On April 07, 2021, President Biden’s administration released a description of its Made in America Tax Plan. One aspect of the plan would replace BEAT with a new regime that would deny corporate deductions by reference to payments to foreign related persons that are subject to a low effective tax rate (ETR), unless the income is subject to an acceptable minimum tax regime. This proposal, referred to as SHIELD (Stopping Harmful Inversions and Ending Low-Tax Developments), is intended to more effectively target profit shifting to low-taxed jurisdictions, relative to the existing BEAT, while simultaneously providing a strong incentive for other nations to enact global minimum tax regimes. The SHIELD appears inspired by the “undertaxed payments rule” (UTPR) in the OECD’s Pillar Two Blueprint, but there are potentially significant differences. The potential for such differences was underlined by a recent U.S. Treasury presentation to the OECD Steering Group of the Inclusive Framework on BEPS, which noted that SHIELD would be consistent only with the “general concept of the UTPR.”
Biden’s plan includes few details on how SHIELD would apply. This article outlines our current understanding of the proposal and flags key open questions. We anticipate at least some of these questions will be answered when more details of the administration’s proposals are released, likely later this month, in the Treasury Department’s annual report on the administration’s revenue proposals (commonly referred to as the “Greenbook”).
SHIELD’s prospects for enactment are highly uncertain
In addition to uncertainty as to the precise details of President Biden’s proposals, it is important to bear in mind that it is far from a foregone conclusion that any of President Biden’s proposals will become law. Because Democrats likely cannot afford to lose any Democratic votes in the Senate and have a very narrow margin in the House of Representatives, it is hard to predict what will be included in final legislation. In addition, because the legislative process is controlled by the leadership of the House of Representatives and Senate rather than the administration, the starting point for any tax bill may not precisely reflect the administration’s view.
As one point of reference, on April 5, 2021, several prominent Democratic members of the Senate Finance Committee, including its Chairman, Senator Wyden, released their own framework to overhaul the U.S. international tax system. Rather than replacing the BEAT as the administration proposes, that framework would instead modify BEAT in ways that could further expand its application to inbound investors in the U.S. Little insight is available as to the view of the House of Representatives on these issues—the Chairman of the House Ways and Means Committee has not, as of yet, publicly expressed any views on the matter. In summary, while change seems probable, and President Biden’s proposals almost certainly represent one form of change that Congress will consider, predicting the precise contents of what might ultimately be enacted is impossible.
What we know about SHIELD
The rate for measuring a low ETR initially would be set at the rate for taxing GILTI, but if the OECD process culminates in a multilateral agreement on a global minimum tax (referred to in the OECD Blueprint as an Income Inclusion Rule (IIR)), the rate would be reset to the agreed OECD minimum rate. President Biden’s proposal would increase the GILTI rate to 21%, though that outcome is also far from certain. Any agreed OECD minimum rate, however, is anticipated to be significantly lower than 21%. Much of the discussion has assumed a 12.5% rate, which was also the assumed rate to assess the revenue implications of Pillar 2 as part of the OECD’s economic impact assessment.
The reference to “effective tax rate” indicates that SHIELD would not rely on nominal statutory rates in the recipient jurisdiction.
In contrast to the current operation of BEAT, SHIELD appears to target primarily non-U.S.-parented groups. U.S.-parented groups generally would be covered by GILTI, which (as modified by Biden’s plan) would constitute a sufficiently strong minimum tax to turn SHIELD off.
It appears that, even if there is a multilateral agreement on an IIR, SHIELD generally would still require ETR testing for payments to companies resident in the jurisdiction of the ultimate parent because such companies likely would not be subject to an IIR. This approach would be consistent with the operation of the OECD’s UTPR.
What we don’t know
Would SHIELD apply only to large taxpayers? BEAT applies only if a taxpayer’s “aggregate group” has average annual gross receipts of $500 million or more for the prior three years. The OECD’s UTPR proposal applies to multinational groups with revenue greater than 750 million euros ($906 million). Although unclear, some threshold to scope out small taxpayers seems likely based on the existence of such limitations under BEAT and the OECD Blueprint.
Do “deductions” include cost of goods sold (COGS)? COGS is currently in scope for the OECD’s UTPR proposal, but out of scope for BEAT, which treats COGS as a reduction of gross income rather than a deduction. In contrast, the “deduction” disallowance rule in the U.S. anti-hybrid rules under tax code Section 267A can apply to preclude taking a hybrid royalty or interest payment into account when determining COGS. Although the administration’s description of SHIELD is critical of the exclusion of COGS from BEAT, it only describes SHIELD as denying “deductions” with no mention of COGS.
When no minimum tax regime applies to a multinational group, would the ETR test apply by reference to the ETR of the recipient jurisdiction, recipient entity, or the payment? Due to concerns regarding preferential regimes such as patent boxes, policymakers may opt to apply it separately to each payment. The OECD’s UTPR proposal applies the ETR test on a country-by-country basis. If this approach is not adopted, how would participation in a consolidation, fiscal unity, group relief, or other loss sharing regime affect the determination of the ETR?
More generally, how would the use of tax attributes, such as net operating losses, affect the determination of the ETR?
How to deal with a lack of information regarding the ETR? The OECD Blueprint addresses this issue by relying on modified financial reporting information. Congress historically has been reluctant to link tax rules to financial accounting, so we would not be surprised if SHIELD required computations to be done using U.S. tax rules by placing the burden of proof on the payor to establish that a payment was not low-taxed. On the other hand, President Biden’s “Minimum Book Tax” proposal may signal openness to tax rules that rely on financial accounts in narrow circumstances.
How far would taxpayers be required to go to determine if a payment is subject to a low ETR, in light of the possibility that a nominally high-taxed payment, recipient entity, or recipient jurisdiction could itself be subject to base stripping:
Would taxpayers have to trace through chains of payments, similar to the section 267A disqualified imported mismatch rules for hybrids?
The OECD’s UTPR would sidestep tracing by looking to whether an MNC group includes any countries with low-taxed income that are not subject to an acceptable minimum tax regime. Nothing in President Biden’s proposal suggests it is intended to go that far, but if it was, the case for allowing modified financial reporting information to be used for testing the ETR would be more compelling.
If a payment is subject to a low ETR how much of the deduction would be denied? According to the proposal, SHIELD “denies . . . U.S. tax deductions by reference to payments made to related parties that are subject to a low effective rate of tax.” Arguably, a natural reading of this language is that the entire deduction would be denied and taxed at the full U.S. corporate income tax rate, although the use of “by reference to” leaves the door open to other interpretations. Alternatively, a proportionate amount of the deduction could be denied as a proxy for the minimum rate, potentially with or without regard to any foreign taxes paid. The OECD’s UTPR proposal is a “top-up” mechanism that denies a proportionate amount of a deduction in the payor jurisdiction by reference to the difference between the minimum rate and the ETR of the relevant jurisdiction.
What if the recipient is tax exempt, such as a foreign pension fund or sovereign wealth fund, or is a collective investment vehicle? The OECD’s UTPR includes exceptions for such recipients.
Is SHIELD consistent with U.S. tax treaty obligations? A U.S. Treasury official recently observed that SHIELD has been “very carefully designed to be fully compliant with our treaty obligations.” Notably, the OECD Blueprint concluded that the UTPR was compatible with the OECD model tax convention, but several public commentators disagreed with that conclusion.
Will SHIELD include a substance-based carve-out? The OECD’s UTPR uses the same calculation as the IIR, including a formulaic substance-based carve-out for payroll and tangible assets within the relevant jurisdiction. SHIELD likely would not include such a carve-out, consistent with the existing BEAT design as well as the administration’s proposal to eliminate the carve-out for QBAI in GILTI.
Most U.S.-parented groups generally should welcome the replacement of BEAT with the inbound-focused SHIELD. Foreign-parented groups also may be better off under SHIELD if the recipients of deductible payments are in high-tax countries (or, eventually, are subject to a globally agreed IIR). On the other hand, there is no indication that the various exceptions from BEAT would be replicated under SHIELD, which could make some foreign-parented groups worse off, especially if there is no multilateral agreement on an IIR and/or the group is based in a jurisdiction that either does not implement an IIR or is slow to implement it. Although there is not sufficient detail to assess the implications for particular taxpayers, it is apparent that there will be a new set of winners and losers that will need to be assessed when more details of the administration’s proposals are released in the Greenbook.