Biden Tax Plan Takes Aim at Trump-Era Investment Incentive

Congress created FDII in the 2017 tax law as a break tied to U.S. companies’ foreign sales. It is designed to provide multinational companies roughly equal tax rates at home and abroad on profits that could be moved across borders. Lawmakers wanted to give companies reasons to put intellectual property, profits and jobs in the U.S. rather than in low-tax foreign jurisdictions.

Now, Biden administration officials say they intend to repeal the FDII deduction and replace it with unspecified tax breaks for research. That decision, announced in President Biden’s infrastructure plan, marked a shift from his campaign tax plan, which didn’t include a repeal.

“I would have thought it would fit their ‘Made in America’ and jobs policy preference fairly well, but obviously they’re not thinking of it that way,” said David Noren, a tax lawyer at McDermott, Will & Emery.

Repealing the break could hurt companies reporting significant benefits from FDII, including

Qualcomm Inc.,

Nike Inc.,

Alphabet Inc.

and

Lockheed Martin Co.

In securities filings, Qualcomm said it had done a restructuring in 2018 and 2019 that put most of its income in the U.S. and made a significant portion subject to FDII. The deduction saved the company $800 million in 2019 and 2020 combined.

For Lockheed, the break was worth $170 million in 2020, after accounting for regulations clarifying that foreign military sales qualify for FDII.

The full impact of the Biden tax plan for these and other companies depends on what emerges from Congress and how it intersects with the other pieces of the administration’s proposal to completely overhaul the international tax system. Repealing FDII is just part of Mr. Biden’s corporate tax agenda, which would raise about $2 trillion over 15 years to pay for roads, bridges, broadband, transit and other projects.

Congress created FDII during the last overhaul of the international tax system, in 2017. Republicans, who controlled the House, Senate and White House at the time, lowered domestic tax rates and made it easier for companies to earn profits abroad and bring them home. The old system encouraged companies to book profits abroad and leave them there.

Their system created a stick and a carrot. The stick was a new 10.5% minimum tax on U.S. companies’ foreign income to make sure companies couldn’t shift profits to low-tax foreign jurisdictions without paying the U.S. anything.

The carrot was FDII, a special deduction that effectively set a 13.125% tax rate on domestic income generated from serving foreign markets. The idea was to spur companies to locate easy-to-move intellectual property in the U.S. when faced with a relatively even tax choice about where to book such income.

The reference to intangible income in the name reflects the fact that such profits often come from highly mobile assets like patents, but they don’t have to. FDII starts by calculating 10% of a company’s tangible assets in the U.S. and measuring profits above that amount to determine the size of the deduction. The idea was to focus the deduction on companies with higher-than-usual profits.

But that calculation means that companies with more tangible assets—such as factories and equipment—get smaller deductions. To FDII critics, including Biden administration officials, that’s a problem because companies can get bigger deductions by moving assets abroad or building less domestically.

“You get penalized for physical investment in the United States,” said David Kamin, deputy director of the White House National Economic Council. “That seems counterintuitive and counterproductive.”

It isn’t clear whether that incentive has changed investing decisions.

“I cannot think of a company who said, ‘We have moved stuff out of the U.S. because of this theoretical incentive,’” said Ray Beeman, a former House GOP tax aide who is now a principal at accounting firm EY LLP. “You don’t do everything for tax purposes.”

It’s also hard to gauge whether FDII encouraged much domestic activity or simply rewarded companies for what they would have done anyway. The Joint Committee on Taxation projected in 2017 that the break would cost $64 billion over 10 years. Tax Notes, a nonprofit publisher, found that companies in the S&P 500 had reported at least $3.8 billion from the break in a year.

“If they lose that, that’s going to cause some pain and some adjustment,” said

Thomas Horst,

managing director of Horst Frisch, a consulting firm that works on international corporate transactions.

Some companies, including Alphabet, have moved intellectual property from low-tax foreign jurisdictions to the U.S. FDII reduced Alphabet’s tax bill by 0.7 percentage point in 2019. That savings jumped to 3 percentage points in 2020, according to its securities filings. An Alphabet spokesman declined to comment on the Biden proposal.

“If all that it achieved is moving legal ownership of [intellectual property] to U.S. companies, then, so what?” said Omri Marian, a tax law professor at the University of California, Irvine.

Democrats say the break is an indirect, inefficient way of encouraging domestic jobs and investment. The Biden administration would shift the money toward research but hasn’t said how.

One possibility is repealing or delaying a piece of the 2017 tax law that requires companies to start spreading their research expenses over multiple years instead of taking immediate deductions. That is slated to take effect in 2022, and there is already pressure from companies and lawmakers from both parties to prevent that from happening.

A proposal from three Democratic senators would keep FDII but alter some details.

FDII itself has been seen as vulnerable to a World Trade Organization challenge as an impermissible export subsidy. Though that hasn’t happened, the prospect may have discouraged companies from relying on it.

“Overall, it was a revenue loser, an enforcement challenge, and a trade agreement breacher, with no discernible benefits to the U.S. economy,” said the University of California, Irvine’s Mr. Marian. “I’m happy to see it gone.”

Write to Richard Rubin at [email protected]