In a letter to Treasury Secretary Steven Mnuchin, ATR urged the department to broaden the high-tax exception that exists under Section 951A Global Intangible Low-Tax Income (GILTI) in order to prevent an unintended consequence to the tax law that may harm American competitiveness and increase taxes on businesses.
The Tax Cuts and Jobs Act passed last year dramatically overhauled the U.S. international tax system. The law added the new GILTI provision, which was designed to counteract base erosion from moving to a territorial system. At the same time, TCJA left the existing subpart F base erosion rules untouched.
These changes have resulted in some unintended consequences. For instance, the law could be currently interpreted as including high-tax, foreign source income in the new GILTI regime. This income would otherwise be subpart F income but for an exception to Subpart F such as the active finance exception or active insurance exception.
This is poor policy that is not required by the statute and should be fixed – high-tax foreign income has historically been exempted from U.S. taxation under the Subpart F rules because it was already taxed in the country of origin.
In effect, this creates a situation where high-tax active CFC income from foreign jurisdictions is now being treated worse than easily-shifted passive CFC income.
This is problematic as the rationale for base erosion provisions is to counteract the possible shifting of intangible income to low tax jurisdictions. As the letter notes, this will create perverse incentives for businesses to restructure and will harm American competitiveness:
This discrepancy could create significant adverse consequences for businesses and result in a net tax increase relative to pre-TCJA law. Businesses will now have perverse incentives to restructure business operations in a way that is costly, that creates future complexity, or that may not be practical in foreign jurisdictions.
This absence of a broadened exception will also harm American competitiveness given U.S. businesses face additional tax on high-tax CFC income, while foreign competitors face no additional tax on their high-tax income.
Treasury should address this issue by interpreting the current high-tax exception in GILTI so that it applies not only to passive Subpart F income, but also to active high-tax non-Subpart F income.
As the letter states, Congress intended for high-tax foreign income to be exempt from GILTI because this type of income is already exempted from U.S. tax based on the conference report to TCJA released by the Senate Finance Committee:
“The Committee believes that certain items of income earned by CFCs should be excluded from the GILTI, either because they should be exempt from U.S. tax – as they are generally not the type of income that is the source of base erosion concerns – or are already taxed currently by the United States. Items of income excluded from GILTI because they are exempt from U.S. tax under the bill include foreign oil and gas extraction income (which is generally immobile) and income subject to high levels of foreign tax.”