President Joe Biden speaks during a joint congressional session April 28.
Melina Mara / Bloomberg News
One of the strangest features of President Biden’s corporate tax plan is the war he is waging on US research and development incentives. See a case study of what happens when a government’s desire to punish taxpayers exceeds its understanding of tax law.
This misstep concerns the tax treatment of immaterial income from abroad (FDII). This is global income from intellectual property such as copyrights or patents in America. The Tax Reduction and Employment Act of 2017 created a new deduction for this income, lowering the effective tax rate to around 13%. The Biden Plan would remove this deduction and increase the tax on this income to the proposed new statutory ceiling of 28%.
The administration says the FDII exemption “gives companies a tax break for moving assets abroad and does not encourage companies to invest in research and development.” You have to read a different tax code because the FDII, as written, does exactly the opposite.
FDII should be the domestic twin for the new global minimum tax that the 2017 reform imposed on overseas intellectual property-related profits. We have described this tax on global low intangible tax revenues, or Gilti. in detail.
In the years prior to 2017, countries such as Ireland, the Netherlands and the UK encouraged companies to deposit intellectual property with subsidiaries in countries where profits would be taxed at lower rates. Gilti and FDII together make the US a more competitive home for intellectual property by lowering the domestic tax rate on those profits compared to the total corporate rate (FDII) while setting an equally effective tax rate on profits in foreign subsidiaries (Gilti).
The point was that because intellectual property is so mobile, a special tax system is needed for this type of profit. Before 2017, the US struggled to tax this income as companies could park their patents and copyrights offshore, book profits there, and save US taxes by never reducing returns.
The 2017 approach is flawed, but the Biden plan to make Gilti more burdensome and at the same time completely remove the FDII is the wrong solution. Initially, this one-two punch from Biden risks reviving incentives for corporate inversions while making it harder for American companies to expand overseas.
Inversions – when an American company acquires a foreign company and relocates its headquarters to the destination country – halted after the 2017 tax reform lowered the tax penalty for companies headquartered in the United States. The White House threatens to impose new restrictions on the practice, knowing that otherwise its tax plan would lead to more inversions.
Perhaps the blocks will work and inversions by themselves will not make a comeback. In the meantime, American companies will struggle to outbid foreign competitors for overseas takeover targets once investors become aware of US tax laws. American companies will also face renewed investor pressures to sell overseas units to avoid the Biden Plan’s penalty taxation on intellectual property income.
The Biden plan could drive more R&D overseas. Other countries have also reformed their tax codes in recent years. After negotiations at the Organization for Economic Co-operation and Development in 2015, governments are now calling on companies to conduct more R&D and other activities in these countries in order to benefit from tax breaks related to intellectual property.
The revision of the OECD was billed in order to curb tax evasion by companies. However, it does trigger a new and healthy form of tax competition as countries seek to encourage more research and development. The Biden Plan’s combination of much higher taxes on land intellectual property profits and stricter taxation on foreign profits of American companies will make Ireland or the UK seem better R&D targets by comparison.
Precisely because intellectual property has to follow other specific economic activities such as manufacturing or research, the damage caused by the Biden Plan is difficult to reverse. Corporations will have workers and buildings overseas that they won’t move in the blink of an eye, even if a future president or congress changes course.
The government calls this the “Made in America” tax plan. Congress should ensure that this is not instead a tax plan for “Research in Europe”.
Wunderland: Negotiations with the opposition, the left concluded, only hinder the achievement of their political goals. Images: AP / Bloomberg News / Getty Images Composite: Mark Kelly
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Published in the print edition from May 1, 2021.