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Build Back Better and the Income Tax Provision

26th October 2021

Back in 2009, when the corporate tax rate in the United States was a prohibitive 35%, American pharmaceutical giant Bristol Myers Squibb reported an effective tax rate (ETR) of 21.1%. If you think that’s impressive, consider this: By 2012, the company’s ETR plunged to negative 7%—thanks, in large part, to a shrewd, or as the IRS might call it, “questionable,” cross-border tax strategy.  

Slated to save the company roughly $1.38 billion in federal taxes, the company’s approach was hardly original. Merck, Apple, and plenty of others, including Bristol Myers Squibb, have all created offshore subsidiaries in low-tax jurisdictions, for the purpose of booking profits inside those desirable low-tax borders, all the while avoiding the high-tax rates that come with doing business back home. Of course, Bristol Myers Squibb was a little savvier than merely booking profits through its entity in low-tax Ireland—it also used an amortization scheme, essentially deducting a portion of the value of company patents over a certain number of years. 

While arrangements like this aren’t illegal, the IRS isn’t exactly a fan. In fact, over the years, the U.S. government has diligently worked to initiate tax laws to prevent such “abusive” tax practices. Certainly, 2017’s Tax Cuts and Jobs Act (TCJA) includes statutes to penalize American profits that land in overseas books, and most recently, the House Ways and Means Committee’s reconciliation spending bill—part of the Build Back Better Act—rewrites many rules about taxing cross-border operations. Where does this plan stand now? How could it alter your company’s tax strategy? Change its effective tax rate? Increase your tax compliance burden? Good questions—and we’ll be unpacking the corporate tax components of Build Back Better right here.  

To start, let’s rewind the clock to early 2021, when the Biden Administration’s legislative agenda could be summed up in two words: Rescue and Recovery. In March, the rescue legislation—the $1.9 trillion, mostly deficit-funded American Rescue Plan Act—was signed into law. It included direct stimulus payments, additional PPP loans, and other small-business stimulus and relief. If only accelerating the recovery side of Biden’s agenda was that simple.  

Under the recovery umbrella, there are two broad proposals: An infrastructure plan, which requires about $1.2 trillion in spending, and an even bigger spender, the $3.5-trillion Build Back Better reconciliation bill, introduced, and largely supported by democrats. The infrastructure bill, which has little to do with taxes, has already passed through the Senate, and for now, it’s anyone’s guess as to how it does in the House. But in terms of corporate tax strategies, it’s the Build Back Better proposal that you want to keep your eyes on. The revenue-raiser proposes tax increases for wealthy individuals and corporations, and it also proposes changes to the tax structure that may require tax executives to revisit corporate tax accounting, overseas business arrangements, and believe it or not, the 2021 fourth-quarter income tax provision. If the tax code is revised and higher tax rates officially go into effect in 2022, deferred tax revaluations—and strategies to milk 2021’s lower rates —will have to be considered now.  

Why Reconciliation? 

In case you haven’t noticed, in the U.S., it’s not easy for one political party to gain the support of the other. And when it comes to passing important fiscal legislation—laws addressing tax, spending, and debt limits—that’s often the requirement. One workaround, however, is reconciliation legislation, which is a tool to make legislation easier to pass, essentially by circumnavigating the need for major bipartisan buy-in. In the Senate, you only need 51 votes (or 50 plus the vice president’s tiebreaker) to pass reconciliation legislation—a simple majority—as opposed to 60, the minimum required through traditional voting. Another plus? Reconciliation legislation can’t be filibustered, so once it gathers momentum it can move through governmental processes and procedures swiftly. While reconciliation may sound like the Yellow Brick Road for a bill to become law, there are limitations: For instance, the government can only use it three times a year. Still, both parties have enlisted reconciliation’s get-the-deal-done powers: Hefty tax cuts under George W. Bush passed through reconciliation. In 2010, the Affordable Care Act was amended through reconciliation legislation, and the TCJA was reconciliation legislation, passing with 51 votes in 2017. Given that the current Senate is evenly split between republicans and democrats, reconciliation can help move legislation forward as democrats would need the full support of their own party, plus only one republican vote—or a vote from the vice president in lieu of that—to secure a win.  

Of course, tax legislation must originate in the House. So, in terms of Build Back Better, the House Ways and Means Committee, the chief tax-writing committee, created a plan to earn $1 trillion in revenue over the next 10 years. Naturally, the federal revenues will stem from tax increases. So far, the bill promises to raise taxes only for wealthy individuals—those making more than $400,000 annually—and corporations, which would carry the rest of the additional tax burden.  

On September 15, the House Ways and Means Committee approved the legislation, a small victory given that it’s just one step forward on a very long road ahead. The House Rules Committee can modify the bill before moving it to the floor, and then it will have to pass through both the House and the Senate, which it’s unlikely to do without modifications.  

Why Plan Now? 

One of the most important proposed changes to the tax code is the corporate income tax rate would not only increase, but also be restructured into a graduated format for most corporations. Those with a taxable income under $400,000 would be subject to a new rate of 18%. Corporations with taxable income between $400,000 and $5 million would be taxed at 18% on the first $400,000 and then 21% thereafter. Companies with taxable income of more than $5 million would have a 18% rate on the first $400,000, 21% rate on the next $4.6 million, and then a 26.5% tax rate on income over $5 million. Finally, corporations with more than $10 million would be subject to a flat 26.5% tax rate. So, for large corporations, the tax rate would go from 21% to 26.5%. Though less than President Biden’s original proposal of a 28% corporate tax rate, Build Back Better would give the U.S. the third-highest corporate tax rate among OECD countries.  

Along with increasing the tax rate, Build Back Better also proposes changes to the tax base—the mix of income and expenses, to which the tax rate is applied. Obviously, both adjustments stand to affect your company’s entire income tax provision, including your current provision, the year the new law comes into effect. However, your deferred tax provision, which calculates the future impact of items on your company’s tax liabilities, would be impacted as soon as the law is passed.  

Since the deferred tax provision is essentially accruing for future events, you’ll lay the groundwork now, calculating how and when temporary book-to-tax differences, net-operating-loss carryforwards, and credit carryforwards will result in additional tax expense or benefit. However, these calculations must comply with all enacted laws applicable in the future period when the temporary book-to-tax difference or carryforward will come to fruition. So, let’s say a version of Build Back Better passes in 2021, but the tax rate and tax code changes don’t go into effect until 2022—a probable scenario, by the way—you won’t have to reckon with this on your current provision until 2022, but your deferred provision will have to comply with the new legislation immediately, as soon as it’s enacted. So, your deferred tax assets and liabilities would have to be revalued in 2021. For deferred tax purposes, it doesn’t matter if a law is in effect, it matters if it has been signed into law.  

Tax planning also stands to affect your income tax provision and tax managers may reevaluate tax strategies to soften the blow of an increased corporate tax rate. This could mean changes to accounting methods, utilizing or holding back on certain tax elections, and other strategies to accelerate income into 2021 and delay deductions into future years. If 2021’s tax rate of 21% is going to be lower than 2022’s 26.5%, then it’s conceivable to be taxed at a lower rate today rather than at a higher rate next year. And if you push a valuable deduction from this year into a higher-rate period, then that deduction becomes even more valuable. Likewise, if you accelerate income expected in future years to this year, a lower-rate period, that income will be spared additional tax – a counterintuitive, yet potentially quite effective, strategy. So, there’s a lot to consider depending on if the bill—or even parts of the bill—are passed. Chances are good that you’ll have to make strategic decisions based on new laws sooner than you may think.  

The Takeaway: 

  • Build Back Better is slated to raise $1 trillion in revenue over the next decade. 
  • Federal revenues will stem from tax increases on the wealthy and corporations. 
  • The corporate income tax rate would increase and be restructured into a graduated format, with rates running from 18% to 26.5%, with a flat 26.5% applicable to large corporations. 
  • New laws stand to affect your company’s current income tax provision and effective tax rate the year the new law goes into effect (likely 2022). 
  • Deferred tax provision will be impacted as soon as the law is passed (likely 2021). 

Build Back Better: The Fine Print 

One of the Biden Administration’s original goals was to bring more jobs home to the U.S. Early proposals were very focused on returning manufacturing jobs to the States and giving companies more incentive to invest here. The House Ways and Means Committee bill addresses these initiatives, starting with changes to the global intangible low-tax income (GILTI) regime, introduced in 2017 as part of the TCJA. 

The GILTI tax was originally conceived to discourage shifting profits from intangible assets to low-tax jurisdictions. It’s an income inclusion on earnings of foreign subsidiaries and, for now, it’s taxed at the 21% corporate tax rate minus the section 250 deduction of 50%, bringing the GILTI rate to 10.5%. That 10.5% is also allowed to be offset by foreign tax credits, subject to expense allocation rules and a 20% haircut. Most companies with positive foreign earnings end up paying some kind of GILTI tax today, which, of course, impacts the income tax provision. The House Ways and Means Committee has proposed changes to GILTI rates. The first change, of course, stems from the changes to the tax rate. With the rate jumping from 21% to 26.5%, the new pre-deduction GILTI rate would be 26.5%. However, there are changes to the section 250 deduction, too. The new proposed deduction rate would go from 50% to 37.5%, bringing the GILTI rate up from 10.5% to 16.6%—or 37.5% off of the 26.5% tax rate.  

A rise in the GILTI rate would be a negative for taxpayers, as they’ll end up owing more tax. But while the new GILTI rate would increase to 16.6%, the question remains: 16.6% of what? In other words, how will the GILTI tax base be affected by the proposed legislation? Currently, GILTI allows companies to offset taxable income of an entity in one country with the loss of an entity in another country. Cross-border offsets are great benefits to taxpayers—they result in loss entities offsetting income of profitable entities, and, ultimately, lower GILTI tax liabilities.  

Build Back Better, however, calculates GILTI with a country-by-country approach, meaning the inclusion is computed for each individual jurisdiction in which a company operates. In this case, offsetting income in one country with a loss in another would not be possible and what once were valuable losses could potentially sit unused. On the flip side, the proposal allows companies to carryforward losses indefinitely, as opposed to the use-it-or-lose-it rule currently enforced. The catch is that the losses must be used to offset GILTI income earned in the same country. The ability to carryforward losses indefinitely could be a huge benefit for certain companies in the future—while others will really struggle with the inability to cross-pollinate losses against income in other jurisdictions.  

In 2017, when GILTI was passed, the qualified business asset investment (QBAI), a 10% offset against GILTI for a portion of routine returns on tangible assets in foreign countries, was seen as controversial. After all, why should the government offer a tax break to companies that keep tangible assets (say, manufacturing equipment) abroad? The new proposal, however, reduces this offset to 5%, lessening the benefit to invest offshore. 

The House Ways and Means Committee’s tax proposal also alters the foreign tax credit rules. Now, after the section 250 deduction, any residual GILTI tax is allowed to be offset by a foreign tax credit. However, the credit is currently subject to a 20% reduction and expense allocation rules, which serve to chip away at the credit for certain expenses—like interest and research and development expenses—seen allocable against GILTI. The usual result is that companies end up paying some residual GILTI tax. However, the proposal would lower the reduction from 20% to 5%, essentially letting companies benefit from more of the foreign tax credit. It would also limit the expenses allocated against GILTI for purposes of the foreign tax credit to just the section 250 deduction, making it the only expense allocated to the GILTI basket. Between the reduced haircut and the reduction in allocated expenses, the GILTI burden would lessen for many companies. However, without that ability to apply losses between cross-border entities and given the higher overall GILTI rate, the new GILTI rules could negate some of the benefits. In the end, the proposed changes to GILTI will affect companies uniquely. You’d be wise to model your tax liabilities based on the new rules and see where you land. As always, strategic tax planning will be key. 

While in rare cases, some companies may treat GILTI as a deferred item on their tax provision—which would require the need for adjustments to the provision in 2021—for most companies, GILTI changes will hit the income tax provision in 2022 as GILTI is a permanent adjustment (and often a considerable driver of a company’s effective tax rate). With GILTI rates increasing and new country-by-country rules, many companies could face a higher effective tax rate, and therefore, higher taxable income overall. On the other hand, the ability to carryforward a loss coupled with the elimination of expense-allocation rules could drive down GILTI tax liabilities, resulting for some companies, in a lower effective tax rate and lower taxable income. Again, modeling it out is the only way to gauge the impact on your provision, which unless you’re one of the few companies that tracks deferred tax assets and liabilities related to GILTI, will happen in 2022.  

The Takeaway: 

  • GILTI is an income inclusion on earnings of foreign subsidiaries. 
  • Build Back Better increase the GILTI rate from 10.5% to 16.6%. 
  • Build Back Better calculates GILTI with a country-by-country approach—companies won’t be able use losses to offset tax liabilities on cross-border entities. 
  • QBAI offset reduced from 10% to 5%. 
  • Upsides: New proposal allows companies to carry losses forward indefinitely and GILTI foreign tax credit rules are relaxed.  
  • These changes will affect companies uniquely. Tax executives should model under the new rules to see how they fare.  

 What About the Foreign Derived Intangible Income Benefit? 

The foreign derived intangible income (FDII) benefit is a deduction given to domestic companies exporting products tied to intangible assets, such as patents, trademarks, and copyrights, held in the United States. Another tax code hot button—as it’s often seen as a reward for doing business in other countries—FDII represents excess income over a fixed return on depreciable tangible property used in a trade or business of a corporation. (Think foreign sales and services.) The Build Back Better proposal takes this section 250 deduction, which is currently a deduction of 37.5% on eligible income, and it reduces that benefit to 21.875%. In fairness, that’s still more of a benefit than the original Biden plan, which moved to completely eliminate the FDII benefit altogether. Currently, if a company’s taxable income is less than the sum of the total section 250 deduction for GILTI and FDII, then the FDII deduction would be reduced. So, companies that don’t have enough income don’t get the full FDII benefit. The Build Back Better proposal, however, eliminates the taxable income limitation on the section 250 deduction, so qualifying businesses with net operating losses or low-income positions that previously had a restricted FDII benefit could benefit from the whole 21.875% deduction.  

Given Build Back Better’s lower FDII deduction under section 250, taxpayers may rightfully anticipate less FDII relief than they had before. But the elimination of the taxable income limitation could mean that more businesses stand to benefit going forward. Companies experiencing less of a FDII deduction will have higher effective tax rates. If you benefit from the elimination of the taxable income limitation, though, your FDII benefit may go up, resulting in a lower effective tax rate. But given that FDII tends to be a permanent adjustment, companies’ provisions will not be impacted by this change until 2022.   

The Takeaway: 

  • Build Back Better reduces the FDII deduction from 37.5% to 21.875%, which makes it less of a benefit for taxpayers. 
  • On the upside, though, The Build Back Better proposal eliminates the taxable income limitation on the deduction, essentially offering the benefit to more companies.  
  • Some companies will win; some will lose.  
  • Companies’ provisions won’t be impacted until 2022.  

Will BEAT rules change? 

Introduced in 2017, the base erosion and anti-abuse tax (BEAT) tax applies to certain deductible, outbound payments made to foreign countries. The 10% minimum tax is meant to prevent base erosion and profit shifting in the U.S. and it’s reserved for payments that are seen as eroding the U.S. tax base. In the Build Back Better proposal, the 10% BEAT rate would remain intact through 2023. Then the rate would jump gradually to 12.5% until it reaches 15% after 2025.  

Still, a major change is who will qualify for the BEAT. Currently, it’s reserved for companies with more than $500 million in receipts and a base erosion percentage of more than 3%, meaning for companies with significant deductible, outbound payments to foreign countries. Build Back Better, however, retains the $500-million threshold, but it gets rid of the 3% base-erosion rule, structuring it so that it will apply to more companies. That’s the bad news. The upside, however, is that tax credits could be used to reduce BEAT, which isn’t the case now. If a company is currently subjected to BEAT, then that business will have a higher effective tax rate. The new BEAT structure will apply to more companies and the increased rate will mean bigger tax bills for many companies. However, some may experience some relief due to the tax-credit offset. Either way, because BEAT is typically a period cost, or permanent adjustment, the impact on the provision would hit in 2022. 

Pull Quote: “The new BEAT structure will apply to more companies and the increased rate will mean bigger tax bills for most companies.” 

Revenue-Raiser Ready 

As with any structural changes to the tax code, there is no single sweeping outcome for all companies—each will be affected uniquely. Generally speaking, however, the goal of the new tax proposal is to raise taxes, including corporate taxes, so most companies should expect to pay more tax than they are paying now, should this law (or even a version of it) pass. That said, there are pieces of it, like GILTI’s new ability to carryforward losses indefinitely or the elimination of FDII’s taxable income limitation, that may be surprisingly beneficial to companies. Still, multinational companies should be prepared for additional compliance burdens, and plan to model out the new tax plan to discover how it affects tax positions.   

Many companies will be forced to look at businesses on a jurisdictional level and evaluate facts and circumstances through a country-by-country lens for purposes of GILTI, which they may not be doing currently. Given that tax rates could increase as soon as next year, you may need to put a new strategy into effect as early as the fourth quarter of 2021. Depending on how things go, some companies may want to make changes to accounting methods to accelerate income in (presumably) more-tax-friendly 2021 or slow down deductions, so you get more value out of them when the new laws go into effect (most likely) in 2022. And let’s not forget, the OECD’s global tax reform is taking shape. How will these laws interact with a 15% global minimum tax? New profit allocation rules?  You’ll need to evaluate all that, too.  

Of course, the House plan still has a way to go before being finalized: The proposal could change—and then morph again—before it hits the House floor. After all, some democrats would have preferred to see higher tax rates from the get-go, and the Biden plan had asked for more taxes on corporate foreign earnings, which may still be a point of contention in Congress. The existence of QBAI and FDII is another hot button as many wanted the benefits repealed altogether. Then there’s the issue of consensus: If republicans aren’t going to support the bill, democrats can’t afford to lose a single vote, which isn’t a given. Again, lots of moving pieces and every company will need to re-visit its income tax provision to see how—and when—the new rules are going to affect your tax burden. Given how much is still up in the air, you may even want to rope a few fortunetellers into the process.