Double Edged Sword – International Taxation Proposals Under The Recent Build Back Better Act May Result in Increased Tax and Compliance Challenges

At a glance

• The main takeaway: The latest version of the Build Back Better Act (BBBA), if passed, will modify the cross-border provisions enacted with the Tax Cuts and Jobs Act in 2017 (TCJA). Some of these changes may benefit certain taxpayers with cross-border income and activities, while others will see tax increases resulting from fewer exemptions and lower deduction amounts.
• Impact on your business: The current language in the bill, which is largely consistent with a recent House Ways & Means Committee proposal, sets an approximate 15 percent benchmark effective tax rate on certain favorably treated foreign income. Among other changes, taxpayers deriving Global Intangible Low-Tax Income (GILTI) and Foreign-Derived Intangible Income (FDII) will see their deduction amounts reduced to achieve that benchmark effective tax rate.
• Next steps: Aprio’s team of International Tax experts can help you react quickly to understand the impact of the BBBA international tax proposals and identify possible planning opportunities in an effort to minimize their impact.

To learn more about these potential impacts, schedule a free consultation today.

The full story:

The Build Back Better Act (BBBA) is the centerpiece of President Biden’s domestic social policy agenda and has been the subject of lengthy negotiations among House and Senate Democrats. This tax overhaul, like almost all tax-related legislation over the past several administrations, will seemingly be passed as a single-party bill through the budget reconciliation process.

The President’s initial international tax framework envisioned even more significant changes in the U.S. tax treatment of cross-border activity and business, however, while still significant, the international provisions in the BBBA are in many respects more taxpayer-friendly. Regardless, if enacted into legislation, U.S. taxpayers will be faced with changes to their tax bill on foreign business and investment.

Below we highlight some of the key material international tax changes to Global Intangible Low-Taxed Income (GILTI), Foreign-Derived Intangible Income (FDII), Foreign Tax Credit (FTC) and Base Erosion Anti-Abuse Tax (BEAT) that are proposed in the BBBA.

GILTI proposed changes

Applying to tax years beginning after December 31, 2022, GILTI will be determined on a country-by-country (CBC) basis rather than an aggregate of controlled foreign corporation (CFC) financial activity regardless of foreign jurisdiction. For corporate taxpayers, the GILTI deduction will be reduced from 50 percent to 28.5 percent, resulting in an effective GILTI rate of 15.02 percent (based on the corporate rate remaining 21 percent). This will require a 15.8 percent foreign tax rate to avoid residual U.S. tax on GILTI inclusions when combined with the 5 percent haircut to GILTI foreign tax credits (discussed below). Further, the return on qualified business asset investment is reduced from 10 percent to 5 percent for CFCs that are not in territories of the U.S. The qualified business asset investment (QBAI) return is generally a presumed return on fixed assets of profitable CFCs, which reduces the amount of foreign income subject to current U.S. federal income tax.

FDII proposed changes

U.S. exporters face potential tax increases generally applying to tax years beginning after December 31, 2022. The BBBA proposes a reduction of the FDII deduction from 37.5 percent to 24.8 percent, yielding an effective FDII tax rate of 15.8 percent. Passed with the TCJA in 2017, FDII is intended to provide an incentive for U.S. companies to invest in the U.S by taxing exported goods and services at a more favorable rate.

FTC  proposed changes

Similar to GILTI, the BBBA proposes to determine any FTC on a CBC basis for all foreign source income baskets and reduces the FTC “haircut” (i.e., the amount of foreign taxes related to GILTI inclusions unavailable for credit by corporate U.S. shareholders) to 5 percent from its current 20 percent level. Unused GILTI foreign tax credits can be carried forward, unlike current law. Further and perhaps most importantly, U.S. expenses will no longer be allocated to the GILTI basket other than the 28.5 percent GILTI deduction referenced above. This change should generally allow a larger foreign tax credit for corporate taxpayers with respect to a GILTI inclusion.

BEAT proposed changes

As part of the TCJA, the BEAT served as a guardrail to reduce the tax benefit of shifting income out of the U.S. Effectively, it is a type of minimum tax where deductible payments (e.g., royalties and interest) are made to related parties. The BBBA proposes to accelerate the increase in the BEAT rates from 10 percent to 12.5 percent for tax years beginning after December 31, 2022 and before January 1, 2024; from 12.5 percent to 15 percent for tax years beginning after December 31, 2023; and from 15 percent to 18 percent for tax years beginning after December 31, 2024. Further, it expands the definition of base erosion payment to include certain amounts capitalized to inventory and recovered through cost of goods sold (COGS). Currently, all amounts included in COGS are not subject to BEAT. Favorably and unlike current law, it provides an exception from qualification as a base erosion payment if U.S. income tax is imposed on the payment or it is subject to “sufficient foreign tax.” There is sufficient foreign tax if a deductible payment is subject to an effective foreign income tax rate that is not less than the lesser of 15 percent or the BEAT rate in effect for that tax year. So, a 15 percent effective foreign income tax rate would be considered “sufficient foreign tax” even when the BEAT rate increases to 18 percent in tax years beginning after December 31, 2024.

Other notable international changes

The subpart F inclusion rules are amended such that a related party only includes U.S. entities or entities with effectively connected income (ECI), and consequently, only CFCs buying from or selling with such related parties with generate subpart F inclusions for foreign base company sales income or foreign base company services income.

If all other qualifications are met, the section 245A 100 percent dividend received deduction is limited to distributions received from CFCs rather than 10 percent owned foreign corporations even if not a CFC (i.e., so-called 10/50 company).

Prospectively, section 958(b)(4) would be reinstated in an effort to prevent “downward attribution” of foreign corporation stock to U.S. persons, which has had the effect of causing more foreign corporations to unexpectedly qualify as CFCs resulting in surprising foreign income inclusions and at times, additional information reporting obligations. In an effort to address transactions that motivated its repeal, a new proposed provision, section 951B, would however replicate certain foreign income inclusions for U.S. shareholders that resulted from the repeal of section 958(b)(4) without replicating all the consequences of repeal.

The bottom line

Despite general effective rate increases, the international proposals within the BBBA provide a mixed bag of favorable and unfavorable taxpayer changes. Consequently, each taxpayer will be affected differently and the best way to prepare yourself and your business is to proactively identify areas in which you may be most affected, and assess and model their potential impact. Unlike some of the proposed purely domestic tax changes, the international provisions of the BBBA will not all be implemented immediately, allowing taxpayers with foreign activities in certain instances time to evaluate their impact and plan accordingly.

That’s where Aprio can help. Our International Tax team experts are well-versed on current international tax laws and the BBBA proposals. We can help you prepare for potential future changes to achieve the best possible tax results.

Let Aprio help you prepare for future tax changes. Schedule a consultation today!

Disclosures

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding this matter.