Treasury and IRS Issue Guidance, Senate Scrutinize Tax Practices, Tax Writers Assert Jurisdiction Over Agreement

Senate Democrats Scrutinize Tax Practices of Pharmaceutical Companies, While Republicans Take Aim at Pillar Two. On Thursday, May 11, the Senate Finance Committee held a hearing that was intended to discuss the perceived tax avoidance by multinational pharmaceutical companies in the wake of the 2017 Tax Cuts and Jobs Act (TCJA). However, none of the Republican lawmakers in attendance focused on pharmaceutical-industry-specific issues, instead, seizing the opportunity to highlight the merit of TCJA and criticize the ongoing implementation of the Organisation for Co-operation and Development (OECD) Pillar Two global minimum-tax regime. In his closing remarks, Senate Finance Committee Chairman Ron Wyden (D-OR) joked that “the Republican side of the committee seems to have attended a different hearing.”

Committee Democrats said that large pharmaceutical companies often hold their most valuable intellectual property (IP) abroad or manufacture products overseas so that they can attribute significant profits to foreign tax jurisdictions. Democrats also claimed that while there was profit shifting before TCJA, the law significantly decreased penalties on companies that relocate their operations and assets abroad. Testifying on the issue, Brad Setser, a fellow at the Council on Foreign Relations, said TCJA’s introduction of the Global Intangible Low-Taxed Income (GILTI) regime incentivized companies to move their production and IP offshore.

Several Republican lawmakers disagreed with Democrats on the merits of TCJA’s international tax provisions, arguing that the law ended inversions, increased domestic research and development (R&D) expenditures and boosted U.S. corporate tax receipts. Moreover, committee Ranking Member Mike Crapo (R-ID) said TCJA led to record-high corporate tax receipts and significantly increased U.S. competitiveness in global markets.

In their questions, Republicans highlighted several aspects of the OECD Pillar Two agreement that they believed were disproportionately harmful to U.S. companies. Ranking Member Crapo and Sen. Chuck Grassley (R-IA) noted that the global minimum-tax rules are more advantageous for countries that use subsidies than those that employ non-refundable tax credits. Specifically, Sen. Todd Young (R-IN) suggested that myriad U.S. corporate tax breaks, like the R&D incentive, would be treated much less favorably under the regime than the direct subsidies used by China to grow its domestic manufacturing sector. Ranking Member Crapo and Sen. Marsha Blackburn (R-TN) also criticized the Biden administration for failing to consult Congress throughout the development of the Pillar Two agreement.

Before the hearing, Chairman Wyden released a Democratic staff memorandum reflecting the updated results of his ongoing investigation into the tax practices of multinational pharmaceutical companies. Among other findings, the report alleges that the average effective tax rate of the seven largest U.S. pharmaceutical corporations was 11.3% in 2021. In conjunction with the memorandum, Wyden published a letter from the Joint Committee on Taxation that estimates the foreign share of the taxable income of large pharmaceutical companies to be approximately 75%.

Discussions regarding international taxation come as several governments have already begun to enact policies to implement the Pillar Two regime. Notably, the European Union reached a preliminary agreement in December for each member country to adopt the changes to their domestic tax laws by the end of 2023. Other countries, such as South Korea, the United Kingdom, Australia and Japan, have also taken steps toward adoption of the global minimum tax.

Tax Worldview

Bicameral Tax Writers Assert Jurisdiction Over Development of Taiwan Tax Agreement. Last week, the chairmen and ranking members of the House Ways and Means and Senate Finance committees issued a joint statement in favor of modifying the tax code to alleviate double taxation between the United States and Taiwan. The renewed interest in legislative action comes as lawmakers from both parties seek to expand trade with Taiwan to counter China’s growing economic and military strength. While the tax writers support the development of “treaty-like benefits” for Taiwan, they note that the current U.S. policy of strategic ambiguity toward the country “precludes [Taiwan] from the typical process of remedying double taxation through a treaty.”

On May 4, Senate Foreign Relations Committee Chairman Bob Menendez (D-NJ) introduced bipartisan legislation that would accomplish the lawmakers’ objectives by allowing the Biden administration to negotiate a “tax agreement” between the American Institute in Taiwan and the Taipei Economic and Cultural Representative Office, which would be subject to congressional approval. In a statement after the bill’s introduction, Chairman Menendez said that “[a]s far as [he was] concerned, [the bill] is a treaty, and virtually all treaties end up in the Foreign Relations committee.”

However, Senate Finance Committee Ranking Member Mike Crapo (R-ID) criticized Chairman Menendez’ position, arguing that the agreement is a “Finance Committee issue” because it will be accomplished through the tax code, not through the traditional treaty ratification process. Tax committee members are now reportedly working on their own proposal. Notwithstanding jurisdictional disagreements, Treasury Secretary Janet Yellen took a neutral position, arguing that the lack of a formal economic agreement with Taiwan is a “very significant problem” and the United States really needs to explore ways to deal with it.

The proposed legislation follows the passage of the CHIPS Act of 2022, which included a broad range of incentives to support the domestic manufacture of semiconductors. However, eligible manufacturers currently face double taxation from business operations in the United States and Taiwan. A tax arrangement between the two countries would address that issue and, presumably, create a formal mechanism for resolving disputes. To date, several other U.S. trade partners have implemented formal tax agreements with Taiwan, including the United Kingdom, Germany and France.

OECD Says Pillar One Agreement Likely in July. At the Tax Council Policy Institute conference last week, Manal Corwin, director of the Centre for Tax Policy and Administration at the Organisation for Economic Co-operation and Development (OECD), said the text of the Pillar One multilateral convention (MLC) would likely be published by the end of July. Corwin noted that the release of the MLC hinges on agreement from the OECD/G20 Inclusive Framework, but “[g]iven the progress to date and the constructive engagement among delegates,” the process is “still on track.”

Pillar One would reallocate the profits of certain multinational corporations to tax jurisdictions where businesses have customers but not a physical presence. Currently, several countries levy unilateral digital service taxes (DSTs) to collect revenue from companies engaging in certain digital activities within their jurisdictions. However, in 2021, the OECD/G20 Inclusive Framework committed not to enact new DSTs until the earlier of Dec. 31, 2023, or the implementation of the MLC.

At the conference, Corwin noted that negotiators continue to debate Amount B under Pillar One, which is intended to encompass the marketing and distribution activities of multinational businesses. The rules are aimed at streamlining the transfer pricing of in-country baseline marketing and distribution activities for taxing jurisdictions, as well as limiting transfer-pricing disputes.

In 2021, nearly 150 tax jurisdictions agreed to the basic principles of the Pillar One agreement. However, Corwin said that after the release of the MLC text, a “critical mass” of countries would need to ratify the agreement through their individual legislative and administrative processes for it to come into effect. To meet this threshold, the MLC must be implemented by the residence jurisdictions of the “substantial majority of the in-scope companies whose profits will be subject” to the agreement, in effect meaning that the United States must ratify the MLC for the “substantial majority” threshold to be satisfied. However, U.S. approval of the MLC would require the Senate to ratify a treaty by a two-thirds affirmative vote, which is unlikely to occur given Republicans’ strong opposition to the agreement. Addressing the possible implementation hurdles, Corwin said the OECD may offer “some form of transition measures … or other ways in which to continue the momentum, again, assuming that the milestones are being met.”

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