David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: back to the minimum.
On August 16, President Biden signed the Inflation Reduction Act (IRA) into law. This bill features a new corporate alternative minimum tax (AMT) to help pay for included healthcare and climate change priorities.
As this is a major change to the U.S. tax system that has inspired a lot of discussion, we thought it best to feature multiple perspectives. Last week, we heard from Kyle Pomerleau of the American Enterprise Institute, who highlighted a number of concerns about the tax. This week, we hear from someone whose input laid some of the groundwork for the new tax.
So joining me now to talk more about this tax and what it means for international taxation is Reuven Avi-Yonah, the Irwin I. Cohn Professor of Law at the University of Michigan. Reuven, welcome back to the podcast.
Reuven Avi-Yonah: Thank you. It's a pleasure to be here. Thanks for inviting me.
David D. Stewart: Now, I talked to you a number of years ago, shortly after the passage of the Tax Cuts and Jobs Act (TCJA). And at the time, that was the most sweeping change that we'd seen in U.S. taxes in decades.
Today, we're talking about the Inflation Reduction Act just as it's being signed. So how big a change are we looking at here?
Reuven Avi-Yonah: It's a significant change. I don't think it's quite at the level of the TCJA, because that included a lot of stuff and it's taken years to deal with it and all of its complications, and we still haven't finished yet. There are areas this day that are still unclear about it. But this is a significant change.
I think both of the tax provisions that are included, as well as the additional funding for the IRS, will make a difference. And we will also deal with this for a while, especially the corporate minimum tax. There was a short time in the '80s where there was something like this, but we really haven't had too much experience with this.
And I suspect that it will take the IRS several years to work out all the kinks and the right regulations and make things clear. And, of course, the problem is that people have to start filing returns for this as early as next year, so I expect that people will have a lot of work to do.
David D. Stewart: Getting to that, the corporate alternative minimum tax. Could you tell listeners about how that works?
Reuven Avi-Yonah: So in general, the idea is that book income has various differences from taxable income. And as you know, American corporations essentially keep two sets of books, one for financial reporting purposes and one for tax purposes. And there are all kinds of differences between them, most of which have to do with various special, essentially what's tax expenditures. That is subsidies for various corporate activities that are reflected for tax, but not for book, because the purpose of book is to accurately reflect the financial picture of the corporation.
And the concern that led to this was that corporations are taking too much advantage of some of these tax expenditures. And as a result, their effective tax rate becomes very low, below what Congress felt was justified. And that's where the corporate alternative minimum tax comes in, where you start with the corporation's book income globally, and you apply a lower rate for that, that is 15 percent. And then you take into account some of these tax expenditures, but not others.
Congress decided that there's a variety of them that are worth keeping for this purpose, even though they're not different from normal book, like R&D (research and development), for example, being expensed and so on. And then, once you do that, you calculate the two taxable tax results, that is one under the normal corporate tax at 21 percent and one under this broader based book tax at 15 percent, and you pay whichever one is higher.
David D. Stewart: So what is the importance of switching to this book earning system? You mentioned that it is companies that are taking advantage of tax expenditures. So if we've passed a tax expenditure and a corporation is taking advantage of that, isn't that the government saying, "This is money we want you to keep to put into this area." This sort of claws that back. Is that how this is working?
Reuven Avi-Yonah: Yeah, basically. The truth is that this is, of course, a classic critique of the whole tax expenditure concept and of the alternative minimum taxes in particular, as we've had an individual alternative minimum tax since 1969, I think.
We've had a corporate alternative minimum tax for a long time. That was structured differently than this, because it wasn't based on book for a long time, until 2017.
And in all these cases, the idea is maybe every particular tax expenditure is justified by itself, or it has good reasons to exist. Although, in some cases I have doubts about that. But when you take them all together. If the end result is that very profitable corporations essentially pay close to zero tax or very low effective tax rates, then maybe Congress feels that it overdid it.
And I think the standard tax policy advice would be, "Why don't we just drop the whole normal corporate tax and just adopt the book tax instead, or the alternative minimum tax instead, because it has a broader base and a lower rate?" And all of these things are usually considered better.
But the reality is that we're never going to do that. For one thing, I think it'll raise significantly less revenue than the 21 percent, to have everything done on a 15 percent basis. And for another, it just seems that, politically, it's not possible to repeal.
Tax expenditures are very difficult. This is the fight that has been going on since Stanley Surrey in the '60s. The idea was, once you adopt the tax expenditure budget and people can see how much it cost to do these various things, Congress would repeal them. Well, that hadn't happened.
So we're kind of in a second best scenario, where you have all of these expenditures, some of which may be less justified than others, and Congress is unable to repeal them fundamentally for political reasons, because each and every one of them has a significant lobbying group that is pushing for it and the opposition, or the tax policy position against it, is much more broadly defused. And so, what Congress says in this kind of context, "Let's just do an alternative that says, 'OK, we give you all of these benefits, but if you use too many of them at once, let's say, we're going to make sure that you don't pay less than X.' And in this case 15 percent of book."
David D. Stewart: So this is a political answer to a policy question. Is there a danger that it's creating too much complexity for the goal that it's seeking to achieve?
Reuven Avi-Yonah: Oh yeah. That's that is obviously the downside. It's more complicated to do this.
Now, having said that, you have to remember, this is only for very profitable, large corporations. In order to be in this area, you have to have on average, a billion dollars in profit for the last three years. So we're talking about maybe 125ish, really our largest corporations. And they can afford the complexity in the sense that they can pay the best accountants, the best tax lawyers to deal with this.
I would also say that, since corporations already do their books — all of this is public information — the added complexity of calculating the tax based on the book is not really that high compared to having two sets of books to begin with.
David D. Stewart: Is there an added complication now that we're talking about a different set of accounting rules that are going to be used? I'm still trying to wrap my head around how that's going to work.
Reuven Avi-Yonah: Nobody knows for sure, I think, not even the people who drafted this tax. I was involved in the work on this from relatively early on, because this was originally an idea that Senator [Elizabeth] Warren (D-Mass.) advanced in her presidential campaign. And then once she got back to the Senate, she outlined this and then worked on it and proposed legislation.
The structure of it, or the details, were different because it cut in at a much lower level of profitability and had a lower rate, but the fundamental notion was similar.
But nevertheless, I think that, until recently, nobody really thought that this would happen, because there were lots of tax ideas floating around. And most people thought, for example, that the reforms the administration's proposing, GILTI, and so on, were more likely to happen than this, because this is in some ways more radical. But now we have it and so people will really have to start dealing with what it means.
And in particular, I think the big problem for me, as well as for most people, is that I'm not an accountant. So I'm not really familiar with how book works. I don't think too many tax lawyers are that familiar with how book works.
Yeah, here and there, there are book issues that have such a large tax implication that we know about it. For example, before 2017 many, many people knew about the permanently reinvested earnings rule. That if you are multinational and you have low tax income overseas and if you bring it back, you're supposed to pay tax on the dividend of 35 percent. For accounting purposes, that is for book purposes, you were allowed not to take a reserve against the tax, as long as you could convince the accounting firm that it was "permanently reinvest".
So that had such huge implications at the time, because there were $3 trillion sitting in that capacity, that even tax lawyers knew about that. But most book rules are not that familiar.
And I think what will happen now is that tax lawyers will have to start talking with the accountants seriously and familiarize themselves with a lot of these. And at the level of detail, there's a lot, of course, to be learned.
And having said all of that, this is not that different from the way it works in almost every other country, including our big trade competitors: Germany, France, China, and so on. None of them have this system where's it's a completely separate set of rules for book and for tax. Essentially, in all of these countries, you start with book and then you make adjustment, just like this tax does in order to reflect various tax policy's goals. But all of them start a corporate tax with book.
And I think we're just, in that way, making ourself more similar to what our trade partners do.
David D. Stewart: Now, you mentioned that you were working with Senator Elizabeth Warren on a similar tax idea. Could you tell us a little bit more about your role there?
Reuven Avi-Yonah: She, or her staff, contacted me early on about what she called, "The Real Corporate Profit Tax," which was this idea basically. And so we lobbed ideas back and forth and then I reviewed a couple of legislative drafts, and I talked to a couple of other lawmakers. And eventually, they came forward with some proposed legislation that was out there. But I think, at the time at least, certainly I — and I doubt that her staff thought that this would become law in any way — because a lot of ideas get lobbed around.
David D. Stewart: Now turning to the context in which this tax is being imposed, you have a discussion at the OECD about reforms to international taxation, specifically with regard to the digital economy. So we have these changes that are potentially on the horizon. But how does this fit into the international tax regime as it stands today? And then we'll get into in the future.
Reuven Avi-Yonah: I think, fundamentally, this is consistent to some extent with the way our international tax rules have been developing since 2017 and also other countries in parallel, leaving aside the OECD work for a moment.
But basically, until 2017, as we mentioned before, we basically had this, essentially, territorial system, because U.S. multinationals were able to defer tax on their foreign source income forever, it seemed like, or for a very long time, and the effective tax rate on that income was very low.
In 2017, we made a pretty radical change, because we abolished deferral and we taxed all of that income currently, albeit at the lower rate, because the GILTI rate is only 10 and a half [percent]. So I thought that was the big conceptual change, especially since for GILTI purposes, you aggregate all CFCs (controlled foreign corporations) into one big blob, essentially.
So you treat at least the foreign portion of the multinational as a single unit and the domestic portion as another unit, and you apply different rates to the domestic portion than to the foreign portion. But it's moving in that direction.
And this is going a little bit further than that, in the sense that book ignores the differential between all the— It treats the whole multinational as a single unit essentially, and it applies this tax, the 15 percent book based tax, uniformly across it. And I think that, that's essentially the culmination of where we've been going for the last five years, or even before that, because these changes were already envisaged in the camp reform from 2014 and before that, and various proposals like that. So this was not particularly new in 2017.
From that perspective, I think, while it is different to some extent, it is congruent with where we have been before. And you could also say that the reason that the OECD and the G20 were going the way they are going with pillar 2 in particular, which we will presumably discuss later, is as a reaction to what we did in 2017. That is, pretty clearly, had we not adopted GILTI, I don't think any of these changes would've happened, because this was in reaction to that.
So I think that the international movement is, to a significant extent, a reaction to it.
David D. Stewart: So between this new book minimum tax and the GILTI and BEAT regime that came in a few years ago, how much space is there left for U.S. multinationals for profit shifting?
Reuven Avi-Yonah: That's an interesting question. And, of course, the answer is that there is space for the simple reason that the tax rates are different, right?
Now, effective tax rates are different and so on, but let's assume for a moment, for simplicity's sake, that you actually pay 21 percent domestically and let's say 10 and half percent on GILTI, right? So at that point, there's obviously an incentive to shift to GILTI. And in fact, GILTI also includes this deemed tangible income return, the first 10 percent of profit on your tangibles. So that's an incentive to shift not just profits, but actual operations overseas. And so it still remains a meaningful differential.
Here, this alternative tax has no differential. It's 15 percent across the board and it also doesn't have any kind of exclusion for tangible investment or anything like that. And so, as a result, I think it reduces the incentive to shift, probably I would say significantly.
Because fundamentally, for each multinational, you have to assess, are they in alternative minimum tax land or are they in regular corporate tax land? And obviously you have to do the calculation both ways. If you are in regular tax land, then you ignore the alternative minimum tax, because you pay more under the regular tax. And at that point, there's an incentive to shift. I would say, if you shift too much, maybe it'll reduce your effective tax rates so much it that maybe you are switched over to the alternative minimum tax.
But if you are in alternative minimum tax land, that there is, I think, significantly less incentive to shift. And in my mind, that's one of the big benefits of this new minimum tax.
David D. Stewart: So would that take pressure off of the transfer pricing system, let's say, where it wouldn't really be that important to figure out the precise pricing?
Reuven Avi-Yonah: That is what I very much hope. I've believed that this is the solution for decades and decades. That what you need to do, or the best solution to avoid endless transfer pricing disputes, is have the same rate apply domestic and internationally. And I was willing to live with a lower rate in order to achieve that result, because I think transfer pricing is such a resource sucker from the IRS, as well as in the private sector.
And recently, of course, the IRS has increased its enforcement of transfer pricing with several big cases going on now. So there's much more transfer pricing litigation than there was, let's say, 10 years ago. And so my hope is that there will be slightly less now.
But you never know, because that depends on how many corporations will be in this AMT territory and how many corporations will be in the regular tax territory, where there's still an incentive to shift.
Although, interestingly enough, one of the counterweights that was put in 2017 in order to prevent this from happening is the FDII rule, where if you are a domestic exporter of either tangibles or intangibles, you get 13.1 to 13.5 percent, and that's supposed to be congruent with the GILTI rate with foreign tax credits.
Now, as far as I can tell, FDII is not reflected in the book tax. So that means that you lose that benefit, but then it's 15 [percent] across the board. So I think that people who benefit from FDII will have to calculate well, how much is that benefit? And does that reduce you below 15 percent? Because if you have a lot of it, paying a 13.1 to 13.5, obviously that's lower than 15, and some of it may go away.
So that's part of the complexity. And as far as I can tell, it's not addressed explicitly, which means that it's not secure against the application of the book minimum tax.
David D. Stewart: Is there any need to revise the U.S. tax treaty network now that we have this tax in place?
Reuven Avi-Yonah: That's a really interesting question and I think something that we will have to think.
Now in principle, the answer is, I think no, for the same reason that GILTI did not require— The general understanding of GILTI, as well as other essentially CFC regimes, like subpart F, is that they don't violate treaties.
There is a position, and some courts have even taken the position, that CFC rules violates treaties, because CFC is a foreign corporation, and if it has business profits that are derived from the United States, then this is taxing a foreign corporation without having a permanent establishment and so on and so forth. The OECD never accepted this view. The U.S. never accepted this view.
So I think, fundamentally, our position is, "We are not violating treaties when we adopt these kind of rules."
And in addition, of course, at least for most provisions, and I think all the relevant ones, we are talking about the tax imposed on the U.S. parent, and the saving clause in all U.S. treaties says, "Treaties cannot change the U.S. taxation of U.S. residents."
And so I think, fundamentally, this particular tax is not an issue. I think the more interesting question that may arise is its interaction with the foreign tax credit. Foreign tax credit are allowed under the book tax, and as far as I can tell, they're not limited the way the foreign tax credits are limited under GILTI to 80 percent, and you can also move them from year to year.
So this will be interesting, because you can imagine situations where foreign countries will adjust their taxes in order to take into account the fact that, for book tax purposes, you can get a credit for the foreign tax more than you can for GILTI purposes, for example.
I'm not sure that was a wise decision. I would've personally preferred to say that you can't have foreign tax credits apply against the book tax, because it is a minimum tax. But, fundamentally, I don't think this is inconsistent with our treaties, and given the foreign tax credit, makes it less likely that foreigners at least will object to it.
David D. Stewart: All right. So turning to the question at the OECD, earlier versions of this reconciliation bill had reforms to GILTI to align it with pillar 2, but that was eliminated. So you have an international minimum tax under pillar 2, and this bill creates a minimum tax, but different. So can these two systems coexist?
Reuven Avi-Yonah: So that's really, I think a key question.
Some people would say, like Mindy Herzfeld in [Tax Notes] as well, pillar 2 is dead as a practical matter, right? And so they don't believe it'll happen.
I don't agree with this position. I think that it will happen, because I think it's not necessary for the U.S. or even the EU to adopt pillar 2 for pillar 2 to happen. I think what is needed is that most of the other G7, or even most of the other G20 that have a corporate tax, will apply to their multinationals. And at that point, it becomes important enough so that other countries will react and the whole pillar 2 architecture comes into play.
So let's assume that pillar 2 happens in the next few years. So at that point, how do you deal with the interaction between that and an unreformed GILTI? And then how do you deal with the interaction between that and this new minimum tax?
So the unreformed GILTI, we were able to negotiate. The U.S. was able to negotiate it. CFC rules, which I think pretty clearly the GILTI qualifies as CFC rules, will have priority over the pillar 2 taxes. So that means you can apply them within the foreign tax credit rules that we have anyway, but you can apply them before any unrelated, under tax payment rule, or you can apply them before any qualified domestic minimum top-up tax. Essentially, the U.S. can apply the GILTI rules regardless of what happens with pillar 2, and they get priorities.
So that, I think, was a significant negotiating achievement by the administration. And this is an unreformed GILTI. Now they were hoping that they would get a reformed GILTI, which clearly is consistent with pillar 2, but they didn't get that.
And the main problem here— There are two issues. One is the country-by-country question. But the main one I think is IRA differential, because even if you ignore country-by-country, the fact that GILTI is only 10 and a half percent and will stay that way, means that potentially there will be top-up taxes applied on top of GILTI.
Now, my view, and this is what I said in this piece that was published in Tax Notes last week, is that conceptually, the two are not that different. And therefore, in my opinion, the administration should be able to negotiate with other countries that apply pillar 2, in order to get recognition for the book tax for pillar 2 purposes. Because, fundamentally, if you think about what pillar 2 is, it's a book-based tax. That is, the beginning point for pillar 2 calculation is the financials. And it is at 15 percent, right? And it is global. And it has a cutoff, although the cutoff is a little different, but it's intended to apply to large multinationals.
So I don't think that what we did here is that different, fundamentally. The idea in both cases was to make sure that large multinationals pay 15 percent, which is kind of the consensus view that that is the appropriate minimum rate for them to pay. And so what needs to happen, ideally, is for the international portion of the minimum tax to be recognized as a CFC rule, even though technically it is not, but fundamentally it is. That is, it is the application of a 15 percent rate to all the foreign affiliates of a multinational working as a unit, and then that the domestic portion of it will be recognized as a qualified domestic minimum top-up tax for pillar 2 purposes.
And I think, in principle, those two can be achieved, especially since I think our trading partners and the OECD would prefer the U.S. to be part of pillar 2, rather than the other way around, given the recognition of the political reality, which is that this is what the U.S. could get politically within the Senate.
I'm not sure that it is impossible to imagine a situation where they will in fact be reconciled. And from that perspective, I think you could argue even that having the book minimum tax is arguably an improvement over a situation where we would have the other way around, namely a conforming GILTI, but no minimum tax.
Because the problem with just having a conforming GILTI is that it doesn't address the question of what happens with all of the domestic parts of the multinational's income. And to the extent that various credits deductions, and so on, reduce that tax below 15 percent — and that was something that was recognized before the minimum tax happened — then UTPRs (undertaxed profit rule) might apply to it, and that would again create potential friction.
This was in fact an argument that was made by opponents of pillar 2 in the United States, "This will take away the green credits. This will take away various other beneficial tax expenditures, R&D, etc."
So now we have a tax that takes all of those into consideration, the ones that Congress thought were particularly beneficial. And if we can persuade our trading partners to accept that as a value to the entity and to accept the rate at 15 [percent] as being whatever their actually getting at, then I think that would be a really good result for the United States, and I think as well as for the OECD.
And whether that will happen is anybody's guess, but I think that's what the administration should be aiming for.
David D. Stewart: So if there isn't the ability to get this considered to be a pillar 2 adoption, is there a danger where we're creating new tax bases and new competing rules and where the OECD had spent many, many years working on the issue of double taxation and then they said, "Wait, now we have a problem with double non-taxation." Is there a chance that the pendulum is basically just swinging back and forth here?
Reuven Avi-Yonah: That's the concern, yes. I would acknowledge that and I think it's a legitimate concern. And I think if the book tax is not accepted, then there might be a lot of double taxation.
David D. Stewart: All right. So my last question for you is: this new tax addresses an issue of too many tax expenditures, making sure that corporations pay at least a certain amount of money. What issue out there do you see as remaining? What is the next thing that Congress, or the OECD, or someone is going to have to take a look at?
Reuven Avi-Yonah: I think in the longer term, it would be really nice to have something more like a consensus within the U.S. and then the OECD about what the appropriate corporate tax rates should be overall, not a minimum rate, but the normal rate. Let's say somewhere between 20 and 25, and then really each of the OECD countries apply that rate to the global income of its multinationals.
Because once you do that, you achieve the economist's dream of having, simultaneously, capital export neutrality and capital import neutrality and capital ownership neutrality, all of that at once, because there will be essentially rate harmonization within some kind of range. And that would enable us to get rid of this minimum tax, right? Because that would mean that the normal corporate tax will operate the way it's supposed to be, and it'll eliminate profit shifting, and so on.
Now we don't have that, because we still have the regular corporate tax with its incentives to profit shift, and many corporations, including many big corporations, will be under that rather than under the minimum tax. And so we haven't solved the fundamental problems.
I think my ideal had always been taxation of multinationals on a global basis. And as long as we don't have any kind of consensus about owner apportionment or anything like that, the only way of achieving that is residence-based taxation of multinationals.
David D. Stewart: Well, Reuven, this has been great. Thank you so much for being here.
Reuven Avi-Yonah: Thank you. Thanks for inviting me. I appreciate it.
David D. Stewart: And now, coming attractions. Each week, we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief, Paige Jones. Paige, what do you have for us?
Paige Jones: Thanks, Dave. In Tax Notes Federal, Lee Sheppard looks at how the corporate minimum tax in the Inflation Reduction Act might apply to private equity firms, despite changes designed to exclude them from its reach. Stephanie Hunter McMahon details resources in the Internal Revenue Code to help those with limited access to abortion services. In Tax Notes State, Anna Cronic and Brian Kirkell explore whether alternative apportionment rules in Arkansas will erode taxpayer certainty. Thomas Norton wonders if the proposed tax cuts by West Virginia Governor Jim Justice (R) will help the state. In Tax Notes International, three NovioTax practitioners revisit the home office permanent establishment issue in light of COVID-19 related restrictions. Costas Michail examines the proposed third EU anti-tax avoidance directive, which aims to prevent the abuse of shell entities. And finally, in Featured Analysis, Marie Sapirie examines the revamped clean vehicle credit in the Inflation Reduction Act.
David D. Stewart: That's it for this week. You can follow me online @TaxStew, that's S-T-E-W, and be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or a review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.
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