The now-enacted international tax reforms in the One Big Beautiful Bill Act (OBBBA or Act) have important implications for multinational enterprises (MNEs). In the early days of the reconciliation process, as Congress weighed the budgetary effects of extending the sunsetting provisions of the Tax Cuts and Jobs Act, international tax practitioners had little reason to expect substantial reforms to the US international tax regime. Extension of the global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), and base erosion and anti-abuse tax (BEAT) rates seemed possible, if not likely. But Congress appeared to have little to no appetite—or budget—to wade into the minutiae of international tax. That outlook was turned on its head when the Senate Finance Committee released its draft legislation. The Senate, armed with draft legislation introduced by Senator Thom Tillis in early May, put forward a set of international reforms that significantly alter the US international tax rules. In this article we discuss these now-enacted reforms in the OBBBA that can have important implications for MNEs.
Introducing “Net CFC Tested Income” (Formerly Known as GILTI)
Under current law, the GILTI regime under §951A imposes US tax on US shareholders of controlled foreign corporations (CFCs) that is calculated based on net CFC tested income above a routine 10% return on the CFC’s tangible property called “net deemed tangible income return.” And a US shareholder’s GILTI receives the benefit of a 50% deduction under §250 (which was originally set to decrease to 37.5% for taxable years beginning after December 31, 2025).
The OBBBA renames the GILTI regime to the “Net CFC Tested Income” regime and removes the “net deemed tangible income return” from the calculation (rendering the term “GILTI” superfluous), applicable to taxable years beginning after December 31, 2025. The deduction percentage for the Net CFC Tested Income (f/k/a GILTI) is decreased to 40% (from 50%) and made permanent.
Further, under current law, the GILTI foreign tax credits are subject to an 80% allowance, or a 20% haircut. Under the OBBBA, the §960(d) deemed paid credit haircut for Net CFC Tested Income (f/k/a GILTI) inclusions is reduced from 20% to 10%, and the haircut for the associated §78 gross-up is also decreased from 20% to 10%. The decrease in the Net CFC Tested Income §250 deduction percentage and the foreign tax credit changes, taken together, result in an effective US tax rate of approximately 12.6% on Net CFC Tested Income (f/k/a GILTI), up from 10.5%. This is an important equalizer attempt between the US effective tax rate applicable to Net CFC Tested Income and the updated effective tax rate of 14% applicable to FDII (which increased from 13.125%), as further discussed below.
In addition, the OBBBA removes the reduction of GILTI eligible income by “qualified business asset investment” (QBAI). Under current law, GILTI is equal to the excess of the shareholder’s “net CFC tested income” over the shareholder’s “net deemed tangible income return” for the taxable year. The “net deemed tangible income return” is determined based on a percentage of the US shareholder’s pro rata share of the CFC’s QBAI and interest expense.
The OBBBA amends the existing GILTI regime to remove the net deemed tangible income return mechanism in its entirety. Thus, a US shareholder must include in its gross income its entire net CFC tested income, not reduced by the deemed tangible income return. The inclusion of a “net deemed tangible income return” reduction in the TCJA was widely criticized to incentivize tangible property to be held by a CFC, which appeared contrary to the goals of the TCJA to incentivize operations in the US. Its removal is another change to equalize the application of FDII and GILTI. Further, this change results in all income of a CFC being subject to tax in the US for most MNEs via an inclusion by its US shareholders. Thus, the §245A dividends received deduction loses even more of its significance as most distributions would be made out of previously taxed earnings and profits (PTEP) under §959 (unless other CFCs in the MNE group have tested losses).
From FDII to FDDEI
Under current law, Foreign-Derived Intangible Income (FDII) is calculated by multiplying Deemed Intangible Income (DII) by the Foreign Derived Ratio, which is calculated by dividing Foreign-Derived Deduction Eligible Income (FDDEI) by Total Deduction Eligible Income (DEI). The calculation of DII also takes into account a 10% return on certain of the corporation’s tangible property called “net deemed tangible income return,” as discussed in GILTI above. The FDII regime provides domestic corporations with a 37.5% deduction with respect to the corporation’s FDII. The deduction rate was set to decrease to 21.875% at the end of 2025.
The OBBBA renames FDII to FDDEI and streamlines the calculation by, in part, removing the multiplication of DII by the Foreign Derived Ratio.
Under the OBBBA, the new deduction rate for FDDEI (f/k/a FDII) is permanently set at 33.34%, which makes the eligible income subject to an approximately 14% (up from 13.125%) effective rate of tax. The Act further amends the FDII regime by removing the concept of return on tangible property as it decreased the FDII eligible income on which US corporations could pay a lower effective rate of tax compared to the 21% corporate income tax rate. This change was important to further promote FDII as a benefit to US companies, as the TCJA was criticized after enactment to disincentivize tangible property ownership in the US by including a decrease for return on tangible property. Now, the previously-named FDII deduction is based solely on the domestic corporation’s FDDEI without any further reductions.
Although the definition of FDDEI remains substantially the same, it is based off of DEI, which now has additional exclusions. FDDEI is DEI derived in connection with (1) property sold to foreign persons for foreign use; or (2) services provided to a foreign person. Under current law, DEI is defined as the excess of the domestic corporation’s gross income—but excluding a number of items such as subpart F and GILTI inclusions, dividends received from CFCs, and foreign branch income—over deductions properly allocable to that income.
The OBBBA adds a new provision to the list of items excluded from DEI. For purposes of calculating DEI, a domestic corporation’s gross income is determined without regard to any income or gain from the sale or other disposition of (1) intangible property, as defined in §367(d)(4); and (2) any other property subject to depreciation, amortization, or depletion by the seller. Sales or other dispositions include deemed sales or dispositions and also §367(d) transactions where intangible property is transferred outside of the US in what would otherwise have been a non-recognition transaction. The OBBBA clarifies that the definition in §250(b)(2)(E) (as re-designated under the OBBBA, formerly §250(b)(5)(E)), which provides that the term “sale” includes any lease, license, exchange, or other disposition, does not apply to this new provision within the definition of DEI. Thus, this exclusion from DEI applies only to actual sales or disposition under US tax law, which normally would not include a non-exclusive license. An earlier version of the OBBBA would have excluded from DEI certain royalty income; to many taxpayers’ relief, the final act does not do this. Further, the provision allows the IRS and Treasury to promulgate exceptions to this rule. This income removal from DEI applies to sales or other dispositions occurring after June 16, 2025.
Importantly, the OBBBA alters the provision regarding deduction allocation to gross income for purposes of calculating DEI. Previously, the domestic corporation’s DEI was reduced by deductions properly allocable to the gross income. Under the revised rule, expenses are also added to deductions, presumably to capture cost of goods sold (COGS), while the properly allocable standard is maintained. A further important change is that deductions now exclude interest expense and research and experimental (R&E) expenditures. This change can have very favorable consequences to the calculation of FDDEI for companies with high interest expense or R&E expenses. Removal of these expenses so they no longer decrease the corporation’s gross income when calculating DEI would allow for DEI to be higher and, thus, for FDDEI to also be higher.
With the exception of the exclusion of sales of intangible property from DEI, the FDII changes apply to taxable years beginning after December 31, 2025.
Foreign Tax Credits
The Act includes four primary changes relating to foreign tax credits. The first relates to the §904 foreign tax credit (FTC) limitation, and establishes a new rule for determining the deductions allocable to foreign source net CFC tested income. Under the prior rules, there was no specific allocation rule for the GILTI basket, so taxpayers were required to allocate and apportion expenses borne in the US to the GILTI basket, which often resulted in a permanent loss of FTCs (because FTCs in the GILTI basket cannot be carried forward). Taxpayers criticized this rule because GILTI was already calculated net of CFC expenses, so the provision started to look less like a global minimum tax that Congress purported to pass in the TCJA. Under the new rule, for purposes of applying the foreign tax credit limitation with respect to the net CFC tested income basket (formerly the GILTI basket), the taxpayer’s taxable income from foreign sources is determined by allocating and apportioning (1) any deduction allowed under §250(a)(1)(B) (relating to the deduction for net CFC tested income and the §78 gross-up for such income) and (2) any other deduction that is “directly allocable” to such income. Importantly, the new rule provides that interest expense and R&E expenditures are not allocated to foreign source net CFC tested income. Any amount or deduction that would, absent such new rule, be allocated or apportioned to foreign source net CFC tested income is re-allocated to US source income. This is a welcome change for most taxpayers because it is likely to increase the amount of FTCs available in the net CFC tested income basket. However, taxpayers should carefully monitor this re-allocation as it could have ripple effects, such as overall domestic losses.
The second foreign tax credit amendment in the Act creates a new source rule within §904(b). New §904(b)(6) provides that, for the purposes of the FTC limitation, income from the sale or exchange outside the US of inventory property, (1) which is produced in the US, (2) which is for use outside the US, (3) to which the third sentence of §863(b) applies (i.e., is generally sourced to the place of production activities with respect to such property), and (4) which is attributable to an office or other fixed place of business of a US person in a foreign country (determined under the principles of §864(c)(5)), is treated as 50% foreign source income. This amendment applies to taxable years beginning after December 31, 2025.
This provision is different from how §863(b) applied before the TCJA. Pre-TCJA §863(b) (and the regulations thereunder) generally provided for 50/50 US/foreign sourcing with respect to inventory property that was produced within the US and sold outside the US (or vice versa). New §904(b)(6) imposes additional requirements to obtain 50% foreign sourcing for relevant inventory property sales. It requires, in addition to the property being sold outside the US, the US person to maintain an office or other fixed place of business (see Treas. Reg. §1.864-7) outside the US to which such sale is attributable, applying the principles of §864(c)(5) (e.g., such foreign office must be a “material factor” in the production of such income, and such office must regularly carry on activities of the type from which such income is derived). In addition, the inventory property must be “for use outside the United States.”
Third, §78 is amended so that there is no §78 gross-up on distributions of previously taxed earnings and profits (PTEP), which applies to taxable years beginning after December 31, 2025, similar to the GILTI FTC rules discussed above. Further, the Act provides that the new 10% GILTI haircut also applies to foreign taxes paid or deemed paid under §960 so that no FTC under §901 is allowed for that 10% to the extent the taxes are allocable to distributions of PTEP with respect to net CFC tested income made after June 28, 2025. These two provisions result in a mismatch of effective dates with respect to distributions of PTEP out of net CFC tested income where PTEP distributions during the second half of 2025 (or longer, depending on the entity’s taxable year) are subject to the 10% haircut, while the GILTI haircut reduction and related §78 reduction from 20% to 10% do not come into effect until 2026 (or a later fiscal year).
Finally, the Act makes a handful of technical corrections to §904. The first is to amend §904(d)(2)(H)(i) to provide that tax imposed under the law of a foreign country or possession of the US on an amount which does not constitute income under US tax principles (i.e., a “base difference”) is treated as imposed on income in the general basket, rather than the foreign branch basket. This technical fix was required since the TCJA was enacted in 2017 because the base difference rule cross referenced §904(d)(1) baskets but had an “old” cross reference that was no longer to the general basket due to TCJA’s addition of new baskets (i.e., GILTI and foreign branch). The second is to amend §904(d)(4)(C)(ii) to provide that, if the Secretary determines a taxpayer has not substantiated the proper basket of a dividend, the dividend is allocated to the passive income basket, rather than the net CFC tested income/GILTI basket, which was also an incorrect cross reference left over from prior to the TCJA. Also, the Act amends §951A(f)(1)(A) to provide that any GILTI (or, now, net CFC tested income) income included in gross income is treated as subpart F income for purposes of all of §904(h), rather than only for purposes of §904(h)(1). This extends the subpart F treatment of net CFC tested income for all parts of the §904(h) source rules for US-owned foreign corporations. These amendments apply to taxable years beginning after December 31, 2025.
BEAT
With the removal of proposed §899, the final bill’s impact on the BEAT is relatively minor. The BEAT rate will increase from 10% to 10.5% for taxable years beginning after December 31, 2025. The BEAT rate was previously slated to increase to 12.5% at the end of 2025.
The Act also permanently extends the favorable treatment of certain credits within the BEAT calculation. A taxpayer’s BEAT liability is equal to the excess of 10% (currently, and 10.5% for taxable years beginning after December 31, 2025) of the taxpayer’s modified taxable income over the taxpayer’s regular tax liability, reduced by most credits. The §41(a) research credit, as well as a haircut portion of other §38 credits, are not treated as reducing the taxpayer’s regular tax liability. This favorable treatment of certain credits was due to expire at the end of 2025. The Act makes the favorable treatment permanent.
Expensing of R&E Expenditures
Under current law, §174 requires that taxpayers capitalize and amortize R&E expenses. Domestic R&E expenses must be amortized over a five-year period, while foreign R&E expenses must be amortized over a 15-year period.
The Act improves the treatment of domestic R&E expenses by establishing a new §174A that allows taxpayers to immediately deduct domestic R&E expenses, including software development costs, paid or incurred in taxable years beginning after December 31, 2024. However, the taxpayer can instead elect on its tax return for each relevant year to capitalize domestic R&E expenses and amortize them over a period of its choosing, as long as it is at least five years.
New §174A also allows taxpayers to elect to deduct any remaining unamortized amounts relating to domestic R&E expenses paid or incurred in taxable years beginning after December 31, 2021 and before January 1, 2025. A taxpayer may elect to deduct these remaining unamortized amounts (1) in the first taxable year beginning after December 31, 2024, or (2) ratably over the two taxable year period beginning with the first taxable year after December 31, 2024.
The Act also establishes an election for certain small businesses to apply §174A retroactively to December 31, 2021. If this election is made, the taxpayer must file amended returns for the relevant taxable years. This election only applies to taxpayers with adjusted gross receipts of less than $31M.
Although these changes with respect to domestic R&E are welcome, taxpayers must carefully consider the implications of the various elections. The election to immediately deduct the remaining unamortized domestic R&E amounts from 2021-2024 and not electing to capitalize domestic R&E expenses in 2025 and future years could result in the application of the corporate alternative minimum tax (CAMT). The BEAT under §59A could also apply as a result of §174A. These issues should be carefully considered and modeled.
Business Interest Limitation
The Act made various changes to the §163(j) limitation on business interest deductions. First and foremost, the Act permanently restored the EBITDA-based calculation of adjusted taxable income (“ATI”). This provision had previously sunset, requiring an EBIT-only based calculation. The change will generally be beneficial to taxpayers by increasing their ability to deduct interest expense. This amendment applies retroactively to taxable years beginning after December 31, 2024.
The Act amends the definition of ATI further to establish that ATI is determined without regard to subpart F and net CFC tested income inclusions, as well as §78 gross ups. The change may be adverse to some taxpayers. This amendment applies to taxable years beginning after December 31, 2025.
The Act also amends §163(j) by inserting a new subsection (10) that coordinates §163(j) with interest capitalization provisions. This new provision establishes that the §163(j) limitation applies to business interest without regard to whether the taxpayer would deduct or capitalize the business interest under an interest capitalization provision (e.g., §266). This section also clarifies that any reference in §163(j) to business interest is treated as including a reference to capitalized business interest. New § 163(j)(10) also establishes an ordering rule, stating that the amount allowed after taking into account the limitation is first applied to the aggregate amount of business interest which would otherwise be capitalized, and then to the aggregate amount of business interest that would be deducted. The Act also amends §163(j)(5) to clarify that the term “business interest” does not include interest capitalized under §263(g) or §263A(f). These amendments apply to taxable years beginning after December 31, 2025.
One-Month Deferral for Specified Foreign Corporations
The Act repeals current §898(c)(2), which provided that a specified foreign corporation may elect a taxable year beginning one month earlier than the US shareholder’s taxable year. The general rule under §898 is that a specified foreign corporation must adopt the taxable year of the majority US shareholder. A “specified foreign corporation” is a CFC that is more than 50% owned (vote or value) by a US shareholder.
This amendment applies to taxable years of specified foreign corporations beginning after November 30, 2025. The Act establishes a transition rule for corporations that are specified foreign corporations as of November 30, 2025. These corporations’ first taxable year beginning after November 30, 2025, will be required to end at the same time as the first required year that ends after this date. For calendar year US shareholder taxpayers, this generally means that the specified foreign corporations would have a roughly one month stub year. The rules also provide that the IRS and Treasury will need to issue regulations to determine how foreign tax credits are to be taken into account for this stub period, which could be particularly important to some MNEs as there may be substantial foreign taxes accrued during this stub period. This repeal of the one-month deferral rule may impact certain considerations with respect to the effective dates of other newly enacted provisions in the Act.
Pro Rata Share Rules
The Act amends the pro rata share rules under §951(a). Under current law, a US shareholder is required to include its pro rata share of a CFC’s subpart F income only if the US shareholder owns stock of the CFC on the last day of the CFC’s taxable year. The Act provides that a US shareholder will now be required to include its pro rata share of a CFC’s subpart F income if the US shareholder owns stock of the CFC “on any day during the CFC year.”
The US shareholder’s pro rata share of subpart F income is the portion attributable to (1) the stock of the CFC; and (2) any period of the CFC year during which the shareholder owned the stock, the shareholder was a US shareholder with respect to the foreign corporation, and the foreign corporation was a CFC. The US shareholder is required to include the subpart F income in its gross income for the US shareholder’s taxable year which includes the last day on which the shareholder owns stock in the CFC.
These changes will be especially important in the context of M&A transactions where §338(g) elections often assisted in closing the taxable year of the CFC.
In addition, the new pro rata share rules include language coordinating with §951A and the new net CFC tested income regime. In general, these corresponding amendments remove references to including net CFC tested income in the US shareholder’s taxable year “in which or with which the taxable year of the controlled foreign corporation ends.”
The new pro rata share rules apply to taxable years beginning after December 31, 2025. The Act establishes a transition rule for dividends paid or deemed paid by a CFC on or before June 28, 2025 if the US shareholder did not own the stock of the CFC during the portion of the taxable year on or before June 28, 2025, or if the dividend was paid or deemed paid after June 28, 2025, and before the CFC’s first taxable year beginning after December 31, 2025. If the dividend does not increase the taxable income of a US person that is subject to federal income tax for the taxable year (including by reason of a dividends received deduction, and exclusion from gross income, or an exclusion from subpart F income), then the dividend will not be treated as a dividend for purposes of applying current §951(a)(2)(B) (i.e. the dividend will not be treated as an actual distribution for purposes of determining the US shareholder’s pro rata share under the current rules).
The Act grants Treasury authority to issue regulations or other guidance to carry out the purposes of the new pro rata share rules, including for purposes of allowing taxpayers to elect, or requiring taxpayers to close, the taxable year of a CFC upon a direct or indirect disposition of stock of such CFC. These regulations or guidance will also presumably need to provide rules for determining the portion of a CFC’s subpart F income that is attributable to the CFC stock owned by a US shareholder during any period of the CFC year.
Downward Attribution
The Act restores §958(b)(4), previously removed under the TCJA, re-establishing limitations on downward attribution of stock ownership from foreign persons in the constructive ownership rules. Restored §958(b)(4) provides that subparagraphs (A), (B), and (C) of §318(a)(3) do not apply to consider a US person as owning stock which is owned by a person who is not a US person. This restoration of §958(b)(4) helps alleviate a myriad of issues that arose after the TCJA where all subsidiaries in a foreign parented multinational structure became CFCs if there was a brother-sister US corporation in the structure. For example, US-based minority investors should generally be pleased to not have to work through a web of reporting rules and exceptions with respect to investments in entities that were only CFCs due to downward attribution.
Though the Act restores these limitations on downward attribution, it establishes a new §951B that allows for downward attribution in situations where there is over 50% ownership of a foreign subsidiary by a foreign parent and a US brother-sister entity exists in the structure. Therefore, foreign-parented, over 50% ownership structures with US subsidiaries can still be implicated under the new rules by likely requiring reporting (and possibly Subpart F and GILTI inclusions, depending on the ownership structure). Section 951B also captures inverted companies where the US shareholder transferred 51% ownership of its foreign subsidiaries and those subsidiaries would no longer be CFCs with the restoration of §958(b)(4).
New §951B creates a new framework for “foreign-controlled US shareholders” of a “foreign controlled foreign corporation” where subpart F provisions apply in the same way that they generally apply to 10% US shareholders and CFCs but by substituting these terms instead, respectively. Further, GILTI applies to “foreign-controlled US shareholders” who are also 10% or more US shareholders under the rules considering the re-establishment of the limitation on downward attribution. The key is that this provision applies to “foreign controlled United States shareholders” and not just 10% US shareholders as defined in §951(b). Thus, it does not result in consequences to 10% US shareholders who are not also “foreign controlled United States shareholders.”
A foreign-controlled US shareholder is defined as any US person who would be a US shareholder if (1) §951(b) were applied when a US person owned more than 50% rather than 10% or more (by vote or value) of a foreign corporation, and (2) the newly restored §958(b)(4) did not apply. A foreign controlled foreign corporation is defined as a foreign corporation that is not a CFC (assuming the downward attribution ban in §958(b)(4) is restored), but would be a CFC if §957(a) were applied (1) by substituting “foreign controlled United States shareholders” for “United States shareholders” and (1) applying downward attribution as if §958(b)(4) had not been restored.
The IRS and Treasury also have authority to promulgate reporting regulations applicable to “foreign controlled United States shareholders” who are captured under §951B. These changes apply to taxable years of foreign corporations beginning after December 31, 2025.
CFC Look-Thru Rule
The CFC look-thru rule in §954(c)(6) was due to expire (again) at the end of 2025. This provision establishes that dividends, interest, rents, and royalties received or accrued from a CFC that is a related person are not treated as foreign personal holding company income to the extent attributable or properly allocable to income of the related person CFC that is neither subpart F income nor income treated as effectively connected with the conduct of a trade or business in the US. Although expected, the Act helpfully permanently extends §954(c)(6).
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.
Author Information
Julia Ushakova-Stein is a Partner in Baker McKenzie’s San Francisco office. Rafic Barrage is a Partner and Katie Rimpfel is a Knowledge Lawyer in the Washington, DC, office.
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