25 06 2018

TCJA Encourages Firms To Shift Profits Offshore, Says ITEP

Aspects of the tax reform legislation in the United States continue to provide an incentive for companies to shift profits offshore, by providing more favorable tax treatment to foreign income than domestic profits, the Institute on Taxation and Economic Policy (ITEP) has said.

The new report on the Tax Cuts and Jobs Act by the ITEP contends that the law has "failed to address some fundamental problems with the US tax code and in some ways has made them worse."

"Congress could have fixed many problems by following one simple principle: tax offshore profits of American companies the same way their domestic profits are taxed. The old system was problematic because it allowed American corporations to 'defer' paying US taxes on offshore profits until those profits were officially brought to the United States. The new system, under TCJA, is problematic because it taxes offshore profits at lower rates than domestic profits. Both approaches tax profits that are reportedly earned offshore more lightly than domestic profits."

The report was particularly critical of the new Global Intangible Low-Taxed Income (GILTI) regime, which was included in the TCJA to discourage US corporations from shifting high-yielding intangible assets such as intellectual property rights to low-tax jurisdictions. GILTI is defined as the portion of the income of a controlled foreign corporation owned by US shareholders that exceeds a notional 10 percent return - a rate that is intended to reflect the normal rate of return on intangible assets. After a 50 percent deduction GILTI is subject to an effective corporate tax rate of 10.5 percent, half the regular 21 percent US corporate tax.

According to the ITEP, the GILTI regime merely provides a new incentive for US corporations to now shift their tangible assets to lower-taxing jurisdictions. Its report states that:

"Under TCJA, some offshore profits of American corporations are effectively subject to a federal tax rate of zero percent. That's because the new rules do not tax offshore profits at all unless they exceed an amount equal to 10 percent of the value of the corporation's tangible assets invested offshore."

"The rules simply assume that offshore profits exceeding 10 percent of these assets are profits from other types of assets (intangible assets like patents) that are easier to shift abroad. The rules call these profits Global Intangible Low-Taxed Income, which may be subject to tax, depending on whether they have been subject to foreign taxes."

"The big problem with this is that it means a corporation can lower its share of offshore income that is subject to tax (lower its GILTI amount) by moving more tangible assets abroad. Suppose an American corporation has one offshore subsidiary which is in the United Kingdom. The American corporation has a factory in the United States that makes goods that are transferred to the offshore subsidiary, which then sells the goods to people in the United Kingdom. The UK subsidiary may have few tangible assets – maybe some stores and an office building. The UK profits exceeding 10 percent of the value of the tangible assets in the United Kingdom are potentially GILTI, subject to US taxes."

"But the corporation could reduce or even zero out its GILTI tax by moving the factory and all its machines to the United Kingdom, increasing the amount of tangible assets held offshore. This would make a smaller share of the UK profits (or perhaps none at all) exceed 10 percent of the company's tangible assets held offshore. A smaller share of the company's offshore profits is GILTI and potentially subject to US taxes."

ITEP's report also criticizes the foreign-derived income attributable to intangibles (FDII) deduction, which is intended to encourage US corporations to hold IP rights in the United States. The FDII regime provides a 37.5 percent deduction on income exceeding a 10 percent normal rate of return for an effective US tax rate of 13.125 percent. However, the ITEP argues that these rules provide an additional incentive for US corporations to shift tangible assets offshore.

"[T]he FDII deduction has the same problem as GILTI," the report said. "The new law defines FDII simply as profits in the United States from selling to foreign markets minus an amount equal to 10 percent of the value of tangible assets held in the United States. The reasoning is that any profits beyond this amount must be from intangible assets, but that is not necessarily true. (The 10 percent threshold is arbitrary.) Like the GILTI rules, the FDII rules could encourage American corporations to shift real assets (and the jobs that go with them) offshore. In this case, corporations would do this to increase the amount of income that is considered FDII and thus eligible for the FDII deduction."

The ITEP also argues that the FDII regime could violate international trade law as it effectively subsidizes profits earned by US companies from exports.

"Such export subsidies are banned under the international agreements of the World Trade Organization. The best that can be hoped for is that companies will largely ignore the FDII deduction because they know that the WTO may pressure Congress to repeal it," the report concluded.