Just Taxes Blog by ITEP

U.S. Should Pursue Biden’s Tax Legislation and International Tax Agreement on Separate Tracks

U.S. Should Pursue Biden’s Tax Legislation and International Tax Agreement on Separate Tracks

June 9, 2021

Steve Wamhoff
Steve Wamhoff
Director of Federal Tax Policy

The agreement announced over the weekend from the finance leaders of the Group of 7 (G7) countries to allow governments to tax some corporate profits based on the location of sales and to implement a 15 percent global minimum tax is a major step forward—but in no way changes the need for Congress to enact President Joe Biden’s tax reforms right now.

The G7 and the OECD have been working for years on rules to prevent corporate tax avoidance. The new G7 deal announced over the weekend would fill in more details of those rules. If the new deal gains the support of a broader set of governments, it could be the biggest international tax reform in generations.

Determining Who Can Tax Profits

The plan that the OECD had already drafted includes a “Pillar 1” that allocates the right to tax corporate profits at least partially based on where a corporation is selling goods or services. Until now, the general rule has been that countries are allowed to tax businesses that are physically present within their borders.

In recent years, more corporations (particularly American corporations) have generated profits by selling to customers in countries where they have little or no physical presence. This means that governments have less ability to tax profits from commerce within their own borders under the traditional approach.

The G7 deal fleshes out the new approach by allowing countries to tax a fraction of corporate profits (20 percent of corporate profits) that exceed a 10 percent profits margin. In other words, extremely profitable companies could be taxed in countries where they do not physically operate but where they nonetheless make money, for example, by selling services online.

There have been efforts in several countries to address this problem by unilaterally imposing digital services taxes on companies that profit from selling services online to customers within their borders. This part of the G7 deal may make those unilateral taxes unnecessary.

Determining a Minimum Level of Taxation

The OECD draft also includes a “Pillar 2” to address corporate tax avoidance by ensuring corporations pay a minimum tax rate on profits no matter where they are earned. Countries participating in the new set of rules would impose a minimum tax on their own “resident” corporations. This means, for example, that if the offshore subsidiaries of an American corporation pay a tax rate that is less than a specified minimum, the United States would tax those offshore profits enough to bring their total tax rate (including foreign taxes and U.S. taxes) up to the minimum rate. The OECD drafters call this Pillar 2’s “income inclusion rule.”

The Biden proposals already submitted to Congress, in the part of the administration’s budget proposal that it calls the American Jobs Plan, would accomplish the same thing. They would require that offshore profits of American corporations are subject to a total effective tax rate of at least 21 percent. The G7 deal would call on countries to do the same thing and set a minimum rate of 15 percent.

The OECD proposals have also tried to address corporations based in countries that do not participate in this effort. Governments in participating countries would tax, or deny tax deductions for, certain payments like interest and royalties that are made to foreign corporations based in countries that do not impose tax of at least the minimum level that other countries agreed upon. The OECD drafters call this Pillar 2’s “under-taxed payments rule.”

For example, foreign-owned corporations in the United States sometimes “borrow” from their foreign parent companies and pay them interest at an artificially high rate. The foreign-owned company in the United States can deduct the interest payments from its income when it calculates U.S. taxes.  Since the “lender” and “borrower” in this situation are really parts of the same company, the whole transaction only exists on paper to move profits offshore. If the country where the parent company is based does not subject its corporations to at least some minimum level of tax, this practice will continue unless the United States denies deductions for those interest payments or imposes a withholding tax on them.

The Biden proposals submitted to Congress would accomplish this with what the administration calls the Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD) rule. Under the SHIELD, an American corporation that is a subsidiary of a foreign corporation would not be allowed to deduct payments (like interest payments or royalties) made to foreign parent companies located in any country with a tax rate below a specific minimum set by international agreement. The administration says that until such international agreement is reached, the minimum would be 21 percent, the same minimum that the president’s plan would impose on offshore profits of American corporations.

Biden’s Tax Proposals Are Still Desperately Needed

The Biden proposals submitted to Congress achieve many of the same things as the G7/OECD proposals, but the proposals submitted to Congress should be enacted without delay, regardless of where international negotiations go from here.

International agreement is more difficult and can take much longer. For example, Pillar 1 of the OECD proposals could require changes to international tax treaties, which require a vote of two-thirds of the U.S. Senate. Biden’s proposals to Congress do not alter treaties and can be enacted through “regular order” or even through budget reconciliation, which only requires 51 votes in the Senate (including the vote of Vice President Kamala Harris when needed to break ties).

Republican lawmakers who enacted the 2017 Trump tax law are already vocally opposing any international agreement that raises taxes on corporations. We cannot wait for them to have an epiphany about the problems associated with companies shifting their profits to offshore tax havens to avoid supporting the societies that make those profits possible.