Déjà Vu All Over Once more: Life Sciences Firms Brace For Extra US And International Tax Reform – Tax

The 2017 Tax Cuts and Jobs Act (TCJA) made sweeping changes to
the Internal Revenue Code (Code). When coupled with the
implementation of the various Action Items included in the
OECD’s Base Erosion and Profit Shifting (BEPS) initiative, life
sciences multinationals responded by making major changes to their
supply chains and structures for holding and exploiting
intellectual property (IP).

The Biden administration has proposed significant changes to the
Code that would increase the corporate income tax rate, alter the
mechanics for taxing foreign income and eliminate incentives
included in the TCJA designed to encourage US multinationals to
hold and relocate IP back to the United States. Moreover, the Biden
proposals are intended to influence the OECD’s Pillar One and
Two process by forcing consideration of a global minimum tax
standard. As a result, life sciences companies, many of whom have
only recently come to grips with the changes wrought by TCJA, will
need to revisit their planning.

TCJA, BEPS and the Life Sciences Industry

TCJA and the OECD’s BEPS initiative forced life sciences
multinationals to make significant changes to their supply chains
and international tax structures. BEPS Action 8 essentially
required life sciences companies to relocate IP to a location where
the multinational had sufficient substance. Action 8 created the
“DEMPE” standard for determining whether sufficient
substance existed. Action 8 has been interpreted to mean that a
company is only entitled to a premium return for the use of IP if
that company had sufficient functionality relating to the
Development, Enhancement, Maintenance, Protection and Exploitation
of IP. As a result of Action 8, many multinationals moved IP to
locations where DEMPE functions existed or could be placed.

At the same time, US life sciences multinationals were grappling
with the changes brought about by TCJA-in particular, new rules for
taxing foreign income. While ostensibly moving toward a
participation exemption system, under the new global intangible
low-taxed income (GILTI) regime, income of a controlled foreign
corporation (CFC) became subject to current US taxation even if
such income was not otherwise subject to tax under existing
anti-deferral measures (i.e., subpart F).

Corporate taxpayers were allowed a 50% deduction on their GILTI
income, making the effective rate of tax on GILTI income 10.5%.
Taxpayers were also entitled to an 80% foreign tax credit (without
carryover) for foreign taxes attributable to the GILTI income. In
theory, as long as the effective rate of foreign tax on GILTI
income was at least 13.125%, there should be no residual US tax
after taking into account the foreign tax credit. In practice,
however, this often does not hold true as a result of the expense
allocation rules and the inability to carryforward foreign tax
credits in the GILTI basket. In some cases, but not always, the
elective “high tax exclusion” permits taxpayers to avoid
the US residual tax on high-taxed GILTI that may otherwise result
from the application of the expense apportionment rules.

Another feature of TCJA was the enactment of the foreign-derived
intangible income (FDII) regime which provided a tax incentive for
the exploitation of IP owned in the United States. The FDII
incentive is a 37.5% deduction on foreign derived intangible
income, in general income earned from sales of property or services
for foreign use above a fixed return on tangible property. The
37.5% deduction equates to an effective rate of tax of 13.125%,
comparable to a combined US and foreign tax rate on moderately
taxed GILTI income.

As a result, life science companies looking to relocate IP in
light of Action 8 could consider a number of countries that had
relatively low tax rates but still high enough to offset a GILTI
inclusion. Ireland, Switzerland (particularly after Swiss tax
reform), Singapore, the Netherlands and the United Kingdom were
common destinations for post-BEPS, post-TCJA restructuring. At the
same time, the FDII incentive also led multinationals to consider
relocating IP back to the United States (or owning newly developed
IP in the United States), especially in cases where the
multinational would not be able to establish sufficient DEMPE
substance elsewhere. Life sciences companies (among others) were
lured by the FDII incentive to relocate IP back to the United
States. All of this decision-making occurred in the context of the
newly lowered corporate tax rate to 21%.

Overlaying GILTI, FDII and the reduced corporate income tax rate
was the enactment of BEAT, the base erosion anti-abuse tax. BEAT
acts as a corporate minimum tax by recalculating taxable income but
excluding deductions for payments made to foreign related parties.
BEAT hits life sciences companies particularly hard in that it may
deny deductions for certain royalties paid to related parties as
well as payments to related parties for certain services performed
outside the United States. For example, life sciences companies
routinely engage foreign contract research organizations (CROs) to
conduct clinical trials outside the United States. Often, a foreign
subsidiary in the group is engaged to consolidate CRO
relationships. Prior to the enactment of BEAT, the US parent
company would reimburse the foreign subsidiary for third-party CRO
costs plus a mark-up. BEAT can deny the US parent a deduction for
the reimbursement payment to the foreign subsidiary.

As a result of these BEAT concerns, many life sciences companies
restructured their supply chains and changed their contractual
relationships with CROs and other vendors. This often resulted in
considerable upheaval as new vendor contracts needed to be agreed
to and accounting systems updated.

Not surprisingly, therefore, the last three years have been
particularly challenging for the tax departments of multinational
life sciences companies. The Biden proposals and the potential
knock-on effect on global tax rates have the potential of forcing
life sciences companies to rethink much of their planning.

The Biden Proposals

On March 31, 2021, the White House released a “Fact
Sheet” describing President Biden’s American Jobs Plan, a
broad jobs and infrastructure plan. The Fact Sheet includes a
high-level summary of the Made in America Tax Plan which would pay
for the American Jobs Plan through corporate tax reform and by
changing or eliminating altogether many of the international tax
provisions enacted under TCJA that primarily impact
multinationals.>1 On April 7, 2021, the US Treasury
(Treasury) released a report providing greater detail on the Made
in America Tax Plan (Treasury Proposal together with the Fact
Sheet, the Biden Tax Plan).2 Finally, on April 8, 2021,
Treasury released its presentation to the Steering Group of the
OECD/G20 Inclusive Framework on BEPS summarizing aspects of the
Biden Tax Plan and proposing changes to OECD’s Pillar One and
Pillar Two initiatives (the “US Proposal”). When reading
these three documents together, the contours of the Biden Tax
Pan-the goal of which is said to be to make American companies and
workers more competitive by eliminating incentives to offshore
investment, substantially reducing profit shifting and countering
competition on corporate tax rates-begin to take shape.

Concurrently, on April 5, 2021, Senate Finance Committee
Chairman Ron Wyden (D-Ore.) and Senators Sherrod Brown (D-Ohio) and
Mark Warner (D-Va.) released a framework for “Overhauling
International Taxation” (the SFC Framework) which is said to
ensure that multinational corporations pay their fair share of US
corporate income tax.3

We describe the proposed changes to US tax law, the United
States’ shift in policy vis-à-vis OECD’s Pillar One
and Pillar Two Blueprints, and the potential impact these proposed
changes may have on companies in the life sciences industry and the
structuring undertaken in response to TCJA.

Increased Corporate Rate

The Biden Tax Plan proposes increasing the federal corporate
income tax rate to 28% from TCJA’s 21% in order to fund US
investments in infrastructure, clean energy and research and
development. Notably, the SFC Framework does not propose a change
to the corporate rate, but does recognize that any changes to the
GILTI rate will depend on the corporate rate. Recently, President
Biden made it clear that he is open to compromise on the rate, and
it is possible a 25% rate, an approximate of the global average
corporate income tax rate, or other corporate income tax rate could
be agreed upon.

Changes to the GILTI Regime

The Biden Tax Plan reiterates a campaign proposal to (1)
increase the rate on GILTI to 21% (75% of the proposed 28%
corporate rate) from 13.125% (10.5% through 2025),4 (2)
apply GILTI to a US shareholder’s earnings and foreign taxes on
a country-by-country basis rather than in an aggregate basket, and
(3) eliminate the exemption from GILTI for deemed returns equal to
10% of a CFC’s foreign depreciable tangible assets
(“qualified business asset investment” or

The SFC Framework supports increasing the GILTI rate, but
whether it equals the US corporate tax rate or remains a lower
proportion of the corporate rate, e.g., 75% (which would result in
GILTI of 18.75% assuming a 25% corporate rate), is an open
question. The final determination likely depends on changes to the
US corporate rate, base stripping protections and other incentives
or disincentives for US and foreign investment.

The SFC Framework states that requiring GILTI to be calculated
on a country-by-country basis would prevent taxpayers from
offsetting, through foreign tax credits, high-tax income generated
from operations in major economies (such as Germany and Japan) with
income from intangibles in low-tax jurisdictions. Two options to
effect a country-by-country determination are presented in the SFC
Framework-(1) expand the existing system for foreign tax credits to
have separate GILTI “country baskets” for each country in
which a company operates or (2) divide global income into low-tax
and high-tax categories and apply GILTI only to the income in the
low-tax income category. Income from high-tax jurisdictions would
be excluded from GILTI through the use of a mandatory high-tax
exclusion (i.e., if a corporation paid taxes in a foreign at an
effective rate above the GILTI rate, the corresponding income would
be excluded from GILTI).

Elimination of FDII

FDII has been criticized as an ineffective
incentive because it only applies above a 10% return on
tangible assets. As a result, according to the Biden Tax Plan, it
encourages US multinationals to move assets or make new investments
abroad so as to increase the amount available to be deducted
as FDII. The Biden Tax Plan would eliminate the FDII regime in
order to no longer incentivize offshoring of assets and instead
reform how the Code promotes and encourages new research and
development in the United States. The Fact Sheet proposes to use
the revenue from the repeal of the FDII deduction to provide other
incentives for R&D.5

The SFC Framework proposes replacing the “deemed intangible
income” concept with a metric referred to as “deemed
innovation income” (DII) which would be an amount of income
equal to the share of expense for innovation spurring activities
that occur in the United States, such as research and development
and worker training. The incentive would be designed to encourage
continual innovation as current year spending would determine the
benefit rather than prior year spending. FDII would be renamed
foreign derived innovation income.6

After the enactment of TCJA and in response to BEPS Action 8,
life sciences companies made critical decisions with respect to how
they hold and exploit IP. Many relocated IP to DEMPE compliant
locations and became subject to tax under GILTI. The proposed
changes to the GILTI regime change that calculus. Now that IP is
located in a DEMPE compliant country, even if a life sciences
company wanted to relocate IP again in response to the Biden
proposals, there would likely be some form of exit tax or other tax
consequences on the movement of the IP out of the foreign

As discussed above, some life sciences companies were lured to
relocate IP back to the United States because of the FDII
incentive. FDII was intended to reward this “good taxpayer
behavior.” A repeal of FDII could be viewed by some as a
“bait and switch” because a taxpayer that repatriated IP
in response to FDII cannot simply move it back offshore to a DEMPE
compliant location without triggering US tax consequences under
sections 367(d) and 482.

A different approach to the perceived flaws in FDII would be to
eliminate the 10% QBAI floor and allow FDII to apply on all
foreign-derived income without regard to the location of tangible
assets. Elimination of QBAI would complement the repeal of the 10%
QBAI base in the proposed revisions to GILTI and move away from the
presumption in TCJA that the GILTI regime should focus only on
excess profits and not capture routine returns. Retaining FDII
would keep open the option for a life sciences company to keep IP
in the United States and relocate IP back to the United States in
response to the proposed changes to GILTI.

Repeal and Replacement of BEAT

The Biden Tax Plan proposes to repeal BEAT and replace it with
“SHIELD” (Stopping Harmful Inversions and Ending Low-tax
Developments). SHIELD would deny multinational corporations US tax
deductions for related party payments subject to a low effective
rate of tax, which would likely be defined relative to the rate
that is ultimately agreed upon in Pillar Two or, if no multilateral
agreement has been reached, then with reference to the new
GILTI rate discussed above.7 SHEILD’s two
significant differences from BEAT are that it would (1) apply to
the first dollar of related party payments, as opposed to the 3%
threshold that applies to life sciences companies now under BEAT,
and (2) apply to all forms of related party payments, including
reductions in gross income (i.e., cost of goods sold), such that it
would include more than the deductible payments currently captured
under BEAT. Is also possible that SHIELD, a rather blunt denial of
deductions, could be structured to apply in a manner analogous to
the complex undertaxed payments and subject to tax rules being
considered as part of the OECD’s Pillar Two proposal.

As noted above, many life sciences multinationals made
significant changes to their supply chains and vendor relationship
to eliminate payments that would be subject to BEAT. In many cases,
those payments would have been made to related parties in countries
with sufficient rates of tax so as to escape the application of
SHIELD. If SHIELD is enacted, life sciences companies will need to
consider whether to unwind the changes made in response to BEAT or
leave their systems in place notwithstanding the fact that payments
may not result in additional tax under the SHIELD regime.

Proposed Changes to Pillar One and Pillar Two

In the US Proposal, the US government expressed support for the
OECD’s Pillar One and Pillar Two initiatives, but proposed
significant changes. Very generally, Pillar One proposed a
“new taxing right” designed to ensure that multinationals
pay tax on residual profits earned from activities in jurisdictions
where they lack sufficient presence under existing tax rules.
Pillar One was designed to apply to consumer facing and automated
digital service businesses. The US Proposal would broaden Pillar
One’s scope to cover all businesses without exception and would
simplify Pillar One by limiting its application to “no more
than 100” multinationals. The intent of the proposal is that
the largest companies (the most profitable, the ones that benefit
the most from global markets, that are the most intangibles-driven,
and that are best equipped to handle the compliance burden) would
be subject to the tax regardless of industry classification or
business model.

The US Proposal would employ a two-step test to narrow the field
to those top companies. First, a proposed revenue threshold would
need to be met-possibly as low as $20 billion has been mentioned in
the press. Such a threshold would capture many more than the top
100 multinationals as $20 billion in revenues is the equivalent of
company #500 on the Fortune Global 500 list. The second threshold
would consider profit margin. Over 25 life sciences companies would
be included based on a $20 billion revenue threshold and most of
those 25, in particular those in the pharmaceutical sector, would
likely be included in this newly envisaged scope of Pillar One
based on profitability.

The Biden administration says limiting the scope based on these
criteria would have the effect of reaching multinationals that are
the most intangible driven and have the highest profit-shifting
potential. The US Proposal notes that following such an approach
would highly reduce the need for business line segmentation,
suggesting that limited exceptions to Pillar One may not be
entirely off the table for large multinationals. As a result, both
US and non-US multinationals would be subject to the Pillar One tax
which would have the impact of addressing previous commentary that
Pillar One inherently discriminated against US tech companies.

With respect to Pillar Two’s global minimum tax regime, the
US Proposal expressed a “wish to end the race to the
bottom” on corporate taxation and strong support for the
shareholder level “top-off” or minimum tax (and backup
UTPR and subject to tax rule) that generally would apply in respect
of the income of a subsidiary not subject to a minimum level of
taxation. However, under the US Proposal the minimum tax would be
21% (instead of the often-discussed but unspecified lower rate,
such as 12.5%). Further, the US Proposal makes reference to the
Biden Tax Plan without much detail but suggests those amendments to
GILTI (i.e., repeal of exemption from US income tax to the extent
of 10% of a subsidiary’s QBAI) should likewise be made to the
Pillar Two Blueprint proposal to exclude from the
“top-off” tax a percentage of payroll expense and
depreciation of tangible assets of a subsidiary. This is a key
point of friction between the Biden administration’s proposed
changes to GILTI which would repeal QBAI versus the discussions
within the OECD, welcomed by many, that would actually expand that
analogous concept to include an allowance not only for tangible
assets but for labor as well.

As noted, a tax rate of 12.5% has often been discussed as a
suggested global minimum tax. This is due in large part to the fact
that Ireland’s corporate income tax rate is 12.5%. In fact,
when the contours of TCJA were first being developed, the effective
rate of tax needed to enable a full foreign tax credit offset to
GILTI was a foreign tax rate of 12.5% (in the first versions of the
TCJA bill, the effective US tax rate on GILTI would have been 10%).
Many observers believed that GILTI was designed to ensure that US
multinationals with substantial operations in Ireland would be able
to fully offset GILTI with Irish taxes.

A global minimum rate of 21% could force Ireland to raise its
corporate rate considerably, making it much less competitive. In
response to the US Proposal, the Irish finance minister recently
reiterated the country’s support for its 12.5% tax
rate.8 It can be expected that Ireland will strongly
resist a global minimum tax rate above 12.5%. Many life sciences
companies have substantial operations in Ireland and will be
monitoring the debate on this issue closely.

Concluding Observations

It is quite likely that the corporate income tax rate will
increase as well as the effective tax rate on foreign income. How
these increases come together will depend on what will surely be a
multitude of compromises made during the legislative process.
Because life sciences companies are inherently global and much of
their profitability derives from IP, each of the proposed changes
in the Biden Tax Plan together with the re-scoping of Pillar One
and the push for a global minimum tax rate has the potential to hit
the industry hard.


1 https://www.whitehouse.gov/briefing-room/statements-releases/2021/03/31/fact-sheet-the-american-jobs-plan/
(last accessed, Apr. 6, 2021).

2 https://home.treasury.gov/system/files/136/MadeInAmericaTaxPlan_Report.pdf
(Last accessed, Apr. 14, 2021).

3 https://www.finance.senate.gov/chairmans-news/wyden-brown-warner-unveil-international-taxation-overhaul-
(last accessed, Apr. 6, 2021).

4 Effective tax rate derived from the Section 250
deduction equal to 50% (reduced to 37.5% in 2026) of the US
corporation’s GILTI income (including the Section 78 gross-up
for foreign taxes attributable to the GILTI inclusion).

5 Other incentives for R&D also factor into the
calculation of the Biden Tax Plan’s new minimum tax of 15% on
book income. The minimum tax would be in addition to a
corporation’s regular federal tax liability, but could be
reduced by R&D credits.

6 The SFC Framework notes that if FDII remains in the
Code, the GLITI and FDII rates should be equalized. Currently
through 2025, GILTI is taxed at an effective rate of 10.5% and FDII
is taxed at an effective rate of 13.125%.

7 The SFC Framework discusses reforming BEAT by adding a
second rate bracket in addition to the current 10% rate such that
“regular taxable income would still be subject to a 10% rate,
while base erosion payments would be subject to a higher
rate.” Additional revenue could be used to restore the value
of domestic tax credits and modify how the BEAT limits foreign tax

8 Speech by Minister for Finance, Paschal Donohoe TD,
to Virtual Seminar on International Taxation with the Department of
Finance (Apr. 21, 2021). http://paschaldonohoe.ie/speech-by-minister-for-finance-paschal-donohoe-td-to-virtual-seminar-on-international-taxation-with-the-department-of-finance/
(last accessed Apr. 26, 2021).

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