Fernway DiarySM

Jun 29, 2021

In 2017, the passage of the Tax Cuts and Jobs Act lowered the maximum US federal corporate tax rate, but also created international tax provisions intended to discourage companies from relocating intellectual property to countries with lower tax rates. Companies still determining the impact of international provisions under TCJA via regulations developed by the IRS and Treasury Department, should be prepared for the possibility of further changes.

The proposed American Jobs Plan Act includes changes to Global Intangible Low-Taxed Income (GILTI) and Foreign Derived Intangible Income (FDII) regulations that could impact both federal and state tax liabilities for cross-border businesses with global operations.

Understanding GILTI and FDII

In general, TCJA represented a shift in US corporate tax policy. GILTI is a new category of foreign income taxed at a lower rate than the regular US federal corporate income tax rate, designed to serve as a proxy for foreign-held intangible assets (such as patents, copyrights, trademarks, and other forms of intellectual property). The calculation for determining GILTI is complex, but its intention is to ensure that foreign subsidiaries of US companies pay a minimum rate of income tax to the US.

FDII, on the other hand, offered domestic companies a deduction to reduce the tax rate on income from exporting goods and services tied to intangible assets (again, intellectual property) held in the US. This was intended to give companies an incentive to keep their IP in the US.

Proposed Federal Changes

Once the amount of profit potentially subject to GILTI is determined, that amount is reduced first by a certain deduction, and then applicable foreign tax credits (FTC). Under current law, the deduction applicable exempts 50{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} of a company’s GILTI from tax liability, a rate set to decline to 37.5{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} in 2026. With the current US federal corporate tax rate of 21{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f}, this yields an effective tax rate of 10.5{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} on GILTI.

Provisions under the proposed American Jobs Plan Act unveiled by President Biden in April 2021 are intended to increase the tax rate on GILTI to 21{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f}, modify how GILTI is calculated, and tax GILTI on a country-by-country basis. These regulations are expected to increase the overall GILTI tax liability for US multinational companies. While the specifics of how rate increases will be accomplished requires further guidance from the IRS, this is expected to be achieved through a reduction in the Section 250 deduction applicable from 50{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} to 25{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f}.

The Biden administration has also proposed eliminating the FDII deduction, which would result in an increase in the overall US federal effective tax rate for businesses currently claiming this benefit.

Effect on State Tax Rates

The treatment of GILTI and FDII is inconsistent across all states in the US. Several states included GILTI in their tax base after TCJA was passed, while others have specifically excluded this from state tax computations. Others have classified it as a foreign dividend eligible for deduction or brought in the Section 250 deduction at the state level to lower the overall US effective tax rate, providing some relief at the state level. Complicating the issue further is the fact that some states have not yet established clear guidance on how (or if) GILTI should be taxed, some allow the FDII deduction while others do not, and others are considering legislative changes to current regulations.

Changes at the federal level will likely automatically trickle down to states that currently conform to the federal corporate tax code. If the American Jobs Plan Act is enacted, this will likely result in state tax increases in states that currently tax GILTI, as well as in those that offer a FDII deduction.

Conclusion

While proposed changes are not yet finalized and subject to further modifications, cross-border businesses should consider the impact of these legislations on their global tax liability. Also, the enactment date on these changes remains unclear.

For more information, please contact your US tax advisory team at youradvisor@fernwaysolutions.com or visit us at www.fernwaysolutions.com.

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