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Economic Analysis: Where Will the Factories Go? A Preliminary Assessment

POSTED ON Jan. 30, 2018
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In the last month there has been debate in the blogosphere, the twitterverse, and even in regular old newspapers about whether the Tax Cuts and Jobs Act (TCJA, P.L. 115-97) will shift job-creating, productivity-enhancing capital expenditure into or out of the United States. For example, a New York Times article disputed President Trump’s claim that “the tax cut will mean more companies moving to America” and asserted that “the bill that Mr. Trump signed . . . could actually make it attractive for companies to put assembly lines on foreign soil” (“Tax Law May Send Factories and Jobs Abroad, Critics Say,” Jan. 8, 2018). J.D. Foster of the U.S. Chamber of Commerce countered: “Rather than triggering an exodus, U.S. and foreign companies will be ramping up their investment in the U.S. substantially following tax reform” (“Tax Reform and the Coming Influx of Business Investment,” Jan. 9, 2018).

From 10,000 feet, it seems clear that a corporate rate reduction from 35 percent to 21 percent will attract capital to the United States. On the other hand, for those familiar with only the textbook definition of a worldwide and a territorial tax system, it may seem as if the much ballyhooed shift from the former to the latter by the TCJA would open floodgates for U.S. multinationals to invest abroad. And then there is the more sophisticated commentary that correctly points out that the new burden on foreign investment imposed by global intangible low-taxed income rules (GILTI, section 951A) is directly reduced if tangible depreciable capital is located outside the United States. In other words, this GILTI provision seems to provide an incentive for U.S. multinationals to locate abroad (Reuven S. Avi-Yonah et al., “The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the New Legislation,” Dec. 13, 2017, updated Dec. 19, 2017; and “The Games They Will Play: An Update on the Conference Committee Tax Bill,” Dec. 18, 2017). Conversely, increased tangible investment in the United States reduces the tax benefits under the foreign-derived intangible income section (FDII, section 250). Yes, these features are totally contrary to the main purpose of the TCJA. But that comes as no surprise to economists who have been pointing out for years that the OECD’s obsession in its base erosion and profit-shifting project with tying taxable profits to real business activity would only further encourage the migration of real business activities to low-tax jurisdictions.

In the long table accompanying this article, we model the effects of these and other major new provisions of the TCJA and see what we can learn about the new law’s overall impact on the balance between foreign and domestic investment. In particular, we calculate an effective tax rate on a $10 million investment in a new factory under four scenarios: (1) in the United States under old law; (2) in the United States under the TCJA; (3) outside the United States under old law; and (4) outside the United States under the TCJA. If the excess of (1) over (3) is less than the excess of (2) over (4), this suggests the TCJA has reduced the tax incentive to invest abroad.

Of course, as is usual in these types of analyses, we are unrealistically ignoring all nontax factors critical in location decisions, such as wage rates, availability of skilled labor, the regulatory environment, politics, tariffs, energy costs, and proximity to customers and supplies. (For more on location decisions, see Michael E. Porter and Jan W. Rivkin, “Choosing the United States,” Harv. Bus. Rev. (Mar. 2012).) We also conveniently ignore all taxes except U.S. and foreign income taxes. This leaves out property, payroll, excise, and VATs that can play major roles in location decisions. On top of all this, we are even excluding some provisions in the new law that may be of particular importance to some taxpayers (for example, the increased industry-specific taxes on financial institutions and the new restrictions on the use of net operating losses).

Overall, the modeling suggests that foreign investment is likely to continue to be tax-advantaged relative to U.S. investment, but that on average that advantage has probably declined because of the TCJA. We emphasize “on average” because there are various factors that can push the changes in both their foreign and domestic tax liabilities either up or down. Those factors include qualification for section 199 deductions (under old law); state income tax rates; degree of leverage; qualification for bonus depreciation (under new and old law); tax basis in depreciable property (for calculating FDII and GILTI under new law); payments to foreign-related parties for services and access to intangible assets; foreign tax rates; and underlying pretax profitability.

It is hoped that for the set of calculations presented here, the values chosen are considered reasonable, but ultimately they at best illustrate results that could affect a typical taxpayer. Readers may want to substitute values that are more pertinent to their own situation or that they believe are more representative of average conditions. (This can most readily be done by sending an email titled “TCJA Spreadsheet” to martysullivan@comcast.net, and the Excel file used to create the table below will be forwarded. Values that may be amended are in the shaded cells.)

A. Partitioning Profit Rates

It has always been useful in tax economics to divide profits into normal and extra-normal (or pure) profits. A normal rate of profit is the lowest rate of return that will induce investors to undertake a project. Extra-normal profits are the gravy that makes capitalism fun.

With that in mind, here are three useful rules of thumb from tax economics. First, 100 percent expensing drives the effective rate of tax on an equity-financed investment earning a normal return to zero. Second, 100 percent debt financing drives the effective tax rate on investment depreciated at an economic rate of depreciation to zero. Third, an investment that is 100 percent expensed and 100 percent debt-financed has an effective tax rate equal to minus the statutory tax rate (for example, minus 21 percent under the TCJA). If projects have rates of return higher than the normal rate, the effective tax rates on those projects would be larger than those described above. One consequence of this, as emphasized by Thomas Neubig, is that in the presence of high rates of return, the importance of expensing relative to lower rates declines (Prior analysis: Tax Notes, Sept. 10, 2007, p. 959). We assume here that the normal rate of return is 5 percent.

The TCJA requires a further partitioning of rates of return because capital expenditures with returns above 10 percent can receive different treatment from investment with lower rates of return. The idea behind this is that returns above 10 percent suggest that income from intangible investments is present, and that it was the intention of Congress to provide an incentive for domestic intangible income and a penalty on foreign intangible income. But the 10 percent figure enshrined in the new law was pretty much pulled out of thin air. And there is no requirement in the law that intangibles be identified to trigger these new provisions.

If foreign tangible capital has a return of less than 10 percent, then the GILTI rules do not apply, and it is only the subpart F rules that prevent taxation from being truly territorial. To the extent foreign tangible capital has a return above 10 percent, the U.S. tax system begins to resemble a worldwide system with a 10.5 percent rate on foreign income.

In the example used in this article, we assume a factory will generate a rate of return on capital of 18 percent. Given the $10 million of investment, this means $1.8 million of income for shareholders and bondholders. The first $500,000 is normal return. The first $1 million is exempt from the GILTI and FDII provisions, but for the remaining $800,000 GILTI and FDII apply. (See Panel A.)

B. Rate Cut, Section 199, and State Taxes

In addition to the 14 percentage point decline in the statutory rate from 35 percent to 21 percent that took effect on January 1, the deduction for domestic production activities (section 199) was repealed. Generally equal to 9 percent of taxable income, the deduction reduced the effective marginal rate to 31.85 percent for qualifying business income.

According to the Joint Committee on Taxation, the section 199 deduction reduced corporate revenues by an estimated $14.6 billion in fiscal 2017 (“Estimates of Federal Tax Expenditures for Fiscal Years 2016-2020,” JCX-3-17 (Jan. 30, 2017)). According to the Treasury Department, total corporate tax receipts for fiscal 2017 were $297 billion (“Final Monthly Treasury Statement for Fiscal Year 2017,” Table 3 (Sept. 2017)). With a deduction equal to 9 percent of taxable income (except for the oil and gas industry, which had a deduction percentage of 6 percent), this implies about 20 percent of taxable corporate profit was eligible for the deduction. This is the figure used in Panel B.

With the rate reduction, there is a decline in value of the deduction for state and local corporate profit taxes. The OECD calculates the average state and local corporate statutory rate to be 6.01 percent. Taking into account the deductibility of the state and local corporate tax against federal income tax and the reduced rate for 20 percent of corporate profits, the average effective combined federal-state corporate tax rate in 2017 was 38.31 percent. The repeal of section 199 and the increased after-federal-tax burden of the state tax, combined with a new corporate rate of 21 percent, yields an average effective combined federal-state corporate tax rate in 2018 of 25.75 percent. So the average effective tax rate reduction is less than the 14 percent decline in the federal statutory rate (that is, 35 percent minus 21 percent). It is 12.5 percentage points (38.2 percent minus 25.7 percent). (See Panel B.)

It is important to keep in mind that this is only an average. For manufacturers in states like Minnesota and Pennsylvania with corporate rates of over 9 percent, the effective reduction from the TCJA is only 9.8 percent (38.3 percent less 28.5 percent), while for corporations in states with no corporate profits tax and no section 199 qualified activity, the rate reduction is the full 14 percent.

C. Interest Deductions

Following the lead of Germany and Italy, Congress in the TCJA adopted a limit on interest deductions equal to 30 percent of earnings before interest, taxes, depreciation, and amortization. Because depreciation usually is a relatively large amount, this is not a tight limitation for most corporations. For his January 6 presentation at the American Economic Association annual meeting, former Council of Economic Advisers Chair Jason Furman assumed that 15 percent of firms are constrained by the interest cap and that corporate capital investment is 32 percent debt-financed and 68 percent equity-financed. To mitigate the effect of the interest rate cap, many firms will shift their financing from debt to retained earnings and new equity. Firms are considering using their foreign earnings repatriated at preferential rates to pay down debt, according to Albert Liguori of Alvarez & Marsal Holdings LLC. (Prior analysis: Tax Notes Int’l, Jan. 22, 2018, p. 291.)

In this analysis, we assume that 30 percent of domestic and foreign investment is debt-financed except for domestic investment under the TCJA, when it is assumed — to account for the new limitations on interest deductions — that only 25 percent of investment is debt-financed. We also assume the normal rate of return is equal to the rate of interest on debt used to finance the investment, so the normal return on the portion of investment that is debt-financed is free from corporate income tax. (See Panel C.)

D. Expensing

Under pre-2018 law with 50 percent bonus depreciation and a 35 percent corporate tax rate, the effective tax rate on the normal return on qualified equity-financed investment was 17.5 percent. Under the TCJA with 100 percent bonus depreciation, the effective tax rate on the normal return on qualified equity-financed investment is zero. (Under prior law, to qualify for bonus depreciation, the original use of the property must begin with the taxpayer and the property must have a recovery period of 20 years or less, such as depreciable computer software, water utility property, or qualified leasehold improvement property. Under the new law, used property is qualified for bonus depreciation, public utility property is not, and extra benefits are available for aircraft.)

In Panel D, we assume that 60 percent of the factory’s capital spending qualifies for bonus depreciation. Given investment of $10 million, the amount of property eligible for expensing is $3 million before the TCJA and $6 million under the TCJA. With a 5 percent normal return, $150,000 is effectively tax free under prior law and $300,000 is effectively tax free under the TCJA. All other investment, including foreign investment, is assumed for the sake of simplicity to be depreciated at the economic rate of depreciation and therefore  — absent other provisions — fully subject to tax at the statutory rate.

E. FDII

The carrot-and-stick approach for attracting excess intangible profits — the patent-box-like benefits provided to U.S. excess profits known as FDII and the immediate worldwide-like taxation of foreign excess profits known as GILTI — undoubtedly makes investment in the United States more favorable. Despite all the references to intangible income, there are many reasons besides the existence of intangible assets for returns to exceed 10 percent. For example, there is luck, monopoly power, monopsony power, exchange rate fluctuations, and the ownership of non-depreciable land.

FDII provides an effective rate of tax of 13.125 percent (computed by applying a 37.5 percent income deduction to income taxed at a 21 percent rate) for intangible income associated with exports. FDII is exports’ share of the excess of total profits over a return defined by statute. That return equals 10 percent of total tangible depreciable assets (measured as the average at the end of each of four quarters during the tax year when net value is determined using straight-line depreciation). We already know from Panel A that total domestic profits in excess of 10 percent are $800,000, and in Panel E we assume that one-quarter ($200,000) of that amount is attributable to exports. The FDII deduction is 37.5 percent of $200,000, or $75,000.

It is interesting that the marginal tax rate on domestic investment depends on which of the three partitioned components of profits (from Panel A) is being considered. (1) For the portion of income that generates less than a 5 percent rate of return, the TCJA effectively wipes out all tax liability if the underlying investment qualifies for bonus depreciation. (If not, the normal 21 percent rate applies.) (2) For the portion of income generating a return in excess of 10 percent, the 13.125 percent rate applies if that return is related to exports. (Otherwise, the normal 21 percent rate applies.) And (3) for the portion of income between the assumed 5 percent normal rate of return and the statutorily determined 10 percent rate, the 21 percent rate always applies. FDII can only enhance the benefit of investing in the United States over what would be available with just a lower corporate rate and 100 percent bonus depreciation.

F. BEAT

Earnings stripping has long been recognized as a problem by policy analysts and as a great opportunity by practitioners with foreign-headquartered multinationals as clients. Deductible royalty payments, interest payments, and service payments to a foreign parent can shrink U.S. tax liability. Apparently, the October 3 testimony before the Senate Finance Committee by professor Bret Wells of the University of Houston Law Center had a major impact on the Senate drafting of the TCJA because his idea of restricting deductibility of payments to foreign related parties became part of the bill.

Under the TCJA (new section 59A), businesses with more than $500 million in gross receipts and more than a de minimis amount of certain related-party payments are potentially subject to a new 10 percent minimum tax, called the base erosion antiabuse tax (BEAT). The alternative tax base is similar to the regular tax base except otherwise deductible payments to a foreign related party (base erosion payments) are excluded from the calculation. Payments to foreign related parties for costs of goods sold are not base erosion payments, and payments to foreign related parties for services provided at cost are not base erosion payments. Also, some tax credits (excluding the research credit and 80 percent of low-income housing and some energy credits) are added to the minimum tax. So with a 21 percent corporate rate and a 10 percent BEAT rate, the additional tax on domestic capital from the BEAT is:

MAX[0, 0.1 * (TI + BEPAY) + BTAXCRED - 0.21TI] or,

MAX[0,(0.1 * BEPAY + BTAXCRED - 0.11 * TI)

In the absence of good tax planning, the BEAT could significantly increase U.S. tax on foreign-headquartered multinationals doing business in the United States. And even though it will, as advertised, put the bulk of its new burden on inbound investment — because U.S.-headquartered multinationals are already subject to U.S. tax on such payments and it is only natural for service and interest payments to flow from subsidiaries to parents — it applies equally to U.S.-headquartered businesses that pay interest on loans, fees for services, and royalties for intellectual property provided by foreign related parties.

It is expected that taxpayers will plan around this provision by burying fees for services and royalties paid to related parties (which are not deductible from the BEAT alternative minimum tax calculation) into the costs of goods sold from related parties (which are deductible under the BEAT). It is also worth noting that the scope of services exempt from the definition of base erosion payments may have been expanded by a colloquy between Sen. Rob Portman, R-Ohio, and Senate Finance Committee Chair Orrin G. Hatch, R-Utah (163 Cong. Rec. S7697 (Dec. 1, 2017)).

In Panel F, base erosion payments are assumed to reduce what would otherwise be taxable income by $2 million or 61 percent. The BEAT is triggered only if base erosion payments reduce taxable income by 52.4 percent (or, in this case, $1.43 million). The 10 percent BEAT rate applies to the $570,000 excess of the $2 million of BEAT payments over $1.43 million. The extra tax liability is $57,000. Depending on the size of base erosion payment relative to taxable income, the BEAT could significantly reduce the tax attraction for investment in the United States by foreign multinationals.

G. U.S. Investment Before TCJA and Now

Panel G summarizes the tax burden on our hypothetical investment in the United States before and after most of the TCJA provisions took effect. Before enactment, the estimated combined federal-state tax rate is 31.9 percent. After enactment, the benefit of the lower rate, 100 percent bonus depreciation, and FDII combine to reduce the effective rate to 18.6 percent. With the addition of the BEAT, the tax rate increases to 21.8 percent.

The remaining panels (H through J) attempt to measure the tax burden of the same investment if located outside the United States.

H. Benefit of Territoriality

The TCJA provides a 100 percent dividends received deduction for foreign-source dividends paid by a controlled foreign corporation to a C corporation that owns 10 percent or more of the dividend-paying CFC. (Ten percent owners of CFCs that are not C corporations are treated harshly under the international provisions of this bill.) The critical issue here is determining the burden of our formerly worldwide system that is now relieved by the move to a territorial system. Some might say it is the present value of after-foreign-tax earnings (less U.S. foreign tax credits) discounted in value to the same estimate of time between the earning and distribution of profits. Many would say the burden was close to zero, especially from a financial statement point of view, because foreign earnings designated as indefinitely reinvested did not have to accrue any U.S. tax on current foreign profits in their bottom line after-tax profits that enter into their earnings-per-share calculations.

One small part of the encyclopedic body of international tax research by Rosanne Altshuler and Harry Grubert provides us with a more sophisticated answer. Altshuler and Grubert take into account that although most foreign earnings are indefinitely reinvested, some actually incur direct U.S. tax costs when they are repatriated (but still gain the benefit of deferral); some would be repatriated in the future (especially if foreign balance sheets without the dividend exemption provided by the TCJA continue to swell); and all firms incurred nontax costs (such as complex tax planning to effectively repatriate without paying U.S. tax, less-than-optimal investment in foreign businesses, and the assumption of U.S. debt to provide domestic cash flow). Altshuler and Grubert estimate that the marginal cost — you can think of it as the implicit U.S. tax rate on pre-TCJA foreign profits — could have been as large as 7 percentage points. (See “Fixing the System: An Analysis of Alternative Proposals for the Reform of International Tax,” National Tax Journal, Sept. 2013, p. 671.) This is the burden of prior U.S. law’s worldwide taxation of foreign profits used in Panel H.

I. GILTI

The TCJA applies current U.S. tax on CFCs’ foreign-source income if that income is low-taxed and generates a high rate of return. GILTI is the excess of after-tax income of a CFC less 10 percent of the adjusted basis of the CFC’s depreciable property plus interest expense. Also included in income is the gross-up under section 78 for deemed taxes paid on GILTI. Foreign taxes attributable to GILTI are calculated by multiplying total foreign taxes paid by an inclusion percentage (equal to GILTI divided by tested income). Foreign tax credits are limited to 80 percent of taxes attributable to GILTI.

In our example, we assume the foreign tax rate is 12 percent and, as spelled out previously, the rate of return on depreciable capital is 18 percent. Fifty percent of GILTI plus the section 78 gross-up equals $342,050. Before foreign tax credits, U.S. tax at 21 percent is $63,210. Foreign taxes allocable to GILTI are $72,240. Creditable foreign taxes are 80 percent of that amount, or $57,790. Net U.S. tax due to GILTI after foreign tax credits is $5,420. If the foreign tax rate was 4 percent instead of 12 percent, the additional U.S. tax from GILTI would be $43.950.170, nearly eight times larger. If the (worldwide) foreign tax rate exceeds 13.125 percent, there is no U.S. tax liability from GILTI.

J. Foreign Investment Before and Now

Panel J summarizes the tax burden on our mythical factory outside the United States before and after January 1. Before the TCJA took effect, the estimated combined federal-state tax rate is 17.4 percent. After enactment of the TCJA, the elimination of the 7 percent burden due to U.S. worldwide taxation more than offsets the new burden imposed by GILTI (at least in this example). As a result of the TCJA, the effective rate on foreign investment is reduced from 17.4 percent to 11.3 percent. Note that this example assumes that the reduction in the U.S. corporate tax rate will not spur tax competition by foreign jurisdictions. If the foreign rates are driven lower by the TCJA, our estimated 11.3 percent effective rate on foreign investment after enactment would be lower.

K. The Tilt Before TCJA and Now

For the example whose calculations are spelled out in the table, the tilt of the international playing field due to taxes before the TCJA was 14.5 percentage points in favor of foreign investment (Base Case). That tilt is reduced to 10.5 percent if the BEAT applies (Base Case), and even more — to 7.3 percent — if the BEAT does not apply (Alternative 1).

Given the myriad possibilities and the limited patience of readers, we have for now only explored a few other possibilities. If in our base case the underlying rate of return on investment is increased from 18 percent to 30 percent, the advantage to foreign investment shrinks even further — from 16.4 percent to 6.5 percent (Alternative 2). This is largely due to increased effects of both FDII and GILTI.

If the rate of return is reduced from 18 percent to 8 percent and the negative effect on domestic investment from the BEAT is not included, the advantage to foreign investment under prior law of 8.5 percent is nearly eliminated to 1.8 percent (Alternative 3). This is in part due to the proportionately larger effect that 100 percent bonus depreciation has in these calculations.

If we reduce the base foreign tax rate from 12 percent to 4 percent, the foreign advantage is only reduced from 21.8 percent to 17.7 percent (Alternative 4). This is in part due to the increased penalty on foreign investment from GILTI.

Other calculations not shown indicate that large base erosion payments can significantly increase U.S. tax and more than offset any advantages of foreign investment under prior law. So, in sum, it seems that based on these few examples, the TCJA moves in the direction that makes policy sense. For U.S.-headquartered multinationals, the tax incentives to invest abroad, although not eliminated, are decreased. And the tax advantages enjoyed by tax foreign-headquartered multinationals doing business in the United States over U.S. firms doing business in the United States are limited.

Calculation of Effective Tax Rate on $10 Million Investment in United States and Abroad Under Prior and Current Law (dollar amounts in thousands)

 

U.S.

Foreign

Pre-TCJA

TCJA

Pre-TCJA

TCJA

A. Partitioning returns

Factory cost, tangible capital expenditures

$10,000

$10,000

$10,000

$10,000

Percent total return on capital (determined by project)

18%

18%

18%

18%

Total return in dollars

$1,800

$1,800

$1,800

$1,800

Normal return percentage (set by economic conditions)

5%

5%

5%

5%

Normal return in dollars

$500

$500

$500

$500

“Intangible” return percentage (set by statute for FDII and GILTI)

10%

10%

10%

10%

Intermediate return in dollars

$500

$500

$500

$500

Excess return in dollars

$800

$800

$800

$800

B. Statutory rate, section 199, and state corporate tax

U.S. statutory rate (“T”)

35%

21%

 

 

Note: Difference in favor of foreign investment

14%

 

 

 

Percentage of corporate profit eligible for section 199 deduction

20%

0%

 

 

Section 199 percentage

9%

0%

 

 

Average rate after section 199 deduction [= T * (0.8 + (1 - 0.09) * 0.2)]

34.37%

21%

 

 

Average state corporate rate (from OECD)

6.01%

6.01%

 

 

Average state rate after federal deduction

3.94%

4.75%

 

 

Combined federal-state corporate statutory rate (“T adjusted”)

38.31%

25.75%

 

 

Note: Difference in favor of foreign investment

12.57%

 

 

 

C. Interest deductions

Percentage of factory cost debt financed

30%

25%

30%

30%

Loan amount

$3,000

$2,500

$3,000

$3,000

Interest rate on loan

5%

5%

5%

5%

Interest cost

$150

$125

$150

$150

Deductible return on capital (zero tax rate)

$150

$125

$150

$150

Domestic investment

D. Benefit of bonus depreciation

Percent bonus depreciation (e.g., 100%, 50%)

50%

100%

 

 

Percentage of factory cost eligible for bonus depreciation

60%

60%

 

 

Normal return with zero rate

$150

$300

 

 

E. Benefit of FDII

Percentage of product exported (“foreign derived”)

 

25%

 

 

Excess return in dollars (excess of 10% of depreciable capital)

 

$800

 

 

Excess returns attributable to exports

 

$200

 

 

FDII deduction percentage (37.5% through 2025, then 21.875%)

 

37.5%

 

 

FDII deduction dollars

 

$75

 

 

F. Penalty of BEAT on domestic investment

U.S. taxable income (gross less interest less bonus less FDII)

 

$1,300

 

 

Base erosion payments (“BEPAY”)

 

$2,000

 

 

Taxable income without deductions for BEPAY

 

$3,300

 

 

Percentage that BEPAY reduces taxable income

 

60.61%

 

 

BEAT min tax rate (5% in 2018, 10% until 2025, and then 12.5%)

 

10%

 

 

BEAT min tax calculation [= 0.1 * (TI + BEPAY)]

 

$330

 

 

U.S. corporate tax rate (TCJA)

 

21%

 

 

Taxable income (“TI”)

 

$1,300

 

 

Tax credits to be added to potential BEAT liability (assumed zero)

 

$0

 

 

Regular tax liability to compare to BEAT min tax liability

 

$273

 

 

BEAT tax = max[0,0.1 * (TI + BEPAY) + BTAXCRED - 0.21 * TI]

 

$57

 

 

G. Summary: tax rate on U.S. investment

U.S. taxable income (gross - interest - bonus - FDII)

$1,500

$1,300

 

 

U.S. corporate statutory rate (adjusted)

38.31%

25.75%

 

 

U.S. tax on U.S. profit

$574.72

$334.72

 

 

U.S. tax rate without BEAT

31.9%

18.6%

 

 

Add any BEAT tax

$0

$57

 

 

Total U.S. tax on U.S. profit

$574.72

$391.72

 

 

U.S. tax rate (as percentage of total return on capital)

31.9%

21.8%

 

 

Foreign investment

H. Territorial taxation

Foreign tax rate

 

 

12%

12%

Foreign taxable income (with interest deduction)

 

 

$1,650

$1,650

Foreign tax

 

 

$198

$198

Implicit effective U.S. tax rate on foreign profit (Altshuler-Grubert)

 

 

7%

0%

Implicit U.S. tax

 

 

$115.50

$0

Combined U.S.-foreign tax (so far)

 

 

$313.50

$198

I. GILTI: U.S. tax on high-return, low-tax foreign income

Total return

 

 

 

$1,650

Foreign tax

 

 

 

$198

Tested income

 

 

 

$1,452

Normal return percentage (set by statute)

 

 

 

10%

“Net deemed tangible income return” [10% of factory less interest]

 

 

 

$850

GILTI [= tested income less 10% factory plus interest]

 

 

 

$602

Inclusion percentage (= GILTI/tested income)

 

 

 

41%

Section 78 gross-up (= foreign tax times inclusion percentage)

 

 

 

$82.09

GILTI plus section 78 gross-up

 

 

 

$684.09

GILTI percentage (50% through 2025, 37.5% afterwards)

 

 

 

50%

GILTI percentage times (GILTI + section 78 inclusion)

 

 

 

$342.05

Tentative U.S. tax on GILTI and gross-up (at 21% rate)

 

 

 

$63.21

Foreign tax rate

 

 

 

12%

Foreign tax on GILTI

 

 

 

$72.24

Foreign tax credit (maximum 80% of foreign tax)

 

 

 

$57.79

U.S. GILTI tax after foreign tax credit

 

 

 

$5.42

Combined U.S.-foreign tax (with GILTI tax, if any)

 

 

$313.50

$203.42

J. Summary: tax rate on foreign investment

Combined U.S.-foreign tax rate (as percentage of total return on capital)

 

 

17.4%

11.3%

K. Comparison: prior law and TCJA

Base case:

Tax rate on investment in factory

31.9%

21.8%

17.4%

11.3%

Differential in favor of foreign investment

14.5%

10.5%

 

 

Alternative #1: without the BEAT

Tax rate on investment in factory (without the BEAT)

31.9%

18.6%

17.4%

11.3%

Differential in favor of foreign investment

14.5%

7.3%

 

 

Alternative #2: base case with total rate of return 30%

Tax rate on investment in factory

34.5%

18.4%

18.1%

11.9%

Differential in favor of foreign investment

16.4%

6.5%

 

 

Alternative #3: alternative #1 with total rate of return 8%

Tax rate on investment in factory

23.9%

12.1%

15.4%

10.3%

Differential in favor of foreign investment

8.5%

1.8%

 

 

Alternative #4: base case with foreign tax rate of 4%

Tax rate on investment in factory

31.9%

21.8%

10.1%

4%

Differential in favor of foreign investment

21.8%

17.7%