US Tax Reform 2.0 – BEAT Down, SHIELD Up?

What we know about Biden’s proposed new ‘SHIELD’ regime so far.

What we know about Biden’s proposed new ‘SHIELD’ regime so far.

On 7 April 2021, the US Department of the Treasury published its detailed ‘The Made in America Tax Plan’. The plan proposes reforms to the Base Erosion and Anti-Abuse Tax (BEAT) regime and replacement with a new ‘SHIELD’ regime, and other reforms to the Global Intangible low-tax income (GILTI) and foreign-derived intangible income (FDII) regimes introduced by the Trump Administration in 2017 as well as several other measures, including an increase in the domestic corporate tax rate to 28 percent. The reforms to the BEAT regime are particularly of interest to UK and other foreign headed multinational groups and have been a key topic of discussion with many clients. This article looks at the SHIELD proposals in more detail.

What is SHIELD?

One aspect of Biden’s plan would replace the existing BEAT regime with a new regime that would deny corporate deductions by reference to payments to foreign related persons that are subject to a low effective tax rate (ETR), unless the income is subject to an acceptable minimum tax regime. This proposal, referred to as SHIELD (Stopping Harmful Inversions and Ending Low-Tax Developments), is intended to more effectively, target perceived profit shifting to low-taxed jurisdictions compared to the existing BEAT, whilst simultaneously providing a strong incentive for other nations to enact global minimum tax regimes. The SHIELD appears to be inspired by and partially aligned with the ‘undertaxed payments rule’ (UTPR) in the OECD’s BEPS 2.0 Pillar Two Blueprint, however there are potentially significant differences. The potential for such differences was underlined by a recent US Treasury presentation to the OECD Steering Group of the Inclusive Framework on BEPS, which noted that SHIELD would be consistent only with the “general concept of the UTPR.”

Biden’s plan includes few details on how SHIELD would apply. This article outlines our current understanding of the proposal and flags key open questions. We anticipate at least some of these questions will be answered when more details of the Administration’s proposals are released, expected later in May 2021, in the US Treasury Department’s annual report on the Administration’s revenue proposals (commonly referred to as the ‘Greenbook’).

SHIELD’s prospects for enactment are highly uncertain

In addition to uncertainty as to the precise details of President Biden’s proposals, it’s important to bear in mind that, in contrast to the UK’s Parliamentary system, it’s far from a foregone conclusion that any of President Biden’s proposals will actually become law. Because it’s likely that the Democrats will be unable to afford to lose any Democratic votes in the Senate and have a very narrow margin in the House of Representatives, it’s hard to predict what will be included in final legislation. In addition, because the legislative process is controlled by the leadership of the House of Representatives and Senate rather than the Administration, the starting point for any tax bill may not precisely reflect the Administration’s view.

As one point of reference, on 5 April 2021, several prominent Democratic members of the Senate Finance Committee, including its Chairman, Senator Wyden, released their own framework to overhaul the US international tax system. Rather than replacing the BEAT as the Administration proposes, that framework would instead modify the BEAT in ways that could further expand its application to inbound investors in the United States. Little insight is available as to the view of the House of Representatives on these issues – the Chairman of the House Ways and Means Committee has not, as of yet, publicly expressed any views on the matter. In summary, while change seems probable, and President Biden’s proposals almost certainly represent one form of change that Congress will consider, predicting the precise contents of what might ultimately be enacted is impossible.

What we currently know about SHIELD

  • The threshold rate for measuring a low ETR initially under SHIELD would be set at the rate for taxing GILTI (Global Intangible Low-Taxed Income, the primary US system for currently taxing the earnings of offshore subsidiaries), but if the OECD BEPS 2.0 process culminates in a multilateral agreement on a global minimum tax (referred to in the OECD Blueprint in the Income Inclusion Rule (IIR)), the threshold rate would be reset to the agreed OECD minimum rate. President Biden’s proposals would also increase the GILTI rate to 21 percent, though that outcome is also far from certain. Any agreed OECD minimum tax rate, however, is anticipated to be lower than 21 percent but higher than the 12.5 percent that was originally in discussion. Where exactly this rate lands is currently the subject of highly politicised negotiations amongst the Inclusive Framework countries – whilst some countries are supportive of the higher rate, others (such as the UK) currently are not and are prioritising gathering political consensus on Pillar One;     
  • The reference to ‘effective tax rate’ indicates that SHIELD would not rely on nominal statutory rates in the recipient jurisdiction; 
  • In contrast to the current operation of the BEAT, SHIELD appears to target primarily non-US-parented groups. US-parented groups generally would be covered by GILTI, which (as modified by Biden’s plan) would constitute a sufficiently strong minimum tax to turn off SHIELD; and
  • It appears that, even if there is a multilateral agreement on an IIR, SHIELD generally would still require ETR testing for payments to companies resident in the jurisdiction of the ultimate parent because such companies would likely not be subject to an IIR. This approach would be consistent with the operation of the OECD’s proposed Pillar Two UTPR.

What we don’t yet know about SHIELD

  • Would SHIELD apply only to large taxpayers? BEAT applies only if a taxpayer’s ‘aggregate group’ has average annual gross receipts of $500 million or more for the prior three years. The OECD’s Pillar Two UTPR proposal applies to multinational groups with revenue greater than €750 million. Although unclear, some threshold to scope out small taxpayers seems likely based on the existence of such limitations under BEAT and the OECD Blueprint;
  • Do ‘deductions’ include cost of goods sold (COGS)? COGS is currently in scope for the OECD’s UTPR proposal, but out of scope for BEAT, which treats COGS as a reduction of gross income rather than a deduction. In contrast, the ‘deduction’ disallowance rule in the US anti-hybrid rules can apply to preclude taking a hybrid royalty or interest payment into account when determining COGS. Although the Administration’s description of SHIELD is critical of the exclusion of COGS from BEAT, it only describes SHIELD as denying ‘deductions’ with no mention of COGS; 
  • When no minimum tax regime applies to a multinational group, would the ETR test apply by reference to the ETR of the recipient jurisdiction, recipient entity, or the payment? Due to concerns regarding preferential regimes such as IP regimes, policymakers may opt to apply it separately to each payment. The OECD’s UTPR proposal applies the ETR test on a country-by-country basis. If this approach is not adopted, how would participation in a tax consolidation, fiscal unity, group relief, or other loss sharing regime affect the determination of the ETR?;
  • More generally, how would the use of tax attributes, such as net operating losses, affect the determination of the ETR?;
  • How to deal with a lack of information regarding the ETR? The OECD Pillar Two Blueprint addresses this issue by relying on modified financial reporting information. The US rules defining taxable income can differ significantly from financial reporting income. Congress historically has been reluctant to link tax rules to financial accounting, so we would not be surprised if SHIELD required computations to be done using US tax rules by placing the burden of proof on the payor to establish that a payment was not low-taxed. On the other hand, President Biden’s ‘Minimum Book Tax’ proposal may signal openness to tax rules that rely on financial accounts in narrow circumstances;
  • How far would US taxpaying entities be required to go to determine if a payment is subject to a low ETR, in light of the possibility that a nominally high-taxed payment, recipient entity, or recipient jurisdiction could itself be subject to base erosion:
    • Would taxpayers have to trace through chains of payments, similar to the US and OECD imported mismatch rules for hybrids?;
    • The OECD’s Pillar Two UTPR would sidestep tracing by looking to whether a multinational corporation (MNC) group includes any countries with low-taxed income that are not subject to an acceptable minimum tax regime. Nothing in President Biden’s proposal suggests it is intended to go that far, but if it was, the case for allowing modified financial reporting information to be used for testing the ETR would be more compelling;
  • If a payment is subject to a low ETR how much of the deduction would be denied? Would the entire deduction be denied and taxed at the full US corporate income tax rate or would only a proportionate amount of the deduction be denied (i.e., a ‘top up’)?
  •  What if the recipient is tax exempt, such as a foreign pension fund or sovereign wealth fund, or is a collective investment vehicle? The OECD’s Pillar Two UTPR includes exceptions for such recipients;
  • Is SHIELD consistent with US tax treaty obligations? Notably, the OECD Pillar Two Blueprint concluded that the UTPR was compatible with the OECD model tax convention, but several public commentators have disagreed with that conclusion; and
  • Will SHIELD include a substance-based carve-out? The OECD’s UTPR uses the same calculation as the IIR, including a formulaic substance-based carve-out for payroll and tangible assets within the relevant jurisdiction. SHIELD likely would not include such a carve-out, consistent with the existing BEAT design as well as the Administration’s proposal to eliminate the carve-out for qualified business asset investment (QBAI) in GILTI.

Implications for UK-parented groups:

  • Non-US parented groups may be better off under SHIELD if the recipients of deductible payments are in high-tax countries (or, eventually, are subject to a globally agreed IIR). On the other hand, currently there’s no indication that the various exceptions from the BEAT would be replicated under SHIELD, which could make some UK-parented groups worse off, especially if there is no multilateral agreement on an IIR and/or the UK either does not implement an IIR or is slow to implement it; and
  • If there is a multilateral agreement at the OECD and the UK implements the agreed upon Pillar Two IIR, SHIELD generally would not deny deductions for payments to non-UK subsidiaries of UK-parented groups covered by the UK’s IIR. However, if SHIELD is enacted this year, there could be a significant gap before the UK implements a compliant IIR.

Whilst there isn’t currently sufficient detail to fully assess the implications for particular taxpayers, it’s apparent that there will be a new set of winners and losers from the SHIELD. Who these are will become clearer once further details of the Administration’s proposals are released in the Greenbook at the end of May 2021.   UK and other non-US parented groups need to carefully assess these imminent developments from Washington to be able to assess the impact of the SHIELD proposals, whilst also keeping an eye on continuing developments at the OECD and EU.

Please speak to your usual KPMG contact for further information.