The Treasury Department is being pressed by Republican lawmakers and business groups to correct a defect in a new tax on foreign earnings that has companies like biotech giant Amgen Inc. saying they may move their research and development operations offshore.
They are asking Treasury to clarify how to properly allocate research and development expenses under the new rules, which are meant to ensure multinationals pay at least a minimum amount of tax on overseas profits earned in countries with lower tax rates than the U.S.
The issue is that the 2017 tax law didn’t account for existing rules requiring companies to attribute certain U.S. business expenses to their taxable foreign income. That lowers the amount of foreign tax credits companies can claim, and having fewer credits means a higher bill under the new overseas-profit tax.
That means companies could pay more U.S. tax on their foreign income if they increase R&D spending in the U.S.—counter to the tax law’s intent to stop U.S. companies from moving operations to lower-tax countries—unless Treasury modifies the expense allocation rules.
“This is the kind of stuff people on the Hill freak out about,” said Robert Russell, an attorney at Alliantgroup LP, who formerly worked at the Internal Revenue Service and Treasury.
It’s also an important issue for multinationals with R&D-intensive operations, including technology and pharmaceutical companies.
“If you create an issue here with allocation then you’re going to be encouraging this R&D activity to move outside,” Jackie Crouse, vice president of taxes at Amgen, said Feb. 14 at a conference hosted by the Tax Council Policy Institute. The biopharmaceutical industry spends about $50 billion a year on research and development, she said.
Treasury is under heightened pressure to address the issues in future regulations, given the improbability of congressional Democrats agreeing to legislative changes to improve the Republican tax law, according to a tax lobbyist speaking on condition of anonymity. Treasury offered relief for some business expenses in initial rules but didn’t address others, including R&D expenses.
“Businesses are going to have to make significant structural decisions involving domestic employment and domestic investment in response to the law, and they might not be able to wait for Congress to act before making those decisions,” said George Callas, who worked as senior tax counsel to former House Speaker Paul D. Ryan (R-Wis.) during the passage of the 2017 tax law.
“Expense allocation rules are largely creatures of Treasury regulations, anyway, and thus it’s appropriate for Treasury to address them rather than waiting for Congress to act,” said Callas, who is now managing director of government affairs and public policy at Steptoe & Johnson LLP in Washington.
The federal GILTI tax, on global intangible low-taxed income, is supposed to kick in if a company is paying a low tax rate—below 13.125 percent—in foreign countries. But some multinationals in high-tax countries are facing a worse tax situation than those in low-tax countries because of the way the rules were drafted.
“There are a lot of expenses that have the ability to reduce your foreign tax credit limitation, so your ability to claim foreign tax credits gets more difficult when you have more expenses that go into” GILTI, said Thomas Plank, senior manager at KPMG LLP in Boston.
Companies may only take foreign tax credits that amount to 80 percent of their GILTI income—meaning the lower your taxable GILTI income, the fewer foreign tax credits you can claim. When companies pay high tax outside the U.S., they can’t claim the equivalent foreign tax credits against their high foreign taxes because of the GILTI’s foreign tax credit limitation.
The proposed regulations (REG-104259-18) attempted to reverse this problem so that companies would only have to allocate half of some domestic expenses to their foreign subsidiaries. This would increase their taxable foreign income and allow them to use more foreign tax credits.
But because the rules don’t address how companies allocate R&D expenses, there are still issues.
“R&D spending is a major issue at the C-suite level. They’re trying to make decisions on whether or not to do R&D spending and that is a big picture company decision. But we tax people are saying R&D spending may throw things off, so we need to redo some calculations to alleviate the impact of this,” Russell said.
Business groups, like the Silicon Valley Tax Directors Group and the National Association of Manufacturers, have submitted comment letters to Treasury requesting regulations that address R&D expense allocation.
A Treasury spokesperson said the department is in the process of studying all comments on the proposed regulations and will consider that feedback as it issues final rules. The IRS declined to comment.
Rob Portman, an Ohio Republican on the Senate Finance Committee, told Bloomberg Tax that there are a “couple things outstanding on GILTI” lawmakers are working to resolve with the Treasury Department.
Any major legislation creates impacts that have to be examined over time, said Rachel Vliem, press secretary for Sen. Mike Enzi (R-Wyo.). Enzi, a finance committee member, has been communicating with Treasury and business leaders about regulations, she said.
The tax lobbyist said stakeholders are asking for an alternative option, or a “safety valve,” to be placed in the regulations.
Such a solution would allow multinationals with foreign subsidiaries in high-tax countries who are still getting hit by the GILTI tax to elect to use older rules for classifying a U.S. company’s foreign income, also known as the Subpart F rules.
Subpart F is a different income category that applies to a multinational’s foreign earnings. Opting into the old foreign income regime would allow companies to claim foreign tax credits up to 100 percent of their Subpart F income and carry over any excess credits for up to 10 years, a benefit currently unavailable under the GILTI regime. The option would also remove the double tax outcome of GILTI.
Selecting the Subpart F regime would also exempt companies from the additional U.S. tax if they face an effective foreign tax rate equal to at least 90 percent of the 21 percent U.S. corporate tax rate, or 18.9 percent. In other words, that high-taxed income wouldn’t be included in GILTI.
The National Association of Manufacturers, which represents manufacturers in all 50 states, said that a better approach would be to allocate no expenses to GILTI, so that the provision works more like the global minimum tax concept Congress intended.
But “allowing for a high-tax exception would at least be similar to the Subpart F high-tax exception and thereby allow taxpayers to essentially exclude high-taxed income” from GILTI, the association said in its comment letter to Treasury.
Having this type of safety valve in the rules would prevent companies from having to restructure their businesses to get that relief and save the IRS administrative headache, the tax lobbyist said.
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