Foreign direct investment is a key economic engine for American prosperity, responsible for millions of American jobs and trillions of dollars in economic impact. Foreign-headquartered companies employ nearly 8 million U.S. workers, and U.S. workers at these companies earn an average of $83,705 annually, 18 percent more than the average private-sector job.International companies pay a wide range of U.S. federal, state and local taxes, including 25 percent of all federal corporate income taxes.International companies are invested in almost every industry and in every state across the United States, but they are especially concentrated in the manufacturing sector – responsible for employing 22 percent of America’s manufacturing workforce and for creating 69 percent of new U.S. manufacturing jobs in the past five years.
GBA believes it is critical that America remains the world’s premier destination for international investment, and that stable U.S. tax policy is a key component of U.S. competitiveness. Currently, two provisions of the House Legislation disproportionately burden employers that have made a deliberate decision to invest in the United States and maintain and create high-quality U.S. jobs.
Proposed Global Interest Limitation Will Hurt Americas Economic Recovery and Would Make the U.S. an International Outlier
The proposed Section 163(n) limitation would create a global interest limitation that would have a chilling effect on foreign direct investment. This additional limitation will significantly increase the cost of capital for employers interested in growing and maintaining operations in the United States and could push future investment abroad. Further, its application is out of step with the accepted norms of ordinary business financing as to what are appropriate levels of debt and interest. The 163(n) provision would add yet another interest limitation and apply concurrently with the existing interest limitations.
The proposed 163(n) limitation would apply in addition to the Section 163(j) limitation, which limits a company’s net interest expense to 30 percent of the company’s adjusted taxable income. As proposed, whichever provision allows the lower deductible amount of interest would be applicable. This would immediately make the United States an international outlier. The OECD/G20 Inclusive Framework, Action 4 recommends that countries which impose both types of limitations allow for a tax deduction for interest equal to the greater of the “163(j)-type” allowable amount or proposed “163(n)-type” allowable amount. All countries that have implemented both limitations have followed that recommendation allowing a deduction for the greater of the two limitations.
As an association representing investors and job creators in the U.S. economy, GBA strongly believes the proposed Section 163(n) limitation would make the United States less competitive and attractive for investment, have unintended consequences, create an unnecessary additional limitation that would unfairly penalize companies interested in expanding their operations in the United States, and should not be implemented.
Tailor the BEAT to Address Clear Base Erosion and Maintain Existing Exemptions
GBA commends the approach taken by the House to focus the BEAT onpayments made to low-tax jurisdictions as well as modifying its tax credit provisions. Specifically,the exemptionforpaymentsmadetojurisdictionswherethetaxrateexceeds theBEATrateis a well-reasoned improvement tothisimperfect tax. However, given that this is a new exception with many undefined details, we remained concerned that Congress’s intent for this to provide relief for those conducting ordinary business activity could be eroded through a potentially subjective regulatory process.
There is one critically flawed BEAT tax provision that remains as part of the Build Back Better (BBB) legislation that needs immediate remedy, as it creates significant unintended consequences and is completely inconsistent with the OECD goal of targeting and appropriately taxing payments made to a low-tax jurisdiction.
As drafted, a potential failure to meet the foreign Effective Tax Rate exception results in a harsh cliff effect. The House Ways and Means Committee, Senate Finance Committee and House and Senate staff members have indicated that this cliff effect is overly punitive – effectively treating payments subject to a 14.9 percent ETR (when the applicable ETR rate is 15 percent) the same as a payment subject to a zero percent ETR. Given the lack of specificity as to how to calculate the foreign recipient ETR, it is entirely conceivable that payments to countries with high statutory tax rates, such as Japan and Germany, could be significantly impacted.
This cliff effect can easily be corrected by adding an adjustment mechanism proportionate to the amount of foreign tax paid by the affiliate on the receipt of the income. Thus, if a resulting foreign ETR turns out to be 14.9 percent due to some nuance in the calculation for a given year, only a proportion of the payment to such country should be subject to the BEAT, whereas a payment to a country with a zero percent ETR would be fully subject to the BEAT.
As noted above, the calculation of the ETR is not yet defined in the BBB legislation with any specificity. It is important to understand that the ETR is very different than a published statutory tax rate.
Despite several years of express focus, the OECD has some recommendations but has yet to finalize a conclusion regarding the ETR calculation due to the complexity involved. Thus, it is critical that the legislative rules for determining the ETR of foreign income tax be prescribed carefully, accurately and fairly given the many complexities that factor into an ETR calculation, such as timing differences, participation exemptions and operating losses. Such calculations should be consistent with global norms and in alignment with the OECD consensus. We realize this cannot be done today, so Congress should direct Treasury to draft its regulations in accordance with the OECD principles, recommendations and, ultimately, its conclusions.
GBA also recommends reconsidering the House Legislation’s approach to entrapping legitimate and essential business activity within the BEAT. Specifically, the proposal limits the cost-of-goods sold (COGS) and related protections as part of the BEAT.
COGS represent necessary business activity – not exotic tax planning. By eliminating the COGS exception, the same profits may be subject to tax in the United States and one or more jurisdictions if not covered by the ETR exception. Additionally, amounts in excess of profits may be subject to U.S. tax with the treatment of legitimate, indirect costs as base erosion payments. Accordingly, the COGS and other 5 COGS-like exceptions (e.g., services cost method, qualified derivative payments, TLAC, etc.) should be maintained.
One final point related to the COGS protections is that the proposed changes by the House create a safe harbor to permit an election that 20 percent of the amount paid to purchase inventory is not subject to the BEAT. If Congress and the Administration want to promote U.S. manufacturing, the COGS modifications should allow U.S. manufacturers a safe harbor exemption of a similarly reasonable amount of indirect costs paid to a foreign related party for the right to manufacture products in the United States.