Last week, New Mexico enacted the most significant state corporate tax reform of the year so far. On top of declining to fold large federal business tax cuts into state law, Senate Bill 151 also took the monumental step of hardening the state’s corporate tax base against offshore profit shifting. This was accomplished through a thoughtful linkage to the federal tax code’s new definition of Net Controlled-Foreign-Corporation Tested Income (NCTI, or “necktie”). Other states would be wise to give serious consideration to New Mexico’s novel approach.
NCTI is a sweeping definition of profits reported by foreign subsidiaries of U.S. companies. It is the somewhat reworked successor to GILTI, or Global Intangible Low-Taxed Income (GILTI), which was first enacted at the federal level in 2017. Bringing this income within reach of state corporate tax law helps prevent corporations from sidestepping their state tax obligations by pretending their profits were generated by foreign subsidiaries in tax havens like the British Virgin Islands or Switzerland. Turning a blind eye to this income, on the other hand, is a recipe for aggressive corporate tax avoidance.
With New Mexico’s new reform, 22 states and the District of Columbia are now including some amount of either NCTI or GILTI in their tax bases. What is especially notable about New Mexico’s inclusion, however, is that it is the first major reform of its type to be enacted after the federal conversion from GILTI into NCTI, and it navigates that new federal landscape in an innovative way.
Up until now, every state taxing GILTI or NCTI put only a portion of that income into its tax base—ranging across states from a low of 5 percent to a high of 60 percent. New Mexico, by contrast, is the first to choose to include 100 percent of NCTI in its pre-apportionment tax base. A new briefing book written by the highly knowledgeable staff of the Multistate Tax Commission (MTC) suggests there is good reason for this approach, arguing that “there is no reason to conform” to the federal government’s 40 percent NCTI deduction, for instance.
New Mexico’ law, notably, also offers traditional “factor representation” for NCTI income. This means New Mexico will determine the appropriate share of NCTI to tax for each company by using an apportionment formula that compares the size of the company’s New Mexico operations to its overall global operations. This approach to GILTI/NCTI has been rarely used up until now, with only New Hampshire, Utah, and Vermont unambiguously offering factor representation in a way that considers the size of a company’s foreign operations. Any state considering a full, 100 percent NCTI inclusion like New Mexico will want to join this group of states to ensure that it taxes only the portion of NCTI related to each company’s in-state activities.
The case for including NCTI in state corporate tax bases is stronger than ever. As the MTC’s staff recently explained (see page 26), states cannot expect the federal government to adequately police the transactions that facilitate offshore profit shifting schemes. Instead, states should be assertive in pursuing either a NCTI reform like New Mexico’s or, better yet, a move to full worldwide combined reporting.
It goes without saying that working families and small businesses cannot avoid paying state taxes by hiding their incomes in offshore tax havens. State lawmakers have a responsibility to ensure that multinational corporations can’t get away with this kind of tax avoidance either. As states revisit their linkages to federal law in light of the recent federal tax rewrite, this is a natural time for them to ensure those linkages are structured in a way that minimizes the risks posed by offshore profit shifting.
