income tax rates to promote investment despite other defensive measures that may be used to address these concerns (for example, switch-over rules and the withdrawal of treaty benefits). The third reason is simply to increase corporate tax payments by home country multinationals.

Similar rationales exist for adopting rules that tax base-eroding payments; however, unlike an FMT, those rules apply equally to domestic- and foreign-based multinationals. The OECD has suggested that a base-eroding payment rule could be limited in scope to payments made to taxpayers in countries that have not adopted a globally coordinated foreign minimum tax. In effect, the base-eroding payment rule would penalize countries that do not comply with the global foreign minimum tax standard.

Ultimately, a foreign minimum tax needs to be evaluated by policymakers in terms of several issues, including base protection, competitiveness, revenue, and complexity. The following discussion describes and considers at a high level some fundamental design elements of a unilateral foreign minimum tax, taking into account these issues and potential policy objectives. This discussion does not try to reach conclusions or recommendations. Rather, it endeavors to identify issues, potential solutions, and benefits and detriments of those solutions. In particular, the discussion addresses measuring the minimum tax base, determining the residual tax imposed, and coordinating with other anti-base-erosion regimes.

B. Measuring the Minimum Tax Base

As an initial matter, a foreign minimum tax must be designed for a particular base of foreign earnings. If the base is measured more broadly than the base on which foreign taxes are imposed, the minimum tax is more likely to apply. Conversely, a minimum tax base can be narrowed to address only the class of earnings with which policymakers are concerned. Further, because a foreign minimum tax is imposed at the shareholder level, it can take into account multiple branches and subsidiaries in varying permutations to best suit the objective of the tax.

The following sections discuss design elements of a foreign minimum tax’s base: the basis (per country or overall) on which to apply a foreign minimum tax; the rules to apply in measuring the minimum tax base; the possibility of excluding routine returns; the treatment of affiliates; and the treatment of timing differences, including losses and other deductions that are carried back or forward.

1. Per Country or Overall

A natural starting point for considering design elements of a foreign minimum tax is whether the tax should be applied on a per-country or overall basis.10 Under the former, the minimum tax base is determined separately for each country in which the ultimate shareholder operates, other than the home country. Under the latter, the minimum tax base is determined in the aggregate for all countries in which the ultimate shareholder operates, other than the home country.

The OECD’s recent public consultation document addressing the tax challenges of the digitalization of the economy has proposed a per-jurisdiction global minimum tax.11 Similarly, the Obama foreign minimum tax would have been a per-country foreign minimum tax.12 Several academics also have advocated that the United States impose a per-country foreign minimum tax.13 A per-country foreign minimum tax aims to prevent a tax incentive for a multinational company to shift profits to a no- or low-tax country in which the average tax rate is below the minimum tax rate.

A per-country foreign minimum tax requires assigning each item of income or expense to one or more countries. In many cases, this is relatively straightforward. For example, income attributable to a Country X permanent establishment presumably would be assigned to Country X for purposes of a per-country foreign minimum tax.

In some cases, however, an item of income (or expense) may be subject to tax (or taken into account) in more than one country.14 In these cases, a per-country foreign minimum tax could provide a tie-breaker rule, or it could simply assign the taxes imposed by all countries to the same per-country category to which the income is assigned. The latter seems most consistent with the objective of a foreign minimum tax to assess the level of tax imposed on income by other countries. Similarly, an item of income (or expense) may be subject to tax (or taken into account) in no country.15 These cases could be grouped into a single category that is fully subject to the foreign minimum tax because no tax was imposed on the net income.

By contrast, some stakeholders have favored an overall basis for imposing a foreign minimum tax. In particular, the U.S. tax on GILTI operates in a manner similar to a foreign minimum tax imposed on an overall basis.16 An overall foreign minimum tax prevents a resident multinational company from reducing its overall tax rate on foreign income below the minimum tax rate.

Initially, an overall foreign minimum tax may be simpler than a per-country approach, because it requires only determining whether items of income (or expense) are subject to tax (or taken into account) in the home country. Because the base is measured on an overall basis, intercompany transactions generally should be disregarded. This can be accomplished by identifying and disregarding intercompany transactions or by allowing the income and expense legs of intercompany transactions to offset each other (and disregarding intercompany transactions with only one leg, such as dividends).17 As discussed in greater detail later, this approach also simplifies coordination with consolidation, anti-hybrid, and base-eroding payment rules and better preserves the value of losses.

In addition, an overall approach may be more consistent with the globally integrated nature of modern multinational firms, which operate supply chains across several jurisdictions. Globally integrated supply chains improve efficiency by eliminating the need to replicate stages of productions in each market and typically are designed to minimize localized risks to global supply, such as currency volatility, political unrest, labor disputes, natural disasters, and facilities disruptions. Modern multinational firms evaluate the performance of their existing investments, and make decisions about new investments, by considering the entirety of the firm’s integrated supply chain, not fragments of the chain taken in isolation. By measuring the tax imposed on the entire integrated supply chain, an overall approach more accurately determines whether or not a given firm’s operations have been subject to a sufficient level of tax so as to satisfy the policy objectives of the foreign minimum tax.18 In contrast, a per-country approach takes a narrower focus, comparing solely the tax rates of the home and host countries, without regard to the rest of the global supply chain that is considered by the firm in making decisions regarding existing and future investments.

A per-country foreign minimum tax is favored by some because it provides fewer opportunities for blending effective tax rates — a fiscal advantage for governments but a competitive disadvantage for local multinational companies. At the same minimum tax rate, a per-country foreign minimum tax typically raises more revenue than an overall foreign minimum tax, but this is not always true.19

Finally, there exist several legal issues that must be considered in designing a foreign minimum tax the presence or magnitude of which may depend on whether an overall or per-country approach is adopted. An overall approach is less likely to be affected by issues relating to interaffiliate transactions because those transactions typically will be ignored (or netted) when determining the minimum tax base. In addition, use of annual accounting periods typically results in fewer distortions of the tax base under an overall approach because it generally produces a wider minimum tax base and timing differences across jurisdictions may be offsetting. These issues, and where relevant the significance of an overall or per-country approach, are discussed in greater detail below.

2. Applicable Laws

An issue of equal importance to the question of a per-country or overall basis is which laws should apply to measure the minimum tax base. Three options seem apparent: (1) the home country’s laws, (2) the host country’s laws, or (3) a commonly accepted set of rules used for this purpose. We address each in turn.

First, the home country’s laws could be used to measure the minimum tax base. This is the approach the United States has taken for GILTI,20 and it is the starting point for the OECD’s GLOBE proposal.21 This appears most consistent with the objective of ensuring that income that would be taxed if earned in the home country is subject to a minimum level of tax if earned abroad.

Measuring the minimum tax base under the home country’s laws raises the possibility of the foreign minimum tax being imposed merely because of differences in the tax base of the home and host countries. These differences could be permanent, such as when the home country taxes a specific class of income and the host country does not. Alternatively, these differences could be temporary, such as when the home and host countries provide different periods and methods for depreciating or amortizing capital expenditures. Note that when a host country provides more generous depreciation and amortization periods and methods, it effectively imposes a reduced rate of tax on routine returns. If the home country provides less generous depreciation and amortization rules, the home country’s minimum tax effectively tops up the reduced rate of tax imposed by the host country on those routine returns.22

Second, the host country’s laws could be used to measure the minimum tax base. This approach eliminates the previously mentioned base differences because the same base is used for measuring the income that should be subject to a minimum level of tax and for measuring the income that is subject to tax in the host country. The result is an exercise in measuring the host country’s effective tax rate. Consequently, this approach raises a new type of base difference: differences between the home country’s tax base and the minimum tax base. Failing to impose the foreign minimum tax on these differences may diminish the efficacy of the foreign minimum tax in protecting the home country’s tax base.

Although any form of foreign minimum tax may encourage the host country to raise its tax rate to the minimum tax rate,23 determining the minimum tax base using the host country’s laws leads to the starkest incentive to do so because the host country’s tax rate completely controls the application of the foreign minimum tax. Also, measuring the minimum tax base under the host country’s laws encourages host countries to narrow their taxes bases, thereby exempting income from both host country tax and the foreign minimum tax. Effectively, host countries are given an incentive to raise their tax rates to the minimum rate threshold and use the increased revenue to narrow their respective tax bases. In addition, using the host country’s laws to measure the base of a foreign minimum tax other than a per-jurisdiction foreign minimum tax could be challenging to implement because it requires either blending different host jurisdictions’ tax bases or applying the foreign minimum tax on a per-jurisdiction basis first and then aggregating the differences between the host jurisdiction tax imposed and the minimum tax required.

Lastly, a foreign minimum tax could be adopted consistent with a global standard, such as generally accepted accounting principles or international financial reporting standards. This does not necessarily eliminate either set of base differences described earlier because the common rule set may differ from both the home country’s tax base and the host country’s tax base. However, it may give countries an opportunity to agree on eliminating the most significant base differences either through the commonly accepted set of rules or through domestic law changes in response to the adoption of the common rule set.

3. Routine Returns

The location of routine returns may be less sensitive to taxes than profits exceeding a routine level. Consequently, some argue that routine returns do not present the same base erosion concerns as supra-normal returns. Under that reasoning, a foreign minimum tax should exclude routine returns as a way more narrowly to tailor the tax to its specific policy objective.

The GILTI rules provide one example of excluding routine returns. Those rules use a formula for measuring routine returns, generally equal to a 10 percent return on the tangible, depreciable property used outside the United States, reduced by the aggregate net interest expense of foreign subsidiaries.24

Measuring routine returns by formula raises several challenges and possibilities for distortion. First, the appropriate rate of return likely varies by industry, actor, market, and time period. Consequently, a fixed rate of return necessarily favors some industries, actors, markets, and time periods over others. Adjustments could be made to correct these distortions, at the cost of additional complexity. For example, a variable rate of return (that is, a risk-free market-based return) with a fixed risk premium could be used instead of a fixed rate, which may partially address rates of return that vary over time, at the cost of less certainty in the application of the rule and greater complexity.25

Also, measuring routine returns formulaically may result in supra-normal returns escaping the minimum tax base. This particularly may be the case if the minimum tax base provides accelerated cost recovery deductions, which effectively exempt a portion of routine returns.

An alternative to measuring routine returns formulaically is to allow a deduction for the minimum tax base for the full cost of capital investments made during the year (expensing). Assuming that the minimum tax rate when the company takes the deduction is the same as the minimum tax rate when the income from the investment is earned, expensing is equivalent to exempting from tax the routine return on the investment.26 This depends, however, on full use of the deduction on a current basis (or carryover of unused deductions with interest).

In an overall foreign minimum tax, gaining a full present-value benefit from expensing is more likely because losses in one country resulting from expensing could offset income in other countries for purposes of the minimum tax base. This is less likely in a per-country foreign minimum tax. In either case, appropriate mechanisms are necessary to carry forward excess deductions adequately. Ideally, these deductions would be immediately refundable or carried forward with interest. If this is not the case, then the longer the deduction carries forward, the greater portion of routine returns is subject to the foreign minimum tax. Carryforwards are likely to be used more quickly in an overall foreign minimum tax than in a per-country foreign minimum tax.

Many countries already offer accelerated cost recovery deductions for capital investments. As discussed earlier, these regimes effectively provide a reduced rate of tax on routine returns.27 Thus, in some respects excluding routine returns simply prevents a foreign minimum tax from being imposed solely because of differences between the cost recovery rules of the home and host countries (assuming the host country’s laws are not used to measure the minimum tax base).

4. Affiliates

Multinational companies frequently operate in multiple jurisdictions, each through multiple branches and subsidiaries owned directly by the parent or indirectly through one or more tiers of subsidiaries. A company may conduct these operations through entities in which it has a range of ownership stakes, which may vary from completely owned by the parent to a less-than-50-percent ownership interest in a third-party joint venture. These complex ownership structures may arise because of acquisitions and divestitures, over time through organic growth, and in response to legal, regulatory, and commercial challenges that companies face. Many countries’ tax systems accommodate these ownership structures, but they do so in different ways that raise challenges for implementing a foreign minimum tax.

a. Consolidation Regimes

A common mechanism for addressing complex ownership structures is some form of tax consolidation. This can take the form of a consolidated group or fiscal unity when a group of commonly controlled entities taxed in the same country is generally treated as a single entity for that country’s tax purposes. It can also take the form of a profit or loss contribution, pooling, or surrender regime in which related entities taxed in the same country may shift profits or losses to one another for purposes of that country’s tax. Still other countries offer no form of tax consolidation. These variations create challenges for implementing a foreign minimum tax by reference to laws other than those of the host country, because the measurement of the minimum tax base may assume strong tax consolidation is available when instead only limited or no relief is available (or vice versa).

For example, if a home country imposes a per-country minimum tax, measured under the home country’s laws, it may seem sensible to aggregate profits and losses of entities and branches that are tax resident in the same country. If that country provides for tax consolidation and each of those entities and branches joins the tax consolidation, losses in one entity may be freely available to offset the profits of another such that complete aggregation aligns with the host country’s tax base. However, if (1) the host country does not allow for tax consolidation, (2) some entities and branches are not allowed to join or do not join the tax consolidation, or (3) there are limitations on the extent to which losses can be shared within the tax consolidation, the home country’s minimum tax base would inappropriately take into account losses not currently available to reduce host country tax. This would have the effect of measuring a higher effective tax rate for the host country. The opposite could be true as well: The home country could measure the minimum tax base by reference only to profitable entities and branches while the host country allows related parties to share losses, resulting in measuring a lower effective tax rate for the host country.

Failing to take into account a host country’s tax consolidation regime (or lack thereof) in measuring the minimum tax base may appear to result in inaccurate measurements of the host country’s effective tax rate, but this is true only from the perspective of the host country’s laws. If the objective is to preserve the home country’s tax base, then the minimum tax base would be measured by reference to the home country’s approach to tax consolidation, not that of the host country.

The primary effect of a tax consolidation regime, at least in some cases, is the use of losses sooner than would occur on a separate-entity basis. In this respect, differences in tax consolidation regimes may be similar to timing differences. As discussed later, timing differences can perhaps be addressed more consistently with the objectives of a foreign minimum tax by adopting shareholder-level foreign minimum tax attributes to reverse the effect in the year the deduction is allowed. If that approach were taken, the distortions created by differences in tax consolidation regimes might be limited to circumstances in which the differences are permanent, such as when losses shared under the minimum tax base’s consolidation regime are never shared under the host country’s laws (or vice versa).

b. Participation Exemptions

Another common mechanism for addressing complex ownership structures is participation exemptions or territorial exemptions. Many countries exempt from tax all or a portion of foreign branch profits and distributions from foreign subsidiaries. Also, some countries exempt from tax all or a portion of gains on sales of foreign subsidiary stock. Including these amounts inflates the minimum tax base and potentially leads to the same earnings being subjected to the foreign minimum tax two or more times. This is not an issue in an overall foreign minimum tax because intercompany dividends should be eliminated.

Conversely, a country may disallow deductions relating to foreign branches and subsidiaries, or losses from sales of foreign subsidiary stock. In those cases, the home country’s tax base is protected even if no foreign minimum tax is due.

Finally, multinationals frequently engage in joint ventures or invest in subsidiaries along with minority shareholders. It seems appropriate for a subsidiary that is almost entirely owned by a common parent to be subject to a foreign minimum tax in the same manner as a wholly owned subsidiary, but where to draw the line is unclear. The United States has generally drawn the line for GILTI at more-than-50-percent-owned subsidiaries,28 although in some cases a 10 percent ownership interest can be sufficient.29 This threshold generally targets control,30 as significant administrative hurdles have been identified regarding the application of GILTI to noncontrolled subsidiaries.31 The OECD’s recent public consultation document addressing the tax challenges of the digitalization of the economy has proposed a per-jurisdiction global minimum tax imposed on subsidiaries at least 25 percent owned by an ultimate shareholder, without providing a rationale for that ownership level.32

If the policy basis for a foreign minimum tax is to protect the home country’s tax base from tax-motivated behavior, an ownership threshold based on control (for example, more than 50 percent, or perhaps higher) seems most appropriate. On the other hand, if the policy basis for a foreign minimum tax is to protect the home country’s tax base from global tax competition, control may be irrelevant (although administrability concerns may necessitate some ownership threshold).

As discussed later, ownership thresholds become even more important in the context of a multilateral foreign minimum tax.33

5. Timing Differences

One last set of complexities in measuring the minimum tax base under a rule set other than the host country’s laws is timing differences (that is, deductions taken into account in one year under the host country’s laws and in another year for purposes of the minimum tax base). Timing differences commonly arise from the application of different accounting conventions, such as with depreciation and amortization, equity-based compensation, advance payments, imputed interest, impairment losses, and differing accounting periods. Although these timing differences reverse over time, they may create the appearance of a high or low effective tax rate in the host country in any given year.34

In addition to timing differences arising from different accounting conventions, many countries restrict the amount of particular deductions that can be taken in a year but allow the disallowed deductions to be carried back or forward to other years. For example, the U.S. limitation on interest deductions (section 163(j)), consistent with action 4 of the OECD BEPS project, operates this way.35 Similarly, a country may limit the number of years a loss can be carried back or forward or the amount of carryback or carryforward losses that can be deducted in the year to which the loss is carried.36

As with other timing differences, failure to take into account deductions that are carried back or forward could result in an inappropriately small minimum tax base (and inflated foreign effective tax rate) in the year the deduction is disallowed, and an inappropriately large minimum tax base (and deflated foreign effective tax rate) in the year to which the deduction is carried. These distortions could be addressed in at least three ways: (1) by modifying the minimum tax base to take into account deductions only to the extent allowed in the current period under the host country’s laws, (2) by considering the minimum tax base over a longer time horizon, or (3) by adopting shareholder-level foreign minimum tax attributes to reverse the effect in the year the deduction is allowed.

As discussed earlier, the first approach undercuts the objective of using the home country’s laws in measuring the minimum tax base. The second and third approaches are discussed in greater detail later.37

The effect of timing differences may be less under an overall than under a per-country minimum tax. For example, suppose two host countries both provide for full expensing and that a company makes a significant capital expenditure in each country every other year. Lower taxable income in the year of investment in one country is offset by higher taxable income in that year in the other country. Thus, there is less volatility in foreign effective tax rates from timing differences under an overall than a per-country minimum tax as long as the timing differences across countries are less than perfectly correlated (in which case the volatility is the same).

C. Determining the Residual Tax Imposed

Once the minimum tax base has been defined, tax imposed by the host country (and potentially other countries) must be considered to determine whether the base has been subject to the minimum tax rate. Only if the minimum tax base is not subject to the minimum tax rate should residual tax be imposed. This section first discusses the taxes that could be taken into account under a foreign minimum tax, then considers circumstances involving multiple layers of foreign taxes, and finally addresses issues relevant to the imposition of residual tax and the existence of excess foreign taxes.

1. Types of Taxes Taken Into Account

At the outset, it appears that because a foreign minimum tax is designed to ensure that a minimum level of tax is imposed on foreign income and that the home country’s income tax base is adequately protected, only income taxes should be considered in determining the residual tax to be imposed. The determination of whether a tax is in the nature of an income tax is neither simple nor novel. Accordingly, it seems appropriate to draw on prior work in this context38 to determine the types of taxes taken into account for purposes of a foreign minimum tax.

As part of this exercise, one needs to consider historic concerns with creditable foreign taxes. For example, the treatment of dual-capacity taxpayers, refunds, and noncompulsory payments is relevant.39 Issues surrounding soak-up taxes and subsidies40 take on greater importance, particularly because foreign minimum taxes give countries an incentive to raise nominal tax rates up to the minimum tax rate and then return the excess revenue to investors in the form of specific or generally applicable government subsidies and services.41

2. Multiple Layers of Foreign Taxes

A foreign minimum tax applies to all earnings, including those not eligible for the benefits of a tax treaty. Thus, for example, a foreign minimum tax must contemplate an item of income being treated as subject to tax in two or more countries at the same time with no resolution of the multiple taxation through treaty or other agreement. Moreover, even when a tax treaty does apply, it may expressly allow for concurrent taxation, such as a withholding tax. Double international taxation also may rise because the taxing authorities disagree on the proper allocation of taxing rights without reaching a resolution, as is frequently the case with transfer pricing disputes. CFC rules provide yet another avenue for the same item of income to be subject to tax in multiple jurisdictions.42

Under an overall foreign minimum tax, multiple country taxation of the same income does not raise concerns, all foreign taxes imposed on all foreign income included in the minimum tax base are taken into account. Under a per-country foreign minimum tax, however, each item of income and tax must be assigned to a country. In cases of multiple country taxation of the same income, the foreign minimum tax could provide a tie-breaker rule or assign all taxes imposed on an item of income to the same per-country category to which the income is assigned.43 The latter seems more consistent with the objective of assessing the level of tax imposed on income earned in a particular country.

Some countries mitigate double taxation by providing a credit to the shareholder for foreign taxes paid by the distributing subsidiary. When a credit is allowed for foreign taxes, it should be taken into account in determining whether the minimum tax rate threshold has been satisfied.

Also note that not all taxes may be known at the time the foreign minimum tax is imposed. Some taxes may be estimates subject to later corrections, while others may be contested and then redetermined to result in additional tax owed (or a refund). Foreign tax redeterminations in particular have become increasingly prevalent as the frequency and magnitude of tax disputes have increased.44 Conceptually, the purest resolution may be to take into account foreign tax redeterminations retroactively, requiring regular reevaluations of the applicability of a foreign minimum tax.45 If the foreign minimum tax uses adequate mechanisms for avoiding timing differences,46 a more administrable approach may be simply to take into account the additional taxes or refunds in the year the redetermination is made.

3. Imposing Residual Tax

After the taxes to be taken into account are identified, they are divided by the minimum tax base to determine the effective rate of tax and to compare it against the minimum tax rate threshold.

Three methods for implementing a foreign minimum tax are (1) the denial of a participation exemption (a deferred approach),47 (2) a current-year inclusion at the shareholder level (or current taxation at the branch owner level) conditioned on the foreign effective tax rate being less than the minimum tax rate (an exemption approach), or (3) a current-year income inclusion at the shareholder level (or current taxation at the branch owner level) at a reduced rate of tax against which a credit is allowed for foreign taxes paid or accrued on the minimum tax base (a credit approach).48 Variations of each of these approaches have been proposed.49 Both the exemption approach and the credit approach can be designed to reach identical results. Accordingly, this report assumes a foreign minimum tax under the credit approach, acknowledging that the considerations discussed later apply equally to an exemption approach.

Whether the exemption or credit method is adopted, the offset or credit for foreign taxes need not be complete. The Obama foreign minimum tax would have been determined as the excess of 19 percent of the minimum tax base over 85 percent of foreign taxes paid or accrued on that base.50 The GILTI rules allow an FTC for only 80 percent of foreign taxes paid or accrued.51 These reduced FTCs, or “haircuts,” impose partial double taxation to discourage foreign soak-up taxes and retain an incentive for companies to reduce foreign taxes below the minimum tax rate.52 Some question whether these haircuts are compatible with bilateral and multilateral tax treaty obligations, which generally require treaty partners to fully mitigate double taxation.53

Beyond haircuts, FTCs historically have been subject to various limitations. A common limitation on FTCs is to restrict them to the amount of domestic tax imposed on the related income.54 This ensures FTCs do not reduce domestic tax on income squarely within the domestic taxing jurisdiction. Imposing such a limitation on FTCs for a foreign minimum tax income inclusion might be viewed as equally appropriate.

Fundamental to the limitation on FTCs taken against domestic income is determining the amount of domestic tax imposed on the foreign income for which the credits are available. A question arises about the treatment of shareholder-level expenses (and branch owner expenses) and whether they should reduce the income for which FTCs are available. Because a foreign minimum tax gives rise to shareholder-level income inclusions solely in determining whether the minimum tax base has been subject to sufficient foreign tax, shareholder-level deductions may not appear relevant.

Nevertheless, some commentators have indicated that a foreign minimum tax should consider shareholder-level expenses in determining the extent to which FTCs may be taken.55 The rationale appears to be based in part on a desire to disallow deductions incurred with respect to income exempt from domestic taxation under a participation exemption or similar territorial regime.56 This conflates the objectives of separate policies: participation exemptions and foreign minimum taxes. Moreover, it creates the strange result of shareholder-level deductions being disallowed only when the shareholder’s foreign effective tax rates are high, while taxpayers that have achieved lower foreign effective tax rates enjoy full deductibility. Disallowing deductions related to exempt income is not a new discussion point, even in international taxation, but its inclusion in a foreign minimum tax regime seems to drift from the policy objectives of the foreign minimum tax while also creating potentially undesirable collateral consequences.

In a vein similar to shareholder-level expenses are shareholder-level losses for other income. Some countries do not allow FTCs to be refunded, instead carrying them forward to future years when the taxpayer otherwise would have domestic tax to pay. Thus, when shareholder-level losses unrelated to the foreign income offset the pre-credit domestic tax liability on the foreign income, there is insufficient domestic tax available to be offset by the credit, and the credit must be carried forward.

A similar approach could be adopted for a foreign minimum tax. Alternatively, the foreign minimum tax could be imposed without regard to other losses, such that the FTC is used in the current year and the losses are carried forward (or back). The GILTI rules adopt neither of those approaches and instead effectively disallow shareholder-level losses to the extent of foreign earnings.57

Other examples of existing laws that disallow FTCs include those applicable when there is insufficient documentation,58 the taxes are paid to a government with severed diplomatic relations,59 the relevant investment is held for a short period,60 or the foreign taxes are partly attributable to base differences.61 In all those cases and others, the policy objectives of the specific limitation must be considered and weighed against the policy objectives of the foreign minimum tax. For example, it may be equally appropriate to deny an FTC because of inadequate documentation for purposes of a foreign minimum tax as for other purposes.62

4. Excess Foreign Taxes

The preceding discussion identified several instances in which friction between the measurement of the minimum tax base and the host country’s tax base can deflate or inflate the foreign effective tax rate measured for a minimum tax base. These include differences in accounting periods and methods (for example, depreciation and amortization), the availability of tax consolidation among affiliates operating in the same country, carrying back or forward NOLs or other deductions, and foreign tax redeterminations.

One consequence of this friction is that residual tax may be imposed under a foreign minimum tax in a year in which the foreign effective tax rate is measured as below the minimum tax rate, even though the average foreign effective tax rate over a period of years meets or exceeds the minimum tax rate. A corollary to this consequence is that in other years no residual tax is imposed under the foreign minimum tax because the foreign effective tax rate is measured as at or above the minimum tax rate. If the excess foreign tax in those other years is not properly taken into account, the aforementioned timing differences have permanent effects, which would undermine the policy objectives of the foreign minimum tax and distort its effect.

Excess foreign taxes may be taken into account under a foreign minimum tax in several ways. One is to use an average foreign effective tax rate, measured over a period of years. The Obama foreign minimum tax was based on a 60-month average ending with the year in which the foreign minimum tax was applied.63 An average could provide transitional relief by taking into account years preceding the effective date of a new foreign minimum tax. Nevertheless, an average is limited by the period of years used and by the nature of an average, which may not adequately take into account periods of change or extraordinary transactions. Moreover, an average could result in a very high effective tax rate in a particular year (potentially exceeding 100 percent) when income historically subject to a low rate of foreign tax is subject to a high current rate of foreign tax as well as the minimum tax in that year.64

Another alternative is to make excess foreign taxes fully refundable. Although this approach is not limited by a period of years or changes over time, it may lead to excessive refunds when the average foreign effective tax rate exceeds the minimum tax rate. Also, refund systems may be prone to abuse and be politically unpopular.

A third alternative that is flexible enough to address the downsides of the foregoing options is to provide a shareholder with an excess FTC that can be carried forward to future years. Under this approach, inflated foreign effective tax rates in earlier years could offset deflated foreign effective tax rates in subsequent years to reflect more accurately the average foreign effective tax rate imposed over time. The number of years to which an excess FTC could be carried forward could be limited, although an indefinite carryforward may best resolve the friction discussed earlier.65

An excess FTC carryforward also is imperfect. For example, when the foreign effective tax rate is measured too low in early years and too high in later years, the carryforward does not offset the residual tax in earlier years and may not be of use later unless the timing differences are cyclical. This could be addressed by also allowing a carryback or by allowing excess FTCs against other current-year income tax to the extent of residual tax imposed in prior years (that is, effectively carrying forward the excess FTC limitation from prior years).66 Either of these solutions, however, may not provide relief for years before the effective date of the foreign minimum tax. Also, excess FTCs that are carried forward for many years may lose value over time because of the time value of money, which could be addressed by indexing excess FTCs for inflation (a common proposal for basis and losses).67

Any consideration of foreign taxes paid over a period of years or of carrying tax attributes back or forward (for example, excess foreign taxes or excess minimum tax limitation) also must take into account ownership changes. One approach is to track attributes at the subsidiary or branch level. This closely links the attributes to the related activities, but for subsidiaries and branches that are aggregated on a per-country or overall basis, this approach requires disaggregating the relevant subsidiaries and branches or otherwise allocating aggregate-level attributes to the individual subsidiaries and branches. An averaging approach (as in the Obama foreign minimum tax) implicitly adopts this approach by taking into account the subsidiary’s or branch’s prior history irrespective of its owners during the averaging period. Another approach is to track attributes at the shareholder (or branch owner) level. This is more administrable, but it raises the possibility of attributes carrying into years in which the shareholder no longer has an ownership interest in (or the branch owner no longer conducts) the activities that gave rise to the attribute. Corporate combinations and divestitures must also be considered, including tax-free transactions in which there is substantial continuity of the business enterprise, such as mergers, reorganizations, and spinoffs.

D. Coordinating With Anti-Base-Erosion Regimes

A central premise for a foreign minimum tax is that it protects the home country’s tax base. However, it is not the only tool to protect the base. Following the OECD’s work on BEPS, countries have used an increasing number of measures to protect their domestic tax bases. A foreign minimum tax should be tailored to take into account these other anti-base-erosion regimes. The following discussion briefly considers two common anti-base-erosion regimes: (1) limitations on deductible payments, and (2) CFC rules.

1. Limitations on Deductible Payments

Many countries limit deductions for payments made to affiliates, at least in part to discourage eroding the domestic tax base through deductible payments to affiliates subject to a lower rate of tax. Two examples of deduction limitations that have grown out of the OECD’s BEPS initiative are interest limitations and anti-hybrid rules.68

In some ways, the interaction of these limitations with a foreign minimum tax can be analogized to their interaction with CFC rules. A foreign minimum tax, however, is far broader in scope than CFC rules. Further, a foreign minimum tax arguably is qualitatively different from CFC rules because it is focused on ensuring that a shareholder’s foreign earnings are subject to a minimum level of tax, whereas CFC rules are designed to include specific passive and mobile income in the home country’s tax base. In any event, CFC rules historically have played a relatively minor role in cross-border taxation, and, as a result, additional consideration of coordinating shareholder and branch owner income inclusions with limitations on deductible payments may be warranted.

a. Interest Limitations

Regarding interest limitations, the OECD recommends as a best practice69 a fixed ratio rule under which countries limit net interest deductions to a fixed percentage (within a corridor of 10 to 30 percent) of earnings before interest, taxes, depreciation, and amortization or, alternatively, a fixed percentage of earnings before interest and taxes (EBIT).70 The OECD also encourages countries to combine a strong and effective fixed ratio rule with a group ratio rule that allows an entity to deduct more interest expense, up to the net third-party interest/EBITDA ratio of its group.71 Implementing a foreign minimum tax alongside such an interest limitation raises two questions: (1) whether the interest limitation should be applied to the minimum tax base, and (2) whether foreign minimum tax income inclusions should be taken into account in determining the shareholder’s or branch owner’s EBITDA or EBIT.

The answer to the first question depends on the law used to measure the minimum tax base. If the host country’s laws are applied, that country’s interest limitation must be taken into account to accurately measure the host country’s effective tax rate. If the home country’s laws are applied, the starting point is to apply the home country’s interest limitations in measuring the minimum tax base, unless there is a reason to deviate from the home country’s laws in this respect.

On one hand, failing to limit interest deductions for purposes of the minimum tax base may encourage taxpayers to concentrate additional interest expense in particular subsidiaries — even if that expense is not deductible in the host country — to reduce the minimum tax base and any residual tax imposed.72 Also, the more deviations between the home country’s tax base and the minimum tax base, the less effective the foreign minimum tax is at protecting the home country’s tax base. These concerns are of less importance in an overall than a per-country foreign minimum tax because inter-company interest expense generally should be disregarded (or netted) in an overall minimum tax.

On the other hand, interest limitations introduce substantial complexity into international taxation, and layering an interest limitation on top of a foreign minimum tax makes the rules even less administrable. This is particularly true as global adoption of interest limitations increases, because each subsidiary or branch of a multinational might be subject to an interest limitation under the host country’s laws and to an interest limitation for purposes of the minimum tax base of each jurisdiction in which a direct or indirect owner of that subsidiary or branch is a tax resident.

The answer to the second question — whether to take into account foreign minimum tax income inclusions in a shareholder’s or branch owner’s EBITDA or EBIT in applying thin capitalization rules — depends in part on the policy objectives of the interest deduction limitation. For example, the OECD’s BEPS action 4 report identifies the use of interest expense to fund tax-exempt or deferred income as one of the key BEPS risks to be addressed by its recommendations.73 This objective is further served by the OECD’s recommendation to consider a group ratio rule that ensures the limitation applies only to the extent interest expense is concentrated in a particular jurisdiction as a base erosion mechanism. Accordingly, the OECD recommends that (1) EBITDA not include nontaxable income such as dividend income that benefits from a participation exemption; and (2) when dividend income is subject to tax that is wholly or partly sheltered by underlying tax credits, the level of dividend income included in EBITDA be reduced accordingly.74

The EU’s anti-tax-avoidance directive includes a similar rule for tax-exempt income but does not explicitly address CFC income inclusions.75 Although not identical, foreign minimum tax income inclusions are similar to dividends from foreign subsidiaries because both represent earnings of the foreign subsidiary. Thus, a similar approach may be appropriate.

In contrast, the stated purpose for the United States imposing a limitation on the deductibility of interest expense is to narrow the disparity in the effective marginal tax rates based on different sources of financing, to produce a more efficient capital structure for companies.76 This objective is not based on whether a taxpayer’s income is subject to no, low, or deferred tax. Accordingly, Treasury has proposed to allow taxpayers to take into account income inclusions under the GILTI and CFC rules, except to the extent the shareholder’s CFCs have incurred interest expense already subject to the limitation.77

b. Anti-Hybrid Rules

Regarding anti-hybrid rules, the OECD recommends denying a deduction in the payer jurisdiction for payments made under hybrid financial instruments and payments made by and to hybrid entities that give rise to a deduction/no inclusion (D/NI) outcome — that is, an outcome in which the payer jurisdiction provides a deduction but the recipient jurisdiction does not recognize a corresponding income inclusion.78 The OECD has identified several arrangements that may give rise to hybrid mismatches, including hybrid financial instruments, disregarded hybrid payments, reverse hybrid entities, and imported mismatch arrangements. Implementing a foreign minimum tax requires considering whether hybrid deduction limitations should be applied to the minimum tax base and whether a payment included in the minimum tax base should be treated as producing a D/NI outcome.

The considerations for denying deductions under the minimum tax base for hybrid arrangements are similar to those for denying interest deductions under the minimum tax base. A per-country foreign minimum tax raises an additional hybrid concern: Transactions may decrease or increase the minimum tax base for a particular country without increasing the local tax base in that country. In this regard, the minimum tax base for the Obama foreign minimum tax would have been adjusted to take into account hybrid arrangements that shift earnings from a low-tax country to a high-tax country for U.S. tax purposes without triggering tax in the high-tax country.79 The concern arises from the dichotomy underlying a per-country foreign minimum tax that applies the home country’s laws to determine the minimum tax base but uses the host countries’ laws to assign items of income and deduction to specific countries.80 Any rule addressing this concern necessarily creates even more complexity.

Whether a payment included in the minimum tax base should be treated as producing a D/NI outcome, it could be argued that anti-hybrid rules should be focused on the jurisdictions in which the parties to the hybrid arrangement are tax resident. Further, treating amounts taken into account under a foreign minimum tax (or under CFC rules) as an income inclusion may encourage taxpayers to structure into being subject to a foreign minimum tax (or CFC rules), particularly when the residual tax is less than the value of the hybrid deduction. On the other hand, anti-hybrid rules are focused on ensuring income is taxed in at least one jurisdiction, not on the rate of tax imposed. That latter inquiry is the province of a foreign minimum tax. Thus, if an item is taken into account in a minimum tax base, arguably it should not be treated as producing a D/NI outcome.

2. CFC Rules

One long-standing anti-base-erosion regime is the current taxation of particular income (generally passive or highly mobile income) earned by CFCs.81 Historically, many countries have adopted CFC regimes that rarely apply. Following the OECD’s BEPS initiative, more countries have begun to implement new CFC regimes or expand the scope of their existing CFC regimes.82

The policy rationale for CFC rules — to include in a home country’s tax base passive or mobile income that could have been earned in the home country but instead was shifted offshore — applies regardless of whether the passive or mobile income is subject to the minimum tax rate under the home country’s foreign minimum tax.83 Also, once the CFC rules apply, the income presumably would be taxed at a rate above the minimum tax rate because it would be included in the home country’s tax base. Accordingly, it seems appropriate for income subject to a home country’s CFC rules to not also be subject to that country’s foreign minimum tax. That is the approach the GILTI rules take.84

When a CFC regime applies, it generally would be more onerous than a foreign minimum tax because it applies at the home country’s full tax rate, not the minimum tax rate. But this may not always be the case if there are differences between the mechanical operations of the regimes. For example, the U.S. CFC rules provide a credit for foreign income taxes paid or accrued for CFC income included in the U.S. tax base.85 This credit can be carried back and forward and can be used to offset U.S. tax on some other non-U.S. income subject to U.S. tax (that is, cross-credited).86 The FTC provided for the GILTI regime, on the other hand, cannot be carried back or forward and cannot be cross-credited.87

Consequently, the U.S. CFC rules may sometimes be more favorable than the U.S. analogue to a foreign minimum tax.88 This demonstrates the need for a country to use consistent rules between its CFC rules and foreign minimum tax if policymakers wish to ensure that the foreign minimum tax is no more onerous than the CFC rules.

Consideration should also be given to coordinating a foreign minimum tax with other countries’ CFC rules. It appears that tax imposed under CFC rules should be taken into account when considering whether the minimum tax base has been subject to tax exceeding the minimum tax rate. For example, if an item of income is subject to no tax in the host country but is subject to a 20 percent tax under another country’s CFC rules, it would be inconsistent with the policy objectives of a foreign minimum tax to treat that income as subject to insufficient foreign tax (unless the minimum tax rate is greater than 20 percent or there is a difference in the measurement of the tax bases for the CFC rules and the foreign minimum tax). This coordination would be addressed by exempting from the minimum tax base income that is subject to CFC rules of the home country or another country (an exemption approach) or by taking into account tax imposed under CFC rules in determining whether the minimum tax rate threshold has been satisfied (a credit approach).

The exemption approach is the same approach that likely would apply for the home country’s own CFC rules.89 Some may view this approach as inadequately protecting the minimum tax base because CFC rules may vary substantially from country to country. Moreover, the tax base for another country’s CFC rules may differ significantly from the home country’s minimum tax base. For example, income that is recognized in the current period in determining a minimum tax base but is recognized in a subsequent period in applying CFC rules could become subject to tax under both regimes.

The credit approach could be relatively easily incorporated into an overall foreign minimum tax because income earned and tax imposed in all countries (other than the home country) are already considered. This approach also could be used in a per-country foreign minimum tax if the additional foreign taxes are assigned to the same per-country category as the CFC’s income.

The coordination approaches discussed in this section largely mirror the approaches for coordinating a multilateral foreign minimum tax.90 However, coordinating a foreign minimum tax with CFC rules adds another layer of complexity insofar as CFC rules are given priority. This is because the coordination must consider not only lower-tier entities subject to foreign tax based on CFC rules, but also upper-tier entities.

V. Coordination of a Multilateral FMT

A. Introduction

The elements of a well-designed unilateral foreign minimum tax are the building blocks of a multilateral foreign minimum tax. A multilateral foreign minimum tax, however, raises new issues regarding coordination and administration. The following sections discuss additional legal issues specific to a multilateral foreign minimum tax: concurrent application of multiple foreign minimum taxes, common elements of coordinated foreign minimum taxes, tax residency changes, and administrative challenges.

B. Concurrent Application of Multiple FMTs

The concurrent application of multiple foreign minimum taxes without coordination may be detrimental for foreign trade and investment, and the accumulation of multiple residual taxes may result in an effective tax rate above the minimum tax rate.91

Example 1: Assume Canada and Germany both implemented unilateral foreign minimum taxes that disregarded any other foreign minimum taxes and Australia implemented a unilateral foreign minimum tax designed to take into account other foreign minimum taxes. Assume further that a Canadian business has invested in a subsidiary tax resident in a low-tax country, resulting in the Canadian foreign minimum tax applying to some or all of the subsidiary’s income.

If a German company and an Australian company both sought to acquire the Canadian company, the Australian company would hold a competitive advantage because the Australian foreign minimum tax would not double tax the subsidiary’s income, whereas the German foreign minimum tax would.92 If the Australian foreign minimum tax also was not designed to take into account the Canadian foreign minimum tax, there would not be competitive disadvantages between the two potential acquirers in this respect, but there would be an equally applicable barrier to invest in the Canadian company because of the multiple foreign minimum taxes.

There are at least three mechanisms available to coordinate the concurrent application of multiple foreign minimum taxes to an item of income93: (1) conditioning the application of the foreign minimum tax on no higher-tier shareholder’s jurisdiction imposing a foreign minimum tax (an ultimate shareholder approach), (2) conditioning the application of the foreign minimum tax on no lower-tier shareholder’s jurisdiction imposing a foreign minimum tax (an immediate shareholder approach), or (3) providing an FTC for residual tax imposed on the relevant item of income because of another foreign minimum tax (a credit approach).94

1. Ultimate Shareholder Approach

Under an ultimate shareholder approach, a country imposing a foreign minimum tax (the ceding country) would not impose that tax if a higher-tier shareholder is subject to a foreign minimum tax substantially similar to that of the ceding country. Under a multilateral foreign minimum tax, this approach ensures that an item of income is subject to only one foreign minimum tax: the one imposed on the ultimate shareholder. If the ultimate shareholder is not subject to a foreign minimum tax (for example, it is tax resident in a country that declines to adopt the multilateral foreign minimum tax), the first lower-tier holding company that is subject to a foreign minimum tax would serve the role of the ultimate shareholder. This approach operates similarly for branches, meaning that the country in which the branch owner is tax resident may be a ceding country.

Example 2: Assume Parent, a Country A company, wholly owns Regional HoldCo, a Country B company, which wholly owns Target, a Country C company, which wholly owns OpCo, a Country D company. Assume that OpCo earns $200 of income subject to a uniform Country D tax of 5 percent and thus pays $10 of Country D tax. Assume further that countries A and C impose foreign minimum taxes that follow an ultimate shareholder approach and with minimum tax rates of 12 percent and 10 percent, respectively.

Under Country A’s foreign minimum tax, the minimum tax base for OpCo’s income is $200. Under Country C’s foreign minimum tax, the minimum tax base for OpCo’s income is $210.95 In this case, if Country A’s foreign minimum tax is substantially similar to that of Country C, Country C is the ceding country. Consequently, Target is not subject to the Country C foreign minimum tax, and Country A imposes $14 of residual tax (that is, $200 * 12 percent - $10) on Parent. See Table 1.

For most multinational enterprises, an ultimate shareholder approach results in the enterprise being subject to only the parent jurisdiction’s foreign minimum tax. Often (but not always) an MNE has more compliance expertise and resources for its parent jurisdiction than for others. Moreover, applying only one foreign minimum tax reduces complexity and compliance burdens. Both of these factors facilitate compliance and enforcement.

Table 1. Ultimate Shareholder Approach

 

Country D

Country C

Country B

Country A

Total

Tax base

$200

$210

$200

 

Tax rate

5%

10%

12%

 

Tentative tax

$10

$21

$24

 

Exemption

$21

 

Credit

$10

 

Tax imposed

$10

$14

$24

The ultimate shareholder approach appears more consistent with the premises of CEN — that is, it is the ultimate shareholder’s capital that is being deployed into the host country and that, under CEN, should be subject to comparable tax rates no matter where it is deployed.

On the other hand, being subject to only the parent jurisdiction’s foreign minimum tax encourages taxpayers to redomicile their parents to jurisdictions with lax foreign minimum taxes. How lax depends on what constitutes a substantially similar foreign minimum tax. This inquiry also affects the extent to which the ceding country’s tax base has been protected. The greater the deviation allowed, the more likely the ceding country’s tax base could continue to be eroded.

Substantial similarity could be determined in several ways. It could be determined qualitatively, comparing the most significant parts of each foreign minimum tax considering the policy objectives of the ceding country. This would produce substantial uncertainty and undermine the administrability of coordinated foreign minimum taxes. A more certain approach is a quantitative analysis (for example, whether the foreign minimum tax imposed on the ultimate shareholder equals at least 90 percent of the foreign minimum tax that would be imposed by the ceding country). This approach is complex and difficult to administer, requiring taxpayers and tax administrators to annually apply multiple foreign minimum taxes, each with unique rules.

A more administrable way to determine substantial similarity is to develop a white list that simply specifies which countries’ foreign minimum taxes are substantially similar to that of the ceding country. A separate white list for each country could create political friction, or at least appear politically motivated, unless there were agreed-upon criteria. For example, the OECD could develop criteria that participating countries agree are necessary to satisfy for a foreign minimum tax to achieve substantial similarity and warrant ceding application of the ceding country’s foreign minimum tax. Possible criteria could include the minimum tax rate, the scope of the minimum tax base, the measurement of the credit allowed for foreign taxes, interaction with other foreign minimum taxes, and the treatment of affiliates and timing differences.

2. Immediate Shareholder Approach

Under an immediate shareholder approach, a country imposing a foreign minimum tax (the ceding country) would not impose that tax if a lower-tier shareholder was subject to a foreign minimum tax substantially similar to that of the ceding country. Under a multilateral foreign minimum tax, this approach ensures that an item of income is subject to only one foreign minimum tax: the one imposed on the immediate shareholder of the subsidiary earning the relevant income. If the immediate shareholder is not subject to a foreign minimum tax (for example, it is tax resident in a country that declines to adopt the global minimum tax), the first higher-tier holding company that is subject to a foreign minimum tax would serve the role of the immediate shareholder. This approach operates similarly for branches, meaning that the country in which the branch owner is tax resident is the country that imposes a foreign minimum tax (if it has one).

Example 3: Assume Parent, a Country A company, wholly owns Regional HoldCo, a Country B company, which wholly owns Target, a Country C company, which wholly owns OpCo, a Country D company. Assume that OpCo earns $200 of income subject to a uniform Country D tax of 5 percent and thus pays $10 of Country D tax. Assume further that countries A and C impose foreign minimum taxes that follow an immediate shareholder approach and with minimum tax rates of 12 percent and 10 percent, respectively.

Under Country A’s foreign minimum tax, the minimum tax base for OpCo’s income is $200. Under Country C’s foreign minimum tax, the minimum tax base for OpCo’s income is $210.96 In this case, if Country C’s foreign minimum tax is substantially similar to that of Country A, Country A is the ceding country. Consequently, Parent is not subject to the Country A foreign minimum tax, and Country C imposes $11 of residual tax (that is, $210 * 10 percent - $10) on Target. See Table 2.

Table 2. Immediate Shareholder Approach

 

Country D

Country C

Country B

Country A

Total

Tax base

$200

$210

$200

 

Tax rate

5%

10%

12%

 

Tentative tax

$10

$21

$24

 

Exemption

$24

 

Credit

$10

 

Tax imposed

$10

$11

$21

As with an ultimate shareholder approach, an important element of an immediate shareholder approach is what constitutes a substantially similar foreign minimum tax. Unlike an ultimate shareholder approach, however, an immediate shareholder approach does not encourage taxpayers to redomicile their parents and instead encourages taxpayers to select holding company jurisdictions with relatively lax foreign minimum taxes. Changing the jurisdiction of a holding company frequently can be an easier endeavor than redomiciling an enterprise’s parent jurisdiction, which means taxpayers are more likely to structure into being subject to the least burdensome foreign minimum tax that still complies with the substantially similar standard.

3. Credit Approach

Under a credit approach, a country imposing a foreign minimum tax (the ceding country) would allow an FTC for residual tax imposed by other countries’ foreign minimum taxes on income within the ceding country’s minimum tax base. A country would be a ceding country on an item of income for any other country in which a shareholder of an entity earning the item of income is a tax resident, if a direct or indirect owner of that shareholder is a tax resident of the potential ceding country. As with the other approaches, this approach operates similarly to branches by treating the branch owner as a shareholder. Conceptually, this approach ensures that an item of income is subject to the highest rate of foreign minimum tax within the largest minimum tax base.

Example 4: Assume Parent, a Country A company, wholly owns Regional HoldCo, a Country B company, which wholly owns Target, a Country C company, which owns OpCo, a Country D company. Assume that OpCo earns $200 of income subject to a uniform Country D tax of 5 percent, or $10. Assume further that countries A and C impose foreign minimum taxes that follow a credit approach and with minimum tax rates of 12 percent and 10 percent, respectively.

Under Country A’s foreign minimum tax, the minimum tax base for OpCo’s income is $200. Under Country C’s foreign minimum tax, the minimum tax base for OpCo’s income is $210.97 In this case, Country A is the ceding country. Country C imposes $11 of residual tax (that is, $210 * 10 percent - $10), and Country A imposes $3 of residual tax (that is, $200 * 12 percent - $10 - $11). See Table 3.

Table 3. Credit Approach

 

Country D

Country C

Country B

Country A

Total

Tax base

$200

$210

$200

 

Tax rate

5%

10%

12%

 

Tentative tax

$10

$21

$24

 

Exemption

 

Credit

$10

$21

 

Tax imposed

$10

$11

$3

$24

Significant complexity arises from applying multiple foreign minimum taxes under a credit approach. In addition, there is another potential complexity that does not arise under the ultimate shareholder and intermediate shareholder approaches: intermediate shareholder expenses. Assume that in Example 4 Country C treats $30 of Target’s deductions for its expenses as related to Target’s foreign minimum tax income inclusion. Consequently, Country C imposes $9.43 of residual tax (that is, ($210 - $30) * 10 percent - $10 * ($210 - $30)/$210). One could view the allocation of these shareholder expenses as a reduction of Country C’s minimum tax base, warranting Country A to impose additional residual tax. Specifically, Country A may impose $4.57 of residual tax (that is, $200 * 12 percent - $10 - $9.43).

By allocating expenses to a foreign minimum tax income inclusion, Country C has effectively prioritized deductions to reduce the Country C tax on the inclusion over FTCs, which precludes Target from reducing the Country C tax on other income with those deductions. Thus, the tax value of the allocated expenses should also be taken into account in determining the total tax imposed by Country C on OpCo’s income. In other words, Country C should be viewed as imposing $11 of residual tax, the $9.43, plus an additional $1.57 in the form of forgone deductions less forgone FTCs (that is, $30 * 10 percent - $10 * $30/$210). Consequently, Country A should still impose $3 of residual tax (that is, $200 * 12 percent - $10 - $11).

It is unclear how the GILTI rules would interact with another country’s foreign minimum tax, but they appear implicitly to adopt a credit approach. Those rules apply on an overall basis but only take into account gross income measured under U.S. law98 and taxes imposed on that income under foreign law.99

If foreign law imposes tax on a subsidiary’s income under a passthrough regime, it seems relatively clear that those taxes are imposed on the subsidiary’s income and, as long as that income is considered in the GILTI base, the taxes are taken into account under the GILTI rules. If instead foreign law imposes tax on a subsidiary’s income when distributed (for example, in relation to a dividends paid deduction scheme akin to the regulated investment company, real estate investment trust, and cooperative rules),100 the distributions are expressly eliminated from the GILTI tax base, but the taxes are taken into account once the earnings return to the U.S. shareholder, to the extent the earnings were included in the GILTI base. If foreign law imposes tax on something between those two poles — for example, on a deemed income inclusion akin to the U.S. GILTI, subpart F, or qualifying electing fund rules — it seems that the foreign taxes could be viewed as attributable to a timing difference between foreign law taking into account the income currently and U.S. law taking into account the income when distributed. In that case the taxes would be taken into account under the GILTI rules currently to the extent imposed on earnings included in the GILTI base.101

C. Common Elements of Coordinated FMTs

The potential concurrent application of multiple foreign minimum taxes to the same income highlights the need for foreign minimum taxes to be designed with common elements. This is true no matter which approach is adopted to mitigate multiple layers of residual tax. As mentioned earlier, under either an ultimate shareholder approach or an immediate shareholder approach, the objectives of a ceding country’s foreign minimum tax are well served only if the ultimate or immediate shareholder country adopts a foreign minimum tax substantially similar to that of the ceding country. The greater the differences between the two foreign minimum taxes, the more difficult it becomes for the ceding country to cede application of a foreign minimum tax to the ultimate or immediate shareholder country in a manner consistent with the policy objectives of the ceding country. Also, under a credit approach, the more the differences between foreign minimum taxes that apply concurrently, the greater the likelihood of additional residual tax being imposed at each tier.

As discussed earlier, developing a set of commonly accepted minimum standards for foreign minimum taxes could help coordinate unilateral foreign minimum taxes. It could also form the basis for a multilateral foreign minimum tax. As the OECD’s GLOBE proposal acknowledges, coordination is necessary to avoid the risk of economic double taxation and the overlapping application of foreign minimum taxes.102

The OECD’s GLOBE proposal identifies a common fixed-percentage minimum tax rate as a possible commonly accepted minimum standard of a multilateral foreign minimum tax.103 The proposal notes that a rate tied to each country’s corporate income tax rate would result in a more complex and opaque international framework given the significant variance in corporate income tax rates across OECD members.104 Although a single common minimum tax rate is less effective at protecting the tax base of countries with higher corporate income tax rates, it provides less incentive for taxpayers to shift tax residencies of ultimate or immediate shareholders, because the foreign minimum tax rate is the same in each adopting country.

D. Residency Changes

A change in a shareholder’s tax residency from one jurisdiction with a foreign minimum tax to another raises questions about whether shareholder-level attributes related to foreign minimum taxes should carry forward under the laws of the new jurisdiction.105 Although similar issues arise for other tax attributes, such as loss carryforwards, foreign minimum tax attributes are unique in that they measure the true foreign effective tax rate imposed on a subsidiary over time. If the new shareholder jurisdiction fails to take into account shareholder-level foreign minimum tax attributes, the foreign effective tax rate may not be measured accurately, resulting in excessive residual tax. Establishing foreign minimum taxes with common elements facilitates allowing foreign minimum tax attributes to carry over from one jurisdiction to another because it reduces the need to reevaluate attributes upon a change in shareholder tax residency. Also, the efficacy of a given country’s foreign minimum tax may affect whether other countries are willing to cede to that country.

E. Administrative Issues

Paramount to any tax system is its administration, which is generally a domestic matter that each country addresses in the manner it prefers. In the context of a multilateral foreign minimum tax, however, administration no longer is merely a domestic matter; the efficacy of each country’s respective foreign minimum tax depends in part on other countries adopting and enforcing the multilateral foreign minimum tax. As more countries adopt and enforce the multilateral foreign minimum tax, the competitive disadvantages for each adopting country resulting from the imposition of a foreign minimum tax diminish, as do the opportunities for taxpayers to avoid a foreign minimum tax by changing tax residency. Additionally, the efficacy of a given country’s foreign minimum tax may impact whether other countries are willing to cede to that country.

The complexity and transparency of a multilateral foreign minimum tax drive its administration. In this respect, it is important to explore simplifications under the OECD’s GLOBE proposal.106 For example, as discussed earlier, coordinating a multilateral foreign minimum tax through an ultimate shareholder or intermediate shareholder approach could be relatively simple if white lists or commonly accepted criteria are used to determine whether the foreign minimum tax imposed on the ultimate or intermediate shareholder is substantially similar to that of the ceding country. On the other hand, a credit approach could lead to significant complexity by, inter alia, requiring taxpayers to compute multiple tax bases for the same activities.

This may then require tax administrators to obtain significant additional information from taxpayers or other tax administrators.107 In turn, requiring significant information reporting and sharing without meaningful protections of privacy and confidential data would inhibit global adoption by implicating political and legal concerns unrelated to the objectives of a multilateral foreign minimum tax. Although these types of issues are of high concern for any new tax, they take on even greater importance in the context of a multilateral foreign minimum tax under which too many barriers to effective administration could ultimately undermine the efficacy of the new rules.

Although promoting enforcement among adopting countries is important, not every country may adopt a foreign minimum tax. Consequently, taxpayers have an incentive to ensure that they are tax resident in non-adopting countries whenever possible to avoid a foreign minimum tax. This incentive is protected against in part by the design of a foreign minimum tax applying to all direct and indirect foreign subsidiaries. That is to say that the application of a multilateral foreign minimum tax to an item of income could be avoided only if no direct or indirect owner (within the applicable ownership threshold) of the entity earning that item of income is tax resident in an adopting country.108

Therefore, a lower ownership threshold for applying a multilateral foreign minimum tax increases the scope of relevant direct and indirect owners and thus increases the likelihood of an item of income being subject to a foreign minimum tax. On the other hand, the lower the ownership threshold, the greater the challenge for taxpayers and tax administrators to obtain sufficient reliable information. Consequently, the ownership threshold for applying a multilateral foreign minimum tax must strike a balance between diminishing the opportunities for taxpayers to avoid a foreign minimum tax through changes in tax residency and ensuring that taxpayers and tax administrators can obtain the information necessary to comply with, administer, and enforce the tax effectively.

VI. Efficiency and Rationale for an FMT

A. In General

In a system that exempts from home country tax income earned in host countries, including by imposing no tax on the distribution of earnings from the foreign affiliate to the domestic parent, there is an incentive to allocate income to foreign affiliates operating in jurisdictions with tax rates below that of the home country. As a result, companies may have an incentive to serve the home country market and foreign markets through foreign affiliates rather than from the home country. To address this possible erosion of the domestic tax base and the potential migration of economic activity, the home country may impose a minimum tax on income earned by affiliates in host countries. Subjecting that income to current home country tax reduces the tax benefit of allocating the income to host countries with lower tax rates.109

Some argue that imposing tax at the full domestic rate may hurt the competitiveness of home country corporations relative to foreign competitors, suggesting a lower minimum tax rate. Proponents of this approach emphasize the importance of CIN and capital ownership neutrality.110 A tax system satisfies CIN if it subjects investments to the same after-tax rate of return for all investors, regardless of the residence of the investor.

By contrast, others advocate that the minimum tax equal the domestic tax rate. Proponents of this approach emphasize the importance of CEN, the condition in which the after-tax rate of return to home country investors is the same regardless of where the investment is made. Such an approach would remove the incentive to shift profit offshore, but may place domestic companies at a disadvantage relative to foreign companies with respect to activity in third countries, potentially violating capital ownership neutrality.

B. Rate Differentials and Efficiency

Different rates of taxes on investment may lead to a loss of efficiency. To illustrate the potential efficiency loss from differential taxation, consider the following example:

Example 5: Suppose an MNE, Company A, is considering where to invest $1,000 that is expected to earn a pretax rate of return of 10 percent. Assume Company A is considering whether to make the investment in its home country, Country H, which imposes a relatively high rate of tax at 25 percent, or in Country L, which imposes a relatively low rate of tax at 5 percent. The investment in Country H would yield a pretax return of $100, on which $25 of tax would be due, for an after-tax return of $75. The investment in Country L would yield the same pretax return of $100, on which $5 of tax would be due, for an after-tax return of $95. Company A prefers to invest in Country L. However, there is no loss of efficiency in this example, because the pretax rates of return are equal in Country H and Country L.

Yet Company A prefers to invest in Country L even if the pretax rate of return in Country H is higher. If the Country L investment yields a pretax rate of return of 10 percent, the Country H investment would have to yield a pretax rate of return of about 12.7 percent to be preferred by Company A. An investment of $1,000 yielding 12.7 percent would produce a pretax return of $127, on which tax of $31.75 would be due in Country H, for an after-tax return of $95.25. This is greater than the after-tax return of $95 on the investment in Country L that would yield 10 percent.

Alternatively, suppose that the investment in Country L yields only 7.9 percent. The $1,000 investment in Country L yields a pretax return of $79, on which $3.95 of tax is due, for an after-tax return of $75.05. This is greater than the after-tax return of $75 on the investment in Country H that would yield 10 percent.

Company A thus may prefer an investment in Country L even if it is less productive than the investment in Country H, which leads to an inefficient allocation of resources, as well as lower investment in Country H. Society has $21 ($100 - $79) fewer goods and services than it otherwise would enjoy.

Rationale for a Minimum Tax

A minimum tax may narrow the spread in after-tax rates of return and thus reduce the magnitude of the loss to society in terms of forgone goods and services.

Example 6: Assume the same facts as Example 5, but suppose that Country H imposes a per-country minimum tax at a rate of 15 percent. Assume that Country H allows an FTC for 100 percent of any foreign taxes paid. Company A now faces a total tax of $11.85 on its investment yielding 7.9 percent in Country L, consisting of $3.95 in Country L plus $7.90 (15 percent * $79 - $3.95) in Country H. The after-tax return of $67.15 is less than the after-tax return of $75 on the investment in Country H that yields 10 percent. The Country L investment would have to yield a pretax rate of return of about 8.9 percent to be preferred by Company A.111 The societal loss resulting from the inefficient allocation of resources is reduced from $21 to $11 ($100 - $89). The $10 efficiency gain in this example is split between Country H ($8.90), Country L ($0.50), and Company A ($0.60).

Relative to the scenario in which there was no efficiency loss because investments in Country H and Country L both yield 10 percent, there is no efficiency gain to be allocated among the parties. A minimum tax in that scenario decreases the after-tax yield in Country L to $85, with Country H gaining $10 at the expense of Company A.

However, others may argue that tax competition has led to a narrowing of the spread in after-tax rates of return and that a minimum tax inappropriately constrains that tax competition. Between 2000 and 2019, the absolute range between the highest and lowest combined statutory corporate income tax rate among OECD countries has fallen from 36.61 percentage points to 23.02 percentage points.112 The top rate has fallen from 51.6 percent in 2000 (Germany) to 32 percent in 2019 (France), while the lowest rate has fallen from 15 percent in 2000 (Chile) to 9 percent in 2019 (Hungary). The standard deviation of corporate income tax rates has fallen by 26 percent (from 7.13 to 5.26) over the same period. Further, the simple average of combined top statutory corporate income tax rates has fallen from 32.2 percent to 23.5 percent from 2000 to 2019. Opponents of a minimum tax may argue that this decline in tax rates also enhances efficiency by reducing the wedge between pretax and after-tax rates of return, reducing the cost of capital, and increasing overall levels of investment and economic output.

C. Benefit Principle and Efficiency

Since at least the days of Adam Smith, economists have recognized the benefit principle as a broad concept of fair and efficient taxation. The benefit principle combines two ideas: (1) taxes should be based on the benefit obtained from the activities of government; and (2) the measure of the benefit is the income of the taxpayer. Taxes may be conceived as the price that would prevail in a market for the government service provided. The tax paid by each taxpayer should approximate the marginal benefit that it receives from the service. The provision of the government service may be described as efficient when the marginal cost of providing the service equals the sum of the marginal benefits taxpayers are willing to pay for.

Jurisdictions may set different levels of taxes and spending. If taxpayers are mobile across jurisdictions, each taxpayer may choose to locate where the level of taxes and spending most closely approximate the levels desired by the taxpayer. Jurisdictions that wish to provide a high level of services must also raise more tax revenue to finance their provision.

The competition among jurisdictions for taxpayers encourages governments to provide services efficiently — that is, the most services for a given level of taxation, or a given level of services at the lowest tax cost.113 One observer has noted that “different national levels of taxation could therefore be regarded to constitute ‘healthy’ tax competition where they are based on what different countries have to offer in terms of public services, public goods, etc., and can therefore also ask in taxes.”114 However, to the extent a jurisdiction seeks to provide a level of services to taxpayers without charging a level of tax commensurate with those services, the competition could be considered excessive and inefficient.

Rationale for a Minimum Tax

This inefficiency may be manifested in two ways based on the benefit principle. First, a company that shifts profit from the jurisdiction in which the economic value was created may result in a mismeasurement of the marginal benefit provided by that jurisdiction. If the benefit is underestimated, the home country provides too little of the public good or distorts the tax rate it imposes. Similarly, the host country that is allocated too much profit may have a distorted level of public good provision and tax rate.

Second, there is a potential inefficiency regarding the shifting of real economic activity. In a desire to attract mobile sources of income, a country may try to provide a higher level of public goods and services than the level of taxes it charges the beneficiary companies for those goods and services. In effect, the country subsidizes the provision of services — including protection of the companies’ profits from the real economic activity — with tax revenue from some other source.

If the cost to the beneficiaries is understated, the country provides too much of the public good or distorts the tax rate it imposes. An artificially low level of national tax “could then be held to unduly restrain other governments in implementing a [tax] policy that strives at least for this very balance of cost and benefits. In this sense, such a low level of taxation could be considered ‘excessive,’ because it undermines the ability of other countries to set their tax rates at a level that reflects an internationally accepted tax fairness standard.”115

The desire to combat this inefficiency may constitute a rationale for a minimum tax. This rationale does not rest on a concern about “shifting taxes to fund public goods onto less mobile bases.”116 In general, efficiency can be improved by such a shift. However, a case for improved efficiency may also be made based on the benefit principle.

Others may argue, however, that although the benefit principle may provide a rationale for the host country to levy a minimum tax for the services it provides to companies, it does not provide a rationale for the home country to levy such a tax.

D. Domestic and Foreign Complementarity

1. Domestic Investment and Foreign Sales

Growth in foreign sales by a domestic company may lead that company to increase domestic investment and employment. For markets served through export, increased demand for its goods abroad requires an expansion of production capacity domestically. Expansion in a foreign market may also be accompanied by increased domestic marketing or management activities. However, increased foreign sales could reduce domestic investment. For example, growth in foreign sales could result in sufficient economies of scale for a company to move manufacturing operations to the foreign market from the domestic market.

Research suggests that faster foreign sales growth is associated with more rapid growth of domestic investment in research and development and greater exports from the domestic parent company to foreign affiliates.117

2. Domestic and Foreign Investment and Employment

Policymakers often are concerned with promoting economic growth in their home country, including domestic investment and employment. The level of domestic investment and employment may be influenced by several factors, including the foreign activity of an MNE. The extent to which foreign investment and employment and their domestic counterparts are complements or substitutes is theoretically unclear.

For example, a company may decide to move existing domestic operations overseas to serve foreign markets from abroad rather than by export from the home country. This might reduce domestic employment not only at the company that relocated operations but also at domestic suppliers, to the extent those relocated operations are supplied by foreign companies in lieu of domestic companies.

However, increased foreign investment also may increase domestic investment through various mechanisms. Increased foreign investment may raise the productivity of domestic investment by providing another market in which to exploit tangible or intellectual property produced domestically or expose the company to new technologies, which could be used domestically. Foreign operations may supply intermediate inputs to the domestic company at a lower cost.

These activities increase the return to domestic investment. Foreign operations of the company may increase the demand for domestically produced intermediate inputs. Profitable foreign expansion may also provide a relatively lower cost of funds for financing increased domestic investment.

Whether foreign investment and domestic employment are substitutes or complements depends on not only whether foreign investment and domestic investment are complementary, but also the extent to which investment (capital) and employment (labor) are substitutes or complements. For example, increased automation of production processes may involve the substitution of machinery to perform the tasks previously performed by low-skilled labor. Alternatively, a new manufacturing or research facility may require additional workers to staff the facility.

The findings of empirical literature on the substitutability or complementarity of foreign and domestic investment and employment are mixed. One study reports time-series evidence that foreign and domestic investment are positively correlated for U.S. companies, but reports contradictory evidence for a sample of OECD companies.118 The authors suggest that omitted variables may bias both estimates. A later study by the same authors that tries to address this issue finds a strong positive correlation between the domestic and foreign activity levels of U.S. multinational manufacturing companies.119 Another study finds that foreign investment by manufacturing companies increases domestic productivity and employment, but it finds no effect on productivity for service sector companies and a decrease in domestic employment.120 A study of Canadian companies concludes that on the whole, outbound foreign direct investment and domestic capital investment are more likely to be complements than substitutes.121

Some studies have found variation in the complementarity of foreign and domestic investment and employment based on the characteristics of the destination of investment. A study of South Korean manufacturing companies finds that foreign investment in less developed host countries reduces short-term employment growth in the parent country, but it finds no significant effect for investment in more advanced countries.122 Another study finds that among U.S. multinational companies, increases in domestic employment are associated with increases in employment of their foreign affiliates in high-income countries.123 The authors find evidence consistent with employment of foreign affiliates in low-income countries being a substitute for domestic employment.

3. Rationale for Minimum Tax

If foreign and domestic investment are complements, that suggests that policies that constrain the foreign activity of domestic companies may have the unintended effect of reducing domestic investment. However, if the effect of foreign investment on domestic investment depends on characteristics of the destination of investment, there may be a rationale for treating income from investment differently based on the characteristics of the country in which it is earned.

For example, as noted, some research has found that foreign investment and employment in high-income countries, but not low-income countries, complement domestic investment and employment. If high-income countries are more likely to have higher effective tax rates on business income, a minimum tax that imposes a lower rate of tax on income earned in high-tax countries places less of a burden on investment when the complementarities are likely to be the greatest. This may limit the negative effects on domestic investment and employment. If a minimum tax allows a credit for taxes paid in the host country or imposes no additional domestic tax on earnings from high-tax countries, it may in part accomplish this objective.

VII. Per-Country vs. Overall FMTs

A. Multilateral vs. Unilateral FMTs

Much of the research to date has analyzed a per-country minimum tax and an overall minimum tax in the context of unilateral action by the United States.124 More recently, it has been noted that the analysis and evaluation of alternative international tax systems including a minimum tax “may be quite different depending on whether its adoption is multilateral or unilateral.”125 For example, unilateral adoption of a minimum tax may create an incentive to locate the parent company in a country that does not impose a minimum tax, “while common adoption would alleviate this problem.”126 A discussion of the effects of multilateral adoption of a minimum tax follows the basic analysis in each section below.

B. Corporate Behavioral Responses

1. Foreign Tax Reduction

Under a per-country minimum tax regime, taxpayers may have no incentive to lower foreign taxes in a host country below the home country minimum tax rate if a full credit for foreign tax paid is allowed against home country minimum tax. Below that rate, the taxpayer may be indifferent between paying tax to the host country or to the home country. There remains an incentive to reduce foreign tax above that rate. If only a partial credit for foreign tax paid is allowed, the taxpayer retains an incentive to reduce foreign taxes to a rate below the home country minimum tax rate.

Under an overall minimum tax, there is an incentive to reduce foreign taxes to the extent the global tax rate is above the home country minimum tax rate. Some cross-country crediting applies. Some of the foreign tax paid to a high-tax country shields income from a low-tax country from home country minimum tax liability. Reducing foreign tax in the high-tax country provides less of a benefit — or alternatively, paying taxes in the high-tax country bears less of a cost — because of the effect of cross-country crediting on minimum tax liability. Thus, there is a weaker incentive to take into account the burden of foreign taxes than under a per-country minimum tax at the same rate.

A multilateral minimum tax effectively raises tax rates worldwide. The effect of multilateral adoption of a minimum tax depends on the treatment of the minimum tax payments to the host country for purposes of the minimum tax calculation in the home country.

Example 7: Suppose that Company A has $100 of income from activities in a host country that imposes a statutory tax rate of 20 percent, and that Company A faces a minimum tax of 15 percent only in its home country. Company A has an incentive to reduce its tax liability in its host country to $15, but no further. However, suppose the host country also imposes a minimum tax of $5 on a foreign subsidiary of Company A for income earned in some third country. If the home country’s minimum tax adopts a per-country approach and assigns the host country tax to the host country, Company A then has an incentive to reduce its host country tax liability to $10, such that the combined foreign taxes paid are $15 for purposes of the home country minimum tax.

Similarly, in the context of an overall minimum tax, multiple minimum taxes that have the effect of increasing the overall effective tax rate on companies above the minimum tax rate in a particular jurisdiction increase the incentive for companies to reduce foreign taxes elsewhere.

2. Location of Deductible Expenses

Companies have an incentive to locate deductible expenses in the jurisdiction with the highest effective marginal tax rate. The relevant tax benefit of locating a deductible expense in a high-tax country instead of a low-tax country is the difference in the effective marginal tax rates between the two jurisdictions. A minimum tax has the effect of raising the value of locating a deductible expense in a low-tax country, reducing the spread between the effective marginal tax rates.

Example 8: Consider Company A, which operates in both Country H, which has a territorial tax system with a 25 percent tax rate, and Country L, which has a territorial tax system with a 5 percent tax rate. If Company A locates a $100 deductible expense in Country H, it saves $25 in tax, whereas if it locates the expense in Country L, it saves only $5 in tax. If Country H imposes a minimum tax at 15 percent, a $100 expense located in Country L now saves Company A $15 in tax.

Relative to the equilibrium achieved under the prior regime, a per-country minimum tax is expected to result in fewer expenses located in high-tax countries and more expenses located in relatively low-tax countries. Under an overall minimum tax, the incentive to keep deductible expenses in a high-tax country depends on whether the company is above or below the minimum tax threshold. For a company above the threshold, there would be little change in the incentives to locate expenses relative to the prior regime. A company below the threshold faces an incentive to move expenses similar to a company under the per-country minimum tax.127

Multilateral adoption of minimum taxes could further narrow the variance in effective marginal tax rates between jurisdictions. This depends on the variation in minimum tax rates across countries, as well as the spread between domestic tax rates and minimum tax rates in each jurisdiction. A country with a larger spread between its domestic tax rate and its minimum tax rate is likely to maintain a larger incentive to locate deductible expenses at home relative to another country that might have a higher domestic tax rate but a narrower difference between its domestic tax rate and its minimum tax rate. If all countries adopt the same minimum tax rate, the relative incentives are similar to those in a world without a minimum tax, but the level of shifting is reduced.

3. Ownership of Low-Tax Subsidiaries

A minimum tax may create an incentive for low-tax subsidiaries to be owned by a parent company in a home country that does not impose a minimum tax.

Example 9: Suppose Country M imposes a minimum tax and Country N does not. Target Subsidiary T is located in low-tax Country L. If Company A, located in Country M, acquires Subsidiary T, the operations of the subsidiary become subject to immediate taxation. If instead Company B, located in Country N, acquires Subsidiary T, Company B incurs no additional tax liability. If Subsidiary T is more productive under ownership by Company A but for tax reasons is acquired by Company B, there is a potential for a loss in economic efficiency.

This is more of a risk under a per-country minimum tax than under an overall minimum tax. Under an overall minimum tax, Company A may have other operations in high-tax countries that could shield Subsidiary T from minimum tax liability. The risk of this type of efficiency loss is diminished if there is multilateral adoption of a minimum tax.

C. Governmental Behavioral Responses

1. Soak-Up Taxes

Host countries may respond to the imposition of a home country minimum tax by raising the tax on domestic operations by home country companies to soak up the minimum tax. If Country H will impose a 15 percent tax on the operations of Company A in Country L, Country L may raise its rate on Company A to 15 percent so that the additional revenue flows to the treasury of Country L rather than to that of Country H. Country L may be able to do this with no further effect on income shifting or the location of investment.128

There may be limits to this type of response. If only one country imposes a minimum tax, a low-tax country can soak up the tax without further affecting domestic investment only if it can discriminate against the operations of companies based in the country imposing the minimum tax. An increase in the domestic tax rate on the operations of companies not subject to a home country minimum tax could have a material effect on host country economic activity. Other countries could see an increase in reported profits.

The high-tax country may design the minimum tax to reduce the incentive for soak-up taxes. The high-tax country could deny a credit against the minimum tax for any soak-up tax (1) whose payment is conditioned on the availability of a home country credit or (2) that is not generally applicable. Limiting to less than 100 percent the credit against minimum tax for foreign taxes paid also reduces the incentive for the host country to soak up the minimum tax.

An overall minimum tax may create less of an incentive for soak-up taxes. If there are countries with tax rates above the minimum tax rate, a low-tax country may continue to attract investment without causing a company operating within its borders to incur minimum tax liability. If the low-tax country increases its tax rate, it may increase tax burdens on companies rather than merely diverting revenue that otherwise would accrue to the home country imposing the minimum tax. Any increased tax burden may alter economic activity within the low-tax country.

A multilateral minimum tax alters the analysis. First, as the adoption of a minimum tax spreads, the need to discriminate in the application of a soak-up tax diminishes. From the standpoint of the host country, more companies should be subject to the higher domestic tax rate the more countries impose a minimum tax. Further, any effect on domestic economic activity from imposing a higher rate on companies from countries that do not impose a minimum tax diminishes as those companies’ share of foreign direct investment in the host country declines. Second, if only one country imposes a minimum tax, that rate establishes the scope for any soak-up taxes. In a multilateral context (and in the absence of discrimination), host countries could impose a tax only up to the lowest minimum tax rate imposed anywhere in the world.

2. Proliferation of Nontax Incentives

If minimum taxes serve to limit tax competition, countries may respond by providing nontax incentives to attract investment. Tax incentives generally are broadly available to any taxpayer meeting the relevant criteria in an all-or-nothing fashion. Nontax incentives are more often discretionary and may result from negotiation between the governmental entity and the beneficiary company.129

Some have argued that discretionary incentives may be more efficient than automatic incentives because they need not benefit inframarginal investments. However, research has identified three fundamental difficulties with discretionary incentives.130 First, they entail higher administrative costs associated with evaluating potential beneficiaries, which may offset any gain from not providing automatic incentives to investment that would have taken place in the absence of the incentive. Second, the review process for discretionary incentives is prone to misclassification error. That is, discretionary incentives may be granted to inframarginal investments, or marginal investments may be denied.131 Third, discretionary incentives are also inherently less transparent than automatic tax incentives, the existence and eligibility criteria of which are generally declared in publicly available legislative text. If granting the discretionary incentive depends on the recommendation of a government official, the procedure is open to potential corruption or other rent-seeking behavior.

Evidence suggests that “discretionary incentives are probably less likely to affect investment decisions than are taxes and tax incentives.”132 In the context of attracting innovation-related investment, it has been argued that tax incentives may be preferable to nontax incentives when the potential innovator has private information about the prospects of a project.133

A per-country minimum tax likely constrains tax competition more than an overall minimum tax and thus is likely to create more pressure to use nontax incentives to attract investment. Similarly, to the extent that multilateral adoption of minimum taxes places more constraints on tax competition, the use of nontax incentives is likely to proliferate.

D. Revenue Effects

Revenue effects of a per-country or overall minimum tax depend on the context in which those provisions are enacted. For example, Harry Grubert and Rosanne Altshuler conduct their analysis against a baseline of a worldwide system with a 30 percent rate. The benefit to companies of exempting dividends is estimated to be about equal to the static revenue gain from a 10 percent per-country minimum tax or a 15 percent overall minimum tax. Such an equivalence is unlikely to hold for proposals enacted from a different baseline. With that caveat in mind, this section proceeds with an analysis comparing the possible revenue effects of a per-country and overall minimum tax.

If a minimum tax increases the attractiveness of investment in the home country and reduces profit shifting, home country tax revenue should rise and tax revenue accruing to low-tax countries should decline. The incentives to shift profits out of low-tax countries also causes revenue in other high-tax countries to rise. The revenue of other countries may also rise if low-tax countries respond to the minimum tax by increasing their domestic tax rates in a nondiscriminatory way.134

However, an overall minimum tax may result in less revenue in the home country than a per-country minimum tax. One researcher has noted regarding the U.S. rules to include in gross income a U.S. shareholder’s GILTI that “the global nature of the minimum tax makes the U.S. the least desirable place to book income for many multinational companies, since if they do not have sufficient FTCs to offset minimum tax due, even high-taxed foreign income is preferable to U.S. income, since it shields income from the GILTI tax.”135 She estimates that under a per-country minimum tax, reductions in low-tax country tax bases would be about twice as large and that U.S. revenue gains from the minimum tax would be more than two and a half times higher.136 Because a per-country minimum tax targets low-tax countries more effectively than an overall minimum tax, high-tax countries that do not enact a minimum tax benefit more from reduced incentives to shift profits.

However, an overall minimum tax allows companies to take advantage of the higher rates in these countries to shield some low-tax country income from home country minimum tax. Without this incentive, these higher-rate countries lose some revenue in a per-country minimum tax regime relative to an overall minimum tax regime. The relative magnitude of these effects depends on how responsive the tax base is to changes in the tax rate and whether this responsiveness varies with the tax rate.137

In a multilateral context, there may be countervailing effects on revenue relative to the case of unilateral adoption of a minimum tax. If profit shifting is further reduced the more countries impose a minimum tax, revenue could increase. However, if many countries adopt a minimum tax, it may be more likely to have an effect on raising the cost of capital, thus increasing the risk that the level of revenue-generating economic activity declines. If a multilateral minimum tax makes it easier for low-tax countries to implement soak-up taxes, the amount of revenue accruing to the home country treasury could decline over time.

E. Treatment of Losses

Pressure on the treatment of losses is greater under a per-country minimum tax than under an overall minimum tax. Under a per-country minimum tax, a company may face income tax liability without having positive income if it is liable for minimum tax for countries in which it has positive earnings but has a loss on its worldwide operations. The treatment of current-year losses as well as the carryover of prior-year losses affects the computation of the average tax rate against which any minimum tax rate is compared. Proposals for minimum taxes have sometimes allowed for a multiyear average of foreign taxes paid in relation to foreign earnings to ease concerns about variation in average tax rates resulting from the timing of losses, as well as the timing of deductions and credits. Computing the tax rate at a higher level of aggregation further mitigates those concerns.

The relative greater importance of the treatment of losses under a per-country minimum tax versus an overall minimum is likely to remain under multilateral adoption of minimum taxes. However, the issue becomes more complex if the minimum taxes are not uniform in their treatment of losses. For example, suppose one country adopts a per-country minimum tax that allows losses to be carried forward on a per-country basis while another country adopts an overall minimum tax with no loss carryforward mechanism. Which regime treats losses more severely may depend on the specific facts for each company.

F. Simplicity

Although the complexity of any tax depends on the specific decisions made in the design of the particular proposal, an overall minimum tax has the prospect of being much simpler than a per-country version. The determination of profits and the computation of the average tax rate for the per-country minimum tax has been described as a “major complication.”138 An overall minimum tax does not require assigning a tax residence to each component of foreign income. A per-country minimum tax also requires rules about the allocation of purchase price in cross-border acquisition transactions. One analyst has said that “if an allowance is given under the minimum tax for acquisitions . . . to equalize the treatment of greenfield and brownfield investments, this is particularly complex.”139

When considering multilateral minimum taxes, the degree of simplicity or complexity may depend in part on the extent of harmonization of the rules across jurisdictions. If the computation of the base of the minimum tax varies significantly in each country, the complexity of the system increases as more countries adopt a minimum tax. A per-country minimum tax multiplies this complexity relative to an overall minimum tax.

VIII. Excluding Routine Returns

A. Rationale

One rationale for excluding routine returns from the application of a minimum tax is to address concerns about international competitiveness. By exempting routine returns from residual home country tax, investments that earn a normal return in a specific foreign country face the same after-tax rate of return for all investors, regardless of the residence of the investor — that is, CIN. Tailoring the minimum tax that way removes any distortion from differences in after-tax rates of return for investments for which companies may face more intense competition.

At the same time, there is an efficiency rationale for the minimum tax. When routine returns are exempted, the minimum tax becomes a tax on large excess returns in low-tax jurisdictions. This moves the tax system for those investments toward CEN, the condition in which the after-tax rate of return to home country investors is the same regardless of where the investment is made. For these investments, companies may face less intense foreign competition. If excess returns are attributable to economic rents, the tax does not distort the decision whether to undertake the investment. The location of the investment may be influenced by tax considerations if the (intangible) asset generating the excess return is mobile, but a company makes the investment if it is more efficient than its competitors.

However, some may argue that companies could receive a greater benefit by redomiciling to a jurisdiction without a minimum tax. The company then would pay additional tax on neither its routine returns nor its supra-normal returns. This may create an incentive for foreign companies to acquire domestic companies to carry out the change in tax domicile. If the assets of the domestic company are more productive when owned by the shareholders of the domestic company than by the shareholders of the foreign company, there may be a loss of efficiency in this case, even if the investment that generates excess returns is undertaken.

B. Incentive Effects

1. Incentives for Companies

By exempting normal returns from taxation, home country MNEs can compete with foreign ones for business that generates normal returns in low-tax countries without incremental home country tax. This implicitly assumes that the assets that generate normal returns are less mobile than assets that generate supra-normal returns. The share of normal returns in overall income influences the economic importance of this incentive. Data suggest that this share may be lower for multinational companies than for purely domestic companies.140 The incentive effects of any particular minimum tax also depend in part on how the exemption of routine returns is accomplished.

Some have noted that a system that relies on applying a rate of return to a base of tangible capital to determine the routine return, as under the GILTI regime, may create incentives that vary by type of investment. Companies can reduce residual minimum tax by locating tangible capital abroad. In addition to the ability to raise the overall global average tax rate by moving the income generated by those assets to a high-tax host country and thereby shelter some low-tax income from minimum tax, tangible capital abroad increases the amount of income exempt from minimum taxation by increasing the measured routine return. The benefit associated with minimum tax savings has the potential to make an otherwise unprofitable investment profitable.

A rule based on tangible capital investment may create distortions across industries that generate normal returns from other types of investment. Although this is generally an issue for services businesses that rely less on tangible capital, commentators have noted that this may be a particular concern for financial businesses.141 The question has been raised whether purchased intangibles are properly excluded from the calculation of normal returns.142 Any method of calculating routine returns that relies on a measure of some subset of investment assets potentially creates an incentive to locate those assets outside the home country to reduce minimum tax liability.

If the deemed normal rate of return is set too high, it may encourage locating low-return tangible capital alongside high-return investments to shield some of the high return from minimum tax. Although that response is limited if the specified normal return is more realistic, “the normal return is set to reflect an aggregate risk; because of variations in risk among investments, some stuffing will always be possible.”143

If the exemption of routine returns is accomplished by reference to the level of tangible assets, the exemption may distort their ownership.144 Specifically, if a domestic company reduces home country minimum tax liability by acquiring tangible assets abroad, it may derive more value from acquiring those assets than a foreign company based in a country without a minimum tax based on tangible assets. The domestic company derives a benefit equal to the minimum tax savings from acquiring the tangible assets. The foreign company does not. Therefore, the domestic company is able to outbid other buyers for ownership of the tangible assets. If the assets would be more productive under foreign ownership, there is an efficiency loss from the exemption of routine returns.

2. Incentives for Countries

Home countries may seek to design minimum taxes in response to the incentives for companies created by exempting routine returns. One issue is how to adjust exempted return for debt. Without any adjustment, a company shields income from taxation equal not only to the full amount of the exempted return but also the amount of interest expense deduction.145

There may be an argument for an overall minimum tax instead of a per-country minimum tax related to the adjustment for debt. If debt were respected on a per-country basis, a company could locate interest deductions in Country A (perhaps with a high tax rate) to finance assets that generate actual or deemed exempt returns in Country B. The exempt return in Country B may not be reduced by the interest expense deductions in Country A. In an overall minimum tax, it is possible to disregard debt between related entities worldwide. This may not be doable under a per-country minimum tax. Stated differently, there is a larger spillover effect of a per-country minimum tax on high-tax countries because of the greater incentive for companies to shift income out of these countries to lower-tax countries.

Host countries seeking to attract tangible capital investment may offer more generous depreciation allowances if the base of tangible capital in exempting routine returns is unaffected.146 That response would magnify the incentive for companies to locate assets that generate an exempt return in a particular country.

Some issues with the determination of an appropriate normal rate of return may be addressed by allowing a deduction for the full cost of the investment in the year in which it is undertaken (expensing). Assuming that the tax rate when the company takes the deduction is the same as the tax rate when the income from the investment is earned, expensing is equivalent to exempting from tax the routine return on the investment.147 Questions about which investments to expense or how to treat purchased versus leased assets remain.

Further, in a world with full expensing, interest expense would not be deductible. If interest were deductible, the marginal tax rate on new investment would be negative. If interest equivalents remain deductible, it could create an incentive for companies to shift financing activity from interest on debt to other forms of payments that remain deductible.

IX. Other Issues

A. International Equity

A unilateral minimum tax affects global companies that are headquartered in the home country but not those headquartered elsewhere. The effect of any minimum tax may depend on which country adopts it and on the distribution of global companies.

For example, of the 100 largest global companies by market capitalization, 54 are headquartered in the United States, 15 in Greater China, and six in the United Kingdom.148 The top 10 countries with the most companies among the 500 largest global companies ranked by revenue are the United States (126), China (120), Japan (52), Germany (32), France (28), the United Kingdom (21), South Korea (16), the Netherlands (15), Switzerland (14), and Canada (12).149 Multilateral adoption of a minimum tax is also likely to have a concentrated effect on the countries with the largest global footprint.

B. Dual System Coordination

The analysis in this report assumes that multilateral adoption of a minimum tax resolves the choice between a per-country and an overall regime in the same way for all countries. Significant additional legal and economic complexity arises if some countries adopt one system while other countries adopt another. Among many other issues, rules would need to specify how minimum tax liability of a subsidiary in a country with an overall minimum tax is allocated in determining the minimum tax liability (and any associated tax credits) of a parent in a country with a per-country minimum tax.

Also, if a tax on base-eroding payments is used as a mechanism to encourage adoption of a sufficiently strong minimum tax, the question arises of whether a jurisdiction with a per-country regime views an overall regime as sufficiently strong to avoid application of the base-eroding payments tax to flows to countries with an overall regime. The resolution of these and other issues determines the incentives companies and countries would face in such a world.

FOOTNOTES

2 See generally section 951A.

4 This report does not address the GLOBE proposal’s complementary base-eroding payments rule.

5 The 60-month period would have ended with the date that the U.S. corporation’s tax year ended or, for CFC earnings, the date that the CFC’s current tax year ended.

6 It is unclear whether the reassigned taxes would have been taken into account in determining a country’s foreign effective tax rate in the following 60 months.

7 It is unclear whether the allowance for corporate equity adjustment could create a loss for any country.

8 Presumably, the determination of high and low effective tax rates would have been made before the recharacterization of hybrid payments.

9 It is unclear whether this result was intended instead of treating that gain as includable in the tax base of the foreign minimum tax.

10 A foreign minimum tax could also be applied on the basis of each item of income, each line of business, or each legal entity, to name a few possibilities.

11 OECD consultation document, supra note 1, at section 3.3. It is unclear whether that proposal is intended to be a per-country minimum tax, as discussed in this report, or a true per-jurisdiction minimum tax. The distinction is relevant with respect to countries with subnational income taxes, such as the United States, Canada, Switzerland, and Germany.

13 See, e.g., J. Clifton Fleming Jr., Robert J. Peroni, and Stephen E. Shay, “Incorporating a Minimum Tax in a Territorial System,” Tax Notes, Oct. 2, 2017, p. 73.

14 For example, a corporation organized in the United States but managed and controlled in another country may be subject to tax in both countries.

15 For example, income earned by a U.S. branch of a non-U.S. corporation may not be subject to tax in either country if the country in which the corporation is tax resident assigns the income to the branch and the United States assigns the income to the home office.

16 See section 951A. At the time of this writing, this aspect of the U.S. rules has not been fully implemented, with Treasury continuing to develop final regulations.

17 For further discussion of accounting for affiliates under a foreign minimum tax, see infra Section IV.B.4.

18 Recognition of the interconnected nature of modern multinational firms drove the decision to make the U.S. GILTI rules apply on an overall basis. See H.R. Rep. 115-409, at 389 (2017) (“The Committee recognizes the integrated nature of modern supply chains and believes it is more appropriate to look at a multinational enterprise’s foreign operations on an aggregate basis, rather than by entity or by country.”); S. Prt. 115-20, at 366 (2017) (“The Committee believes that calculating GILTI on an aggregate basis, instead of on a CFC-by-CFC basis, reflects the interconnected nature of a U.S. corporation’s global operations and is a more accurate way of determining a U.S. corporation’s global intangible income.”).

19 For example, a per-country foreign minimum tax measured by reference to the home country’s laws could raise less revenue than an overall foreign minimum tax imposed with the same minimum tax rate when there are intercompany transactions that are deductible under the home country’s laws but not the host country’s laws. Although this could be the result of hybridity, it may also be the result of the host country imposing limitations on some deductions (for example, interest). For a discussion of coordinating a foreign minimum tax with other anti-base-erosion regimes, see infra Section IV.D.

20 See reg. section 1.951A-2(c)(2) (requiring a non-U.S. corporation’s tested income or loss, and thus a U.S. shareholder’s GILTI, to be determined as if the foreign corporation were a U.S. corporation).

21 See OECD work program, supra note 3, at para. 68. The OECD has suggested adjusting this base, however, to get closer to a common rule set, an approach discussed later.

22 For further discussion on considering routine returns when measuring the minimum tax base, see infra Section IV.B.3.

23 For a discussion of potential behavioral responses of countries to foreign minimum taxes, see infra Section VII.C.

24 See section 951A(b)(2).

25 Such an approach was proposed by the House during the consideration of the GILTI rules but ultimately was not adopted in the final bill. Compare H.R. 1, 115th Cong., 1st Sess., section 4301 (Nov. 28, 2017), with H.R. 1, 115th Cong., 1st Sess., section 14201 (Dec. 14, 2017).

26 See infra Section VIII.B.2 and note 149.

27 See supra note 21 and accompanying text.

28 The EU’s anti-tax-avoidance directive (ATAD) has drawn a similar line for CFC rules. See Council Directive (EU) 2016/1164, article 7(1)(a) (July 12, 2016).

29 See section 957(a) (defining a CFC, including for purposes of the GILTI regime, as a non-U.S. corporation more than 50 percent owned by U.S. shareholders). But see sections 318(a)(3) and 958(b) (attributing a common parent’s ownership of a non-U.S. corporation to a U.S. corporation in some cases, thereby creating a risk that a non-U.S. corporation could be treated as a CFC even when not controlled by U.S. shareholders).

30 See, e.g., H.R. Rep. No. 87-1447, Pt. XIV.A (1962).

31 See, e.g., Kimberly S. Blanchard, “Top Ten Reasons to Limit Section 958(b)(4) Repeal,” 47 Tax Mgmt. Int’l J. 405 (2018); Edward Tanenbaum, “Downward Attribution CFCs,” 47 Tax Mgmt. Int’l J. 341 (2018); and Tanenbaum, “The 2017 Tax Act: CFCs — The More the Merrier?” 47 Tax Mgmt. Int’l J. 202 (2018).

32 OECD consultation document, supra note 1, at section 3.3, para. 96. The document acknowledges that additional consideration is needed regarding the ability of minority shareholders to access the information required. Id. at section 3.3, para. 100.

33 See infra Section V.E.

34 For a discussion of foreign minimum tax mechanisms to ease timing differences, see infra Section IV.C.4.

35 See OECD/G-20 BEPS, “Limiting Base Erosion Involving Interest Deductions and Other Financial Payments: Action 4 — 2015 Final Report,” at para. 27 (Oct. 2015). The United States is one of the most recent adopters of such a rule. See section 163(j) (as amended by the TCJA). Limitations on interest deductions are discussed further infra in Section IV.D.1.a.

36 See, e.g., section 172(a)(2) (limiting NOL carryforwards to 80 percent of the taxpayer’s taxable income in the year to which the loss is carried forward).

37 See infra Section IV.C.4.

38 See, e.g., reg. section 1.901-2.

39 See, e.g., reg. section 1.901-2(a)(2)(ii), (e)(2), and (e)(5).

40 See, e.g., reg. section 1.901-2(c) and (e)(3).

41 These behavioral responses to foreign minimum taxes become more challenging in the context of a multilateral foreign minimum tax when a country’s resulting increased rate of tax and provision of government subsidies or services may be too general to fall within the traditional definition of a soak-up tax or tax-related subsidy. For a discussion of countries’ potential behavioral responses to foreign minimum taxes, see infra Section VII.C.

42 See infra Section IV.D.2. In the same vein as CFC rules, foreign minimum taxes also create the possibility of an item of income being subject to tax once in the host country and again, up to the minimum tax rate, in the home country. The interaction of multiple foreign minimum taxes is discussed infra in Section V.

43 The Obama foreign minimum tax would have followed a variation of the latter approach, assigning the income and all taxes imposed on it to the jurisdiction with the highest tax rate among those to which the income was subject to tax. See Treasury, supra note 12, at 11; and JCS-2-15, supra note 12, at 27.

44 For example, recent state aid cases in the EU have raised the specter of effective tax rates increasing significantly on a retroactive basis.

45 This is the approach taken under the GILTI rules. See section 905(c). Commentators have begun to highlight related complexities. See Doug McHoney, Prae Kriengwatana, and Bobby Gardner, “Back to the Future: Navigating the Section 905(c) Timing Rules,” 45 Int’l Tax J. 29 (2019).

46 For a discussion of foreign minimum tax mechanisms to ease timing differences, see infra Section IV.C.4.

47 Some countries incorporate minimum tax rates into the applicability of their participation exemptions. These mechanisms generally are based on statutory rates, however, and do not apply with the same level of precision as the foreign minimum taxes discussed in this report. A foreign minimum tax implemented through a denial of a participation exemption was proposed by stakeholders as part of U.S. tax reform but was not pursued by policymakers. See Martin A. Sullivan, “Designing Anti-Base-Erosion Rules,”  (describing “Option D” as developed by “a group of companies” and presented to the staffs of Congress’s taxwriting committees).

48 A variation of any of these methods could be to tax the earnings on a deferred or current basis at the home country’s full rate of tax in all circumstances (e.g., where the host country employs a regime the home country views as a harmful tax practice). Taxing above the minimum tax rate, however, may be punitive and does not appear to further the policy objective of ensuring foreign earnings are subject to a minimum level of tax. Consequently, this report does not consider such a variation.

49 See, e.g., Treasury, supra note 12, at 9 (proposing a 19 percent per-country foreign minimum tax taking into account 85 percent of foreign taxes paid or accrued on the minimum tax base); Tax Reform Act of 2014, H.R. 1, 113th Cong., 2d Sess., section 4211 (Dec. 10, 2014) (discussion draft) (proposing a 15 percent per-entity foreign minimum tax with a credit for 100 percent of foreign taxes paid or accrued on the minimum tax base); Max Baucus, “Summary of Staff Discussion Draft: International Business Tax Reform,” section 904(a)(2) (Nov. 19, 2013) (proposing current taxation of foreign subsidiary income taxed at a rate less than 80 percent of the maximum U.S. corporate tax rate); Fleming, Peroni, and Shay, supra note 13; and Harry Grubert and Rosanne Altshuler, “Fixing the System: An Analysis of Alternative Proposals for the Reform of International Tax,” 33 Nat’l Tax J. 671 (2013).

50 See Treasury, supra note 12, at 10.

51 See section 960(d)(1).

52 See H.R. Rep. No. 115-409, at 390 (2017); Senate Budget Committee, “Reconciliation Recommendations Pursuant to H. Con. Res. 71,” S. Print No. 115-20, at 366 (Dec. 2017); and JCS-2-15, supra note 12, at 49.

53 See, e.g., OECD Model Tax Convention on Income and on Capital, article 23 (Nov. 21, 2017); United Nations Model Double Taxation Convention, article 23 (2017); and United States Model Income Tax Convention, article 23 (2016).

54 See, e.g., section 904(a); and William H. Byrnes et al., Foreign Tax and Trade Briefs, chs. Austria, Korea, Lithuania, Mexico, New Zealand, Norway, Peru, Portugal, and Singapore (2019).

55 See Fleming, Peroni, and Shay, supra note 13.

56 Many countries, including the United States, have adopted limitations on interest deductions based on the OECD’s BEPS work, as further discussed infra in Section IV.D.1.i.a. These limitations are designed to reduce disproportionate home country leverage. Consequently, there is less (or perhaps no) need to address shareholder-level interest expense in the context of a participation exemption or similar territorial regime.

57 See sections 904(c) (preventing FTCs for GILTI from being carried forward, including when the carryforward would arise from shareholder-level losses), and 250(a)(2) (preventing the reduced rate of tax applicable to GILTI from applying to the extent a shareholder’s GILTI exceeds its taxable income, such as because of shareholder-level losses).

58 See section 905(b).

59 See section 901(j).

60 See section 901(k) and (l).

61 See section 901(m).

62 For a discussion of administrative considerations relevant to a multilateral foreign minimum tax, see infra Section V.E.

63 See Treasury, supra note 12, at 10.

64 See JCS-2-15, supra note 12, at 42.

65 The OECD has considered similar issues in the context of limitations on interest deductions. See BEPS action 4 report, supra note 35, at paras. 155-167. Much of the analysis in that context depends on the objective of those limitations: to curb base erosion. Thus, carryforwards should be considered in light of the objective of a foreign minimum tax. For example, the OECD cautions against long or indefinite carryforwards of unused interest capacity because it could create an incentive to erode the base in future periods so as to use the unused capacity. Id. at para. 164. Conceptually, a long or indefinite FTC carryforward creates a similar incentive — namely, to shift profits to low- or no-tax jurisdictions in future periods. Shifting profits between high-tax and low-tax jurisdictions, however, may be a time-consuming and expensive endeavor that taxpayers cannot nimbly undertake, in contrast to generating interest deductions from related-party loans, which controlled groups frequently can create and eliminate with relative ease. Thus, practical issues relevant to a foreign minimum tax that are not present in the context of limitations on interest deductions may be viewed as warranting longer and more flexible carryforwards.

66 This latter approach bears a resemblance to the U.S. overall domestic loss rules, under which U.S.-source income is recharacterized as foreign-source income for FTC purposes in years following a domestic loss to ensure that domestic losses do not permanently eliminate access to FTCs. See section 904(g).

67 This raises additional design questions about the choice of an appropriate index. An index based on economywide inflation preserves the purchasing power of the forgone credit, while an index based on the opportunity cost of funds to the company reflects the company’s cost of financing the implicit loan to the government. There are more choices, and the appropriateness of each choice depends somewhat on the theory behind indexing.

68 See OECD, “OECD/G-20 Base Erosion and Profit Shifting Project — Explanatory Statement,” at 13, 14 (2015) (describing BEPS actions 2 and 4).

69 See BEPS action 4 report, supra note 35, at para. 22 et seq.

70 To date, only one country has adopted an interest limitation based on a percentage of EBIT: Denmark, which limits interest deductions based on 80 percent of EBIT. Absent a change in law, the United States will become the second country to limit interest deductions based on EBIT beginning in 2022, albeit at a lower percentage (30 percent). See section 163(j)(8)(A)(v).

71 See BEPS action 4 report, supra note 35, at para. 24.

72 An interest limitation does not completely eliminate this incentive. For example, a taxpayer with profits in a low- or no-tax jurisdiction has an incentive to shift deductions to that jurisdiction to reduce the residual minimum tax. The incentive is particularly strong for deductions that are nondeductible in other jurisdictions. The incentive is also stronger under a per-country foreign minimum tax than an overall foreign minimum tax.

73 See BEPS action 4 report, supra note 35, at para. 360.

74 Id.

75 See ATAD, supra note 28, at article 4(2).

76 H.R. Rep. No. 115-409, at 247 (2017); S. Print No. 115-20, at 165-166 (2017).

77 See prop. reg. section 1.163(j)-7(d)(2).

78 See OECD, “OECD/G-20 Base Erosion and Profit Shifting Project — Neutralising the Effects of Hybrid Mismatch Arrangements” (2017) (BEPS action 2 report).

79 See Treasury, supra note 12, at 11.

80 This concern may arise outside the context of hybrids, such as when intercompany deductions accrue under the laws of the home country and the payer host country in the same year in which the intercompany income accrues under the laws of the home country but in a different year than that in which the income accrues under the laws of the recipient host country.

81 A foreign minimum tax may present a new form of CFC regime, aimed at a much broader base of CFC income. For further discussion on coordinating a foreign minimum tax with other foreign minimum taxes, see infra Section V.

82 A prominent example is the EU’s ATAD, which generally requires EU member states to implement CFC rules under which the non-distributed income of a low-taxed CFC must be included in the member’s tax base when that income (1) is within one of a prescribed list of limited categories and the CFC does not carry on substantive economic activity, or (2) arises from nongenuine arrangements that have been put in place for the essential purpose of obtaining a tax advantage. See ATAD, supra note 28, at article 7.

83 On the other hand, one could argue that a multilateral foreign minimum tax may obviate the need for CFC rules. This is particularly the case when CFC rules apply only to low-taxed income and the effective tax rate thresholds for the CFC rules and foreign minimum tax are close. Replacing CFC rules with a multilateral foreign minimum tax on a global basis would eliminate the complexity of coordinating these rules.

84 Section 951A(c)(2)(A)(i)(II).

85 Section 960(a).

86 Section 904(c), (d)(1)(D).

87 Section 904(c), (d)(1)(A).

88 See also Michael J. Caballero and Isaac Wood, “Restoring a ‘Not GILTI’ Verdict for High-Taxed Income,” Tax Notes, Oct. 8, 2018, p. 189.

89 Conceivably, every country with CFC rules could adopt a commonly accepted standard such that the rule for coordinating a home country’s foreign minimum tax with its own CFC rules would also coordinate the foreign minimum tax with every other country’s CFC rules. Uniform global adoption of such a standard seems unlikely.

90 See infra Section V.B.

91 Although the concurrent application of foreign minimum taxes is most likely to arise in tiered structures, it could also arise when the same item of income is included in more than one minimum tax base, such as because different rules relate to beneficial ownership, permanent establishments, or income recognition.

92 Of course, a country that imposes no foreign minimum tax would hold a greater competitive advantage, which highlights the anti-competitive nature of a unilateral foreign minimum tax.

93 Although we proceed with respect to a single item of income, the following discussion applies equally to aggregated items of income, including an overall approach.

94 Under any of the proposed approaches, a tiebreaker rule is still necessary for shareholders that are tax residents in two or more countries that impose a foreign minimum tax. In addition, any item of income or expense could be taken into account by multiple subsidiaries or branches with an organization under the different laws of the different host countries, each under separate chains of intermediate owners. This report focuses only on the simple (and more common) fact pattern of an item recognized once by a single subsidiary or branch.

95 The larger Country C minimum tax base may result from, for example, Country C measuring the minimum tax base under its own laws and not allowing all the deductions allowed under the laws of Country D.

96 The larger Country C minimum tax base may result from, for example, Country C measuring the minimum tax base under its own laws and not allowing all the deductions allowed under the laws of Country D.

97 The larger Country C minimum tax base may result from, for example, Country C measuring the minimum tax base under its own laws and not allowing all the deductions allowed under the laws of Country D.

98 See reg. section 1.951A-2(c)(2) (requiring a non-U.S. corporation’s tested income or loss, and thus a U.S. shareholder’s GILTI, to be determined as if the foreign corporation was a U.S. corporation).

99 See prop. reg. sections 1.904-6(a)(1)(i) and 1.960-1(d)(3)(ii)(A).

100 See section 851 et seq.; section 856 et seq.; and section 1381 et seq.

101 See prop. reg. section 1.960-1(d)(3)(ii)(B)(2). Alternatively, the taxes may not be viewed as attributable to a timing difference but instead related to the subsidiary’s income on a current basis, reaching the same result. Compare prop. reg. section 1.904-6(a)(1)(i), with prop. reg. section 1.904-6(a)(1)(iv). Note that this aspect of the U.S. GILTI rules has not been finalized, and future regulations may be instructive.

102 See OECD work program, supra note 3, at para. 57.

103 See id. at para. 64.

104 Id. at para. 63.

105 There may be no need to consider shareholder changes when attributes are carried forward at the subsidiary level. For example, determining a subsidiary’s average effective tax rate over a period of years may not change when the ultimate shareholder changes tax residences.

106 See OECD work program, supra note 3, at paras. 68-71.

107 For example, the level of information required under CbC reporting is insufficient to substantiate a foreign minimum tax computation. The privacy and confidentiality concerns raised in the development of CbC reporting standards would be exacerbated by the additional information needed to administer a foreign minimum tax.

108 The aforementioned approaches to mitigating multiple layers of residual tax under a multilateral foreign minimum tax demonstrate this design feature by ensuring that at least one foreign minimum tax among the countries in which direct and indirect owners are tax resident applies. See supra Section V.B.

109 Legislative history provides these arguments as the rationale for enactment of the GILTI regime in the United States. See S. Print No. 115-20, at 370-371.

110 A tax system satisfies capital ownership neutrality if it does not distort the ownership of capital assets when the productivity of an investment depends on its ownership.

111 An investment of $1,000 yielding 8.9 percent produces a pretax return of $89, on which tax of $4.45 is due to Country L and minimum tax of $8.90 (15 percent * $89 - $4.45) is due to Country H, for an after-tax return of $75.65. This is greater than the $75 after-tax return on the investment in Country H yielding 10 percent.

112 OECD Tax Database.

113 For a description of one model of such competition, see Charles M. Tiebout, “A Pure Theory of Local Expenditures,” 64 J. Pol. Econ. 416 (Oct. 1956). For a modification of the Tiebout model to the international setting, see J. Samuel Barkin, “Racing All Over the Place: A Dispersion Model of International Regulatory Competition,” 21 Eur. J. Int’l Rel. 171 (Mar. 2015).

114 Johannes Becker and Joachim Englisch, “OECD Public Consultation Document Addressing the Tax Challenges of the Digitalisation of the Economy,” at 3 (Mar. 2019).

115 Id.

116 OECD work program, supra note 3, at 25.

117 Mihir A. Desai, C. Fritz Foley, and James R. Hines Jr., “Domestic Effects of the Foreign Activities of U.S. Multinationals,” 1 Am. Econ. J.: Econ. Pol. 181 (Feb. 2009).

118 Desai, Foley, and Hines, “Foreign Direct Investment and the Domestic Capital Stock,” 95(2) Am. Econ. Rev. 33-38 (May 2005).

119 Desai, Foley, and Hines, “Domestic Effects,” supra note 117.

120 Cesare Imbriani, Rosanna Pittiglio, and Filippo Reganati, “Outward Foreign Direct Investment and Domestic Performance: The Italian Manufacturing and Services Sectors,” 39 Atlantic Econ. J. 1 (Dec. 2011).

121 Steven Globerman, “Investing Abroad and Investing at Home: Complements or Substitutes?” 20 Multinational Bus. Rev. 217 (2012).

122 Peter Debaere, Hongshik Lee, and Joonhyung Lee, “It Matters Where You Go: Outward Foreign Direct Investment and Multinational Employment Growth at Home,” 91 J. Dev. Econ. 301 (Mar. 2010).

123 Ann E. Harrison, Margaret S. McMillan, and Clair Null, “U.S. Multinational Activity Abroad and U.S. Jobs: Substitutes or Complements,” 46 Indus. Rel. 347 (Apr. 2007).

124 See, e.g., Grubert and Altshuler, supra note 49, at 671-712; and Kimberly A. Clausing, “Profit Shifting Before and After the Tax Cuts and Jobs Act” (Oct. 29, 2018).

125 IMF, “Corporate Taxation in the Global Economy,” IMF Policy Paper No. 19/007, at 21 (Mar. 10, 2019).

126 Id. at 23.

127 This calculus can change if shareholder and branch owner expenses are taken into account in measuring the residual tax imposed by the home country. See supra Section IV.C.3.

128 Grubert and Altshuler, supra note 49, at 697.

129 Peter S. Fisher and Alan H. Peters, “Industrial Incentives: Competition Among American States and Cities,” W.E. Upjohn Institute for Employment Research (1998).

130 John Kim Swales, “The Relative Efficiency of Automatic and Discretionary Regional Aid,” 42 Env’t & Plan. A: Econ. & Space 434 (Feb. 2010).

131 The discretion in tax incentives generally applies at the design stage and not at the implementation stage. Although tax incentives, depending on their design, may also benefit inframarginal investments, the universal nature of tax incentives does not result in inframarginal investments receiving the benefits, because the investments were incorrectly identified as requiring the subsidy.

132 Fisher and Peters, supra note 129, at 33 and 107.

133 Daniel J. Hemel and Lisa Larrimore Ouellette, “Beyond the Patents-Prizes Debate,” 92 Tex. L. Rev. 303 (Dec. 2013).

134 Nigel Chalk, Michael Keen, and Victoria Perry, “The Tax Cuts and Jobs Act: An Appraisal,” IMF Working Paper WP/18/185 (Aug. 2018).

135 Clausing, supra note 124, at 3-4 (emphasis in original).

136 Clausing notes that the analysis does not include “effects on the ‘real’ shifting of jobs or assets . . . and the likely tax policy responses of other countries.” Id. at 24.

137 Tax base elasticities may be nonlinear such that tax bases are likely more responsive to changes in tax rates at lower tax rates and less responsive at higher tax rates. Tim Dowd, Paul Landefeld, and Anne Moore, “Profit Shifting of U.S. Multinationals,” 148 J. Pub. Econ. 1 (Apr. 2017). Using nonlinear tax elasticities, the effects for high-tax countries are roughly the same under either a per-country or overall minimum tax. Using linear tax elasticities, the tax base of high-tax countries expands more under an overall minimum tax than under a per-country minimum tax. Clausing, supra note 124, at 32 and 44.

138 Grubert and Altshuler, supra note 49, at 703.

139 Id.

140 A survey of large MNEs suggests that less than 11 percent of overall CFC income is net deemed tangible income return; the surveyed enterprises are among the largest companies and may not be representative of all companies subject to minimum tax. Although not strictly comparable, the authors of another study estimate that 10 percent of qualified business asset investment in the United States as a share of the sum of income items less the sum of deduction and expense items is 62 percent for all U.S. companies, 20 percent for companies with positive deemed intangible income, 44 percent for companies with exports, and 19 percent for companies with foreign-derived intangible income. The latter two categories include companies that are more likely to be multinationals. Dowd and Landefeld, “The Business Cycle and the Deduction for Foreign Derived Intangible Income: A Historical Perspective,” 71 Nat’l Tax J. 729 (Dec. 2018).

141 Dana L. Trier, “International Tax Reform in a Second Best World: The GILTI Rules,” 97 Taxes 59 (Mar. 2019) (“The discrimination in the operation of the regime against financial institutions remains problematic.”). Grubert and Altshuler, supra note 49, at 680 (“This issue is of particular concern for financial businesses. Consideration might be given to net of debt active business assets if they can be precisely defined.”).

142 Trier, supra note 141, at 60.

143 Id.

144 Dhammika Dharmapala, “The Consequences of the Tax Cuts and Jobs Act’s International Provisions: Lessons From Existing Research,” 71 Nat’l Tax J. 707 (Dec. 2018).

145 Kartikeya Singh and Aparna Mathur, “The Impact of GILTI and FDII on the Investment Location Choice of U.S. Multinationals,” American Enterprise Institute Economics Working Paper 2018-05, at 16 (May 2018).

146 Sebastian Beer, Alexander Klemm, and Thornton Matheson, “Tax Spillovers From U.S. Corporate Income Tax Reform,” IMF Working Paper WP/18/166, at 24 (July 2018).

147 One can demonstrate the equivalence mathematically. The after-tax value of allowing a deduction for the investment is given by C * (1 + r)n * (1 - t), where C equals the capital investment, r is the annual rate of return, n is the number of years the investment is held, and t is the tax rate. The after-tax value of exempting the return is (1 - t) * C * (1 + r)n. Note that (1 - t) * C represents the reduced amount that can be invested in the scenario in which the return is exempt, because tax must be paid first. The expressions are mathematically equivalent when t is unchanged.

148 PwC, “Global Top 100 Companies by Market Capitalization” (Mar. 31, 2018). Greater China includes Hong Kong and Taiwan.

149 Luca Ventura, “World’s Largest Companies 2018,” Global Finance, Nov. 30, 2018.

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