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Economic Analysis: Marginal Tax Rates on U.S. Outbound Tangible Investment

Posted on Sep. 9, 2019

Although details of the law and individual circumstance make it difficult to generalize about the tax treatment of global intangible low-taxed income, we will venture a few observations. Please note that here we are calculating the effect of changes in profit on taxes resulting from movement in tangible capital, as distinguished from pure profit shifting with no movement of capital.

First, if the net deemed tangible income return (that is, 10 percent of qualified business asset investment less interest) and allocable expense are zero, some generalizations about the Tax Cuts and Jobs Act carry over. Excess-credit taxpayers are in effect on a territorial system, so they pay only foreign tax and their U.S. tax liability is zero. Excess-limit taxpayers, instead of getting 100 percent compensation (credits) for foreign income taxes, now pay U.S. tax equal to the U.S. minimum tax rate plus 20 percent of foreign taxes. (This 20 percent “skin in the game” provides U.S. taxpayers an incentive to minimize foreign taxes.) In this case, the crossover point between excess-limit and excess-credit taxpayer is an average foreign tax rate on GILTI income of 13.125 percent. Figures 1 through 4 show marginal tax rates for tangible investment under a wide variety of circumstances.

Second, as under prior law, possibilities remain for cross-crediting. Cross-crediting is the reduction of U.S. tax when an excess-limit taxpayer invests in a high-tax country and the absence of U.S. tax when an excess-credit taxpayer invests in a low-tax country. Cross-crediting is indicated in the table in the shaded cells and occurs in figures 1 through 4 when excess-limit taxpayers invest in high-tax jurisdictions and excess-credit taxpayers invest in low-tax jurisdictions.

Third, new under the TCJA’s GILTI rules, foreign investment with a rate of return of less than 10 percent tends to reduce tax on GILTI (so there is possibly a subsidy instead of a tax for foreign investment). The overall effect will depend on the impact on the foreign tax credit. In some circumstances, the taxpayer-favorable effects of cross-crediting and a rate of return below 10 percent combine to provide significant subsidies for foreign investment. You can see this on the left-hand side of Figure 3 and on the right-hand side of Figure 4.

Fourth, as all GILTI cognoscenti are well aware, expenses allocated to the GILTI category can significantly raise the U.S. rate of tax on foreign investment no matter how high the foreign average rate may be (therefore violating the notion of GILTI as a minimum tax). Expense allocation rules under the statute and the regulations are highly complex. Two more things to keep in mind about expense allocations to the GILTI basket: The larger they are, the more the crossover rate between an excess-credit and excess-limit taxpayer shifts, dropping below its 13.125 percent maximum average foreign tax rate (demarcated with a vertical line in the figure), and because of the scrambling of the FTC limitation calculations, excess-credit taxpayers no longer have a marginal tax rate on investment equal to the foreign rate. In those circumstances, the overall marginal rate falls below the foreign rate because U.S. cuts offset some of the effect of additional foreign tax.

Marginal Tax on Tangible Foreign Investment Under GILTI Rules
(assumes all taxpayers eligible for section 250 deduction)
(cross-crediting occurs in shaded cells)

 

Simulation 1

Simulation 2

Simulation 3

Simulation 4

 

Foreign tax rate on marginal investment = 20%

Foreign tax rate on marginal investment = 3%

Foreign tax rate on marginal investment = 20%

Foreign tax rate on marginal investment = 3%

 

ROR on marginal investment = 30%

ROR on marginal investment = 5%

A. Excess-credit taxpayers (average foreign tax rate = 30%)

QBAI = 0, EXP = 0

30%

5%

30%

5%

QBAI = 25, EXP = 60

29.2%

4.6%

22.3%

-2.1%

B. Excess-limit taxpayers (average foreign tax rate = 3%)

QBAI = 0, EXP = 0

13.3%

7.4%

3.5%

-4.9%

QBAI = 25, EXP = 60

17.9%

7.7%

8.2%

-4.6%

Source: Detailed calculations from downloadable spreadsheet. QBAI is qualified business asset investment. EXP indicates expenses potentially allocable to GILTI category.

Simplicity Defenestrated

In concept, a minimum tax is as simple as it is elegant. If a multinational pays foreign tax above the minimum rate on its foreign investment, no home country tax is due. If a multinational pays foreign tax at a rate below the minimum tax rate, a home country tax is due on the shortfall. The marginal tax rate on foreign investment is either the home country rate or the minimum tax rate.

Well, you can toss your idealized concepts of a minimum tax out the window. Marginal effective tax rates will vary significantly, depending on whether a taxpayer is excess-credit or excess-limit, the amount of QBAI, the amount of allocated expense, the rate of return on investment, the tax rate on the marginal investment, and (not discussed here) whether the taxpayer is eligible for the section 250 deduction.

The numbers in the table suggest two reforms to the calculation. First, the QBAI mechanism should be jettisoned so all marginal tax rates will not depend on the rate of return and the negative marginal tax rates (that is, subsidies) for foreign investment under Simulation 4 in the table are eliminated. Second, an alternative minimum tax mechanism should be devised independently of the foreign tax credit, and its inordinately fastidious FTC limit rules should be eliminated. In the examples used here, expense allocation rules don’t make a meaningful or significant quantitative difference.

Figure 1. Marginal Tax Rates on New Investment (20% Rate of Return)   In a High-Tax-Rate (30%) Foreign Jurisdiction
Figure 2. Marginal Effective Tax Rates on New Investment (20% Rate of Return)  In a Low-Tax-Rate (5%) Foreign Jurisdiction
Figure 3. Marginal Tax Rate on New Investment (5% Rate of Return) in a High-Tax-Rate (30%) Foreign Jurisdiction
Figure 4. New Investment (5% Rate of Retrun) in a Low-Tax-Rate (5%) Foreign Jurisdiction
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