Springtime in DC. Peak bloom for the cherry blossoms around the Tidal Basin and peak season for an administration to release its FY2023 budget proposal. Included in the President’s budget, and detailed by the concurrently released Treasury Greenbook, is a request for over $2.5 trillion in revenue proposals.
The Greenbook can be seen as a signal of the priorities of an administration, as well as a bit of a wish list. The FY 2023 Greenbook takes things a step further by estimating revenue using a baseline assumption that almost all revenue provisions in the House-passed version of the Build Back Better Act (BBBA) are in effect. The BBBA has been stalled since late December and while a sign of life has popped up every once in a while, the clock is ticking for Democrat members of the House and Senate who are running for re-election. Overall chances of both the BBBA and the revenue proposals in the Greenbook being enacted this year are like picking a certain Northeast-based team to make the Elite Eight – it could happen, but odds are highly against it.
Even with the slight chance that all of these provisions are enacted, any time an administration releases its Greenbook, it’s important to walk through some of the key provisions to get a sense of priorities. One such priority is improving tax administration and compliance and RSM will be issuing a separate alert.
Business and international taxation
Increased corporate tax rate
The proposal would increase the corporate income tax rate from 21% to 28%. A corresponding increase would be made to the GILTI (global intangible low-tax income) tax rate.
The increased corporate tax rate would apply to be taxable years beginning after Dec. 31, 2022. For taxable years straddling Dec. 31, 2022, a blended rate would apply.
The Administration isn’t giving up on increasing the corporate tax rates. Almost any hope for increase in tax rates was scuttled by Sen. Sinema so it may be unlikely that Dems could get 50 votes in the Senate to increase rates in this new budget.
Buried GILTI rate change
The House-passed Build Back Better Act (BBBA) reduces the section 250 deduction for global intangible low-taxed income (GILTI) resulting in a 15% rate on GILTI (15.8% factoring in the 5% haircut on GILTI foreign tax credits). The Greenbook assumes that the House-passed changes to section 250 will be enacted into law. Therefore, the proposal to increase the corporate tax rate to 28%, without any further adjustments to section 250, means the GILTI effective tax rate would increase to 20%.
Interestingly, the Treasury Greenbook one year ago proposed swapping the Foreign Derived Intangible Income (FDII) deduction for “additional support for research and experimentation expenditures.” Although not explicit, this was widely seen as a proposal to restore full, immediate deductibility of research and experimentation expenditures, probably on a permanent basis, as was the law from 1954-2021. The Greenbook released this week, however, has no mention whatsoever of research and experimentation, or of FDII, or of section 174.
Aligning tax free treatment more closely with control of stock vote and value
The proposal would require shareholder groups to control of 80% of both stock vote and value to qualify for tax-free corporate contribution or reorganization treatment in certain situations. This proposal would limit situations where a transaction’s treatment as taxable or tax-free can be impacted by utilizing a class of stock with little or no voting power; it would be effective for transactions occurring after Dec. 31, 2022.
Repeal the BEAT and replace it with an UTPR
The Greenbook is proposing scrapping the Base Erosion and Anti-Abuse Tax (BEAT) and replacing it with an undertaxed profits rule (UTPR) that is consistent with the UTPR described in the OECD’s Pillar Two model rules (also referred to as the Anti Global Base Erosion or GloBE rules). These model rules seek enforcing a minimum 15% effective tax rate on profits earned by large multinational enterprises in each jurisdiction where they earn profits. Where a jurisdiction has companies that do not pay a minimum effective tax rate of 15%, the jurisdiction in which the parent company is based will collect the additional top-up tax by way of the Income Inclusion Rule (IIR). Should the parent jurisdiction not implement an IIR, the tax is collected in other jurisdictions through the UTPR, by way of denying tax deductions (or other equivalent mechanisms) to collectively pay the top-up tax amount locally.
The Greenbook proposal states that the UTPR would not apply with respect to income subject to an IIR, including income that is subject to GILTI, and therefore generally would not apply to US-parented multinationals. In addition, the UTPR would apply only to financial reporting groups that have global annual revenue of $850 million or more in at least two of the prior four years.
Under the UTPR, domestic group members would be disallowed US tax deductions to the extent necessary to collect the hypothetical amount of top-up tax required for the financial reporting group to pay an effective tax rate of at least 15% in each foreign jurisdiction in which the group has profits. The amount of this top-up tax would be determined based on a jurisdiction-by-jurisdiction computation of the group's profit and effective tax rate consistent with the GloBE model rules. The top-up amount would be allocated among all of the jurisdictions where the financial reporting group operates that have adopted a UTPR consistent with the GloBE model rules. When another jurisdiction adopts a UTPR, the proposal also includes a domestic minimum top-up tax that would protect US revenues from the imposition of UTPRs by other countries.
The computation of profit and the effective tax rate for a jurisdiction is based on the group’s consolidated financial statements with certain adjustments. In addition, the computation of a group’s profit for a jurisdiction is reduced by an amount equal to 5% of the book value of tangible assets and payroll with respect to the jurisdiction. The deduction disallowance applies pro rata with respect to all otherwise allowable deductions and applies after all other deduction disallowance provisions in the Internal Revenue Code, with an excess amount of UTPR disallowance carried forward indefinitely.
The proposal to repeal the BEAT and replace it with a UTPR would be effective for tax years beginning after Dec. 31, 2023.
Create a new general business credit for onshoring a US trade or business
Similar to last year’s Greenbook, the proposal would create a new general business credit equal to 10% of the eligible expenses paid or incurred with onshoring a US trade or business. ‘Onshoring’ means reducing or eliminating a business or line of business currently conducted outside the US and starting up, expanding, or otherwise moving the same business within the US, but only to the extent that this action results in an increase in US jobs. Eligible expenses are limited solely to expenses associated with the relocation of the business and do not include capital expenditures or costs for severance pay and other assistance to displaced workers. While the eligible expenses may be incurred by a foreign affiliate of the US taxpayer, the tax credit would be claimed by the US taxpayer.
Additionally, the Greenbook proposal would disallow deductions for expenses paid in connection with offshoring a US trade or business, to the extent that this action results in a loss of US jobs. In addition, no deduction would be allowed against a US shareholder's GILTI or Subpart F income inclusions for any expenses paid or incurred in connection with moving a US trade or business outside the US
The proposal would be effective for expenses paid or incurred after the date of enactment.
Prevent basis shifting by related parties through partnerships
The proposal reduces the ability of related partnerships to shift basis amongst themselves and introduces a matching rule to prohibit any related partner in the distributing partnership from benefitting from the step-up if the related partner disposes of the distributed property in a fully taxable transaction.
Expand access to retroactive QEF elections
Currently, taxpayers are allowed to make a retroactive Qualified Electing Fund (QEF) election with respect to a passive foreign investment company (PFIC) only with the consent of the Commissioner of Internal Revenue and only if the taxpayer relied on a qualified tax professional in failing to make the election earlier, granting consent does not prejudice the interests of the government, and the request is made before a PFIC issue is raised on audit. The proposal would modify section 1295(b)(2) to permit a QEF election by taxpayers at such time and in such manner as shall be prescribed by regulations.
The proposal would be effective on the date of enactment. The Greenbook proposal states it is intended that regulations or other guidance would permit taxpayers to amend previously filed returns for open years.
Expand the definition of ‘foreign business entity’ to include taxable units
Section 6038 of the Internal Revenue Code requires a US person who controls a foreign business entity (a foreign corporation or foreign partnership) to report certain information with respect to the entity. The Greenbook proposal would modify the reporting rules in section 6038 to treat any taxable unit in a foreign jurisdiction as a ‘foreign business entity’ for purposes of section 6038. Thus, a single legal entity operating in multiple foreign jurisdictions would be treated as a separate ‘foreign business entity’ in each jurisdiction and the reporting rules in section 6038 would be applied separately for each foreign business entity.
The proposal would apply to tax years of a controlling US person that begin after Dec. 31, 2022, and to annual accounting periods of foreign business entities that end or are within such tax years of the controlling US person.
Increase threshold for simplified foreign tax credit rules and reporting
At present, individuals may elect to claim a foreign tax credit without filing Form 1116, Foreign Tax Credit (Individual, Estate, or Trust), by entering the credit directly on his or her return. To be eligible to make this election, all of the individual’s foreign source income must be passive income, all of the income and any foreign taxes paid on the income must be reported on a qualified payee statement, and the total creditable foreign taxes must be less than $300 ($600 for joint filers). The Greenbook proposal would increase the threshold in the last requirement to $600 ($1,200 in the case of a joint return) and index this amount to inflation.
The proposal would be effective for foreign income taxes paid or accrued in tax years beginning after Dec. 31, 2022.