This week, the Chairman of the Ways & Means Committee, Rep. Jason Smith (R-MO), introduced legislation in response to the global minimum taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. that would escalate taxes on companies and individuals from countries that impose extraterritorial and discriminatory taxes on U.S. taxpayers. This follows from the bipartisan concern regarding tax policies adopted by other countries specifically targeting U.S. businesses or the U.S. tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. .
Under the proposal, an additional 5 percent tax would be added every year for four consecutive years (for a cumulative 20 percent additional tax) under the conditions outlined in the bill. The income subject to the tax would be limited to U.S. profits and earnings of foreign companies and individuals who are neither U.S. citizens nor residents.
The legislation is another step that Republican members of Congress are taking to show their displeasure with the global minimum tax. But the legislation is also much more than that. It is the next chapter in a long story about how U.S. policymakers have responded to foreign rules targeting U.S. businesses.
The details of the proposal are important, and future Tax Foundation research will dig into those details. However, ahead of that analysis, it is important to see where this proposal sits in the context of similar efforts throughout recent U.S. tax policy history (and even the pre-World War II era).
An important question in international tax ruleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden. s is which country gets to tax the income of companies or individuals earning income in multiple jurisdictions. Over time, a complex network of tax treaties between countries, and norms around those policies, has developed to address that question. That complexity can lead to outcomes that are not obviously aligned with the underlying economics of cross-border trade and investment. Policymakers often question whether, absent cross-border tax norms, such a significant share of corporate profits would be reported in low-tax jurisdictions.
Addressing the challenges of the current system is a fraught exercise. Countries most commonly act in their own interest even when some level of coordination among jurisdictions could be beneficial.
As the U.S. corporate sector has grown over the decades with many successful multinational companies, other countries have desired to tax what they believe is their share of taxable profits. The U.S. approach to dealing with foreign encroachment on the U.S. tax base has been to pressure other jurisdictions to avoid policies that unfairly target U.S. companies.
During the 1930s, France was assessing a tax on U.S. businesses resulting in the double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. of dividends. Meanwhile, France and the U.S. were negotiating a tax treaty that would have eliminated this type of double taxation. The treaty was signed in April 1932 and was promptly ratified by the U.S. Senate by June of that year. France was slower to act and continued its efforts to collect exorbitant taxes based on its prior law.
Effectively, France was working to collect taxes from U.S. subsidiaries operating in France based on the worldwide profits of the parent companies, and not just on the income earned in France.
Without the tax treaty in place, the U.S. government recognized the need to create a means for recourse against France.
As Rep. Fred Vinson (D-KY) said in early 1934,
My friends, there are nations throughout this world who are not particularly friendly to Uncle Sam in a business way, and when they get an opportunity to dig into the pocketbook of his citizens, whether individual or corporate, they have not hesitated so to do. There is one country, France, that is not satisfied with taxing the income of American individuals and American corporations as they tax their own citizens: they are not satisfied with getting a tax upon the income that is actually derived in their own country; but when the American parent company of that subsidiary declares dividends, they place a corporate tax upon these dividends, derived from whatever source.
Rep. Vinson went on to describe what eventually became Section 891 of the U.S. tax code and concluded, “This power can be used to protect American business from present discrimination and will probably help restrain foreign countries from further discriminatory levies.”
Section 891 (which still remains part of U.S. law) gives the president the authority to double the rate of tax on citizens and businesses from a foreign country if that foreign country is subjecting U.S. citizens or businesses to discriminatory or extraterritorial taxation. To date, this provision has never been used.
Section 891 was enacted as part of the Revenue Act of 1934 on May 10, 1934. France ratified the tax treaty nearly a year later, in April 1935.
Mitchell B. Carroll, a special attorney with the U.S. Treasury at the time, drew a direct line between the adoption of the new retaliatory tool and France’s ratification of the treaty.
Fast forward 82 years, and Section 891 appears again. This time it is not because France is taking an extraterritorial taxation approach to U.S. companies, but rather it is the European Commission, the executive branch of the European Union.
In 2016, Georgetown University law professor Itai Grinberg (recently a Deputy Assistant Secretary at the U.S. Treasury Department) published an article analyzing the approach that the European Commission was taking in its investigation of some U.S. companies’ tax practices. He offered up Sec. 891 as a tool to discourage the Commission from taking an aggressive and discriminatory approach.
Even more recently, when several European countries (including France) adopted digital services taxes (DSTs), Section 891 came back into the conversation. Those policies were transparently pitched by politicians as targeting large, U.S. digital companies, and U.S. policymakers took note of the discriminatory nature of the approach. Chairman Grassley (R-IA) and Ranking Member Ron Wyden (D-OR) of the U.S. Senate Finance Committee authored a letter in June 2019 to Treasury Secretary Steven Mnuchin asking him to ”consider all available tools” to address the DSTs, and they specifically referenced Section 891 as one of those tools.
The bipartisan letter from Wyden and Grassley was backed up by bipartisan and bicameral concerns about the DSTs. Earlier in 2019, Wyden and Grassley were joined by House Ways & Means Committee Chairman Richard Neal (D-MA) and Ranking Member Kevin Brady (R-TX) in a statement calling for “measured and comprehensive solutions, and abandon unilateral measures.”
The Trump administration approached the digital services taxes issue on two fronts. After the U.S. Trade Representative filed a report finding France’s DST to be discriminatory, the Trade Representative moved to implement retaliatory tariffTariffs are taxes imposed by one country on goods or services imported from another country. Tariffs are trade barriers that raise prices and reduce available quantities of goods and services for U.S. businesses and consumers. s. This back and forth led to a temporary stand-off in early 2020 as discussions of a possible multilateral solution to the digital tax issue continued.
The other front was at the international negotiations. Starting in early 2019, the Organisation for Economic Co-operation and Development (OECD) had begun to coordinate a multilateral solution, both for the DSTs and a global minimum tax.
Unfortunately, to date, the DSTs are still on the map. Recent language from the OECD gives countries flexibility to maintain their DSTs even in the context of a multilateral agreement (which I believe has a low likelihood of being implemented). Additionally, a new extraterritorial tool has been introduced into the mix.
The global minimum tax includes a rule best known by the acronym “UTPR” which once meant the Undertaxed Payments Rule, but over time has broadened far beyond “payments.” In the context of the 15 percent global minimum tax rules that are being adopted across the world, the UTPR acts as a vacuum cleaner. It can effectively reach beyond a country’s borders to tax the profits of jurisdictions in which the effective tax rate for certain companies is below 15 percent.
The Republic of Korea may be the first country to enforce this rule in 2024, but many other jurisdictions are preparing to enforce the UTPR in 2025 (including members of the European Union).
DSTs and the UTPR are different in many ways, but U.S. policymakers should be concerned about the extraterritorial nature of both. As I reminded members of Congress in my recent testimony before the Senate Finance Committee, “There was bipartisan concern from members of this committee when the digital services taxes were introduced, exposing U.S. companies to extraterritorial taxation. Now, the current global minimum tax rules do just that: expose U.S. companies to extraterritorial taxation.”
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