Avi-Yonah: Medtronic II And The Profit-Shifting Problem

Reuven S. Avi-Yonah (Michigan; Google Scholar), Medtronic II and the Profit-Shifting Problem, 176 Tax Notes Fed. 1575 (Sept. 5, 2022):

In this article, Avi-Yonah looks at the Tax Court’s recent Medtronic II [v. Commissioner, T.C. Memo. 2022-84 (Aug. 18, 2022)] decision and considers how the new corporate alternative minimum tax may provide a solution to the problem of adjudicating transfer pricing in the absence of comparables.

Conclusion
Despite its flaws, the corporate AMT offers the most promising path to a permanent solution to the profit-shifting problem because it finally disregards the separateness of CFCs from the parent and applies the same rate to the U.S. and foreign income of the entire group.

To make the corporate AMT an effective anti-profit-shifting regime, the threshold should be lowered (for example, to $100,000 average annual income, as originally suggested by Sen. Elizabeth Warren, D-Mass.), and the rate should be increased to 21 percent or higher. If those two steps are taken, the regular corporate tax could be repealed in its entirety, and what is now the corporate AMT could be adopted as a substitute rather than as an alternative to the regular corporate tax. At a rate of 21 percent, the corporate AMT will raise more revenue than the existing corporate tax, since its base is broader.

Repealing the regular corporate tax also means repealing section 482 (as it applies to U.S. corporations), subpart F, and GILTI. The risk is that some future Congress might choose to reinstate the differential tax rate on foreign profits, and that in the absence of these safeguards, profit shifting might become rampant again. But several competing considerations seem to address this concern. First, if the corporate AMT rate is set at 21 percent, it will be at the lower end of the OECD average, which weakens the competitiveness argument for lowering the tax rate on foreign income. Second, the likely adoption of pillar 2 of BEPS 2.0 by our major trading partners will establish a 15 percent floor on their taxes, and if the United States adopts a 21 percent tax that applies to the entire income of its multinationals, other G-7 countries may follow suit. Third, after this kind of structural change is adopted, it is less likely to be reversed by future Congresses, as illustrated by the equivalence of the dividends and capital gains rate since 2003 (despite frequent rate changes for both). If a future Congress is concerned with competitiveness, it should reduce the overall corporate rate rather than reduce only the rate on foreign income, because it is the overall rate that determines the cost of capital. Finally, it is hard to base any tax reform proposal on trying to predict what future Congresses might do.