This week, Ways and Means Committee Chairman Rep. Jason Smith (R-MO), introduced legislation in response to the global minimum tax that would increase taxes on companies and individuals from countries that impose extraterritorial and discriminatory taxes on US taxpayers. . This stems from bipartisan concerns about tax policies adopted by other countries that specifically target US businesses or the US tax base.
Under the proposal, a 5 percent tax would be added annually for four consecutive years (a cumulative 20 percent surcharge) under the terms of the bill. Taxable income is limited to US profits and profits of foreign companies and individuals who are neither US citizens nor residents.
The legislation is another step Republican members of Congress are taking to express their displeasure with the global minimum tax. But legislation is much more than that. It’s the next chapter in a long story of how US policymakers have responded to foreign rules aimed at US businesses.
The details of the proposal are important, and future Tax Foundation research will examine these details. Before that analysis, however, it is important to see where this proposal stands in the context of similar efforts throughout recent US tax policy history (and even in the pre-World War II era).
An important question in international tax rules is which country gets to tax the income of companies or individuals that earn income in multiple jurisdictions. Over time, a complex web of tax treaties between countries and the norms surrounding these policies have evolved to address this issue. This complexity can lead to outcomes that are clearly inconsistent with the underlying economics of cross-border trade and investment. Policymakers often question whether, in the absence of cross-border tax rules, such a significant share of corporate profits would have been recorded in low-tax jurisdictions.
Addressing the challenges of the current system is a difficult exercise. Countries most often act in their own self-interest even when some level of coordination between jurisdictions may be beneficial.
As the US corporate sector grew for decades with many successful multinational companies, other countries wanted to tax what they believed to be a share of taxable profits. The US approach to foreign encroachment on the US tax base has been to pressure other jurisdictions to avoid policies that unfairly target US companies.
During the 1930s, France assessed taxes on US businesses, resulting in double taxation of dividends. Meanwhile, France and the US were negotiating a tax treaty that would eliminate this type of double taxation. The treaty was signed in April 1932 and promptly ratified by the US Senate in June of that year. France was slower to act and continued efforts to collect excessive taxes under its previous law.
In effect, France has worked to collect taxes from US subsidiaries operating in France based on the worldwide profits of the parent companies, not just the income earned in France.
Without a tax treaty, the US government recognized the need to create remedies against France.
As Rep. Fred Vinson (D-KY) said in early 1934,
My friends, there are nations all over the world that are not particularly friendly to Uncle Sam in a business sense, and when they have an opportunity to dig into the pocketbooks of its citizens, whether individual or corporate, they don’t hesitate to do so. There is one country, France, which is not satisfied with taxing the incomes of American individuals and American corporations because they tax their own citizens: they are not satisfied with taxing the income which is actually earned in their own country; But when the US parent company of that subsidiary declares dividends, they charge corporate tax on those dividends, from whatever source they come from.
Rep. Vinson described what eventually became Section 891 of the U.S. tax code, concluding, “This power can be used to protect American businesses from today’s discrimination and will probably help deter future discriminatory foreign taxes.”
Section 891 (which still remains part of US law) gives the president the power to double the tax rate on foreign nationals and businesses if that foreign country subjects US citizens or businesses to discriminatory or extraterritorial taxation. To date, this provision has never been used.
Section 891 was enacted as part of the Revenue Act of 1934 on May 10, 1934. France ratified the tax treaty almost a year later, in April 1935.
Mitchell B. Carroll, then special counsel to the US Treasury, drew a direct line between the adoption of the new retaliatory instrument and France’s ratification of the treaty.
82 years and 891 parts will appear again. This time it’s not because France is taking an extraterritorial approach to taxing American companies, but because it’s the European Commission, the EU’s executive branch.
In 2016, Georgetown University law professor Itay Greenberg (lately Deputy Assistant Secretary at the US Treasury Department) published an article analyzing the approach the European Commission used when investigating the tax practices of some US companies. He suggested that Sec. 891 as a tool to prevent the Commission from taking an aggressive and discriminatory approach.
Even more recently, when several European countries (including France) adopted Digital Services Taxes (DST), Section 891 re-entered the conversation. The policy was clearly portrayed by policymakers as targeting large, American digital companies, and US policymakers took note of the discriminatory nature of the approach. Chairman Grassley (R-IA) and US Senate Finance Committee Ranking Member Ron Wyden (D-OR) wrote a letter to Treasury Secretary Steven Mnuchin in June 2019 asking him to “consider all available tools” to address DSTs. specifically cited section 891 as one such instrument.
Wyden and Grassley’s bipartisan letter was backed by bipartisan and bicameral concerns about DSTs. In early 2019, Wyden and Grassley were joined by House Ways & Means Committee Chairman Richard Neal (D-MA) and Rep. Kevin Brady (R-TX) in a statement calling for “measured and comprehensive solutions and no unilateral measures.”
The Trump administration has approached the issue of digital services taxes on two fronts. After the US Trade Representative reported that France’s DST was discriminatory, the Trade Representative moved to impose retaliatory tariffs. This led to a temporary standoff in early 2020 as discussions continued about a possible multilateral solution to the digital tax issue.
The second front was international negotiations. Starting in early 2019, the Organization for Economic Co-operation and Development (OECD) began coordinating a multilateral solution for both DSTs and the global minimum tax.
Unfortunately, to this day, DSTs are still on the map. Recent OECD language gives countries the flexibility to maintain DSTs even in the context of a multilateral agreement (which, in my view, has a low likelihood of implementation). Additionally, a new extraterritorial tool was introduced into the mix.
The Global Minimum Tax includes a rule, best known by the acronym “UTPR”, which once stood for the taxation of payment rule, but over time has expanded beyond “payments”. In the context of the 15 percent global minimum tax rule adopted worldwide, the UTPR acts as a vacuum cleaner. It can effectively reach across country borders and tax the profits of jurisdictions in which the effective tax rate for certain companies is below 15 percent.
The Republic of Korea may be the first country to enforce the rule in 2024, but many other jurisdictions are preparing to enforce the UTPR in 2025 (including EU members).
DST and UTPR are different in many ways, but US policymakers should be concerned about the extraterritorial nature of both. As I reminded members of Congress in my recent testimony before the Senate Finance Committee, “there has been bipartisan concern among members of this committee about introducing digital services taxes that would expose American companies to extraterritorial taxation. Now, the current global minimum tax rules do just that: they distort US companies’ exposure to extraterritorial taxation.