White house proposed changes will impact middle market tech companies

ARTICLE | June 30, 2021

Authored by RSM US LLP

President Biden, as part of a multitrillion-dollar infrastructure plan, is seeking to change how multinationals are taxed, with the goal of attracting more revenue to the federal government and encouraging multinationals to keep jobs and investment in the United States. Technology companies should be prepared to see significant changes, possibly this year, which will affect the rules governing global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII) and the base erosion and anti-abuse tax (BEAT).

Recently the Treasury Department issued the much-anticipated Greenbook that provides more details on how President Biden would like to alter some of the international tax provisions. Following is a summary of these proposals. It is important to note that these are just proposals, and the final provisions, if enacted by Congress into law, may be different. 

GILTI tax rate increase

The current law as implemented by the Tax Cuts and Jobs Act imposes a 10.5% tax on so-called GILTI from controlled foreign corporations (CFC) unless certain exceptions apply. 

Biden’s proposal would increase the GILTI tax rate to 21%; require GILTI to be computed on a country-by-country basis (to restrict the blending of GILTI income with GILTI losses and prevent cross-crediting of foreign taxes); and eliminate the deduction for qualified business asset investments (known as QBAI) that allows a reduction to GILTI in the amount of a 10% return on the CFC’s adjusted tangible assets value. The proposed changes would be effective for taxable years beginning in 2022.

Global technology companies, with multi-CFC structures, would likely see an increase in U.S. tax costs related to their CFC operations with a GILTI tax rate increase to 21%. The country-by-country limitation would also negatively affect technology companies. For example, a CFC providing services to the group at a predetermined profit margin and paying less local tax due to local incentives, such as R&D credits or deductions, would be subject to GILTI rules. Though this is true under current law, the proposed country-by-country limitation may limit the ability to offset this GILTI inclusion with any GILTI losses arising from other jurisdictions. The country-by-country limitation would further increase tax costs because technology companies would not be able to offset the U.S. tax assessed on GILTI from a low-taxed jurisdiction with unused foreign tax credits derived from a high-tax jurisdiction. Technology companies are less likely to be affected by the elimination of a QBAI offset, as most do not carry significant fixed assets.

FDII deduction elimination or revamp

Currently, technology companies taxed as C corporations can claim a reduced tax rate (13.125%) on FDII received from foreign persons. This benefit applies only to U.S. corporations that are subject to the U.S. income tax. The most common types of FDII-eligible income for technology companies are service and royalty income; however, the FDII benefit is also applicable to sales of tangible or intangible property. 

The Biden administration wants to eliminate the FDII benefit, effective for taxable years beginning in 2022, in exchange for expanding the R&D credit or making it more effective—with the goal of encouraging more companies to locate innovation activity in the United States. The Greenbook does not provide much detail on how the administration plans to enhance the R&D credit.

Since most technology companies are global, the elimination of the FDII benefit will likely result in an increased tax burden on U.S. outbound revenue. It remains to be seen whether the expanded R&D credit can offset the tax savings lost from the elimination of the FDII and whether it can incentivize technology companies to relocate their foreign R&D function to the United States.

BEAT elimination or revamp

BEAT is a tool to prevent U.S.-based businesses from shifting profits out of the United States to other countries. Under BEAT, multinational corporations are subject to a 10% tax on their modified taxable income. The BEAT rules apply only when a corporate taxpayer averages annual gross receipts from U.S. activities of at least $500 million for the previous three years and has a base erosion percentage of at least 3%. Both criteria are based on the aggregate taxpayer group principle, which is testing whether BEAT applies when combining the attributes of U.S. companies connected by a common ownership. The BEAT rules often connect ownership through private equity funds—a common ownership structure for technology companies. Base erosion payments generally consist of intercompany interest, royalties or, in certain cases, services paid to foreign related parties.

The Biden administration does not believe BEAT is effective and proposes to replace it with a mechanism called SHIELD (Stopping Harmful Inversions and Ending Low-Tax Developments) under which certain deductions, in whole or in part, would be denied when paid or deemed paid to a related party located in a low-tax jurisdiction. Determination of what constitutes a low-tax jurisdiction is likely to be based on a rate agreed to under the Pillar Two initiative of the Organization for Economic Co-operation and Development (OECD). Just recently, at the G7 meeting, the governments agreed that a minimum rate of 15% is adequate, providing support for the initiative that the OECD plans to finalize this year. SHIELD would apply, with certain exceptions, to companies earning $500 million or more in global annual revenues, reflecting a significant change from the current BEAT rule that applies the same threshold to revenues but limits it to U.S. corporations or U.S. branches that are members of the affiliated group.

Technology companies, including inbound companies, that are subject to BEAT should take note and keep an eye on further developments. The proposal to replace BEAT with SHIELD would be effective for tax years starting in 2023.

Takeaway

President Biden’s proposed changes to the U.S. international tax system would significantly affect multinationals in the technology industry since most technology companies are currently impacted by GILTI, FDII, and sometimes BEAT. Although these are only currently proposals  that  may significantly change in the process of becoming law, they provide a few guideposts for what levers the President and the Democrats have their sights on pulling in order to help raise revenue for the sweeping infrastructure plan. It is likely that one or more of these provisions will result in higher effective rates of taxation on foreign income, and consequently it is prudent that companies start contemplating, planning, and modelling various scenarios now to be ready to act timely if the proposals become law.