Among all the topics addressed in the 2017 Tax Cuts and Jobs Act (the “TCJA”), provisions regarding international tax law might be the most challenging provisions for non-experts. For those who simply expected that the worldwide tax system would be converted to the territorial tax system, the provisions introduced by the TCJA must have been somewhat puzzling, especially because the discussion after the reform has been focused more on a few more new acronyms that might not even be relevant to the territorial tax system. Susan Morse's new article, International Cooperation and the 2017 Tax Act, is an excellent guide that assists readers in understanding the important international tax provisions in the TCJA and the rationale behind the provisions. One of the great things about the article is that it explains the new rules against the backdrop of the ongoing dynamics in international tax policy — that is, the interplay between competitiveness and cooperation among the players.
The TCJA reduces the corporate tax rate from 35% to 21%. Morse adds that the TCJA further reduces the effective rate for foreign-derived intangible income (“FDII”) to 13.125% (increasing to about 16.4% in 2026) if the FDII is connected to certain exports. The dual rate structure resembles other countries' patent box regimes, with a potential risk of violating the World Trade Organization's ban on export subsidies.
The TCJA also implements a measure to combat base erosion by imposing a minimum tax, called Base Erosion and Anti-Abuse Tax (“BEAT”), on certain excessive deductible payments, such as interest and royalties, made by certain U.S. corporations to related foreign corporations. For the foreign-source income of foreign subsidiaries of U.S. multinationals, the TCJA adopts a "now or never" approach by imposing a one-time repatriation tax in Section 965. This does not mean that the TCJA converts the tax system to the territorial tax system. Subpart F remains in the Code, and a minimum tax on global low-taxed intangible income (“GILTI”) is imposed on controlled foreign corporations.
After an overview of the key international provisions in the TCJA, Morse turns to two important frameworks in international tax - competitiveness and cooperation. The history of international tax policy is a continuous interplay between competitiveness and cooperation. A country that lowers its corporate tax rate is able to attract more capital for investment. The country’s revenue may increase in the short run. However, in the long run, other countries will join the competition by reducing their corporate tax rates, resulting in a race to the bottom. As a result, the global community agrees to level the playing field and cooperates to preserve the tax base and combat offshore profit shifting. Such cooperation is often achieved through multilateral agreements, but sometimes unilateral measures taken by a country might set the trend for other countries towards a more desirable path.
The TCJA's rate reduction in the new dual rate structure (21% statutory rate and 13.125% effective rate for FDII) contributes to competitiveness. On the other hand, BEAT is in line with a global effort to combat base erosion targeting tax havens. Morse demonstrates that GILTI minimum tax structure supports the corporate tax regimes in global fiscal policy by encouraging the convergence of global corporate tax rate at about 13.125%. One could possibly challenge Morse’s argument regarding the convergence of corporate tax rate because it depends on subsequent behavioral response such as foreign countries' tax rate change and a company's tax planning. However, as a theoretical matter, I agree that it is plausible to expect such convergence, which does occasionally occur around "notches" in tax law. As such, BEAT and GILTI minimum tax may contribute to the global cooperation as a unilateral measure to support the existence of corporate tax. Morse further states that BEAT and GILTI minimum tax can further such global cooperation even when it has never been their intended purpose.
As Morse concludes, whether the TCJA's two cooperative elements - GILTI minimum tax and BEAT - actually help preserve corporate tax in other countries depends on the details of those two rules and the response from other countries. The devil is in the details. In 2018, although the IRS released a series of announcements, including recent proposed regulations on GILTI, practitioners are concerned about the complexity of the proposed regulations. Significant uncertainty still exists with regards to Section 965 repatriation tax, as well as provision on GILTI, FDII, and BEAT. Thus, one should wait for the final regulations on international tax provisions of the TCJA, which will most probably be made available sometime in mid-2019. In the meantime, the soon-to-be-available IRS website for major international tax provisions of the TCJA may provide some guidance for taxpayers. At the same time, it is interesting that other countries are considering tax policies similar to BEAT and GILTI, as observed by another commentator.