Last month, Senate Finance Committee Chair Ron Wyden of Oregon and fellow Finance Committee Democrats Sherrod Brown of Ohio and Mark Warner of Virginia released a draft proposed overhaul of the international tax regime (the “Wyden Proposal”). The Wyden Proposal would make significant changes to key aspects of the 2017 Tax Cuts and Jobs Act, including changes to the GILTI, BEAT and FDII regimes. The Wyden Proposal would also make sweeping changes to the calculation and availability of foreign tax credits. However, the proposal leaves a number of key tax rates blank—presumably to provide flexibility for the legislative process and meeting budgetary targets.
The Wyden Proposal would make several changes to the GILTI calculation. At a high level, it would eliminate the offsets for QBAI and tested losses. It would also turn the GILTI high-tax exception into a mandatory high-tax exclusion: all high-taxed income and the foreign taxes associated with that income would be removed from the GILTI calculation. In addition, the determination of whether income is high taxed would be made on a country-by-country basis. These changes are in line with the framework issued by the three Senators earlier this year. As in the framework, important tax rate decisions are still to be determined.
The mandatory high-tax exclusion would be implemented by adding a new carve‑out to the definition of tested income, for “high‑taxed tested income.” This term would mean income of a CFC that is subject to an effective foreign tax rate greater than the GILTI rate, and that would otherwise be tested income. The effective foreign rate would be computed separately for each tested unit of a CFC.
The Wyden Proposal would define “tested unit” in a manner largely consistent with the current GILTI high-tax exception (HTE) regulations. A tested unit of a CFC would mean (1) the CFC, (2) an interest held directly or indirectly by the CFC in a pass-through entity that is a tax resident of a foreign country or is treated as a corporation (or otherwise as not fiscally transparent) under the CFC’s
home-country tax law, and (3) any branch whose activities are carried on directly or indirectly by the CFC and that gives rise to a taxable presence in the country where it is located.
The Wyden Proposal would also include a tested unit combination rule. This rule would be similar to, and somewhat broader than, the combination rule under the current GILTI HTE regulations. All tested units of a CFC that are tax residents of the same foreign country would be treated as a single tested unit. Additionally, if two or more CFCs are members of the same expanded affiliated group, all tested units of those CFCs that are tax residents of the same foreign country would be treated as a single tested unit, but only for purposes of applying GILTI to a U.S. shareholder that is also a member of the group. The term “expanded affiliated group” would be defined by reference to § 1504(a), substituting “more than 50 percent” for “at least 80 percent,” and including foreign corporations and insurance companies in the group. Partnerships could not be used to break affiliation. Treasury would be granted authority to write regulations to include branch tested units in the combined tested unit concept.
The ability to combine tested units of different CFCs would be an appropriate technical change to the current GILTI HTE regulations. Consider, for example, a U.S. parent company that owns French CFC1, which owns French CFC2. In Year 1, CFC1 has 100 of income and CFC2 has (100) of loss. CFC1 and CFC2 file consolidated returns in France, and no French tax is due in Year 1. Under current rules, CFC1 would be low-taxed. Its 100 of income would be tested income, with no associated foreign taxes. Under the Wyden Proposal, CFC1 and CFC2 would be combined, and would have no tested income or tested loss. This will be an important change, especially if the GILTI rate is increased significantly from its current 10.5%.
Interestingly, while the Wyden Proposal would provide an extensive definitional framework for the tested unit concept, it would provide no guidance at all on the computational aspects of determining the effective foreign rate. For example, would we apply a books‑and‑records approach to assign gross income, deductions and foreign taxes to different tested units, as under the current GILTI HTE regulations? The Wyden Proposal is silent on this point. It does say that an item is generally assigned to the lowest-tier tested unit to which it is properly attributable. This is in line with the current regulations.
The Wyden Proposal would specifically provide that tested units with tested losses would be treated as high-taxed. Thus, tested losses would be excluded from the GILTI calculation.
Foreign taxes imposed on high-taxed income could not be credited or deducted. The Wyden Proposal also has a placeholder for timing issues in GILTI. This could include, perhaps, taking into account foreign NOL carryovers, and/or timing differences between U.S. and foreign law.
A few changes would also be made to the GILTI foreign tax credit under § 960(d). As with other tax rate choices, the Wyden Proposal leaves the question of the haircut percentage to be determined, indicating a haircut between 0 - 20%. It would also allow for regulations to expand the definition of tested foreign income taxes to include income taxes paid by a U.S. shareholder’s foreign parent company with respect to the income of a CFC. Presumably, this authority is meant to pick up Pillar Two GloBE minimum taxes imposed at the group parent level. It could also potentially apply in foreign consolidated groups.
A new Form 5471 reporting requirement would be added. The gross income, deductions and taxes of each tested unit would have to be reported. We found it noteworthy that Congress, at least, still believes statutory authority is required to impose a new reporting requirement.
The effective date would be prospective: the proposed GILTI changes would apply to taxable years of foreign corporations beginning after the date of enactment. This would generally mean 2022 for
Subpart F Changes
The Wyden Proposal also would update certain Subpart F FTC rules to make them more closely align with the GILTI rules.
An FTC haircut would apply to Subpart F income. The amendment to § 960(a) implementing the change is still bracketed as
[80 - 100]% of foreign income taxes. Thus, the FTC haircut could be anywhere from 0 - 20%. The discussion draft notes that the FTC haircuts for Subpart F and GILTI could be the same, but that they do not necessarily have to be the same.
The FTC haircut would also be added to FTCs on previously taxed earnings and profits (PTEP) so that withholding taxes and net income taxes are treated similarly. The extent of the haircut could be anywhere from 0 - 20% (the amount is still bracketed).
As with GILTI, the percentage limitations do not apply for purposes of determining the § 78 gross-up.
Like for GILTI, the Wyden Proposal makes the high-tax exception to Subpart F mandatory. The exclusion would apply when the effective foreign tax rate is higher than the maximum U.S. corporate rate. The 90% factor would be eliminated. The effective foreign rate would be determined on a CFC-tested unit basis, separately for general and passive basket income.
Thus, the Subpart F high-tax exclusion rules would generally be the same as the rules for the GILTI high-tax exclusion, including the use of the tested unit, the aggregation rules, and the rules for losses. The main difference would be the tax rate used to measure whether income is “high taxed.”
These changes would also be prospective only: they would apply to CFC tax years beginning after the date of enactment.
High-Tax Foreign Branch Income
The Wyden Proposal would create a new high-tax exclusion
rule for foreign branches in new § 139J. Income would be considered high-tax foreign branch income if it is subject to a tax rate greater than the highest U.S. corporate rate or greater than the highest individual rate. High-tax foreign branch income earned by a U.S. corporation would be exempt from tax.
The effective foreign income tax rate would be computed separately for each foreign branch, but an aggregation rule would apply to same-country branches.
The foreign tax credits that are taken into account in determining the effective rate of foreign tax would be potentially subject to a haircut of 0 - 20%, though the amount is still bracketed.
There would be no FTC or deduction for foreign taxes imposed on high-tax foreign branch income. FTCs would also be disallowed for loss branches.
The Wyden Proposal would define a “foreign branch” to mean any branch if (1) its activities are carried on directly or indirectly by the taxpayer; (2) it is not a tested unit of a CFC of the taxpayer; and (3) it gives rise to a taxable presence in its country.
The changes would also be prospective, applying to taxable years beginning after the date of enactment.
Changes to Make FDII into an Innovation Box
The Wyden Proposal would retain the deduction for FDII, but rework it to serve as a sort of “innovation box” to incentivize certain R&D and job-training activities in the U.S. The basic framework of new § 250 would remain the same: only certain categories of deduction eligible income that is derived from provision of goods or services for use outside of the U.S. would qualify. Unlike a pure innovation box, new
§ 250 would remain an export incentive. In addition, other aspects of the rules, such as expense allocations and the taxable income limitation, would remain in place.
A key element of new § 250 would be to limit the amount of § 250 deduction to the U.S. corporation’s “domestic innovation income,” defined as a yet-to-be determined percentage of the U.S. corporation’s qualified R&D expenditures and qualified job training expenses. Qualified R&D expenditures are defined as R&D expenses allowed as a deduction under § 174 and attributable to activities performed in the U.S. (If the mandatory capitalization of R&D beginning in 2022 is not changed through legislation, the qualified R&D amount would be limited to the amount allowable as amortization during the year at issue. If so, the benefits of the Wyden “innovation box” would be significantly postponed.) Qualified job training expenses are expenses associated with certain recognized types of job training programs towards achieving recognized post-secondary credentials. Qualified job training expenses must be incurred for the benefit of non-highly compensated employees.
The Wyden Proposal could be seen as an attempt to salvage the FDII deduction by re-aligning it with certain U.S. activities that the Code wants to incentivize. For tech companies that conduct significant U.S.-based R&D, new § 250 could still provide significant benefits to holding foreign IP in the U.S. (depending, of course, on the percentage used to determine innovation income). The new proposals would also correct the perverse effects of the current rules regarding QBAI as a limitation on the FDII deduction.
Allocation and Apportionment Relief under Section 861 – but only After Cross-Crediting is Repealed
After TCJA’s introduction of GILTI and lowering of the corporate rates, allocation and apportionment of expenses under § 861 took on renewed importance. The Wyden Proposal would give taxpayers relief from allocation and apportionment of certain expenses against foreign source income, by providing that all U.S.-conducted R&D expense and all U.S.-based stewardship functions are allocated solely to domestic source income. This is aimed at encouraging multinational companies to retain R&D and headquarters jobs in the U.S. Expenses of foreign conducted R&D activities, which is borne by the U.S. parent through intercompany agreements, would continue to be subject to allocation and apportionment under § 1.861-17. Interest expense would still be subject to allocation and apportionment for foreign tax credit limitation purposes.
While this proposed change to § 861 will be helpful to taxpayers, its effects should be considered in context of the changes to the foreign tax credit regime, discussed above. Under a new regime where the high-tax exclusion is mandatory, taxpayers will have limited if any ability to engage in “cross crediting” of high-taxed foreign income against low-taxed foreign income. Companies with high-taxed foreign earnings would no longer be able to claim a foreign tax credit on that income due to the mandatory high-tax exclusions. Thus, not many taxpayers would be in an excess credit position and the new change may not have as much relevance as it would in the current foreign tax credit system.
Notably absent from the Wyden Proposal is the Bluebook’s proposed changes to § 265 to disallow deductions attributable to the
tax-exempt portion of GILTI.
Making the BEAT’s Bite a Little Sharper
The Wyden Proposal would revise and retain the BEAT. A placeholder is noted in the proposal for a coordination of BEAT with the more radical SHIELD proposals made in the Greenbook. If SHIELD were adopted, BEAT would seem to be unnecessary and it is unclear how the legislation envisions BEAT interacting with SHIELD.
The Wyden Proposal would revise the BEAT formula in a way to cause it to be more effective in raising revenue from inbound companies. Currently, the BEAT is imposed only if the taxpayer’s modified tax liability, determined at a 10% rate without regard to base erosion tax deductions, exceeds the taxpayer’s regular tax liability. In the case of an inbound situation, where the U.S. group does not have significant NOLs or foreign tax credits, the formula by its terms allows a significant degree of base erosion through deductible-related party payments. By contrast, a U.S. parented group which makes related party payments to its subsidiaries could more readily incur a BEAT liability to the extent foreign tax credits reduce its regular tax liability.
Without correcting the punitive treatment of foreign tax credits or reforming the treatment of NOLs in the BEAT, the Wyden Proposal would change the definition of base erosion tax liability to mean 10% of the taxpayer’s regular tax liability, plus an unstated percentage of the taxpayer’s modified tax liability determined without regard to base erosion tax benefits. The impact of the revised calculation can be seen in the following simple inbound example:
Assume a U.S. subsidiary has $100 of taxable income (without regard to intercompany payments), $50 of interest expense payable to foreign parent and no NOLs or tax credits. Such a taxpayer’s regular tax liability ($10.5) would exceed its modified tax liability under § 59A at a 10% rate ($10). (Effectively, in a situation with no NOLs or credits, the current BEAT rules allow the taxpayer to cut its tax liability in half through base erosion payments). Under the Wyden Proposal, the taxpayer would owe a BEAT liability equal to the BEAT rate (left blank) multiplied by the $50 reduction of the taxpayer’s regular tax liability through the base erosion payments.
The Wyden Proposal would change the treatment of credits to permit all of the taxpayer’s general business credits to be used, whereas current law only allows 80% of certain general business credits to be used.
Other aspects of the BEAT, such as treatment of NOLs and foreign tax credits, the cliff effect of being an “applicable taxpayer” with 3% base erosion payments and treatment of COGS, would remain unchanged.
The interaction between the Wyden Proposal’s BEAT and GILTI changes is also interesting. High-taxed CFC tested income would be excluded from the U.S. return altogether, rather than included with unusable excess credits. Since the BEAT does not allow for FTCs, the GILTI change could reduce BEAT exposure for some.
Overall, the Wyden Proposal would not make changes that are as
far-reaching as President Biden’s tax proposals that were part of his campaign and have been offered up by his Treasury Department. Nevertheless, many important questions remain unanswered, not least of which are tax rates and the extent to which taxpayers can utilize foreign tax credits.