5 Things Any US MNC Board Director Should Know About Tax Strategy in 2024
A company’s tax expense in the US can be as high as 25-30% of its pre-tax US taxable income, and is one of the largest expense items on a company’s P&L. Thus, effective tax management plays an important part in optimizing profitability and cash flow. Board directors of a US-based multi-national company (“MNC”) should ideally be aware of the tax environment their company is operating under in 2024 and beyond. This article identifies five most important trends for any board director of a US MNC to consider.
1. US 21% Federal Income Tax Rate Under Pressure to Increase While Non-US Minimum Tax Rate Rising to 15% Starting in 2024
The current US federal corporate income tax rate is 21%. While Congress is under pressure to raise the corporate tax rate to pay for government programs, a divided House and Senate make it difficult to enact legislation to increase the US corporate tax rate in 2024 or in the near future.
That is not to say that a corporate tax rate increase is completely out of the question. For example, President Joe Biden’s Fiscal Year 2025 Budget includes a proposal to raise the corporate income tax rate from the current 21% to 28%. Recently, House Ways and Means Chair Jason Smith stated that even some Republicans in Congress would like to hike the current corporate tax rate.
While the US tax rate change may be stalled, the rest of the world is raising the floor for minimum tax from the previous 0% to 15%, effective January 1, 2024, with the adoption of the so-called “Pillar 2” regime. This regime requires a country to adopt a 15% minimum tax or be subject to a “top-up” tax by other countries that adopt such regime, effectively causing the minimum tax rate on the income to be 15%. Consequently, many US-based MNCs expect to see an increase in their effective tax rates associated with their non-US income compared to what they were able to enjoy historically for many years.
Although the Pillar 2 regime was inspired by the US tax reform in 2017, and the US Treasury actively promoted the Pillar 2 regime, the US has not yet formally embraced or adopted this regime for political reasons. However, under Pillar 2, it is possible that if a US-based MNC’s US effective tax rate falls below 15% due to, for example, research and development tax credits or new energy tax credits, the MNC may have to pay a top-up tax to other countries where the MNC happens to have an affiliate, even if that affiliate is a subsidiary of the US parent company.
Consequently, it is important for the board of directors to continue monitor the US tax legislation on the one hand and model out the impact of Pillar 2 and plan accordingly to mitigate the negative impact if any on the other.
2. Substantial Tax Compliance Burden and Tax Modeling Challenges Due to Increased Complexity
Tax compliance and modeling are easier said than done as the US tax rules become more sophisticated and rules of many countries become more intertwined.
The historical US federal corporate income tax regime is complex enough, while the Tax Cuts and Jobs Act (“TCJA”) of 2017 layers on more complexity by adding three other regimes. They are: (i) the Global Intangible Low-Taxed Income (“GILTI”) regime, (ii) the Foreign Derived Investment Income (“FDII”) regime, and (iii) the Base-Erosion and Anti-Avoidance Tax (“BEAT”) regime.
In addition, the US later enacted another corporate alternative minimum tax (“CAMT”) as part of the Inflation Reduction Act (“IRA”) in 2022, which uses financial statement income as basis for its computation, as opposed to the regular taxable income for regular tax computation.
With the Pillar 2 regime becoming effective at the beginning of 2024, US MNCs now must ascertain if they could be subject to the Pillar 2 top-up tax and, if they do, must compute, and report it. Before doing that, companies may apply certain transitional safe-harbor rules to evaluate whether they can defer full Pillar 2 computation for 1-3 years. Note that the Pillar 2 regime uses “GloBE” income as its basis for computation, while the transitional safe-harbor rules use modified financial statement income, all are different from the income tax basis used for regular US tax and CAMT discussed above.
These layers upon layers of computations are both complex and data intensive. It takes time to set up the right system and requires significant effort in analyzing, understanding, and coordinating the different sets of rules. Companies are expecting great challenges in conducting tax modeling as well as continuing to be tax compliant absent of adequate funding and data strategy.
Consequently, board directors should be aware of the challenges and should consider allocating the right resources to ensure that its business projections are accurate, its tax compliance has the highest level of integrity, and its tax strategies are optimal through rigorous tax modeling.
3. Tax Authorities Worldwide Focusing on How Companies Organize People, Function, Assets and Risks
Historically, some companies allocated income and thus tax outcome not entirely based on where value-driving activities are taking place or where assets and risks are located. With the entire world taking on anti-profit shifting and base erosion initiatives, and the advent of the Pillar 2 regime, tax authorities worldwide now have enhanced focus on where key decision-makers are located, what functions are performed at each location, where income-generating assets are located, and which entities assume the economic risks in their commercial endeavor. Gone are the days when companies could simply set up a shell company in a tax heaven jurisdiction and legally reduce their worldwide tax liabilities.
To be tax compliant, companies must start with analyzing, understanding and be deliberate about how they organize their business operations to figure out what kinds of tax outcome will follow from such business arrangement.
Therefore, a board member should be aware of this paradigm shift and demand that tax strategy evolves around people, function, assets, and risks and not the other way around. The board should encourage the business to incorporate tax into every and all business decision processes to ensure full alignment around the company’s mission and strategy.
4. Increasing Tax Audit Activities and Controversies in the US and All Around the World
Over the years, US Congress has initiated a lot of effort to shut down US tax “loopholes” by amending the tax laws, while the administration is doing its part by issuing regulations and auditing companies the IRS views as exploiting the tax systems inappropriately. In addition, the most recent IRA legislation allocated $80B in additional funding to the IRS to upgrade its system and hire more IRS agents. As a result, companies can expect increased audit activities and controversies in the US.
Moreover, just as those US audits start ramping up, foreign countries around the world will be highly incentivized to compete under Pillar 2 to try and impose a top-up tax on US MNCs wherever possible. This may lead to double or triple taxation of the same dollars of profit, absent an effective global dispute resolution system under the Pillar 2 regime.
Companies in the business of offering digital platforms, providing digital services, or providing services which incorporate sophisticated digital solutions, such as AI (Artificial Intelligence), are facing added scrutiny. As the tax rules have not fully kept up with the fast advancement in technology, there are many grey areas where countries can explore to find new ways to grab tax revenue for themselves. For example, a few years back, certain EU countries proposed a digital service tax (“DST”) on companies which have no physical presence in those countries. Countries pushed the pause button on that effort, while they were busy negotiating and adopting Pillar 2. However, the conversation is still alive, and DST may circle back in a couple of years. For another example, the fast adoption of AI technology could raise a new round of questions from tax authorities around the world on the question of which country or countries should entitle to tax the underlying profit from the AI-based technology and thus retain the associated tax revenue.
Against the above background, board members should prepare for the potential rise of controversies and audit activities, sufficiently resource the company to fend off or resolve any tax controversies, and most importantly, help guide the design of a tax strategy which is sustainable and cost-effective for the long-term to avoid controversy in the first place.
5. Tax Viewed as a Part of Environmental, Social, and Governance (“ESG”) Strategy
Nearly all large global companies have recognized the importance of ESG and have incorporated some ESG information into their reporting. One aspect of the ESG reporting involves transparency and disclosure of a company’s total contribution to society through the payment of its fair share of the tax. The reporting obligation may be a herculean effort, because it requires an assembly of information which expands beyond just income taxes to include indirect taxes, property taxes, and payroll taxes, which are not centralized in most companies. This effort is more than just a reporting exercise. It requires thoughtful planning and deliberation, just like all other items in the ESG strategy.
Governments, customers, and even investors may be looking at a company’s tax contribution in deciding what kind of relationship it would have with the company. For example, some institutional investors may exclude companies they consider not ESG-compliant from their investment universe based on tax and transparency reporting. Certain government agencies may exclude a company from bidding on government contracts for failure to make adequate contribution.
On the other hand, tax may also offer unique opportunities for a company to enhance its ESG profile. The IRA created new categories of energy tax credits and made them transferrable to any companies to offset their US tax liabilities. All US companies can now take part in the new energy market by buying tax credits, which enable new energy projects to get off the ground or to continue, which would have not been possible without the tax credits. All companies should investigate the connection between its ESG strategy and the new energy tax credits to see if there are synergies and alignment.
In summary, a board director should approach tax with an ESG lens and require strategy and accountability from their senior executives.
ABOUT YANG YE
Yang Ye is currently VP of Finance and Tax, General Tax Counsel, Kidneycare at Baxter International Inc (NYSE: BAX). He is a member of the Private Director Association (“PDA”) and serves as a board member and Audit Committee Chair at Marnita’s Table. Previously he also served as board director at a number of companies located in the Netherlands and Luxembourg.
Disclaimer: The views and opinions expressed in this blog are solely those of the authors providing them and do not necessarily reflect the views or positions of the Private Directors Association, its members, affiliates, or employees.