GILTI by Country Is Not as Simple as it Seems

May 18, 2021

If policymakers wanted companies to pay a minimum level of tax regardless of where they earn profits around the world, what would be the best way to achieve that? One idea that has been proposed by the Biden administration and other governments has been a global minimum tax calculated for each country where a business earns profits.

In the abstract, this might make sense. If a company earns profits in Spain and pays taxes at its 25 percent corporate tax rate, then a global minimum tax of 15 percent would not apply. However, if a company earns profits in Ireland with a 12.5 percent corporate rate, then the minimum tax would apply.

However, getting to such a simple policy is not easy and there are pitfalls all along the way.

For the U.S., policymakers are interested in changing the tax on Global Intangible Low Tax Income (GILTI) to be calculated on an individual country level. While GILTI was intended to work as a minimum tax, in many cases it operates more like an arbitrary surtax on foreign earnings that have already been taxed abroad, resulting in total effective tax rates that can exceed the U.S. statutory tax rate of 21 percent.

The problems inherent in the GILTI calculation make it unsuitable as the basis for a minimum tax calculated for each country and show the challenges inherent in designing any global minimum tax of that sort.

U.S. companies are subject to GILTI tax on 50 percent of their foreign profits that are above a 10 percent return on foreign tangible assets. If a company has already paid taxes on those foreign profits, the company can only claim foreign tax credits that are worth up to 80 percent of taxes paid. If the company has more foreign tax credits than tax liability, extra credits cannot be used in the future.

Other foreign tax credit rules can also increase the tax burden on GILTI. Some expenses that are incurred in the United States are required to be allocated to foreign income in the process of calculating foreign tax credits. This inflates foreign deductions and reduces foreign taxable income which, in turn, reduces foreign tax credits that could be used to partially offset additional tax liability on GILTI.

The GILTI structure was designed with intangible, low tax income in mind, as the name implies, but it actually affects companies in a variety of ways. If a company has all its foreign earnings in a jurisdiction that does not have a corporate tax, then GILTI acts as a minimum tax on those profits, generally at an effective rate near 10.5 percent, which is half the current U.S. corporate rate.

However, this is not a typical situation. Many companies have their foreign operations near their customers in jurisdictions where they would owe at least some amount of corporate tax on their foreign earnings.

Some companies have fewer choices about where to locate their foreign operations than others. A mining company must go where the minerals are. A consumer goods company may have to locate near population centers depending on how well its products travel. Even digital services companies may need to locate their data centers close to large cities or where affordable power sources are.

When foreign taxes have already been paid (even above 10.5 percent), and GILTI still applies, then it is not working as a minimum tax. The more exposure a company has to higher tax jurisdictions, the harder GILTI can bite, and it quickly looks more like a surtax on foreign earnings than a minimum tax.

Relative to country-level minimum tax proposals, GILTI currently takes an averaging approach. GILTI is calculated by blending a company’s foreign profits, losses, and taxes together. If a company has lots of losses in one country, then that can offset the profits in other countries. It is a measure of net foreign income (much of which has already been taxed by other countries). This essentially averages income across countries, but an alternative approach would allow companies to use excess foreign tax credits in the future (via carryforwards) to essentially tax average net foreign income over time.

Think of an NBA team with one standout player who scores most of the points. If the player scored 40 points in a game where the team lost by a score of 120-100, it still counts as a loss. Teams do not improve in rankings just because one player does well; at the end of the day, in that scenario, the team lost.

However, if GILTI is changed to be calculated for each individual country, then a company with one standout, profitable operation in a year and several unprofitable operations in other jurisdictions could still owe taxes to the U.S. government.

Country-level calculations for GILTI would also require companies to split their bookkeeping for the numerous jurisdictions where they do business. If right now a company is working in 80 jurisdictions, then calculating GILTI for each country would involve a massive new compliance burden.

The other side of a compliance burden is the administrative burden. Policymakers should not forget that every complicated tax policy must be enforced by the Internal Revenue Service. The expanded workload on government auditors should not be ignored.

It is a nice talking point to be able to say that a minimum tax applies in every country a business has operations in. However, achieving that goal by expanding GILTI would have serious consequences.

It would increase the tax burden of a policy that already produces higher tax rates than intended. It would lead to unfair outcomes for businesses that have profits in some jurisdictions and losses in others. It would also dramatically increase the burden for both compliance and enforcement.

If policymakers want a recipe to dramatically expand the complexity of U.S. international tax rules and the burden on U.S. multinational businesses, then a tax on foreign earnings calculated at the country level would be the way to do it.

Alternatively, policymakers could focus on mitigating the unintended consequences of GILTI and other recent international tax rules.

Launch Resource Center: U.S. International Tax Reform

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Global Intangible Low Tax Income (GILTI) is a special way to calculate a U.S. multinational company’s foreign earnings to ensure it pays a minimum level of tax. GILTI was adopted as part of the 2017 Tax Cuts and Jobs Act (TCJA) and can lead to high tax burdens on foreign profits, putting U.S. companies that operate abroad at a disadvantage.

International 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.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.

Taxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income.