We have described in past US Tax Tips the recently enacted, Global Intangible Low Taxed Income (GILTI) provisions and the potential impacts on United States persons in Canada who own enough shares in Canadian corporations such that those Canadian corporations would be a controlled foreign corporations (CFC) for U.S. tax purposes.
GILTI is treated as a new form of subpart F income meaning that the United States shareholder must include their pro-rata share of GILTI on their U.S. income tax return even though it may not be taxable personally in Canada. Even worse, where the United States shareholder is a natural person, there is no credit for the underlying corporate tax paid by the Canadian corporation.
GILTI is also subject to being included in its own foreign tax credit basket. As such the inclusion of GILTI can result in an actual tax liability for United States shareholders. An election, under IRC §962, may be made by the taxpayer to address the potential double tax issue.
Under this election, a United States shareholder, who is an individual, can elect that certain income of the Canadian corporation, be taxed as if the shareholder was a United States corporation as opposed to an individual. This allows the corporate income to be (i) taxed at the U.S. corporate rate of 21% (instead of at the individual’s marginal tax rate which may be as high as 37%) and (ii) by doing so the underlying actual corporate taxes are eligible to be claimed as a foreign tax credit. If the IRC §962 election is being made with respect to GILTI, however, the eligible foreign taxes are reduced by 20% in computing the foreign tax credit.
Other potential relief, however, appears to be on its way.
In determining what income is subject to the GILTI provisions, the corporation’s gross income is reduced for certain items of income that are already subject to U.S. tax under other provisions of the Internal Revenue Code. Such exceptions include U.S.-source effectively connected income, passive income subject to the subpart F inclusion provisions and other passive investment income that would be subpart F income except for the high tax kick out provision. In general, foreign source active business income would be caught under the GILTI provisions.
On June 14th, 2019 the U.S. Treasury and the IRS released Notice 2019-12436 entitled “Guidance under Section 958 (Rules for Determining Stock Ownership) and Section 951A (Global Intangible Low-Taxed Income).”
What is being proposed is a new exception in determining what gross income would be classified as gross tested income (GILTI). The CFC’s controlling shareholder(s) would make an election to exclude, from gross tested income, gross income that is subject to foreign tax at an effective rate that is greater than 90% of the maximum U.S. corporate rate. The maximum U.S. corporate rate is currently 21% so the threshold would be 18.9% (21% x 90%). If the Canadian effective tax rate is in excess of 18.9% then that income will not be subject to a GILTI inclusion on the U.S. return.
Canadian corporate tax rates vary depending on whether the corporation is a CCPC or not. If the corporation is not a CCPC (or if a CCPC the active business income is well above the Small Business Deduction (“SBD”) threshold such the effective tax rate on Active Business Income (“ABI”) exceeds 18.9%) the 2019 general corporate tax rate varies from a low of 26.5% (Ontario and the Northwest Territories) to a high of 31% (Nova Scotia and Prince Edward Island). The lowest general corporate rate of 26.5% is in excess of 18.9% so any ABI subject to these rates would be excluded from GILTI under these provisions.
This particular item of relief, however, would not assist CCPCs which take advantage of Small Business Deduction. The 2019 small business rates vary from 9% (Manitoba) to 15% (Quebec). These rates, by themselves, are below the current threshold of 18.9%.
For CCPCs, the shareholders may consider making the IRC §962 election. The IRS, however, had previously ruled that a United States shareholder, who is an individual, may claim the 50% deduction, under IRC §250, for any GILTI or Foreign-Derived Intangible Income (FDII) when an IRC §962 election is being made. As such, the effective U.S. corporate tax rate, on the GILT inclusion would 10.5% (1/2 of 21%). 80% of eligible foreign taxes paid may be claimed as a foreign tax credit against the GILTI U.S. tax. For a CCPC in Manitoba 80% of 9% equals 7.2%. Using this example, there would U.S. tax of 3.3% (10.5% – 7.2%) as the CCPC has not paid enough Canadian corporate tax to eliminate the U.S. tax. As such, small Canadian business may still be subject to a small level of double taxation under GILTI.
United States persons who are Canadian residents, generally, did not establish their Canadian corporations to defer or eliminate U.S. tax. They did so, because they live and work in Canada, invest in Canada, they plan and conduct their affairs as Canadians, which they are.
In our opinion, many provisions of the TCJA failed to address how these changes would impact U.S. persons who live abroad. These individuals are simply not on the U.S. Congress’ radar.
Canada applies a de minimis threshold in regard to many of its foreign reporting requirements. For example, a T106, “Information Return of Non-Arm’s Length Transactions with Non-Residents”, is not required to be filed unless the reportable transactions exceed Cdn $1,000,000.
The U.S. could easily include such a de minimis threshold. There could even be recapture provisions to clawback the de minimis threshold for larger taxpayers (those who are the real targets of these provisions) such that Treasury does not lose any tax revenue to which they are entitled. Such a provision would eliminate a significant number of foreign small businesses from these far reaching and, frankly, intrusive provisions. Something to consider (in our opinion anyway).
Obviously the GILTI provisions rules are extremely complex. Cadesky U.S. Tax Ltd. is a full service firm providing U.S. consulting, planning and compliance services. 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.