States are now taking time to think about how to address the most complicated provisions of the 2017 federal tax act (Pub. L. No. 115-97), which are the most substantial changes to the U.S. tax system since 1986. Among the top issues are those concerning income earned by multinational companies.
In this interview, Todd Betor, a senior associate with Eversheds Sutherland’s state and local tax group and recent author of an article for Bloomberg’s Daily Tax Report: State on the state and local tax impact of the 2017 federal tax act’s international tax provisions, discusses the potential challenges arising from a state-level taxation of global intangible low-taxed income (GILTI) and a base erosion and anti-abuse tax (BEAT) imposed on U.S. taxpayers.
Bloomberg Tax: In your Bloomberg article, you discuss GILTI, which essentially leads to base expansion without a rate deduction at the state level. How do you think states will respond with respect to GILTI?
Betor: Given the mix of responses from states thus far, it is difficult to predict how, if at all, a state will conform to GILTI. The responses have ranged from full decoupling of GILTI (both I.R.C. §§ 951A and 250) to conforming to the income inclusion for GILTI under I.R.C. § 951A, but requiring taxpayers to add back to income the amount of GILTI deducted under I.R.C. § 250. The latter response, which has received strong push-back from taxpayers, is one that we have seen states affirmatively make (e.g., Idaho), but is also a default response in those states conforming to I.R.C. § 951A where their starting point for calculating state taxable income is federal taxable income before special deductions—on the assumption that I.R.C. § 250 will be a special deduction. Regardless of how a state chooses to respond to GILTI, it may not be the final say on GILTI. For example, we have seen Georgia go from enacting legislation that would include GILTI in state taxable income to enacting legislation providing for the full exclusion of GILTI in less time than it has taken other states to simply release a statement that they are evaluating the impact of the TCJA.
Another piece to states’ responses to GILTI is how GILTI will interact, if at all, with their existing foreign dividends received deduction (DRD) or other subtraction modification for foreign source income. For example, a state may require taxpayers to include GILTI within their state tax base, but then provide a subtraction modification for all or a portion of GILTI.
Bloomberg Tax: How can corporate taxpayers change their business tax structures to mitigate the effects of GILTI in states that conform to both GILTI and the GILTI deduction (I.R.C. § 951A and I.R.C. § 250)? Same question, but as it pertains to states that conform to GILTI under I.R.C. 951A but do not conform to the GILTI deduction under I.R.C. 250?
Betor: Taxpayers would be wise to proceed with extreme caution in making any business tax structure changes to respond to a state’s treatment of GILTI. There is no universal answer and changing for one state could lead to unwanted results in another.
Bloomberg Tax: Can you explain the significance of the Kraft decision and how GILTI factors in? Would a GILTI or BEAT at the state level lead to treatment of domestic commerce more favorably than foreign commerce?
Betor: In Kraft, the U.S. Supreme Court found that Iowa’s inclusion of dividends from foreign subsidiaries, but not from domestic subsidiaries, in a taxpayer’s apportionable income tax base unconstitutionally discriminated against foreign commerce. States may thus run afoul of Kraft by including GILTI in a taxpayer’s apportionable income tax base where there is not a similar income inclusion from domestic subsidiaries.
Taxpayers that do not have international operations likely do not get hit by the international tax provisions of the TCJA. Those taxpayers that do fall under the purview of these provisions can reduce their effects at the detriment to their foreign operations. Because of that, someone could say that GILTI or a state level BEAT leads to the treatment of domestic commerce more favorably than foreign commerce. However, the answer is not that easy.
Bloomberg Tax: What are the potential constitutionality and conformity issues of GILTI in a separate versus combined reporting state?
Betor: Kraft issues are likely more apparent in separate reporting states, where the income of domestic subsidiaries is not included in a taxpayer’s tax base. With respect to conformity issues, there is likely to be increased complexity in determining the amount of GILTI attributable to separate taxpayers.
Bloomberg Tax: What can states do in terms of factor relief or GILTI relief? Would a state tax on a repatriated amount lead to distortion? Is it an extraterritorial tax?
Betor: States that require taxpayers to include GILTI in their state income tax base could permit taxpayers to include in their apportionment factors amounts from CFCs. Alternatively, states could provide for a subtraction modification in-line with their treatment of foreign-dividends and/or subpart F income. Whether a tax on GILTI is distortive is going to be case-by-case, but I think we will see strong arguments made that it is.
Bloomberg Tax: What are your thoughts on why more states have not published guidance?
Betor: I think states are taking their time to consider the full impact of the changes to the federal tax code made by the TCJA, including GILTI. These are the most significant changes to the federal tax code in over 30 years and we are still waiting on the IRS for guidance.
Bloomberg Tax: When do you expect that states will update their conformity to key provisions?
Betor: We will likely to see the focus of states’ conformity continue to be on those provisions that are effective for 2017, e.g., the transition tax in I.R.C. § 965. However, with most state legislatures out of session now, we will likely not see any updates until their fall legislative sessions, unless a special session is called before then.
Bloomberg Tax: Are there any states you expect will take a nontraditional approach to conformity to the new provisions?
Betor: There really has not been a traditional approach taken by states in conforming to the TCJA provisions. With that said, we will likely see those selective conformity states provide an interesting mix of conformity to the provisions.
Bloomberg Tax: What do you think the compliance burden will look like for states that do not conform to the I.R.C.?
Betor: It is likely that taxpayers will see some increase to their compliance burden in those states that do not conform to the revised I.R.C. However, given the mix of how states are conforming to the new provisions, the compliance burden for each state is likely to increase regardless.
Bloomberg Tax: What are your predictions with respect to states’ conformity to federal tax reform?
Betor: My only prediction is that states will continue to be unpredictable in their conformity.
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Should states adopt state-level taxation of GILTI and/or conform to the federal BEAT provision?
For more information on the impact of Pub. L. No. 115-97, examine Bloomberg Tax’s Tax Reform Roadmap, showing detailed comparisons between pre-reform law and impending changes, with pertinent cites attached.
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