The Biden Administration has set an ambitious course for tax reform and the tax world is abuzz. It wants to overhaul our corporate tax system, particularly the international aspects. In addition, it wants to increase taxes on the wealthy, defined as taxpayers making more than $400,000 per year, which should ring familiar from the presidential campaign. The Biden Administration ties these tax increases to particular spending proposals, most notably infrastructure spending and programs designed to grow and support the middle class, but its goals are more profound. It aims to raise more revenue generally, address income inequality, and make the tax law more efficient. The Biden Administration is “going big” and taking on some big challenges in the process, perhaps none greater than seeking “a near-elimination of profit shifting.” It does little good to raise the U.S. corporate tax rate if multinational companies can shift profits to avoid it. To solve this problem, the Biden Administration needs to convince not only Congress, but also the international community, of its approach.
Profit shifting occurs when a multinational company steers income from a high-tax jurisdiction to a low-tax or no-tax jurisdiction, for example, by transferring intangible property to a subsidiary in Bermuda, which has no corporate income tax, and paying the subsidiary a handsome royalty for use of the intangible property. The royalty payment is deductible in the U.S. and reduces U.S. tax without any corresponding increase in tax in Bermuda. Companies such as Apple, Pfizer and Coca-Cola have long escaped U.S. corporate tax this way to the tune of $60 billion per year in lost tax revenue. In 2017, Congress arguably made the problem worse by lowering the corporate tax rate on U.S. income from 35% to 21% and imposing a 10.5% minimum tax on worldwide intangible income, cheekily named Global Intangible Low-Taxed Income or GILTI. These changes were designed to reduce the tax burden on U.S. companies competing in a global marketplace. But under this system, U.S. companies can pay half the tax on profits derived from intangible property simply by locating it outside the U.S. Congress also exempted from GILTI a normal rate of return on tangible property located outside of the U.S., equal to 10% of its cost basis, making the incentive to offshore tangible property even stronger.
The surefire way to eliminate profit shifting is to impose the same amount of tax on income recognized abroad as income recognized domestically. But the Biden Administration cannot do that, because it wants to increase the corporate tax rate on U.S. income to 28% to raise more revenue and a tax rate of 28% on foreign income would harm the ability of U.S. companies to compete in places like Ireland where the corporate tax rate is a mere 12.5%. The rate discrepancy would mean that a U.S. company would have to earn a pretax profit of $121.50 for every $100 earned by a foreign company to get the same economic result. Not letting the perfect be the enemy of the good, the Biden Administration instead wants to increase the GILTI rate to 3/4th of the corporate tax rate on U.S. income, or 21%, and eliminate the exemption on profits from tangible property.
The lynchpin for much of what the Biden Administration hopes to accomplish with the corporate tax comes down to convincing the world – or at least the largest economies – to follow its lead on raising rates. If other nations adopt a 21% minimum corporate tax, then the playing field is even and the central argument against raising U.S. corporate tax rates goes away. The good news is that over 135 countries are engaged in an effort to reach consensus on a global minimum tax through the Organization for Economic Cooperation and Development. The bad news is that those talks, called the Base Erosion and Profit Shifting Project or the BEPS Project, have dragged on for years and thus far have focused on rates well below 21%. To lay the groundwork for raising U.S. corporate tax rates and avoiding profit shifting, the Biden Administration needs to sell those priorities to the rest of the world.
Andrew Weiner is the Director of the Graduate Tax Program and a Practice Professor of Law at Temple University Beasley School of Law.