February 14, 2023
Federal Policy Director
February 14, 2023
The new corporate minimum tax enacted as part of last year’s Inflation Reduction Act will address some of the worst corporate tax dodging, but what else is needed? A group of Democrats have answered this question with the No Tax Breaks for Outsourcing Act, a bill that would eliminate Trump tax law provisions that tax offshore profits of American corporations more lightly than their domestic profits. This proposal is more relevant than ever because it would help the U.S. implement the global minimum tax the Biden administration negotiated with the international community.
Offshore Corporate Tax Dodging Is Rampant
There is overwhelming evidence that multinational corporations are gaming our tax system and will continue to do so without further reform. For example, American corporations, as a group, reported to the IRS that they earned $60 billion in the Cayman Islands in 2019. This is impossible, because the entire economic output of that tiny nation was just $6 billion that year. Similarly, American corporations reported that they earned $31 billion in Bermuda, even though that country’s economic output was just $7 billion.
American corporations are obviously engaging in accounting gimmicks to claim that profits actually earned in the United States (or other countries with functioning tax systems) are earned in countries where they will not be taxed.
The most obvious tax havens are often territories of western countries that treat them as independent for tax purposes (thus allowing this type of corporate tax avoidance) but dependent for other purposes, as we recently explained. Thankfully, all these nations have signed the global minimum tax agreement to put an end to this – and now they need to implement it. For the U.S., the No Tax Breaks for Outsourcing Act would bring us most of the way to accomplishing that.
How the Bill Fits into the Current Tax Debate
The debate over corporate taxes right now is a bit confusing. The Inflation Reduction Act, which President Biden signed into law last year, requires the very biggest corporations (those with average profits exceeding $1 billion over three years) to pay at least 15 percent of their profits in taxes, with certain exceptions.
The global minimum tax negotiated with the OECD may initially seem similar – it also has a 15 percent rate – but, as we have explained, it is a completely different set of rules to specifically target corporations shifting profits offshore to avoid taxes. It has been signed by nearly all the world’s governments, including the U.S., but Congress needs to enact legislation to implement it. The No Tax Breaks for Outsourcing Act could be that legislation, or at least the main part of it.
The Legislation Would End Breaks for Offshore Profits of American Corporations
The bill would repeal the provision in current law allowing American corporations to effectively pay taxes on their offshore profits at just half the rate they pay on their domestic profits. This means they would be required to pay at least a 21 percent rate on offshore profits rather than the 10.5 percent required under the Tax Cuts and Jobs Act, better known as the Trump tax law. (Corporations would continue to get credits for most of the taxes they pay to foreign governments to prevent double taxation.)
As a result, corporations could no longer avoid taxes with accounting schemes that claim their profits are generated in Bermuda or Ireland or some other tax haven. They would pay taxes at a rate of at least 21 percent no matter where they claim to earn their profits. This is more than enough to bring American corporations into compliance with the global minimum tax’s minimum rate of 15 percent for offshore profits.
The bill would also remove the rule that completely exempts certain offshore profits from U.S. taxes. The Trump tax law does not tax offshore profits at all unless they exceed 10 percent of the value of the corporation’s tangible assets invested offshore. Tangible assets are what most people think of as “real” investments, such as machines, factories, and stores.
The idea behind this was apparently to (very mildly) discourage companies from using accounting gimmicks to make profits earned in a country with a normal tax system appear to be earned in a tax haven country where they were not doing any real business. The drafters were not concerned about offshore profits that seem, at least vaguely, to be the result of actual business activities in a foreign country. But the problem with this approach is that American corporations might reduce their tax bills by moving real assets and business offshore, which is obviously not a great result for our economy or for American workers.
This legislation would therefore remove the main breaks that allow American corporations to pay taxes of less than 21 percent on their offshore profits. Even better, it would apply tax rules to corporate profits per-country rather than worldwide. The current rules apply worldwide, meaning higher taxes that a corporation pays in one country could offset very low taxes it pays in another country.
For example, imagine an American corporation has subsidiaries operating in many different countries. It pays taxes to the government of one country where it operates at a rate of just 5 percent but pays tax rates in other countries at much higher rates. If the U.S. imposes a worldwide minimum tax (as is true under the current rules) then the corporation may owe no additional taxes to the U.S. if its total taxes paid to all foreign governments worldwide exceeds to the minimum rate.
Under the No Tax Breaks for Outsourcing Act, American corporations would be required to pay at least 21 percent on the profits they generate in each country where they report profits, calculated separately. This means that the company in this example would almost definitely owe additional taxes to the U.S. government on the offshore profits that were taxed at just 5 percent in the country where they were supposedly earned. This is also how the OECD’s global minimum tax would work (albeit at a lower rate).
The bill would also block corporate “inversions,” the practice by which American corporations claim a merger with a foreign company has converted them into a foreign entity for tax purposes even though most of their ownership has not changed. It would also treat corporations that are managed and controlled in the U.S. as American companies for tax purposes, meaning they would obtain no tax benefits by setting up subsidiary companies in the Cayman Islands or Ireland.
The Bill Would Stop Foreign Corporations from Stripping Earnings Out of the U.S.
The provisions of the bill discussed so far would effectively stop American corporations from shifting profits offshore. Another part of the bill would address foreign-owned corporations that operate in the U.S. and manipulate debt to strip earnings out of the county.
American companies that are subsidiaries of foreign corporations sometimes claim to borrow from, and make interest payments to, their foreign parent companies, and then tell the IRS that they have little or no U.S. profits as a result. In reality, the “lender” and “borrower” in this situation are all part of the same company and controlled by the same people, so the arrangement serves no purpose other than to avoid U.S. taxes. The bill would crack down by limiting deductions for interest payments when a U.S. subsidiary claims a disproportionate share of interest expenses.
The No Tax Breaks for Outsourcing Act Would Create a Simpler, Fairer Tax System
The details may seem complicated, but what the No Tax Breaks for Outsourcing Act would accomplish is quite simple. American corporations would not pay lower taxes on their offshore profits than they do on their domestic profits. Foreign-owned corporations would not have additional opportunities to strip profits out of the U.S. The convoluted schemes used to shift profits offshore would be of no benefit and thus come to an end. As a result, the entire corporate tax system and its administration would be much simpler. The OECD’s global minimum tax has the same goals, and this bill would put the United States in a very good position to fully implement that agreement.