Jan 19, 2022
As we advised in Tax Tip 20-04 , significant additional disclosure and filing requirements for trusts were announced in the 2018 Federal Budget and are scheduled to apply for trust’s 2021 and subsequent tax years.
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:
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.
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.
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:
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