The Verdict - GILTI: Global Intangible Low-Taxed Income
On June 14, 2019, the U.S. Treasury Department (Treasury) and the Internal Revenue Service (IRS) released the highly anticipated final regulation under Section 951A - Global Intangible Low-Taxed Income (GILTI).
GILTI, as briefly discussed in our previous blog - International Tax Overview: Moving Forward with Tax Cuts and Jobs Act (TCJA), is a new anti-deferral provision under Section 951A enacted by the Tax Cuts and Jobs Act (TCJA) that requires a deemed intangible income inclusion by U.S. shareholders of certain foreign corporations. Under prior law, U.S. owners of foreign corporations were able to defer recognizing taxable income until there was an actual distribution of earnings back to the U.S owners. GILTI ensures that U.S. shareholders pay a minimum tax on a current basis on new category of income called “deemed intangible income”. As we continue to go through the 2018 tax filing season we are discovering how far reaching and burdensome GILTI can be due to the current tax impact on foreign earnings and the extremely complex reporting and compliance requirements under Section 951A regulations.
If the following two factors are present, you may be subject to GILTI:
- U.S. Shareholder – United States Person (citizens, residents, domestic entities) owning at least 10%, directly or indirectly, of the foreign corporation’s voting stock or value (Pre-TCJA, only voting stock was considered).
- Controlled Foreign Corporation (CFC) – any foreign corporation of which more than 50% of the vote or value is owned by U.S. shareholders on any day during a given year.
U.S. individuals who own foreign corporations directly or through a domestic pass-through entity should pay special attention to planning opportunities discussed below which may allow the CFC owners to minimize their GILTI exposure.
Fundamentally, Section 951A imposes a 10.5% minimum tax on GILTI inclusions, subject to a partial GILTI deduction and foreign tax credit limitations. The GILTI inclusion is the deemed intangible income of a CFC which is essentially the excess of the foreign earnings above a 10% net deemed tangible income return. It is important to note, CFC’s deemed Intangible Income is not necessarily based on its intangible assets or its income derived from those assets. Therefore, due to the mechanics of the GILTI calculation, any CFC income may be considered deemed intangible income for the purposes of GILTI.
The GILTI inclusion amount is calculated using a complex formula which requires an annual determination of the following items for each CFC the shareholder owns:
- Tested Income – the excess of the CFC’s gross income over properly allocable deductions (excludes Subpart F Income, Foreign Base Company Income, and Income Effectively Connected with a U.S. trade or business, among other items);
- Tested Loss – the excess of properly allocable deductions over the CFC’s gross income without regard to the exclusions described above;
- Qualified Business Asset Investment (QBAI) – the average of a CFC’s aggregate adjusted basis in specified tangible property used in a trade or business determined under the Alternative Depreciation System (ADS).
The above items are aggregated and used to calculate the Net Tested Income and Net Deemed Tangible Income Return.
- Net CFC Tested Income = aggregate prorate share of CFC tested income minus CFC tested losses.
- Net Deemed Tangible Income Return = 10% times adjusted bases of tangible property of the CFC.
Once the U.S. shareholder has determined their net deemed tangible income return for the year, that amount is subtracted from the pro rata share of the CFC’s net tested income or loss. Any dollar of income above the net deemed tangible income return is considered GILTI, no due process needed!
50% GILTI Deduction - A U.S. corporate taxpayer (and certain individuals who make a Section 962 election discussed below) may claim a Section 250 deduction, subject to certain limitations, equivalent to 50% of their GILTI (reduced to 37.5% for tax years starting after 2025) before application of foreign tax credits.
Foreign Tax Credit Limitation – A foreign tax credit may be claimed by a corporate taxpayer (and certain individuals who make a Section 962 election discussed below) for 80% of certain foreign income taxes paid by a CFC. Application of the deduction and the tax credits will generally eliminate the U.S. tax owed on the U.S. corporate shareholder's GILTI if the tested income is subject to an effective foreign income tax rate above 13.125%, for tax years before 2026, and 16.406% thereafter.
GILTI Considerations for CFC Ownership through Pass-through Entities
- Tax structures involving a CFC have never been more meaningful than after the enactment of TCJA and Section 951A. Since beneficial provisions of 951A are generally only available to C Corporations (Section 250 – 50% GILTI Deduction and Deemed Foreign Tax Credits), U.S. individuals who own CFC’s directly or through a domestic pass-through entity (S Corporation, Partnership) should carefully consider the following options which can help minimize the effects of GILTI and reduce the taxpayer’s effective worldwide income tax rate. Any changes in entity structure require careful modeling and consideration of tax and non-tax consequences to determine the best overall option.
- Section 962 Election - allows a U.S. individual shareholder of a CFC to elect to be subject to corporate income tax rates on amounts that are included in his or her gross income under GILTI and Subpart F (not discussed). Some of the noteworthy U.S. income tax consequences of a U.S. individual making a Section 962 election are as follows:
- The individual’s GILTI inclusion is taxed at the corporate tax rate of 21% (corporate tax rate);
- The individual is entitled to a Section 250 GILTI deduction in the amount of 50% of GILTI (proposed regulations under Section 250);
- The individual is entitled to a deemed paid foreign tax credit with respect to GILTI inclusions, as if the individual were a domestic corporation;
- When the CFC makes an actual distribution of earnings that have already been included in gross income under GILTI, Section 962 requires that the earnings be included in the gross income of the shareholder again to the extent they exceed the amount of U.S. income tax paid on the inclusions at the time the Section 962 election was made.
- Inbound liquidations of CFC – an inbound liquidation of a CFC would effectively treat the CFC as a domestic entity, and if no CFC exists there would be no GILTI.
- Deemed liquidation likely will be a taxable event to the U.S. individual;
- Tax-free liquidation may be attainable if at least 80% of the foreign entity's shares are owned by a domestic corporation;
- Domestic and foreign tax and non-tax consequences of the inbound liquidation should be considered;
- Deemed inbound liquidation - a check-the-box (i.e., entity classification) election is filed to treat a foreign entity as a disregarded entity and flow-through for tax and the CFC will constructively distribute all its property to the U.S. individual.
- U.S. Blocker Company - in U.S. blocker structure, the U.S. individual contributes their shares of the CFC to a U.S. domestic corporation.
- Domestic and foreign tax and non-tax consequences of the U.S. individual's transfer of stock in the CFC to U.S. entity should be considered;
- U.S. entity could get a 50% deduction under Section 250 (reduced to 37.5% for tax years starting after 2025) for any GILTI inclusion and allowable deemed foreign tax credits;
- Allowable Section 245A dividend received deduction for certain distributions from the CFC to the U.S. domestic corporation;
- Distributions from the U.S. domestic corporation to the shareholder subject to additional layer of tax (taxed at preferred qualified dividend tax rate of 15%-20%).
On June 14, 2019, the Treasury and the IRS published final regulations on GILTI under Section 951A which are generally consistent with the proposed regulations published on September 13, 2018, with certain notable differences:
- Provides guidance to determine the amount of global intangible low-taxed income included in the gross income of certain U.S. shareholders of foreign corporations, including U.S. shareholders who are members of a consolidated group;
- Retains, with certain modifications, the anti-abuse provisions that were included in the proposed regulations;
- Revises the domestic partnership provisions to adopt an aggregate approach for purposes of determining the amount of global intangible low-taxed income included in the gross income of a partnership’s partners under Section 951A with respect to controlled foreign corporations owned by the partnership;
- Provides guidance relating to the determination of a U.S. shareholder’s pro rata shares of a controlled foreign corporation’s Subpart F income and global intangible low-taxed income included in the U.S. shareholder’s gross income, as well as certain reporting requirements relating to inclusions of Subpart F income and global intangible low-taxed income;
- Rejects the tested loss carryforward recommendations from the comments on the proposed regulations, therefore net tested losses will not be allowed to offset future net tested income for the purposes of GILTI. This was never in the proposed regulations, but many were hoping for the adoption of this provision.
In addition, the Treasury and the IRS issued final regulations under Sections 78, 861 and 965 relating to certain foreign tax credit aspects of the transition to an exemption system for income earned through foreign corporations.
The Treasury and the IRS also issued new proposed regulations under IRC Sections 951(b) and 951A which includes an election that would apply a high-tax exception to GILTI when the tax imposed on a tentative net tested income item exceeds an 18.9% corporate tax rate. The applicability of the high-tax exception would be tested at the level of a single qualified business unit (QBU) and would apply to all CFCs controlled by the same domestic shareholders. However, in the current form the Proposed GILTI high-tax exception cannot be relied on.
The international tax provisions are highly complex and will likely continue to increase the tax compliance burdens for even the simplest corporations with foreign operations and their shareholders. This is the second article of a three-part series discussing the international tax provisions. We will continue to examine the implications of these regulations in detail and the significant changes which have been made since the enactment of the Tax Cuts and Jobs Act (TCJA).
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Article Prepared By: Daniel Waszkiewicz