There are a couple of developments on the GILTI front that readers may find interesting. First, last month the IRS issued final and proposed regulations involving GILTI and the high-tax exclusion. Second, one of Democratic U.S. Presidential nominee Joe Biden’s tax proposals is the doubling of the effective GILTI corporate tax rate from 10.5% to 21%.
To understand the potential impact of these, you first need to have a general understanding of what the GILTI provisions are meant to do and their current impact.
What is GILTI (Global Intangible Low Taxed Income)?
GILTI was introduced under the 2017 Tax Cuts and Jobs Act (“TCJA”). The goal was to provide a dis-incentive for U.S. based companies to hold their Intellectual Property (IP) in low tax jurisdictions, such as Ireland. GILTI would be reported on the “United States shareholder’s” U.S. tax return on a flow through basis similar to subpart F income. It did not matter whether the GILTI was actually distributed or not.
It is abundantly clear (in this author’s mind) that when the legislation was enacted the U.S. Congress did not consider U.S. persons living abroad nor foreign small businesses. The law was aimed at the large multi-national enterprises (MNEs). As such, the introduction of GILTI created a significant tax and compliance burden on many U.S. taxpayers who owned business through foreign corporations.
How does GILTI work (a non-comprehensive summary)?
If a foreign company is subject to the GILTI provisions (which is a question of fact based on share ownership) the GILTI computation starts with gross revenue. Certain categories of gross income are then excluded including (i) income effectively connected with a U.S. trade or business; (ii) subpart F income; (iii) gross income subject to the (subpart F) high-tax exception; (iv) dividends received from a related person (as defined under U.S. tax law); and (v) any foreign oil and gas extraction income. In general, these excluded items are subject to potential U.S. taxation under separate rules.
From the remaining non-excluded gross income, you would then deduct expenses (including corporate taxes) properly allocable to such income. This determines “tested income”.
GILTI = tested income less the shareholder’s net deemed tangible return for such taxable year.
One of the components in the computation of the “net deemed tangible return” is based on the level of specified tangible property used in a trade or business of a corporation. In other words, fixed assets (we are simplifying here).
GILTI is then included in the United States shareholder’s income on a look through basis.
Two points become clear:
- Where the foreign corporation is capital intensive (i.e., manufacturing), the net deemed tangible return would be higher and the GILTI inclusion less (all things being equal). Foreign corporations that primarily provide services or which are sales oriented will have higher levels of GILTI (since they have no or minimal fixed assets), and are more impacted by the GILTI provisions.
- If the foreign corporation was carrying on an active business (such that none of the exclusions apply) there would be a taxable GILTI inclusion EVEN if the foreign corporate taxes were significant higher than the corresponding U.S. tax though the recent finalized Regulations address this issue for many taxpayers (see below). The underlying foreign corporate taxes do not flow through to the United States shareholder (they are paid by the foreign corporation not the United States shareholder) and, as such, cannot be claimed as foreign tax credit by the United States shareholder.
The IRC §962 Solution
The election under IRC §962 is one solution to (ii) above. Under this provision, a United States shareholder who is an individual may elect to have any subpart F income and GILTI taxed as if the income was earned in a hypothetical U.S. corporation as opposed to including the income on their U.S. personal income tax return. This election allowed the hypothetical U.S. corporation to then claim a foreign tax credit for a portion of the foreign corporate taxes paid. If the effective foreign corporate tax on GILTI was 13.125% or more, there would be no hypothetical U.S. corporate tax and no actual U.S. tax impact with respect to GILTI. Some filings, yes, but no actual U.S. tax to the United States shareholder. The U.S. taxable event would then occur when an actual distribution (i.e., a dividend) was paid out of the foreign corporation.
Final and Proposed Regulations Issued
In July, 2020 the IRS issued IR 2020-165 indicating that both Final and Proposed Regulations (REG-127732-19) were issued with respect to GILTI and the high-tax exclusion. Proposed Regulations (REG-101828-19) had been issued in June 21, 2019 with respect to the high-tax exclusion. Those prior Proposed Regulations have now been issued in Final.
Final Regulations
When initially enacted, the GILTI high-tax exclusion only applied with respect to passive subpart F income. The Final Regulations establish an elective exclusion for high-taxed CFC income that does not otherwise qualify for the subpart F high-tax exclusion. By making the GILTI high-taxed election, active income of a CFC taxed at a minimum effective rate is excluded from the scope of tested income.
- By making the GILTI high-taxed election, gross tested income does not include gross income subject to foreign income tax at an effective rate that is greater than 90% of the maximum tax rate specified in section 11 (18.9% based on the current maximum tax rate of 21%).
- The Proposed Regulations contained a 5-year lock-in and lock-out period once the election was made or revoked, respectively, that made it difficult to evaluate the election’s impact over the 5-year period. The Final Regulations provide that the GILTI high-taxed election can be made annually.
- For previous tax years, taxpayers may choose to apply the GILTI high-tax exclusion retroactively to taxable years of foreign corporation that begin after December 31, 2017, and before July 23, 2020, and to taxable years of U.S. shareholders in which or with which such taxable years of the foreign corporations end.
Proposed Regulations
Though the GILTI HTE (high-tax exclusion) regulations have been finalized, these do not conform with the subpart F high-tax exception rules. The Proposed Regulations aim to conform and simplify (that is a relative term!) these different sets of rules.
Democratic Presidential Nominee Joseph Biden’s Tax Proposals
Joe Biden, as part of his Presidential campaign, has released a number of tax proposals. One of the proposals relates to GILTI. First, he has proposed raising the U.S. corporate tax rate from 21% to 28%.
Because of the ability to deduct 50% of the GILTI inclusion in computing U.S. corporate taxable income, the U.S. effective federal corporate tax rate on GILTI is 10.5% instead of the statutory 21%. He has proposed raising the effective GILTI rate to 21%. This is accomplished by reducing the GILTI deduction from 50% to 25%. As such the GILTI federal rate would be 21% (28% x (1-25%)).
Some questions/thoughts come to mind:
- If the U.S. federal corporate tax rate increases to 28%, the 90% GILTI high-tax exclusion would increase to 25.2% (assuming there is no change in how the GILTE HTE threshold is computed). As such many more CFCs may no longer qualify for the GILTI HTE.
- Even with a corporate tax rate of 28%, many U.S. based corporations may still enjoy corporate tax savings by shifting income to lower taxed jurisdictions.
- The IRC 962 election may no longer be as effective for eliminating double tax for U.S. individual shareholders. Currently the GILTI foreign tax credit is restricted to 80% of the foreign taxes otherwise eligible. If the foreign corporate tax rate exceeds 26.25% (21% / 80%) it would appear that the election may still be a viable option.
- If the foreign corporation’s tax rate is less than 26.25%, there will be tax leaking and a level of double taxation to the United States individual shareholder. For example, if the foreign corporate tax rate was 19%, a United States shareholder would have IRC 962 tax of 5.8% [21% – (19% x 80%)]
- The proposals refer to U.S. multinationals. It is clear, once again, that the plight of U.S. citizens abroad has not been considered!
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Cadesky U.S. Tax Ltd. is a full service advisory and compliance firm. We monitor U.S. tax news that may be of interest to our readers and share our thoughts in U.S. Tax Tips. If you require our assistance please do not hesitate to reach out to us.
