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GILTI High-Tax Regs Show New Influence Of Book Income In Tax

By Alex M. Parker and Molly Moses · 2020-08-14 20:00:35 -0400

Recent U.S. Treasury Department regulations that ask taxpayers to use financial data to measure offshore profits are yet another example of a growing trend toward blurring the once-bright line between tax returns and accounting statements.

Joe Biden, the presumptive Democratic nominee for president, has proposed a 15% corporate minimum tax based on a company's financial statements. (AP)

Tax officials at the U.S. and the Organization for Economic Cooperation and Development are looking to global accounting standards to devise tax rules that can reconcile complex national tax systems. Meanwhile, politicians — including former Vice President Joe Biden, the presumptive Democratic nominee for president — point to disparities between the income corporations put on their tax returns and the profits they report to shareholders as evidence of drastic tax avoidance.

Tax and accounting experts advise caution about the growing use of financial statements in tax, noting that the rules for accounting and the rules for tax are often different for important reasons. Accounting is meant to most accurately reflect a company's economic viability for investors, while legislatures use the tax code to encourage or discourage certain activities — and losing sight of that could create unexpected consequences.

Regardless of that debate, though, reliance on financial accounting may be inevitable as tax authorities do their best to cope with a tax landscape that is increasingly global.

In July, Treasury and the Internal Revenue Service issued both final and proposed regulations on the high-tax exception to the tax on global intangible low-taxed income, a provision of the 2017 Tax Cuts and Jobs Act . The politically controversial exemption negates an apparent fluke in the TCJA's international framework that left some taxpayers with significant GILTI liabilities, even though they had already paid high foreign taxes on the same income. Treasury proposed a high-tax exception to GILTI, similar to a preexisting Subpart F exception.

The July package included final regulations on GILTI, as well as proposed regulations coordinating the GILTI and Subpart F exemptions. To better conform the two, the proposed regulations advise taxpayers to use "appropriate financial statements" to determine the gross income of the relevant foreign unit. Those statements could include audited or unaudited statements prepared in accordance with recognized standards, such as U.S. generally accepted accounting principles or international financial reporting standards.

"The Treasury Department and the IRS have determined that this new standard will provide more accurate and reliable information and will promote certainty in cases where there may be various forms of readily available financial information," the proposed regulations stated.

In this situation, the purpose of using financial accounting data — often called book income — is to ensure that the taxable income is measured in a way that conforms to both U.S. and the foreign jurisdiction's rules.

"We're trying to evaluate whether [a controlled foreign corporation's] income has been taxed at a 'high' foreign rate. And to do that you'd want to try to capture, as best as you can, the foreign tax base," said Elizabeth Stevens of Caplin & Drysdale Chtd. "So applying U.S. tax accounting principles doesn't necessarily make sense there. You'd want to look at something that gets you closer to the foreign tax accounting principles."

The OECD is also looking to book income as it devises a new global corporate minimum tax as part of its project to overhaul the international tax rules. Under the project's so-called second pillar, countries would be encouraged to create a minimum tax on their companies' foreign income if it is taxed below a yet-to-be-determined rate. Proponents of the proposal say it will discourage income-shifting to low-tax jurisdictions through the use of valuable intangible assets such as intellectual property.

Broadly, the policy is similar to GILTI. But because it would be a new global standard, the rules need to coordinate the tax bases of different jurisdictions. The proposal is also looking to global financial accounting rules, but the approach has been anything but simple. In practice, the accounting rules of countries can differ in subtle but important ways, despite global standards such as the international financial reporting standards.

"People think your financial accounting is a fixed set of books so that if you do yours and I do mine and we both come up with 100, then that's exactly right," said Peter Barnes, a professor of tax at the Duke University School of Law and a former senior tax counsel for General Electric Co. "Financial accounting standards around the world are not the same."

Meanwhile, on the campaign trail, Biden has proposed a 15% corporate minimum tax, based on a company's financial information. The campaign has released few details about the proposal, but the candidate himself has blasted companies such as Inc. for reporting low tax liabilities but high profits.

"I don't think any company, I don't give a damn how big they are, should absolutely be in a position where they pay no tax and make billions and billions and billions of dollars," Biden told a CNBC interviewer in May.

Moves to base tax more on book income have been accused of ignoring the sometimes legitimate reasons why book and tax income would differ. The TCJA included many proposals that encourage companies to invest more by allowing them to immediately deduct most expenses. The timing difference may create significant tax savings in one year, but it does not mean that the company will ultimately pay less in taxes.

Another big difference is how the tax system and accounting rules measure the cost of stock options, which can create bigger deductions for companies with skyrocketing share prices. But the difference isn't necessarily more beneficial to taxpayers overall.

Stevens noted that the point of tax accounting rules is to "match the timing of items of income and deductions and really try to capture economic income in a given year." Financial accounting is doing something different, she said.

"It's not just to reflect the future state of the company but to help investors evaluate its prospects going forward," Stevens said. "So there are differences in the timing of when items are recognized. We have two sets of standards that are trying to do two slightly different things."

While book income may seem like a practical way to coordinate tax rules, Barnes warned that the nuances may be hidden to those outside the financial accounting world.

"Clearly there are a lot of tax people who understand financial accounting. But there are a lot of tax people who don't," he said. "People think, just take your financial reporting as if it's some dropped-from-the-heavens number. It's not. There are different rules in different countries and a lot of judgments that have to be made."

--Editing by Tim Ruel and John Oudens.

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