Reinvigorating manufacturing and creating jobs is a central theme for the Biden administration. While the erosion of the U.S. manufacturing base has been a concern for more than two decades, the pandemic and the resulting supply chain disruptions have highlighted the weaknesses in the nation’s industrial footprint and supply chain capabilities.
In response, manufacturing companies are reevaluating their global supply chains, including setting up operations near their larger original equipment manufacturer customers in foreign countries, manufacturing critical products in multiple countries and expanding their geographic reach through tech-enabled business models. As companies rethink their global footprint, they also have to bear in mind the changes in tax rules that target global income. These rules have garnered a lot of attention due to concerns that the government has been losing out on taxing income that U.S.-based multinational companies earn outside of the United States.
Over the years, successive presidential administrations have tried to tackle this issue through various approaches. President Trump’s Tax Cuts and Jobs Act (TCJA) in 2017 was one of the more significant attempts by the U.S. government to tax companies’ overseas profits. The Biden administration also plans to raise taxes on foreign earnings, and so a focus on global income takes on even greater importance given the United States’ need to finance a post-pandemic recovery and efforts to rebuild the economy.
As manufacturing companies rethink their global footprint, they have to bear in mind the changes in tax rules that target global income.
On May 28, the U.S. Department of the Treasury released an explanation of the Biden administration’s various federal and international tax proposals, known as the Green Book. Below are some of the more significant provisions relevant to middle market global manufacturers.
- President Biden’s tax plan calls for an increase in corporate tax rates from 21% to 28%. This may be difficult to achieve, given the Republican stance against corporate tax rate increases. However, corporate rates may rise to somewhere in the middle, especially if Democrats are able to pass tax changes through the budget reconciliation process, which only requires a simple majority vote in the Senate.
- The TCJA taxed at 10.5% profits earned by foreign subsidiaries of U.S.-based companies if those profits exceeded a certain threshold (i.e., 10% of fixed assets). This is referred to as Global Intangible Low-Taxed Income, or “GILTI” tax. Some companies have tried to manage this liability by increasing their capital investments (in order to increase the amount exempt under the GILTI tax), where possible, as part of a broader supply chain evaluation. Biden proposes removing this threshold and taxing the resulting additional GILTI income at a higher rate of 21% (this rate is linked to the corporate tax rate of 28% and will change accordingly). If Congress changes the corporate rate to 28%, a 21% tax on foreign earnings treated as GILTI will still provide a modest incentive to operate outside the United States.
In addition, the Biden administration proposal would no longer allow companies to offset losses earned in some countries against profits earned in other countries for purposes of computing their GILTI tax liability.
- Prior to the Green Book’s release, the Biden administration floated the idea of an offshoring penalty tax as a surtax on profits. However, this penalty did not make its way into the Green Book, which instead included a proposal to eliminate any deduction for expenses incurred to offshore a trade or business that results in a loss of U.S. jobs. Conversely, in the case of a trade or business being “on-shored,” a credit of 10% for those “on-shoring” expenses would be provided. (It’s important to note that just because an item did not make it into the Green Book does not mean it couldn’t eventually make its way into legislation.)
- The TCJA provided incentives to U.S. companies regarding certain export sales and service income. It seems likely that these will be repealed, in which case the government might direct resulting savings toward promoting research and development activities.
In addition to the U.S. tax proposals that the administration has outlined in the Green Book, there are ongoing discussions at a global level between developed nations that call for a global minimum tax of 15%. In particular, the tax policy arm of the Organisation for Economic Cooperation and Development (OECD) has proposed a minimum tax that multinational companies have to pay on their global profits, which is intended to discourage companies from keeping their profits in low-tax jurisdictions. Treasury Secretary Janet Yellen announced in early July that “a group of 130 nations has agreed to a global minimum tax on corporations,” but discussions are ongoing. The interplay between domestic tax proposals and these global discussions will influence U.S. tax policy negotiations. For example, if companies around the world are required to pay a 15% global minimum tax, should U.S. companies be the only ones with a higher tax bill of 21% because of the above GILTI rules?
There are quite a few boxes to be checked before either U.S. tax policy or global tax policy is agreed upon, approved and implemented by the U.S. Congress. Timing is also critical: global minimum tax discussions would obviously need to be completed before U.S. tax policy changes in order for them to have a direct impact on current policy negotiations in Congress. If U.S. lawmakers fail to pass tax legislation before the midterm elections in November 2022, the tax policy landscape could change dramatically should Republicans win a majority in either the House or Senate. Arguably from a political perspective, these legislative actions need to be made in 2021, given 2022 is an election year, and typically raising taxes in an election year is not favored by Congress. Global tax policy proposals will continue to be at the forefront of the U.S. policy debate, and taxpayers will need to evaluate a variety of iterations before the debate is over. Global manufacturers reevaluating their supply chains need to model the significant tax policy alternatives forming part of the global tax policy debate in order to best prepare for the future.