Over the course of the last year, it has become clear that Democratic lawmakers want to change U.S. 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. rules for large companies. However, as proposals have been debated in recent months, there are have been clear divides between U.S. proposals and the global minimum tax rules.
Before getting too far into the weeds, it is worth noting that I am no fan of minimum taxes and it would be nice if Congress would change the underlying tax code to limit credits or deductions they think are too generous rather than complicate things further with new definitions of income and opaque rules. Simplicity matters.
The Inflation Reduction Act (IRA) recently passed by the Senate includes an alternative minimum tax on companies that at first glance may seem like it was inspired by (or at least might be like) the global minimum tax. Both taxes are aimed at large companies, use financial accounting rules for the 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. , and apply a 15 percent rate. That is where the similarities end.
However, those similarities could lead some to suggest the U.S. is adopting measures in line with the global minimum tax, but that is not entirely accurate.
As shown in the following table, there are multiple differences between the policies. In some areas, the policies take directly opposite approaches. In short, the InflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. Reduction Act policy is kind to tax creditA 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. s and write-offs for capital investments while the global minimum tax is stingy toward tax credits.
If the Inflation Reduction Act gets adopted in the United States and the global minimum tax is adopted elsewhere, the differences between the policies could still lead to stinginess toward tax credits for the largest companies.
The global minimum tax is part of an agreement among more than 130 jurisdictions that was reached in 2021. In December 2021 model rules were released that described how the rules were meant to work.
The rules have three main layers. The first applies to purely domestic income (Qualified Domestic Minimum Top-up Tax), the second applies to foreign income in a company’s subsidiaries (Income Inclusion Rule), and the third applies to the income of foreign entities that are not subject to the prior two rules (the Under-taxed Profits Rule).
The global minimum tax applies to companies with more than €750 million (US $769 million) in revenues, and it levies a 15 percent minimum rate on a company’s financial accounting income after several adjustments including adjustments for taxes that have already been paid.
The corporate alternative minimum tax in the Inflation Reduction Act first came to light as part of a presidential campaign proposal from Sen. Elizabeth Warren (D-MA). It was also included in the Build Back Better Act which passed the House of Representatives in the fall of 2021. All of this happened before the global minimum tax model rules were released.
The current proposal in the Inflation Reduction Act applies to companies with more than $1 billion in financial profits (averaged over the most recent three years) and levies a 15 percent rate on adjusted financial accounting income.
The key differences between the policies lie in the adjustments to financial accounting income. As a reminder, financial income is what companies report to their shareholders and is calculated using accounting rules established by those in charge of accounting standards (the Financial Accounting Standards Board in Norwalk, CT). Taxable incomeTaxable 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. is calculated using different rules (as defined in Title 26 of the U.S. Code).
If pure financial accounting income were adopted, the policy would erode tax credits and deductions for capital investments that can push tax rates below the 15 percent minimum in years when companies are heavily investing in things like research and development or building factories and purchasing lots of equipment.
The corporate alternative minimum tax in the Inflation Reduction Act provides an exemption for tax credits and costs for capital investments. This means that even if a tax credit or a significant purchase of machinery pushes a company’s tax rate on their financial statement below 15 percent, those credits and deductions would not get clawed back by the minimum tax.
The global minimum tax, however, only provides an exemption for certain tax credits including those that are payable to businesses (also known as refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit (EITC). s). If a company benefits from the U.S. research and development credit, it would get clawed back, though.
The global minimum tax has different treatment of capital investment in two ways. First, deductions for capital investment are measured at a 15 percent tax rate rather than being deducted at a country’s corporate tax rate. Also, the global minimum tax has a carveout for tangible assets that reduces the amount of additional tax a company might have to pay even if its tax rate is below 15 percent.
The global minimum tax has an additional carveout for payroll costs which is not reflected in the Inflation Reduction Act corporate alternative minimum tax.
The mismatches between the policies mean that companies could end up facing both taxes. If a foreign jurisdiction that has adopted the global minimum tax rules is looking to tax a U.S. company that benefits from tax credits or deductions that are protected by the Inflation Reduction Act, then additional tax could be owed to that foreign jurisdiction. In that case the tax credits and deductions for capital investment could be caught by the two separate rules.
Three areas of U.S. tax law that do not get special exemptions from the corporate alternative minimum tax are stock-based compensation, income that would otherwise be offset by losses from years prior to 2019, and income taxed at a lower rate because of Foreign Derived Intangible Income (FDII).
In general, the Inflation Reduction Act does not reflect the rules of the global minimum tax, but rather represents an additional layer of tax on large companies. Put these two layers of tax together, in addition to the regular corporate tax, and we would now have three layers of complex, opaque tax rules for U.S. companies to deal with, each distorting business investment decisions in somewhat different ways and contributing to a higher overall tax burden on U.S. business investment.
| Inflation Reduction Act: Corporate Alternative Minimum Tax | Global Minimum Tax: Qualified Domestic Minimum Top-up Tax | |
|---|---|---|
| Rate | 15% | 15% |
| Exclusion for Tangible Assets | Depreciation deductions are excluded | 8% incrementally reduced to 5% over the first five years |
| Exclusion for Payroll Costs | None | 10% incrementally reduced to 5% over the first five years |
| Loss Carryovers | Capped at 80% of adjusted financial income and limited to losses after 2019 | Included in Deferred Tax Asset |
| Foreign Tax Treatment | Provides a credit for foreign taxes | Deferred tax asset recast at 15% rate |
| Jurisdictional Calculation | Applies to the worldwide income of U.S. companies | Applies to domestic income |
| Threshold for Application | $1 billion in financial profits | €750 million (US $769 million) in global revenues |
| Income Definition | Financial profits as defined by accounting standards and adjusted to align closer to taxable profits | Financial profits as defined by accounting standards and adjusted to align closer to taxable profits |
| Treatment of Tax Credits | Provides a carveout for U.S. tax credits | If a credit is not refundable, it would get clawed back |
| Treatment of Capital Investment | Capital investment deductions get clawed back | Included in the deferred tax asset measured at a 15% rate |
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Source: Author’s analysis of the Inflation Reduction Act as passed by the United States Senate, and the Global Minimum Tax Model Rules, https://www.oecd.org/tax/beps/tax-challenges-arising-from-the-digitalisation-of-the-economy-global-anti-base-erosion-model-rules-pillar-two.pdf. |
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