Global Minimum Tax Incentive Rules Threaten US R&D Investment

Unfavorable treatment of the highly lucrative US R&D credit under the global minimum tax is threatening to expose American companies to higher taxes and prompting some to rethink new investments in the US.

The US credit—which is worth hundreds of millions of dollars of tax reduction for some companies—would subject US businesses to large amounts of top-up tax by foreign governments, even when operations are on US soil, practitioners and industry groups warn.

“Our modeling shows that there is a significant amount of income that is exposed to top-up tax,” said Danielle Rolfes, partner in charge at KPMG’s Washington National Tax Practice. “The treatment of the US R&D credit is a significant contributor to that exposure.”

Under the minimum tax rules, the credit is viewed as a reduction in tax expense, sending a company’s effective tax rate below the 15% minimum.

As a result, businesses are likely to consider new investment in places like Ireland and Singapore, where incentives are tweaked to soften the blow of the global minimum tax, practitioners said.

If the global minimum tax is “reversing” the usefulness of the US credit for American companies, Rolfes said, it will “absolutely” affect where companies spend their next R&D dollar.

Treasury Secretary Janet Yellen and US delegates to the Organization for Economic Cooperation and Development have said for months that it’s an administration priority to resolve the issue, but countries have yet to publicly announce an agreement.

If the Treasury Department isn’t able to negotiate favorable consideration of the credit with members of the Inclusive Framework—countries involved in the global tax deal negotiations—another option would be to amend the credit through legislation to make it compliant with the global minimum tax rules.

But the idea that Congress would greenlight a fix, which might involve billions more in cost to the government, is “far-fetched,” said Anne Gordon, vice president of international tax policy at the National Foreign Trade Council.

Top-Up Tax

The global minimum tax, also known as Pillar Two of the OECD-led agreement, is designed to charge companies a minimum rate of 15% in every country where they operate.

The levy contains a highly controversial backstop rule, called the undertaxed profits rule, or UTPR. It allows countries applying the rule to top-up tax on a company when both its parent country and its subsidiary’s local jurisdiction aren’t charging the 15% minimum rate.

Under Pillar Two, qualified refundable tax credits, like many included in President Joe Biden’s 2022 tax-and-climate law, are viewed as an increase in income, rather than a reduction in tax expense. If companies use the credits, the incentive is less likely to trigger top-up tax.

The US R&D credit, however, is non-refundable. Under the Pillar Two guidance, it’s considered a reduction in tax expenses, making companies that take advantage of it more vulnerable to top-up tax.

The US hasn’t adopted the global minimum tax rules, but its companies will be exposed to the UTPR.

US businesses are shielded from the UTPR until 2026 because of a temporary safe harbor built into the global levy’s rules. And though 2026 is a year-and-a-half away, fixing the R&D issue is top of mind.

“For several years now it’s been a policy-level concern, but it’s becoming a much more real numbers-based concern for companies now,” said Megan Funkhouser, senior director of policy, tax, and trade at the Information Technology Industry Council.

Chad Hungerford, global Pillar Two leader at Deloitte Tax LLP, told Bloomberg Tax that one of the “most common” questions his clients ask him is whether there will be a “US R&D fix.”

Investment Abroad

In countries like Ireland, Singapore, Bermuda, and the island of Jersey—what are colloquially referred to as tax havens--there’s a race to offer new, attractive incentives that are compliant with the Pillar Two regime.

Ireland, for example, changed both its R&D and film tax credits to be refundable. Singapore announced a refundable investment credit in February to encourage research and development, establishment of manufacturing facilities, and green transition activities.

Both Hungerford and Gordon said companies consider many attributes when deciding to make investments.

Gordon said the talent pool, legal stability, and strategic business opportunity are contributing factors. Hungerford said the US is still an attractive place to do research, because it has access to some of the best universities in the world and, for the technology industry, is home to a semiconductor hub in Silicon Valley.

If the US and a foreign country’s attributes match in every way except for better treatment of R&D, it makes sense to make new investments elsewhere, Hungerford added.

“If I could do the same research either place, and I think I’ve got the same talent either place—every single time that multinational is going to choose Ireland,” he said.

Fixes

Thus far, the US government has been unsuccessful in negotiating an agreement for more favorable treatment of the R&D credit with the Inclusive Framework.

Pascal Saint-Amans, a partner at the Brunswick Group and former director of the OECD’s Center for Tax Policy and Administration, said that if other countries make concessions to the US on this issue, it will undermine the effectiveness of Pillar Two.

“So this is a conundrum,” he said. “And I don’t see an easy solution.”

Treasury’s Acting Deputy Assistant Secretary for International Affairs Scott Levine reiterated in March that addressing the R&D credit issue through administrative guidance was a “top priority” for the Biden administration.

It’s very unlikely that if Treasury is unable to negotiate favorable treatment of this US incentive, Congress would pass new R&D tax credit legislation.

“There are ideological reasons that Republicans in Congress prefer a non-refundable credit. They prefer to give a credit only to companies that make a return on the investment for ideological reasons that have nothing to do with tax competition,” Rolfes said.