The Fiscal Year (FY) 2025 budget proposal by the Biden Administration includes several significant reforms to international taxation. The proposals are detailed in the Treasury Department’s General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals, commonly referred to as the “Green Book.”

The Biden Administration’s FY2025 Budget proposes significant adjustments to the Global Intangible Low-Taxed Income (GILTI) regime, which was introduced by the Tax Cuts and Jobs Act (TCJA) of 2017. The Administration has also proposed replacing Base Erosion Anti-Abuse Tax (BEAT), also introduced by the TCJA, with a new framework known as the Undertaxed Profits Rule (UTPR), which aligns more closely with global efforts under the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) project.

Base Erosion and Profit Shifting

Following the 2007-2009 financial crisis, policymakers became increasingly concerned about the use of tax planning strategies by multinational corporations to exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid. Approximately 69 percent of U.S. multinational enterprises’ (MNE) foreign profits are currently held in tax havens or low-tax jurisdictions.[1]

In response to these concerns, the OECD launched the BEPS project in 2012 at the request of the G20. The project outlined 15 steps that would be compiled into an overarching Action Plan to coordinate a modernization of the international tax system. In October 2015, the OECD published its final Action Plan, which was endorsed by the finance ministers of all G20 countries, including the United States.

The BEPS project consists of two broadly defined provisions, referred to as “pillars.” Pillar One pertains to the allocation of business profits to various countries. It rewrites the rules to allocate profits based on the jurisdictions where a company’s goods or services are used or consumed. Pillar Two is aimed at establishing an effective global minimum tax rate of 15 percent.

The Pillar Two Model Rules, also known as Global Anti-Base Erosion (GloBE) Rules, include the Income Inclusion Rule (IIR) and the UTPR. The IIR is designed to ensure that the parent entity of a MNE is taxed on its share of the income of its foreign subsidiaries if that income is subject to an effective tax rate below a specified minimum rate. The UTPR is a backstop rule that allows other countries where the MNE operates to impose a “Top-Up” tax if the jurisdiction where the MNE is headquartered does not have an effective tax rate meeting the global minimum.

The general framework of the BEPS rules has been agreed upon, but the formal adoption of the rules is still being negotiated and clarified. Over thirty countries have signaled their intent to eventually adopt BEPS, and if that number continues to grow, BEPS may become a de facto global tax regulation.

Proposed Changes in FY2025 Budget

• Align the GILTI rules more closely with the global minimum tax standards established by the OECD’s Pillar Two rules.

Global Base Erosion Rules

The GloBE rules are a set of tax regulations developed by the OECD as part of the BEPS 2.0 project to impose a global minimum tax of 15 percent on multinational enterprises. The rules are designed to ensure that large MNEs pay a minimum level of tax on the income arising in each jurisdiction where they operate.

The tax mechanism under GLoBE involves several layers: if the country where income is earned doesn’t impose the necessary top-up tax, the parent company’s home country can apply the tax through the IIR. Alternatively, other countries can enforce it by denying deductions under the UTPR.

Existing international taxes in the U.S., like the GILTI, are somewhat aligned with GLoBE, and there were discussions under the Build Back Better Act and the FY2023 budget proposal to adjust U.S. tax rules to be more in line with GLoBE. However, the Inflation Reduction Act ultimately did not incorporate these specific changes but introduced an alternative minimum tax on large corporations.

Global Intangible Low-Taxed Income

The GILTI tax was also introduced as part of the TCJA to help transition the U.S. from a territorial tax system to an international tax system. The GILTI tax is a special way to calculate a U.S. multinational company’s foreign earnings to ensure it pays a minimum level of tax. It is designed to discourage U.S. corporations from shifting profits to low-tax jurisdictions by holding intangible assets, such as patents, copyrights, and trademarks, in foreign subsidiaries.

Under a territorial tax system, a country only taxes the income earned within its borders, and foreign earnings are generally not subject to domestic taxation. However, the GILTI tax changed the incentives for tax avoidance and where companies hold their intellectual property (IP). It uses a formulaic approach to tax most active earnings above a 10 percent return on assets, even if those earnings are not derived from intangibles. This means that the GILTI tax assumes that any “supernormal” returns (i.e., those above 10 percent) are from IP or other intangibles.

The GILTI tax is intended to balance incentives for businesses to keep intangible assets in the U.S. against choosing to place those assets in offshore jurisdictions. It allows the U.S. to be relatively indifferent about where U.S. companies do business in the world, so long as companies are paying at least a minimum rate of tax. If a U.S. company uses a foreign low-tax jurisdiction to avoid paying U.S. taxes, the GILTI tax gives the U.S. the opportunity to charge a top-up tax to ensure the minimum is paid.

However, GILTI is not a full transition to a global tax system, but rather a hybrid approach, incorporating elements of both territorial and worldwide taxation. GILTI requires U.S. companies to pay tax on their foreign earnings whether they are repatriated or not, which is a characteristic of a territorial taxation system. However, it retains some elements of worldwide taxation as it taxes all foreign earnings of U.S. companies, not just those earned in the U.S.

Currently, GILTI is taxed at an effective rate of 10.5 percent, which is achieved by applying a 50 percent deduction under Section 250 of the Internal Revenue Code to the U.S. corporate tax rate of 21 percent. This regime specifically targets income that exceeds a 10 percent return on certain tangible assets of the foreign subsidiary. Aligning the GILTI rules more closely with the global minimum tax standards involves reducing the deduction for GILTI from 50 percent to 25 percent, effectively doubling the GILTI tax rate to 21 percent. The proposal reflects a push towards greater consistency with international tax norms, fostering a more level playing field in the taxation of multinational enterprises.

• Replace the BEAT with the UTPR, which better aligns with the OECD’s Pillar Two Model Rules.

Base Erosion and Anti-Abuse Tax

BEAT operates as a minimum tax targeting large U.S. corporations, including U.S. affiliates of foreign multinational corporations, that make deductible payments to related foreign parties. Its goal is to limit the erosion of the U.S. tax base by ensuring that a portion of the payments made to foreign affiliates is taxed, regardless of other tax benefits the corporation may claim.

The applicability of BEAT is determined by two factors: average annual gross receipts of more than $500 million over the preceding three years and a base erosion percentage (the ratio of deductible payments made to foreign affiliates to total deductions) of at least 3 percent. Corporations subject to BEAT must calculate their tax liability twice: once under the regular corporate income tax system and once under the BEAT system. The BEAT calculation involves adding back disallowed deductible payments to the corporation’s taxable income.

The BEAT rate was initially set at 5 percent in 2018, increased to 10 percent in 2019, and is scheduled to rise to 12.5 percent in 2026. If the BEAT calculation exceeds the regular tax liability, the corporation must pay the difference as an additional tax.

Critics argue that BEAT is complex and may inadvertently capture transactions that do not constitute aggressive tax avoidance. Its broad application could also affect benign cross-border transactions. Moreover, the effectiveness of BEAT in curbing profit shifting has been questioned, as it may be circumvented by sophisticated tax planning.

Undertaxed Profits Rule

The UTPR is part of the global minimum tax framework under Pillar Two and serves as a secondary mechanism to the IIR. It is designed to ensure that MNEs pay a minimum level of tax on their profits. Specifically, the UTPR comes into play when profits in a particular jurisdiction are taxed below a globally agreed minimum rate, currently set at 15 percent. The rule acts as a backstop to the IIR by addressing any remaining tax deficits that were not covered under the IIR. It operates by either denying deductions for payments made to low-tax jurisdictions or by requiring an equivalent adjustment, thus effectively increasing the tax paid on these profits to meet the minimum threshold.

According to the Green Book, the UTPR would apply to both domestic corporations that are part of non-U.S. groups and U.S. branches of non-U.S. corporations. The UTPR would disallow U.S. tax deductions to the extent necessary to collect the hypothetical amount of top-up tax required for the financial reporting group to pay an effective tax rate of at least 15 percent in each jurisdiction in which the group has profits. In short, the BEAT is a 10 percent alternative minimum tax calculated by adding back certain deductions to taxable income, while the UTPR denies deductions to U.S. affiliates of large foreign multinationals that have offshore affiliates paying a less than 15 percent effective tax rate on their net profits.

The implementation and operation of the UTPR involves complex calculations and allocations based on the number of employees and other factors within the jurisdictions where the MNE operates. If the effective tax rate in a jurisdiction falls below the minimum rate and the IIR has not fully addressed this shortfall, the UTPR allocates the required top-up tax to jurisdictions that have adopted the rule. This allocation is based on a formula that considers various. factors such as the number of employees in each jurisdiction. The UTPR ensures that profits are taxed at least at the minimum rate globally, thereby reducing the incentive for profit shifting and base erosion through strategic corporate tax planning.

Potential Costs

The Joint Committee on Taxation (JCT) has outlined the potential revenue impacts for the U.S. from adopting the GLoBE rules, predicting either a loss of $175 billion or a gain of $224 billion between 2023 and 2033, depending on corporate profit-shifting behaviors. Under different global adoption scenarios, the JCT estimates that U.S. revenues could decrease by $122 billion if the rest of the world adopts GLoBE and the U.S. does not, decrease by $57 billion if both adopt it, increase by $237 billion if only the U.S. adopts it, and increase by $102.6 billion if the U.S. adopts major components excluding the UTPR while the rest of the world does not.[2]

TCS has consistently advocated for efficient and responsible use of taxpayer dollars in international taxation issues. We have highlighted the need for reforms to ensure that multinational corporations pay their fair share of taxes and have criticized practices such as base erosion and profit shifting that allow companies to exploit gaps in tax rules.

[1] Gravelle, Jane G., and Mark P. Keightley. “The Pillar 2 Global Minimum Tax: Implications for U.S. Tax Policy.” Congressional Research Service, January 31, 2024. https://sgp.fas.org/crs/misc/R47174.pdf.

[2] Gravelle and Keightley, “The Pillar 2 Global Minimum Tax,” 2.