In recent months, there has been considerable talk on Capitol Hill of combining highway funding legislation with a sweeping overhaul of the tax rules affecting multinational businesses. The general concept—which has some bipartisan support—is that revenue raised by a deemed repatriation of untaxed foreign earnings of U.S. companies could be used to fund highway spending, while at the same time modernizing the international tax rules and enhancing incentives for innovation. This limited legislative success could then serve as a step towards more expansive tax reform in the future.
A printable version [PDF 103 KB] of this report is available.
The talk about enacting such “limited scope tax reform” escalated in July 2015 and can be expected to continue now that Congress has returned from the August recess and when it tries (again) to find a multi-year solution to highway funding concerns.
Enacting even limited scope tax reform in the near future would be difficult and the chances of such reform becoming law this year, while not zero, appear to be small. The potential implications of the tax law changes being discussed, however, would be substantial, and some of the changes could affect businesses with solely domestic operations as well as those with multinational operations. Further, proposals for international tax reform and innovation incentives, even if unsuccessful, could be building blocks for future legislative efforts. Thus, businesses would be well advised to monitor developments this fall.
In recent years, talk about tax reform generally has centered on reform of the entire Internal Revenue Code, including the provisions relating to the taxation of individuals. Nonetheless, as 2015 has progressed, congressional tax-writers appear to have abandoned efforts to enact comprehensive tax reform before the next presidential election. Among the many obstacles are the policy differences between the administration and congressional Republicans regarding the appropriate individual rate structure and revenue.
As a result, some members of Congress have shifted their focus to modernizing the tax rules applicable to multinational businesses and toward providing enhanced incentives for innovation in the near future—issues with respect to which there is some bipartisan agreement, at least as a “down payment” on enacting more comprehensive tax reform in 2017 or thereafter. Further, some lawmakers believe that a multi-year highway bill could be a vehicle for such legislation because repatriation could pave the way for multi-year highway funding.
Although different lawmakers may have different reasons for trying to advance limited scope tax reform this year, some of the commonly cited reasons for the current effort include the following.
Interest in implementing a “patent” or “innovation” box: Some lawmakers are concerned that action by some European countries with respect to their patent box regimes in light of the OECD base erosion and profits shifting (BEPS) project may result in the migration of technology jobs overseas. Very generally, these patent box regimes offer a reduced rate of tax on income attributable to certain intellectual property. Thus, some U.S. lawmakers are interested in enacting U.S. patent or innovation box legislation.
In fact, on July 29, two senior members of the Ways and Means Committee—Rep. Charles Boustany (R-TX) and Rep. Richard Neal (D-MA)—released for public comment a discussion draft, technical explanation, and request for feedback regarding an “innovation box” proposal. This draft proposal generally would substantially lower the rate of tax for C corporations with respect to dispositions and licenses of intellectual property (IP) and products produced using IP. The draft proposal would benefit many C corporations, including those with multinational operations. Read TaxNewsFlash-United States
Nevertheless, as currently drafted, the proposal does not appear to apply to individuals or passthrough entities. The proposed bill would add the deduction for innovation box profits to a new section in Part VIII of subchapter B of Chapter 1 of the Internal Revenue Code—this part of the Code relates to special deductions for corporations. Note that, under section 1363(b), an S corporation generally is treated as an individual for income computation purposes.
OECD base erosion and profit shifting (BEPS) project: Congressional tax-writers have been closely watching the activities of the OECD’s BEPS project and considering possible implications for U.S.-headquartered companies and the U.S. tax base. Some are concerned that the U.S. government would be forced to respond legislatively to changes in tax laws that could be made in other countries under the auspices of the BEPS project’s recommendations.
Apparent belief that Congress and the White House actually could reach agreement on a package of multinational tax reforms: Although the details of the international tax provisions in the comprehensive tax reform bill introduced last year by then Ways and Means Chairman Dave Camp (the “Camp reform bill”) and the Obama Administration’s most recent budget proposal differ, there is agreement among interested parties that the current system is broken in many respects and that there are substantial conceptual similarities between the proposed solutions. Read a KPMG chart [PDF 683 KB] showing similarities between the Camp reform bill and the administration’s budget proposal.
Further, from public comments made and the apparent level of private dialogue taking place among the various interested parties, it appears that some congressional Republicans and officials at the White House believe they may be able to reach consensus on some sort of international tax modernization package.
Revenues currently dedicated to the “highway trust fund” recently have been falling billions of dollars short of highway funding needs each year. With many members of Congress averse to increasing the gas tax, lawmakers are looking for additional ways to fund highway spending. Some lawmakers believe that deemed repatriation of the estimated over $2 trillion of foreign earnings of U.S. multinational corporations could provide revenue that could be used to fund a multi-year highway spending bill. Some lawmakers, however, also believe that from a political and revenue standpoint, deemed repatriation to fund highway spending can work only if it is part of a larger package that also addresses modernization of the current international tax rules, prevents future U.S. tax base erosion, and provides enhanced incentives for U.S. innovation.
The potential link between highway funding and international tax modernization was apparent in recent negotiations between the House and the Senate on the short-term highway bill that was enacted in July 2015.
Facing highway funding that was set to expire at the end of July, the House and Senate ultimately agreed to a short-term bill, by extending highway funding until October 29, 2015. The president signed this extension into law.
As a result, Congress will have to re-visit highway spending again in the fall, and repatriation, international tax modernization, and innovation boxes are likely to be discussed as Congress considers (again) how long to extend highway funding and how to offset the costs of that spending.
If Congress does put together a multi-year highway spending bill that includes limited scope tax reform, what kinds of tax provisions might the bill include? Although it is impossible to know with certainty, possibilities include:
There are those who believe that enacting limited scope tax reform this year would be very difficult. For example, from a “big picture” perspective, some of the issues and obstacles that would need to be confronted are:
Moreover, even if these issues could be surmounted, there could be other difficult issues relating to the design of an innovation box and multinational tax modernization package. For example:
In a cost estimate dated July 14, 2015, the Congressional Budget Office (CBO) estimated that implementing the Senate six-year highway bill (S. 1647) would cost about $157 billion over a five-year period and about $256 billion over a 10-year period. As indicated below, it is not clear how much an innovation box would cost; however, depending upon the scope and the amount of rate reduction provided, it could be substantial. Keep in mind that the Joint Committee on Taxation (JCT) estimated that a previous proposal for elective repatriation at a reduced rate for a temporary period of time would lose revenue. That proposal was not part of a broader overhaul of the international tax rules. By contrast, in the context of a broader tax reform proposal, the JCT estimated that a mandatory (deemed) repatriation of offshore earnings at reduced rates would raise about $170 billion in revenue1 (not taking into account possible macroeconomic effects).2
As indicated above, tax-writers are giving significant attention to issues associated with intellectual property and international tax modernization.
Further, even though enacting limited scope tax reform this year could be very difficult, congressional efforts on these issues today can be expected to shape tax reform discussions in the future—and technical design decisions made by policymakers now could be hard to change in the future. Thus, businesses would be well advised to stay tuned to what lawmakers continue to say—and do—now that Congress has returned from recess.
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