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Senate Finance Chairman Wyden releases international tax reform discussion draft

August 2021

In brief

Senate Finance Committee Chairman Ron Wyden (D-OR) and Finance Members Sherrod Brown (D-OH) and Senator Mark Warner (D-VA) today released discussion draft legislation (the ‘Discussion Draft’) and a six-page, section-by-section staff description (the ‘Description’) on international tax reform proposals. The Discussion Draft builds on concepts set forth in a framework outline of proposals for overhauling international taxation that was released by Chairman Wyden, Senator Brown and Senator Warner on April 5, 2021.  

The Discussion Draft and the Description provide additional insight into how Chairman Wyden and Finance Committee Democrats may propose to change current international tax provisions related to global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), the base erosion and anti-abuse tax (BEAT), and subpart F in general. Public comments are requested by September 3, 2021.

Chairman Wyden’s release of the Discussion Draft follows House approval on August 24 of a Senate-passed budget resolution that provides reconciliation instructions for spending and tax relief provisions that would be offset in part by corporate and individual tax increases. With passage of the budget resolution, House and Senate committees, including the House Ways and Means and Senate Finance Committees, can begin drafting reconciliation legislation. The budget resolution sets a non-binding deadline of September 15 for committees to draft and report legislation for further action in the House and Senate.  

Action item: The House and Senate tax committees are preparing to act on legislation that likely would increase corporate and individual tax rates and make significant changes to current international tax rules, along with other changes to current tax law. Stakeholders should continue to communicate with policy makers on the potential effects of tax increase proposals on their employees, job creation, and investments in the United States and abroad.

In detail

Senate Finance Chairman Wyden is preparing for action on a reconciliation bill in his committee with today’s release of the Discussion Draft. Recent approval by both the House and Senate of an FY 2022 budget resolution with reconciliation instructions provides the procedural protections needed to enact a significant spending and tax bill with only Democratic votes over the expected opposition of Congressional Republicans. 

Observation: While the budget resolution sets a non-binding deadline of September 15 for the House and Senate committees to report legislation for further action in both chambers, it is unclear whether the Ways and Means Committee and the Finance Committee, will be able to report legislation acceptable to both moderate and progressive Democrats in both chambers in such a short period of time. 

The Discussion Draft released today by Finance Chairman Wyden generally aligns with several of the international tax proposals offered earlier this year by President Biden to pay for a variety of spending priorities, but meaningfully differs from the administration’s approach on some specific provisions. In a press release, Chairman Wyden described the Discussion Draft as a starting point for conversations in the Democratic caucus on how to reform the international tax system and noted that additional international tax policies are also under consideration.

Chairman Wyden has stated that decisions on rates and overall revenue to be raised will be made by the full Democratic caucus. For example, the Discussion Draft does not specify a new GILTI tax rate, which President Biden has proposed to increase to 21% along with his proposal to increase the US corporate tax rate to 28%. The April 5 Framework stated that it was an open question whether the GILTI rate should equal the US corporate tax rate or remain at a lower proportion of the US rate (e.g., 75% as proposed by the Biden administration). The Framework noted that prior Democratic proposals had suggested taxing foreign earnings at a rate between 60% and 100% of the US corporate tax rate.

Global intangible low-taxed income (GILTI) and subpart F income

  • The Discussion Draft includes the following proposed changes to the rules for GILTI (including a name change) and subpart F income:
  • Eliminate the exemption for the deemed return from qualified business asset investment (QBAI) by defining the GILTI inclusion amount (referred to as the ‘global inclusion of low-tax income’) as net CFC tested income, rather than the excess of net CFC tested income over the net deemed tangible income return. 
    • Provide a country-by-country system for GILTI by imposing a mandatory high-tax exclusion. The provision would effectively impose US tax on tested income amounts not otherwise excluded as ‘high-tax tested income.’ 
    • Define high-tax tested income as tested income with an effective rate that after incorporating any foreign tax credit (FTC) haircut, is greater than the GILTI rate, where the effective tax rate would be determined on a tested-unit basis.  
    • Define a ‘tested unit’ to include controlled foreign corporations (CFCs), foreign branches owned by a CFC, and interests in certain passthrough entities held by a CFC.  
    • Bifurcate the operations of CFCs into separate tested units by treating the operations outside of the CFC’s country of tax residence as a branch or other separate interest. 
    • Aggregate (1) all tested units in the same CFC and in the same country into a single tested unit and (2) all tested units in the same country that are members of the same expanded affiliated group into a single tested unit.  
    • Treat income of a tested unit with a tested loss as high-tax tested income, thereby causing the tested losses, as well as any foreign taxes, attributable to that tested unit to be excluded from GILTI.
    • Extend the aggregation rules for tested units to also apply to losses such that a tested unit with losses is only treated as a high-tax tested unit if there is a loss once all aggregation rules have been applied. 

Observation: It is not yet clear how the effective tax rate will be calculated as the Discussion Draft does not state a specific formula. Under current rules, the formula would be the tested unit's after-haircut percentage of allocable taxes, divided by the tested unit's tested income grossed up for the numerator. However, the effective tax rate could be calculated by taking the after-haircut percentage of allocable taxes and dividing it by the local country's pre-tax taxable income; or the after-haircut percentage of allocable taxes could be divided by the tested unit's tested income less allocable shareholder expenses, grossed up for the numerator. Moreover, the effective tax rate calculation could take into account prior-year losses, measured under US tax principles or local tax principles, or could be determined as an average over a period of time.

  • Apply the high-tax exclusion to subpart F in the same manner as GILTI, including the use of the tested unit, the aggregation rules, and the rules for losses. Income that would be in the passive basket would be separately basketed from income that would be in the general basket for purposes of the high-tax exclusion. 
  • Impose new reporting requirements for the amounts of income and deductions attributable to, and the effective tax rate of, each tested unit.
  • Pursuant to the Description, the Senate Finance Committee continues to consider the best way to address timing issues associated with the country-by-country high-tax exclusion; however, the Description notes that special rules dealing with timing should operate within the framework of the proposed high-tax exclusion and retain the country-by-country purpose that prevents losses in one country from offsetting income in another. 
  • The foregoing proposed amendments to the GILTI and subpart F rules would apply to tax years of foreign corporations beginning after the enactment date of the proposals in the Discussion Draft and to tax years of United States shareholders in which or with which such tax years of foreign corporations end.

Foreign tax credits

The Discussion Draft would make significant changes to the FTC system by:

  • Updating the FTC rules in the following manner: 
    • Apply a similar FTC haircut for subpart F as for GILTI. 
    • Extend the FTC haircut to taxes imposed on previously taxed earnings and profits to ensure that withholding taxes and net income taxes are treated similarly.  
    • The FTC haircut amount is yet to be determined; however, the Description notes the haircut could be anywhere from zero to 20%.
  • Extending the high-tax exclusion to foreign branches of taxpayers in new Section 139J and excluding ‘high-tax foreign branch income’ (defined as gross income subject to a tax rate greater than the corporate rate or highest individual rate, as applicable) from a taxpayer’s gross income. Like GILTI and subpart F, the high-tax foreign branch exclusion would be determined on a country-by-country basis, with branches in the same country being aggregated, and FTCs attributable to income that is not high-tax subject to the same haircut as subpart F and GILTI FTCs (a haircut of between zero and 20%).  FTCs attributable to branches with losses would be disallowed. 
  • Treating research and experimentation (R&E) expenses and stewardship expenses as entirely US-source if the activities were conducted within the US. The treatment of R&E and stewardship expenses relating to activity performed outside the United States would continue to be treated in the same manner as under current law. 
  • The foregoing proposed amendments would apply to tax years beginning after the enactment date of the proposals in the Discussion Draft. There is also a transition rule for qualified R&E.

Observation: The Discussion Draft contains no provision related to interest expense, indicating interest would continue to be allocated and apportioned as under current law.

Foreign-derived intangible income (FDII)

The Discussion Draft includes several amendments to the FDII regime, including some name changes. The Discussion Draft would propose to:

  • Retain the acronyms FDII and DII, but refer to newly defined concepts ‘foreign-derived innovation income’ and ‘domestic innovation income’ rather than to ‘foreign-derived intangible income’ and ‘deemed intangible income.’ The change from current DII to new DII is the most extensive amendment to section 250 and would, as discussed further below, determine the FDII deduction based on the amount of certain R&D or worker training expenses incurred by the taxpayer. 
  • Retain the general calculation of FDII (i.e., FDII = DII * (FDDEI/DEI). However, new DII is based on different factors than the current DII. Current DII is equal to DEI minus 10% of QBAI. Newly defined DII would be equal to the lesser of (i) the domestic corporation’s DEI or (ii) the sum of a percentage (to be determined) of the domestic corporation’s (a) ‘qualified research and development expenditures’ attributable to activities conducted in the United States and (b) ‘qualified worker training expenses’ attributable to activities conducted in the United States. 
    • The term qualified research and experimental expenditures means research and experimental expenditures that are eligible to be deducted under Section 174.  
    • The term ‘qualified training’ expenditures means any expenditures for the ‘qualified training’ of any ‘non-highly compensated employee.’
      • The term ‘qualified training’ means training (i) that results in the attainment of a recognized post-secondary credential and (ii) is provided through one of four enumerated categories of training, education, or apprenticeship programs.
      • The term ‘non-highly compensated employee’ means an employee of the taxpayer whose annual remuneration for services provided to the taxpayer does not exceed $82,000 (which amount would be adjusted annually for inflation beginning after 2022).
  • Retain the annual Section 250 deductions for (i) FDII (as newly defined), (ii) Section 951A inclusions, and (iii) the Section 78 gross-up associated with such Section 951A inclusions, but reduce and equalize the percentage applied to each such amount in determining the allowed deductions. The Discussion Draft does not provide the new deduction percentage.
  • Retain the taxable income limitation, amended to include the Section 78 gross-up amounts (in addition to FDII and Section 951A inclusion amounts), thereby addressing the so-called ‘GILTI glitch.’
  • Retain without modification the rules for determining DEI and FDDEI and the rules applicable to related-party transactions.
  • Retain the foreign-derived ratio (i.e., the ratio of FDDEI to DEI) to apply to DII (as newly defined) in determining FDII (as newly defined).

Observation: The Discussion Draft does not provide an effective date for the amendments to be made to the Section 250 deduction and the FDII regime. 

BEAT v. SHIELD

The Discussion Draft would retain the BEAT (instead of repealing it in favor of the Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD), as proposed in President Biden’s proposals), with important changes:

  • Modify the current BEAT system into a two-rate system with the addition of a second higher rate applied to ‘base erosion income’ (the exact percentage to be determined). That is, the base erosion income (taxed at the higher BEAT rate) plus regular income (taxed at 10%) would be equal to the current-law modified taxable income.  
  • Increase the higher BEAT rate on base erosion income by 2.5 percentage points after 2025 similar to the scheduled increase to the 10% BEAT rate on regular income under current law. 
  • Continue to consider the best way to incorporate the Biden Administration’s SHIELD proposal into the BEAT. 
  • Account for all Section 38 general business credits for purposes of BEAT; as a result, and the base erosion minimum tax amount would be decreased in some cases.

The amendments made to Section 59A would apply to tax years beginning after the enactment date of the proposals in the Discussion Draft.

Observation: As noted above, the drafters continue to consider the best way to incorporate the Biden Administration's SHIELD proposal; however, the Biden Administration’s proposal would have a delayed effective date, as opposed to the immediate effective date set forth in the Discussion Draft, because several important details on the application of SHIELD are not known.  For example, it is unclear how broadly 'payment' would be defined in this context.  

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Rohit Kumar

Washington National Tax Services Co-Leader, PwC US

Pat Brown

Washington National Tax Services Co-Leader, PwC US

Marco Fiaccadori

Partner, Transfer Pricing, PwC US

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