Inter

1. “Subpar” F?
The Role of Anti-Deferral in a Post-GILTI (and
Maybe Pillar Two) World

2. Summary
1. Survey of the development of U.S. and global international taxation
2. The resurgence of source taxation
3. The proliferation of residence taxation
4. Whether and to what extent subpart F advances tax policy in light of these new
developments in source and residence taxation?
5. Much of what subpart F was meant to do would be achieved by a modified GILTI, possibly
conformed to the Pillar Two GloBE tax mandated by the Inclusive Framework
6. Congress should eliminate overlapping regimes in favor of a single, well-thought-out and
effective residence-based tax for most foreign business income
7. Subpart F’s role should be restricted to the taxation of passive income and certain disfavored
entities

3. 1. Development of U.S. and
Global International Taxation

4. The Underlying Policy Dilemma
Which Neutrality Wins?
Domestic
Sales Only
Domestic & Foreign
Sales
U.S.
Incorporated
Dutch
Incorporated
Basic Corp.
21% on all income
Acme Corp.
21% on U.S.-earned income
?? on foreign-earned income
Indus BV
15% on all income
Nederland BV
15% on Dutch-earned income
0-low% on foreign-earned
income
Acme vs. Basic
• If the United States does not require Acme to pay tax on
all of its income at the full U.S. rate, Acme will have a
financial edge over Basic when it sells into the U.S.
market
Acme vs. Nederland and Indus
• If the United States requires Acme to pay tax on all of its
income, including its income from producing and selling
widgets to Dutch customers, it will be at a competitive
disadvantage compared to Nederland and Indus
A choice must be made between the two competitive
frontiers: is it more important for Acme to be equal to Basic
(from a tax standpoint), or for Acme to be equal to
Nederland and Indus?

5. The Pre-1962 Framework
Worldwide taxation with deferral
• Favored Acme’s competitive footing vis-à-vis Nederland and Indus as
opposed to Basic
• Full U.S. tax on repatriation of Acme’s foreign earnings so advantage
over Basic theoretically a matter of timing
• Incentive for Acme’s foreign investment compatible with post-WWII
foreign policy

6. The Pre-1962 Framework
Ideal conditions for tax avoidance
• Treaty networks minimized source taxation
• Practical difficulty challenging transfer pricing
• Base company subsidiaries achieved a rate lower than that imposed on Basic or Indus
• Engagement in “harmful” tax competition (i.e., tax havens)
I shall recommend that the Congress enact legislation to prevent the abuse of foreign
"tax havens" by American capital abroad as a means of tax avoidance. In addition, I have
asked the Secretary of the Treasury to report by April 1 on whether present tax laws may
be stimulating in undue amounts the flow of American capital to the industrial countries
abroad through special preferential treatment, and to report further on what remedial
action may be required. But we shall not penalize legitimate private investment abroad,
which will strengthen our trade and currency in future years.
President Kennedy’s Special Message to the Congress on Gold and the Balance of Payments Deficit, Feb. 6, 1961

7. The Adoption of Subpart F
• Compromise between deferral and full inclusion
• Permitted U.S. multinationals to continue to defer U.S. tax on active
foreign business income
• Prophylactic measure against extreme (but hard to police) transfer
pricing abuses
• What problem was subpart F trying to solve?
• Capital export neutrality purists lost the battle
• Wanted to allow Acme to compete on equal terms with Indus
• But not to do better than Indus, tax-wise (maybe even if
Nederlands did)

8. Critical Features and Assumptions of Subpart F
• Anti-deferral rules targeted CFC transactional structure, rather than tax rate
disparity per se
• Required both regarded related party transactions and arrangements involving
entities located in jurisdictions other than those in which manufacturing
occurred, the people providing services were located, or where the CFC’s
customers were
• Rate disparity only targeted by branch rule regulations (not statute)
• Assumptions:
• High-tax locations were necessary for “active” business income (i.e., manufacturing and
services)
• Services would be performed physically on site
• Legal entities would be regarded as CFCs or partnerships
• Essentially a bet that US taxpayers could not/would not move actual business
operations to foreign, low-tax jurisdictions

9. The “Decline and Fall” of Subpart F
• Globalization and profound shift in supply chain arrangements between
1962 and the turn of the 21st
Century
• Development of low-tax production countries
• But Treasury/Congress also allowed evisceration of subpart F rules so
that many more things were treated as “active business operations”
falling outside the scope of subpart F
• Contract manufacturing regulations in 2008
• Narrowing of “substantial assistance” rules in Notice 2007-13
• Check-the-box regulations (2006)
• U.S. legal and regulatory facilitation of IP ownership transfers
• Enactment of section 954(c)(6)
Was the U.S. “giving up” on subpart F, or recognizing that it had to adapt
so as not to “penalize legitimate private investment abroad”?

10. Contract Manufacturing
• 2008 regulations expressly granted “manufacturing” status to a CFC engaging a
contract manufacturer (related or third party), provided the CFC’s employees made a
“substantial contribution” to the manufacturing process
“Final regulations addressing [foreign base company sales income] were first published
in 1964 . . .. Since then, global economic expansion and globalization have led to
significant changes in manufacturing. Many multinational groups have extensive
manufacturing networks that straddle geographic borders. These cross-border
manufacturing networks are created primarily to leverage expertise and cost
efficiencies. In addition, the use of contract manufacturing arrangements has become a
common way of manufacturing products because of the flexibility and efficiencies it
affords. Accordingly, updated rules in this area are important to the continued
competitiveness of U.S. businesses operating abroad.”
• Preamble to the proposed contract manufacturing regulations

11. Notice 2007-13
• Narrowed the application of the foreign base company services
income rules by limiting “substantial assistance” to assistance
provided by U.S. persons, and providing a single cost-based test.
“Since the regulations were published in 1968, there has been a
substantial expansion in the reach of the global economy, particularly in
the provision of global services. As a result, many of the U.S.
multinationals that provide services outside of the United States
currently have globally integrated businesses with support capabilities
for unrelated customer projects in different geographic locations,
largely based on factors such as expertise and cost efficiencies.”

12. Check-the-Box
• Regulations issued in 1997 provided electivity for “eligible entities” to be
classified as a regarded corporation or a flow-through entity
• Disregarded entities combined with low-tax jurisdictions (Country Y) provided
subpart F planning opportunities:
USP
Principal
X
F Sub
X incorporated
Y tax resident
Active non-FBC sales
or services income
Early stage IP
(license
or CSA)
FinCo
Y
F Sub
X
IP
license
Royalty
Buy-in /
royalty
Loan Interest
See Notice 98-11
USP

13. Section 954(c)(6) “Look-Thru Rule”
• In 2006, Congress took CFC-to-CFC payments of dividends, interest, rents and royalties
out of the definition of foreign personal holding company income, to the extent the
payments were made out of non-ECI active foreign income
• Currently extended through tax years beginning before January 1, 2026
“Most countries allow their companies to redeploy active foreign earnings with no additional
tax burden. The Committee believes that this provision will make U.S. companies and U.S.
workers more competitive with respect to such countries. By allowing U.S. companies to
reinvest their active foreign earnings where they are most needed without incurring the
immediate additional tax that companies based in many other countries never incur, the
Committee believes that the provision will enable U.S. companies to make more sales overseas,
and thus produce more goods in the United States.”
House Report to Tax Increase Prevention and Reconciliation Act of 2005, PL 109-222, May 17, 2006

14. 2. The Resurgence of Source
Taxation

15. The Resurgence of Source Taxation
• Avoiding subpart F not that helpful unless also avoiding tax at source
• Not everything could be done in a low-tax country
• And higher-tax foreign countries started wanting to collect source-based tax
• Revenge of the Indus?
• Or just need for new revenue?
• Pre-BEPS source taxation
• Treaty limitation on benefits provisions
• Interest deduction limitations
• BEPS 1.0
• Anti-hybrid rules
• PE
• DEMPE
• Transparency
• Nonincome taxes

16. BEPS 2.0: Pillar 1
• Enhanced nexus rules
• Mandated profit shares
• Market jurisdictions get percentage of “excess profits”
• Minimum return for distribution activities
• But will it go forward?

17. Limitation on Benefits Provisions
• Treaties exempt foreign taxpayers from many withholding taxes
• Conceptualized as a “trade” of tax revenues
• Lower taxation of foreigners matched by heavier taxation of residents
• Reciprocal withdrawal of withholding taxes reduces tax credits that would otherwise
offset residence tax obligations
• But it is a trade only if obligations reciprocal
• Foreign investor must come from country willing to give up tax on U.S. taxpayers
• Foreign investors from countries unwilling to give that tax shouldn’t be entitled to
withholding tax relief
• LOB provisions aimed at preventing foreigners from uncooperative countries
from accessing exemptions by pretending to be from a treaty country
• But some countries that profited from role as intermediaries for foreigners
from uncooperative countries often prevailed in treaty negotiations
• And no guarantee that residence countries would actually impose offsetting
tax

18. Thin Cap Rules
• Limitations on ability to deduct interest expenses
• Not always limited to related party debt
• Ensures that some proportion of gross income makes it to taxable
income (maybe)
• Channels base erosion into other deductible payments, such as
• Royalties
• Transfer prices

19. Anti-Hybrid Rules
• In the U.S., Code Secs. 245A and 267A
• In the EU, the ATAD Directive
• Disallowance of deductions when no matching inclusions on the
recipient’s side

20. Broadening the Definition of a Permanent
Establishment
• Less emphasis on existence of fixed place of business
• More imputation from use of other entities’ fixed places of business
• Agency permanent establishments
• Technical “conclusion of contract” not required
• Home office approval had to involve substantial risk analysis and oversight to
be respected
• “Principal role leading to the conclusion of contracts” deemed enough
• And sometimes just negotiation of primary contract provisions
• Treatment of subsidiaries as “dependent agents”

21. DEMPE
• Income from intangibles allocated not on basis of formal ownership,
but on where “value created” through “development, enhancement,
maintenance, protection or exploitation” of the value of IP
• As a practical matter, a bare-bones cost-sharing agreement was not
enough to justify an income allocation

22. Transparency
• Corporations have to file annual reports detailing profits, sales,
employees and taxable income on a country-by-county basis
• Allows tax authorities to zero in on situations in which taxable
income allocations seem inconsistent with location of underlying
factors
• Countries have to disclose summaries of administrative tax rulings
such as arm’s-length pricing decisions
• Harder to hide agreements with multinational taxpayers

23. Digital Services Taxes
• Taxes on gross receipts derived from provision of online advertising,
intermediary activities or sales of user-collected data
• Configured as excise taxes
• Not covered by tax treaties
• Not creditable against income tax obligations
• But economic burden may fall on users
• Certainly got U.S. attention
• Factor in joining Inclusive Framework
• Which, if implemented, may lead to their repeal

24. BEPS 2.0: Pillar One
• Eliminates the permanent establishment requirement entirely for
large multinational groups
• Automatic tax nexus in any country from which taxpayer derives €1 million or
more of revenue
• Automatic allocation of income to market countries
• ¼ of revenues in excess of 10 percent profitability threshold allocated to
market countries in proportion to revenues
• Automatic return for “baseline marketing and distributions activities”
• Specifics yet to be determined

25. 3. Enhanced Residence Taxation

26. The Road to Global Intangible Low-Taxed
Income (“GILTI”)
• Recognition of subpart F’s “ineffectiveness” and decreasing “relevance”
• 2000 Treasury tax policy study: “Targeting related party transactions may no longer be
an effective way to address tax disparity.”
• Alternatives to worldwide taxation + deferral + subpart F:
• Territorial system
• Repeal of deferral / full inclusion
• Current taxation of foreign income at some rate lower than the U.S. corporate rate
• Extend subpart F to currently tax foreign income falling below a certain effective rate
threshold
• Any new system ideally would address base erosion, “runaway plants” and the
“lockout effect” without unduly harming competitiveness
• Proposals from Obama, Camp, Enzi, Baucus and others
• Grubert & Altshuler 2013

27. The Enactment of GILTI – 2017 TCJA
• Tested income and tested loss of all of a U.S. shareholder’s CFCs are
aggregated at the U.S. shareholder level
• U.S. shareholder subtracts “net deemed tangible return” (10% of pro
rata share of QBAI)
• Section 960(d) deemed paid foreign tax credit
• No tested foreign income taxes for tested loss CFCs
• U.S. shareholder is deemed to pay only 80% of the “inclusion percentage” of
aggregate tested foreign income taxes
• Inclusion percentage = GILTI ÷ total tested income
• Separate section 904 limitation for GILTI
• No carryover/back of foreign taxes in the GILTI basket
• Subpart F left in place largely untouched

28. GILTI as a “Minimum Tax”?
• Legislative history:
• Pure territoriality would make base erosion too attractive
• GILTI is an anti-base erosion backstop to the section 245A DRD
• Intended to impose 10.5% U.S. tax on foreign income subject to an effective
foreign tax rate of less than 13.125%, after FTC:
As foreign tax rates on GILTI range between zero percent and 13.125 percent,
the total combined foreign and U.S. tax rate on GILTI ranges between 10.5
percent and 13.125 percent. At foreign tax rates greater than or equal to 13.125
percent, there is no residual U.S. tax owed on GILTI, so that the combined
foreign and U.S. tax rate on GILTI equals the foreign tax rate.
Conference Report p. 626-27
• Companion to FDII, which taxes U.S. export income at the same 13.125%
effective rate
• Capital export neutrality—but only for exports, and only sort-of

29. BEPS 2.0 – Pillar Two
• “Anti Global Base Erosion” (“GloBE”) rules
• Income Inclusion Rule (“IIR”): Requires the jurisdiction of the ultimate
parent of a covered multinational enterprise to impose a “top-up” minimum
tax on undertaxed foreign income (i.e., below 15%)
• Undertaxed Profits Rule (“UTPR”): Allows every country in which a U.S.
multinational operates a secondary right to impose a top-up tax on a
company if a different related entity (in a different jurisdiction) is taxed
below 15%, on any profits that are not already topped up
• Both the IIR and any “qualified domestic minimum top-up tax” (“QDMTT”) get priority
ahead of the UTPR
• The target 15% effective tax rate is calculated based on financial
accounting income and “covered taxes”
• Covered taxes include regular tax expenses (including adjustments for
deferred tax assets and liabilities) and taxes imposed under a CFC regime
• Hitting the 15% target is determined on a country-by-country basis

30. BEPS 2.0 – Pillar Two
• Takes tax competition head-on
• Compare incremental reforms under BEPS 1.0
• “Tax policy is at the core of countries’ sovereignty, and each country has the
right to design its tax system in the way it considers most appropriate.”
‒ OECD Secretary-General report to the G20 Finance Ministers and Central Bank
Governors, Moscow, Russia at 36 (Jul. 19–20, 2013)
• “The work on harmful tax practices is not intended to promote the
harmonisation of income taxes or tax structures generally within or outside
the OECD, nor is it about dictating to any country what should be the
appropriate level of tax rates.”
‒ OECD, Countering harmful tax Practices More Effectively, taking into Account
transparency and Substance, Action 5—2015 Final report (2015)
• Chances of success?
• What will Congress do?

31. Corporate AMT on Book Income
• Effective for tax years beginning after December 31, 2022
• “Applicable corporations” must calculate tentative minimum tax:
• TMT = (15% x adjusted financial statement income) – CAMT FTC
• Treasury must provide regulatory guidance on these inputs
• AFSI includes CFC income
• CAMT FTC = CFC taxes (limited to 15% of CFC AFSI) + applicable corporation’s
section 901 taxes on applicable financial statement
• CAMT liability = TMT – regular tax liability + BEAT liability
• Gives rise to indefinitely carried-forward CAMT credit

32. 4. The Way Forward?

33. What a Difference 60 Years Make
1962 2002
U.S. economic and political hegemony A multi-polar world with regional hegemons?
Manufacturing-centric economy anchored to physical (high-tax)
locations serving consumer bases in developed countries
Globalized economy with overall tax rate decline, evolved manufacturing and supply
networks, heavy digital focus, business activities serving customers “anywhere,”
multiplication of market jurisdictions
U.S.
Law
• 52% top U.S. corporate rate (35% starting in the 1990s)
• Worldwide taxation with deferral
• One residence-based anti-base erosion regime (subpart
F)
• Few protections against base erosion of U.S. source
income (treaties, interest limitations)
• 21% U.S. corporate rate
• Narrow participation exemption with multiple residence-based anti-base erosion
regimes
• GILTI (minimum tax on aggregate (or c-by-c) foreign income)
• CAMT (alternative minimum tax on aggregate US & foreign book income)
• Subpart F (full U.S. tax on certain CFC transactions)
• Tighter source-based anti-base erosion measures
• BEAT
• 163(j)
• LOB treaty provisions
Foreign
Law
• Mostly broad participation exemption systems with no
residence-based taxation regimes (e.g., CFC regimes)
• Source taxation rights ceded via treaty and otherwise
unprotected by anti-base erosion measures
• Potentially very low effective tax rates on foreign income
• Participation exemptions with CFC regimes
• Barriers to interest deductibility
• Wide adoption of LOB treaty provisions
• Local country implementation of BEPS policies
• More aggressive transfer pricing enforcement
Supranational
“Law”
• None relevant to taxation • OECD BEPS project phases producing broad consensus
• BEPS 1.0 led to wide adoption of anti-base erosion measures (anti-hybrid,
PE, DEMPE transfer pricing, transparency)
• BEPS 2.0 Inclusive Framework – Global formulary apportionment and
minimum taxation?

34. Revisiting U.S. International Tax Policy Goals
• Goals in 1962 articulated as:
• Preventing tax haven abuse
• Taxing passive income currently
• Promoting equity
• Promoting economic efficiency
• Avoiding undue harm to the competitiveness of U.S. multinationals
(Treasury Office of Tax Policy Study, 2000)
• Boiled-down version for 2022: preventing base erosion and profit shifting
• Is capital export neutrality having another moment? Capital import neutrality?
Capital ownership neutrality?
• What about competitiveness (and the threat of inversion / loss of multinationals)?
• Global consensus vs. loss of sovereignty?

35. What Role for U.S. Residence-Based Taxation?
Domestic
Sales Only
Domestic & Foreign
Sales
U.S.
Incorporated
Dutch
Incorporated
Basic Corp.
21% on all income
Acme Corp.
• 21% on U.S.-earned income
• 15% minimum tax on foreign-
earned income (calculated
potentially three times in
three different ways)
• ??% on base eroding
transactional structures of
particular concern
Indus BV
15% on all income
Nederland BV
15% on Dutch-earned income
15% minimum tax on foreign-
earned income
Acme vs. Basic
• How many Basics are there that can be viewed as true
“competitors” (or even comparable) to Acme?
Acme vs. Nederland and Indus
• Nederland’s 15% minimum tax on foreign-earned income
assumes either Pillar Two is adopted or there is
continued expansion of taxation at source (or both)
• The “multinational tax rate” available to both Acme and
Nederland is limited to a 15% floor
Two questions emerge:
1. Is there any justification for Acme to be subject to three
minimum taxes on foreign income?
2. What value does a fourth subpart F regime add?

36. Minimum Tax on Active Foreign Income –
Recommendations
• The U.S. should condense the overlapping minimum tax regimes
(GILTI and CAMT, with potential application of P2) so that only a single
regime applies to CFCs
• A Pillar Two-compliant CFC regime (i.e., that meets the requirements
of an IIR) would simplify matters for U.S. multinationals by ruling out
GloBE’s application to foreign income
• GILTI is a better minimum tax on foreign income than CAMT, but it
needs to be fixed to work as “intended”

37. Minimum Tax Candidate #1: Corporate AMT
• Doesn’t meet Pillar Two standards at present
• How easy (or not) to conform to Pillar Two?
• How close are underlying tax bases (US accounting income vs. Pillar Two
taxable income)?
• Would have to switch from overall blending of foreign operations to
county-by-country testing
• Would have to switch from blending between US and foreign operations
to country-by-country testing
• Is it an improvement over current law in the absence of Pillar Two?
• Applies to domestic as well as foreign income
• What does it add to GILTI?
• Higher tax rate
• No exemption for deemed tangible income return
• Maybe more rational tax credit rules

38. Minimum Tax Candidate #2: GILTI
• Doesn’t meet Pillar Two standards at present
• How easy (or not) to conform to Pillar Two?
• Higher tax rate required
• Would “deemed tangible income return” have to conform to “substance
based income exclusion”?
• What about differences in the computation of the tax base (i.e. other
discrepancies between current definition of gross income for GILTI
purposes and that for a Pillar Two tax)?
• Would have to be supplemented by complementary “qualified domestic
minimum top-up tax” at the U.S. level to protect against UTPRs
• How well does it work in the absence of Pillar Two?
• Section 904 application “breaks” GILTI as a minimum tax
• Is it the right tax rate? Do we get CEN with FDII?
• Should “blending” between high and low tax CFCs be allowed?

39. What to Do About “Subpar” Subpart F?
• Artificial tax structures the least of the current problems
• Business in the digital age depends much less on being anchored to physical
manufacturing sites in high-tax countries
• Much operational substance outside the U.S. in low tax countries
• Unclear how much attributable to Subpart F v. DEMPE v. life
• Especially given development of more flexible contract manufacturing and
substantial assistance standards
• Section 954(c)(6) abandoned policing foreign-to-foreign base erosion
• The current problem is that non-artificial structures generate tax advantages
which are beyond the scope of subpart F
• The special “multinational tax rate” diminished due to revival of source
taxation
• But there are lots of viable production countries with lower-than-US tax
rates—and 15% is lower than 21% and certainly lower than 28%!

40. What does subpart F still achieve?
• Full taxation at US rates of passive income
• Could this be blended into PFIC regime?
• Might be difficult
• Implementation of certain penalty regimes
• Protection against U.S. base erosion?
• Can we get rid of FBC sales and services rules for foreign supply
chains? What about supply chains with a related U.S. party?
• No look-through under § 954(c)(6) for intercorporate debt,
royalties, etc. paid by U.S. businesses
• But…only affects US multinationals
• Don’t we want to protect against U.S. base erosion by foreign
multinationals as well?
• If so, maybe focus should be on beefing up taxation at source, not
residence tax