Minnesota’s GILTI Budget Fix: It May Not Be That Simple

In the waning moments of the 2023 session, when the tax conference committee pulled the plug on a worldwide combined reporting proposal, $430 million of new revenue had to be replaced expeditiously to fund the DFL’s ambitious fiscal agenda.  Filling a hole of that size might be expected to require a whole new section or article in the omnibus tax bill, but was mostly accomplished by inserting one sentence into the conference committee report:

Global Intangible Low Taxed Income: Any amounts included in taxable income pursuant to section 951A of the Internal Revenue Code, are dividend income.

Politically, and to some extent practically, taxing GILTI as a dividend received made sense as an alternative to worldwide combined reporting.   For starters it’s also a tax on multinational corporations – an always popular target – with the added benefit of specifically addressing profit shifting behavior by these firms.  Second, corporations already report GILTI income on their tax returns.  Finally, it avoids the numerous and complicated administrative and enforcement issues in implementing mandatory worldwide combined reporting.  (This is especially relevant as a smallish state attempting to break new ground by itself with policy observers and interests in other states cheering us on from the sidelines.  As Red Sox owner John Henry said to Billy Beane in Moneyball, “the first guy through that wall, he always gets bloody, always.”)

But in the world of corporate income taxation nothing is ever as superficially simple and straightforward as it may seem.  Complicating issues regarding GILTI taxation have been brought to light in a recent State Tax Notes article entitled “Minnesota’s New Approach to Taxing Foreign Income is Unfair and Unwise.”¹  Authored by senior officials of the Council on State Taxation, a trade association consisting of multistate corporations engaged in interstate and international business, it raises several issues regarding the wisdom of “how and how much” Minnesota is taxing this income and the legal and constitutional matters likely to be raised in the years ahead.   Given the absence of any discussion or vetting of these matters in the tax committees this year, it's worth a closer look at these arguments and concerns.

Minnesota as a National Outlier

Of the 44 states taxing corporate income, only 21 tax GILTI income in some form.   However, according to the authors, several structural features distinguishes Minnesota from those that do tax GILTI specifically and foreign income generally which together make the state a significant national outlier: 

• Amount of GILTI income subject to taxation -- Minnesota includes 50% of corporate GILTI income in its tax base.  That conforms to federal tax treatment but is an amount shared by only 8 other states.   Most of the more populous, high income, high tax, “corporate headquarter heavy” state peers include far less GILTI income in their tax base.  For example, New York, Massachusetts, New Jersey all include only 5% of GILTI income in their corporate tax base.

• Tax rate -- This larger base is exposed to what will soon be the highest state corporate tax rate in the nation.  At 9.8%, Minnesota will soon surpass New Jersey for this title when that state’s 2.5% surcharge in existence since 2018 sunsets in 2024 reducing its top rate to 9%.

• Higher taxation of foreign dividends -- Minnesota taxation of foreign earnings via GILTI was augmented this session by higher taxation of regular dividends from foreign subsidiaries.   The state has increased the share of foreign dividends (and subpart F Income) subject to corporate taxation from 20% to 50%.  Taxing both GILTI income as well as regular foreign dividend income is relatively rare across the country, and none do so at Minnesota’s combination of rates and shares subject to taxation.  Notably, the federal government taxes GILTI at 50%, but provides a foreign tax credit and excludes taxation of foreign dividends.   As the authors observe, “in a head-spinning turn of tax policy, Minnesota switched from taxing a much smaller to a much larger share of foreign source income than the federal government.”

• No foreign factor representation – Perhaps the most significant departure from other state treatment of foreign income – and the issue most likely to get the lawyers and courts involved in the future – is the absence of foreign factor representation in apportioning income.   A bedrock principle of constitutionally sound state taxation is that if multijurisdictional income is included in a tax base, the factors that contributed to producing that income need to be taken into consideration in order to allocate the appropriate amount of a company’s total of taxable income to a state for tax purposes.  Minnesota is a “single sales factor apportionment” state meaning the share of total sales in Minnesota determines what share of a company’s taxable income is taxable by the state.  Over half the states taxing foreign earnings have some form of factor representation in their taxation; Minnesota does not.  The authors also observe that the state’s failure to do so is also a departure from the Multistate Tax Commission’s recommended model rules for apportioning foreign-source income (in which Minnesota, as a “sovereignty member,” participates as a regular participant and financial supporter of the Commission.)

On any one of these four structural elements, an individual state peer or peers might be found.  As the authors note, what makes Minnesota unique is that in all four areas, Minnesota’s statutory approach to taxing this income is the most aggressive to be found anywhere in the country.  Taken together, the result is tax policy well outside of the national mainstream among the states taxing this income.  

Does Any of This Matter?

This statutory approach is also how you obtain an estimated $430 million of new biennial tax revenue quickly when you suddenly need it.  The question arises: from a standpoint of traditional tax policy concerns such as revenue reliability, fairness, and competitiveness, how does this approach stand up?

With respect to state competitiveness, the primary risk would seem to one of business perception and intangibles.  From a pure economics standpoint, we might not expect decision-making regarding the location of new plant and people in the state by large multinational corporate entities to be particularly influenced by any of this.  That’s because using single sales factor apportionment, the size of a multinational’s state tax burden is determined by the share of company sales in the state, not the share of company property and payroll in the state. 

However, this aggressive foreign earnings pursuit certainly could well be perceived as yet more evidence of an anti-business attitude and environment in Minnesota, especially when coupled with other tax and regulatory policies enacted this session.   It would be naïve to think growing executive anger and frustration combined with closer scrutiny and greater skepticism of the value proposition to business provided by the state’s higher tax burdens couldn’t affect future business decision-making.  

With respect to fairness and revenue reliability, the primary concern resides in the lack of factor apportionment described above.   Much of the discussion in the article examines how, as the authors state, “Minnesota’s approach to taxing foreign income likely violates the U.S. Constitution’s commerce clause under precedent related to discrimination, fair apportionment, and foreign commerce.”   The discussion of case history and accompanying legal arguments are well beyond the scope of this article (and for that matter beyond our pay grade, as well).  The authors do conclude, “given the constitutional infirmities of Minnesota’s new approach… revenues raised under this new statutory regime are insecure,” and “protracted litigation will certainly follow from audit assessments or refund claims and it will likely take years before the issue is resolved.”

If that is the case, one might ask, why are a number of other states taxing this foreign source income and also doing so without foreign apportionment?   One explanation is that debate continues to exist on whether GILTI income is actually foreign income at all.   Advocates of taxing foreign source income argue most or all GILTI income is only shifted domestic income that does not need factor relief because the multinational’s domestic factors are already in the apportionment formula.   Critics in turn argue Congress never intended GILTI to be equated with domestic income and never said so in print or otherwise.  They also argue the formula for calculating GILTI practically assures foreign-source income that a state has no business taxing gets included in GILTI – something especially true for financial and service sector businesses with modest capital investments outside the United States.

As all this indicates, the topic is a complex, protracted, billable hour sandbox.  Which suggests another reason why Minnesota’s approach might be a difference-maker with respect to future legal and constitutional challenges.   Such challenges are likely evaluated not just on their merits but on the costs and benefits of pursuing them.   Massachusetts taxes both GILTI and foreign dividends without factor representation but only 5% of these income bases are taxed.  In contrast, Minnesota exposes 10 times the amount in these tax bases to taxation.  That might make a difference in how a multinational feels about a court case.

How all this shakes out is anyone’s guess.   But it’s clear there is a disconnect between how this policy should have been approached in the last legislative session and how it was actually handled.   The money may start to roll in, but the odds seem to be pretty good that the final chapter on all this has yet to be written.

Footnotes

¹ “Minnesota’s New Approach to Taxing Foreign Income is Unfair and Unwise.” Frieden and Nicely, Tax Notes State, Volume 109, August 21, 2023