CONTENTS
Page
INTRODUCTION AND SUMMARY ........................................................................................... 1
I. GENERAL OVERVIEW OF U.S. CORPORATE INCOME TAX................................... 2
A. Taxable Income ............................................................................................................ 2
1. In general ................................................................................................................ 2
2. Income recognition ................................................................................................. 3
3. Expense recognition ................................................................................................ 6
4. Recovery of capital expenditures .......................................................................... 11
5. U.S. tax rules applicable to foreign activities of U.S. taxpayers .......................... 15
B. Corporate Tax Liability .............................................................................................. 17
1. In general .............................................................................................................. 17
2. Corporate alternative minimum tax ...................................................................... 17
3. Tax credits............................................................................................................. 19
4. Excise taxes........................................................................................................... 21
II. OVERVIEW OF SELECT ISSUES OF U.S. TAXATION OF CROSS-BORDER
ACTIVITY ........................................................................................................................ 26
A. Select U.S. Tax Rules Common to Inbound and Outbound Taxation........................ 26
1. Residence .............................................................................................................. 26
2. Entity classification............................................................................................... 27
3. Source of income rules.......................................................................................... 28
4. Transfer pricing..................................................................................................... 29
B. Select U.S. Tax Rules Applicable to Foreign Activities of U.S. Taxpayers .............. 34
1. Subpart F income .................................................................................................. 34
2. GILTI .................................................................................................................... 38
3. Foreign tax credit .................................................................................................. 40
4. Dividends-received deduction .............................................................................. 42
5. FDII ....................................................................................................................... 43
6. Gain recognition on outbound transfers of intangible property ............................ 45
C. OECD Two-Pillar Solution ........................................................................................ 47
1. Pillar One .............................................................................................................. 48
2. Pillar Two.............................................................................................................. 53
III. ECONOMIC ANALYSIS ................................................................................................ 59
A. Introduction ................................................................................................................ 59
1. Global economic environment .............................................................................. 59
2. Neutrality conditions and their limits ................................................................... 61
3. Evaluating international tax rules based on behavioral margins .......................... 62
B. Location of Reported Profits and Transfer Pricing .................................................... 63
1. Background ........................................................................................................... 63
2. Location of reported profits .................................................................................. 63
3. Transfer pricing..................................................................................................... 64i

4. Implications for the effect of U.S. international tax rules on U.S.
pharmaceutical companies .................................................................................... 65
C. Location of Intangible Property and the Returns to Intangible Investment ............... 68
1. Background ........................................................................................................... 68
2. Location of intangible property ............................................................................ 68
3. Returns to intangible investment (patent boxes and research activity)................. 69
4. Implications for the effect of U.S. international tax rules on U.S.
pharmaceutical companies .................................................................................... 70
IV. TRENDS IN U.S. PHARMACEUTICAL FOREIGN- AND U.S.-SOURCEINCOME AND ACTIVITIES .......................................................................................... 71
A. Worldwide and U.S. GAAP Average Tax Rates for Large Corporations .................. 71
B. Corporate Tax Return Information for Large Pharmaceutical Companies ................ 74
C. Foreign Income and Taxes ......................................................................................... 83
D. Domestic and Foreign Activity as Reported on Country-by-Country Form 8975 ..... 85
APPENDIX A: SELECTION OF DIGITAL SERVICE TAXES ............................................... 90
APPENDIX B: SELECTION OF COUNTRIES ADOPTING PILLAR TWO .......................... 93ii

INTRODUCTION AND SUMMARYThe Senate Committee on Finance has scheduled a public hearing on May 11, 2023, titled“Cross-border Rx: Pharmaceutical Manufacturers and U.S. International Tax Policy.” This
document, 1 prepared by the staff of the Joint Committee on Taxation, describes legal andeconomic background on U.S. taxation of U.S. multinational corporations and their cross-borderactivities.
Part I includes a general overview of present law relating to U.S. corporate income
taxation, with a focus on selected provisions relevant to U.S.-based pharmaceutical companies.
Part II provides a summary of select issues of U.S. taxation of cross-border activity.
Subpart A describes select U.S. tax rules common to multinational corporations, subpart B is a
general overview of select U.S. tax rules applicable to foreign activities of U.S. taxpayers, andsubpart C provides a high-level overview of the latest status of the Organisation for Economic
Cooperation and Development’s two-pillar solution.
Part III provides an analysis of recent economic literature that addresses cross-bordertaxation.
Part IV analyzes data based on U.S. corporate tax filings from 2014 through 2020 toprovide insight on trends in U.S. pharmaceutical foreign- and U.S.-source income and activities.

This document may be cited as follows: Joint Committee on Taxation, Present Law and Economic
Background Relating to Pharmaceutical Manufacturers and U.S. International Tax Policy (JCX-8-23),
May 9, 2023. This document can be found on the Joint Committee on Taxation website at www.jct.gov.
11

I. GENERAL OVERVIEW OF U.S. CORPORATE INCOME TAX
Corporations organized under the laws of any of the 50 States or the District of Columbia
generally are subject to the U.S. corporate income tax on their U.S.-source and certain foreignsource income. 2 Foreign corporations generally are subject to the U.S. corporate income tax
only on income that is effectively connected with a U.S. trade or business.
A. Taxable Income
1. In general
The taxable income of a corporation generally is its gross income less allowabledeductions, computed based on the corporation’s methods of accounting. Large C corporations(i.e., those with average annual gross receipts for the three-taxable-year period ending with theprior taxable year that exceed $29 million (for 2023 3)) are generally required to use an accrual
method of accounting. 4 Under the accrual method of accounting, items of income generally
accrue when all the events have occurred that fix the right to receive the income and the amountof the income can be determined with reasonable accuracy, but no later than the taxable year inwhich such income is included as revenue for financial reporting purposes. 5 Items of expense
generally may not be deducted prior to when all the events have occurred that fix the obligation
to pay the liability, the amount of the liability can be determined with reasonable accuracy, andeconomic performance has occurred. 6
For businesses involving the sale of property to others (e.g., drug manufacturers), grossincome is total sales less the cost of goods sold, plus any income from investment and fromincidental or outside sources. 7 Gross income is determined on an annual or taxable year basiswith the amount of each item of gross income (e.g., total sales) for the taxable year determined
under the taxpayer’s method of accounting for each item. 8 In determining gross income, theUnder subchapter S of the Internal Revenue Code of 1986, as amended (the “Code”), a small businesscorporation may elect not to be subject to the corporate income tax (i.e., may make an “S corporation election”). If
an S corporation election is made, the income of the corporation flows through to the shareholders and is taxable
directly to them.
2

3Sec. 3.31 of Rev. Proc. 2022-38, 2022-45 I.R.B. 445.

4Sec. 448. Special methods of accounting that provide an exception to the all events test may apply(e.g., special methods for long term contracts subject to section 460). Unless otherwise indicated, all sectionreferences are to the Code.
5

Sec. 451.

6

Sec. 461.

7

Treas. Reg. sec. 1.61-3(a).

See Automobile Club of New York, Inc. v. Commissioner, 32 T.C. 906, 914 (1959), aff’d 304 F.2d 781(2 Cir. 1962) (“…net income under the statute is computed on an annual basis, and…there is no necessary
correlation in any given year between receipts and expenses. Expenses with respect to income not yet earned are
8

nd

2

amount of total sales included as an item of gross income is determined in accordance with the
taxpayer’s method of accounting under the income recognition rules. 9
2. Income recognition
An accrual method taxpayer generally includes sales, gross receipts, and other items ofgross income that have been realized in income no later than the taxable year in which suchincome is included as revenue for book purposes. Advance payments received for the sale ofgoods, services, or certain other items of income may generally only be deferred using a oneyear deferral method. 10 An advance payment generally occurs when a taxpayer receives
payment before the taxpayer provides goods, services, or other items to its customer.
Reduction for cost of goods soldAs previously noted, for businesses involving the sale of property, in determining grossincome for the taxable year, sales are reduced by cost of goods sold. The amount of cost of
goods sold included as a subtraction from total sales is determined in accordance with the
taxpayer’s methods of accounting for items included in cost of goods sold. 11 An amount may
not be taken into account in the computation of cost of goods sold, and thus reduce total sales,
any earlier than the taxable year in which economic performance occurs with respect to suchamount. 12 Once economic performance occurs, amounts may only be taken into account in thecomputation of cost of goods sold if they are not required to be capitalized and are not subject toany other provision of the Code that requires the deduction to be taken in a taxable year later
than the year when economic performance occurs.

deductible when paid or accrued; and conversely, income is reportable when received or accrued, notwithstandingthat some, or even all, expenses allocable thereto have not yet been incurred”); and Hagen Advertising Displays, Inc.
v. Commissioner, 47 T.C. 139 (1966), aff’d 407 F.2d 1105 (6th Cir. 1969) (“Nothing in [Treas. Reg. sec. 1.61-3(a)]suggests that an attempt must be made to match a particular purchase with a particular sale or a particular item ininventory”).
9

Sec. 451.

10

Sec. 451(c); Treas. Reg. sec. 1.451-8(c).

11Treas. Reg. sec. 1.61-3(a). See, e.g., secs 263A, 461(h), and 471. See also, e.g., line 2 of Form 1120,
Form 1120S, or Form 1065, as well as Form 1125-A. A taxpayer’s gross profit is generally determined bysubtracting returns and allowances and cost of goods sold from gross receipts or sales. See line 3 of Form 1120,
Form 1120S, or Form 1065.

Treas. Reg. secs. 1.61-3(a), 1.263A-1(c)(2)(ii), and 1.446-1(c)(1)(ii). For a liability that arises out of theprovision of services or property to the taxpayer by another person, economic performance occurs as the otherperson provides such services, as the other person provides such property, or as the taxpayer uses such property. Fora liability that requires the taxpayer to provide property to others, economic performance occurs as the taxpayer
provides the property to the other person. Sec. 461(h)(2)(A) and (B). A liability includes any item allowable as adeduction, cost, or expense for Federal income tax purposes. In addition to allowable deductions, the term includes
any amount otherwise allowable as a capitalized cost, as a cost taken into account in computing cost of goods sold,as a cost allocable to a long-term contract, or as any other cost or expense. See Treas. Reg. secs. 1.4461(c)(1)(ii)(B) and 1.461-4(c)(1).
12

3

Accounting for inventories
In general, for Federal income tax purposes, taxpayers must account for inventories if the
production, purchase, or sale of merchandise is a material income-producing factor to thetaxpayer. 13 In those circumstances in which a taxpayer is required to account for inventory, thetaxpayer must maintain inventory records to determine the cost of goods sold during the taxable
period. 14 Cost of goods sold generally is determined by adding the taxpayer’s inventory at the
beginning of the period to the purchases made during the period and subtracting from that sum
the taxpayer’s inventory at the end of the period. 15 Because of the difficulty of accounting for
inventory on an item-by-item basis, taxpayers often use conventions that assume certain item orcost flows. Among these conventions are the first-in, first-out (“FIFO”) method, which assumes
that the items in ending inventory are those most recently acquired by the taxpayer, 16 and thelast-in, first-out (“LIFO”) method, which assumes that the items in ending inventory are thoseearliest acquired by the taxpayer. 17
FIFO valuation methods
Treasury regulations provide that taxpayers that maintain inventories under section 471
may determine the value of ending inventory under the cost method or the lower-of-cost-ormarket (“LCM”) method. 18 Under the LCM method, the value of each article in ending
inventory is written down if its market value is less than its cost. 19 Additionally, subnormal
goods, defined as goods that are unsalable at normal prices or in the normal way because ofdamage, imperfections, shop wear, changes of style, odd or broken lots, or similar causes, may
be written down to bona fide net selling price, under either the cost or LCM method. 20

13
Sec. 471(a); Treas. Reg. sec. 1.471-1. Taxpayers with average annual gross receipts for the threetaxable-year period ending with the prior taxable year that do not exceed $29 million (for 2023) are not required toaccount for inventories under section 471, but rather may either account for inventories as nonincidental materials
and supplies or conform to their financial accounting treatment of inventories. See sec. 471(c).
14Treas. Rec. sec. 1.471-2(e).

15See, e.g., Form 1125-A, Cost of Goods Sold.

16

Treas. Rec. sec. 1.471-2(d).

17Sec. 472; Treas. Reg. secs. 1.472-1 to 1.472-8.

18
Treas. Reg. sec. 1.471-2(c). See Treas. Reg. sec. 1.471-3 for the rules on valuing inventories under thecost method, and Treas. Reg. sec. 1.471-4 for the rules on valuing inventories under the LCM method. Taxpayers
valuing their inventory under section 472 (using a LIFO method) must maintain such inventories at cost.
19

Treas. Reg. sec. 1.471-4(c).

20Treas. Reg. sec. 1.471-2(c).

4

LIFO
Under the LIFO method, it is assumed that the last items entered into inventory are thefirst items sold. 21 Because the most recently acquired or produced units are deemed to be soldfirst, cost of goods sold is valued at the most recent costs; the effect of cost fluctuations isreflected in the ending inventory, which is valued at the historical costs rather than the mostrecent costs. 22 Compared to FIFO, LIFO produces net income that more closely reflects thedifference between sale proceeds and current market cost of inventory. When costs are rising,the LIFO method results in a higher measure of cost of goods sold and, consequently, a lower
measure of income when compared to the FIFO method. The inflationary gain experienced by
the business in its inventory generally is not reflected in income, but rather, remains in ending
inventory as a deferred gain until a future period in which the quantity of items sold exceeds
purchases. 23
Section 263A
Section 263A and the regulations thereunder require that direct costs and certain indirect
costs incurred by the taxpayer (i.e., costs for which economic performance has occurred) must be
capitalized and included in the basis of property produced or acquired for resale by the taxpayer
with the capitalized costs recovered by including such amounts in cost of goods sold when theunderlying inventory or property is sold. 24 Capitalizable indirect costs include royalty payments
incurred by reason of production or resale activities (commonly referred to as “sales-based
royalties”). 25 Sales-based royalties, which are common in the pharmaceutical industry, may
either be (i) entirely allocated to property produced or acquired for resale by the taxpayer that has
been sold (i.e., deducted as cost of goods sold in the taxable year of sale), or (ii) allocatedbetween cost of goods sold and ending inventory. 26

21

Sec. 472(b).

22
Thus, in periods during which a taxpayer produces or purchases more goods than the taxpayer sells (aninventory increment), a LIFO method taxpayer generally records the inventory cost of such excess (and separately
tracks such amount as the “LIFO layer” for such period), adds it to the cost of inventory at the beginning of theperiod, and carries the total inventory cost forward to the beginning inventory of the following year. See Sec.
472(b); Treas. Reg. sec. 1.472-1.

Accordingly, in periods during which the taxpayer sells more goods than the taxpayer produces orpurchases (an inventory decrement), a LIFO method taxpayer generally determines the cost of goods sold of theamount of the decrement by treating such sales as occurring out of the most recent LIFO layer (or most recent LIFO
layers, if the amount of the decrement exceeds the amount of inventory in the most recent LIFO layer) in reverse
chronological order.
23

24

Sec. 263A; Treas. Reg. sec. 1.263A-1(c)(4).

25

Treas. Reg. sec. 1.263A-1(e)(3)(ii)(U).

Treas. Reg. sec. 1.263A-1(e)(3)(ii)(U)(2). See also Treas. Reg. sec. 1.263A-1(c)(5) and Rev. Proc.
2014-33, 2014-22 I.R.B. 1060.
2653. Expense recognition
As noted above, items of expense generally may not be deducted by an accrual method
taxpayer prior to when all the events have occurred that fix the obligation to pay the liability, theamount of the liability can be determined with reasonable accuracy, and economic performancehas occurred. 27 Allowable deductions include ordinary and necessary business expenditures, 28
such as salaries, wages, contributions to qualified retirement plans and certain other employee
benefit programs, repairs, bad debts, taxes (other than Federal income taxes), contributions tocharitable organizations (subject to an income limitation), advertising, interest expense (subject
to limitation), certain losses, selling expenses, and other expenses. In the event these deductions
exceed gross income, a net operating loss (“NOL”) deduction may be allowed in other years, as
described below. Deductions are also allowed for certain amounts despite the lack of a direct
expenditure by the taxpayer. For example, a deduction is allowed for all or a portion of theamount of dividends received by a corporation from another corporation (provided certain
ownership requirements are satisfied). 29
Expenditures that produce benefits in future taxable years for a taxpayer’s business or
income-producing activities (such as the purchase of plant and equipment) generally arecapitalized 30 and recovered over time through depreciation, amortization, or depletion
allowances. 31 In some instances, taxpayers can recover their costs more quickly than under thegeneral rules. An additional first-year depreciation deduction is allowed equal to up to 100
percent of the adjusted basis of qualified property. 32
Certain expenditures may not be deducted, such as dividends paid to shareholders,expenses associated with earning tax-exempt income, 33 certain meal and entertainment

27

Sec. 461.

28

Sec. 162.

29

Sec. 243.

30

Sec. 263.

31

See, e.g., secs. 167, 168, 197, and 611.

Sec. 168(k). The 100-percent allowance is subject to a phasedown in 2023 through 2026 (2024 through2027 for certain longer-lived and transportation property). Sec. 168(k)(6).
32

For example, the carrying costs of tax-exempt State and local obligations (see sec. 265) and thepremiums on certain life insurance policies are not deductible (see sec. 264).
33

6

expenses, 34 certain qualified transportation fringe and commuter benefits, 35 certain highly
compensated employee remuneration in excess of $1 million per year, 36 a portion of the intereston certain high-yield debt obligations that resemble equity, 37 as well as fines, 38 penalties, 39
bribes, 40 kickbacks, 41 illegal payments, 42 and settlements subject to nondisclosure agreements
paid in connection with sexual harassment or abuse. 43
Certain allowable deductions commonly incurred in the pharmaceutical industry
Rebates and chargebacks
In the United States, sales discounts for pharmaceuticals are generally issued tocustomers at the point-of-sale, through an intermediary wholesaler/distributor in the form of achargeback, or in the form of rebates through contractual or legal agreements with the private
and public sector (e.g., Medicaid and Medicare Part D). 44 The liability to pay a chargeback or
rebate is generally deductible when paid by the taxpayer to the wholesaler/distributor. 45
However, an accrual method taxpayer who has adopted the recurring item exception method of
accounting for its chargeback or rebate liabilities may generally deduct such liabilities for which
it has a fixed and determinable liability by the end of its taxable year (i.e., the taxable year of thesale to the end customer) if it pays the wholesaler/distributor by the earlier of the date the it files
a timely income tax return (including extensions) for such taxable year or the 15th day of theGenerally, deductions are prohibited with respect to entertainment, amusement, or recreation. Sec. 274.
In addition, a deduction for any expense for food or beverages is generally limited to 50 percent of the amountotherwise deductible. Sec. 274(n). There are exceptions to the general rule limiting deductions for food or beverage
expenses to 50 percent of the otherwise deductible amount, including an exception for expenses for food orbeverages provided by a restaurant and paid or incurred after 2020 and before 2023. Sec. 274(n)(2)(D).
34

35
Employers are disallowed deductions for expenses associated with providing qualified transportation
fringe benefits unless amounts are reported and properly included in employee compensation (see sec. 274(a)(4) and(e)(2)) and are disallowed deductions for other commuter benefits generally (see sec. 274(l)).
36Sec. 162(m).

37Sec. 162(e)(5).

38

Sec. 162(f).

39

Ibid.

40

Sec. 162(c).

41

Ibid.

42

Ibid.

43

Sec. 162(q).

44

See Rev. Rul. 2008-26, 2008-21 I.R.B. 985; Field Attorney Advice (“FAA”) 20121602F (Apr. 20,

45

See sec. 461; Treas. Reg. secs. 1.461-1 and 1.461-4(g)(3).

2012).

7

ninth calendar month following the close of such taxable year (e.g., by September 15, 2023, forthe 2022 calendar taxable year). 46
Alternatively, Medicaid rebates paid to State agencies by pharmaceutical manufacturers
under the Medicaid Rebate Program are generally treated as purchase price adjustments that are
subtracted from gross receipts. 47 Medicaid rebates are made with the purpose of reaching anagreed-upon selling price for drugs that are negotiated before the sale takes place and is treatedas an adjustment to the manufacturer’s gross receipts. However, the Internal Revenue Service(“IRS”) generally limits this treatment to Medicaid rebates that a pharmaceutical manufacturer
pays pursuant to the Medicaid Rebate Program. 48
Income tax treatment of employer stock transferred to an employee
Specific rules apply to property, including employer stock, transferred to an employee inconnection with the performance of services. 49 These rules govern the amount and timing ofincome inclusion by the employee and the amount and timing of the employer’s compensation
deduction. In the case of stock transferred to an employee, the employer is generally allowed adeduction (to the extent a deduction for a business expense is otherwise allowable) equal to theamount included in the employee’s income as a result of transfer of the stock. 50 An employee
generally must recognize income for the taxable year in which the employee’s right to the stock
is first substantially vested (i.e., the earlier of when the stock is transferable or not subject to a
substantial risk of forfeiture). 51 Thus, if the employee’s right to the stock is substantially vested
when the employee receives the stock (e.g., a bonus stock award), income is recognized (and acorresponding employer deduction is generally allowed) for the taxable year in which received.
If the employee’s right to the stock is not substantially vested at the time of receipt (e.g., a
restricted stock award or restricted stock unit), income is generally recognized (and acorresponding employer deduction is generally allowed) for the taxable year in which theemployee’s right becomes substantially vested. 52 The amount includible in the employee’s
46

See sec. 461(h) and Treas. Reg. sec. 1.461-5. See also FAA 20121602F (Apr. 20, 2012).

47

See Rev. Rul. 2008-26, 2008-21 I.R.B. 985.

48

Ibid.

49

Sec. 83.

Sec. 83(h). The deduction is allowed for the employer’s taxable year in which or with which ends thetaxable year for which the amount is included in the employee’s income. The amount of the deduction may belimited by section 162(m) if the stock is granted to a covered employee (as defined in section 162(m)(3)), and it
could be subject to capitalization under section 263A if, for example, the stock is granted to an employee involved in
production activities.
50

51

See section 83(c) for the definition of substantial risk of forfeiture.

Under section 83(b), if an employee’s right to the stock is property is not substantially vested at the timeof receipt, the employee may nevertheless elect within 30 days of receipt to recognize income for the taxable year ofreceipt. The employee makes an election by filing with the IRS a written statement that includes the fair market
value of the property at the time of receipt and the amount (if any) paid for the property. The employee must also
52

8

income is the excess of the fair market value of the stock over the amount, if any, paid for thestock. 53
Limitation on deduction for interest
The amount allowed as a deduction for business interest for a taxable year is generally
limited to the sum of: (1) the business interest income of the taxpayer for the taxable year,(2) 30 percent of adjusted taxable income of the taxpayer for the taxable year (not less than zero),and (3) the floor plan financing interest of the taxpayer for the taxable year. 54 Thus, other thanfloor plan financing interest, business interest expense in excess of business interest income isgenerally deductible only to the extent of 30 percent of adjusted taxable income. 55 The amountof any business interest expense not allowed as a deduction for any taxable year may be carriedforward indefinitely. The limitation generally applies at the taxpayer level (although special
carryforward rules apply in the case of partnerships). In the case of a group of affiliatedcorporations that file a consolidated return, the limitation applies at the consolidated tax return
filing level. 56
Adjusted taxable income for purposes of section 163(j) generally means the taxable
income of the taxpayer (A) computed without regard to (i) any item of income, gain, deduction,or loss that is not properly allocable to a trade or business; (ii) any business interest or businessinterest income; (iii) the amount of any net operating loss deduction; (iv) the amount of any
deduction allowed under section 199A; and (v) in the case of taxable years beginning before
January 1, 2022, any deduction allowable for depreciation, amortization, or depletion; andprovide a copy of the statement to the employer. A section 83(b) election is available with respect to grants ofrestricted stock (i.e., nonvested stock), and does not generally apply to the grant of options. Alternatively, under
section 83(i), certain employees of privately held corporations may make an election to defer income that would
otherwise be recognized under section 83(a) upon the exercise or settlement of qualified equity grants. For a
description of section 83(i), see Joint Committee on Taxation, General Explanation of Public Law No. 115-97 (JCS1-18), December 2018, pp. 266-276. See also IRS Notice 2018-97, 2018-52 I.R.B. 1062 (providing guidance on thesection 83(i) election).
53

Sec. 83(a). See Treas. Reg. sec. 1.83-7(a) for rules governing the taxation of nonqualified stock options.

Sec. 163(j). Taxpayers with average annual gross receipts for the three-taxable-year period ending withthe prior taxable year that do not exceed $29 million (for 2023) and certain regulated public utilities are not subject
to this limitation. Sec. 163(j)(7)(A)(iv). Taxpayers in real property or farming trades or businesses (as defined in
section 163(j)(7)(B) and (C)) may elect not to be subject to this limitation.
54

For taxable years beginning in 2019 or 2020, the limitation was 50 percent. Sec. 163(j)(10)(A)(i). In
addition, a taxpayer could elect to substitute its 2019 adjusted taxable income for its 2020 adjusted taxable income.
Sec. 163(j)(10)(B). For a detailed description of section 163(j) and the special rules applicable to taxable years
beginning in 2019 and 2020, see Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in
the 116th Congress (JCS-1-22), February 2022, pp. 335-340.
55

See Treas. Reg. sec. 1.163(j)-4(d) (providing that a consolidated group has a single section 163(j)limitation and generally treating all members of the consolidated group as a single taxpayer for section 163(j)purposes).
56

9

(B) computed with such other adjustments as provided by the Secretary. 57 For taxable years
beginning after December 31, 2021, adjusted taxable income for purposes of the section 163(j)limitation on business interest is computed with regard to any deduction for depreciation,amortization, or depletion. 58
Charitable contributions of inventory
In general, an income tax deduction is permitted for charitable contributions, subject tocertain limitations that depend on the type of taxpayer, the property contributed, and the doneeorganization. 59 Charitable contributions of cash are deductible in the amount contributed.
Subject to several exceptions, contributions of property are deductible at the fair market value ofthe property. One exception provides that the amount of the charitable contribution is reducedby the amount of any gain which would not have been long-term capital gain if the property
contributed had been sold by the taxpayer at its fair market value at the time of thecontribution. 60 As a result of this exception, a taxpayer’s deduction for charitable contributionsof inventory generally is limited to the lesser of the taxpayer’s basis in the inventory or the fairmarket value of the inventory. However, for certain contributions of inventory, a C corporation
may claim an enhanced deduction equal to the lesser of (1) basis plus one-half of the item’s
appreciation (i.e., basis plus one-half of the fair market value in excess of basis), or (2) two times
basis. 61 To be eligible for the enhanced deduction, the contributed property generally must be
inventory of the taxpayer, contributed to a charitable organization described in section 501(c)(3)(except for private nonoperating foundations), and the donee must (1) use the property consistent
with the donee’s exempt purpose solely for the care of the ill, the needy, or infants; (2) nottransfer the property in exchange for money, other property, or services; and (3) provide thetaxpayer a written statement that the donee’s use of the property will be consistent with suchrequirements. 62 In the case of contributed property subject to the Federal Food, Drug, andCosmetic Act, as amended (e.g., drugs, medical devices, etc.), the property must satisfy theapplicable requirements of such Act on the date of transfer and for 180 days prior to thetransfer. 63 In addition, if a taxpayer contributes inventory at a time when it could not reasonably
expect to realize its usual selling price (e.g., a donation of drugs close to their expiration date),

57

Sec. 163(j)(8).

58

Sec. 163(j)(8)(v).

59

Sec. 170.

60

Sec. 170(e)(1)(A).

61

Sec. 170(e)(3)(B).

62

Sec. 170(e)(3)(A)(i) to (iii).

Sec. 170(e)(3)(A)(iv). The Federal Food, Drug, and Cosmetic Act and subsequent amending statutes arecodified into Title 21, Chapter 9, of the U.S. Code.
63

10

the value of the item is not its usual selling price, but rather the amount for which the item would
have been sold at the time of the contribution. 64
Charitable contributions by a C corporation generally may not exceed 10 percent of thecorporation’s taxable income for the taxable year. 65 Excess contributions may be carriedforward for up to five taxable years. 66 Thus, the enhanced deduction may be limited, dependingon the corporation’s taxable income for the taxable year of the contribution.
NOL deduction
For NOLs arising in taxable years beginning after 2020, the NOL deduction is generally
limited to 80 percent of taxable income (computed without regard to the NOL deduction anddeductions under sections 199A and 250), and excess losses generally may be carried forward
indefinitely, but not back (with certain exceptions). 67
4. Recovery of capital expenditures
A taxpayer generally must capitalize the cost of property used in a trade or business orheld for the production of income and recover such cost over time through annual deductions fordepreciation or amortization. 68 The period for depreciation or amortization generally begins
when the asset is placed in service by the taxpayer. 69
Additional first-year depreciation deduction
An additional first-year depreciation deduction is allowed equal to 100 percent of theadjusted basis of qualified property acquired after September 27, 2017, and placed in service
before January 1, 2023 (January 1, 2024, for certain property with a recovery period of at least

Treas. Reg. sec. 1.170A-1(c)(3). See also Rev. Rul. 85-8, 1985-1 C.B. 59 (dealing with apharmaceutical manufacturer’s charitable contribution of products shortly before their expiration date).
64Sec. 170(b)(2)(A). In the case of sole proprietorships, S corporations, or partnerships (or other non-C
corporations), different limitations apply at the individual owner, shareholder, or partner (or member) level
depending on the type of recipient organization and property contributed. See sec. 170(b)(1).
65

66

Sec. 170(d)(2).

67
Sec. 172. For a discussion of the rules that apply to NOLs arising in taxable years beginning before
2021, see Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 116th Congress(JCS-1-22), February 2022, pp. 325-329.

Secs. 263(a) and 167. In general, only the tax owner of property (i.e., the taxpayer with the benefits andburdens of ownership) is entitled to claim tax benefits such as cost recovery deductions with respect to the property.
68

69

Treas. Reg. secs. 1.167(a)-3, 1.167(a)-10(b), 1.167(a)-11(e)(1)(i), 1.167(a)-14, and 1.197-2(f).

1110 years or certain transportation property, 70 and certain aircraft 71). 72 The 100-percent allowanceis phased down by 20 percent per calendar year for property acquired after September 27, 2017,and placed in service after December 31, 2022 (after December 31, 2023, for longer production
period property and certain aircraft). 73 This additional first-year depreciation is commonlyreferred to as “bonus depreciation.” 74
Amortization of certain intangible assets
A taxpayer generally must capitalize certain amounts paid to acquire or create an
intangible asset. 75 This includes amounts paid or incurred to acquire a patent, to obtain certain
rights from a government agency, and any transaction costs incurred to facilitate such amounts(e.g., legal fees). 76 Certain intangible assets are subject to 15-year straight-line amortization
under section 197 (“section 197 intangibles”). 77 Section 197 intangibles include, for example,
any patent, copyright, formula, process, design, pattern, knowhow, format, or similar item; anylicense, permit, or other right granted by a governmental unit; and any franchise, trademark, ortrade name. 78 However, certain rights acquired separately from the acquisition of assets
constituting a trade or business (or substantial portion thereof) are not subject to 15-year
amortization under section 197 and are instead subject to amortization under section 167,
depending on the type of interest or right separately acquired. 79 For example, an interest in apatent that is not acquired as part of the acquisition of a trade or business is not a section 197

Property qualifying for the extended placed-in-service date must have a recovery period of at least 10
years or constitute transportation property, have an estimated production period exceeding one year, and have a costexceeding $1 million. Transportation property generally is defined as tangible personal property used in the trade orbusiness of transporting persons or property. Sec. 168(k)(2)(B). Property defined in section 168(k)(2)(B) is
hereinafter collectively referred to as “longer production period property.”
70

71
Certain aircraft which is not transportation property, other than for agricultural or firefighting uses, also
qualifies for the extended placed-in-service date, if at the time of the contract for purchase, the purchaser made anonrefundable deposit of the lesser of 10 percent of the cost or $100,000, and which has an estimated production
period exceeding four months and a cost exceeding $200,000. Sec. 168(k)(2)(C).

Sec. 168(k). The bonus depreciation deduction is generally subject to the rules regarding whether a costmust be capitalized under section 263A.
72

73

Sec. 168(k)(6)(A) and (B).

For a detailed description of bonus depreciation, see Joint Committee on Taxation, Tax Incentives for
Domestic Manufacturing (JCX-15-21), March 12, 2021.
74

75

Treas. Reg. sec. 1.263(a)-4(c) and (d).

76Treas. Reg. sec. 1.263(a)-4(c)(1)(vii), (d)(5)(i), and (e).

77Sec. 197(a); Treas. Reg. sec. 1.197-2(f).

78Sec. 197(d)(1).

79

See sec. 197(e)(4) and Treas. Reg. sec. 1.167(a)-14.

12

intangible, but instead is generally amortized either over the patent’s remaining useful life orunder the income forecast method of section 167(g). 80
In the pharmaceutical industry, capitalizable amounts paid to obtain or facilitate agovernmental right include those amounts attributable to new drug applications (“NDA”) 81 andabbreviated new drug applications (“ANDA”) 82 filed with the U.S. Food and Drug
Administration (“FDA”) (e.g., legal fees incurred in connection with preparing the applications
and obtaining FDA approval). 83 Once approved by the FDA, an NDA or ANDA is generally
amortizable under section 197 (i.e., generally recovered ratably over a 15-year period, beginningon the first day of the month the FDA approval is obtained). 84 Similarly, the cost of acquiring apriority review voucher (“PRV”) from a third-party pharmaceutical company in order to expedite
the processing of an NDA filed with the FDA is generally required to be capitalized, and thenmay subsequently be amortized under section 197 beginning in the month that the FDA approves
the NDA. 85 Alternatively, if a taxpayer does not use a PRV to expedite the processing of an
NDA filed with the FDA and instead intends to resell it or hold it for investment, the cost of the
PRV is not amortizable, but rather will generally be recovered through the recognition of gain orloss when the taxpayer sells, transfers, or exchanges the PRV. 86
Pharmaceutical companies also generally incur significant legal expenses to defend
patent infringement litigation. While expenses to defend or perfect title to intangible property
are generally capitalizable, 87 patent infringement expenses are generally deductible as ordinary
80
Sec. 167(g)(6)(D); Treas. Reg. sec. 1.167(a)-14(c)(4). Under the income forecast method, a property’s
depreciation deduction for a taxable year is generally determined by multiplying the adjusted basis of the property
by a fraction, the numerator of which is the gross income generated by the property during the year, and thedenominator of which is the total forecasted or estimated gross income expected to be generated prior to the close of
the tenth taxable year after the year the property is placed in service. See sec. 167(g).

A drug manufacturer formally proposes that the FDA approve the new drug for sale and marketing in the
United States through an NDA. See, e.g., Actavis Laboratories FL Inc. v. United States, 161 Fed. Cl. 334 (2022)(“Actavis”); and Mylan, Inc. & Subsidiaries v. Commissioner, 156 T.C. 137 (2021) (“Mylan”).
81

82
A generic drug manufacturer may submit an ANDA that piggybacks on an approved brand name drug’s
NDA by specifying that the generic has the same active ingredients as, and is biologically equivalent to, the alreadyapproved brand name drug. See Actavis and Mylan, supra.

Sec. 263(a); Treas. Reg. sec. 1.263(a)-4(b)(1)(v), (c)(1)(viii), and (d)(5). See also, Actavis, supra;
Mylan, supra; and FAA 20114901F, September 14, 2011.
83

84

See Mylan, supra; and FAA 20114901F, September 14, 2011.

See IRS Chief Counsel Advice 202304009, December 22, 2022. The PRV Program accelerates theapproval and marketability of new treatments for certain neglected and rare diseases. See 21 U.S. Code secs. 360n(tropical diseases), 360ff (rare pediatric diseases), and 360bbb-4a (agents that present national security threats).
Congress most recently renewed expiring PRV Programs in sec. 321 of Title III of Subdivision BB of theConsolidated Appropriations Act, 2021, Pub. L. No. 116-260.
85

86

Ibid.

87

Treas. Reg. sec. 1.263(a)-4(d)(9).

13and necessary trade or business expenses to defend against gains or profits lost by the patent
owner. 88 For example, the Tax Court recently held in Mylan that legal expenses incurred by apharmaceutical manufacturer to defend against patent infringement lawsuits, including thoserelated to ANDAs filed by the taxpayer, are deductible ordinary and necessary business
expenses. 89 However, the IRS generally views NDA and ANDA litigation expenses ascapitalizable amounts paid to acquire, create, or facilitate an intangible asset (i.e., as costs
incurred in pursuing FDA approval of the NDA or ANDA), and has appealed the Tax Court’s
ruling in Mylan with respect to the treatment of such costs to the Third Circuit Court ofAppeals. 90
Capitalization and recovery of research and experimentation expenditures
For taxable years beginning after December 31, 2021, amounts defined as specified
research or experimental expenditures are required to be capitalized and amortized ratably over a
five-year period (15-year period for expenditures that are attributable to research that is
conducted outside of the United States 91), beginning with the midpoint of the taxable year inwhich the specified research or experimental expenditures were paid or incurred. 92 Specified
research or experimental expenditures subject to capitalization include expenditures for softwaredevelopment. 93 Specified research or experimental expenditures exclude expenditures for theacquisition or improvement of land or for depreciable or depletable property used in connection
with the research or experimentation, but do include the depreciation and depletion allowances of88

See Mylan and Actavis, supra, and Woodward v. Commissioner, 397 U.S. 572, 577 (1970).

Supra. In holding that the patent litigation expenses related to the ANDAs filed by the taxpayer weredeductible, the Tax Court noted that “[a]lthough the filing of an ANDA … triggers the opportunity for patent
litigation as well as the FDA review process, this statutory design does not transform the patent litigation into a stepin the ANDA approval process.” 156 T.C. at 156-157.
89

90

See Mylan v. Commissioner, No. 22-1193 (3rd Cir. 2022).

For this purpose, the term “United States” includes the United States, the Commonwealth of Puerto
Rico, and any possession of the United States. Sec. 174(a)(2)(B), by reference to 41(d)(4)(F).
91

Sec. 174(a). For taxable years beginning before January 1, 2022, taxpayers may elect to: (1) deduct
currently research or experimental expenditures (former sec. 174(a), prior to amendment by Public Law 115-97),(2) capitalize research or experimental expenditures and recover them ratably over the useful life of the research, but
in no case over a period of less than 60 months (former sec. 174(b), prior to amendment by Public Law 115-97), or(3) capitalize and amortize research or experimental expenditures over a period of 10 years (sec. 59(e)). The
election under section 59(e) to amortize research or experimental expenditures over a 10-year period does not apply
to research or experimental expenditures incurred in taxable years beginning after December 31, 2021. A technicalcorrection may be necessary to reflect this intent. Guidance published by the IRS is consistent with this intent. See
the 2022 Instructions for Form 4562, Depreciation and Amortization (Including Information on Listed Property), p.
15; and IRS Publication 535, Business Expenses, p. 36. See also, Joint Committee on Taxation, Technical
Explanation of the House Ways and Means Committee Chairman’s Discussion Draft of the “Tax Technical andClerical Corrections Act” (JCX-1-19), January 2, 2019, p. 7; and the “Tax Technical and Clerical Corrections Act”
Discussion Draft, p. 18, available.at https://republicanswaysandmeansforms house.gov/uploadedfiles/tax technical and clerical corrections act discussion draft.pdf (lastaccessed May 4, 2023).
92

93Sec. 174(c)(3).

14

such property. 94 Research or experimental expenditures also exclude the costs of acquiring
another person’s patent, model, production, or process (commonly referred to as “in-processR&D”). 95
In the case of retired, abandoned, or disposed property with respect to which specified
research or experimental expenditures are paid or incurred, any remaining basis may not berecovered in the year of retirement, abandonment, or disposal, but instead must continue to beamortized over the remaining amortization period. 96
5. U.S. tax rules applicable to foreign activities of U.S. taxpayers
In general, income earned directly by a U.S. person from the conduct of a foreign trade orbusiness is taxed currently, 97 while income earned indirectly through certain related foreign
entities (i.e., controlled foreign corporations (“CFCs”)) 98 is taxed in the year earned or not at all.
Indirect earnings of CFCs are generally taxable in one of two ways. First, the earnings may
constitute income to U.S. shareholders under the traditional anti-deferral regime of subpart F,
which applies to certain passive income and certain other related-party income that is readily
movable from one jurisdiction to another. 99 Second, the earnings may be subject to section
951A, which applies to some foreign-source income of a CFC that is not subpart F income(referred to as global intangible low-taxed income (“GILTI”)). Subpart F income is taxed at full
rates, while GILTI is taxed at preferential rates, both without regard to whether the income isdistributed to shareholders. The preferential rate on GILTI is achieved by means of allowing
corporations a 50-percent deduction (a “section 250 deduction”) on their GILTI (and the94Sec. 174(c)(1).

95

Treas. Reg. sec. 1.174-2(a)(6)(vi).

96Sec. 174(d).

97Such income is called foreign branch income. See sec. 904(d)(2)(J).

A CFC generally is defined as any foreign corporation in which U.S. persons own (directly, indirectly,
or constructively) more than 50 percent of the corporation’s stock (measured by vote or value), taking into accountonly “U.S. shareholders,” that is, U.S. persons that own at least 10 percent of the stock (measured by vote or value).
Secs. 951(b), 957, and 958. Special rules apply with respect to U.S. persons that are shareholders (regardless of
their percentage ownership) in any foreign corporation that is not a CFC but is a passive foreign investmentcompany (“PFIC”). See secs. 1291 through 1298. The PFIC rules generally seek to prevent the deferral of passive
income through the use of foreign corporations.
9899

Subpart F comprises sections 951 through 965.

15

corresponding section 78 gross up amount). 100 A foreign tax credit generally is available tooffset, in whole or in part, the U.S. tax owed on foreign-source income. 101
Foreign earnings not subject to tax as subpart F income or GILTI generally are exempt
from U.S. tax. To exempt those earnings, dividends received by corporate U.S. shareholders
from specified 10-percent owned foreign corporations (including CFCs) generally are eligible fora 100-percent dividends-received deduction (“DRD”). 102
For a deeper discussion of select issues, see Part II.B. below.

100
Sec. 250(a)(1)(B). The section 250 deduction for GILTI is only available for C corporations that areneither regulated investment companies (“RICs”) nor real estate investment trusts (“REITs”). The section 250
deduction also applies with respect to foreign-derived intangible income of certain corporations, discussed in moredetail below.

Foreign tax credits limited in a tax year generally may be carried back one year or forward 10 years.
Sec. 904(c). In contrast with the general rules allowing carrybacks and carryovers of excess foreign tax credits, nocarrybacks or carryovers of excess foreign tax credits are allowed in the GILTI foreign tax credit limitation
category. In addition, a 20-percent foreign tax credit disallowance applies to foreign income taxes paid with respect
to GILTI. Sec. 960(d). Foreign tax credits are not available for foreign taxes paid or accrued with respect todividends qualifying for the 100-percent dividends received deduction. Sec. 245A(d).
101

Sec. 245A. The DRD is not limited to dividends from CFCs, but rather may be available with respect
to any dividend received from a specified 10-percent owned foreign corporation by a domestic corporation which isa U.S. shareholder with respect to such foreign corporation.
102

16

B. Corporate Tax Liability
1. In general
A domestic corporation generally is subject to Federal income tax at a rate of 21 percent
rate.
Domestic corporations that are affiliated through 80-percent or more corporate
ownership may elect to file a consolidated return in lieu of filing separate returns. 104
Corporations filing a consolidated return generally are treated as a single corporation; thus, thelosses of one corporation can offset the income (and thus reduce the otherwise applicable tax) ofother affiliated corporations.
103

Certain corporations whose annual gross receipts meet or exceed certain thresholds are
subject to an additional tax under section 59A (the base erosion and anti-abuse tax, discussed
below).
In contrast to the treatment of capital gains in the individual income tax, no separate rate
structure exists for corporate capital gains. A corporation may not deduct the amount of capital
losses in excess of capital gains for any taxable year. Disallowed capital losses may be carriedback three years or carried forward five years.
Corporations generally are taxed at lower rates on their foreign-derived intangible income(“FDII”). 105 The preferential rate is accomplished by the allowance of a 37.5-percent deduction
under section 250, resulting in an effective tax rate of 13.125 percent on FDII (discussed below).
2. Corporate alternative minimum tax
For taxable years beginning after December 31, 2022, large C corporations meetingcertain requirements (“applicable corporations”) are subject to a new corporate alternative
minimum tax that is based on adjusted financial statement income. 106 The tax equals the excess(if any) of (1) the tentative minimum tax for the taxable year, over (2) the regular tax (as definedin section 55(c)) plus the tax imposed by section 59A for the taxable year. 107 The tentative
minimum tax for an applicable corporation for a taxable year is the excess of (i) 15 percent of the103

Sec. 11.

104

See secs. 1501-1504.

A corporation’s FDII is its deemed intangible income multiplied by the percentage of its income(computed with certain exceptions) derived from serving foreign markets. A corporation’s deemed intangible
income is the excess of its income (computed with certain exceptions) over a 10-percent return on the aggregate ofits average quarterly adjusted bases in certain depreciable tangible property. The deduction for FDII is not available
for RICs or REITs. Sec. 250.
105

106

See secs. 53(e), 55(b)(2), 56A and 59(k) and (l).

107Sec. 55(a).

17adjusted financial statement income (“AFSI,” as reduced by certain financial statement NOLs 108)for the taxable year, over (ii) the book minimum tax foreign tax credit for such taxable year. 109
In the case of any corporation that is not an applicable corporation, the tentative minimum tax forthe taxable year is zero. 110 In general, an applicable corporation is entitled for any taxable year
to a credit against its Federal income tax in an amount equal to the minimum tax credit for suchtaxable year. 111
Section 56A sets forth the general definition of AFSI, which is used for purposes ofdetermining the corporate alternative minimum tax liability and, with certain modifications
provided in section 59(k), for purposes of determining whether a corporation is an applicablecorporation subject to the corporate alternative minimum tax. AFSI is the net income or loss ofthe taxpayer set forth on the taxpayer’s applicable financial statement for such taxable year,
adjusted as set forth in section 56A. Adjustments to net financial statement income include
adjustments for: (1) statements covering different taxable years, (2) consolidated tax returns,(3) dividends and other amounts, (4) earnings of certain partnerships, (5) certain foreign income,(6) certain Federal and foreign taxes, (7) income of disregarded entities, (8) patronage dividends
and per-unit retain allocations of cooperatives, (9) certain items of Alaska Native Corporations,(10) amounts attributable to elections for direct payment of certain credits, (11) reasonable
mortgage servicing income, (12) defined benefit pensions, (13) tax-exempt entities,(14) depreciation, and (15) qualified wireless spectrum. The Secretary is directed to issue
regulations to prevent the omission or duplication of any item, to address corporate organizations
and reorganizations, and to address the effect of these provisions on partnerships with anapplicable corporation as a partner.
In general, a corporation is an applicable corporation subject to the corporate alternative
minimum tax if it meets the average annual AFSI test for one or more taxable years which areprior to such taxable year, and end after December 31, 2021. 112 A corporation meets such test
for a taxable year if its average annual AFSI for the three-taxable-year period ending with suchtaxable year exceeds $1 billion. In the case of a foreign-parented corporation, there is anadditional test requiring that the average annual AFSI of the corporation (not including incomeof the group not subject to U.S. tax) for the three-taxable-year period ending with such taxable be

Solely for purposes of determining an applicable corporation’s alternative minimum tax liability, AFSI
is reduced by the lesser of the aggregate amount of financial statement NOL carryovers to the taxable year, or 80
percent of the AFSI computed without regard to the financial statement NOL deduction. Financial statement NOL
carryovers are the amount of net loss (if any) set forth on the corporation’s applicable financial statement for taxable
years ending after December 31, 2019. See sec. 56A(d) (providing the AFSI deduction for a financial statement
NOL) and 59(k)(1)(B) (disregarding the AFSI deduction for a financial statement NOL for purposes of determining
whether a corporation meets the average annual AFSI test).
108

109

Secs. 55(b)(2) and 59(l).

110Sec. 55(b)(2)(B).

111

Sec. 53(e).

112Sec. 59(k).

18$100 million or more. Aggregation rules and certain adjustments apply in determining AFSI for
purposes of determining whether a corporation is an applicable corporation. 113
3. Tax credits
General business credits, including the research credit and orphan drug credit (discussed
below), generally may offset up to approximately 75 percent of the sum of a corporation’s
normal income tax and alternative minimum tax. 114 Any general business credit in excess of thislimitation generally may be carried back one year and forward up to 20 years. 115
Corporations may reduce their tax liability by any applicable general business credits. 116
The three largest dollar amount credits are the research credit (discussed below), the low-income
housing credit, and the energy credit, which provide incentives for intangible investment,
affordable housing investment, and energy production, respectively. 117 Other credits applicableto businesses include the orphan drug credit (discussed below), investment tax credits (including
an investment credit for qualified investments in an advanced manufacturing facility (i.e., asemiconductor manufacturing facility)), the work opportunity credit (applicable to a portion of
first-year wages paid to individuals from certain targeted groups), the employer-provided childcare credit (applicable to certain expenditures to provide child care for employees), and theemployer credit for paid family and medical leave (applicable to wages paid to employees onfamily and medical leave). 118
Research credit
A taxpayer may generally claim a research credit equal to 20 percent of the amount bywhich the taxpayer’s qualified research expenses for a taxable year exceed its base amount forthat year. 119 Thus, the research credit is generally available with respect to incremental increases

113

See sec. 59(k).

114Sec. 38.

115

Sec. 39.

116

Business credits also apply to the business income of individuals.

See Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2022-2026(JCX-22-22), December 22, 2022.
117

118
Certain of these credits are scheduled to expire in 2024 or later. For more information on expiringprovisions of the Code, see Joint Committee on Taxation, List of Expiring Federal Tax Provisions 2022-2034(JCX-1-23), January 18, 2023.

Sec. 41(a)(1). For a detailed description of the research credit, see Joint Committee on Taxation, Tax
Incentives for Domestic Manufacturing (JCX-15-21), March 12, 2021.
11919

in qualified research. An alternative simplified credit (with a 14-percent rate and a different baseamount) may be claimed in lieu of this credit. 120
A 20-percent research credit also is available with respect to the excess of (1) 100 percentof corporate cash expenses (including grants or contributions) paid for basic research conductedby universities (and certain nonprofit scientific research organizations) over (2) the sum of(a) the greater of two minimum basic research floors plus (b) an amount reflecting any decreasein nonresearch giving to universities by the corporation as compared to such giving during afixed-base period, as adjusted for inflation. 121 This separate credit computation commonly isreferred to as the “basic research credit.”
Finally, a 20-percent research credit is available for a taxpayer’s expenditures on researchundertaken by an energy research consortium for energy research. 122 This separate credit
computation commonly is referred to as the “energy research credit.” Unlike the other research
credits, the energy research credit applies to all qualified expenditures, not just those in excess ofa base amount.
Orphan drug credit
Section 45C provides a 25-percent tax credit for qualified clinical testing expenses
incurred in the testing of certain drugs for rare diseases or conditions, generally referred to as“orphan drugs.” Qualified clinical testing expenses are costs incurred to test an orphan drug after
the drug has been approved for human testing by the FDA but before the drug has been approvedfor sale by the FDA. 123 A rare disease or condition is defined as one that (1) affects fewer than
200,000 persons in the United States, or (2) affects more than 200,000 persons, but for which
there is no reasonable expectation that a business could recoup the costs of developing a drug forsuch disease or condition from sales in the United States of the drug. 124
Amounts included in computing the credit under this section are excluded from thecomputation of the research credit under section 41. 125 If a taxpayer claims the orphan drug
credit, it either (i) reduces its otherwise allowable deduction for qualified clinical testing120

Sec. 41(c)(4).

121
Sec. 41(a)(2) and (e). The base period for the basic research credit generally extends from 1981
through 1983.
122

Sec. 41(a)(3).

123

Sec. 45C(b).

124

Sec. 45C(d)(1).

125

Sec. 45C(c).

20expenses by the amount of the credit allowed, or (ii) elects a reduced credit by an amount equal
to the credit multiplied by the highest corporate tax rate. 126
4. Excise taxes
Excise tax on certain stock repurchases
In the case of repurchases of stock after December 31, 2022, section 4501 imposes a
nondeductible 127 one percent excise tax on the aggregate fair market value of stock that acovered corporation repurchases during the taxable year, subject to certain adjustments andexceptions. A covered corporation is any domestic corporation the stock of which is traded onan established securities market (within the meaning of section 7704(b)(1)). 128
Annual fee on branded prescription pharmaceutical manufacturers and importers
An annual fee is imposed on covered entities engaged in the business of manufacturing orimporting branded prescription drugs for sale to any specified government program or pursuant
to coverage under any such program. 129 The aggregate annual fee imposed on all covered
entities is $2.8 billion for calendar year 2023. 130 The aggregate fee is apportioned among thecovered entities each year based on their relative market share of branded prescription drug sales
taken into account during the previous calendar year. A covered entity is any manufacturer orimporter with gross receipts from branded prescription drug sales. The fee is considered to be anondeductible tax for purposes of section 275 and therefore is not deductible against income
taxes. 131
Excise tax on taxable vaccines
An excise tax is imposed on any taxable vaccine sold by the manufacturer, producer, or
importer of such vaccine. 132 Manufacturers, producers, and importers are responsible for paying
126

Sec. 280C(b).

127

Sec. 275(a)(6).

In addition, the provision may apply to certain acquisitions of stock of foreign corporations(e.g., acquisitions of stock of covered surrogate foreign corporations, defined as any surrogate foreign corporation(as determined under section 7874(a)(2)(B) by substituting “September 20, 2021” for “March 4, 2023” each place it
appears) the stock of which is traded on an established securities market (within the meaning of section 7704(b)(1)).
Sec. 4501(d)(2).
128

Sec. 9008 of the Patient Protection and Affordable Care Act (“PPACA”), Pub. L. No. 111-148, as
amended by section 1404 of the Health Care and Education Reconciliation Act of 2010 (“HCERA”)), Pub. L. No.
111-152.; see also Treas. Reg. sec. 51.1 - 51.11.
129

Sec. 90008(b)(4) of the PPACA. The aggregate annual fee amount for each year is set by statute; forcalendar year 2019 and thereafter the amount is $2.8 billion. Ibid.
130

131

Sec. 9008(f)(2) of the PPACA.

132

Sec. 4131.

21

75 cents per dose of a taxable vaccine upon the sale of the vaccine, but the tax does not apply if it
has already been imposed on a prior sale of such vaccine. 133 Vaccines which include multiple
taxable vaccines are taxed cumulatively as if each taxable vaccine were a separate dose—that is,
if two taxable vaccines are combined, then the tax imposed is $1.50 per dose. 134 Similarly,
fractional doses are taxed at the same fraction of the amount of such tax imposed on a wholedose. 135 Doses which are used by a manufacturer, producer, or importer before being sold aretaxed as if the vaccine were sold by such manufacturer, producer, or importer. 136
Excise tax for noncompliance with the Drug Price Negotiation Program
Applicable pharmaceutical manufacturers, producers, and importers who do not comply
with certain requirements of the Drug Price Negotiation Program administered by the Secretaryof Health and Human Services (“HHS”) 137 are subject to a nondeductible excise tax ranging
from 65 to 95 percent on designated drug sales during periods of noncompliance. 138
5. The base erosion and anti-abuse tax
The base erosion and anti-abuse tax (the “BEAT”) is an additional tax imposed on certain
multinational corporations with respect to payments to foreign affiliates. 139
The BEAT applies only to corporate taxpayers with average gross receipts in excess of$500 million and is determined, in part, by the extent to which a taxpayer has made payments toforeign related parties. 140 The BEAT generally does not apply to taxpayers for which reductions
to taxable income (“base erosion tax benefits”) arising from payments to foreign related parties(“base erosion payments”) are less than three percent of total deductions (i.e., a “base erosion
percentage” of less than three percent). 141

133

Secs. 4131(b)(1) and 4132(b)(4).

134

Sec. 4131(b)(2).

135

Sec. 4132(c)(3).

136

Sec. 4132(c)(1).

137

Part E of Title XI of the SSA, secs. 1191-1198 of the SSA.

138

Sec. 5000D, enacted by Pub. L. No. 117-169, August 16, 2022.

139

Sec. 59A.

140
For this purpose, a related party is, with respect to the taxpayer, any 25-percent owner of the taxpayer;
any person who is related (within the meaning of sections 267(b) or 707(b)(1)) to the taxpayer or any 25-percent
owner of the taxpayer; and any other person who is related (within the meaning of section 482) to the taxpayer.
Sec. 59A(g). The 25-percent ownership threshold is determined by vote or value.
141

Sec. 59A(e).

22A base erosion tax benefit generally reflects the reduction in taxable income arising fromthe associated base erosion payment. A base erosion payment generally is any amount paid or
accrued by a taxpayer to a foreign person that is a related party of the taxpayer and with respect
to which a deduction is allowable. 142 A base erosion payment includes any amount paid or
accrued by the taxpayer to a foreign related party in connection with the acquisition by the
taxpayer from the related party of property of a character subject to the allowance fordepreciation (or amortization in lieu of depreciation). 143 Base erosion payments generally do notinclude any amount that constitutes a reduction in gross receipts, including payments for cost of
goods sold. Certain other payments are excluded from the definition of base erosion payment,
including certain payments for services 144 and any qualified derivative payments. 145
For a taxpayer subject to the BEAT (an “applicable taxpayer”), the additional tax (the“base erosion minimum tax amount” or “BEAT liability”) for the year generally equals theexcess, if any, of 10 percent of its modified taxable income over an amount equal to its regular
tax liability 146 reduced (but not below zero) by the sum of a certain tax credits under chapter 1 of
the Code. 147 Modified taxable income is the taxpayer’s regular taxable income determined
without regard to a certain portion of any NOL deduction allowed for the taxable year andwithout regard to any base erosion tax benefit with respect to certain items (i.e., base erosion
payments), including (1) certain deductible payments made to foreign related parties,(2) deductions allowed for depreciation (or amortization in lieu of deprecation) with respect toproperty acquired from foreign related parties, and (3) reinsurance premiums paid to foreign
related parties. 148

142

Sec. 59A(d)(1).

Sec. 59A(d)(2). A base erosion payment also includes any premium or other consideration paid or
accrued by the taxpayer to a foreign related party for any reinsurance payments that are taken into account under
section 803(a)(1)(B) or 832(b)(4)(A). Sec. 59A(d)(3).
143

144

Sec. 59A(d)(5).

Sec. 59A(h); see also Treas. Reg. sec. 1.59A-3(c)(6) (providing an election to waive certain deductions
to reduce “allowed deductions” for purposes of determining base erosion tax benefit).
145

146

As defined in section 26(b).

Sec. 59A(b). Credits that reduce regular tax liability (i.e., increase the base erosion minimum tax
amount, if any) are all section 38 credits except for (1) the research credit and (2) applicable section 38 credits.
Applicable section 38 credits are the low-income housing credit, the renewable electricity production credit, and theenergy investment credit. The exception for applicable section 38 credits generally may not reduce the base erosion
minimum tax amount by more than 80 percent (determined without regard to the exception for applicable section 38
credits). Sec. 59A(b)(1)(B)(i)(II).
147

An applicable taxpayer’s modified taxable income is its taxable income for the taxable year increasedby (1) any base erosion tax benefit with respect to any base erosion payment and (2) the base erosion percentage of
any NOL deduction allowed under section 172 for such taxable year. Sec. 59A(c)(1).
148

23

Special rules apply to banks and securities dealers. 149 For taxable years beginning after
December 31, 2025, the 10-percent rate on modified taxable income is increased to 12.5 percent,and regular tax liability is reduced (and the base erosion minimum tax amount is therefore
increased) by the sum of all the taxpayer’s income tax credits for the taxable year. 150
6. Transition tax on U.S. shareholders of certain controlled foreign corporations
In 2017, many changes were made to the taxation of the foreign activities of U.S.
persons, which had the effect of moving the United States from a worldwide system with limiteddeferral toward a participation exemption system with current inclusion of certain additional
income. As part of the transition to this new participation exemption system, Congress enacted a
one-time tax (the “transition tax”) on undistributed foreign earnings that accrued before theeffective date of the new system. The transition tax allowed for the uniform applicability of theparticipation exemption with respect to post-enactment foreign earnings of foreign subsidiaries.
The transition tax requires certain foreign corporations to include as subpart F income theuntaxed and undistributed foreign earnings that were accumulated by those corporations intaxable years since 1986. The U.S. shareholders of those corporations are subject to thetransition tax with respect to the shareholders’ pro rata shares of such subpart F income.
The transition tax generally applies for the last taxable year beginning before January 1,
2018, requiring that any U.S. shareholder of a specified foreign corporation must include inincome its pro rata share of the accumulated post-1986 deferred foreign income of thecorporation. However, a portion of that pro rata share of foreign earnings is deductible,
depending on the proportion of the deferred earnings that are held in cash or other assets. The
structure of the allowable deduction results in a bifurcated rate of tax on amounts required to be
included in income: the rate is 15.5 percent for cash assets and eight percent for noncash assets.
A corresponding portion of the credit for foreign taxes paid with respect to such income isdisallowed, thus limiting the credit to the taxable portion of the included income. 151 A U.S.
shareholder may elect to forgo the use of an NOL deduction to offset the amount included under
the transition tax, and if the U.S. shareholder so elects, neither the section 951 inclusion nor any
related deemed paid foreign tax credits may be taken into account in computing the NOL
deduction for that year. 152

Sec. 59A(b)(3) (providing that an applicable taxpayer that is a member of an affiliated group that
includes a bank (as defined in section 581) or securities dealer registered under section 15(a) of the Securities
Exchange Act of 1934 is subject to a tax rate on its modified taxable income that is one-percentage point higher than
the generally applicable tax rate) and (e)(1)(C) (providing that for purposes of determining whether they are subject
to the BEAT, banks and securities dealers are subject to a base erosion percentage threshold of two percent (rather
than three percent)).
149

150

Sec. 59A(b)(2).

151

The separate foreign tax credit limitation rules of section 904 continue to apply, with coordinating rules.

152

Sec. 965(n).

24A taxpayer may elect to pay the transition tax over an eight-year period without accruing
underpayment interest. Special rules are provided for S corporations and REITs.

25

II. OVERVIEW OF SELECT ISSUES OF U.S. TAXATIONOF CROSS-BORDER ACTIVITY
The following discussion provides an overview of select principles, issues, and rules
relating to the U.S. taxation of income from cross-border business activity of large U.S.
multinational corporations, including those in the pharmaceutical industry, as well as a generaldescription of the current status of the Organisation for Economic Cooperation andDevelopment’s proposed two-pillar solution to addressing certain base-erosion and profit shifting
concerns.
A. Select U.S. Tax Rules Common to Inbound and Outbound Taxation
The United States imposes source-based taxation on U.S.-source income of nonresident
alien individuals and other foreign persons. Under this system, the application of the Codediffers depending on whether income arises from outbound investment (i.e., foreign investmentsby U.S. persons) or inbound investment (i.e., U.S. investment by foreign persons). While theUnited States taxes inbound and outbound investment differently, certain rules are common to
the taxation of both, including rules relating to residency, entity classification, source
determination, and transfer pricing.
1. Residence
The Code defines U.S. person to include all U.S. citizens and residents as well as
domestic entities such as partnerships, corporations, trusts and estates. 153 Partnerships andcorporations are domestic if organized or created under the laws of the United States, any State,or the District of Columbia, unless, in the case of a partnership, the Secretary prescribes
otherwise by regulation. 154 All other partnerships and corporations (i.e., those organized under
the laws of foreign countries) are foreign. 155 Other jurisdictions may use factors such as situs ormanagement and control to determine residence. As a result, legal entities may have more than
one tax residence, or, in some cases, no residence. In such cases, bilateral treaties may resolve
conflicting claims of residence.
Exception for corporate inversions
In certain cases, a foreign corporation that acquires a domestic corporation or partnershipmay be treated as a domestic corporation for Federal tax purposes. 156 That result generally
applies following a transaction in which, pursuant to a plan or a series of related transactions:153

Sec. 7701(a)(30).

154

Sec. 7701(a)(4).

155
Sec. 7701(a)(5) and (9). Entities organized in a possession or territory of the United States are notconsidered to have been organized under the laws of the United States.

Sec. 7874. The Treasury Department and the IRS have promulgated detailed guidance, through both
regulations and several notices, addressing these requirements under section 7874 since the section was enacted in
2004, and have sought to expand the reach of the section or reduce the tax benefits of inversion transactions.
156

26

(1) a domestic corporation becomes a subsidiary of a foreign-incorporated entity or otherwisetransfers substantially all of its properties to such an entity; (2) the former shareholders of thedomestic corporation hold (by reason of the stock they had held in the domestic corporation) atleast 80 percent (by vote or value) of the stock of the foreign-incorporated entity after thetransaction (often referred to as “stock held by reason of”); and (3) the foreign-incorporated
entity, considered together with all companies connected to it by a chain of greater than 50percent ownership (the “expanded affiliated group”), does not have substantial business activities
in the entity’s country of organization, compared to the total worldwide business activities of the
expanded affiliated group. If the above requirements are satisfied except that the “stock held by
reason of” the acquisition is less than 80 percent, but at least 60 percent of the stock of theforeign corporation, the foreign corporation is not treated as a domestic corporation and isinstead considered a surrogate foreign corporation for the acquired domestic company which isan expatriated entity that must recognize certain “inversion gain” post-acquisition
restructuring 157 and may be subject to other consequences under the provisions enacted in2017. 158
Pharmaceutical companies have inverted in several mergers with foreign companies thathave attracted attention. 159 Of the 60 inversions documented from 1983 through 2015,
pharmaceutical companies experienced the most inversion activity. 160
2. Entity classification
The Code defines various entity classifications, including partnership and corporation; 161such classification matters for many Federal income tax purposes. In addition, certain entities
other than “per se” corporations (e.g., incorporated domestic business entities, banks, insurance

An excise tax may be imposed on certain stock compensation of executives of companies that
undertake inversion transactions. Sec. 4985. In addition, dividends from certain surrogate foreign corporations are
excluded from qualified dividend income within the meaning of section 1(h)(11)(B) and are ineligible to be taxed as
net capital gains. Sec. 1(h)(11)(C)(iii). As a result, individual shareholders in such corporations cannot claim thereduced rate on dividends otherwise available under section 1(h)(11).
157

158
See secs. 59A(d)(4) (providing that payments made to expatriated entities that reduce gross receipts arebase erosion payments) and 965(l) (disallowing the partial participation exemption deduction for computing thetransition tax and assesses the additional transition tax in the year of inversion if an entity inverts within 10 years of
the transition tax enactment).

See $42.9 billion merger of Medtronic with Covidien plc in Ireland, and Mylan’s $5.3 billion merger
with the international division of Abbott Laboratories, available at: https://news medtronic.com/2014-06-15Medtronic-to-Acquire-Covidien-for-42-9-billion-in-Cash-and-Stock#:~:text=%2D%20Medtronic%2C%20Inc.,(NYSE%3A%20MDT)%2C%20a%20global%20leader%20in%20medical%20technology,a%20cash%2Dand%2Ds
tock%20transactionx, and https://www.prnewswire.com/news-releases/mylan-completes-acquisition-of-abbotts-nonus-developed-markets-specialty-and-branded-generics-business-300042793 html.
159

CBO, “An Analysis of Corporate Inversions,” September 2017, available at:https://www.cbo.gov/system/files/115th-congress-2017-2018/reports/53093-inversions.pdf
160

161

Sec. 7701(a)(2) (defining partnership and partner) and (a)(3) (defining corporation).

27

companies, and any entity included in a list of foreign business entities) 162 are eligible to electtheir classification. Under the so-called “check-the-box” regulations, these eligible entities may
elect their classification as a corporation, a partnership, or an entity disregarded as separate fromits owner (“DRE”). 163 A DRE is treated in the same manner as a sole proprietorship, in the caseof an entity owned by an individual, and in the same manner as a branch or division, in the caseof an entity owned by a corporation or partnership. Both foreign and domestic entities may
make the election. 164
As a result of the check-the-box regulations, an entity formed in the United States andoperating in at least one other jurisdiction may be treated as a hybrid entity (i.e., treated as apartnership or disregarded entity for U.S. tax purposes but as a corporation for foreign tax
purposes) or a reverse hybrid entity (i.e., treated as a corporation for U.S. tax purposes but as apartnership or disregarded entity for foreign tax purposes).
Congress has recognized that such hybrid entities or reverse hybrid entities may
improperly reduce subpart F income, allow for payments that generate deductions without
offsetting inclusions, and use tax treaties to reduce withholding tax on payments that are notsubject to tax under the laws of any jurisdiction, and have accordingly attempted to limit theiruse as a tax planning tool. 165
3. Source of income rules
Various factors determine the source of income for U.S. tax purposes, including the status
or nationality of the payor or recipient and the location of the activities or assets that generate theincome. The Code includes extensive rules on determining whether income is considered to be

162

Treas. Reg. sec. 301.7701-2(b).

163

Treas. Reg. sec. 301.7701-3.

Following the statute, for purposes of the check-the-box regulations, an entity is “domestic” if it iscreated or organized in the United States or under the law of the United States; an entity is “foreign” if it is notdomestic. Treas. Reg. sec. 301-7701-5(a); see generally sec. 7701(a)(4) and (5).
164

165
See section 267A(a), which generally disallows a deduction for any interest or royalty paid to a related
party to the extent that the amount is not included in the related party’s income under the tax law of the country where
the recipient is resident for tax purposes or is subject to tax, or the related party is allowed a deduction for the amountin that country. See also section 894(c), which denies treaty withholding tax benefits to foreign persons with respect
to an item of income if the treaty partner does not view the foreign person as earning the item of income, the treaty
does not have a provision addressing the treatment of an item of income derived by a partnership, and the foreigncountry does not impose tax on a distribution of such item of income from such entity to such foreign person. Section
894(c) was enacted in response to a perceived problem under the U.S.-Canada tax treaty involving a U.S. corporationand U.S. limited liability company (“LLC”) both owned by a single Canadian corporation. The LLC makes loans to
the U.S. corporation to finance the U.S. corporation’s operations, with the U.S. corporation paying interest to the LLC.
Because the LLC is treated as a partnership for U.S. tax purposes but as a corporation for Canadian tax purposes, theinterest, while deductible for the U.S. corporation, is not includible as income of either the LLC or the Canadianowners; absent Sec. 894(c) the interest payments also would be eligible for decreased withholding tax under the tax
treaty. See H.R. Rep. No. 148, 105th Congress, 1st Sess. 550 (1997).

28

from U.S. sources or from foreign sources. 166 Special rules are provided for certain industries,(e.g., transportation, shipping, and certain space and ocean activities) as well as for income partly
from within and partly from without the United States. 167
While many rules for determining source have been unchanged over the years, changes
made in 2017 addressed the sale of inventory by eliminating the title passage rule. Gains,profits, and income from the sale or exchange of inventory property that is either (1) produced(in whole or in part) inside the United States and then sold or exchanged outside the UnitedStates, or (2) produced (in whole or part) outside the United States and then sold or exchanged
inside the United States is allocated and apportioned solely on the basis of the location of
production activity. 168 For example, income derived from the sale of inventory produced
entirely in the United States is wholly from U.S. sources, even if title passage occurs elsewhere.
Likewise, income derived from the sale of inventory produced entirely in another country iswholly from foreign sources, even if title passage occurs in the United States. If inventory is
produced only partly in the United States, the income derived from its sale is sourced partly in
the United States regardless of where title to the property passes.
4. Transfer pricing
General rule—arm’s length standard
Section 482 authorizes the Secretary to allocate income, deductions, credits, orallowances among related business entities when necessary to clearly reflect income or otherwise
prevent tax avoidance. Comprehensive Treasury regulations under that section generally adopt
the arm’s-length standard as the method for determining whether a particular allocation isappropriate. 169 Under that standard, the amount of profit allocated to each related taxpayer must
be measured by reference to the amount of profit that a similarly situated taxpayer would realize
in a similar transaction with unrelated parties bargaining at arm’s length. The arm’s length
standard is broadly accepted internationally, including all members of the OECD as well as
many nonmembers. 170

166

Sections 861 through 865, generally.

167

Sec. 863.

168
Sec. 863(b). The rules relating to the determination of source of income with respect to the sale ofinventory are complex, and the results may differ depending, in part, on the relevant activities undertaken, thestructure of the arrangement, and the entity classification of relevant participants. See, e.g., secs. 861(a)(6),862(a)(6), 863(b)(2), and 865(e)(2).

Section 1059A buttresses section 482 by limiting the extent to which costs used to determine custom
valuation can also be used to determine basis in property imported from a related party. A taxpayer that imports
property from a related party may not assign a value to the property for cost purposes that exceeds its customs value.
169

OECD (2022), OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations 2022 (“OECD Guidelines”), OECD Publishing, Paris, https://doi.org/10.1787/0e655865-en. The
publication was approved by the OECD/G20 Inclusive Framework on BEPS on January 7, 2022.
170

29

Special rules for intangible property transfers
Section 482 requires that the income with respect to a transfer of intangible property becommensurate with the income attributable to the intangible. By requiring inclusion of amounts
commensurate with the income attributable to the intangible, Congress was responding toconcerns regarding the effectiveness of the arm’s-length standard with respect to intangible
property—including, in particular, high-profit-potential intangibles. 171
A U.S. person may transfer intangible property to a related person (typically, a foreign
affiliate) in one of four ways: Outright transfer of the intangible property; a license of theintangible property, in which the U.S. person transfers less than all substantial rights in theintangible property to the foreign affiliate; the provision of a service by the U.S. person to theforeign affiliate using the intangible property, rather than a direct transfer of the property; andfinally, a transfer by the U.S. person of intangible property through a qualified cost-sharing
arrangement with one or more foreign affiliates, under which the participants make resources
available and contribute funds (through a combination of cash and existing intangible property
rights) toward the joint development of a new marketable product or service. A qualified costsharing arrangement is an agreement between taxpayers under common control that satisfies therequirements prescribed under regulations. 172 The method of transfer may determine whether
the applicable section is section 482 or section 367(d). 173
Despite consensus around the use of arm’s length standard and extensive guidance,questions surrounding the difficulties posed by intercompany pricing requirements were raised,
including recurring definitional and methodological issues and concerns about the use ofaggressive transfer pricing. 174 In 2013, the OECD began a study of the existing international
standards for transfer pricing and challenges presented by those standards in relation tointangible assets, risk and capital allocation, and other transactions which would not, or would
only very rarely, occur between third parties. 175 Similar definitional and methodological issues

171

H.R. Rep. No. 99-426, p. 423.

172

Treas. Reg. sec. 1.482-7. See also OECD Guidelines, Chapter VIII “Cost contribution arrangements.”

Sec. 367(d) (described further in Part B.6) requires use of transfer pricing principles in determining gain
to be recognized from a transfer within scope of that section. In addition, special rules may apply in the case of aU.S. taxpayer’s transfer or property to a partnership with related foreign partners under sections 704(c) and 721(c)and related regulations.
173

174
Joint Committee on Taxation, Present Law and Background Related to Possible Income Shifting andTransfer Pricing (JCX-37-10), July 20, 2010.

OECD, Addressing Base Erosion and Profit Shifting, 2013, available at
http://dx.doi.org/10.1787/9789264192744-en; OECD, Aligning Transfer Pricing Outcomes with Value Creation,
Actions 8-10: 2015 Final Reports, October 5, 2015. The findings of the report in 2015 resulted in further guidance
that has since been incorporated in the OECD Guidelines.
175

30

raised in litigation 176 led to clarification of the definition of intangible property and valuation
methods in 2017, as described below.
Definition of intangible property
For purposes of section 482, intangible property is defined by reference to the provision
governing gain recognition from outbound transfers of intangible property. 177 That provision
includes a list of enumerated items that specifically include goodwill, going-concern value, andworkforce-in-place. It clarifies the definition by replacing the residual category of “any similar
item” with “any item the value of which is not attributable to tangible property or the services of
any individual” and removing certain language to make clear that neither source nor amount ofvalue is relevant in determining whether property in one of the other enumerated categories iswithin the scope of the definition. 178
Valuation of intangibles
Section 482 provides that “[f]or purposes of this section, the Secretary shall require thevaluation of transfers of intangible property (including intangible property transferred with otherproperty or services) on an aggregate basis or the valuation of such a transfer on the basis of therealistic alternatives to such a transfer, if the Secretary determines that such basis is the mostreliable means of valuation of such transfers.” 179 The mandated use of the aggregate basis
valuation method in these cases under section 482 is consistent with regulations promulgatedprior to the 2017 revision of the statute, which required that synergies created by the interrelatedSee, e.g., Veritas Software Corp. v. Commissioner, 133 T.C. 297 (Dec. 10, 2009) (including goodwill
and going concern value within the definition would “expand” the regulatory definition in effect for the tax year
before the Court), non-acq., AOD-2010-05, I.R.B. No. 2010-49 (Dec. 6, 2010); Medtronic Inc. & Consolidated
Subs. v. Commissioner, T.C. Memo. 2016-112 (accepting taxpayer use of the comparable uncontrolled transaction
method with few adjustments), vacated and remanded 900 F.3d 610 (8th Cir. 2018) (further findings required toevaluate whether the methodology accepted by the Tax Court was the best method), T.C. Memo. 2022-84 (Tax
Court adopts an unspecified method to determine pricing); and Amazon.com, Inc. v. Commissioner, 148 T.C. No. 8(2017), aff’d 934 F.3d 976 (9th Cir. 2019) (holding that “workforce in place, going concern value, goodwill, andwhat trial witnesses described as ‘growth options’ and corporate ‘resources’ or ‘opportunities’” all fell outside thedefinition under prior law).
176

177
Sec. 367(d)(4). The definition of intangible property was formerly in section 936(h)(3)(B), as amended
by section 14221 of Public Law 115-97. That operative definition of intangible property was moved to section
367(d) as a conforming amendment to the repeal of section 936 as deadwood, in the Consolidated Appropriations
Act 2018. See Pub. L. No. 115-141, Division U, Title IV, at sec. 401(d)(1)(C) (the repeal of section 936) and sec.
401(d)(1)(D)(viii)(I) (definition of intangible property added to section 367(d)) (March 23, 2018).

Prior to amendment, section 936(h)(3)(B) read as follows: The term “intangible property means any -(i) patent, invention, formula, process, design, pattern or know-how; (ii) copyright and literary, musical or artistic
composition; (iii) trademark, trade name or brand name; (iv) franchise, license or contract; (v) method, program,system, procedure, campaign, survey, study, forecast, estimate, customer list or technical data; or (vi) any similar
item, which has substantial value independent of any individual.
178

Sec. 482. A contemporaneous expansion of the regulatory authority under section 367 makes clear that
the IRS may require the use of aggregate basis valuation and apply the realistic alternative principle in valuation of
intangibles transferred in outbound restructuring of U.S. operations.
179

31

nature of intangible assets that are transferred in one or more contemporaneous transactions be
properly taken into account in order to reach an arm’s length result. 180 The approach is also
consistent with Tax Court decisions in cases outside of the section 482 context, in whichcollections of multiple, related intangible assets were viewed by the Tax Court in theaggregate, 181 as well as existing cost-sharing regulations. 182
Similarly, the realistic alternative principle was explicit in regulations as an underpinningof all transfer pricing methodologies for a transfer of intangibles. “Realistic alternative” wasfirst adopted as an expressly articulated principle in 1994, following IRS defeats in Bausch &Lomb v. Commissioner, 183 Eli Lilly v. Commissioner, 184 and G.D. Searle & Co. v.
Commissioner. 185 In determining the income attributable to a taxpayer that participated in a
specific transfer of intangibles, the method of valuation chosen must yield results consistent withthe economic results from alternative arrangements that were realistically available to that
taxpayer. The degree of consistency between anticipated benefits from the transactions under the
chosen pricing method and the anticipated benefits of a realistic alternative to the transaction
indicates the reliability and appropriateness of the valuation. 186 This principle is predicated on
the notion that a taxpayer enters into a particular transaction only if none of its realistic
alternatives is economically preferable to the transaction under consideration.
Transfer pricing and challenges to blocked income regulations
Under limited exceptions, the IRS will respect a foreign law proscription that limits
cross-border payments when determining whether an arm’s length price was paid for cross-180

14, 2018.

See Treas. Reg. secs. 1.482-1(f)(2), 1.482-4(c)(1); Treas. Reg. sec. 1.482-1T, which sunset September

181
See, e.g., Kraft Foods Co. v. Commissioner, 21 T.C. 513 (1954) (thirty-one related patents must bevalued as a group and the useful life for depreciation should be based on the average of the patents’ useful lives);
Standard Conveyor Co. v. Commissioner, 25 B.T.A. 281, p. 283 (1932) (“[I]t is evident that it is impossible to value
these seven patents separately. Their value, as in the case of many groups of patents representing improvements on
the prior art, appears largely to consist of their combination.”); Massey-Ferguson, Inc. v. Commissioner, 59 T.C. 220(1972) (taxpayer who abandoned a distribution network of contracts with separate distributorships was entitled to an
abandonment loss for the entire network in the taxable year during which the last of the contracts was terminatedbecause that was the year in which the entire intangible value was lost).

See Treas. Reg. sec. 1.482-7(g)(2)(iv) (if multiple transactions in connection with a cost-sharing
arrangement involve platform, operating and other contributions of resources, capabilities or rights that arereasonably anticipated to be interrelated, then determination of the arm’s-length charge for platform contribution
transactions and other transactions on an aggregate basis may provide the most reliable measure of an arm’s-length
result).
182

183

933 F.2d 1084 (2d. Cir. 1991).

184

856 F.2d 855 (7th Cir. 1988).

185

88 T.C. 252 (1987).

186

See Treas. Reg. sec. 1.482-7(g)(2)(iii) and Examples (1), (2) and (3), thereunder.

32

border goods or services (the “blocked income regulation”). 187 The validity of the blocked
income regulation has been challenged in two recent cases involving aspects of Brazil’s domestic
law: 3M Company and Subsidiaries, 188 and The Coca Cola Company and Subsidiaries. 189 In
both cases, the taxpayers presented alternative theories based on the Administrative Procedure
Act, as well as standards of judicial deference and prior case law on blocked income. 190
In 3M Company and Subsidiaries, 191 the Tax Court recently upheld the validity of theregulation in a fully reviewed opinion with nine judges in the majority and eight dissenting. In
doing so, the Court analyzed the conditions in the regulation for recognizing a foreign law
prohibition. The blocked income regulation recognizes a foreign legal prohibition only if four
requirements are met: (1) the foreign law or regulation was publicly promulgated, (2) it applies
to both controlled and uncontrolled parties, (3) it prevents the payment in any form, and (4) the
taxpayer has exhausted efforts to seek remedy under local law. The Court found that the foreign
law prohibition in question failed both the first and second of those four requirements.
In the second case, The Coca Cola Company and Subsidiaries, presenting a similar
challenge to the blocked income regulation, the Court reserved on the issue 192 after resolving theissues regarding transfer pricing methodology, and subsequently requested further briefing inlight of the holding in 3M Company and Subsidiaries. 193

187

Treas. Reg. sec. 1.482-1(h)(2).

188

3M Company and Subs. v Commissioner, 160 T.C. No. 3 (Feb. 9, 2023) (“3M Company”).

189

The Coca-Cola Company & Subs. v. Commissioner, 155 T.C. 145 (Nov. 18, 2020) (“Coca-Cola”).

See, e.g., Commissioner v. First Security Bank of Utah, 405 U.S. 394 (1972) (in an application ofsection 482 in a domestic context, a Federal prohibition against banks engaging in insurance business precluded
allocation of insurance premium income to the Bank); Procter & Gamble Co. v. Commissioner, 961 F.2d 1255 (6thCir. 1992), aff’g 95 T.C. 323 (1990) (recognized Spanish law prohibition).
190

191

3M Company, supra.

192

Coca-Cola, supra, 155 T.C. at 185.

193

The Coca-Cola Company & Subs. v. Commissioner, T.C. Dkt. No. 31183-15, Dkt. Entry No. 773.

33

B. Select U.S. Tax Rules Applicable to Foreign Activities of U.S. Taxpayers
1. Subpart F income
Under subpart F, U.S. shareholders of a CFC must include in income their pro rata sharesof subpart F income, without regard to whether the income is distributed to the shareholders. 194
In effect, U.S. shareholders of a CFC are treated as having received a current distribution of the
CFC’s subpart F income. With exceptions described below, subpart F income generally includes
passive income and other income that is readily movable from one jurisdiction to another.
Subpart F income consists of foreign base company income, 195 insurance income, 196 and certain
income relating to international boycotts and other violations of public policy. 197
Foreign base company income
Foreign base company income consists of foreign personal holding company income,which includes passive income such as dividends, interest, rents, and royalties, and a number ofcategories of income from business operations, including foreign base company sales income
and foreign base company services income. 198
Foreign personal holding company income
Foreign personal holding company income (“FPHCI”) generally includes income from
dividends, interest, royalties, rents, annuities; net gains on certain property transactions; net gains
from commodities transactions; net gains from foreign currency transactions; income equivalent
to interest; income from notional principal contracts; payments in lieu of dividends; and amounts
received under certain personal service contracts. 199
Several exceptions apply to exclude certain income from FPHCI. For example, FPHCI
does not include certain dividends, interest, rents, and royalties received by a CFC from a related
corporation organized and operating in the same foreign country in which the CFC isorganized. 200 The same-country exception is not available to the extent that the payments reduce
the subpart F income of the payor. Another exception excludes from FPHCI dividends, interest,

194Sec. 951(a).

195

Secs. 952(a)(2) and 954.

196

Secs. 952(a)(1) and 953.

197

Sec. 952(a)(3)-(5).

198

Sec. 954.

199

Sec. 954(c)(1)(A)-(H).

200

Sec. 954(c)(3).

34

rents, and royalties received or accrued by one CFC from a related CFC to the extent attributableor properly allocable to income of the payor that is not subpart F income. 201
In addition, there is an “active business” exception for rents and royalties that are derived
from an active trade or business conducted by the CFC and not received from a related party. 202
In general, payments by a branch to its owner are disregarded. Thus, in this context, royalty
payments by a branch to its CFC owner are disregarded. A branch may include a foreign entitythat has elected for U.S. Federal tax purposes to be disregarded as an entity separate from its
CFC owner (a “disregarded entity” or “DRE”).
Foreign base company sales income
Foreign base company sales income (“FBC sales income”) is income derived by a CFC inconnection with (1) the purchase of personal property from a related person and its sale to any
person; (2) the sale of personal property to any person on behalf of a related person; (3) thepurchase of personal property from any person and its sale to a related person; or (4) thepurchase of personal property from any person on behalf of a related person. In each of thesituations described in items (1) through (4), the property must be both manufactured and soldfor use outside the country in which the CFC is organized for the income from its sale to beconsidered FBC sales income. 203
There are several exceptions to FBC sales income, including the same country
manufacturing exception, same country sales or use exception, and the CFC manufacturingexception. The same country manufacturing exception excludes from FBC sales income any
income from the sale of goods manufactured in the country in which the CFC is organized. 204
The same country sales or use exception excludes from FBC sales income any income from thesale of goods for the use, consumption, or disposition in the country in which the CFC isorganized. 205
A second manufacturing exception (i.e., the CFC manufacturing exception), which is set
forth in regulations, provides that FBC sales income does not include income from the sale ofproperty that the CFC manufactures, purchases, or sells outside the country in which the CFC isorganized if the CFC does not violate the branch rule (discussed below). 206 Manufacturing isdefined by physical manufacturing tests such as the substantial transformation test and theSec. 954(c)(6). This exception, colloquially referred to as the CFC look-through rule, applies to taxable
years of foreign corporations beginning before January 1, 2026, and to taxable years of U.S. shareholders with orwithin which such taxable years of foreign corporations end.
201

202

Sec. 954(c)(2)(A).

203

Sec. 954(d)(1).

204

Sec. 954(d)(1)(A).

205

Sec. 954(d)(1)(B).

206

Treas. Reg. sec. 1.954-3(a)(2).

35

substantial activity test, as well as nonphysical activities such as the substantial contribution
test. 207
Manufacturing, purchasing, and selling through branches
To qualify for the CFC manufacturing exception, a CFC that manufactures, purchases, orsells outside its country of organization through a branch must satisfy the “branch rule.” Under
the branch rule, a CFC must show (in effect) that the use of the branch is not to move income
from a high-tax jurisdiction to a low-tax jurisdiction. The branch rule provides that, if a CFC
manufactures, purchases, or sells through a branch outside its country of organization and the useof the branch has “substantially the same effect” as would the use of a wholly owned subsidiarycorporation of the CFC, then the branch and the CFC are treated as separate corporations forpurposes of determining FBC sales income of the CFC.
The use of the branch has “substantially the same effect” if a tax rate disparity test is met.
The test looks to whether the tax rate of the branch is too low in comparison to that of the CFC.
Under the sales branch rule, the test looks to whether the tax rate of the sales branch is too low incomparison to the CFC (where the manufacturing is). 208 Under the manufacturing branch rule,the test looks to whether the tax rate of the CFC (where the sales are) is too low in comparison to
the manufacturing branch. 209 If the relevant tax rate (under either test) is too low, then therelated income is FBC sales income.
Foreign base company services income
Foreign base company services income (“FBC services income”) is income (whether inthe form of compensation, commissions, fees, or otherwise) derived in connection with theperformance of technical, managerial, engineering, architectural, scientific, skilled, industrial,commercial, or like services which (1) are performed for or on behalf of any related person, and(2) are performed outside the country in which the CFC is organized. 210
FBC services income does not include income derived in connection with theperformance of services which are directly related to (1) the sale or exchange by the CFC ofproperty manufactured, produced, grown, or extracted by the CFC and which are performed
Under the substantial transformation test, a CFC is considered to have manufactured a product if the
CFC purchases and substantially transforms personal property prior to its sale, such as processing and convertingwood pulp into paper. Treas. Reg. sec. 1.954-3(a)(4)(ii). Under the substantial activity test, a CFC is considered tohave manufactured a product through the assembly or conversion of component parts, provided the activities aresubstantial in nature. Treas. Reg. Sec. sec. 1.954-3(a)(4)(iii). Under the substantial contribution test, a CFC does
not have foreign base company income if the CFC engages in certain activities, such as oversight and direction of
manufacturing activities, vendor selection, and quality control, that make a substantial contribution to the
manufacturing process. Treas. Reg. Sec. sec. 1.954-3(a)(4)(iv).
207

208

Treas. Reg. sec. 1.954-3(b)(1)(i)(b).

209

Treas. Reg. sec. 1.954-3(b)(1)(ii)(b).

210

Sec. 954(e)(1).

36

before the time of the sale or exchange, or (2) an offer or effort to sell or exchange suchproperty. 211
Insurance income
Insurance income subject to current inclusion under subpart F includes any income of a
CFC attributable to the issuing or reinsuring of any insurance or annuity contract in connection
with risks located in a country other than the CFC’s country of organization. 212
Investments in U.S. property
U.S. shareholders also must include their pro rata shares of a CFC’s untaxed earnings
invested in certain items of U.S. property. 213 For this purpose, U.S. property generally includes
tangible property located in the United States, stock of a U.S. corporation, an obligation of a U.S.
person, and certain intangible assets (such as patents and copyrights) acquired or developed by
the CFC for use in the United States. 214 There are specific exceptions to the general definition of
U.S. property, including for bank deposits, certain export property, and certain trade or businessobligations. 215
Other exceptions
An exception to foreign base company income and insurance income (the “high-tax
exception”) is available for any item of income received by a CFC if the taxpayer establishes thatthe income was subject to an effective foreign income tax rate greater than 90 percent of the
maximum U.S. corporate income tax rate in effect at the time the income was earned (e.g., forincome earned by a CFC in tax year 2020, more than 90 percent of 21 percent, or 18.9
percent). 216
There is also an exclusion from subpart F income for certain income of a CFC that isderived in the active conduct of a banking or financing business (“active financing income”). 217
With respect to income derived in the active conduct of a banking, financing, or similar business,

211

Sec. 954(e)(2). Other exceptions apply for income otherwise excluded from subpart F income.

212

Sec. 953(a) and (e).

213

Secs. 951(a)(1)(B) and 956.

214

Sec. 956(c)(1).

215

Sec. 956(c)(2).

Sec. 954(b)(4). This exception applies to an item of income that would otherwise be included inforeign base company income or insurance income within the meaning of sections 954(a) and 953, respectively. See
also Treas. Reg. sec. 1.954-1(d).
216

217

Sec. 954(h).

37a CFC is required to be predominantly engaged in such business and to conduct substantial
activity with respect to such business, and other requirements must be met.
For a securities dealer, foreign personal holding company income excludes any interest or
dividend (or certain equivalent amounts) from any transaction entered into in the ordinary courseof the dealer’s trade or business as a dealer in securities within the meaning of section 475. 218
Exclusion of previously taxed earnings and profits
A U.S. shareholder may exclude from its income actual distributions of earnings andprofits from a CFC that were previously included in income by the U.S. shareholder undersubpart F. 219 Any income inclusion resulting from an investment in U.S. property also may be
excluded when such earnings and profits are ultimately distributed. 220
Basis adjustments
A U.S. shareholder of a CFC generally increases the basis in its CFC stock by the amountof subpart F income inclusions and generally reduces the basis in its CFC stock by the amount ofany distributions that are excluded from its income as previously taxed earnings and profits. 221
2. GILTIA U.S. shareholder of a CFC also must include in gross income its GILTI. GILTI is theexcess of the shareholder’s net CFC tested income over the shareholder’s net deemed tangible
income return. The shareholder’s net deemed tangible income return equals the excess of
10 percent of the aggregate of its pro rata share of the qualified business asset investment(“QBAI”) of each CFC over certain interest expense. 222
The formula for GILTI is:
𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 = 𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 − [(10% × 𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄) − 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸]

Although a GILTI inclusion is generally treated in the same manner as a subpart F
inclusion, GILTI is not subpart F income. GILTI is computed at the U.S.-shareholder level
rather than the CFC level, with a U.S. shareholder allowed to offset tested income of its CFCs
with tested loss of other CFCs in computing net CFC tested income. When computing tax
218

Sec. 954(c)(2)(C).

219

Sec. 959(a)(1).

220

Secs. 959(a)(2) and 956.

221

Sec. 961.

The interest expense that reduces a U.S. shareholder’s net deemed tangible income return is that which
is taken into account in determining its net CFC tested income for the taxable year to the extent that the interest
income attributable to such interest expense is not taken into account in determining the shareholder’s net CFC
tested income.
222

38

liability associated with GILTI, U.S. shareholders may not take into account certain tax attributesof CFCs with tested loss, such as foreign tax credits and QBAI. In addition, the foreign tax
credit limitation is applied separately with respect to GILTI, and no carryovers and carrybacks ofexcess foreign tax credits are allowed in the GILTI foreign tax credit limitation category.
Net CFC tested income
Net CFC tested income means the excess of the aggregate of the shareholder’s pro rata
share of the tested income of each CFC over the aggregate of its pro rata share of the tested lossof each CFC. 223
The tested income of a CFC is the excess of the gross income of the CFC determined
without regard to certain amounts that are exceptions to tested income (referred to in thisdocument as “gross tested income”) over deductions (including taxes) properly allocable to suchgross tested income. The exceptions to tested income are: (1) any effectively connected income
described in section 952(b); (2) any gross income taken into account in determining the CFC’s
subpart F income; (3) any gross income excluded from foreign base company income orinsurance income by reason of the high-tax exception under section 954(b)(4); 224 (4) any
dividend received from a related person (as defined in section 954(d)(3)); and (5) any foreign oil
and gas extraction income (as defined in section 907(c)(1)).
The tested loss of a CFC means the excess of deductions (including taxes) properly
allocable to the CFC’s gross tested income over the amount of such gross tested income.
Qualified business asset investment
QBAI means, with respect to any CFC for a taxable year, the average of the aggregate of
the CFC’s adjusted bases in specified tangible property that is both used in its trade or businessand of a type with respect to which a deduction is generally allowable under section 167. 225 The
adjusted basis in any property generally must be determined using the alternative depreciation
system under section 168(g) as in effect on December 22, 2017.
Specified tangible property means any property used in the production of tested
income. 226

Sec. 951A(c)(1). Pro rata shares are determined under subpart F principles (i.e., the rules ofsection 951(a)(2) and the regulations thereunder).
223

See also Treas. Reg. sec. 1.951A-2(c)(1)(iii) and (c)(7) (providing an election to apply the high-tax
exception described in section 954(b)(4) to exclude from tested income of a CFC any gross income of such CFC thatis subject to an effective rate of income tax imposed by a foreign country greater than 90 percent of the maximum
rate of tax specified in section 11).
224

225

Sec. 951A(d)(1).

Sec. 951A(d)(2). Specified tangible property does not include property used in the production of tested
loss; thus, a CFC with a tested loss in a taxable year does not have QBAI for such taxable year.
226

39

Treatment as subpart F income
GILTI inclusions generally are treated in the same manner as amounts included as
subpart F income. 227
Preferential rate on GILTIThe preferential rate on GILTI is achieved by allowing corporations a deduction equal to50 percent 228 of their GILTI (including the corresponding section 78 gross-up amount). 229
3. Foreign tax credit
Subject to certain limitations, U.S. citizens, resident individuals, and domestic
corporations are allowed a credit for foreign income taxes they pay. In addition, a domestic
corporation is allowed a credit for foreign income taxes paid by a CFC with respect to income
included by the corporation as subpart F income and GILTI; such taxes are deemed to have been
paid by the domestic corporation for purposes of calculating the foreign tax credit. 230
The foreign tax credit generally is limited to a taxpayer’s U.S. tax liability on its foreignsource taxable income. The limit is intended to ensure that the credit mitigates double taxationof foreign-source income without offsetting U.S. tax on U.S.-source income. 231 The limit iscomputed by multiplying a taxpayer’s total pre-credit U.S. tax liability for the year by the ratio of
the taxpayer’s foreign-source taxable income for the year to the taxpayer’s total taxable income
for the year. If the total amount of foreign income taxes paid and deemed paid for the year
exceeds the taxpayer’s foreign tax credit limitation for the year, the taxpayer may (in certain
cases) carry back the excess foreign taxes to the previous year or carry forward to one of thesucceeding 10 years. 232 No carryback or carryover of excess foreign tax credits are allowed in
the GILTI foreign tax credit limitation category.

227

Sec. 951A(f)(1).

228
For taxable years beginning after December 31, 2025, the deduction for GILTI is reduced to37.5 percent. Sec. 250(a)(3)(B). In other words, for taxable years beginning before January 1, 2026, the effective
U.S. tax rate (i.e., taking into account the effect of the deduction) on GILTI is 10.5 percent. For taxable years
beginning after December 31, 2025, the effective U.S. tax rate on GILTI rises to 13.125 percent.

Sec. 250(a)(1)(B). Under section 78, a taxpayer claiming the foreign tax credit with respect to foreignsource income generally must include in income the amount of the related foreign taxes paid.
229

Secs. 901, 903, and 960; see also secs. 1291(g) and 1293(f) (providing, in the PFIC context,
coordination with foreign tax credit rules). On January 4, 2022, Treasury published in the Federal Register final
regulations relating to the foreign tax credit, including, inter alia, modifications to the requirements for determining
whether a foreign levy qualifies as a foreign income tax for purposes of section 901 or a tax in lieu of an income tax
for purposes of section 903. T.D. 9959, 87 F.R. 276 (Jan. 4, 2022); see also Treas. Reg. secs. 1.901-2 and 1.903-1.
230

231

Secs. 901 and 904.

232

Sec. 904(c).

40Deemed-paid taxes
For any subpart F income included in the gross income of a domestic corporation, thecorporation is deemed to have paid foreign taxes equal to the aggregate foreign income taxes
paid or accrued with respect to such income by the CFC.
For any GILTI included in the gross income of a domestic corporation, the corporation isdeemed to have paid foreign taxes equal to 80 percent of the corporation’s inclusion percentage
multiplied by the aggregate foreign income taxes paid or accrued with respect to tested income(but not tested loss) by each CFC with respect to which the domestic corporation is a
U.S. shareholder. 233
Allocation and apportionment of expenses
To determine its foreign tax credit limitation, a taxpayer must first determine its taxable
income from foreign sources by allocating and apportioning deductions between U.S.-sourcegross income and foreign-source gross income in each limitation category. In general,
deductions are allocated and apportioned to the gross income to which the deductions factuallyrelate. 234 However, subject to certain exceptions, deductions for interest expense, stewardshipexpenses, and research and experimental expenses are apportioned based on certain ratios. 235
For example, interest expense is apportioned based on the ratio of the corporation’s foreign ordomestic (as applicable) assets to its worldwide assets. 236
Limitation categories (“baskets”)
The foreign tax credit limitation is applied separately to GILTI, foreign branch income, 237
passive category income, and general category income. 238 For this purpose, GILTI and foreign
branch income include only income that is not passive category income. Passive category
income includes passive income, such as portfolio interest and dividend income, and certain

233
Sec. 960(d)(1). The inclusion percentage means, with respect to any domestic corporation, the ratio ofsuch corporation’s GILTI divided by the aggregate amount of its pro rata share of the tested income (but not tested
loss) of each CFC with respect to which it is a U.S. shareholder. Tested foreign income taxes do not include any
foreign income tax paid or accrued by a CFC that is properly attributable to the CFC’s tested loss (if any).
234

Treas. Reg. sec. 1.861-8(b) and (c) and Temp. Treas. Reg. sec. 1.861-8T(c).

Treas. Reg. sec. 1.861-8 through Temp. Treas. Reg. sec. 1.861-14T and Treas. Reg. sec. 1.861-17 set
forth detailed rules relating to the allocation and apportionment of expenses.
235

236

Sec. 864(e)(2).

237
Foreign branch income is defined for this purpose as “the business profits of [the U.S. taxpayer] which
are attributable to 1 or more qualified business units (as defined in section 989(a)) in 1 or more foreign countries.”
Sec. 904(d)(2)(J).

Sec. 904(d); Treas. Reg. sec. 1.904-4(a). The foreign tax credit limitation is also applied separately tocertain additional separate categories. See Treas. Reg. sec. 1.904-4(m).
238

41

specified types of income. 239 All other income is in the general category. Passive income istreated as general category income if earned by a qualifying financial services entity or if highly
taxed (i.e., if the foreign tax rate is determined to exceed the highest tax rate specified in
section 1 or 11, as applicable). 240 Dividends (and subpart F inclusions), interest, rents, androyalties received by a U.S. shareholder from a CFC are assigned to the passive category to theextent the payments or inclusions are allocable to passive category income of the CFC. 241
Dividends received by a 10-percent corporate shareholder of a foreign corporation that is not a
CFC are also categorized on a look-through basis. 242
Special rules apply to the allocation of income and losses from foreign and U.S. sources
within each category of income. 243 Foreign losses from one category first offset foreign-source
income from other categories. Any remaining overall foreign loss offsets U.S.-source income.
The same principle applies to losses from U.S. sources. In subsequent years, any losses deductedagainst another category or source of income are recaptured. That is, an equal amount of income
from the same category or source that generated a loss in a prior year is recharacterized asincome from the other category or source against which the loss was deducted. Foreign-source
income in a particular category may be fully recharacterized as income in another category,whereas only up to 50 percent of income from one source in any subsequent year may berecharacterized as income from the other source.
A taxpayer’s ability to claim a foreign tax credit may be further limited by a matchingrule that prevents the separation of creditable foreign taxes from the associated foreign income.
Under this rule, a foreign tax generally is not taken into account for U.S. tax purposes, and thus
no foreign tax credit is available with respect to that foreign tax, until the taxable year in which
the related income is taken into account for U.S. tax purposes. 244
4. Dividends-received deduction
As discussed above, income earned indirectly through CFCs is taxed either in the year
earned (as subpart F income or GILTI) or not at all. Distributions of previously taxed earnings
and profits do not constitute dividends. 245

239

Sec. 904(d)(2)(A)(i) and (B).

240

Sec. 904(d)(2)(B).

241

Sec. 904(d)(3).

242

Sec. 904(d)(4).

243

Sec. 904(f) and (g).

244Sec. 909.

245

Sec. 959(d).

42A domestic U.S. shareholder generally is allowed a 100-percent DRD for the foreignsource portion of dividends received from a specified 10-percent owned foreign corporation, 246
provided that certain holding period requirements are satisfied. 247 A specified 10-percent owned
foreign corporation is any foreign corporation (other than a PFIC that is not also a CFC) withrespect to which any domestic corporation is a U.S. shareholder. 248
The term “dividend received” is intended to be interpreted broadly, consistent with themeaning of the phrases “amount received as dividends” and “dividends received” under
sections 243 and 245, respectively. The DRD is not available for any hybrid dividend. 249
No foreign tax credit or deduction is allowed for any taxes paid or accrued with respect toany dividend that qualifies for the DRD. 250 Further, no foreign tax credit or deduction is allowed
for any taxes paid or accrued with respect to the U.S.-source portion of any dividend received bya domestic corporation from a qualified 10-percent owned foreign corporation. 251
5. FDII
Domestic corporations generally are taxed at preferential rates on their FDII. 252 The
preferential rate is achieved by allowing corporations a deduction equal to 37.5 percent of theirSec. 245A(a). The foreign-source portion of any dividend equals the amount of the dividend multipliedby the percentage of undistributed earnings that are attributable neither to ECI nor to certain dividends received fromdomestic corporations. Sec. 245A(c).
246

A domestic corporation is not permitted a DRD in respect of any dividend on any share of stock that isheld by the domestic corporation for 365 days or less during the 731-day period beginning on the date that is 365
days before the date on which the share becomes ex-dividend with respect to the dividend. For this purpose, theholding period requirement is satisfied only if the specified 10-percent owned foreign corporation is a specified 10percent owned foreign corporation at all times during the period and the taxpayer is a U.S. shareholder with respect
to such specified 10-percent owned foreign corporation at all times during the period. Sec. 246(c)(5).
247

248
Sec. 245A(b); see also sec. 951(b) (providing that a domestic corporation is a U.S. shareholder of aforeign corporation if it owns, within the meaning of section 958(a), or is considered as owning by applying therules of section 958(b), 10 percent or more of the vote or value of the foreign corporation).

A hybrid dividend is an amount received from a CFC for which section 245A(a) would allow a DRD
and for which the CFC received a deduction (or other tax benefit) with respect to any income, war profits, or excess
profits taxes imposed by any foreign country or possession of the United States. Sec. 245A(e)(4).
249

Sec. 245A(d). For purposes of computing the foreign tax credit limitation, a domestic corporation thatis a U.S. shareholder of a specified 10-percent owned foreign corporation must determine its foreign-source taxable
income (and entire taxable income) by disregarding: (1) any dividend for which the DRD is taken and (2) any
deductions properly allocable or apportioned to (A) income (other than amounts includible under section 951(a)(1)or 951A(a)) with respect to stock of such foreign corporation, or (B) the stock to the extent income with respect tothe stock is other than amounts includible under section 951(a)(1) or 951A(a). Sec. 904(b)(4).
250

251

Sec. 245(a)(8).

252

Sec. 250(a)(1)(A).

43

FDII. 253 FDII is calculated by multiplying a corporation’s “deemed intangible income” by thepercentage of its “deduction eligible income” that is derived from serving foreign markets(i.e., “foreign-derived deduction eligible income”). 254 A corporation’s deemed intangible
income equals the excess, if any, of its deduction eligible income over a 10-percent return on its
qualified business asset investment (“QBAI”). 255 The formula for FDII can be expressed as thefollowing:
𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 = [𝐷𝐷𝐷𝐷𝐷𝐷𝑢𝑢𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 − (10% × 𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄)] ×

𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼

For purposes of computing FDII, a domestic corporation’s QBAI is the average of theaggregate of its adjusted bases, determined as of the close of each quarter of the taxable year, in
specified tangible property 256 used in its trade or business and of a type with respect to which a
deduction is allowable under section 167. 257 The adjusted basis in any property generally must
be determined using the alternative depreciation system under section 168(g) as in effect on
December 22, 2017.
Deduction eligible income and foreign-derived deduction eligible income
Deduction eligible income means, with respect to any domestic corporation, the excess (ifany) of the gross income of the corporation determined without regard to certain amounts thatare excluded from deduction eligible income (referred to in this document as “gross deduction
eligible income”) over deductions (including taxes) properly allocable to such gross income. 258
Foreign-derived deduction eligible income means, with respect to a taxpayer for its
taxable year, any deduction eligible income of the taxpayer that is derived in connection with

For taxable years beginning after December 31, 2025, the deduction for FDII is reduced to
21.875 percent. Sec. 250(a)(3)(A). In other words, for taxable years beginning before January 1, 2026, the effective
U.S. tax rate (i.e., taking into account the effect of the deduction) on FDII is 13.125 percent. For taxable years
beginning after December 31, 2025, the effective U.S. tax rate on FDII is 16.406 percent.
253

254

Sec. 250(b)(1).

255

Sec. 250(b)(2). If the quantity in this formula is negative, deemed intangible income is zero.

Specified tangible property means any tangible property used in the production of deduction eligible
income. For this reason, the adjusted basis of tangible depreciable property held by a foreign branch generally is
excluded from QBAI because foreign branch income is excluded from gross deduction eligible income.
256

The definition of QBAI for purposes of computing FDII relies on the definition of QBAI for purposesof computing GILTI under section 951A(d), determined by substituting “deduction eligible income” for “tested
income” in section 951A(d)(2) and without regard to whether the corporation is a CFC. Sec. 250(b)(2)(B).
257

Sec. 250(b)(3)(A). The amounts excluded from deduction eligible income are: (1) subpart F income;(2) GILTI; (3) financial services income; (4) any dividend received from a CFC with respect to which thecorporation is a U.S. shareholder; (5) any domestic oil and gas extraction income of the corporation; and (6) any
foreign branch income.
258

44

(1) property that is sold 259 by the taxpayer to any person who is not a U.S. person and that the
taxpayer establishes to the satisfaction of the Secretary is for a foreign use 260 or (2) services
provided by the taxpayer that the taxpayer establishes to the satisfaction of the Secretary areprovided to any person, or with respect to property, not located within the United States. 261
Foreign use means any use, consumption, or disposition that is not within the UnitedSpecial rules for determining foreign use apply to transactions that involve property orStates.
services provided to domestic intermediaries or to certain related parties. 263
262

Special rules apply with respect to property or services provided to domestic
intermediaries 264 and with respect to certain related party transactions. 265
Taxable income limitation
If the sum of a domestic corporation’s FDII and GILTI (including GILTI-attributablesection 78 gross-up amounts) exceeds its taxable income determined without regard to thisprovision, then the amount of FDII and GILTI (including GILTI-attributable section 78 grossup) for which a deduction is allowed is reduced (but not below zero) by an amount determinedby such excess.
6. Gain recognition on outbound transfers of intangible property
If a transfer of intangible property to a foreign affiliate occurs in connection with certain
corporate transactions (e.g., section 351 or 361), nonrecognition rules that may otherwise apply
are suspended. The transferor of intangible property must recognize gain from the transfer as
though the transferor had sold the intangible (regardless of the stage of development of theintangible property) in exchange for payments contingent on the use, productivity, or dispositionof the transferred property in amounts that would have been received either annually over the

For purposes of determining FDII, the terms “sold,” “sells,” and “sale” include any lease, license,
exchange, or other disposition. Sec. 250(b)(5)(E).
259

If property is sold by a taxpayer to a person who is not a U.S. person and after such sale the property is
subject to manufacture, assembly, or other processing (including the incorporation of such property, as a component,
into a second product by means of production, manufacture, or assembly) outside the United States by such person,then the property is for a foreign use.
260

261

Sec. 250(b)(4).

262

Sec. 250(b)(5)(A).

263

Sec. 250(b)(5)(B) and (C).

264

Sec. 250(b)(5)(B).

265

Sec. 250(b)(5)(C).

45

useful life of the property or upon disposition of the property after the transfer. 266 The
appropriate amounts of those imputed payments are determined using transfer-pricing principles.

266

Sec. 367(d).

46

C. OECD Two-Pillar Solution
The remainder of this section describes the current status of the OECD project
undertaken at the direction of the G-20 267 to address base-erosion and profit shifting (“BEPS”)
concerns. 268 Although other actions taken in the BEPS project have been adopted by various
jurisdictions, including the United States, 269 the OECD final report on how to address problems
presented by the digital economy did not provide proposed standards or solutions. 270 Since then,many jurisdictions have taken unilateral action to target certain aspects of digital services
provided in general by large technology companies headquartered in the United States, including
by imposing unilateral digital services taxes (“DST”).
At the urging of the G-20, the OECD continued to work on the project, and proposed
blueprints of two pillars as a solution. 271 Following public consultations and further
development of those pillars, in October 2021, the Inclusive Framework agreed in principle tothe two pillars to address the tax challenges arising from the current state of international
taxation of multinational enterprises (“MNEs”). 272 Pillar One seeks to revise the principles
governing profit allocation among related parties and the amount and kind of contact between abusiness and a country (i.e., nexus) that is deemed sufficient to justify that country’s taxation ofthat business. Pillar Two seeks to establish a set of rules to enforce a minimum global level ofincome taxation, addressing structures used by certain MNEs that allow for the shifting of profits
into jurisdictions with low or zero tax rates.

267
In asking the OECD to develop a response to the economic challenges arising from global
digitalization, the G-20 explicitly directed that non-OECD and non-G-20 members be included to ensure global
consensus. The resulting body, the OECD/G-20 Inclusive Framework on BEPS, formed in 2015, now has over 140
members. A list of members may be found https://www.oecd.org/tax/beps.

For an overview of that project, see Joint Committee on Taxation, Background, Summary, andImplications of the OECD/G20 Base Erosion and Profit Shifting Project (JCX-139-15), November 30, 2015. This
document can be found on the Joint Committee on Taxation website at www.jct.gov.
268

269
Changes to U.S. law enacted in 2017 ameliorated certain aspects of those concerns; the introduction of
GILTI and section 245A dividends-received deduction ensure that certain income previously eligible for deferral is
now taxed at a minimum level in the year earned or not at all, thus ending most deferral and the “lockout” effect.

OECD, Addressing the Tax Challenges of the Digital Economy, Action 1 - 2015 Final Report, October
5, 2015, available at http://www keepeek.com/Digital-Asset-Management/oecd/taxation/addressing-the-taxchallenges-of-the-digital-economy-action-1-2015-final-report_9789264241046-en.
270

Tax Challenges Arising from Digitalisation—Report on the Pillar One Blueprint, (“Pillar One
Blueprint”), available at http://www.oecd.org/tax/beps/tax-challenges-arising-from-digitalisation-report-on-pillarone-blueprint-beba0634-en htm and Tax Challenges Arising from Digitalisation—Report on the Pillar Two
Blueprint, (“Pillar Two Blueprint), available at http://www.oecd.org/tax/beps/tax-challenges-arising-fromdigitalisation-report-on-pillar-two-blueprint-abb4c3d1-en htm.
271

OECD (2021), Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from theDigitalisation of the Economy, OECD, Paris, https://www.oecd.org/tax/beps/statement-on-a-two-pillar-solution-toaddress-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-october-2021 htm.
272

47

1. Pillar One
Under the terms of the Pillar One Blueprint, and all subsequent iterations of the terms of
Pillar One, members of the Inclusive Framework agree to rescind existing, and forgo future,
digital services taxes and other unilateral measures in return for international consensus
regarding the proper allocation of taxing rights with respect to certain profits of multinational
enterprises. Such allocation would include ceding taxing rights to market jurisdictions, within aframework that ensures tax certainty for the affected firms within scope of the measure. Since
initial publication of the Pillar One Blueprint, the specific components of the proposal havechanged with each iteration of the components in documents published by the OECD Secretariat
and no consensus document exists. Instead, technical work toward an agreed upon set of model
rules and commentary continues. Ultimately, such rules and commentary will serve as the basis
for a multilateral instrument to be signed by members for implementation. 273
The following aspects of Pillar One are addressed below, based on the most current
publications: the scope and required nexus, the determination of the residual profit that isallocated to market jurisdictions (“Amount A”), including a proposed market and distribution
safe harbor; 274 the allowance for a fixed routine return reportable to market jurisdictions(“Amount B”); 275 and the administrative framework to ensure tax certainty by preventing
disputes and requiring arbitration in certain cases. 276
Scope and nexus
To determine whether a taxpayer is within scope of Pillar One (i.e., a “covered entity”),
both revenue thresholds and the nature of activities are considered. A covered entity is defined
as an entity in a multinational group, or a covered group, where the revenues of the group for theperiod are greater than €20 billion, and the pre-tax profit margin of the group is greater than 10
percent. Revenues and profits from qualifying extractives and regulated financial services are
excluded. 277 In addition, in certain cases, a particular line of business or segment may be treatedas a standalone entity that is within scope as a disclosed segment. Although the impetus of the
project is concern about the digitalization of the economy, the United States has successfullyargued that the digital industry cannot and should not be ring-fenced: that is, the resolution
OECD (2023) OECD Secretary-General Tax Report to G20 Finance Ministers and Central Bank
Governors, India, February 2023, OECD, Paris, https://www.oecd.org/g20/topics/international-taxation/oecdsecretary-general-tax-report-g20-finance-ministers-india-february-2023.pdf.
273

OECD (July 2022) Progress Report on Amount A of Pillar One, (“July Progress Report”) OECD Paris
https://www.oecd.org/tax/beps/progress-report-on-amount-a-of-pillar-one-july-2022.pdf
274

OECD (2022) Public Consultation Document Amount B under Pillar One (“Amount B Report”),
OECD Paris https://www.oecd.org/tax/beps/public-consultation-document-pillar-one-amount-b-2022.pdf
275

276
OECD (2022) Progress Report on the Administration and Tax Certainty Aspects of Amount A of Pillar
One, (“Tax Certainty Progress Report”), OECD Paris https://www.oecd.org/tax/beps/progress-report-on-theadministration-and-tax-certaint-aspects-of-amount-a-of-pillar-one-two-pillar-solution-to-the-tax-challenges-of-thedigitalisation-of-the-economy.htm
277

July Progress Report See pp. 10-12, and Schedules B and C of the report.

48

should not define a specific subset of companies that are to be treated differently from all otherresidents in any of the countries within the Inclusive Framework, noting both the continuing
trend toward digitalization of all industries, as well as the risk that any such ring-fencing would
disproportionately affect U.S. companies.
Together, the revenue thresholds and activity tests are intended to help identify themarkets in which the end user is located, both by applying revenue sourcing rules that will varywith the type of service or good as well as particular market revenue thresholds. Revenues aretreated as arising in a jurisdiction, or sourced to a jurisdiction, depending on the type of revenue.
For example, revenues sourced from location-specific services are sourced to the place ofperformance of the service. Revenues sourced from online advertising services are sourced to
the location of the viewer of the advertisement. 278
A covered entity or group has nexus with a jurisdiction for the relevant taxable period if
its revenues arising in the jurisdiction are equal to or greater than €1 million. However, if thejurisdiction’s GDP is less than €40 billion, nexus is satisfied if the covered group’s revenues in
the jurisdiction are equal to or greater than €250,000.
The expectation is that the thresholds will be based on consolidated financial statementsof a multinational group prepared using acceptable financial accounting standards such as
Generally Accepted Accounting Principles (“GAAP”) and International Financial ReportingStandards (“IFRS”). 279
Amount A: Allocation of the new taxing rightOnce scope and nexus have been determined, the portion of residual profits that are to beallocated to a particular market jurisdiction is identified by use of a formula.
Amount A of Pillar One works by reallocating taxing rights on 25 percent of the residual
profits (profits in excess of 10 percent of revenues) of covered groups to market jurisdictions,regardless of whether they have a physical presence in such jurisdictions.
The formula for this determination is as follows:
Q = (P – (R x 10%)) x 25% x L/R,
where –
Q represents the amount of profit allocated to the jurisdiction,
P is the adjusted profit before tax, which is the financial accounting profit or lossof a covered group, adjusted to exclude tax expense or tax income and other items, and278

July Progress Report, pp. 14-15.

279

July Progress Report, p. 24; Pillar One Blueprint, p. 101.

49

L/R is the allocation key that represents the ratio of revenues arising in thatjurisdiction (or “L”) to the revenues of the whole group (or “R”). 280
Safe harbor for marketing and distribution
After determining the portion of profits that may be eligible to reallocate to a jurisdiction,a marketing and distribution safe harbor may also be available for certain covered groups. If themarketing and distribution safe harbor were to apply, then all or a portion of the amount eligible
for allocation under Amount A would be reduced. This adjustment downwards in the profits
allocated to the jurisdiction is intended to relieve double taxation that may result if a jurisdiction
has already been allocated profits under existing transfer pricing rules. Although the safe harborhas been discussed in terms of marketing and distribution, its calculation is prescribed in terms ofdetermining a fixed rate of return on depreciation and payroll to establish a cap on allocable
residual profits more generally (looking at “nonroutine returns” within the jurisdiction) andpermits a fixed offset percentage of those returns to be used to offset Amount A. If adequate
returns for routine in-country return on depreciation and payroll were already reported in ajurisdiction, or if the notional safe harbor amount already exceeds the amount eligible forallocation under Amount A, then no allocation is to be made to that jurisdiction. The applicableoffset percentage is not yet stipulated.
This marketing and distribution safe harbor adjustment is subject to further deliberation at
the OECD to address concerns that a pure return on depreciation and payroll approach could
result in inappropriate outcomes for routine activities with a low payroll and asset base. 281
Allocation of elimination profits
The obligation to eliminate double taxation with respect to Amount A is also allocatedamong those jurisdictions identified as a relieving jurisdiction for a covered group. First, there isa calculation of the elimination profit 282 which is a sum of financial accounting profit or loss in ajurisdiction, adjusted for various items, similar to the concept of Global Anti-Base Erosion
income (“Globe income”) in Pillar Two. Second, there is an identification of jurisdictions forwhich the elimination profit equals at least 95 percent of the group’s total profit. Third, thejurisdictions are grouped into four tiers, depending on profitability as measured by reference toreturn on depreciation and payroll in the jurisdiction relative to the overall profitability of thegroup. 283 Finally, the obligation to eliminate double taxation is allocated to the jurisdictions withthe highest return on depreciation and payroll and iteratively to the next highest return on
280

July Progress Report, pp. 15-17.

281

July Progress Report, p. 17, footnote 3.

282

July Progress Report, Schedule I, p. 86-94.

July Progress Report, p. 20, paragraph 5. Tier 1 includes the most profitable jurisdictions with returnon depreciation and payroll of over 15x of the group’s overall return on depreciation and payroll, Tier 2 jurisdictions
with return on depreciation and payroll over 1.5x, Tier 3A with return on depreciation and payroll over 0.4x andTier 3B with return on depreciation and payroll over 0.1x.
28350depreciation and payroll until the obligation to eliminate double taxation has been fully
allocated. 284
If there are multiple Tier 1 jurisdictions, the jurisdiction with the highest return on
depreciation and payroll eliminates double tax through a reduction of taxable profits until thatjurisdiction’s return on depreciation and payroll is equal to the return on depreciation and payrollof the second jurisdiction. Once the first jurisdiction has the same return on depreciation andpayroll as the second jurisdiction, the jurisdictions jointly reduce their return on depreciation andpayroll until they are at the level of the third jurisdiction, which then also reduces its return on
depreciation and payroll. If double taxation is not fully relieved from Tier 1 profits, Tier 2
jurisdictions (return on depreciation and payroll > 1.5x) are required to relieve double taxationaccording to the same waterfall. If double taxation is not fully relieved from Tier 1 and Tier 2
jurisdictions, the same then applies to Tier 3A (return on depreciation and payroll > 0.4x) andTier 3B (return on depreciation and payroll > 0.1x). 285
Amount B
Sensitivity to the fact that routine transactions are frequent sources of transfer pricing
disputes, and that many jurisdictions have limited capacity to handle such disputes, prompted aneffort to identify a subset of transactions for which a streamlined approach to intercompany
pricing is appropriate, as well as a streamlined pricing methodology and a basis for identifying
an arm’s-length result where comparable transactions may be unavailable. 286 Amount B isintended to be limited in scope to those transactions that can be reliably evaluated under astreamlined qualitative analysis and a streamlined pricing methodology, the outcomes of which
provides results that are consistent with existing transfer-pricing norms.
By limiting Amount B to controlled transactions that involve routine distribution ormarketing activities within the distributor or marketer’s jurisdiction of residence, for which the
distributor does not undertake significant risk, potential exemptions may be appropriate, and theotherwise required necessary analysis of functions may be streamlined. In developing thecriteria for determining what transactions should be considered within scope of Amount B, anonexclusive list of disqualifying activities, such as research and development, manufacturing,financing, or procurement, are under consideration. If an existing advanced pricing agreement
covers the transaction for the group, such transaction is excluded from the scope of Amount B.
In addition, the routine nature of the in-scope transactions may allow for streamlined
pricing methodology, possibly as a variation of a transactional net margin method. Whether sucha streamlined methodology is required or elective remains under consideration, as are questions
such as whether the availability of comparable transactions in the local market should bedeterminative of the pricing methodology permitted. In particular, whether the use of theAmount B methodology will be required even if another method may be determined to be the284

July Progress Report, pp. 20-22 and Schedule J.

285

July Progress Report, Schedule J.

286

Amount B Report, Section 1.5 at p. 6 and Section 2.12 at p. 8.

51most appropriate method remains an open issue. Work continues with respect to thedevelopment of both common benchmarking search criteria and a global dataset. 287
An implementation framework has not yet been designed for this aspect of Pillar One andcould ultimately take the form of either an elective safe harbor or a prescribed standard for
determining baseline or distribution activities. The principles to be considered in thedevelopment of such framework include the flexibility of existing transfer pricing guidelines
requiring a balance of reliability of the methods chosen as well as administrability.
Tax certainty
The need for improved administrative procedures that both prevent disputes as well as
offer robust dispute resolutions methods has been a feature of Pillar One since the Blueprint was
published in 2020. The scope and type of measures, however, have changed over time.
Tax certainty for Amount A
In late 2022, the OECD described a framework for achieving tax certainty for Amount A
as well as issues related to Amount A. With respect to the latter, there is little agreement about
what constitutes an issue related to Amount A. In addition to the dispute prevention effect ofbroad consensus on proper use of specified percentages and formulas to compute Amount A, anadministrative framework that includes uniform standards for documentation, currency
conversion rules, and filing requirements, may minimize disputes. Different measures ofcertainty may be provided at different stages of the process of determining Amount A. For
example, early confirmation of whether an entity is within scope of Pillar One is expected. 288
Details regarding the processes anticipated for dispute resolution with respect to Amount
A is expected to include mandatory arbitration of the type included in several of the most recent
U.S. tax treaties. 289 The extent to which the scope of such arbitration will include related orcorrelative adjustments that arise as a result of reallocation is uncertain, but under consideration,
due to the nature of the new taxing rights as an overlay on traditional transfer pricing rules. The
scope of mandatory arbitration expected to be included in a multilateral instrument may need toaccommodate existing treaty networks of member jurisdictions, though it is expected to establish
a minimum standard. In addition, safe harbors for advanced pricing agreements in place are
anticipated, with the expectation that future such agreements would be in conformity with Pillar
One principles.

287

Amount B Report, p. 30.

288

Tax Certainty Progress Report, p. 63 and related flowchart.

Bilateral tax treaties of the United States with Belgium, Canada, France, Germany, Japan, Spain, andSwitzerland include provisions in which arbitration in certain disputes between competent authorities is mandatory.
A table of all bilateral treaties can be found on the IRS website: https://www.irs.gov/businesses/internationalbusinesses/united-states-income-tax-treaties-a-to-z.
289

52

Tax certainty for Amount B
In contrast to Amount A, no specific administrative procedures for assuring certainty
with respect to Amount B have been proposed, though the general mutual agreement proceduresof treaty networks are expected to remain relevant to future disputes. Instead, certainty is
expected by incorporation of Amount B principles into transfer pricing guidelines. More
importantly, if the methodologies of Amount B are implemented, it is expected that the range ofissues or disputes that would arise are expected to be significantly truncated by the streamlined
methodologies applicable to Amount B. Because the need for Amount B arose as a result ofconcern about the number of resource-intensive disputes in jurisdictions that may lack theresources to process such cases efficiently, 290 additional administrative measures may be needed
to streamline not only the computational methodology but also the administrative review.
Digital services taxes and other unilateral measures
The final action reports on BEPS failed to resolve the concerns arising from digitalizationof the economy that allowed foreign multinational companies without a physical presence in thejurisdiction to earn revenues generated by the digital activity within their jurisdiction, without
incurring taxation under existing international norms of taxation. In response, jurisdictions
proposed digital services taxes (“DSTs”) and other similar unilateral measures to target therevenue generated by such activities. DSTs can target a range of digital activities, including
advertising, streaming, the operation of intermediary services (such as online marketplaces), andthe collection and sale of user data.
The terms of the OECD’s draft multilateral instrument include a definition of digital
services taxes and similar measures that are unacceptable, prohibited measures under Pillar
One. 291 Such taxes generally are not income taxes, but instead are taxes imposed on marketbased criteria in a manner that either explicitly or in practice applies only to foreign and foreignowned businesses. Value-added taxes, transaction taxes, and anti-abuse measures are generally
not within the scope of the prohibited measures. Article 37 requires that all members rescind
digital services taxes and similar measures; Article 38 would proscribe allocation of residual
profits under Amount A to jurisdictions in violation of Article 37. An administrative process toreview whether a levy or tax is in violation of Article 37 is expected. For a list of provisions
enacted in various jurisdictions that are expected to be rescinded under the terms of Pillar One,see Appendix A.
2. Pillar Two
In December 2021, the OECD published “Global Anti-Base Erosion Model Rules (Pillar
Two),” which provides for a system of taxation based on financial accounts applying a minimum

290

Amount B Report, pp. 28-29, paragraph 43.

OECD (December 2022) Pillar One—Amount A: Draft Multilateral Convention Provisions on Digital
Services Taxes and Other Relevant Similar Measures, https://www.oecd.org/tax/beps/public-consultation-documentdraft-mlc-provisions-on-dsts-and-other-relevant-similar-measures.pdf.
291

53

rate of 15 percent on a jurisdictional (country-by-country) basis (the “Model Rules”). 292 In
March 2022, the OECD published general commentary (and related examples) on the Model
Rules, 293 and in December 2022, the OECD published guidance on a transitional safe harbor, aframework for a permanent safe harbor, and transitional penalty relief. 294 Most recently, inFebruary 2023, the OECD published administrative guidance on the Model Rules to addresscertain specific questions in need of clarification and simplification. 295 For a list of provisions
enacted in various jurisdictions adopting at least some aspects of the Model Rules under Pillar
Two, see Appendix B.
The Model Rules
Pillar Two seeks to establish a set of rules to enforce a minimum global level of income
taxation for MNEs. The intent is to address structures that allow for the shifting of profits into
jurisdictions with low or zero tax rates. For each country in which an MNE operates, the Model
Rules calculate a top-up tax (which may be zero) on an income tax base that follows fromfinancial accounting principles. This country-by-country approach may limit the tax savings
from shifting income between foreign countries. For example, if either a CFC or its branch does
not pay an effective rate of tax equal to 15 percent on its income in its country of organization oroperation, top-up tax may be imposed by that country or another country under the rules
described below.
Companies in scope
The Model Rules apply to MNE groups (and their constituent entities) that have annual
revenue of €750 million or more in the consolidated financial statements of the ultimate parent
entity in at least two of the four fiscal years immediately preceding the tested fiscal year. 296 An
MNE group (or here just MNE) means a collection of entities that are related through ownershipOECD (2021), Tax Challenges Arising from the Digitalisation of the Economy – Global Anti-Base
Erosion Model Rules (Pillar Two): Inclusive Framework on BEPS, OECD, Paris https://www.oecd.org/tax/beps/taxchallenges-arising-from-the-digitalisation-of-theeconomy-global-anti-base-erosion-model-rules-pillar-two htm.
292

293OECD (2022), Tax Challenges Arising from the Digitalisation of the Economy – Commentary to the
Global Anti-Base Erosion Model Rules (Pillar Two), First Edition: Inclusive Framework on BEPS, OECD
Publishing, Paris, https://www.oecd.org/tax/beps/tax-challenges-arising-from-thedigitalisation-of-the-economyglobal-anti-base-erosion-model-rules-pillar-two-commentary.pdf. For the related examples, see OECD (2022), Tax
Challenges Arising from the Digitalisation of the Economy –Global Anti-Base Erosion Model Rules (Pillar Two)
Examples, OECD, Paris, https://www.oecd.org/tax/beps/tax-challenges-arising-from-the-digitalisationof-theeconomy-global-anti-base-erosion-model-rules-pillar-two-examples.pdf.

OECD (2022), Safe Harbours and Penalty Relief: Global Anti-Base Erosion Rules (Pillar Two),
OECD/G20 Inclusive Framework on BEPS, OECD, Paris, https://www.oecd.org/tax/beps/safe-harbours-andpenalty-relief-global-anti-base-erosion-rules-pillar-two.pdf.
294

OECD (2023), Tax Challenges Arising from the Digitalisation of the Economy – Administrative
Guidance on the Global Anti-Base Erosion Model Rules (Pillar Two), OECD/G20 Inclusive Framework on BEPS,
OECD, Paris, www.oecd.org/tax/beps/administrative-guidance-global-anti-base-erosion-rules-pillar-two.pdf.
295

296

Art. 1.1.1 of the Model Rules.

54

or control such that the assets, liabilities, income, expenses, and cash flows of those entities areincluded in the consolidated financial statements of the ultimate parent entity with at least one
entity (or permanent establishment) that is not located in the jurisdiction of the ultimate parent
entity. 297 The ultimate parent entity generally is one that owns (directly or indirectly) acontrolling interest in any other entity and in which no other entity owns a controlling interest. 298
Application of the top-up tax
Top-up tax is due with respect to income in a jurisdiction if book income (“Globe
income,” discussed below) in the jurisdiction is subject to an effective tax rate (“ETR”) of lessthan 15 percent. The additional top-up tax may be collected first by the source country, 299
second by the residence country of the MNE’s ultimate parent entity, 300 third by the residence
country of a lower-tier parent entity, 301 and finally by the residence country of any otheraffiliated entity. 302
Globe income and the base of the top-up tax
Globe income (or loss) in a country generally is the net income (or loss) determined foran entity in preparing consolidated financial statements of the ultimate parent entity. 303 If Globe
income in a country is subject to an ETR of less than 15 percent, then the Globe income issubject to top-up tax.
The ETR for a jurisdiction is equal to the sum of the “adjusted covered taxes” paid in thatjurisdiction divided by the net Globe income in that jurisdiction. 304 Adjusted covered taxes are
the current tax expenses that have accrued for purposes of calculating that year’s financial
accounting net income, adjusted for certain deferred tax assets and deferred tax expenses, as wellas other differences between tax reporting and financial reporting. 305

297

Art. 1.2.1 and 1.2.2 of the Model Rules.

298

Art. 1.4.1 of the Model Rules.

299

Under a “qualified domestic minimum top-up tax” (“QDMTT”).

300

Under an “income inclusion rule” (“IIR”).

301

Also under an IIR.

302

Under an “undertaxed profits rule” (“UTPR”).

303

Art. 3.1.2 of the Model Rules. Several adjustments are made. Art 3.2.1 of the Model Rules.

304

Art. 5.1.1 of the Model Rules.

305

Art. 4.1 of the Model Rules.

55

The base of the top-up tax (“excess profit”) generally is Globe income 306 less thesubstance-based income exclusion for the country. 307 The substance-based income exclusion is
five percent of (1) eligible payroll costs in the country, and (2) the carrying value of eligible
tangible assets in the country. 308 Thus, for companies that have payroll costs and eligible
tangible assets in the relevant country, the amount of top-up tax always is less than the amount ofadditional tax necessary to increase the ETR on Globe income to 15 percent.
In other words:
Top-up tax = (15% – ETR) x (net Globe income – substance-based income exclusion) 309
Ordering of the top-up tax
Qualified domestic minimum top-up tax (“QDMTT”)
The primary right to tax income (including Globe income) arising in a jurisdiction is withthe jurisdiction (the source country) itself. Thus, if in country X an MNE earns Globe incomethat is subject to an ETR of less than 15 percent, country X has priority in applying a top-up tax.
The mechanism for applying that top-up tax (i.e., a top-up tax on domestic income) is the
QDMTT.
A natural question arises: why would country X choose to apply a new tax (the QDMTT)
instead of simply changing its local corporate tax, whether by increasing the rate (to 15 percent)or expanding the base (to resemble Globe income more closely)? The answer is that the tax basefor purposes of determining an MNE’s ETR is generally greater than the tax base for purposes ofdetermining the top-up tax. A 15-percent corporate tax that followed the Model Rules indetermining its tax base would tend to collect more corporate tax than required under the top-up
tax. 310 In other words, the QDMTT represents the only way under Pillar Two for a country tocollect in every case the minimum tax liability due with respect to Globe income arising in its
jurisdiction.
As described below, if a source country does not impose a QDMTT, the Model Rules
allow other countries to collect any top-up tax due with respect to Globe income earned in thesource country.

306“Globe” income is an acronym for Global Anti-Base Erosion income (officially, “GloBE” income).

307

Art. 5.2.3 of the Model Rules.

308
Art. 5.3 of the Model Rules. Initially, the substance-based income exclusion is set to be 10 percent for
eligible payroll costs and eight percent for the carrying value of eligible tangible assets, both phased down to five
percent over a 10-year transition period.
309

See Art. 5.2 of the Model Rules.

A 15-percent corporate tax that followed the base of the top-up tax would be treated in most cases as
having an ETR of less than 15 percent.
310

56

Income inclusion rule (“IIR”)
The secondary right to collect a top-up tax with respect to Globe income earned in asource country is with the jurisdiction of the MNE’s ultimate parent entity. 311 This top-up tax isknown as the IIR. The mechanism is like other tax regimes (“CFC taxes”) that require an
ultimate parent entity to pay current tax on the income of controlled foreign corporations(“CFCs”), including Subpart F income and GILTI under U.S. law. 312 In terms of ordering,
QDMTTs come before CFC taxes, and CFC taxes come before IIRs (which all come before
UTPR, as discussed below).
If the jurisdiction of the ultimate parent entity does not impose an IIR, jurisdictions of
any intermediate parent entities (i.e., between the ultimate parent entity and the source country)
are allowed to collect under their own IIRs any top-up tax due with respect to Globe income
earned in the source country. The IIR has ordering rules to ensure that Globe income in acountry is subject to top-up tax exactly once.
Undertaxed profits rule (“UTPR”)
The final mechanism providing for the collection of top-up tax is the UTPR. If top-up
tax is due, but the source country does not impose a QDMTT and no parent entity is in ajurisdiction imposing an IIR, then countries in which other MNE affiliates are located maycollect the top-up tax under a UTPR. Those countries share the top-up tax according to thenumber of employees in each UTPR jurisdiction and the value of tangible assets in each UTPR
jurisdiction. 313
Tax credits, grants, and the ETR
The ETR on Globe income in a source country may depend on the treatment of certain
incentives provided by the country. Grants are treated as additions to Globe income; tax credits
are treated as reductions to taxes paid for purposes of calculating the ETR. Certain refundable
tax credits (i.e., “qualified refundable tax credits”), however, are treated as grants and, therefore,
increase Globe income rather than reduce taxes paid. 314
For example, consider an MNE in country X with Globe income of 100x, taxes of 20x,
and tax credits of 6x. Before accounting for credits, the MNE has an ETR of 20 percent
311

Art. 2.1.1 to 2.1.3 of the Model Rules.

312

See generally Part I of this document.

The formula is: UTPR percentage = (50 percent of number of employees in a UTPR jurisdiction /number of employees in all UTPR jurisdictions) + (50 percent of net book value of tangible assets in a UTPR
jurisdiction / net book value of tangible assets in all UTPR jurisdictions). Thus, the allocation of UTPR liability ishalf by number of employees and half by net book value of tangible assets.
313

Art. 4.1.2(d) of the Model Rules. The Model Rules generally define qualified refundable tax credits as“a refundable tax credit designed in a way such that it must be paid as cash or available as cash equivalents withinfour years from when … [the MNE] satisfies the conditions for receiving the credit under the laws of the jurisdiction
granting the credit.”314

57

(20x/100x). Whether the MNE is subject to top-up tax depends on the treatment of the credits.
If the tax credits are qualified refundable tax credits, then the ETR is 18.9 percent (20x/106x),
well above 15 percent. If the tax credits are not qualified refundable tax credits, however, thenthe ETR is 14 percent (14x/100x) and the MNE is subject to top-up tax.

58

III. ECONOMIC ANALYSIS
A. Introduction
1. Global economic environment
In general
Global economic development and changes in how the largest companies conduct theirworldwide operations have made U.S. international tax rules increasingly important forpolicymakers and the private sector. Income growth in developing countries has opened newmarkets for U.S. MNEs to sell goods and services. Improvements in infrastructure andinformation technology have lowered the cost of establishing certain business operations, such as
manufacturing facilities, abroad. 315 U.S. MNEs have grown increasingly reliant on global supply
chains to produce goods more efficiently and to serve foreign markets more effectively. 316 In
addition, foreign MNEs have risen in prominence and now compete with U.S. MNEs in manymarkets. These and other developments have put pressure on U.S. international tax rules toaddress and accommodate the more complicated ways in which U.S. MNEs organize themselves,
serve foreign markets, and structure their production networks. Moreover, as U.S. MNEs
generate increasing amounts of income abroad, overall economic positions and investment
decisions may become more sensitive to how their foreign-source income is taxed.
Pharmaceutical industry
The pharmaceutical industry engages in a substantial share of total spending in researchand development (see Figure 8 in section IV. below), as governments and corporations seek tofight a variety of diseases. Prices for pharmaceutical products continue to rise, as does concern
about these increases and their effect on patient access to prescription medicines. 317
To better understand the economics of the pharmaceutical industry, consider the
incentives and pressures. Research and development, costs for new drugs, and the failure, ishigh; further, a successful drug is often easily imitated. For those reasons, patent protection isimportant to justify the expense and the risk. Patents give the holder the first-mover advantage,
allowing the holder the opportunity to establish strong brand recognition and product loyalty
before other corporations enter the market. This, along with the lack of good substitutes for
significant new drugs, often give the corporation holding the patent monopoly power. When a
In 2019, IP-intensive industries accounted for 41 percent of domestic activity or output. For descriptive
analysis on the growth of IP-intensive industries, see https://www.uspto.gov/sites/default/files/documents/uspto-ipus-economy-third-edition.pdf.
315316
For analysis of the growth in foreign value-added in U.S. manufactured products, see Robert Johnson,“Five Facts about Value-Added Exports and Implications for Macroeconomics and Trade Research,” Journal of
Economic Perspectives, vol. 28, no. 2, Spring 2014, pp. 119-142; and Pol Antras and Davin Chor, “Global Value
Chains,” Handbook of International Economics, vol. 5, Elsevier, 2022.

Darius N. Lakdawalla, “Economics of the Pharmaceutical Industry,” Journal of Economic Literature,
vol. 56, no. 2, June 2018, pp. 397-449.
317

59

corporation has monopoly power over a patent product, this may lead to prices higher thancompetitive levels for the patent product. This, in turn, may lead governments to counter with adiverse set of price control mechanisms. 318 On the other hand, when patents expire, genericsubstitutes often introduce vigorous price competition. The extent to which generics capture
market share from the branded original drugs depends on government regulatory policies, thereimbursement policies of healthcare insurers, and the organization of health care provider
institutions. 319
While the Federal government regulates market exclusivity and efficacy within thepharmaceutical industry, the government (especially through Medicare and Medicaid) is also amajor customer. This creates a unique situation that sometimes results in the government
exercising monopsony power 320 against the patent monopolies. Patent monopolies create
incentives for private customers, such as insurance companies, to grow large enough to exercise
countervailing market power. The creation of similar but not identical pharmaceuticalinnovations from other drug manufacturers reinforces this monopsony power, as does theprospect of future competition by generic manufacturers producing identical drugs. 321 All thesesources of competition influence price negotiation among public and private customers, and nonprice competition like marketing investments.
In industries that depend on creating and using valuable intellectual property, such as thepharmaceutical industry, global operations may involve performing research and development in
the United States, transferring the resulting intellectual property to an affiliate in a low-tax
jurisdiction, manufacturing through an affiliate in a second jurisdiction, and selling the final
product around the world through an affiliate in a third (often again low-tax) jurisdiction. 322
Whether this arrangement represents a loss of revenue to the United States depends on
the transfer price for the intellectual property, the price for the use of the intellectual property
abroad, or the amount paid by the foreign affiliate to cover its share of the research anddevelopment performed in the United States.

318

1297-1336.
319

F.M. Scherer, “The Pharmaceutical Industry,” Handbook of Health Economics, vol. 1, part B, 2000, pp.
Ibid.

320
Monopsony power arises when the buyer has the ability to lower the price of a product or service byreducing the quantity they purchase.
3211297-1336.

F.M. Scherer, “The Pharmaceutical Industry,” Handbook of Health Economics, vol. 1, part B, 2000, pp.

322

See generally Joint Committee on Taxation, Present Law and Background Related to Possible Income
Shifting and Transfer Pricing (JCX-37-10), July 20, 2010, and Joint Committee on Taxation, Testimony of the Staffof the Joint Committee on Taxation Before the House Committee on Ways and Means Hearing on Transfer Pricing
Issues (JCX-38-10), July 20, 2010. These documents can be found on the Joint Committee on Taxation website atwww.jct.gov. See also Amgen, Inc. & Subs. v. Commissioner, Dkt. Nos. 16017-21 and 15631-22.

60

2. Neutrality conditions and their limits
When assessing international tax rules, economists generally start from the position thattaxes distort economic activity to the extent that they change economic behavior in ways that
result in inefficient levels or patterns of investment. 323 Analysts have settled on a number ofgeneral principles when it comes to evaluating whether tax rules promote economic efficiency inthe purely domestic, closed-economy context. One general principle is that the pattern of
aggregate investment may be more economically efficient if taxes are neutral with respect to thetype of investment being made, or more specifically, if effective marginal rates of taxation are
the same across investments. In particular, efficiency is enhanced if investments are made basedon pre-tax rates of return rather than after-tax rates of return. If effective marginal rates oftaxation vary by the type of investment made (e.g., because of different cost recovery rules orinvestment incentives), that may result in an inefficient allocation of resources and lead to lower
levels of production relative to a tax-neutral environment. Specifically, more resources flow to
low-taxed sectors than would be the case if taxes were neutral with respect to types ofinvestment, and fewer resources are devoted to more highly taxed sectors. This will generally
lead to lower levels of productive efficiency in the economy and reduce national welfare.
In the cross-border, open-economy context, there is significantly less consensus on theprinciples that should be used to evaluate international tax policy. In the early economic
literature, a number of neutrality conditions—the most prominent of which are capital export
neutrality and capital import neutrality—were proposed to evaluate whether the international tax
system promotes global (and not necessarily national) welfare. 324 The usefulness of these
efficiency criteria or general guides to the development of international tax policy has beenquestioned by a number of commentators. Their validity relies on special (and not necessarily
realistic) assumptions concerning the substitutability of domestic and foreign investment andintangible capital. 325 Moreover, some question whether principles used to evaluate whether
international tax rules promote global welfare should be used by policymakers when designing
their national tax systems, since policymakers may be more concerned with national, as opposed
to global, welfare. Nonetheless, these neutrality principles are useful places to start when

323
Economists also recognize that taxes can be used to fund government spending and correct for market
failures (i.e., instances where the absence of government intervention results in too little or too much of an economic
activity). See the discussion in Joint Committee on Taxation, Economic Growth and Tax Policy (JCX-47-15),
February 2015, pp. 3-5.

The classic reference is Peggy B. Musgrave, Taxation of Foreign Investment Income: An Economic
Analysis, Johns Hopkins Press, 1963.
324

For a discussion of the usefulness of the neutrality conditions and the assumptions under which they canbe used as efficiency criteria, see American Bar Association Task Force on International Tax Reform, “Report of the
ABA Task Force on International Tax Reform,” Tax Law Review, vol. 59, no. 3, 2005-2006, pp. 652-812; Harry
Grubert and Rosanne Altshuler, “Corporate Taxes in the World Economy: Reforming the Taxation of Cross-Border
Income,” in John W. Diamond and George R. Zodrow (eds.), Fundamental Tax Reform: Issue, Choices, andImplications, the MIT Press, 2008, pp. 319-354; and David A. Weisbach, “The Use of Neutralities in International
Tax Policy,” National Tax Journal, vol. 68, no. 3, September 2015, pp. 635-652.
325

61

considering how to evaluate the international tax rules that a country adopts, and their limitations
may shed light on what other principles or approaches may be more useful for analysis.
Capital export neutrality refers to a condition under which the overall effective tax rate on
the return to investments made by a resident in any given country is the same regardless of where
the investment is made. In other words, the decision made by a resident to invest at home orabroad is not influenced by tax considerations. As applied to U.S. international tax rules, thiscondition is generally met if the foreign-source income of U.S. residents is taxed at the same rate
as their U.S.-source income.
Capital import neutrality refers to a condition under which the overall effective tax rateon the return to investments made in any given country is the same regardless of the residence of
the investor. As applied to U.S. international tax rules, this condition is met if foreign
investments made by U.S. investors in any given country face the same overall tax burden as
investments made by any other investor in that country. If the other investors are residents incountries that exempt foreign-source income from taxation and the United States exempts theforeign-source income of U.S. residents from taxation, then capital import neutrality is satisfied.
3. Evaluating international tax rules based on behavioral margins
Rather than evaluating tax systems based on whether they satisfy an overarchingneutrality condition, recent economic research has focused on how international tax rules affecteconomic behavior in more specific dimensions of policy relevance, in particular those relating
to preserving the income tax base and promoting domestic investment, employment, and growth.
The remainder of Part III surveys the economic literature on (1) the location of reported
profits and transfer pricing, and (2) the location of intangible property and returns to intangible
investment. These dimensions are interrelated. For example, increasingly common profitshifting practices include transfer pricing and complex global structuring related to intangible
property, in which an MNE effectively underprices intangible capital when “sold” from one ofits entities in a high-tax jurisdiction to another of its entities in a low-tax jurisdiction or engages
in a series of transactions among subsidiaries that are strategically located in order to reduce the
MNE’s effective global tax rate. 326
The remainder of Part III describes how this literature may relate to the level of the U.S.
corporate income tax rate, the GILTI inclusion and deduction, the deduction for FDII, and the
BEAT for U.S. pharmaceutical companies. Since these provisions were enacted within the last
six years and have important differences with tax rules in other countries, studies analyzing the
economic effects of these provisions are limited.

Faith Guvenen, Raymond J. Mataloni, Jr., Dylan G. Rassier, and Kim J. Ruhl. “Offshore Profit Shifting
and Aggregate Measurement: Balance of Payments, Foreign Investment, Productivity, and the Labor Share,”American Economic Review, vol. 112, no. 6, 2022, pp. 1848-1884.
326

62

B. Location of Reported Profits and Transfer Pricing
1. BackgroundAs reflected in the OECD BEPS Project, policymakers are concerned that the location of
profits derived from the sale of goods and services is not aligned with where the value
underlying those goods and services was generated, thus reducing tax revenue. For example, in
the United States, there has been a concern that a large share of U.S. corporate profits is locatedin low-tax jurisdictions where corporations have relatively little employment and tangible
investment, even though the innovations generating those profits may have been developed in the
United States. 327 Some commentators have noted that the geographic distribution of profits,even if legal, is at least partly artificial to the extent that it does not reflect where the real
economic activity generating those profits is located. 328 Others have disputed thischaracterization and also contended that requiring a closer link between the location of profits
and the location of real economic activity will cause U.S. corporations to shift U.S. employment
and investment to low-tax jurisdictions and result in economic distortions. 329
2. Location of reported profits
There is a large empirical literature analyzing the general question of how responsive thelocation of profits is to differences in tax rates across countries (without taking a position on
where taxable income should be located as an economic matter). One survey of the literaturefinds that a one percentage-point reduction in the tax rate of a host country is predicted to lead to
a 0.8 percent increase in the profits reported by a foreign subsidiary located in that country. 330
However, a number of the studies reviewed in the survey are limited in that they (1) rely on
financial statement data rather than tax data, and (2) exclude from their analysis, because of data
For a discussion of the issues, see Gabriel Zucman, “Taxing across Borders: Tracking Personal Wealthand Corporate Profits,” Journal of Economic Perspectives, vol. 28, no. 4, Fall 2014, pp. 121-148; and James R.
Hines Jr., “Treasure Islands,” Journal of Economic Perspectives, vol. 24, no 4, Fall 2010, pp. 103-126. An analysis
of certain tax planning strategies MNEs may use in some cases to shift income to low-tax jurisdictions can be foundin Joint Committee on Taxation, Present Law and Background Related to Possible Income Shifting and Transfer
Pricing (JCX-37-10), July 20, 2010. This document can be found on the Joint Committee on Taxation website atwww.jct.gov.
327

328
See Kimberly A. Clausing, “Profit Shifting before and after the Tax Cuts and Jobs Act,” National Tax
Journal, vol. 73, no. 4, December 2020, pp. 1233-1266.

For a discussion on the possible limits of using the location of employment and investment as the basis
for assessing where income is earned, see James R. Hines Jr., “Income Misattribution under Formula
Apportionment,” European Economic Review, vol. 54, no. 2, 2009, pp. 108-120. Some researchers have argued thatmethodological issues have caused estimates of profit shifting out of the United States to be overstated. See thediscussion in Kimberly A. Clausing, “Profit Shifting before and after the Tax Cuts and Jobs Act,” National Tax
Journal, vol. 73, no. 4, December 2020, pp. 1233-1266.
329

330
Josh H. Heckemeyer and Michael Overesch, “Multinationals’ Profit Response to Tax Differentials:
Effect Size and Shifting Channels.” Canadian Journal of Economics, vol. 50, no. 4, November 2017, pp. 965-994.
The methodology used in this paper was extended and updated in Sebastian Beer, Ruud de Moiij, and Li Liu,
“International Corporate Tax Avoidance: A Review of the Channels, Magnitudes, and Blind Spots,” Journal of
Economic Surveys, vol. 34, no. 3, July 2020, pp. 660-688. This survey reports a slightly larger average estimate.

63

availability, a significant number of low-tax jurisdictions. One paper analyzing tax return datafrom all U.S. CFCs reports a generally larger response of the location of profits to tax rate
differentials, with the responsiveness dependent on the level of the host country tax rate. 331 The
paper finds that a change in the host country tax rate from five percent to four percent results in a
4.7 percent increase in reported profits, while a change from 30 percent to 29 percent results in a
0.7 percent increase in reported profits.
Puerto Rico is an example of a low-tax jurisdiction that is attractive to shift reported
taxable income from the United States. Prior to the repeal of section 936 332 in 1996, thefavorable tax treatment of Puerto Rican affiliates of U.S. corporations resulted from a
combination of Puerto Rican and United States law. 333 Using corporate tax return data on
section 936 companies in manufacturing, one study develops a structural econometric model ofthe joint decisions regarding investment and income shifting on U.S. activity in Puerto Rico. 334
The results suggest that the income shifting advantages are the predominant reason for U.S.
investment in Puerto Rico. After the repeal of section 936, many papers focus on the effects of
the repeal on the manufacturing industry in Puerto Rico. Despite the use of various data andmethodologies, these papers generally find a consistent negative effect of the repeal of section
936 on the number of establishments, employment, wages, and exports in the manufacturingindustry of Puerto Rico. 335
3. Transfer pricing
Another set of papers has analyzed potential channels for profit shifting, particularly thechannels through which transfer prices are set. These papers examine the extent to whichtransfer prices, which should reflect arm’s length prices, may deviate from arm’s length prices.
These studies generally rely on import and export price data collected by government agencies
and compare prices charged to related and unrelated parties for similar products (although therelated-party price data is sometimes estimated and not actually observed). An early study basedon aggregate U.S. import and export price data (i.e., across all companies for specific products)
finds that a one percentage-point reduction in the tax rate of a destination country is associated331
Tim Dowd, Paul Landefeld, and Anne Moore, “Profit Shifting of U.S. Multinationals,” Journal of
Public Economics, vol. 148, no. 1, April 2017, pp. 1-13.

In general, prior to 1996 section 936 allowed subsidiaries of U.S. firms operating in Puerto Rico to pay
no federal taxes on their Puerto Rican profits, even if those profits were returned to the United States.
332

Zoltan M. Mihaly, “Tax Advantages of Doing Business in Puerto Rico,” Stanford Law Review, vol. 16,
no. 1, December 1963, pp. 75-106.
333

Harry Grubert and Joel Slemrod, “The Effect of Taxes on Investment and Income Shifting to Puerto
Rico,” The Review of Economics and Statistics, vol. 80, no. 3, August 1998, pp. 365-373.
334

335
Wilfredo Toledo, “Foreign Direct Investment and Manufacturing Growth: The Case of Tax Incentives
in Puerto Rico,” Modern Economy, vol. 8, 2017, pp. 272-281; and Zadia M. Feliciano and Andrew Green, “U.S.
Multinationals in Puerto Rico and the Repeal of Section 936 Tax Exemption for U.S. Corporations,” NBER
Working Paper 23681, August 2017. The data and methodology used in this paper was extended and updated in
Zadia M. Feliciano, “IRS Section 936 and the Decline of Puerto Rico's Manufacturing,” Centro Journal, vol. 30, no.
3, Fall 2018, pp. 30-42.

64with a 1.8 percent decrease in the related-party export price (relative to prices charged tounrelated parties), and that a one percentage-point reduction in the tax rate of an origin country is
associated with a two percent increase in the related-party import price charged by thatcountry/paid to that country (relative to prices charged to unrelated parties). 336 A more recent
study using firm-level Danish export data finds that a one percentage-point reduction in the tax
rate of a low-tax country is associated with a 0.6 percent decrease in export prices of MNEs withaffiliates in that country (relative to prices charged to unrelated parties). 337 Using French tax andtrade data, some economists find that the effect, with respect to the price of exported goods,
mainly arises in exports to particularly low-tax jurisdictions and not elsewhere. 338 In contrast,
another recent study relying on firm-level tax and trade data from the United Kingdom finds thata one percentage-point increase in the tax rate of a destination country results in a three percent
decrease in export prices charged to related parties in the United Kingdom (relative to unrelatedparties), and that the decrease became 4.5 percent after the United Kingdom adopted a territorial
tax system. 339 The difference in results is not necessarily a reflection of differences in the tax
sensitivity of transfer prices across countries, but that the methodological approach across these
papers varies.
4. Implications for the effect of U.S. international tax rules on U.S. pharmaceuticalcompanies
CFC rules have been used to address profit shifting by reducing the tax advantage oflocating profits in low-tax jurisdictions. One paper examining European MNEs finds that homecountry CFC rules lowered profits reported in low-tax host jurisdictions and increased profits inhigher-tax jurisdictions. In addition, the paper estimates that half of the resulting increase in thetax base accrues to the home country enforcing the CFC rule (with the other half accruing toother higher-tax jurisdictions as income is shifted out of low-tax jurisdictions). 340
In the U.S. context, the GILTI provisions (including the GILTI deduction) were intended,in part, to address potential base erosion that would result from the 100-percent DRD, and Joint

Kimberly A. Clausing, “Tax-Motivated Transfer Pricing and U.S. Intrafirm Trade Prices,” Journal of
Public Economics, vol. 87, nos. 9-10, September 2003, pp. 2207-2223.
336

Anca D. Cristea and Daniel X. Nguyen, “Transfer Pricing by Multinational Firms: New Evidence from
Foreign Firm Ownerships,” American Economic Journal: Economic Policy, vol. 8, no. 3, August 2016, pp. 170-202.
337

Ronald B. Davies, Julien Martin, Mathieu Parenti, and Farid Toubal, “Knocking on Tax Haven’s Door:Multinational Firms and Transfer Pricing,” The Review of Economics and Statistics, vol. 100, no. 1, March 2018, pp.
120-134.
338

339
Li Liu, Tim Schmidt-Eisenlohr, and Dongxian Guo, “International Transfer Pricing and Tax
Avoidance: Evidence from Linked Trade-Tax Statistics in the United Kingdom,” The Review of Economics andStatistics, vol. 102, no. 4, October 2020, pp. 766-778.

Sarah Clifford, “Taxing Multinationals beyond Borders: Financial and Locational Responses to CFC
Rules,” Journal of Public Economics, vol. 173, no. 1, May 2019, pp. 44-71.
340

65

Committee staff estimated the GILTI provisions to raise tax revenue. 341 Using quarterly datafrom Standard and Poor’s Compustat, a recent study examines MNE’s responses to Public Law
115-97 (“the 2017 legislation”) and finds that spending and investment behavior depends onliquidity, investment opportunities, and borrowing costs. In particular, the study finds that
MNEs with high foreign cash and most likely to be subject to tax under the GILTI provisions
increased their foreign but not domestic capital expenditures. The fact that the GILTI inclusion
is reduced by a return on the basis of foreign tangible assets may provide U.S. MNEs with an
incentive to invest in foreign tangible assets instead of domestic tangible assets. 342 In addition, a
study that also uses Compustat data finds that the 2017 legislation, mainly the decrease in the
U.S. corporate tax rate from 35 percent to 21 percent, reduced the tax burden for public U.S.
corporations’ domestic, not foreign, earnings, resulting in equal tax relief to purely domestic U.S.
corporations and U.S. MNEs. 343 The authors argue that this equalized burden likely reduces the
incentive to shift earnings to foreign jurisdictions relative to years before 2018. 344
Using a combination of survey data, tax data, and firm financial statements, anotherrecent study finds evidence that, consistent with incentives introduced in the law, U.S. MNEs
book a larger share of their profits in the United States after 2017. The share of profits bookedabroad has decreased by about 3-5 percentage points, to about 27 percent for all U.S. MNEs, or
between 10 and 16 percent for all U.S. MNEs. 345 The authors argue that the lower U.S.
corporate rate and current inclusion of GILTI reduce the incentives for U.S. MNEs to bookprofits in tax havens, but the move to a territorial system increases the incentives to shift income
to low-tax countries. In addition to investment in the United States by U.S. MNEs, one study
finds that while foreign MNEs did not increase their real property investments after 2017, they
did increase the earnings they retained in the United States. 346
While the research on the effect of tax differentials on transfer prices has largely focusedon inbound payments, one implication of the research is that tax differentials affect how transfer
prices are set. To the extent that this is true, and to the extent that this interpretation of theresearch applies to outbound payments as well (i.e., tax rate differentials may create an incentive
to price outbound related-party payments at higher than arm’s length prices if the payee
Joint Committee on Taxation, Estimated Budget Effects of the Conference Agreement for H.R. 1, the“Tax Cuts and Jobs Act” (JCX-67-17), December 2017. This document can be found on the Joint Committee on
Taxation website at www.jct.gov.
341

342
Brooke D. Beyer, Jimmy F. Downes, Mollie E. Mathis, & Eric T. Rapley, "U.S. Multinational
Companies’ Payout and Investment Decisions in Response to International Tax Provisions of the Tax Cuts and Jobs
Act of 2017," Journal of the American Taxation Association, January 2022.

Scott D. Dyreng, Fabio B. Gaertner, Jeffrey L. Hoopes, and Mary E. Vernon, “The Effect of U.S. Tax
Reform on the Taxation of U.S. Firms; Domestic and Foreign Earnings,” January 2023, forthcoming.
343

344

Ibid.

Javier Garcia-Bernardo, Petr Jansky, & Gabriel Zucman, "Did the Tax Cuts and Jobs Act Reduce Profit
Shifting by US Multinational Companies?" NBER Working Paper Series, May 2022.
345

Matheson, Thornton, Alexander Klemm, Laura Power, and Thomas Brosy, “The Impact of the Tax
Cuts and Jobs Act on Foreign Investment in the United States,” IMF Working Paper 22/79, 2022.
346

66

jurisdiction is lower tax than the payor jurisdiction), existing economic research may offer some
support for one possible motivation for enacting the BEAT (which limits the ability of foreign
corporations from taking advantage of certain deductions). 347 However, these results generally
have limited applicability to the BEAT because (1) base erosion payments under the BEAT are
not affected by the home-country tax rate of the related party, and (2) the studies focused on thepricing of goods.
Changes in the 2017 legislation generally reduced the incentive to book profits abroad,including (1) the decrease in the U.S. corporate rate from 35 percent to 21 percent, (2) taxation of
GILTI, and (3) the taxation of base erosion payments to foreign affiliates. One recent survey ofannual reports filed with the U.S. Securities and Exchange commission by a group of 15 large
pharmaceutical companies argues that the foreign share of worldwide profits has stayed roughly
constant since 2015 (around 75 percent), with a relatively large increase in 2020 (to 82 percent)and followed by a relatively large decline in 2021 (to 63 percent). 348 The incentive to keep
profits out of the United States while reduced, was not eliminated; blending of losses, taxes, andQBAI in GILTI continues to shield some low tax income.

Committee Recommendations as Submitted to the Committee on the Budget Pursuant to H. Con. Res.
71, S. Prt. 115-20, p. 396.
347

Martin A. Sullivan. “Pharma Profits Are Mostly Overseas, But Only Amgen Is In Tax Court,” Tax
Notes International, vol. 109, March 2023.
348

67

C. Location of Intangible Property and the Returns
to Intangible Investment
1. Background
The taxation of income derived from intangible property has become a central issue ininternational tax policy discussions for at least two reasons. First, the returns to intangible
property are a particularly mobile source of income and account for a significant share of profits
reported by MNEs. 349 Second, the research activity associated with the development ofintangible property is an important driver of innovation and economic growth. 350 In the U.S.
context, part of the policy motivation for enacting the deduction for FDII was to encourage thelocation of more intangible income, and potentially some of the activity giving rise to that
intangible income, in the United States, and make the U.S. tax system more neutral with respect
to where U.S. MNEs locate intangible property and income (under the view that the UnitedStates was a less favorable location under prior law). 351
2. Location of intangible property
There is evidence that the location of certain intangible property within MNEs issensitive to tax policy. A series of papers studying European MNEs and their intangible property
holdings finds that they tend to hold more intangible property in affiliates located in lower-tax
jurisdictions and have fewer patent filings in affiliates located in higher-tax jurisdictions. 352
However, these papers do not answer the question of whether lower tax rates result in increased
overall levels of intangible property in the MNE group. In contrast to these findings on
intangible property in European MNEs, one paper studying corporations listed in the Standard
and Poor’s 500 Index finds that U.S. marginal tax rates have no significant effect on where U.S.
trademarks are held, and that offshore trademark ownership is influenced more by foreign

Harry Grubert, “Intangible Income, Intercompany Transactions, Income Shifting, and the Choice ofLocation,” National Tax Journal, vol. 56, no. 1, pt. 2, March 2003, pp. 221-242. These profits may also be a sourceof wage growth. One paper examining surplus profits arising from patent allowances finds that workers capture, inthe form of higher earnings, approximately 30 cents of every dollar of surplus generated from the patent. See
Patrick Kline, Neviana Petkova, Heidi Williams, and Owen Zidar, “Who Profits from Patents? Rent-Sharing at
Innovative Firms,” Quarterly Journal of Economics, vol. 134, no. 3, August 2019, pp. 1343-1404.
349

The benefits of U.S. research activity are largely localized but may also be diffused internationally.
One study finds that the median U.S. multinational firm realizes 20 percent of the return to its U.S. research anddevelopment investment abroad. See L. Kamran Bili and Eduardo Morales, “Innovation in the Global Firm,” The
Journal of Political Economy, vol. 128, no. 4, April 2020. Note that intangible property may include property, suchas certain marketing intangibles, that do not result from scientific research.
350

351
Committee Recommendations as Submitted to the Committee on the Budget Pursuant to H. Con. Res.
71, S. Prt. 115-20, p. 375.

Matthias Dischinger and Nadine Riedel, “Corporate Taxes and the Location of Intangible Assets within
Multinational Firms,” Journal of Public Economics, vol. 95, nos. 7-8, August 2011, pp. 691-707; and Tom
Karkinsky and Nadine Riedel, “Corporate Taxation and the Choice of Patent Location within Multinational Firms,”
Journal of International Economics, vol. 88, no. 1, September 2012, pp. 176-185.
352

68

activities than tax rates. 353 In particular, for trademarks held offshore, host-country taxes have asignificant effect on location choice only if U.S. CFC rules do not apply. The U.S. trademark
locations of European MNEs, however, are more responsive to U.S tax rates.
3. Returns to intangible investment (patent boxes and research activity)
From the perspective of investment, employment, and economic growth, the research
activities associated with intangible property are potentially more important than where theintangible property is located. Several countries have adopted “patent boxes” that offer
preferential treatment to income generated from patents that are located in those countries, andresearch on patent boxes may offer insight into whether the location of intangible property isaccompanied by increased research activities. In contrast to some of the overarching results inthe papers described in the previous section, one paper has found that patent boxes have a small
effect on patent transfers (with more noticeable effects for patent boxes that do not have any
local development requirement), but have no effect on research spending and patented inventionsin the countries offering patent boxes. 354 Another paper predicts that patent boxes may
encourage the location of new patents but lead to significant losses in tax revenue. 355 One
survey of economic research on policies to promote innovation finds that, from a tax policy
perspective, research credits are relatively effective tools to promote research spending, but thecost of patent boxes outweighs their benefits. 356
Some of the research surveyed above was conducted prior to the OECD agreement on the
Modified Nexus Approach for patent boxes, which requires a link between research spending
and the intangible property underlying the patent-related income receiving the tax benefit(i.e., nexus). One study analyzes how a patent box in one country affects research anddevelopment (“R&D”) activity in other countries and how that relationship depends on therequirement for nexus and relocation costs of R&D activity. 357 Using MNE affiliate-level data,
the study finds that patent box regimes that do not require nexus (i.e., has low relocation costs of
R&D activity) exert positive cross-border effects on R&D activity. Therefore, existing economic
research suggests that a jurisdiction that sets preferential rates on patent-related income alone
may not increase research activity in that jurisdiction.

Jost H. Heckemeyer, Pia Olligs, Michael Overesch, “‘Home Sweet Home’ Versus International Tax
Planning: Where Do Multinational Firms Hold Their U.S. Trademarks?” National Tax Journal, vol. 71, no. 3,
September 2018, pp. 485-520.
353

Fabian Gaessler, Bronwyn H. Hall, and Dietmar Harhoff, “Should There Be Lower Taxes on Patent
Income?” Research Policy, vol. 50, no. 1, January 2021, pp. 104-129.
354

355
Rachel Griffith, Helen Miller, and Martin O’Connell, “Ownership of Intellectual Property andCorporate Taxation,” Journal of Public Economics, vol. 112, no. 1, April 2014, pp. 12-23.

Nicholas Bloom, John Van Reenen, and Heidi Williams, “A Toolkit of Policies to Promote Innovation,”
Journal of Economic Perspectives, vol. 33, no. 3, Summer 2019, pp. 163-184.
356

Thomas Schwab and Maximilian Todtenhaupt. “Thinking Outside the Box: The Cross-border Effect of
Tax Cuts on R&D,” Journal of Public Economics, vol. 204, December 2021.
357

69

4. Implications for the effect of U.S. international tax rules on U.S. pharmaceuticalcompanies
To the extent that (1) taxes influence the location of intangible property and (2) the
location of intangible income follows the location of intangible property, preferential rates on
intangible income offered by a country may result in more intangible income being located inthat country. The application of this result to the deduction for FDII (paired with the deduction
for GILTI) is unclear because the calculation of deemed intangible income is formulaic and notbased on items of income tied to intangible property. In addition, only a portion of deemed
intangible income, depending on foreign income derived by the U.S. corporation, benefits fromthe FDII deduction, while the taxes studied in the economics literature on the effect of taxationon the location of intangible property generally apply to all intangible-related income (andsometimes all income) earned by the company.
Thus far, there is no causal research on how the deduction for FDII and GILTI effects
U.S. pharmaceutical companies. There is a descriptive study that documents the changing natureof outbound royalties from Ireland for U.S. pharmaceutical and information and communication
technology companies. The study finds that from 2016 to 2020 outbound royalty payments by
U.S. pharmaceutical MNEs to related parties in Ireland have reduced from €24 billion to €14
billion. Over the same time period, outbound royalty payments linked to U.S. information andcommunication technology MNEs in Ireland have risen from €28 billion to €57 billion. 358 This
analysis focuses on the following events during this time period: (1) the one-time transition tax
on pre-2018 profits of U.S. MNEs which had benefitted from deferred taxation, (2) the U.S. tax
due on what is deemed to be GILTI, (3) the relief provided by the United States for FDII, and(4) changes to the information and communication technology sector’s licensing arrangements
for the use of their intellectual property by their international operations.

Seamus Coffey, “The changing nature of outbound royalties from Ireland and their impact on the
taxation of the profits of US multinationals,” Ireland’s Department of Finance, June 14, 2021, available athttps://www.gov.ie/en/publication/fbe28-the-changing-nature-of-outbound-royalties-from-ireland-and-their-impacton-the-taxation-of-the-profits-of-us-multinationals-may-2021/. This paper studies the time period 2016 to 2020,
because pre-existing double Irish structures ended by January 2020. In general, a double Irish structure consists of acorporation setting up two subsidiaries in Ireland: a holding and operating Irish company. The holding company
registers in a tax haven, which allows it to avoid paying taxes on its profits.
358

70

IV. TRENDS IN U.S. PHARMACEUTICAL FOREIGN- AND
U.S.-SOURCE INCOME AND ACTIVITIESThe staff of the Joint Committee (“Joint Committee staff”) has examined preliminary
aggregate taxpayer data from tax year 2014 to tax year 2020 to provide information on the tax
positions of U.S. pharmaceutical corporations.
A. Worldwide and U.S. GAAP Average Tax Rates
for Large Corporations
Using generally accepted accounting principles (“GAAP”), Table 1 reports theworldwide and U.S. average tax rates (“ATRs”) for three different groups of large, publicly
traded corporations: (1) all corporations (subject to the sample limitations below),(2) manufacturing corporations (two-digit NAICS codes 31 to 33, excluding pharmaceutical
corporations), and (3) pharmaceutical corporations (four-digit NAICS code of 3254). 359 The
data underlying the tax rate calculation are drawn from the Compustat database, which is
populated from financial statements (e.g., Form 10-K) filed with the Securities and Exchange
Commission (“SEC”). 360 361 The sample is limited to U.S. headquartered corporations thatappeared in the Compustat database in each year from 2014 to 2020 (i.e., a balanced panel), had
positive pre-tax income from foreign operations in at least one of those years, and had at least$100 million in assets in 2016. The ATRs presented here are weighted by income and calculatedusing corporations that report positive pre-tax income. The worldwide ATR is calculated as
taxes paid divided by pre-tax income. The domestic rate is calculated as Federal income taxes
paid divided by domestic pre-tax income. Each of these items are reported on the income
statement as part of Form 10-K. Tax years 2017 and 2018 are excluded from the table for two
reasons. First, income and deductions were shifted between these two years in response to thepassage of Public Law 115-97. 362 Second, many corporations had section 965 repatriation tax
liability in these years. However, because that liability was generated from income earned inprior years, it is inconsistent with an ATR calculation, which measures the average tax rate paid
on income earned in a given year. 363 If it were possible to reallocate the section 965 liability to
359

The three categories of corporations include 206, 74, and 11 corporations, respectively.

360
Standard and Poor’s (S&P). 2023. Compustat-Capital IQ. S&P Global Market Intelligence.
https://wrds-www.wharton.upenn.edu/pages/about/data-vendors/sp-global-market-intelligence/.

Tax return data lack comprehensive information on worldwide income, which prevents the estimationof worldwide ATRs. The Joint Committee staff presents financial statement ATRs here, which are common in theaccounting, economics, and finance literatures.
361

Tim Dowd, Chris Giosa, and Thomas Willingham, “Corporate Behavioral Responses to the TCJA for
Tax Years 2017-2018,” National Tax Journal, vol. 73, no. 4, December 2018, pp. 1109-1134.
362

363
Section 965 imposed a one-time transition tax on a U.S. shareholder’s pro-rata share of certain
undistributed and previously untaxed post-1986 foreign earnings and profits earned by a specified foreign
corporation at the end of such specified foreign corporation’s last taxable year beginning before January 1, 2018.
The transition tax constituted an additional tax expense for financial reporting that increased effective tax rates
reported on Form 10-K in 2017 and 2018 (in some cases by more than 50 percent) pursuant to the Financial
Accounting Standard Board’s Accounting Standards Codification 740.

71the income that generated the liability (i.e., in prior years going back to 1986), it would change
the ATRs of corporations in the 2014 to 2016 period in the table. 364

Corporations
All

Table 1.—Worldwide ATRs for Large Corporations
Worldwide ATRs
Domestic ATRs
2014-20162019-20202014-20162019-2020
27.9
16.7
25.7
11.3

Manufacturing

24.1

17.9

25.7

15.4

Pharmaceutical

19.6

11.6

27.0

15.7

Prior to Public Law 115-97, Financial Accounting Standards Board Accounting Standards Codification
740 allowed U.S. corporations to assert that their investment in a foreign subsidiary was permanent and that theforeign earnings would be indefinitely reinvested. Corporations that made this assertion recorded a permanent
reduction in their effective tax rate equal to the residual U.S. federal income tax. Corporations that did not make thisassertion did not reduce their effective tax rate. Rather, such corporations recorded a deferred tax liability toindicate to investors that they anticipated recognizing U.S. tax on such amounts in a future year. Consequently,
corporations that made an indefinite reinvestment assertion recognized a tax liability in 2017 or 2018 pursuant to thesection 965 repatriation tax and were required to report an increase of their effective tax rate (because suchcorporations never accounted for the tax in their financial statements). Conversely, corporations that did not makean indefinite investment reduced their reported deferred tax liability, resulting in a decrease in their effective tax rate
in 2017 or 2018 (because such corporations recorded a higher tax rate on such amounts for financial reporting inprior years than the section 965 repatriation tax actually imposed).
364

Reporting of the repatriation tax liability in 2017 and 2018 varied. Many corporations did not provide
sufficient detail on Form 10-K to isolate the repatriation tax liability because they netted it with other items (forexample, the research and development credit). In other cases, the reported repatriation tax included the reversal ofpreviously established deferred tax liabilities on unremitted earnings (as noted above, a reduction of the effective taxrate).

72

Several conclusions may be inferred from Table 1. First, the average worldwide ATRs
for all large corporations, manufacturing corporations, and pharmaceutical corporations declined
by seven to nine percentage points after the enactment of Public Law 115-97. Second, each ofthese groups of corporations experienced larger declines in domestic ATRs, ranging from 10 to
14 percentage points on average. This decline is consistent with the reduction in the top
statutory corporate tax rate from 35 percent to 21 percent, as enacted in Public Law 115-97.
Third, pharmaceutical corporations on average had lower worldwide ATRs and higher domestic
ATRs than manufacturing and all corporations, before and after the passage of Public Law 11597.

73

B. Corporate Tax Return Information for Large
Pharmaceutical Companies
This section focuses on information reported from corporate tax returns (e.g., Form
1120). In the figures below reporting shares, the Joint Committee staff compare various
measures of profit, income, and deductions against gross income. Because a good estimate ofrevenue (i.e., sales or turnover) is not available from the tax data, the Joint Committee staff
present the figures against a close (albeit imperfect) proxy: gross income. To avoid confounding
the inferences from those share graphs with legislated changes in the tax of certain income items,
gross income is defined as total income reported on line 11 of Form 1120, plus cost of goods
sold reported on line 2, less section 965 income and GILTI income reported on Schedule C ofForm 1120. 365 The reported shares are income weighted average shares.
The full sample is a balanced panel and includes all corporations that (1) reported at least$100 million in assets in 2016, as reported on line 12a of Schedule M3 of Form 1120, (2) were
not foreign owned, and (3) had at least one controlled foreign corporation in 2016. In the figures
below, the group “large pharmaceutical” comprises the 21 largest pharmaceutical corporations interms of total worldwide assets, as reported on Schedule M3 in 2016. The group “large
manufacturing” is a weighted set of 21 manufacturing corporations (excluding pharmaceutical
corporations). The Joint Committee staff uses a combination of asset and return on asset toweight the different groups in these figures to represent as closely as possible similar sizedcorporations (as measured by assets and revenue). 366

365
Section 965 created a deemed income inclusion of accumulated non-previously taxed earnings. Theseearnings were taxed in tax year 2017 at reduced rates of eight percent for non-cash assets and 15.5 percent for cash
assets. The rate reduction was achieved by a deduction applied to the income. Because of accounting year
differences, some taxpayers reported their section 965 tax liability on their 2017 tax return, while other filers
reported their section 965 tax liability on their 2018 tax return. The 2017 version of Form 1120 was not modified toreflect section 965. Taxpayers were instructed to attach a PDF (or portable document format) file to their return toreflect their inclusion amount and liability. As a result, section 965 income may and does appear in many locations
on the 2017 version of Form 1120. For tax year 2018, Form 1120 includes on Schedule C the section 965(a)inclusion amount income as part of dividends (on line 15, column (a)) and the related section 965(c) deduction
amount (on line 15, column (c)).

This special weighting is necessary because the largest manufacturing corporations are substantiallylarger than the largest pharmaceutical corporations. The Joint Committee staff present a set of weighted averages inorder to provide a comparable group of large non-pharmaceutical manufacturing corporations (labeled below as“large manufacturing”). This was done by dividing the sample into 25 groups based on their assets and return on
assets reported on Form 1120 for tax year 2016. Lastly, the Joint Committee staff apply weights such that the
distribution of large non-pharmaceutical manufacturing corporations mirrors the distribution of large pharmaceutical
corporations.
366

74

In Figure 1, gross profit is gross receipts less cost of goods sold (i.e., U.S. sales by the
U.S. taxpayer less cost of goods, as reported on Form 1125). For pharmaceutical corporations,gross profits comprised approximately 30 percent of gross income from 2014 to 2020. Figure 2
shows the average amount of GILTI included in billions from 2018 to 2020. Pharmaceuticalcompanies had much larger GILTI inclusions on average than either all corporations or large
manufacturing, averaging over $4 billion a year in 2019 and 2020.
Figure 1.—Gross Profit as a Percentage of Gross Income by Year75

Figure 2.—Average Amount of GILTI by Year in Billions of Dollars

76Figure 3 shows the level of gross income including GILTI by year in billions of dollars
for large pharmaceutical and large manufacturing. The increase in GILTI income forpharmaceutical companies shows up as a large swing in gross income in the years after 2017,highlighting the necessity to use a measure of gross income excluding GILTI.
Figure 3.—Gross Income Including GILTI by Year for Large Manufacturing
and Pharmaceutical Corporations in Billions of Dollars

77

Royalties and other income (as reported on line 10 of Form 1120) 367 are also important
for large pharmaceutical corporations. As seen in Figures 4 and 5, large pharmaceutical
corporations generally have about eight percent of their gross income attributable to royalties,
and between eight and ten percent of their gross income attributable to other income. Regarding
royalties, this percentage is between five and eight times greater than the percentages reported by
the other large corporations. Regarding other income, this percentage is between two and six
times greater than the percentages reported by the other large corporations.
Figure 4.—Royalties as a Percentage of Gross Income by Year

367
Other income is income that is not reported on lines 1 through 9 of Form 1120. Lines 1 through 9
include gross receipts less cost of goods, dividends, interest, rents, royalties, and capital gains and losses. Per
instructions for line 10 Form 1120, other income includes recoveries of bad debts, Form 6478 biofuel producer
credit, Form 8864 biodiesel and aviation fuels credits, refunds of taxes deducted in prior years, partnership income,transferred loss amount under section 91, certain last in first out recapture amounts, certain portions of section
481(a), income from cancellation of debt, and income from passive foreign investment companies.

78

Figure 5.—Other Income as a Percentage of Gross Income by Year79

The next set of figures, Figures 6 to 9, show specific expense and deduction items
claimed by the relevant taxpayers as a percentage of gross income. Figure 6 shows cost of goods
sold, as reported on line 2 on Form 1120, as a percentage of gross income. Cost of goods sold asa percentage of gross income is substantially higher for large manufacturing corporations thanlarge pharmaceutical corporations.
Figure 6.—Cost of Goods Sold as a Percentage of Gross Income by Year

80

Figure 7 reports total deductions as a percentage of gross income. Total deductions are
the sum of deductions claimed on lines 12 through 26 of Form 1120 and do not include special
deductions (e.g., section 250). Combined with the results from Figure 3 (Gross Income in levels
including GILTI), which showed large pharmaceuticals had more gross income than large
manufacturing, large pharmaceutical companies have not only more deductions as a share but
also substantially more deductions on average than large manufacturing corporations.
Figure 7.—Total Deductions as a Percentage of Gross Income by Year81

Consistent with higher royalties as reported in Figure 4, Figure 8 reports R&D
expenditures, as reported on Form 6765, 368 are substantially higher for large pharmaceutical
corporations than large manufacturing corporations and all other large corporations.
Figure 8.—R&D Expenditure as a Percentage of Gross Income by Year

Form 6765, Credit for Increasing Research Activities. The amounts reported here may be a lower
bound, as not all research expenditures are eligible for the section 41 research credit.
368

82

C. Foreign Income and Taxes
Large corporations may use branches or disregarded entities (“DREs”) in various tax
planning structures that, for example, may avoid the treatment of certain related party income as
subpart F income. Taxpayers can elect, on Form 8832, to treat certain entities as DREs for U.S.
tax purposes. Figure 9 shows that large pharmaceutical corporations have a substantially higher
average number of DREs than large manufacturing corporations and all large corporations.
Moreover, after the passage of Public Law 115-97, the number of DREs increases sharply from2017 to 2019. In contrast, the average number of Forms 5471 (“Information Return of U.S.
Persons With Respect to Certain Foreign Corporations”) was flat over the period for large
pharmaceuticals at approximately 80 per corporation. This indicates that large pharmaceuticals
are seemingly increasing their usage of DREs, not simply converting existing CFCs that are notdisregarded.
Figure 9.—Average Number of DREs by Year

83

Figure 10 shows the average value of foreign tax credits claimed by corporation and year.
Large pharmaceutical corporations have foreign tax credits on average between $200 million in2017 and $680 million in 2018. 369 The prominent decline in 2017 may be due to fiscal year
filers delaying repatriations in 2017 until they were eligible in 2018 for more favorable
treatment. 370 In contrast, large manufacturing corporations have foreign tax credits on average
between $40 million and $86 million. Also, large manufacturing corporations exhibit arelatively low year in 2017 of $49 million and a relatively high year in 2018 of $74 million.
Figure 10.—Average Value of Foreign Tax Credits Claimed
by Year in Millions of Dollars

369

repatriation.

The $680 million outlier in 2018 includes foreign tax credit amounts attributable to the section 965

Tim Dowd, Chris Giosa, and Thomas Willingham, “Corporate Behavioral Responses to the TCJA for
Tax Years 2017-2018,” National Tax Journal, vol. 73, no. 4, December 2018, pp. 1109-1134.
370

84

D. Domestic and Foreign Activity as Reportedon Country-by-Country Form 8975
In 2016, the IRS began collecting data that conforms to the OECD country-by-country
reporting standards by using Form 8975. 371 On this form, large corporations reported theirprofits, revenues, assets, and tax on a jurisdiction-by-jurisdiction basis. Filing was voluntary in
the first year of the program and mandatory thereafter. Here, the Joint Committee staff report
information on the set of corporations that filed Form 8975 in 2018, 2019, and 2020. For the
purposes of the following figures (Figures 11 to 14), the Joint Committee staff limits the sample
to corporations that appear in each year from 2018 to 2020. Each figure contains averages for all
corporations required to file Form 8975 and separately for pharmaceutical and manufacturingcorporations. 372
In addition, the Joint Committee staff present a set of weighted averages in order toprovide a comparable group of large non-pharmaceutical manufacturing corporations (labeled
below as “large manufacturing”). This was done by dividing the sample into 25 groups based on
their tangible assets and return on tangible assets reported on Form 8975 for the 2018 to 2020
period. Lastly, the Joint Committee staff apply weights such that the distribution of large nonpharmaceutical manufacturing corporations mirrors the distribution of large pharmaceutical
corporations. 373

Form 8975 is required by Treasury Regulation section 1.6038-4 and includes both corporations andpartnerships as the ultimate owner. Corporations are approximately 90 percent of the ultimate owners and reportapproximately 95 percent of the revenues. There are several important ambiguities to note when interpreting thisdata. MNEs can and do use a variety of financial reporting standards and can choose whichever one they would liketo use for reporting information on Form 8975 (e.g., an MNE may use different financial reporting standards withrespect to different operations in different countries). Consequently, what is included in the income and tax items
will differ across MNEs. Additionally, despite a change from the original instructions for Form 8975, some
taxpayers appear to be reporting profits and related party revenues on an aggregate rather than a consolidated basis,
leading to potential double counting in certain data items. This is likely less of an issue for unrelated revenues,
tangible assets, taxes, and employees. Finally, taxpayers were instructed to report as stateless all income, assets, andemployees for entities that are passthroughs or transparent for tax purposes in a given jurisdiction. As a result, theJoint Committee staff dropped the stateless category from our calculations to further reduce instances of double
counting of income.
371

Construction of the sample in this subsection is based on Form 8975 and is not identical to the sample
used in the prior subsection, though there may be substantial overlap.
372

Because of the reliance on profit/loss reporting, this weighting procedure is affected by the double
counting issues discussed earlier.
373

85

Figure 11 displays the average amount of unrelated revenues by corporation andjurisdiction. Here, the average amount of unrelated revenues is defined as the average amount ofrevenues from unrelated persons. The Joint Committee staff have categorized jurisdictions by“low tax” and “high tax” based on the median GAAP ATR within the jurisdiction in 2020. 374
Figure 11 shows that the average pharmaceutical corporation subject to country-by-country
reporting requirements exhibit larger unrelated revenues and a larger foreign share of thoserevenues than the average reporting corporation. The weighted “large manufacturing”
corporations have larger unrelated revenues.
Figure 11.—Average Unrelated Revenues by Corporation and Jurisdiction

374
The GAAP ATR was calculated as tax accrued divided by profit for entities reporting positive profit.
Jurisdictions with median GAAP ATRs below 12.5 percent were classified as low tax, and jurisdictions above 12.5
percent were classified as high tax. This measure of tax rates is susceptible to the double counting issues stemmingfrom aggregate reporting, but the use of the median rates here reduces the impact of outlier entities. Inspection
shows that these median rates are largely similar to statutory rates for many jurisdictions.

86

Figures 12 and 13 report employee counts and amount of tangible assets by corporationand jurisdiction. On average, large pharmaceutical corporations report a higher share of
employees and tangible assets in low-tax jurisdictions than the overall sample as well as theweighted sample of manufacturing corporations. Their overall foreign share of both employees
and assets are higher than the overall sample but roughly similar to the weighted manufacturing
sample.
Figure 12.—Average Employees by Corporation and Jurisdiction

87Figure 13.—Average Tangible Assets by Corporation and Jurisdiction88Lastly, Figure 14 presents statistics on taxes accrued by corporation and jurisdiction.
First, the reporting in 2018 was affected by the treatment of section 965 tax liability. Aside fromthat anomaly, the results for taxes accrued show similar shares of foreign taxes relative to total
taxes for both large manufacturing and pharmaceutical corporations. In the case of large
pharmaceutical corporations, more of those accrued to low tax jurisdiction.
Figure 14.—Average Taxes Accrued by Corporation and Jurisdiction

89

APPENDIX A: SELECTION OF DIGITAL SERVICE TAXES
Digital services taxes (“DSTs”) refer to unilateral attempts by countries to impose taxes on the revenue generated by the digital
activity of (largely) foreign multinational companies operating within their jurisdiction. Often, companies who generate digitalrevenue across many jurisdictions do not maintain a physical presence in the countries in which they operate. DSTs are a mechanism
for taxing the activity of companies who might otherwise fall out of the country’s income tax base. DSTs can target a range of digital
activities, including advertising, streaming, the operation of intermediary services (such as online marketplaces), and the collection
and sale of user data. For example, the United Kingdom’s DST imposes a two percent tax on the revenue from online marketplaces,
search engines, and social media platforms which derive value from United Kingdom users. Austria’s DST imposes a five percent tax
on revenues from digital advertisement services. Certain countries, like Colombia and Belgium, have proposed or enacted laws thatdeem a foreign company to have a significant economic presence (“SEP”) if they provide digital services to domestic users.
Companies with SEP status are subject either to the country’s income tax or to a tax on their revenues. The table below gives an
overview of some the various DSTs proposed or enacted by countries.
Country

Status

Effective Date

Type

Rate

Argentina

EnactedDecember 15, 2020

WHT

8 percentAustria*

EnactedJanuary 1, 2020

DST

5 percentBelgium

Waiting for
Global Solution

Expected 2023 if global
consensus is not reached

DST/Digital PE

3 percentBrazilProposed

TBD

DST

1 percent – 5 percent(depending on revenue)

CanadaProposed

January 1, 2024
(on revenues earned as ofJanuary 1, 2022)

DST

3 percentColombia

EnactedJanuary 1, 2024

SEP or alternatively WHT

10 percent WHT or 3 percent
income tax

Republic ofCongo

EnactedJanuary 1, 2021

WHT

10 percent

Costa Rica

EnactedNovember 19, 2019

General income tax ondigital tourist rental
services income

NA90Country

Status

Effective Date

Type

Rate

Czech Republic

Proposed(rejected)

TBD

DST

7 percent but may be reduced
to 5 percent

Denmark

Proposed

TBD

DST

6 PercentFrance*Hungary

EnactedEnactedDSTDAT

3 percent7.5 percent

India*

Enacted

1/1/2019
July 1, 2017
(Implementation delayed
until December 31, 2023)
April 1, 2022

SEP

N/A

EnactedApril 1, 2020

DST

2 percent

EnactedJune 1, 2016

DAT

6 percentMarch 31, 2020

Digital PE

NA

March 31, 2020

DST

N/A

IsraelWaiting for
Global Solution
Waiting for
Global Solution
EnactedApril 11, 2016

Digital PE

NA

Italy*

EnactedJanuary 1, 2020

DST

3 percent

Kenya

EnactedJanuary 1, 2021

DST

1.5 Percent

Malaysia

EnactedMay 13, 2019

WHT

Variable

MexicoEnactedJune 1, 2020

WHT

Variable

Nepal

Proposed

July 17, 2022

DST

2 percentNigeria

EnactedFebruary 3, 2020

SEP

6 percentPakistan

EnactedJuly 1, 2018

WHT

10 percent

Paraguay

EnactedJanuary 1, 2021

WHT

4.5 percent

Peru

EnactedJanuary 1, 2007

WHT

30 percent

PolandEnactedJuly 1, 2020

DST

1.5 percent

Proposed

TBD

DAT

5 Percent

Proposed

TBD

DST

7 PercentIndonesia

91Country
Portugal

StatusEnactedEffective Date
February 17, 2021

Type
Exhibition levyRate
4 percent

EnactedFebruary 17, 2021

Annual levy

1 percentSierra Leone

EnactedJanuary 1, 2021

DST

1.5 percent

Slovakia

EnactedJanuary 1, 2018

Digital PE

N/ASpain*

EnactedJanuary 16, 2021

DST

3 percentTaiwanEnactedJanuary 1, 2017

WHT

Tanzania

EnactedJuly 1, 2022

DST

To be agreed with the tax
authority
2 percentTunisia

EnactedJanuary 1, 2020

DST

3 percent

Turkey*EnactedJanuary 1, 2019WHT

15 percent

EnactedMarch 1, 2020

DST

United Kingdom* Enacted

April 1, 2020

DST

7.5 percent but the President can
reduce to 1 percent or increase to
15 percent

Uruguay

EnactedJanuary 1, 2018

Non-resident income tax

12 percent

VietnamEnactedJanuary 1, 2021

WHT

Variable

Zimbabwe

EnactedJanuary 1, 2019

General income tax oncertain digital services
income5 percent2 percent* Entered into agreement with the United States whereby the United States terminates tariffs imposed under Section 301 of the Trade Act of 1974 in exchange
for country making any DST liabilities collected before the implementation of Pillar One creditable against future Pillar One taxes.
DAT: Digital Advertising Tax
DST: Digital Service Tax
PE: Permanent Establishment
SEP: Significant Economic Presence
WHT: Withholding Tax
Source: Joint Committee compilation from text of local country statutes.

92

APPENDIX B: SELECTION OF COUNTRIES ADOPTING PILLAR TWO
Country

Legislation

Status

IIR

UTPR

QDMTT

Canada2023 Budget stated government’s plan to introduce
draft legislation implementing IIR and QDMTT,with UTPR to follow at later time, March 28, 2023.

Plan to Introduce
legislation

Yes
(From
December 31,
2023)

Yes
(From
December 31,
2024)

Yes
(From
December 31,
2023)

Enacted Law

Japan

Japanese Parliament passed legislation which
included the implementation of certain Pillar Two
global minimum tax rules, March 28, 2023.

Yes(From April 1,
2024)

No

No

Liechtenstein

Government published draft legislation and open
consultation on measures to implement a global
minimum tax, March 29, 2023.

Draft Legislation
Published

Yes(From January
1, 2024)

Yes(From January
1, 2025)

Yes(From January
1, 2024)

Korea enacted new global minimum tax rules toalign with the OECD’s Pillar Two Model Rules,
December 31, 2022.

Enacted Law

South Korea

Yes(From January
1, 2024)

Yes(From January
1, 2024)

No

Switzerland

The Swiss Federal Council opened consultation ona temporary ordinary entitled for the
implementation of Pillar Two, August 17, 2022.

Draft Legislation
Published

Yes(From January
1, 2024)

Yes(From January
1, 2024)

Yes(From January
1, 2024)

UnitedKingdom

Building on draft legislation published in July 2022,
Finance (No. 2) Bill was introduced in the House ofCommons and included measures to implement a‘Multinational Top-Up Tax’, March 23, 2023.

Legislation
Introduced to
Parliament

Yes
(From
December 31,
2023)

No
(Intention to
implement atlater time)

Yes
(From
December 31,
2023)

EU Directive

EU

Unanimous agreement on EU Global Minimum Tax
Directive for the implementation of Pillar Two
global minimum tax rules among member states,
December 14, 2022.

Yes
(From
December 31,
2023)

Yes
(From
December 31,
2024)

Optional for
Member States

93

EU Member Countries

Germany

The German Federal Ministry of Finance publisheda consultation including a draft law to implement
the EU Global Minimum Tax Directive, March 20,
2023.

Draft Legislation
Published

Yes
(From
December 31,
2023)

Yes
(From
December 31,
2024)

Yes
(From
December 31,
2023)

Ireland

Ireland’s Department of Finance published a
Feedback Statement including possible draft
legislation to implement the EU Global Minimum
Tax Directive, March 31, 2023.

Feedback
Statement

Yes
(From
December 31,
2023)

Yes
(From
December 31,
2024)

No
(Intention to
implement atlater time)

Open consultation on draft legislation entitled
Draft Legislation“Minimum Tax Rate Act 2024”, to implement Pillar
PublishedTwo, October 24, 2022.

Yes
(From
December 31,
2023)

Yes
(From
December 31,
2024)

Yes
(From
December 31,
2023)

Swedish Special Investigator submitted an interim
report which included draft legislation for the
implementation of the EU Global Minimum Tax
Directive, February 7, 2023.

Yes(AfterDecember 31,
2023)

Yes
(AfterDecember 31,
2024)

Yes
(AfterDecember 31,
2023)

The
Netherlands

SwedenDraft Legislation
Published

Note: Other countries that have introduced or plan to introduce legislation adopting Pillar Two: Australia, Azerbaijan, Bulgaria, EU member countries (Austria,
Belgium, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Greece, Hungary, Italy, Latvia, Lithuania, Luxembourg, Malta, Poland, Portugal,
Romania, Slovakia, and Slovenia), Guernsey, Indonesia, Jersey, Malaysia, Mauritius, New Zealand, Norway, Qatar, Singapore, South Africa, Thailand, United
Arab Emirates, and Vietnam.

Source: Joint Committee compilation from text of local country statutes and Council Directive (EU) 2022/2523 of 14 December 2022.

94