This week, the Chairman of the Ways and Means Committee, Rep. Jason Smith (R-MO), introduced legislation in response to the global minimum tax that would increase taxes on businesses and individuals from countries that impose discriminatory and offshore taxes on US taxpayers. This stems from bipartisan concern regarding tax policies adopted by other countries that specifically target US companies or the US tax base.

Under the proposal, a 5 percent additional tax would be added each year for four consecutive years (for a cumulative 20 percent additional tax) under conditions outlined in the bill. Income subject to tax would be limited to US earnings and the earnings of foreign companies and individuals who are not US citizens or residents.

The legislation is another step that Republican members of Congress are taking to show their discontent with the global minimum tax. But legislation is also much more than that. It’s the next chapter in a long story about how US politicians have responded to foreign rules targeting US companies.

The details of the proposal are important, and future research by the Tax Foundation will delve into those details. Before that analysis, though, it’s important to see where this proposal stands in the context of similar efforts throughout the recent history of US tax policy (and even the pre-WWII era). .

An important question in international tax rules is which country can tax the income of companies or individuals that earn income in multiple jurisdictions. Over time, a complex web of tax treaties between countries and rules around those policies have developed to address this issue. That complexity can lead to results that are obviously not aligned with the underlying economics of cross-border trade and investment. Policymakers often wonder whether, in the absence of cross-border tax rules, such a significant part of corporate profits would be reported in low-tax jurisdictions.

Addressing the challenges of the current system is a tense exercise. Countries often act in their own interest, even where some level of coordination between jurisdictions could be beneficial.

As the American corporate sector has grown over the decades with many successful multinational companies, other countries have wanted to tax what they believe to be their share of taxable profits. The US approach to dealing with foreign encroachment on the US tax base has been to pressure other jurisdictions to avoid policies that unfairly target US companies.

During the 1930s, France was evaluating a tax on American corporations that resulted in double taxation of dividends. Meanwhile, France and the US were negotiating a tax treaty that would have eliminated this type of double taxation. The treaty was signed in April 1932 and was promptly ratified by the United States Senate by june of that year France took longer to act and continued his efforts collect exorbitant taxes based on his previous law.

In effect, France was working to collect taxes from US subsidiaries operating in France based on the worldwide profits of the parent companies, and not just on income earned in France.

With no tax treaty in place, the US government recognized the need to create a means of recourse against France.

As representative Fred Vinson (D-KY) said in early 1934,

My friends, there are nations all over the world that are not particularly friendly to Uncle Sam in terms of business, and when given the opportunity to pick in the pockets of their citizens, be they individuals or companies, they have not hesitated to do so. There is one country, France, that is not satisfied with taxing the income of American individuals and American corporations as they tax their own citizens: they are not satisfied with getting a tax on income that is actually earned in their own country; But when the US parent company of that subsidiary declares dividends, it imposes a corporate tax on these dividends, derived from whatever source.

Representative Vinson went on to describe what eventually became Section 891 of the US tax code, concluding: “This power can be used to protect American businesses from current discrimination and will likely help prevent foreign countries from apply more discriminatory taxes”.

Section 891 (which remains part of US law) gives the president the authority to double the tax rate on citizens and businesses of a foreign country if that foreign country is subjecting US citizens or businesses to discriminatory or extraterritorial taxes. To date, this arrangement has never been used.

Section 891 was enacted as part of the Revenue Act 1934 on May 10, 1934. France ratified the tax treaty almost a year later, in April 1935.

Mitchell B. Carroll, a special counsel for the US Treasury at the time, drew a direct line between the adoption of the new retaliatory tool and the ratification of the treaty by France.

Fast forward 82 years, and Section 891 appears again. This time it’s not because France is taking an offshore tax approach to US companies, but it’s the European Commission, the executive branch of the European Union.

In 2016, Georgetown University law professor Itai Grinberg (recently Deputy Assistant Secretary of the US Treasury Department) published an article analyzing the approach the European Commission was taking in its investigation of the tax practices of some US companies. He offered Sec. 891 as a tool to discourage the Commission from taking an aggressive and discriminatory approach.

Even more recently, when several European countries (including France) adopted digital services taxes (DST), Section 891 was brought back into the conversation. Those policies were transparently portrayed by politicians as targeting big US digital companies, and US lawmakers took note of the discriminatory nature of the approach. Chairman Grassley (R-IA) and Ranking Member Ron Wyden (D-OR) of the US Senate Finance Committee. wrote a letter in June 2019 to Treasury Secretary Steven Mnuchin asking it to “consider all available tools” to address DST, and they specifically referred to Section 891 as one such tool.

Wyden and Grassley’s bipartisan letter was backed by bipartisan and bicameral concerns about DSTs. In early 2019, Wyden and Grassley were joined by House Ways and Means Committee Chairman Richard Neal (D-MA) and Ranking Member Kevin Brady (R-TX). in a sentence calling for “measured and comprehensive solutions, and abandon unilateral measures.”

The Trump administration tackled the issue of taxes on digital services on two fronts. After the US Trade Representative filed a report Finding France’s DST to be discriminatory, the Trade Representative moved to implement retaliatory fees. This back and forth led to a temporary stalemate in early 2020 as discussions continued on a possible multilateral solution to the digital tax problem.

The other front was in international negotiations. Since early 2019, the Organization for Economic Cooperation and Development (OECD) had begun coordinating a multilateral solution, both for DSTs and a global minimum tax.

Unfortunately, to date, DSTs are still on the map. Recent OECD language gives countries flexibility to maintain their DSTs even in the context of a multilateral agreement (which I think is unlikely to be implemented). Plus, a new offshore tool has been thrown into the mix.

The Global Minimum Tax includes a rule better known by the acronym “UTPR,” which once stood for the Low Tax Payments Rule, but has been expanded well beyond “payments” over time. In the context of the 15 percent global minimum tax rules being adopted around the world, the UTPR acts as a vacuum cleaner. It can go beyond the borders of a country to tax the profits of jurisdictions in which the effective tax rate for certain companies is less than 15 percent.

The Republic of Korea may be the first country to enforce this rule in 2024, but many other jurisdictions are preparing to enforce the UTPR in 2025 (including members of the European Union).

DST and UTPR are different in many ways, but US lawmakers should be concerned about the extraterritorial nature of both. As I reminded members of Congress in my recent testimony before the Senate Finance Committee, “There was bipartisan concern from members of this committee when digital services taxes were introduced, exposing American businesses to offshore taxation. Now, the current global minimum tax rules do exactly that – they expose American companies to offshore taxation.”

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