Corporate Income Taxation in a Global Economy (R47003) by Jane G. Gravelle, Mark P. Keightley, and Donald J. Marples (23 pages)
The taxation of corporate income in a global economy is arguably the most complex area of U.S. tax policy. The United States’ increasing interconnection with the rest of the world through trade and financial investment and the growing importance of intangible assets make formulating corporate income tax policies more complex and yet more important to revenue and economic activity. This report presents the basic concepts of corporate income taxation in a global economy.
A starting point for understanding international corporate income taxation is determining which country has the first right to tax multinational corporate profits. The international and historical norm has been that the first right to taxation belongs to the country in which a corporation’s assets are located. Another norm is that corporate income should not be subject to double taxation (i.e., two countries imposing tax on the same income). Even if the first right to tax is with the country where a corporation’s assets are held, the corporation’s home country may also tax income earned abroad by its resident firms after allowing for credits for foreign taxes paid to avoid double taxation. Many countries have largely territorial systems that do not generally impose taxes on income earned outside their borders except to prevent profit shifting. The United States has a minimum tax on foreign-source income: the tax on global intangible low-taxed income, or GILTI (with credits allowed for 80% of foreign taxes), which imposes a residual tax on income of foreign subsidiaries. GILTI has an exemption for 10% of tangible assets, as well as a tax rate that is lower than the regular corporate tax rate. The Organisation for Economic Co-operation and Development (OECD) and G20 have proposed a similar worldwide minimum tax for all countries to adopt, the global anti-base erosion (GLoBE) tax. (This proposal is Pillar 2 of their two-pillar approach to address base erosion.)
Three important issues affected by international tax rules are (1) the location of tangible investment; (2) profit shifting; and (3) the tax treatment of digital companies. The current system, where income from tangible investments is largely untaxed except by the country of location, often encourages investments in low-tax countries. Investment moves from the United States to lower-tax countries, which can reduce the U.S. capital stock, lower wages, and reduce economic efficiency as capital is not deployed to its best uses. These effects are likely to be small because of the importance of other factors that determine the location of production. Nevertheless, equalizing the tax rates on the return to domestic capital and foreign-located capital can reduce these effects. One way to accomplish this would be to eliminate the deduction for tangible assets from GILTI, as well as making other changes to increase GILTI taxes that affect investment in tangible and intangible assets.
Profit shifting, which one estimate indicates loses close to $80 billion in annual U.S. corporate revenue, occurs when firms transfer the rights to intangible assets into low-tax countries. It can also occur when firms locate debt in high-tax countries, reducing income taxed in those countries and increasing it in low-tax countries. In addition to GILTI, a number of U.S. tax rules aim to limit profit shifting, including an alternative base erosion and anti-abuse tax (BEAT) that adds back certain payments to related foreign subsidiaries to the corporate tax base and taxes them at a lower rate. BEAT can address shifting of profits from U.S. parents to foreign subsidiaries and shifting by foreign parents out of U.S. subsidiaries. Several proposals are under consideration to change tax rules that contribute to profit shifting, including the House-passed version of H.R. 5376 (the Build Back Better Act). One of these proposals would increase the tax rate on GILTI. Another would impose the foreign tax credit limitations on a per-country basis so that firms could not use unused credits in countries with taxes that exceed the U.S. tax due to offset taxes in low-tax countries. A third would allocate worldwide interest deductions in proportion to the share of worldwide income. The United States would also likely benefit from the proposed GLoBE tax, which would reduce the attractiveness to foreign multinationals of foreign low-tax jurisdictions compared to the United States.
There has also been interest in developing proposals to allow user countries a share of the residual tax on large multinational digital companies, which often locate subsidiaries in no-tax countries. Some countries have argued that they should have the right to tax these profits because their users create value. Some of these countries have begun to impose excise taxes on the revenues of digital companies in their country. This concept of taxing rights is inconsistent with traditional norms under which the rights to tax require some physical presence and are allotted based on the location of investment. The OECD/G20 countries (including the United States) have agreed to allocate a share of these profits under another part of their proposals to address base erosion (known as Pillar 1). Countries would agree to eliminate their digital excise taxes. The United States would likely find Pillar 1 to reduce revenues, and Congress may face decisions on whether to take action.