Currently, in addition to the current prospects for Brazilian tax reform, there is also a lot of talk about the possibilities of new changes to the American tax system. President Joe Biden presented a set of proposals that, if approved, will significantly modify some of the rules introduced by the Tax Cuts and Jobs Act of December 2017. It should be noted that the proposal presented in the United States is still in its initial stages and may undergo several and important changes in the coming months.
Overall, some of the goals behind the new proposed increases in US taxes include combating global warming, reducing inequality, and financing a reform of US infrastructure, including construction, maintenance, and renovation of American highways.
It is important to note that the proposed new rules should not bring any changes to US taxation on foreign passive income, meaning that currently existing (and more onerous) taxation will be maintained on financial investments that US tax residents and US nationals maintain in other countries. It should also be noted that companies with untaxed accounting income of USD 2 billion or more, and that have a significant volume of passive income outside the US, may also be subject to a minimum 15% taxation if the effective rate applied to them on their income falls below this percentage.
The proposals are quite varied and broad and it is not possible to specify exactly which of them will be transformed into law at this time. In any case, Brazilians who have investments in the United States, or who have US tax residency (or citizenship), need to be aware of and alerted to possible changes and the possible impacts that such changes may have on their investments and assets.
Among the most relevant proposals, we would like to briefly touch on the following:
Increase in the Income Tax rate for legal entities from 21% to 28%, while the maximum rate for individuals can be increased from 37% to 39.6%. Interestingly, at least with regards to individuals, the maximum rate will return to the level prior to the December 2017 reform.
The so-called long-term capital gains tax, which applies to individuals when the asset is held for more than one year, can have its maximum rate changed from 20% to 39.6% for individuals who earn more than USD 1 million annually. The Net Investment Income Tax (NIIT) of 3.8% should continue to be levied based on these assumptions.
In addition, the NIIT will become applicable to the income of partners in active transparent companies who make more than USD 400,000.
For those with subsidiaries outside the United States, taxation under the Global Intangible Low-Taxed Income (GILTI) regime may become more costly considering that the proposal would remove the 50% deduction from the tax base, making the base rate 21%, in addition to other changes in the way its calculation is performed.
The deduction for the so-called Foreign Derived Intangible Income (FDII) is also expected to be revoked, whose rules may be replaced by incentives for the deduction of expenses with research and development (R&D). The reason for the revocation of the FDII would be partially due to the fact that companies with a greater number of tangible assets (equipment etc) have fewer deductions. In practice, companies could get additional deductions simply by reallocating assets outside the US, or building fewer hard assets within the US.
Restrictions on the use of credits referring to income taxes paid abroad in connection with the sale of equity interests of foreign legal entities considered fiscally hybrid are foreseen. That is, it is a restriction applicable to legal entities whose existence is disregarded in the United States, but which are treated as different taxpayers from the persons of their partners abroad.
The deduction limit for the payment of state and local taxes, currently at USD 10,000 since the 2017 reform, is expected to be maintained.
The unrealized capital gain of assets to be inherited shall be taxed when the amount exceeds USD 1 million (USD 2 million in the case of those who file a joint Income Tax return), with the provision also being made to continue the exclusion from taxation of the gain on the so-called primary residences in the ranges of USD 250 thousand and USD 500 thousand. Even so, it is foreseen that the taxpayer may elect that certain illiquid assets transferred by succession are taxed within 15 years. This proposal is for individuals only, excluding charitable donations. Capital gain taxation should be deductible for succession tax purposes, which will be very beneficial, particularly for individuals who fall within the current maximum rate of 40% applicable to the succession.
Finally, a considerable increase in the budget of the Internal Revenue Service (IRS), the US federal agency responsible for verifying tax collection and the reporting of relevant income and assets, is also expected. If approved, it will be the first increase in the IRS budget in over 10 years.
Internationally, a minimum 15% tax is also provided for companies that have untaxed accounting income of USD 2 billion or more. There is an attempt here to approach the OECD’s progress towards a world minimum taxation. Under the American proposal, a company subjected to this new rule must pay the tax at a rate of 15% on global income, computed before taxation, but calculated after subtracting the operating losses of previous years, and also research and development (R&D) expenses and credits from taxes paid abroad. Companies whose regular taxation results in a value higher than the proposed rule will not need to be subject to the new taxation.
Also under the international aspect of American taxation there exists a current tax known as the Base Erosion and Anti-Abuse Tax (BEAT), applicable to legal entities that are not fiscally transparent and that have gross revenue above USD 500 million. The proposal aims to replace it with a new taxation regime to be called Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD). Unlike the existing BEAT, the idea is that SHIELD is mainly applicable to companies that are controlled by groups of companies outside the United States. After all, groups of companies controlled by American companies are already currently subject to the regime known as Global Intangible Low-taxed Income (GILTI). The logic follows the intention of the reform to increase the GILTI tax burden from 10.5% to 21%, which should mean that companies subject to this regime do not need to be subject to SHIELD. Anyway, considering that the intention of the rules that will govern SHIELD aims to tax large multinational groups, the definition of an exemption range for its application is still awaited. Apparently, the SHIELD regime was based, albeit generically, on the “undertaxed payments rule” (UTPR) of the OECD Pillar 2 Project. Although many details of SHIELD have not yet been released, it is known that the idea is that the effective tax rate applied to the entire group of companies outside the US will play an important role in determining the taxation by SHIELD.
Written by Roberto P. Vasconcellos, senior tax consultant at Drummond Advisors