FY 2023 budget plan proposals affecting corporate businesses
The Biden administration’s fiscal year 2023 budget blueprint, released on 28 March 2022, consists of a mix of familiar proposals and new initiatives that reflect the President’s policy objectives. The proposals are described in more detail in the General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals, commonly referred to as the “Green Book,” that was released with the budget, and include the President’s now familiar calls for increasing the top corporate tax rate to 28%.
International tax proposals were eagerly anticipated, and as expected, align U.S. international tax rules more closely with the Pillar Two rules under the agreement reached in 2021 by 137 jurisdictions under the sponsorship of the OECD Inclusive Framework on Base Erosion and Profit Shifting.
This article looks at some of the proposals that would affect corporate businesses.
Corporate income tax rate hike
C corporations, unlike an S corporation, the income of which passes through to its shareholders for a single level of tax, pay an entity-level income tax, and their shareholders pay a second level of tax on distributions that come out of either current or accumulated (past) earnings and profits of the corporation. Before the Tax Cuts and Jobs Act of 2017 (TCJA), a C corporation’s tax was computed on taxable income in the U.S. within a progressive tax system, with the highest rate reaching 35% (before offsetting any available tax credits). The TCJA replaced a graduated tax schedule with a flat tax of 21%, which is applied to all C corporations, before offsetting eligible credits. The administration’s proposal would increase the tax rate for C corporations from 21% to 28%, roughly halfway between the pre-TCJA and post-TCJA rates. The purpose of the corporate income tax rate increase is intended to raise revenue to help pay for the Biden administration initiatives.
Many multinational corporations (MNEs) pay effective tax rates on worldwide income that are far below the statutory rate, due in part to low-taxed foreign income, as discussed below. The proposal would keep the global intangible low-taxed income (GILTI) deduction constant, raising the GILTI rate in proportion to the increase in the corporate rate through the application of the higher rate on the portion not excluded from the deduction. This removes the incentive to shift profits and activity offshore as the domestic rate is increased with respect to that foreign-source income of foreign subsidiaries owned by U.S. corporations. Thus, the 28% corporate income tax rate would consequently increase the GILTI rate in tandem. The new GILTI effective rate would be 20%, applied on a jurisdiction-by-jurisdiction basis.
This proposal would be effective for taxable years beginning after 31 December 2022. The rate increase would therefore impact calendar year corporate taxpayers for the 2023 calendar year. However, for fiscal year taxpayers with taxable years beginning before 1 January 2023, and ending after 31 December 2022, the corporate income tax rate would be equal to 21% plus 7% times the portion of the taxable year that occurs in 2023. This proposal may discourage investments in C corporations and might work to provide an increased incentive to fund these corporations through debt rather than equity, since the rate of return on equity investments available to shareholders decreases by 7%, or the amount of cash that is spent on taxes before excess after-tax earnings are reinvested into the business or are distributed to shareholders.
If enacted, the proposal would also encourage tax planning to manage taxable income between years, that is, to defer deductions to higher-taxed years (e.g., 2023), while accelerating income to lower-taxed years (e.g., 2022).
For financial reporting purposes, companies will need to monitor the legislative process to understand when any pending tax law changes would be enacted. ASC 740, Income Taxes, requires that the tax effect of changes in tax rates and tax laws on both current and deferred taxes be recognised as part of continuing operations in the period in which the law change is enacted. In the U.S., a law change is considered enacted when the President signs a bill into law.
International tax proposals
The FY 2023 budget and Green Book incorporate measures originally proposed in the 2022 Green Book, as well as the American Jobs Plan, and newly released details regarding proposed changes that, if enacted, would significantly modify key international tax legislation enacted under the TCJA, including the effective rates of GILTI and foreign-derived intangible income (FDII), removal of the base erosion and anti-abuse tax (BEAT) rules, while also introducing a new undertaxed profits rule (UTPR) consistent with the OECD’s Pillar Two model rules. An overview of the proposed changes is outlined below.
- GILTI and FDII: As a result of the proposed increase of the corporate income tax rate to 28%, the effective rate of GILTI and FDII would increase to 20% and 21%, respectively. These effective rates also assume that the IRC Section 250 deduction for GILTI and FDII would be reduced to 28.5% and 24.8%, respectively, as a baseline from the Build Back Better Act. The baseline also assumes that GILTI would be calculated on a country-by-country basis. Consequently, the threshold rate for determining whether a CFC’s earnings under GILTI or subpart F would be eligible for the high-tax exception would also increase to 25.2% (90% of the increased corporate income tax rate of 28%).
- BEAT and UTPR: The administration’s proposal would repeal the current BEAT provisions and replace them with a UTPR, which is intended to be similar to the UTPR under the OECD’s Pillar Two model rules and would apply to foreign-parented MNEs operating in low-tax jurisdictions with financial reporting groups that have global annual revenue of USD 850 million or more in at least two of the prior four years. Additionally, when another jurisdiction adopts a UTPR, a domestic minimum top-up tax would be applied in an attempt to protect U.S. revenues from the imposition of a UTPR by other countries.
Under the proposed UTPR, domestic corporations that are part of a foreign-parented MNE group, as well as domestic branches of foreign corporations, would be disallowed U.S. deductions in an amount determined by reference to low-taxed income of foreign entities and foreign branches that are members of the same financial reporting group (including the common parent of the financial reporting group). Specifically, domestic group members would be disallowed 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% in each foreign jurisdiction in which the group has profits. The amount of the top-up tax would be determined based on a jurisdiction-by-jurisdiction computation of the group’s profit and effective tax rate consistent with the Pillar Two model rules, which would take into account all income taxes, including the corporate alternative minimum tax. The top-up amount would be allocated among all the jurisdictions where the financial reporting group operates that have adopted a UTPR consistent with the Pillar Two model rules.
This proposal would be effective for tax years beginning after 31 December 2023.
- Tax credit for onshoring jobs to the U.S. Effective for expenses paid or incurred after the date of enactment, the administration’s proposal would incorporate a new business credit for onshoring a U.S. trade or business. The onshoring tax incentive, which is substantially similar to the proposal included in the administration’s fiscal year 2022 budget proposal, would provide a new general business credit equal to 10% of the eligible expenses paid or incurred in connection with onshoring a U.S. trade or business (limited to expenses associated with the relocation of the trade or business and would not include capital expenditures, costs for severance pay or other assistance to displaced workers). Onshoring a U.S. trade or business is defined as reducing or eliminating a trade or business (or line of business) currently conducted outside the U.S. and moving the same trade or business to a location within the U.S., to the extent that this action results in an increase in U.S. jobs.
- Tax deduction disallowance for offshoring jobs: Also effective for expenses paid or incurred after the date of enactment, the administration’s proposal would include a disallowance of deductions for offshoring a U.S. trade or business. Specifically, to reduce the tax benefits associated with a U.S. company moving jobs outside of the U.S., the proposal would disallow deductions for expenses paid or incurred in connection with offshoring a U.S. trade or business. Offshoring a U.S. trade or business means reducing or eliminating a trade or business, or a line of business currently conducted inside the U.S. and starting up, expanding or otherwise moving the same trade or business outside of the U.S., to the extent the action results in a loss of U.S. jobs. Additionally, no deduction would be allowed against a U.S. shareholder’s GILTI or subpart F income inclusions for any expenses paid or incurred in connection with moving a U.S. trade or business outside of the U.S.
- Expanded definition of foreign business entity: The administration’s proposal would expand the definition of “foreign business entity” by treating any taxable unit in a foreign jurisdiction as a foreign business entity for purposes of IRC Section 6038. Therefore, information would be required to be reported separately with respect to each taxable unit, and penalties would apply separately for failures to report with respect to each taxable unit. This provision would be effective for tax years of a controlling U.S. person that begin after 31 December 2022, and to annual accounting periods of foreign business entities that end with or are within such taxable years of the controlling U.S. person. Additionally, the annual accounting period for a taxable unit that is a branch or disregarded entity would be the annual accounting period of its owner.
The budget proposal includes several measures addressing the tax treatment of digital assets, including proposals to modernize certain tax rules relating to securities, including nonrecognition rules applicable to certain securities lending transactions and the mark-to-market rules under IRC Section 475, to extend them to cryptocurrencies and other digital assets. The proposals would also expand certain reporting requirements to digital assets. For a more detailed coverage of the digital asset proposals in the 2023 budget, see the article in this issue.)
The administration’s FY 2023 budget and Green Book provide important details regarding the proposed changes to the U.S. tax landscape. It remains to be seen whether these proposed changes will be enacted as outlined or if additional changes will be made.