Recent White House and U.S. Department of Treasury announcements propose comprehensive tax reform on how U.S. multinational companies (MNC) will be taxed.
Treasury argues that the current tax system enacted as part of the Tax Cuts and Jobs Act (TCJA) of 2017 encourages profit-shifting and off-shoring incentives (Op-ed by Janet Yellen, Wall Street Journal, April 7, 2021). Thus, the Biden administration and the Department of Treasury are proposing a new global minimum tax and the repeal of the Base Erosion and Anti-Abuse Tax (BEAT). Regulators argue that the BEAT is an ineffective tax because firms can engage in tax planning strategies to avoid the tax. These strategies have caused the BEAT to fall short in generating tax revenue. Specifically, according to the IRS Statistics of Income division, the BEAT only generated $1.8 billion in tax revenue in 2018, which is less than half of what the Joint Committee on Taxation (JCT) forecast when the new law was enacted (Treasury Made In America Tax Plan Report).
Recent empirical research provides evidence consistent with firms engaging in tax planning to avoid the BEAT. In a recent study, my fellow co-authors Stacie Laplante and David Samuel of the University of Wisconsin–Madison and Christina Lewellen of North Carolina State University and I estimate that firms engage in strategic cost reclassification to avoid paying $4.2 billion in BEAT. These results provide timely evidence that contributes to the current policy debate on the effectiveness of the BEAT and documents how firms tax plan to avoid the BEAT explaining the revenue shortfall.
The BEAT was enacted as part of the TCJA. One of the TCJA’s most significant changes is shifting from a worldwide to a territorial tax system. This change makes moving income from the U.S. to lower-tax-rate jurisdictions more attractive to MNCs because the resulting tax savings are permanent. In contrast, the tax savings were merely deferred under the previous worldwide tax regime. To combat this increase in income-shifting incentives, the TCJA included the BEAT, which imposes a minimum tax on a modified tax base that adds back certain related-party payments to taxable income. Notably absent from the related-party add-backs is cost of goods sold (COGS), providing firms with an incentive to reclassify certain related-party payments as COGS.
In this study, the authors use subsidiary-level data to show a pattern of results consistent with firms subject to the BEAT increasing the amount of intercompany payments classified as COGS relative to a control group of firms not subject to the BEAT. These results are also concentrated in firms that have subsidiaries located in tax havens, have more patents abroad, and have a history of engaging in tax-motivated income shifting.
Overall, these results offer timely and relevant empirical evidence that contributes to the current debate on whether to repeal the BEAT. Importantly, these findings are limited to a sample of publicly traded firms with the required data. Thus, they likely offer a conservative estimate of the overall tax savings firms achieve through this tax planning strategy. Furthermore, the JCT projected the BEAT to raise $7 billion in tax revenues over the 2019-2020 tax years. These results suggest BEAT tax collections will likely fall short of those estimates.
Dan Lynch is an associate professor in the Department of Accounting and Information Systems at the Wisconsin School of Business.
Stacie Laplante is an associate professor in the Department of Accounting and Information Systems at the Wisconsin School of Business.
David Samuel is a doctoral student of accounting and information systems at the Wisconsin School of Business.