Biden Proposes Ending the GILTI Loophole

Alex Parker covers an interesting and important tax policy issue:

Former Vice President Joe Biden’s recent proposal to secure medical supply chains in the wake of the COVID-19 pandemic includes tweaks to the 2017 federal tax overhaul, reigniting the debate about whether its international provisions are pushing manufacturing facilities offshore   .   .   .   the TCJA exempted most foreign income from taxation as part of a shift toward a more territorial tax system, similar to those used in Europe and much of the world. But it also enacted new provisions, including the GILTI tax and the base erosion and anti-abuse tax, which lawmakers said would block companies from shifting U.S. income abroad.

Many of the structures for tax avoidance that have drawn public scrutiny and outrage over the past decade have involved intangibles, which are relatively easy to move from jurisdiction to jurisdiction to chase the lowest tax rate. But the very attribute that makes them difficult to tax also makes them difficult to define. Rather than attempt to pinpoint the intangibles themselves, the TCJA instead targets unusually high returns on tangible assets.

Under the GILTI provision, the total foreign income of a U.S. company, beyond a 10% return on its offshore depreciable tangible assets, is taxed at 10.5%. That rate is half of the overall corporate rate of 21%.

As the bill was passed by Congress in 2017, Democrats and outside critics quickly noted that the GILTI tax could encourage companies to shift investments in tangible assets abroad. Because the GILTI tax kicks in only at a 10% return on foreign tangible property, the more valuable that property is, the smaller the ultimate GILTI tax bill will be.

Even further, because GILTI is calculated at the global level, in most cases it would not matter where new tangible assets were located; as long as they were offshore, they would decrease the GILTI tax. A reduced rate on foreign-derived intangible income, or domestic income defined through a formula similar to GILTI, also creates a similar incentive, critics contend. If a company has tangible assets at home, it will have less income defined as FDII, and less of the tax benefit.

The 2017 tax cut for rich people was written in secret by Republicans who had told us that it would somehow stop transfer pricing manipulation and would encourage onshoring. But when the details were released, a lot of economists including conservative economics were taken back by the complexity of the international provisions.

Parker’s discussion is interesting even though he might be faulted for not defining FDII and GILTI. FDII stands for Foreign Derived Intangible Income while GILTI stands for Global Intangible Low-taxed Income where both are defined as profits minus a 10 percent return to tangible assets, which is a crude attempt to allow intangible profits sourced in the U.S be taxed at a 12.5 percent rate instead of the 21 percent corporate tax rate. A lot of the large life science multinationals have found a way of sourcing profits in a tax haven. Rather than vigorously enforcing our transfer pricing rules, the Republican tax cut for rich people decided to let them be taxed a 10.5 percent, which does not exactly discourage shifting profits abroad. But hey they did set up a complex set of rules that kept the Big Four accounting firms and international law firms gainfully employed trying to figure out how to manipulate these rules. But Biden’s first concern here was how these complex rules might actually encourage shifting production abroad. Parker also notes:

Brad Setser, a senior fellow at the Council on Foreign Relations and the former deputy assistant secretary for international economic analysis at the U.S. Treasury Department, has blamed the provision for a 20% increase in pharmaceutical imports since 2018.

“The rise in pharmaceutical imports is likely, in part, a reaction to the incentives to offshore pharmaceutical production that were included in the Tax Cuts and Jobs Act,” Setser said Feb. 5 in testimony to the U.S. House Ways and Means Health Subcommittee.

Brad has written a lot of very interesting things on transfer pricing so it is time to go read his latest on this issue as well.