On-Demand: Biden Tax Proposal | Key International Aspects as Adjusted by Congress
We reviewed the comprehensive tax legislation package and its impacts on taxpayers.
Miri Forster:Welcome, everyone, and thanks for joining our webinar today. My name is Miri Forster and I'm a principal and co-leader of EisnerAmper's tax controversy and dispute resolution practice.
Miri Forster:As a follow on to last month's webinar where we talked about many of the domestic aspects of the Biden's plan, I'm delighted to be here today with Todd, Chip, and Henric to highlight the plan's international provisions along with proposed modifications by members of Congress. It's a historic time internationally. Negotiations on the Biden plan come amidst the G20 endorsement of global tax reform, including a global minimum tax rate of 15%.
If you like sports as much as my family does, I'm sure you were glued to the TV during the men's Euro soccer games and now to the Olympics in Tokyo. Go team USA. For our agenda, Chip and Todd will provide some background in how certain international provisions came to be and what may evolve from them in the future. I'll share expectations for IRS enforcement and talk a little bit about some of the international exam trends that we're seeing right now. Henric will close us out with the impact of the Biden plan on transfer pricing. Todd, onto you.
Todd Schorb:Okay. Thanks, Miri, and thank you Lexi. Want to echo Miri's welcome to everyone. Thanks for joining us today. I appreciate you giving us a little bit of your time. We're going to talk a little bit about history and then we're going to talk about some of the proposals that are in front of us now, and then talk about some of the specific impacts that we may see on some of the current regimes impacting multinational taxpayers. If we think about historically where we were, we had what we call tax reform in 2017 when we got the Tax Cut and Jobs Act.
Before that, what we had was a worldwide taxation of system if you recall where US citizens were subject to tax on their worldwide income, although that tax wasn't actually assessed until they were either repatriating that income or deemed to have repatriated that income via one of the anti-deferral regimes, such as Subpart F, 956, et cetera. At the same time, a lot of the world actually had what was called territorial systems. That's where individual taxpayers in any given jurisdiction were subject to tax in that jurisdiction. One of the key aspects of the Tax Cut and Jobs Act that we got in 2017 was to move us from a worldwide system of taxation to a more territorial system.
Really what we got was a hybrid territorial system, which we'll talk about in a second. One of the key parts of the TCJA was to move us from a worldwide system to a territorial system, and that was done via the 965 Transition Tax which we have up here which was also known as the Mandatory Repatriation. A couple of years ago, we went through that process, which is probably painful for a lot of people to calculate their own repatriated earnings, determine what was going to be subject to the Mandatory Repatriation, look at the rates that were applicable, look at the various elections that were available, et cetera, and determine what was done.
That moved us, in theory, to this territorial tax system. It's a hybrid territorial tax system that we have today because even though we have participation exemptions for corporate owners and moving back dividends from overseas, we still have some of the anti-deferral regimes in place. We have Subpart F, we have 956 and the like. So, we really currently have a hybrid territorial system. If you look to the slide, the TCJA also gave us GILTI, the Global Intangible Low-Taxed Income regime, FDII, a benefit for Foreign-Derived Intangible Income, BEAT, which was the Base Erosion and Anti-Abuse Tax. It also gave us, as I mentioned, the 245 Participation Exemption and it reduced the top corporate rate from 35% down to 21%, a significant drop.
This was all done also against the backdrop of the BEPS initiative from the OECD, the Base Erosion and Profit Shifting initiative, which is one of the initiatives that's been going on globally, calls for increased transparency, increased reporting, and also to address perceived tax abuses in terms of companies moving tax basis and income from one jurisdiction to other jurisdictions in search of better benefits, better rates, et cetera. Finally, since the passage of the TCJA, we have received numerous proposed and finalized regulations, we've had rulings, we've had interpretations, and of course we've had increased filing requirements.
The compliance requirements have continued to grow each year, number of forms and also the size of the forms, the volume of each individual form, as the forms really continue to become more of a roadmap for auditors, which is something that I know Miri is going to talk about a little later. With that, I think that may move us to our first polling question.
Lexi D'Esposito: Polling question one. After passage of the TCJA, what was the biggest focus for your business? A, GILTI, B, FDII, C, BEAT, or D, other.
Todd Schorb:Thank you. It's a shame because I just said some really brilliant points. It's interesting. It looks like Global Intangible is a big item for a lot of people. The FDII benefit, maybe not so much. BEAT continues to be applicable to certain people, and then other is a large chunk guessing that's probably the rate change, et cetera. Okay, interesting. Thank you, everyone. Okay. So, we're going to go ahead and now we're going to talk about what's on our plate now, the various plans that we have in place now. As Miri indicated, this is a rapidly changing landscape, we have a lot of different pressures and things going on, and so this is what we have and you can see the trends that are evolving out of it, I think is the most important thing.
When the White House introduced the Biden plan, the official White House note had a couple of quotes that I find interesting. First, they began by saying that the Tax Cut and Jobs Act "Only made an unfair system worse." So they started with a pretty open statement that they really had a lot of issue with the aspects of the TCJA. And they said, "One of the biggest problems is that it incentivizes moving profits, production, and income overseas," and that that's actually the opposite of what we should be looking for. With that in mind, we'll look at the Made in America Tax Plan that the Biden administration has given us.
I have to say that every time I go to read MATP, I want to say, "Make America," and then I have to say, "Okay, wait a minute. That was another acronym." On March 31st of this year, the White House gave us The American Jobs Plan, which in addition to calling for over two trillion in infrastructure-focused spending, it introduced several proposed changes to the US corporate tax laws that impact multinationals. They refer to that as the Made in America Tax Plan, MATP. The White House Fact Sheet stated that, "The president is proposing to fix the corporate tax code so that it incentivizes job creation investment here in the US," which we just talked about, "stops unfair and wasteful profit shifting to tax havens and ensures that large corporations are paying their fair share." So, again, just in that quote, you can see the disdain for the TCJA.
Again, one of the stated goals that they want to move creation of R&D and infrastructure back to the US and that wasteful profit shifting to tax havens. Those are the perceived abuses that BEAT and some of the other global trends are also addressing, so you can see it here. Key stated goals of the Made in America Tax Plan are raising the corporate income tax rate to 28% from its current 21%; strengthening the global minimum tax, US multinational corporations; encouraging foreign jurisdictions to maintain a more robust system of minimum taxes; a 15% minimum tax on book income of large companies with high profits compared to little taxable income; eliminating the incentives for excess profits on a tangible assets and replacing with more incentives for R&D, another term that we'll continue to see here; and "ramping up enforcement" of corporate tax avoidance.
A couple of additional notes here. You can see these things, again, aligning with the BEPS initiatives and some of the overall things that they've said. As Miri mentioned, excuse me, that there is a minimum tax rate that I think we've all seen certain countries agreeing to. We are going to, by the way, plan on addressing those on a separate future webinar that we hope everyone will join us for. The minimum tax on book income is interesting as well. The fact sheet that the White House released when they released the Made in America Tax Plan stated that the current average effective tax rate for US multinational corporations was 8%. They said that that shows an inherent unfairness, shows that corporations are not paying their fair share, et cetera.
So, despite which side of the aisle you may sit on that discussion, you can see that they're trying to have a multifaceted attack, right? They want to raise the statutory rates, they want to raise other aspects, but they also want to see the effective tax rates that companies, multinationals, are subject to go up. So, how are we going to achieve a lot of these goals? Most of them are going to be achieved through significant changes to the regimes that the Tax Cut and Jobs Act introduced just a few years ago. We're going to see some significant changes to the GILTI, the BEAT, and the FDII regimes. Okay, second thing that's on our plate right now. After about a week after the Made in America Tax Plan was released, we got what we're calling the Wyden Proposal.
The Senate Finance Committee chair, Senator Wyden, along with senators Brown and Warner, who are all Democrats, introduced their own tax plan in April 5th, which was called Overhauling International Taxation, which we're calling the Wyden Proposal. The Wyden Proposal mirrors the Made in America Tax Plan in a lot of ways. Differs a little bit in execution, but it shares a lot of the same overarching themes that we've discussed, focus on having companies pay what is deemed to be a fair share, addressing infrastructure and investment in the US, et cetera. The Senate Finance Committee release actually said, "The international tax system should focus on rewarding companies that invest in the US and its workers, stop incentivizing corporations to shift jobs and investment abroad, and ensure that big corporations are paying their fair share."
The Wyden Proposal also provides some further details while focusing on the changes to the TCJA regimes that we mentioned, GILTI, BEAT, FDII. These comments continue to come against the OECD global movements where we also have the transitional period on international tax matters. Most noticeably, they OECD just released or has released in October of last year rather Pillars One and Two, which are non-consensus documents addressed at taxing an increasingly digitalized economy and creating a global minimum tax rate, something that, again, we've seen recently with some of the meetings, et cetera. Again, we see US tax law and global tax law evolving, changing on at least maybe parallel paths as they go forward.
Now that takes us to the most recent guidance we got, which was the Treasury Green Book. That came out on May 30th of this year when the U.S. Department of the Treasury released its general explanations of the administration's fiscal year 2022 revenue proposals and that's what's referred to as the Green Book. It's designed to build on themes and points in the Made in America Tax Plan and provide further specific details. I think the key takeaway is that when you take the Made in America Tax Plan, the Wyden Proposal, and the Green Book, we begin to get at least a feel for some of those big themes that they are trying to address or going to want to address, and also some of the things that they're tackling or focusing on as ways to address these things.
So, I think a couple of things. A, there's a few overriding things that we mentioned, right? Really four in my mind. One is eliminating the perceived incentive to move jobs, investment, and profits overseas, encouraging investment and hiring in the US, making sure companies pay what is deemed to be a fair and reasonable and appropriate tax. Then when taken together, all of those things should lead to increased public and private investment in infrastructure and R&D in the US which should benefit the US economy. One final note that I'll put here in terms of just documenting some of the original plans that when they came out were fairly vague.
The Made in America Tax Plan, the tax section was really only a couple of pages long. The Wyden plan, I think, was about nine pages long, so we got a little bit more detail. Then the Green Book, I think the section of the Green Book that talks about taxes is 19 pages out of 114 total pages. So, we're gradually getting a little more detailed, a little more granular with some of the things that we're trying to look at. I see one of the questions that just popped up and I did want to address is that, no, the Wyden Proposal actually was from the Democrats on the Senate. It was officially the Senate Finance Committee, but it was drafted by the Democrats and so it was an additional plan that was put out there.
There have been talks and rumblings in recent weeks that there may be other plans drafted in the House perhaps by Republicans and multiple groups as they're all competing. We'll talk about that a little bit later. Okay. Now we're going to begin to talk about some of the specific regimes and the changes that are being addressed, the first one being GILTI. Tax Cut and Jobs Act gave us the Global Intangible Low-Taxed Income or GILTI regime. If you recall, GILTI requires an income inclusion for US shareholders of a CFC, which if you're a corporation was taxed at an effective tax rate of 10.5% because of the 250 deduction. That rate was going to increase down the road in 2025 due to that reduced deduction.
A key difference between this GILTI regime and the other anti-deferral regimes is that the base is actually different. The base in GILTI was tested income whereas the base that most of us who are accustomed to dealing with when it comes to Subpart F, 956 is earnings and profits. So, tested income being a slightly different base. GILTI was applied to your net tested income. Your net tested income can be reduced by what is called the Deemed Tangible Income Return, the DTIR. A big portion of the DTIR is what was called QBAI. That's the Qualified Business Asset Investment which consists of certain specified tangible assets used in the generation of net income. That was determined on a quarterly basis, you had to use your alternative depreciation system.
Finally, foreign tax credits are available to offset your QBAI taxes, but they are subject to an 80% haircut. They also are a "use it or lose it", which means you don't get to carry them forward or backwards, you have to use them in the year generated. So, before we go to the next slide, if you think about what the things are that the plans are trying to attack, the Deemed Tangible Income Return and the QBAI, you could see people saying that, "Look, these are... " If you look at how QBAI is defined, it's the tangible assets used in the generation of net income. So, obviously net income would be earned by the CFC in the foreign jurisdiction.
So, the QBAI are the assets that are in place to generate CFCs, they're foreign assets and that forms part of this Deemed Tangible Income Return that's in place to reduce ultimately your GILTI burden. So, as we move to a comparison of the plans that we've talked about so far, across the Made in America Tax Plan, the Wyden plan, and the Green Book, all three of these propose or address completely eliminating the Deemed Tangible Income Return and with it the QBAI portion of that. So, they want to remove the DTIR benefit, so that reduction that was in place to reduce your net tested income and ultimately your GILTI liability, and a big part of that was this QBAI, right?
They said, "Look the current GILTI regime actually encourages you to put assets and production in place overseas because that reduces your GILTI." So, they want to remove the QBAI and the DTIR. Secondly, if you look at the GILTI rate across the regimes, currently, as we said, it's a reduced rate that's available for corporations. The Made in American Tax Plan wants to raise that to be at least equal to 75% of the current maximum corporate proposed rate of 28%. The Green Book, I'm going to hop over, actually takes the same approach and says it should be equal to 21%, which would be equal to three quarters of the current maximum corporate rate. The Wyden plan is interesting.
Simply to note that the Wyden plan actually says that the rate on GILTI is currently an open question. It says that, A, that it's an open question because you really should decide that after you see all the other aspects of tax reform that gets settled on for multinationals and then this should be one of the final decision points almost. They also mentioned that there's a strong argument to suggest at least the GILTI rate should be equal to 100% of the corporate rate. So, again, we see the DTIR benefit being removed, we see potentially much higher rates being applied to our GILTI income, right? So, some things in place that could significantly rise that GILTI exposure that people are facing.
Determination. Determined on a country by country basis in the Maid in America Tax Plan, because they want to remove your ability to offset your GILTI impact on country by country basis. The Green Book also says, "We're going to remove it on a country by country basis and we're going to have separate foreign tax credit limitations for each foreign jurisdiction." So, that's a lot more tracking, a lot more reporting, et cetera. Of note, they also say that, "We're going to repeal the high tax exemption to both Subpart F and GILTI." If you recall, Subpart F and GILTI, certain income streams may be exempt from those tax regimes if the rate being applied to those income streams is significantly high enough compared to the US rate.
Finally, I'm going to jump back to the Wyden plan. The Wyden plan at least suggested two different things. They said, "Hey, we could have foreign tax credit baskets on a country by country basket basis, or perhaps we could have just two baskets for high income countries and low-taxed income countries. So, again, some flexibility there. Domestic incentive. There was no domestic incentive in either the Made in America Tax Plan or the Green Book. There was one in the Wyden plan in terms of sourcing some of your R&D. Finally, other. The Green Book does propose removing the exemption from GILTI for the Foreign Oil and Gas Extraction Income, or FOGEI, which is always one of my favorite tax acronyms.
Then finally, the timing. The Green Book gives us the suggested timing, which would be effective for tax years beginning after December 31st, 2021. So, again, fairly quick when this might come up. I think that takes us to the next polling question, Lexi.
Lexi D'Esposito:Polling question two. What potential change to the GILTI regime would impact your business the most? A, elimination of QBAI and DTIR components. B, increased rate, or C, country by country determination.
Todd Schorb:While everybody is doing that, there was one more question that we can address as the tax increases will be retroactive. Again, I think most of these are aimed to be effective for tax years beginning after December 31st of this year. So, this would be our last year with the current GILTI and FDII and BEAT and some of the other rules that we're talking about in the corporate rate, et cetera.
Todd Schorb:Increased rate, which I think is in line with the last question that we discussed. So, interesting. Okay. One last slide on GILTI. It's sort of, what can you do now? One of the challenges is, again, is that none of these things are set in stone. It's still very much a moving state, right? There's not a lot of things that you would necessarily do right now because we don't have firm rule changes in place. However, some of the things that you could consider is Subpart F planning, right? Looking at your income stream that have been treated as GILTI and making sure that, would they be better treated as Subpart F? Are they more appropriately treated as Subpart F?
They'd be subject to different foreign tax credit rules and some of those things, right? Wouldn't have the use it or lose it aspects. QBAI management. To the extent if QBAI is going to get removed, if you have foreign assets that are going to be placed in service perhaps next year, there could be an incremental benefit to placing them in service earlier so that you get that QBAI benefit in the last year where we have that ability to reduce our GILTI impact with the Deemed Tangible Income Return. Again, modeling is really going to come up on a lot of these. It's trying to model the interrelated impact of a lot of these proposed changes on your current tax status.
Modeling the proposed elimination of the high tax exemption for Subpart F and GILTI, which I know a lot of people take advantage, and also to the extent it's applicable, analyzing the impact of the FOGEI regime, which is in terms of FOGEI being subject to GILTI. One of the thing that I'll note here, and I know Miri alluded to it earlier and we've gotten some questions on it, we continue to see competing proposals. There's a lot of proposals that are coming out from different people, even in the last couple of days. I've seen articles suggesting that the House may propose its own tax and spend act.
I think the one thing, no matter which side of the aisle you sit on, things are fairly contentious. So, it wouldn't surprise me if other groups splintered and made their own proposed tax proposals as well. So, it's an interesting time. It's also probably a little bit of an unsure time as we go through. I think with that, I think we're going to hand it off to Chip and let him talk about BEAT for a little while. Chip?
Chip Niculae:Thank you, Todd. Good afternoon or good morning for the people in other places around the world and including good evening for those in Asia. My name is Chip Niculae and I'm international tax director with EisnerAmper in the New Jersey office. I deal predominantly in international inbound and outbound transactions from a structuring perspective and from a compliance aspect. With that being said, let's get a little bit into Base Erosion and Anti-Avoidance Tax, or Anti-Abuse Tax.
You have a little bit of a primer of the rule as it was established a couple of years ago before we go in and start digging into some of the legislative proposals and information that's out there in very limited amounts since we're only talking about three paragraphs with respect to BEAT when we're looking at the Biden proposal and even with the Green Book. With that being said, I wanted to just mention that the Tax Cuts and Jobs Act added this new Internal Revenue code, Section 59A, which was generally intended to prevent erosion of the US tax base by imposing a Base Erosion and Anti-Abuse Tax on some large corporations.
If we step back and recall, BEAT specifically attempted to prevent US companies from shifting profits out of the US to other countries where they would have a lower tax rate or be subject to a lower tax rate. Some of the unintended consequences here were that you didn't necessarily only have BEAT applicable as it was originally discussed to US subsidiaries of foreign multinationals and specific US companies that were shifting US income, but now BEAT as drafted also applies to US multinationals that are involved in foreign transactions. Let's get into some of the nuts and bolts here and say, okay, the BEAT rate is 5% for 2018, 10% from 2019 to 2025, and after 2025 and onwards, it's going to be 12.5% if it survives.
Well, if you're subject to BEAT, you must be a C corporation, you must have average annual gross receipts of at least $500 million for the last three years, and have a base erosion percentage of 3%, 2% for some banks and security dealers. So, in order to have BEAT apply, you may need to satisfy the tests mentioned above. In the middle market, you basically see companies that have these gross receipts of over $500 million being subject to BEAT. However, what we've also noticed is that companies that have been acquired in the last couple of years and were not at a gross receipt of $500 million had to go back to their parent firm, parent company, and discuss whether the foreign company's operations, foreign company's US operations, combined with our clients' US operations would amount to income that was subject to BEAT or gross receipts that would be triggering BEAT.
So, it's important to look at affiliated group here, it's important to look to its control of the aggregate group, and consider all components, both foreign and domestic, in determining whether gross receipts and base erosion percentage tests are satisfied and therefore subject to BEAT. Specifically, it's important to note though that when it comes to the foreign entities, foreign entities may have effectively connected income of a US trader business, in which instance that aspect alone will be incorporated into BEAT analysis. In certain instances, you have foreign corporations that are subject to tax on net earnings on their US income tax treaties.
Important to note that generally, base erosion payments are payments or accruals made to taxpayers to a foreign related party that are either deductible payments, payments made in connection with the acquisition from foreign related party, or depreciable amortizable property, or premiums paid for reinsurance. Important here to also know is that base erosion payments are generally determined on a gross basis and cost of goods sold are an exception to the BEAT analysis. So, you don't have to incorporate BEAT payments, you don't have to include costs of goods sold in your BEAT analysis.
Now that we have this background on BEAT, a general view of it, now we could step and look at the Made in America Tax Plan, the Green Book, and the Wyden Proposal. Specifically, when it comes to the Biden proposal, we look at the Stopping Harmful Inversion, Ending Low-Tax Developments, or SHIELD regime. I find that a little bit amusing because if you take all the acronyms, I mean, what are we going to do? We're going to see that GILTI, BEAT, or imagine this one. I mean, this is a little bit a tax nerd joke, but for those that grew up on comic books or you have kids that watch Avengers, what if let's say the Biden administration named, let's say, Nick Fury as commissioner of the IRS, imagine, and then Nick Fury has to discuss SHIELD.
I mean, that for me would be a little bit amusing. Just want to throw some humor out there in a very dry and limited subject. Now, go into the next page here and looking at the breakdown and what is intended to happen to BEAT. As Todd mentioned in his presentation, there's a common theme here, very anti-Tax Cuts and Jobs Act in its usefulness going forward. Then there's also what I consider Senator Ron Wyden's proposal which seems to be trying to split the BEAT and try to give a chance at any proposals to make it through Congress and BEAT actually get to some Republicans on board and get tax legislation implemented. So, what happens to BEAT if we have the Made in America Tax Plan. Sort of like the make America great, make in America tax plan-
Todd Schorb:I set you up. I planted that feed, Chip. Sorry.
Chip Niculae:Yeah, it's one of those things. The Biden proposal really looks to completely get rid of BEAT and it's intended to replace it with something called SHIELD as discussed, which will deny deductions on payments to foreign related parties if the payment is subject to a low effective tax rate. Not a lot of details, what we do know is no credit shouldn't be available against a SHIELD. Now, when it comes to the rate, here's where it gets very interesting.
As Todd mentioned, when it comes to SHIELD, the way it's drafted both in the Green Book and also with respect to the Biden proposal, what they specifically say, that, now, if we don't come to some sort of multi-lateral global tax agreement with all these other jurisdictions that have signed on board, I think it's 79 so far, then at that point, we're going to go with a GILTI 21% rate until that rate is amended by a multinational agreement. Okay. Now, as mentioned, they're talking about 15%. Well, that's a significant drop from 21 to 15%. Also, here's another key component. This will be effective after December 31st, 2022. Why is this important?
If we look at some of the timeline that the OECD has put in place and with all the G20 day, all these other jurisdictions that are discussing it. They have put in place a timeline where by October 2022, they want to have everybody on board and a signed agreement. Now, think about this. November 2022, we have the elections, and then by December 31st, 2022, we're going to have this proposal adopted. To me, it looks very unlikely. Now, when we look at the Wyden proposal, I think it's a little bit more realistic. They do want to retain and amend BEAT. They want to allow full value of domestic business tax credits, reduce BEAT, so take away some of those unintended consequences that BEAT has had.
And there is a little bit open question when it comes to relief for foreign tax credits. You'll you see that they're really trying to reach across the aisle and undo some of the unintended consequences that BEAT has had over the last couple of years. They talk about retaining the 10% rate for regular taxable income. Question is, what is regular taxable income? Then they're talking that if something is deemed to be a base erosion payment, there will be a higher rate. That's going to be interesting what that higher rate would be. Will it be the 15% that they're looking at, this multilateral agreement on a global basis, or will it be a 21% equivalent for a GILTI rate that I think even Todd alluded to when he left out a little bit open.
Now, we look at the Green Book. To me, the Green Book is just a reflection of the Biden plan. It talks about repealing or replacing SHIELD, disallows deductions for gross payments made to foreign related parties that are subject to low effective tax rates. Here's a caveat. There's a little bit of a BEAT component here, the BEAT component being that it's applicable to global annual revenues above 500 million. Interestingly enough, we don't have to look back to three years or look at average of three years, it's on an annual basis. That gives us a little bit more information on how this is going to apply.
Treatment of credits. It doesn't take into account the Wyden proposal, no credit is available. From a rate perspective, it's exactly as we discussed. It's a GILTI equivalent 21% rate and it's going to be until there's an agreement, some sort of multilateral agreements with other jurisdictions. Interesting so, I find democratic process very tedious and it takes time and it takes debate. So, seeing this get done by 2022, it's very hard for me. It maintains the timeline that Biden has in place. These are my final comments and conclusion. To me, SHIELD seems to target rate arbitrage while at the same time looking to eliminate the cliff effect created by base erosion percentage, that three, 2% we discussed above.
It may also eliminate the additional BEAT created by tax credits and it could increase a tax rate's BEAT liability. Based on the details so far, we're not sure whether SHIELD would address all the outcomes, the unintended outcomes that BEAT has had. Without going into details, the one thing that's important beyond the discussion of this call is that, if you look at the proposal, SHIELD comes with some anti-inversion rules, which basically, there's been this trend since 2017 or actually 2015 with the 7874 rules, with the BEAT put in place, and now SHIELD to try to discourage US companies from not only shifting operations abroad, but at the same time looking to also prevent US companies from moving abroad completely.
With that being said, I'd like to thank everyone for taking time to attend this and also to hand off to Todd. Thank you.
Todd Schorb:Thanks, Chip. Okay. Now we're going to discuss the final or the last of the regimes that TCJA gave us. This one will be fairly quick. But FDII was one of the other ones, regimes that we were given. It was section 250 and it allowed a deduction for FDII. So, FDII was a benefit, we got a benefit. FDII rules were designed to exist in tandem with the GILTI rules. FDII also relied on QBAI, just as GILTI did, but they had different impacts on the regimes. FDII allows a deduction for the portion, which is determined formulaically of course, of the intangible income that was derived from foreign operations.
So again, what it's designed to do, you can say that both the Made in America Tax Plan and Wyden Proposal stated that FDII has encouraged shifting of investment and income to foreign markets and that it needs to be replaced with incentives and encourage investment in R&D and infrastructure in the US. While the Wyden system does leave the door open for the modified FDII system in some way, shape, or form, but the Made in America Plan and the Green Book state that it should be repealed. So, if we go to our comparison chart, again, for the FDII regime itself, both the Made in America Tax Plan in the Green Book suggest eliminating this in its entirety. Wyden suggested it could be kept in place with some caveats or potential changes.
One thing to notice is that both the Made in America and the Green Book say that FDII should be replaced with R&D incentives. We really don't have any guidance into what those R&D incentives may be right now, if it's credits, deductions, what that is, what would be the applicable expenses, investments, et cetera. That's one thing to keep in mind. Getting rid of FDII really shouldn't come as a surprise to a lot of us because if you recall from day one, the World Trade Organization came out and said that this was a violation of their subsidies or global subsidies regime, and from day one Biden himself has said they need to get rid of this because it was contrary to what they thought needed to be done in the country.
With that, I think we're going to take again. What you can do now is very tough because it's a moving landscape, but consider the impact if this is the last year of eligibility, so you might lose that FDII benefit going forward. Also, if you're considering things to do with QBAI, remember that QBAI is a part of GILTI as well. So, to the extent that you change QBAI, it's going to impact both GILTI and FDII, so you need to impact the modeling of it, do the modeling to estimate the impact.
Finally, one thing that you could do is analyzing impact of not only the lost FDII deduction, but also beginning to get a handle on what your R&D expenditures and investments are and where they are, so that even when the incentives come in, you might be in a position to analyze and say, "Okay, here's how they're going to impact us, these are the things we may be eligible for or not eligible for, and these are the next steps we should." With that, I think we have one more polling question and then we're going to go to Miri.
Lexi D'Esposito:Polling question three. What potential changes to the current international regimes are you most concerned with? A, changes to GILTI. B, replacement of BEAT with SHIELD. C, elimination of FDII. Or D, other.
Miri Forster:I was just trying to lighten the mood. While Chip was talking about comics, I wanted everyone to know, in the early '60s, Superman had a comic entitled, Superman Owed $1 billion In Taxes. So, comic books have been interested in all these regimes for many, many years as well.
Todd Schorb:The merge of tax and comic books, I think that's the ultimate nerdery to Chip's point.
Todd Schorb:I love it.
Todd Schorb:Interesting. Okay. Miri, and I think with that, it's yours.
Miri Forster:Great. Thanks so much. The legislative landscape gets more and more interesting every day as Todd and Chip have been talking about. With respect to the IRS and its funding and its enforcement, there have been dramatic changes. Back in May when treasury released its Green Book, it included substantial increases to IRS funding, over 13 billion for fiscal year 2022. That was a 10% increase from enacted levels of fiscal year 2021, and over 80 billion for the next 10 years. That was going to focus on a number of areas, but in terms of enforcement would have been corporations and high wealth individuals with 400,000 of income and higher.
Than at the end of June, the 80 billion was drastically cut to 40 billion. Then last week, the funding boost was completely pulled from the infrastructure package. Apparently, some Republicans thought that even 40 billion was excessive and others had heard rumors that the Republicans were going to add some more funding to reconciliation. So, now we don't have any funding at all anywhere. So, the question is, what will happen? Will it become part of budget resolution instead because we know that the IRS needs money for their taxpayer services, to modernize their systems, et cetera? We all know that a group of bipartisan lawmakers were working throughout the weekend on the text of the Infrastructure Bill.
I hear more details on that may come out this afternoon. But at this point, I'm pretty skeptical about the IRS funding being included, seems more likely it'll get into the budget resolution process, which needs only 50 Democrats to pass. I know Senate majority leader, Chuck Schumer, has said he intends to pass infrastructure and budget resolution with reconciliation instructions before the August recess. House leader, Nancy Pelosi, has said she won't take up infrastructure until the Senate passes reconciliation. So, we're really going to have to see what happens here and if the IRS gets any money in the process.
While Congress is continuing to negotiate, IRS enforcement is actually already on the rise and that's across the board for individuals, partnerships, and corporations. So, if more funding is approved, it's only going to increase the enforcement trend. It's important to keep in mind that with more IRS exam activities, you really should do your best to keep contemporaneous documents to show those positions. You have to do it when it's fresh in everybody's mind and when the documentation is easy to gather and maintain. That's the best way to manage risk and maximize your certainty. So, increased enforcement on international tax issues is showing itself in a number of ways.
First, over the past six months, the IRS has released many practice units and they highlight international tax. You see them on the screen right now. Practice units, they're used by the IRS's job aids and training materials. So, they're really great. They give you insight on the issues that the IRS is currently looking at and they also show you how an agent might approach an issue on audit. One of the recent practice units that the IRS released was on the section 965 Transition Tax that Todd spoke about at the start of our presentation. The IRS is actively examining taxpayers to make sure that painful transition tax calculation was performed correctly.
The calculations, like Todd said, required corporations to go back years and years and look at E&P data and not all the corporations had great records. So, now the IRS has a large group of taxpayers, it's looking at those computations to make sure they were performed right. In addition, we're seeing a lot of IRS notices for taxpayers who elected to pay the transition tax in installments because the way those payments went in, sometimes they got confused with the regular estimated tax payments, and if they weren't accounted for properly, it would trigger an acceleration of the entire transition tax. So, we're working with lots of clients in those situations to try to help them get those transition taxes allocated to the right places.
You'll also see on this slide there are recent practice units on foreign tax credits, including the calculation of allowable foreign tax credits for individuals, and the allocation and apportionment of expenses, losses, and deductions against foreign source income and determining FTC limitations. Then in June and July, the IRS issued practice units on GILTI and FDII as they exist under the TCJA that Todd and Chip talked about. If changes to these regimes are enacted under president Biden, you can be sure that the IRS will be watching as well. We also know that the IRS is focused on international tax compliance, which when we look at their compliance campaigns, several years ago, they announced a campaign approach to enforcement.
So, instead of looking at an enterprise as a whole, they've shifted to an issue-based approach focusing on those issues they believe present the highest compliance risk. Two recent campaigns we just want to highlight. One is the Puerto Rico Act 22 campaign. It promoted the relocation of taxpayers to Puerto Rico offering tax incentives and credits and a way for Puerto Rico to help its economy. But now the IRS wants to make sure that the taxpayers under the act are claiming benefits properly. Some are excluding income that was subject to US tax, some are erroneously reporting US source income as Puerto Rico income to avoid US tax. So, that's the focus on those and the IRS is conducting several exams on that.
Then last month, the IRS introduced another interesting campaign focused on financial services entities that engage in lending activities. The campaign looks at whether a foreign investor is subject to US tax on effectively connected income from lending transactions engaged in through a US trader business. Now, generally, foreign investors who only trade for their own accounts are not engaged in US trader business because there's a safe harbor rule in the Internal Revenue Code. But the safe harbor rule isn't available to dealers, including entities engaged in a lending business or to foreign investors in partnerships engaged in those activities.
The IRS, while they've formalized the campaign now, they've been looking at this issue at least since 2015 when they released chief counsel advice memo on the topic and the taxpayer who was the subject of the chief counsel memo actually now has a tax court case pending. So, be ready for more activity on this issue going forward as well. Then a third way we know international tax compliance is a high priority for the IRS is to the issuance of the new schedule K-2 and K-3. The new K-2 and K-3 are intended to increase transparency for partners and shareholders by standardizing the way that US international tax information is presented and to allow the IRS to more efficiently verify tax compliance on international tax matters.
2021 is the first year that the K-2 and the K-3 are required and non-compliance can actually result in significant penalties. Fortunately, the IRS has recognized the heavy compliance burdens related to these new forms and gathering all that information in a short period of time, so they have announced some transitional penalty relief for 2021. You can find that information in notice 2021-39. But essentially, you'll get the relief if the taxpayer can make a good faith effort to comply. If you want to know more about the transitional penalty relief and what constitutes good faith effort, there is an article on notice 2021-39 in the widget section of your screen since we're running out of time.
Also, the K-2 and the K-3 are not substitutes for existing international information reporting obligations. As Todd said, filing requirements grow each year, so you'll still have your 5471s, 5472s, 926s, 8621 requirements as appropriate. Those forms, if you don't comply, also carry very hefty penalties. So, last to mention on IRS enforcement is the considerable focus both by the IRS and globally on transfer pricing. I'm going to pass it on to Henric in a minute to move on with that discussion. Before that though, Lexi, I think we have a polling question.
Lexi D'Esposito:Polling question four. Do you think the IRS will receive the additional funding it is looking for? A, yes. B, no. Or C, not sure.
Miri Forster:I will say that whether the IRS gets their funding or not, like I said before, IRS enforcement is increasing, they are hiring like crazy. We see every day different revenue agent and national office positions that they're looking to fill. They've hired about 50 partnership specialists in the past six to nine months, so they are gearing up for, I would say, more of a enforcement eruption regardless of whether the funding comes or not.
Miri Forster:Looks pretty evenly split. Thanks, Lexi. All right, Henric, over to you.
Henric Adey:Thank you, Miri. I think we're going to have the last couple of minutes to discuss the transfer pricing impact. As Miri was mentioning, from a transfer pricing perspective, I always say it's always the best practice to document on a contemporaneous basis and have an ex ante view of the documentation in front of a potential auditor than really kind of developing a defense exposed when the audit is actually taking place. We also have seen with the COVID-19 crisis last year and the ongoing funding needs that will be there, there will be a lot more pressure going forward on reviews of transfer pricing regimes.
I think two key observations there as well are the R&D regimes that we're seeing. With the Made in America Tax Plan, I think there is also a push forward to really make sure that innovation is being brought back or is being maintained in the US. Also, when we look at supply chains and value chains, there was a push back to manufacturing and maintaining supply chains in the US as we see more difficulties in global supply chains due partially through to the COVID pandemic and other factors globally that pertain to it. I think as we always know, substance is a very important issue as you document your transfer pricing positions when we talk about R&D regimes.
I saw a question early on in the question and answer segment here, we have a lot of contract software development regimes in Asia, and I think everywhere, it is really this push to really make sure that you have a very good documentation of the DEMPE functions that are really applicable to those development functions. That's the development, the enhancement, the maintenance, the protection, and the exploitation of the IP. And not just the investment that is associated with getting those functions of the ground, but rather, who is really responsible for the risk of developing these things and who was really the main idea driver when it comes down to development?
I think there is a lot of the times this interaction with also the human resource aspect where you have job descriptions and organization charts where you can really pinpoint who is reporting to whom and what is really the chain of command here when we talk about these very important high value functions that are potentially under review in a cross border setting. So, value chains and supply chains, I think, are very important to keep documenting them and also keep making sure that you really capture the changes that may have taken place as part of a pandemic and as you go forward and maybe change certain important supply chain factors within an organization.
We know that important individuals were not necessarily located in countries that they usually reside in due to travel restrictions and so forth, and so that's something important to document and look at and making sure that that's put in place, and the continuous evolving of intangibles, right? What are the intangibles? How are they being developed? How are they being documented and protected? I know we have like about two minutes left and maybe want to have some finishing remarks before we end up, but here are some of the key recommendations and observations. I think there are going to be a lot of potentially important pieces to consider.
I think creation is encouraged to be maintained in the US, supply chains are opposed to stay within the country, so there might be local incentives to review and really put into effect. Then always, as Miri said earlier, if you can prove and show that you keep contemporaneous documentation, as things change and as things are evolving, your audit defense is going to be so much easier than putting something into place retroactively. With that said, I think we have one minute to spare, so I leave it to the team for any few last minute comments or questions before we wrap up called our webinar.
Transcribed by Rev.com
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