What is SHIELD?
On April 7, 2021, President Biden's administration released a description of its Made in America tax plan. One aspect of the plan would replace BEAT with a new regime that refuses corporate deductions by referring to payments to overseas affiliates subject to a low effective tax rate (ETR) unless income is subject to an acceptable minimum tax regime. This proposal, known as SHIELD (stopping harmful inversions and ending low-tax developments), aims to shift profits to low-tax areas more effectively than the existing BEAT, while at the same time providing a strong incentive for other nations to take action on global minimum tax systems. The SHIELD appears to be inspired by the “Under Taxed Payments Rule” (UTPR) in the OECD's Pillar Two blueprint, but there may be significant differences. The potential for such differences was recently highlighted by a presentation by the US Treasury Department to the OECD Steering Group of the Inclusive Framework on BEPS, in which it was stated that SHIELD was only compatible with the "general concept of the UTPR".
Biden's plan provides few details on how SHIELD would be applied. This article describes our current understanding of the proposal and highlights important open questions. We expect at least some of these questions to be answered when more details on the administration's proposals are released, likely later this month in the Treasury's annual report on the administration's proposed revenue (commonly referred to as the "Greenbook").
SHIELD's prospects of entry into force are highly uncertain
In addition to the uncertainty about the exact details of President Biden's proposals, it should be noted that it is by no means a given that President Biden’s proposals become law. With Democrats unlikely to be able to afford to lose Democratic votes in the Senate and with a very narrow margin of maneuver in the House of Representatives, it's hard to predict what will go into the final legislation. Because the legislative process is controlled by the House and Senate leadership rather than the administration, the starting point for tax legislation may not accurately reflect the administration's view.
As a reference point, on April 5, 2021, several prominent Democratic members of the Senate Finance Committee, including its chairman, Senator Wyden, published their own framework for revising the US international tax system. Instead of replacing the BEAT, as the administration is proposing, this framework would instead modify BEAT in such a way that its application to inbound investors in the US could be further expanded. Little is known of the House of Representatives' views on these issues – the Chairman of – The House Ways and Means Committee has not yet issued any public views on the matter. In summary, a change seems likely and President Biden's proposals are almost certainly one form of change that Congress will consider. However, it is impossible to predict the exact content of what might ultimately take effect.
What we know about SHIELD
- The tax rate for measuring a low ETR would initially be set at the tax rate for taxing GILTI. However, if the OECD process culminates in a multilateral agreement on a global minimum tax (referred to as the Income Inclusion Rule (IIR) in the OECD draft), the rate would be reset to the agreed OECD minimum rate. President Biden's proposal would increase the GILTI rate to 21%, although that result is far from certain. However, an agreed OECD minimum rate is likely to be well below 21%. Much of the discussion has assumed a rate of 12.5%, which was also the rate at which the revenue impact of the second pillar was assessed in the OECD's economic impact assessment.
- The reference to the “effective tax rate” indicates that SHIELD would not rely on the nominal statutory tax rates in the recipient's jurisdiction.
- Unlike the current operation of BEAT, SHIELD appears to be primarily accessing non-US groups. Groups with US parents would generally be covered by GILTI, which (as modified by Biden's plan) would be a sufficiently strong minimum tax to turn SHIELD off.
- In general, even if there was a multilateral agreement on an IIR, SHIELD would still require ETR testing for payments to companies located in the ultimate parent's jurisdiction, as such companies would likely not be subject to an IIR. This approach would be compatible with the operation of the OECD's UTPR.
What we don't know
- Would SHIELD only apply to large taxpayers? BEAT only applies if the “total group” of a taxpayer has average gross annual income of $ 500 million or more over the past three years. The OECD's UTPR proposal applies to multinational corporations with a turnover of more than 750 million euros. Although unclear, some threshold for identifying small taxpayers seems likely to be based on the existence of such restrictions under BEAT and the OECD blueprint.
- Do "deductions" include the cost of goods sold (COGS)? COGS currently falls within the scope of the OECD's UTPR proposal, but not within the scope of BEAT, which treats COGS as a gross income reduction rather than a deduction. In contrast, the "deduction" prohibition rule in the US Anti-Hybrid Rules under Section 267A of the Tax Code may apply to prevent a hybrid royalty or interest payment from being taken into account in determining the COGS. Although the administration's description of SHIELD criticizes the exclusion of COGS from BEAT, it describes SHIELD only as a rejection of "deductions" with no mention of COGS.
- If a multinational group does not have a minimum tax system, would the ETR test refer to the ETR of the recipient jurisdiction, recipient organization, or payment? Due to concerns about preferential regimes such as patent boxes, policy makers may choose to apply them separately to each payment. The OECD's UTPR proposal applies the ETR test from country to country. How would participation in a consolidation, tax unit, group relief or other loss-sharing scheme affect the determination of the ETR if this approach is not adopted?
- How would the use of tax attributes such as net operating losses more generally affect the determination of the ETR?
- How do I deal with a lack of information regarding the ETR? The OECD Blueprint addresses this problem by building on revised financial reporting information. In the past, Congress has been reluctant to link tax law to financial accounting. Therefore, we wouldn't be surprised if SHIELD had to perform calculations using US tax rules, placing the burden of proof on the payer to determine that a payment was not taxed low. On the other hand, President Biden's proposal on “minimum book tax” may signal openness to tax regulations that, in tight circumstances, rely on financial accounts.
- How far would taxpayers need to go to determine if a payment is subject to a low ETR, given the possibility that a nominally highly taxed payment, a recipient entity, or a recipient jurisdiction could itself be subject to basic stripping:
- Would taxpayers need to keep track of payment chains, similar to Section 267A of the Disqualified Imported Non-Conformity Rules for Disqualified Hybrids?
- The OECD's UTPR would bypass traceability by checking whether an MNC group includes countries with low taxed incomes that are not subject to an acceptable minimum tax regime. Nothing in President Biden's proposal suggests going that far, but if it were, it would be more imperative to use modified financial reporting information to test the ETR.
- If a payment was subject to a low ETR, how much of the deduction would be withheld? According to the proposal, SHIELD denies ". . . US tax deductions by reference to related party payments subject to a low effective tax rate. “A natural reading of this language is that the entire deduction would be withheld and taxed at the full US corporate tax rate, although the use of“ with reference to ”leaves the door open to other interpretations. Alternatively, a prorated amount of the deduction could be refused to replace the minimum rate, possibly with or without consideration of foreign taxes paid. The OECD's UTPR proposal is a "top-up mechanism" that will refuse a reasonable amount of a deduction in the payer's jurisdiction by reference to the difference between the minimum rate and the ETR of that jurisdiction.
- What if the recipient is tax-exempt, e.g. B. a foreign pension fund or a sovereign wealth fund, or if it is a collective investment vehicle? The OECD's UTPR contains exceptions for such recipients.
- Does SHIELD comply with the obligations of the US tax treaty? A Treasury Department official recently stated that SHIELD was "very carefully designed to fully meet our contractual obligations." In particular, the OECD draft concluded that the UTPR was compatible with the OECD model tax treaty, but several public commentators disagreed with this conclusion.
- Will SHIELD include a substance-based carve-out? The OECD's UTPR uses the same calculation as the IIR, including a formula-based segregation of payrolls and property, plant and equipment within each jurisdiction. SHIELD would likely not include a spin-off that is consistent with the existing BEAT design as well as the administration's proposal to eliminate the spin-off for QBAI in GILTI.
Closing remarks
Most US parenting groups should generally welcome the replacement of BEAT with the input-oriented SHIELD. Foreign parenting groups may also be better off on SHIELD if the recipients of deductible payments are in high tax jurisdictions (or ultimately subject to a globally agreed IIR). On the other hand, there is no indication that the various BEAT exceptions would be repeated under SHIELD, which could result in some groups with foreign parents doing worse, especially if there is no multilateral agreement on an IIR and / or the group is based into a jurisdiction that either does not implement an IIR or is slow to implement it. While there is not enough detail to assess the impact on specific taxpayers, it is evident that there will be a new set of winners and losers to be assessed when further details of the management's proposals are published in the Green Paper.
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.
Information about the author
Danielle Rolfes is a partner and co-head of the International Tax Group in the Washington National Tax (WNT) practice of KPMG LLP, and Jonathan Galin is a senior manager in the Rolfes group. Marcus Heyland is Managing Director of WNT's Economic Valuation Services group.
The information in this article is not intended to be “written advice relating to one or more federal tax matters” subject to the requirements of Section 10.37 (a) (2) of Treasury Circular 230. The information contained herein is of a general nature and based on government agencies, which are subject to change. The applicability of the information to specific situations should be determined in consultation with your tax advisor. This article reflects the views of the authors only and does not necessarily represent the views or professional advice of KPMG LLP.
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