Richard Rubin of the Wall Street Journal quotes me in a new article noting that the U.S. is no longer going to be a chump in terms of profit shifting out of the U.S. I like the vocabulary.com definition of chump: Chump is a very informal word for someone who falls for every trick and scheme, or who believes everything you tell them. If you get an email from an African prince asking for your bank account information so he can give you a lot of money, and you respond excitedly, ready to collect the cash, you're a chump.
The 2017 tax law change not only reduced the federal corporate tax rate to 21%, but also enacted a number of rules consistent with the OECD/G20 BEPS Project. These include anti-hybrid rules (BEPS Action 2), the so-called GILTI alternative minimum tax (AMT) on foreign source income (tightening controlled foreign corporation (CFC) rules, BEPS Action 3), excess interest deduction limitation (BEPS Action 4), a tougher intangible transfer pricing rule (BEPS Action 8-10) and a new tax on certain related party payments susceptible to transfer mispricing. These anti-BEPS provisions are estimated by the JCT to raise more than $600 billion over ten years.
The Congressional Budget Office’s April 2018 Budget and Economic Outlook estimates that the 2017 tax changes will reduce profit shifting out of the US by over 20% ($65 billion out of an annual $300 billion). The lower tax rate reduces the incentive for many multinational enterprises (MNEs) to stop locating debt in their US subsidiaries or headquarters and reduces the incentive for transferring intellectual property (IP) out of the US. The CBO claims that only “a small portion” of the reduced profit shifting is from transfer mispricing, although transfer mispricing occurs with debt as well as IP transfers. At a 35% corporate tax rate, $300 billion of profit shifting resulted in a $105 billion annual revenue loss. At a 21% rate, it falls to $63 billion. A $65 billion reduction at 21% will increase US revenues by $14 billion annually.
A $14 billion annual pickup seems low given the 21% corporate tax rate plus the other anti-BEPS provisions. Ireland with a 12.5% corporate rate, countries with lower “patent box” tax rates, and Caribbean tax havens remain, and the move toward a territorial system (100% dividend exemption) even with the foreign source income AMT, means some companies at some margins will still have an incentive to shift taxable income out of the U.S. In other cases, now there will be some companies at some margins shifting taxable income into the U.S. Thus, I am more optimistic than the CBO is about the potential positive effects of the US tax changes on MNE economic decisions towards US activity once the uncertainty of the new rules is reduced and the positive effects on reduced profit shifting.
One reason that the $65 billion of reduced profit shifting might be reasonable is the US tax change is occurring after the meaningful changes following the OECD/G20 BEPS Project and its on-going implementation by the 113 country BEPS Inclusive Framework. The Country-by-Country reporting by almost 10,000 MNEs of their profits, taxes and certain economic activities across countries provides important transparency to tax administrations, and is expected to reduce egregious transfer mispricing. The revised OECD transfer pricing guidelines will eliminate the so-called “cash boxes”, where significant intangible income is assigned to a subsidiary in a low-tax-rate country despite minimal economic activity other than financing graciously provided by the parent. The BEPS Inclusive Framework is enforcing one of the BEPS minimum standards requiring actual economic nexus to benefit from special low tax rate for “patent boxes” or other “tax subsidies”. The U.S. continues to be an active participant in the OECD BEPS Inclusive Framework.
Even with a 21% corporate tax rate, the U.S. will need to be on close guard to combat continued attempts at profit shifting as well as closing new unintended tax minimization opportunities that will definitely arise. Although new data to analyze the reduction in profit shifting won’t be available immediately, the playing field in international tax planning is no longer tilted strongly against the US. The US is no longer easy picking for international tax planning. The U.S. is not yet a champ in the international tax area, but it is no longer a chump.