How Does Current Law Treat International Taxation?

The United States employs a hybrid international tax system that combines elements of both worldwide and territorial taxation, substantially reformed by the Tax Cuts and Jobs Act of 2017. Under this system, U.S. corporations are subject to tax on their worldwide income, but with several key provisions that modify this basic framework:

1. A Dividends Received Deduction (100%) for foreign-source dividends from 10%-owned foreign corporations (creating a quasi-territorial system). It acts as an exemption for certain foreign income.
2. The Global Intangible Low-Taxed Income (GILTI) regime imposes a minimum tax on foreign earnings above a routine return, on a globally-blended basis;
3. The Foreign-Derived Intangible Income (FDII) rules provides preferential rates for export income;
4. And the Base Erosion Anti-Abuse Tax (BEAT)  disincentivizes profit shifting through deductible payments to foreign affiliates.

The system also includes long-standing Subpart F rules that require immediate taxation of passive and easily-shifted income from Controlled Foreign Corporations (CFCs). Additionally, the U.S. foreign tax credit system aims to prevent double taxation of foreign-source income by allowing U.S. taxpayers to credit foreign income taxes paid against their U.S. tax liability.

The system operates through complex "basketing" rules that separate foreign income and credits into different categories - primarily general income, passive income, and GILTI - with credits from one basket generally unable to offset U.S. tax on income in another basket. Each basket has its own limitation calculation, generally restricting the credit to the amount of U.S. tax that would have been imposed on the foreign-source income in that basket, with excess credits eligible for carryback one year and carryforward ten years (though notably, GILTI credits cannot be carried to other years). The system is further complicated by expense allocation rules that require certain U.S. expenses to be allocated against foreign income, potentially reducing foreign tax credit capacity, and by complex sourcing rules that determine whether income is foreign or domestic source.¹

The recently enacted Corporate Alternative Minimum Tax (CAMT) adds another layer of complexity, due to its interaction with the international tax system. It imposes a 15% minimum tax on the adjusted financial statement income (AFSI) of large corporations with average annual financial statement income exceeding $1 billion over a three-year period on a globally blended basis. It operates alongside the regular corporate income tax system, with affected corporations paying the greater of their regular tax liability or the CAMT. AFSI begins with the corporation's book income as reported on financial statements, then applies modifications for depreciation, treatment of foreign taxes as deductions rather than credits, specific rules for controlled CFCs, and adjustments for certain tax credits and net operating losses (NOLs). The system creates complexity in international taxation due to its interactions with foreign tax credits, the Pillar 2 global minimum tax requirements, and existing international provisions like GILTI. The CAMT calculation includes special rules for aggregating income of related entities, specific treatments for partnerships and consolidated groups, and various adjustments for items like pension contributions and mortgage servicing income. Implementation continues to evolve through Treasury guidance, particularly regarding technical aspects of the AFSI calculation and the treatment of various financial statement items. The CAMT likely does not qualify as Pillar 2 compliant because of its alternative income definition and its application to worldwide income rather than country-by-country.

The GILTI tax is designed to reduce profit shifting to countries with low tax rates. It targets income from copyrights, patents, and other intangible assets that are more easily moved to low tax countries. More generally, it serves to tax any above normal returns. It uses a formula to assess a minimum level of tax on foreign earnings. However, this minimum tax does not qualify under Pillar 2 as a compliant minimum tax.

While both CAMT and GILTI aim to establish minimum taxation on multinational enterprises, CAMT and GILTI's global blending approach, which aggregates income and losses across all jurisdictions, goes against the Pillar 2 requirement of country-by-country calculations. GILTI's effective rate of 10.5% (increasing to 13.125% after 2025) also falls below Pillar 2's 15% minimum threshold, although limits on foreign tax credits are likely to make the post-2025 rate sufficiently high. Additionally, GILTI's 10% qualified business asset investment (QBAI) exemption is potentially more generous than Pillar 2's carve-out, which uses a lower percentage and phases down over time.² U.S. MNEs potentially face additional taxes in jurisdictions that have adopted Pillar 2 unless the U.S. makes adjustments to its treatment of international income. Adopting country-by-country treatment and increasing the effective GILTI rate to 15% would likely be enough to qualify under Pillar 2.³ These additional taxes are forgone revenue the U.S. would receive from U.S. MNEs that are paying tax on foreign-sourced income. The U.S. would also potentially receive revenue from foreign corporations (and U.S. MNEs) on U.S.-sourced income as part of Pillar 2 implementation.