Can GILTI and the GloBE be harmonized in a Biden administration?

By Daniel Bunn, Tax Foundation, Washington, DC

Countries participating in the OECD Inclusive Framework’s negotiations on cross-border tax rules hope to reach an agreement by mid-2021. After negotiations stalled somewhat in 2020, there is hope that US Treasury Secretary Janet Yellen’s commitment to reaching an agreement will allow progress to be made this year.

One piece in the negotiations is the proposal for a global minimum tax. As part of the 2017 tax reform, the US adopted a tax on global intangible low tax income (GILTI), a sort of minimum tax on the foreign earnings of US companies.

GILTI has inspired policymakers in other countries to look for ways to reach an agreement on a global version of GILTI. A detailed outline for such a proposal, the global anti-base erosion (GloBE) rules, was released in October 2020.

The goal of the Inclusive Framework’s negotiations on GloBE is to reach an agreement that would minimize differences in taxing cross-border income. However, the US negotiating position in the recent past has been to ask that GILTI be an approved minimum tax regime rather than to amend US rules to conform to the GloBE.

This is a critical point because GILTI and the GloBE have some differences. These include differences both in the tax rate and the tax base—two important features of any tax policy. Those differences could increase if the proposals that President Biden made during his campaign were to become part of US law.

Despite the differences, policymakers should recognize the complexities and economic costs of imposing broad minimum taxes on cross-border earnings.

GILTI and its problems

GILTI can be defined as a US businesses’ foreign income that is subject to US tax on an annual basis. It is a new class of foreign income introduced by the 2017 tax reform legislation.

The calculation for GILTI includes net tested income and a deduction for 10 percent of depreciable tangible assets. The tax on GILTI applies after a 50 percent deduction, leading to a 10.5 percent effective tax rate on GILTI (half the US corporate tax rate of 21 percent). The 10.5 percent rate arises in the absence of foreign taxes paid on earnings included in GILTI.

The 10 percent deduction for depreciable tangible assets is a formulaic approach to a substance-based carveout. Because it is based on tangible assets, services companies with less physical capital involved in foreign markets will have a smaller deduction and be more likely to be caught by GILTI. Additionally, companies with very long-lived assets whose current depreciable value is minimal will also likely be caught by GILTI.

Many countries have rules that tax foreign earnings of multinationals. However, those rules regularly draw a line between active and passive earnings. The formulaic substance-based carveout in GILTI results in a much broader tax base than a tax on passive earnings. In fact, the US rules for Subpart F already tax passive earnings of US multinationals, suggesting that the GILTI tax base is much broader than passive earnings.

If a US company has paid foreign taxes on earnings covered by GILTI, the tax liability calculation gets complicated. Foreign tax credits applicable to GILTI are limited in two ways. First, they are limited to 80 percent of their value. Second, they are limited by standard US rules for foreign tax credits, which include requirements to allocate some domestic expenses to foreign earnings, reducing the value of applicable foreign tax credits.

Both limits lead to extra US tax on foreign earnings that may have already been taxed (in some cases at relatively high rates). This means taxes on GILTI result in double taxation in some cases.

In theory, if a company has foreign tax credits to apply to GILTI, the effective tax rate could rise to 13.125 percent. However, expense allocation can cause effective rates on GILTI to be much higher than 13.125.

Regulations were implemented in 2020 to exclude some highly taxed foreign earnings from GILTI. The high-tax exclusion rules address part of the problem caused by the interplay between expense allocation and GILTI. Highly taxed foreign earnings are defined as those taxed above 18.9 percent (90 percent of the US corporate rate of 21 percent).

GILTI also does not allow excess foreign tax credits to be carried forward. This means that GILTI liability will be volatile for many companies that have high foreign taxes in some profitable years and losses in other years. This contributes to the uncertainty that companies face in understanding the taxes they would owe on any given foreign investment.

GILTI is also calculated on a worldwide, blended basis rather than by jurisdiction. This means companies can mix high-tax earnings with low-tax earnings when calculating GILTI.

Additionally, GILTI has some scheduled changes which will cause the effective rates on foreign earnings to rise after 2025.

The GloBE and a different approach to minimum taxation

In contrast, the OECD Inclusive Framework proposal for the GloBE is designed with the goal of eliminating double taxation of cross-border earnings. While there are several parts of the policy that are subject to further discussion and agreement, GloBE is expected to be different from GILTI in several ways.

The GloBE’s income inclusion rule is designed to be a top-up tax on foreign earnings of companies. If a company is paying taxes at a 10 percent effective rate on its foreign earnings and the minimum rate is 12.5 percent, then the country where that company is headquartered could tax the 2.5 percentage-point difference between the minimum and the effective rate.

The tax base for the GloBE is based on profits reported on a business’s financial statements. Because of the difference between financial profits and taxable profits, a variety of adjustments are proposed to make financial profits look more like taxable profits.

The economic impact assessment of the GloBE utilized minimum tax rates between 7.5 percent and 17.5 percent. Without a political agreement, though, it is uncertain where exactly the GloBE minimum rate would fall.

The GloBE proposal has a broad, formulaic carveout for economic substance that includes depreciable tangible assets (similar to GILTI) and payroll costs. This would likely be a broader tax base than would result from rules that define and tax passive foreign income, but the tax base for the GloBE would be narrower than GILTI.

The OECD Inclusive Framework proposal would also allow carryover of excess foreign taxes to ensure that the taxes applied under GloBE recognize profitability and taxation over time. This is intended to help minimize tax burden volatility for companies subject to GloBE.

The GloBE is expected to apply on a jurisdictional basis rather than allow for worldwide blending of foreign earnings. This could be subject to change as negotiations progress, but jurisdictional calculations for GloBE seem likely.

The Biden and Yellen approach on GILTI

Treasury Secretary Janet Yellen has commented that the US administration’s goal is to have an effective minimum tax agreed to at the global level.

It is unclear how this view will work out in the ongoing negotiations over the GloBE because GILTI and the GloBE have significant differences. Two policy proposals from President Biden’s campaign regarding GILTI would increase those differences, while another would create some alignment.

First, the Biden campaign recommended raising the GILTI rate to 21 percent, a rate that is much higher than what has been expected for the GloBE.

Even beyond the Biden campaign’s approach, the rate on GILTI is set to rise after 2025 under current law (16.4 percent), and Biden’s separate proposal to raise the US corporate tax rate to 28 percent would have a knock-on effect for the high-tax exclusion.

Second, the Biden campaign and some congressional Democrats have recommended removing GILTI’s formulaic substance carveout, broadening the GILTI tax base even beyond the current breadth.

These proposals are couched in the argument that the substance carveout in GILTI paired with the lower rate will cause offshoring. This argument is flawed for several reasons, including the very low likelihood that a company would increase its foreign tangible assets simply to minimize its exposure to tax on GILTI.

The one area where the Biden campaign’s approach on GILTI and GloBE is in line is on jurisdictional calculations.

Jurisdictional calculations will likely mean serious compliance challenges because business units are not commonly arranged based on country borders. Foreign business units may include subsidiaries and earnings in multiple jurisdictions.

To comply with jurisdictional blending requirements, companies would need to significantly adjust their bookkeeping to align with the burden of jurisdictional calculations for taxation.

Misalignment on the rate and the substance carveout and alignment on jurisdictional calculations still leaves several other open questions on how the two policies might converge or remain distinct.

The remaining differences relate to foreign tax credits. On the issues of expense allocation, carryovers of foreign tax credits, and the 20 percent haircut on foreign tax credits, GILTI is not aligned with GloBE. Each of these foreign tax credit problems with GILTI can lead to double taxation, and, if nothing else, GILTI should be reformed in ways that follow the GloBE’s aspiration to avoid double taxation.

Harmonization or divergence?

GILTI has underlying problems that directly contribute to double taxation. On those issues, lessons from the GloBE should inform policymakers.

In areas where the Biden campaign recommended changes to GILTI, the proposals would make GILTI even more distinct from the GloBE. The one thing the two approaches share is the jurisdictional approach to taxation, and that, by itself, is likely to be a heavy compliance burden on businesses.

If GILTI and the GloBE are to be harmonized, there is clearly lots of work to do. Policymakers in the US and other OECD Inclusive Framework countries should focus on minimizing compliance burdens and the economic costs that will be associated with a broad-based minimum tax on cross-border earnings.

–Daniel Bunn, Vice President of Global Projects, Tax Foundation, Washington, DC