Analyzing Wyden’s Tax Proposals

Robert Goulder of Tax Notes and Reuven Avi-Yonah of the University of Michigan Law School discuss the potential issues in the latest international tax proposals spearheaded by Senate Finance Committee Chair Ron Wyden, D-Ore.

Here are a few highlights from their discussion, edited for length and clarity.

Robert Goulder: Welcome to the September edition of In The Pages. We’re talking about the discussion draft released by the chairman of the Senate Finance Committee, Senator Ron Wyden, D-Ore. His proposals, if enacted, would change some of the international provisions adopted under the Tax Cut and Jobs Act.

To help us make sense of this, we’ve called in Professor Reuven Avi-Yonah from the University of Michigan Law School. His recent article, “Gucci Gulch Redux: The Problems of the Wyden Proposal” examines these same issues. Professor, thank you for joining us.

Reuven Avi-Yonah: Thank you.

Robert Goulder: The fact that you referred to Gucci Gulch in your headline suggests you think that some lobbying has been going on.

Reuven Avi-Yonah: I suspect it’s going as we speak. It was also going on while TCJA was being enacted, except that the process seems to be more transparent this time. My recollection is that four years ago it was pretty opaque.

Robert Goulder: Back in April you likened some of Wyden’s proposals to certain Bush-era tax ideas. Now you’re saying they’ve grown worse. Can you describe your objections, starting with the global intangible low-taxed income provisions?

Reuven Avi-Yonah: There are several differences. The main one concerns applying GILTI on a country-by-country basis, which is what the administration has proposed. That’s designed to prevent the temptation to shift income out of the United States into low-tax jurisdictions, in order to average them with high-tax jurisdictions. There’s a long history of that that goes back to the various baskets we had in the 1986 Act, and even before that, so this is not new.

What the Wyden proposal does instead is it has this high-tax exclusion, which is really taken over from something the Trump Treasury gave to the multinationals with no basis in the statute — which is to apply the subpart F high-tax exception to GILTI. I was really surprised a Democratic senator would take something done by the Trump Treasury and inserted into his proposal.

There are other problems. The thing that bothers me the most is that it enshrines in the tax code an exemption for some sort of foreign-source income. For 100 years, from 1918 to 2018, we had a rule that taxed income “from whatever source derived.” U.S. persons were taxed on all their income. And then, in 2017 we got a participation exemption through the mechanism of the qualified business asset investment.

Now, Wyden and the White House want to get rid of QBAI, but once you have this high-tax exception you keep an amount that is total exempt from U.S. taxation. I think that’s problematic. I don’t care that much about rates. Rates go up and rates go down, but it’s the structure that I mind. And this is a structural defect.

Robert Goulder: We also have a high-tax exemption for subpart F. Supporters of the Wyden proposal would say it’s desirable to have symmetry between GILTI and subpart F. Does that sort of conformity gain us anything in terms of policy?

Reuven Avi-Yonah: No, I don’t think so. In terms of subpart F, it has many, many problems — derived primarily from the fact that it’s really old. Subpart F is from 1962.

There are now more than 30 countries that have so-called controlled foreign corporation rules. Subpart F was the first. These other countries learned from our experiences. They did things significantly better along the lines of what the OECD is proposing. That is, primarily, taking the foreign tax rate into account not just when it’s too high, but also when it’s too low — the minimum tax approach. And that’s essentially, to some extent, what GILTI does with foreign tax credits.

GILTI is a significantly better regime than subpart F, so I don’t see any reason why GILTI should confirm itself to subpart F. In fact, I think it is plausible to argue — especially with a revised GILTI regime that doesn’t have QBAI — that we might as well just repeal subpart F.

One thing I don’t understand is why it is that every time we add something to the tax code, we never delete anything that is essentially redundant. That’s just an invitation for game [playing]. I mean, the use of the high-tax exception from subpart F into GILTI is something that was clearly not intended, and had we deleted subpart F when we adopted GILTI it wouldn’t have been on the table.

Robert Goulder: They say a CbC approach for GILTI is too complicated. Compliance would be too burdensome on companies. But you’re not buying those arguments?

Reuven Avi-Yonah: No, I don’t buy those arguments.

On the complexity front, this is reminiscent of what was done in Gucci Gulch in 1986. The Reagan Treasury proposed having both baskets and a per-country rule. They said, “The problem is you can have high-tax and low-tax income together, so let’s superimpose baskets on the per-country approach.” And the multinationals all said, “Oh, this is way too complicated.” So, they eventually dropped the per-country rule and just went with the baskets.

We are talking about super sophisticated taxpayers with endless tax advice and a lot of money to spend on it. Do we really believe that it’s too complicated to do country-by-country, especially since we’ve already had country-by-country for foreign tax credit purposes for many decades before 1986? No, there’s no real complexity here.

In addition, the high-tax exclusion involves its own complexity. In fact, if you just compare the Biden proposal to the Wyden proposal, the Wyden proposal is significantly more complicated because of the high-tax exclusion. It has to do with branches. It has to do with losses. It has to do with timing. There are all kinds of issues that arise because of that.

Then there’s the point that if the two proposals are both the same in terms of complexity, why not just adopt that one? Well, they’re not the same because this is much more complicated. And they’re also not the same because the moment you have something like the high-tax exception it can be gamed. It can be gamed in the same way that the high-tax exception from subpart F was gamed.

The problem is basically this: The amount of tax that you pay to the foreign country is determined by the foreign country, but the base for calculating the effective tax rate is calculated based on U.S. principles. The Supreme Court said so. And because of that, it’s possible to create deductions that the U.S. will see but the foreign country does not see.

For example, financial instruments that we treat as debt and the foreign countries treat as equity and therefore don’t allow the deduction for interest. You can create artificially high-tax environments, and that invites profit shifting because the amount is exempt and so on.

I really don’t think the high-tax exclusion is the way to go.

Robert Goulder: Before we leave the topic of GILTI, I wanted to get your thoughts on QBAI. Why do we need it? Why not have guilty apply across the board? 

Reuven Avi-Yonah: I think we don’t need it. That’s one thing the Biden administration and Wyden agree on. Unfortunately, House Ways and Means Committee Chairman Richard Neal, D-Mass., takes the other view, as we have now seen.

I hope they will get rid of QBAI because, as everybody has pointed out since TCJA, this is simply an invitation to move factories and jobs overseas because it’s based on tangible assets. That’s the last thing we want to do. That’s the thing Democrats unanimously criticized the TCJA for, so why should they leave it in?

Robert Goulder: At one point in your article, you expressed a personal preference about the U.S. rate structure. You wouldn’t have a problem if the rate on foreign profits matched the rate on domestic profits. Some will argue that GILTI needs a reduced rate because otherwise you’ll lose competitive. What are your thoughts on that?

Reuven Avi-Yonah: I never bought into that, and for a variety of reasons.

First, the big advantage of having the same rate is that then you can get rid of outbound transfer pricing. The vast majority of our transfer pricing cases — which are really complicated and really expensive for the IRS to litigate — are outbound, not inbound. Think about all the resources we could save if we equalized the rates, because transfer pricing is all about exploiting rate differentials.

Why would you really think that competitiveness depends just on the foreign rate, as opposed to the overall effective rate of the multinational? I would think the competitiveness of a multinational depends on the total rate that they pay on all of their income. That’s what they report to shareholders, and so on, and how that rate compares with foreign rivals.

I did some empirical work before TCJA to show that the top 100 EU multinationals had the same rate, basically, as the top 100 American multinationals — even though we had an allegedly worldwide regime and they had allegedly territoriality regime. I think it’s the same now. If you adopt a reasonable rate, say 25 percent, there’s no reason that’s not competitive. I mean, Germany for example is at 30 percent and they have more robust CFC rules than we do. So, I think that’s point number one.

Number two, what’s the evidence that multinationals lack competitiveness? They were super competitive before TCJA. They’re super competitive now. If you look at the list of the top multinationals in the world, that’s really dominated by the Americans, just like they were in the 1960s.

There was a period, in between, where there was more competition. But now you can say the main competition comes from China, but the big Chinese digital firms are really only prominent in China. They’re not competitive yet with Facebook, Google, and Amazon. We are kind of the champions of the world, so I don’t see what’s the evidence for that.

Besides, this ignores the fact we are now well into a process in the OECD of making sure that there’s a level playing field, and that there would be a minimum tax that applies to everybody. Because of that, I think it’s really important which rate we choose, because then we can argue for the OECD to ratchet it up a little.

Robert Goulder: Let’s move on to foreign-derived intangible income. The Biden administration would get rid of it all together, whereas the Wyden proposal would replace it with some type of enhanced research and development incentive. That gets me thinking, don’t we already have rewards in the tax code for R&D?

Reuven Avi-Yonah: We certainly have rewards for R&D.

First, it’s expensed, right? Based on normal ideas, if you were doing something that generates future income you should be capitalizing it, not expensing it.

Second, and R&D is notorious for this, you can have R&D conducted in the U.S. and all the related income is generated overseas, but they allow you to deduct the expenses against U.S. income rather than foreign income, as it is supposed to be under the normal way we allocate and apportion deductions.

Finally, I don’t see the point of having something like FDII. The main flaw of FDII is simple; it is export contingent. And because it’s export contingency, it’s a blatant violation of WTO rules.

We open ourselves up to the EU suing us, and then trade sanctions. If you go back far enough there was the domestic international sales corporation regime, and then there was the foreign sales corporation regime, and then there was extraterritorial income.

We had decades of these fights with the EU. In 2004 we abolish it because they place trade sanctions on Florida oranges in an election year. We went through all of that, then here we go back again with FDII as an export incentive. Keeping it makes no sense to me.

Robert Goulder: Let’s talk about the base erosion and antiabuse tax. The administration wants to just replace it with this new regime called the Stopping Harmful Interference in Elections for a Lasting Democracy Act. Wyden, again, has a different take. What are your thoughts there?

Reuven Avi-Yonah: The BEAT provisions are less developed in the Wyden proposal. They say they might add more elements in the future. Maybe some kind of compromise can be reached. One thing that is missing from the Wyden proposal something on inversions. That’s a problem because if you increase the GILTI rate, the one way that you can get out is by inverting. You really need to do something about that, in my opinion.

BEAT has many problems. There’s the fact that cost of goods sold is not included. There’s the whole thing the Trump Treasury did with the cost services method and not applying it to the whole amount, but only to the markup. BEAT was estimated to raise a lot of money back in 2017, and it has raised much, much less than that. Obviously there are problems with the BEAT that need to be fixed, and I’m not sure this does it.

Robert Goulder: Any discussion of these changes must be done with an eye towards the OECD. I have a question about who’s deferring to whom. Is the OECD inclusive framework waiting to see what Congress does with GILTI and BEAT, or are we waiting to see what the OECD settles on regarding pillar 1 and pillar?

Reuven Avi-Yonah: You could say both sides are waiting for the other one.

But I think when the Biden administration put out the green book, they thought it was more likely that the OECD will finish first. The OECD, as far as I understand it, has a firm deadline of finishing by October. The SHIELD proposal, for example, hinges on the OECD pillar 2 being in place in order to work properly.

But Congress works differently. And my understanding is that we are now in a rush to finish everything even before the OECD completes the process.

Therefore, I think it will go the other way. That is, if we succeed in passing this it will serve as a basis for what the OECD does. This is why I’d like for the GILTI rate to be as high as possible, and not 16.5 percent as Neal has just proposed. A higher GILTI rate would, in my opinion, push the OECD in the right direction.

Robert Goulder: Last question, and it’s about politics. I can’t help but notice that these are all Democratic lawmakers, Wyden and Neal, yet they’re pushing back against the Biden administration. It’s almost like they’re doing the Republicans bidding for them. Why is that? 

Reuven Avi-Yonah: Tough question. I don’t know. I’m a tax expert, politics is not my business. Obviously lobbying may explain part of it.

There might be other stuff going on. For example, Wyden has other proposals that he introduced by himself, such as the mark-to-market proposal, and now the new partnership tax proposal. Sen. Sherrod Brown, D-Ohio, has this excise tax on stock buybacks, which I wholly approve of.

Whether any of these things makes it through to the final package, who knows? These are proposals they introduced in their personal capacity, rather than as committee chairs. I suspect that what’s going on is simply that, in order to get everybody on board, you need to modify what the administration wanted. That happened in the TCJA also, notoriously.

Beyond everything else, the administration wants to get the package through. Unless you get it through, the whole $3.5 trillion infrastructure package collapses, and that is the main agenda of the administration. I think the administration would not object to compromising on tax things.

The political constraint is that you only have a few votes to spare in the House and zero votes to spare in the Senate. You need everybody to go along. That’s why Wyden teamed up with Brown, a progressive, with Sen. Mark Warner, D-Va., as a moderate, before he introduced it.