The Tax Cuts and Jobs Act passed by Republicans at the end of 2017 dramatically improved the U.S. tax code. This law reduced tax rates for individuals, corporations, and small businesses and updated the outdated worldwide system of taxation by moving closer to a territorial system of taxation.
Thanks to these reforms, unemployment is at 3.7 percent, a 50-year low. Wages have grown by 3.1 percent over the past 12 months and GDP has averaged 3 percent quarter-to-quarter growth since the tax cuts were passed.
Despite these gains, there were some unintended outcomes resulting from the tax cuts. For instance, the new GILTI provision (Global Intangible Low-Tax Income) was designed to prevent taxpayers from eroding the U.S. tax base by improperly assigning income to low tax jurisdictions. However, GILTI was based off the pre-TCJA tax system which required companies to allocate a portion of domestic expenses to foreign income for purposes of calculating foreign tax credits. In the post-TCJA world, this resulted in additional foreign tax liability and meant that GILTI inadvertently taxed high-tax foreign income that was previously exempt from U.S. taxation.
It is clear based on the conference report to the TCJA that Congress never intended to exempt high-tax foreign income:
“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.”
Fortunately, Treasury’s GILTI rules released last month help alleviate this problem.
Under the rules, businesses can apply a high-tax exception that exempts foreign income if this income is subject to foreign taxes above 90 percent of the corporate rate (18.9 percent based on the 21 percent corporate rate).
This is a positive step toward upholding the integrity of the new, territorial tax system and protecting taxpayers from double taxation.
Moving forward, lawmakers should continue examining GILTI and the international provisions of the TCJA so that these provisions do not unduly burden legitimate business activity.