GILTI reshapes a whole world of tax
Global intangible low-taxed income, or GILTI, is a new concept added to the Tax Code by the Tax Cuts and Jobs Act that creates a new category of foreign income that gets added to corporate taxable income each year — and substantially alters the landscape of international tax.
“The TCJA threw everything upside down because it created a new foreign income category and substantially eliminated the deferral regime,” said Ciprian Niculae, tax director in the International Services Group at Top 100 Firm EisnerAmper.
Prior to the TCJA, the U.S. had a worldwide tax regime where U.S. taxpayers, including both businesses and residents, were taxed on their worldwide income. U.S. shareholders were generally able to defer the U.S. federal income tax liability on their foreign subsidiaries’ income until the earnings were repatriated to the U.S. in the form of distributions or other forms of payments. GILTI was created to discourage U.S. multinationals and investors from moving U.S. operations offshore, shift income streams out of the U.S. to lower-tax jurisdictions, and prevent the erosion of the U.S. tax base.
“It does away with the deferral regime we’ve had in place since 1962 that allowed U.S. companies to defer the U.S. federal income tax liability on the income of their controlled foreign corporations,” said Niculae. “GILTI gets around substantially all the exceptions to Subpart F, and therefore, the majority of CFC income is subject to U.S. tax.”
“The combination of GILTI and the Subpart F regimes generally no longer permit U.S. companies and investors to defer paying U.S. tax on the income that sits offshore — that’s the stick,” he said. “The carrot is the 50 percent deduction for GILTI under IRC Section 250, available to domestic corporations and foreign tax credits related to the GILTI income. However, the major problem faced by U.S. taxpayers with a GILTI inclusion is that excess foreign tax credits remaining in the GILTI basket at year-end may not be carried forward and are lost.”
“Initially, the TCJA only allowed U.S. C corporations to benefit from the IRC Section 250 deduction,” he said. “This put individual shareholders of CFCs, as well as partnerships and S corporations, at a disadvantage. For example, if the CFC had net tested income, a U.S. parent corporation, in theory, should have been subject to an effective U.S. tax rate of 10.5 percent [one-half of the corporate tax rate of 21 percent] on the GILTI inclusion, albeit before taking into account foreign tax credits. However, individuals, S corporations and partnerships were not extended the benefits of IRC Section 250.”
Since that result was unfair to non-corporate taxpayers subject to GILTI, the IRS had to level the playing field, according to Niculae. “The IRS remedied the problem by issuing proposed regulations under Section 250 that a U.S. individual/shareholder making an election under Section 962 to be taxed as a C corporation on the earnings of the CFC may benefit from the 50 percent deduction on GILTI income. As a result, the 962 election can be made by an individual who directly owns stock in one or more CFCs, or indirectly owns the CFC stock through a partnership or an S corporation.”
“International tax planning involving GILTI and/or Subpart F income comes down to a number-crunching game,” he said. “If a U.S. taxpayer owns a CFC that is in a tax loss position, the taxpayer could consider electing to have the foreign entity characterized as a foreign disregarded entity for U.S. federal income tax purposes. The check-the-box election should eliminate the statutory complexities and tax liability resulting from GILTI and subpart F, allow the foreign losses to be utilized by the U.S. parent entity or individual shareholders, and where applicable, increase the taxpayer’s [net operating loss] carryforwards,” said Niculae. “Nevertheless, it is important to note that tax planning inherently involves multiple considerations, provisions and rules.”
The proposed GILTI regulations issued on June 14, 2019, by the Treasury Department and the IRS furnished additional guidance about the high-tax exception from GILTI, and HTE election, Niculae noted.
“However, tax practitioners have to wait for the proposed GILTI regulations to be finalized before it can be determined whether the HTE is a viable tax planning alternative for clients. Unless Treasury finalizes the HTE proposed regulation before year-end and makes it retroactive, the exception will not be able to be used in 2019,” he said.