In its FY2024 explanation of the Biden Administration's revenue proposals (Greenbook), the United States (US) Treasury offers a few new international tax proposals as part of the administration's FY 2024 Budget (Budget). Most proposals in this year's Budget appeared in prior budget proposals or proposed legislation. The international tax proposals would:

Raise the corporate income tax rate to 28% and limit the Internal Revenue Code¹ Section 250 deduction to 25%, thereby raising the effective rate on global intangible low-taxed income (GILTI) to 21%

Modify the GILTI regime to align with the global minimum tax rules under Pillar Two of the Base Erosion and Profit Shifting initiative of the Organisation for Economic Co-operation and Development (OECD)

Replace the Base Erosion Anti-Abuse Tax (BEAT) with an "undertaxed profits rule" (UTPR) that is consistent with the UTPR in the Pillar Two rules

Repeal the deduction for foreign-derived intangible income (FDII)

Create a new general business credit equal to 10% of eligible expenses incurred when onshoring a trade or business to the United States

Disallow deductions for expenses incurred when moving a US trade or business offshore

Eliminate the exceptions in computing a controlled foreign corporation’s (CFC) earnings and profits (E&P) for purposes of Section 952(c)

Create a second type of US shareholder to include in income amounts determined with respect to non-taxed dividends

Limit foreign tax credits (FTCs) on sales of hybrid entities

Restrict deductions of excessive interest expense

Modify the treatment of certain derivative transactions for foreign investors

Permit taxpayers to retroactively elect, in certain circumstances, to treat a passive foreign investment company (PFIC) as a qualified electing fund (QEF) without Internal Revenue Service (IRS) consent

Require Section 6038 reporting for each foreign "taxable unit"

The proposals have various effective dates. While the prospects for enactment are dim this year, taxpayers should familiarize themselves with these proposals in case they appear as revenue offsets in later legislation.

Increased corporate and GILTI rates

The Budget would raise the corporate tax rate to 28% from 21%, thereby increasing the effective GILTI rate. Other changes to the Section 250 deduction for GILTI would increase the effective GILTI rate to 21%. The reduction to the Section 250 deduction would apply to tax years beginning after 31 December 2022.

Changes to the GILTI regime, international dividend received deductions, and inversion rules

The Budget would change numerous aspects of the GILTI regime to eliminate perceived incentives to move US operations offshore and to comply with the global minimum tax rules under Pillar Two. These changes include:

Taxing a US shareholder's entire net CFC tested income by eliminating the exemption for qualified business asset investments (effective for tax years beginning after 31 December 2023)

Decreasing the global minimum tax inclusion under Section 250 to 25%, which would increase the GILTI rate to 21% when combined with the proposed corporate rate of 28% (effective for tax years beginning after 31 December 2022)

Requiring US shareholders to effectively calculate their global minimum tax separately for each foreign jurisdiction in which their CFC operates, eliminating the ability to reduce US tax on income from low-taxed jurisdictions with foreign taxes paid in higher-taxed jurisdictions (effective for tax years beginning after 31 December 2023)

Disallowing only 5%, rather than 20% of a shareholder's FTCs (effective for tax years beginning after 31 December 2023)

Permitting US shareholders to carry net operating losses forward (within a single jurisdiction) and to carry FTCs forward 10 years (within a single jurisdiction) (effective for tax years beginning after 31 December 2023)

Accounting for foreign tax paid under an Income Inclusion Regime (IIR) by a foreign parent on CFC income that would otherwise be part of the domestic corporation's global minimum tax inclusion (effective for tax years beginning after 31 December 2023)

Limiting a US shareholder's dividends-received deduction (DRD) to either 50% or 65% of foreign-sourced dividends from a "qualified foreign corporation" that is not a CFC, depending on whether the shareholder owns at least 20% of the corporation's stock (effective for distributions after the date of enactment)

Broadening Section 265 to prohibit deductions allocable to foreign gross income that is either exempt from tax or effectively taxed at a lower rate through other deductions (effective for tax years beginning after 31 December 2023)

Expanding the reach of the inversion rules in Section 7874, both by redefining the circumstances in which a foreign acquiring corporation is treated as a US corporation (including reducing the relevant ownership threshold from 80% to merely more than 50%) and by adding new scenarios in which the requisite domestic entity acquisition can be found (effective for transactions completed after the date of enactment)

Requiring US shareholders, for the purposes of calculating stock losses on the disposition of foreign stock, to reduce their basis in a foreign corporation's stock by the sum of any stock-related: (i) Section 245A DRDs; (ii) Section 250 deductions for GILTI inclusions; and (iii) deductions for Section 965 transition tax inclusions (effective for dispositions occurring on or after the date of enactment (regardless of whether the deductions under Section 250 or 965(c) were claimed in tax years preceding that date)).

Replacing BEAT with UTPR

The Budget would repeal the BEAT and replace it with a UTPR that is consistent with the Pillar Two Model Rules.

Under the Budget, both domestic corporations and domestic branches of foreign corporations would be denied US tax deductions to the extent necessary to collect the hypothetical top-up tax required for the financial reporting group to pay an effective tax rate of at least 15% in each foreign jurisdiction in which the group has profits (UTPR Top-up Tax). For this purpose, a "financial reporting group" would be any group of business entities that prepares consolidated financial statements (i.e., statements determined in accordance with US Generally Accepted Accounting Principles, International Financial Reporting Standards, or other methods authorized under regulations) and includes at least one domestic entity or domestic branch and at least one foreign entity or foreign branch.

As contemplated in the Pillar Two Model Rules, both US-parented and foreign-parented multinationals operating in low-tax jurisdictions (with financial reporting groups' global annual revenue of €750 million or more in at least two of the prior four years) would fall within the UTPR's scope. The Budget explicitly states, however, that the UTPR would not apply to income that is subject to an IIR that is consistent with the Pillar Two Model Rules, including income subject to GILTI; as such, the UTPR would generally not apply to US-parented multinationals.

The amount of UTPR Top-up Tax would be determined based on a jurisdiction-by-jurisdiction computation of the group's profit and effective tax rate, taking into account all income taxes, including the new Corporate Alternative Minimum Tax (CAMT).² Although not explicitly stated in the Green Book, income taxes presumably would include the adjustments described in the Pillar Two Model Rules, including for deferred tax expenses.

The Budget also includes a domestic minimum top-up tax that would preclude the imposition of UTPR by other countries. This top-up tax would equal the excess of (a) 15% of the financial reporting group's US profit (determined using the same rules as under the UTPR to determine the group's profit for a jurisdiction), over (b) all the group's income tax paid or accrued with respect to US profits (including federal and state incomes taxes, CAMT, and creditable foreign income taxes incurred on US profits).

Finally, the Green Book states, without any further detail, that "the proposal would also ensure that taxpayers continue to benefit from tax credits and other tax incentives that promote US jobs and investment" whenever another jurisdiction adopts the UTPR.

Consistent with the OECD Pillar Two proposal, the Budget's UTPR proposal would take effect in 2025. For additional details on this proposal, see EY Global Tax Alert, US | FY2023 Budget includes new details on international tax proposals, dated 1 April 2022.

Repeal and replace the FDII tax benefit

The Budget would repeal the tax benefit for FDII and use the revenue to provide other unspecified incentives to encourage R&D, effective for tax years after 31 December 2023. See EY Global Tax Alert, US Treasury Green Book offers new details on international tax proposals, dated 1 June 2021.

Onshoring and offshoring rules

The Budget would create a new general business credit for onshoring expenses, while disallowing deductions for offshoring expenses. In each case, the relevant expenses are solely those incurred in relocating a trade or business to or from the United States, respectively, and do not include capital expenditures or costs for severance pay and similar assistance to displaced workers.

The onshoring credit would equal 10% of relevant expenses incurred when onshoring a trade or business to the United States. An offshoring rule would disallow deductions for relevant expenses incurred when offshoring a trade or business from the United States.

The onshoring and offshoring rules would apply to expenses paid or incurred after the date of enactment. For more details on this proposal, see EY Global Tax Alert, US | FY2023 Budget includes new details on international tax proposals, dated 1 April 2022.

Eliminating the exceptions in computing a CFC's E&P for purposes of Section 952(c)

Section 952(c)(1)(A) limits a CFC's subpart F income for a particular tax year to the CFC's E&P for that tax year. Other provisions in Section 952(c) allow a US shareholder to reduce its inclusion under Section 951(a)(1)(A) by the amount of certain CFC E&P deficits.

Section 312 governs the computation of a domestic corporation's E&P. Among other rules, E&P is computed without regard to three special accounting methods (e.g., the installment method under Section 453), notwithstanding that the corporation computed its taxable income using those methods. Computing a corporation's E&P without regard to these three accounting methods generally has the effect of increasing the corporation's E&P.

In general, a CFC must compute its E&P according to the same rules applicable to a domestic corporation. Under current law, however, solely for purposes of Section 952(c) (including the provisions previously described), a CFC's E&P is computed to reflect the three accounting methods. A CFC, therefore, has two different E&P computations under current law. The amount of E&P for Section 952(c)(1) is generally lower. As a result, amounts otherwise includible under Section 951(a)(1)(A) are deferred (and in certain cases might be eliminated). The amount of E&P for all other purposes is generally higher. Consequently, for example, the E&P might be distributed in a dividend qualifying for a deduction under Section 245A.

According to Treasury, the exceptions that apply in computing E&P for Section 952(c) enable abuse. The proposal would eliminate the exceptions for tax years of foreign corporations ending on or after 31 December 2023 (and for US shareholders' tax years in which or with which those tax years end).

Creating a second type of US shareholder to include in income amounts determined with respect to non-taxed dividends

During a CFC's tax year, certain US shareholders of that CFC must include in gross income under Sections 951(a) and 951A(a) their pro rata share (a term of art) of the CFC's subpart F income and GILTI tested items in that tax year. The relevant US shareholders (inclusion shareholders) are those that own CFC stock on the last day of the CFC's tax year on which it constitutes a CFC (the last CFC day and inclusion stock). In general, an inclusion shareholder's pro rata share for a tax year is reduced if the CFC distributed a dividend in the tax year, on the inclusion shareholder's inclusion stock, to a person other than the inclusion shareholder.

Under current law, a dividend can reduce an inclusion shareholder's pro rata share even if the recipient of the dividend was eligible for an offsetting deduction under Section 245A or the dividend was excluded from the subpart F income of a CFC recipient by reason of an exception thereto (e.g., Section 954(c)(3)). Consequently, a dividend can cause amounts that inclusion shareholders would have included in income absent a dividend distribution to escape inclusion altogether. Treasury Reg. Section 1.245A-5 was intended to address this phenomenon but does not encompass all scenarios involving such "non-taxed dividends."

The proposal is intended to reduce this effect of non-taxed dividends. It generally would create a second type of inclusion shareholder: a US shareholder that owned stock of the relevant CFC during the CFC's tax year but not on the last CFC day thereof. This new type of inclusion shareholder with respect to a CFC generally would be required to include in gross income an amount determined with reference to any non-taxed dividend distributed by the CFC during the tax year.

The proposal would apply to tax years of foreign corporations beginning after the date of the enactment (and to US shareholders' tax years in which or with which those tax years end). For more details on the proposal, see EY Tax Alert 2021-9023.

Limit FTCs on sales of hybrid entities

In the case of a sale of a foreign target corporation with a Section 338 election, Section 338(h)(16) currently prevents the E&P generated from the deemed asset sale resulting from the election from changing the source or character of the gain on the stock sale from capital gain for FTC purposes. Without the limitation in Section 338(h)(16), foreign-source income would typically result from the deemed asset sale, which would allow for increased FTC utilization. The proposal seeks to impose a similar limitation for FTC purposes on sales of specified hybrid entities (an entity that is treated as a corporation for foreign tax purposes but as a partnership or disregarded entity for US tax purposes), or taxable changes in the classification of an entity for US tax purposes.

The proposal would be effective for transactions occurring after the date of enactment.

Limit deductions of excess interest expense

The proposal includes a limitation on interest expense of entities that are members of a multinational group that prepares consolidated financial statements (financial reporting group) in accordance with US GAAP, IFRS or other method identified by Treasury under regulations. Very generally, the proposed limitation would arise where the member's net interest expense for financial reporting purposes (on a separate-company basis) is greater than the member's proportionate share of the financial reporting group's net interest expense on the group's consolidated financial statement, with proportionate share being determined on an EBITDA ratio (such excess amount is excess financial statement net interest expense). In that case, a deduction would be disallowed equal to the member's net interest expense for US tax multiplied by the ratio of the member's excess financial statement net interest expense to the member's net interest expense for financial statement purposes. Certain exceptions may apply (e.g., financial services).

The proposal would be effective for tax years beginning after 31 December 2023.

Modify the treatment of certain derivative transactions for foreign investors

Current law requires foreign investors in US partnerships to pay tax on income effectively connected to the conduct of the partnership's US trade or business (ECI), as well as some or all of the gains from a sale of an interest in that partnership. Current law also imposes US withholding tax on dividends and dividend equivalents paid to foreign investors. Dividend equivalents include payments under specified notional principal contracts, or certain equity-linked instruments, that depend, directly or indirectly, on the payment of a dividend from US sources.

According to Treasury, foreign investors that acquired their partnership interest through a derivative financial instrument (e.g., total return swap) may take the position that they do not owe US tax on the partnership's ECI. They could also argue that payments received on those financial instruments are foreign source, so US withholding rules, including rules for dividend equivalents, do not apply or only apply to a small portion of the payment.

The proposal would tax certain income of foreign investors that enter into derivative transactions with respect to investments in particular partnerships. In particular, the proposal would "treat the portion of a payment on a derivative financial instrument (including a securities loan or sale-and-repurchase agreement) that is contingent on income or gain from a publicly traded partnership or other partnership specified by the Secretary … as a dividend equivalent, to the extent that the related income or gain would have been treated as ECI if the [investor directly] held the underlying partnership interest. " Treasury notes, however, that taxpayers should not draw inferences about "the application of current law to derivative transactions on interests in partnerships with ECI."

The proposal would be effective for tax years beginning 31 December 2023.

Retroactive QEF elections

The Budget would permit a taxpayer to retroactively elect to treat a PFIC as a QEF without IRS consent, in certain circumstances. This expanded availability of retroactive QEF elections is intended to encourage more QEF elections and reduce the costs and burdens of current law on taxpayers and the IRS alike.

The proposal would be effective on the date of enactment. Further, Treasury intends to issue regulations or guidance permitting taxpayers to amend previously filed returns for open years. For more details on this proposal, see EY Global Tax Alert, US | FY2023 Budget includes new details on international tax proposals, dated 1 April 2022.

Section 6038 reporting for foreign taxable units

The Budget would expand the scope of Section 6038 to require information reporting on a "taxable unit" basis and would impose penalties for failure to report. In effect, this would require separate reporting at the level of any foreign disregarded entity or foreign branch, if located in a country outside of where its owner is tax resident.

The Budget would also authorize Treasury to treat a US person that is a resident in a foreign jurisdiction as a resident of the United States for purposes of identifying taxable units subject to Section 6038 reporting. These proposals would apply to tax years of a. controlling US person beginning after 31 December 2023, and to annual accounting periods of foreign business entities ending with or within those tax years. For more details on this proposal, see EY Global Tax Alert, US | FY2023 Budget includes new details on international tax proposals, dated 1 April 2022.

Implications

The tax proposals identified in this Tax Alert are designed to raise tax revenues to fund the Biden Administration's priorities. If enacted, they would significantly increase taxes on US multinational companies. Their prospects for enactment, however, appear dim, given the current composition of Congress. Nonetheless, taxpayers should keep track of these proposals. The fact that these proposals appeared in past legislation and budgets indicates that they could be used again as revenue offsets in future legislation.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (United States), International Tax and Transaction Services

Craig Hillier, Boston | craig.hillier@ey.com

Colleen O’Neill, Washington, DC | colleen.oneill@ey.com

Enrica Ma, Washington, DC | enrica.ma@ey.com

Martin Milner, Washington, DC | martin.milner@ey.com

Arlene Fitzpatrick, Washington, DC | arlene.fitzpatrick@ey.com

Allen Stenger, Washington, DC | allen.stenger@ey.com

Published by NTD’s Tax Technical Knowledge Services group; Maureen Sanelli, legal editor

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Endnotes

All “Section” references are to the Internal Revenue Code of 1986, and the regulations promulgated thereunder.

It appears that the Administration views the CAMT, which applies to a worldwide group (and thus includes income of foreign affiliates), as a domestic tax that would be partially pushed down to various foreign affiliates for purposes of measuring their effective tax rate under Pillar Two.