One concept introduced in 2017 by the Tax Cuts and Jobs Act
(TCJA) was Global Intangible Low-Taxed Income (GILTI). One priority of TCJA was to ensure that U.S. taxpayers were not mitigating their U.S. tax liability by migrating assets to low- or no-tax jurisdictions. As a result, anti-deferral rules were created to ensure a minimum income tax was paid on the earnings generated by these foreign assets, regardless of whether distributions were actually made.
The TCJA initially aimed at discouraging U.S. taxpayers (and particularly multinationals) from shifting profits on intangible assets, such as intellectual property rights, to countries with low or no income tax. However, it quickly became clear that GILTI encompassed more foreign earnings than just income derived from intangible assets.
Although the GILTI statute was introduced in 2017, proposed regulations were not released until late 2018, and the final regulations to interpret the statute were not issued by the U.S. Treasury until 2019. Based on the various tax provisions introduced (but not yet passed) by Congress and the Administration, tax advisers expect changes to take effect in the coming years. However, this article will focus on existing rules.
WHAT IS GILTI?
GILTI is an anti-deferral regime, like Subpart F income, which generally prevents taxpayers from artificially shifting income to low- or no-tax jurisdictions. It operates as a minimum inclusion of foreign income reduced by a net return on fixed assets used in the business, regardless of whether actual distributions have been made. GILTI applies to U.S. shareholders of a controlled foreign corporation (CFC). But only certain U.S. shareholders have a GILTI inclusion, namely C corporations and individuals.
For GILTI purposes, flow-through U.S. shareholders (e.g., partnerships) are treated as an aggregate, as opposed to an entity. As a result, partnerships and other flow-through entities report GILTI information to the owners.
A CFC is a foreign corporation in which U.S. shareholders own more than 50 percent of the combined total voting power of voting stock or more than 50 percent of the value of the company’s stock.
HOW THE GILTI INCLUSION IS CALCULATED
By definition, GILTI refers to a U.S. shareholder’s share of net CFC tested income over a shareholder’s net deemed tangible income return.
- Tested income
is the excess, if any, of a CFC’s gross tested income over deductions, including foreign income taxes. Gross tested income is gross income in excess of specific items — Subpart F income, income effectively connected with a U.S. trade or business, dividends from a related person, any foreign oil and gas extraction income and “high tax” income..
- Subpart F income is excluded as it is already separately taxed, so a U.S. shareholder of a CFC will have to calculate the Subpart F income inclusion first.
- “High tax” refers to 90 percent of the U.S. corporate income tax (21 percent). Foreign income that is effectively taxed at 18.9 percent or more is considered high-taxed and can be excluded from GILTI.
- Items of income and deductions that constitute GILTI generally require tax adjustments from book income/loss.
- Net tested income is a U.S. shareholder’s share of tested income minus tested loss. Unlike Subpart F income, which is calculated at the level of a CFC, GILTI is calculated at a U.S. shareholder level. This implies that, in order to calculate a U.S. shareholder’s GILTI inclusion, one must look at the aggregate tested income of all the CFCs in which the U.S. person is a U.S. shareholder. Generally, a U.S. shareholder’s pro-rata share of tested loss will offset their pro-rata share of tested income.
- Net deemed tangible income return (NDTIR) is 10 percent of the U.S. shareholder’s pro-rata share of qualified business asset investment (QBAI) minus specified interest expense.
- QBAI is a CFC’s average aggregated adjusted basis in specified tangible property as of the close of each quarter of such taxable years. Tangible property refers to the fixed assets that are specifically used in the trade or business of the CFC and with respect to which a depreciation deduction is allowable. In other words, it is tangible property (excluding land) used in the production of tested income. Once the net basis is calculated, the amount is multiplied by 10 percent. U.S. shareholders can only reduce their GILTI inclusion by the 10 percent QBAI of net tested income for CFCs. If a CFC has a tested loss, the U.S. shareholder will not be able to take advantage of the basis in the assets of that specific CFC.
- Specified interest expense is the excess of the aggregate interest expense minus aggregate interest income. Legislators provided relief by allowing the tested loss QBAI to reduce the interest expense, even though a QBAI deduction is not allowed for such CFCs.
Because GILTI is calculated at the U.S. shareholder level, each CFC of a U.S. shareholder must calculate its GILTI items (i.e., tested income/loss, foreign income tax, QBAI and specified interest expense). The items are reported on Schedule I-1 of Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations.
All U.S. shareholders must report their pro-rata share of the GILTI items on Form 8992. The total aggregate tested income will be offset by 10 percent QBAI, which is itself reduced by the pro-rata share of specified interest expense.
The actual GILTI inclusion and the resulting GILTI tax liability depend on whether the U.S. shareholder is a C corporation or an individual.
HOW GILTI IS REPORTED ON AN INDIVIDUAL’S TAX RETURN
For U.S. individual shareholders, the net GILTI inclusion will be reported as “other income” and taxed at the individual’s marginal income tax rate, up to 37 percent. U.S. individual shareholders may be able to mitigate their tax liability by electing to be treated as a C corporation for the limited purpose of Subpart F income and GILTI and follow the same steps described above (50 percent deduction for GILTI and foreign tax credit). This will be covered in a future blog post.
HOW GILTI IS REPORTED ON A C CORPORATION’S TAX RETURN
For C corporation U.S. shareholders, additional steps are taken to calculate their GILTI tax liability.
- Section 250 deduction: A C corporation U.S. shareholder must include a gross-up to its GILTI inclusion, which consists of their foreign income tax accrued or paid related to their tested income.
- The grossed-up amount (net GILTI inclusion + gross-up) is subject to a 50-percent deduction, limited to the total federal taxable income from all sources for the year, assuming there is no net operating loss (NOL).
- NOLs apply before the 50-percent deduction, which means that if a C corporation U.S. shareholder has sufficient NOLs, NOLs may entirely offset the GILTI inclusion.
- Form 8993, Section 250 Deduction for Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI) is used to calculate the 50-percent deduction and the limitation, if any, to taxable income/loss and NOLs.
- Foreign tax credit: The C corporation U.S. shareholder must calculate their GILTI inclusion percentage (which is a ratio of the net tested income divided by the net GILTI inclusion). The GILTI inclusion percentage will be used to calculate the tested foreign income tax available to offset the U.S. tax liability.
- The GILTI provisions only allow a credit of up to 80 percent of the blended foreign income taxes (the sum total of tested income taxes from the tested income CFCs).
- Furthermore, there is no carryover of loss for the foreign tax credit in regards to GILTI. The ultimate foreign tax credit is tested foreign income tax multiplied by the inclusion percentage and multiplied by 80 percent.
- Because the TCJA lowered the corporate tax rate from 35 percent to a flat 21 percent, the foreign tax credit is limited to the 21 percent U.S. tax liability. Any excess foreign tax credit is not carried forward and is lost to the C corporation U.S. shareholder.
While the TCJA intended to ensure that a minimum tax was paid on foreign earnings, these foreign earnings are effectively taxed at 10.5 percent (50 percent deduction multiplied by the 21-percent corporate tax rate). With the haircut on the foreign tax credit of 80 percent, a U.S. shareholder C corporation would need to pay 13.125 percent of foreign income tax to not be subject to any U.S. tax liability (10.5 percent divided by 80 percent).
This legislation also modified tax rules by generally exempting the earnings of foreign subsidiaries’ active businesses from U.S. corporate taxation when repatriated. Thus, assuming the U.S. corporate shareholder paid a blended foreign income tax at an average of 13.125 percent, it would be able to repatriate foreign earnings tax-free.
Some of the current discussions by Congress and the Biden Administration regarding changes to GILTI would be to determine GILTI on a country-by-country basis rather than implementing just one calculation, effectively disallowing a blended foreign income tax credit.
As laid out before, GILTI affects U.S. individual shareholders differently than corporate shareholders. Individuals are not eligible for foreign tax credit on GILTI income, do not get a Section 250 deduction (50-percent exclusion of GILTI income) and are taxed at marginal rates, which can be as high as 37 percent. There may be ways to mitigate an individual U.S. shareholder’s GILTI tax liability, which will be covered in another post.
Unsure of how the rules summarized above may apply? Please reach out to GHJ’s International Tax Practice for assistance.