The GILTI Tax | New anti-deferral rules for shareholders of controlled foreign corporations
Disclaimer: The new tax rule on GILTI is complex and will require guidance from Congress or the IRS for additional clarification. Please contact your Lurie advisor to discuss your specific situation.
The 2017 Tax Cuts and Jobs Act introduced a number of significant tax changes as it relates to US Shareholders of Controlled Foreign Corporations (CFCs). Some changes accelerated the taxation of foreign earned income and some deferred the US taxation of foreign earned income. The GILTI provisions are designed to accelerate the taxation of certain foreign earned income in the right circumstances for US shareholders of CFCs.
What is GILTI? Global Intangible Low-Taxed Income
Although the name implies the provision has a narrow base, it is much broader. It is not only income earned in a low tax jurisdiction that is subject to the review.
C-Corporation shareholders are the only shareholders who can benefit from certain provisions of the new act that will protect higher-taxed income from being included in the US tax base on a current basis.
The types of US taxpayers more likely to be affected by these provisions are:
- Individuals,
- Flow-through shareholders of CFCs, especially when the CFC has a low fixed asset base, and
- US Corporate shareholders of CFCs in low tax jurisdictions or that have a low fixed asset base.
Why the new GILTI regime?
The purpose of the GILTI provisions is to discourage US companies from moving intangible assets and their income outside of the US tax net and then be able to repatriate the income to the U.S. potentially tax free.
Who is subject to GILTI?
GILTI only applies to US shareholders who own CFC stock directly or indirectly through another foreign corporation, foreign partnership, or foreign trust or foreign estate.
The GILTI rules are applied for any foreign corporation that was considered a CFC at any time during the taxable year.
What is a US shareholder for this purpose?
- A US person who owns directly or constructively 10% or more of the total voting stock of the foreign corporation or more than 10% of the total value of all classes of stock of the foreign corporation.
- A US person includes US citizens and residents, domestic partnerships, corporations, estates and trusts.
What is a Controlled Foreign Corporation?
Any foreign corporation if:
- More than 50% of the total combined voting power of all classes of stock entitled to vote, or total value of the stock of such corporation, is owned (directly or constructively) by US shareholders on any day during the taxable year of the foreign corporation.
How does GILTI work?
GILTI = Net CFC Tested Income – ((10% X QBAI)-Interest Expense)
Definitions
- Tested Income is the gross income of the CFC with certain adjustments including appropriately allocated expenses[i]. Net CFC Tested Income is the sum of each CFC Tested Income less the sum of each CFC Tested loss.
- Qualified Business Asset Investment (QBAI) is the average at each quarter end of the aggregate adjusted bases in tangible property used in the trade or business and depreciable property.
- Interest expense adjustment relates to the ultimate net income expense inclusion related to the shareholder’s Net CFC Tested Income. If the interest expense taken exceeds the interest income included in determining tested income an adjustment is needed.
In some cases this calculation is simple; in others it is not. It is necessary to determine the Net CFC Tested Income and the QBAI of the CFC and the attributable interest expense. If the Net CFC Tested Income exceeds 10% of the QBAI, adjusted for interest expense, the US shareholder may have an income inclusion.
If the answer to the GILTI equation is positive then this is the income to be included in the US shareholders taxable income. Individual shareholders and non-corporate investors of flow-through entity shareholders include their allocated share of GILTI in their US taxable income and it is subject to the applicable ordinary tax rate for that shareholder.
C-Corporation shareholders have two additional calculations available to them to reduce the ultimate US taxation on the GILTI income inclusion:
- C-Corporations are eligible for a special deduction under the new IRC code section 250 equivalent to 50%[ii] of the GILTI inclusion, with special limitations based on taxable income. Thus, the US effective tax rate for C-Corporation shareholders may be effectively reduced to 10.5%.
- C-Corporations are eligible to claim an indirect foreign tax credit against the net income. This credit is at 80% of the standard deemed paid credit allowed. GILTI has its own separate foreign tax credit limitation basket and excess credits cannot carryforward. Thus, if the CFC paid taxes in their home jurisdiction in excess of 80% of 10.5% the C-Corporation will likely not have a US tax due on the GILTI income.
Example
A US individual shareholder owns 100% of the CFC. The CFC is a service based company. CFC’s gross income is $100,000. Allocable deductions under IRC 954(b)(5) are $75,000. The average quarterly tangible property value is $10,000. There is no interest expense.
Net CFC Tested Income: $25,000 ($100,000 – $75,000)
QBAI: $10,000
GILTI = $25,000 – ($10,000*.1) = $24,000
Given that the US shareholder is an individual, this amount is included in the owners US taxable income with no other offsets or credits.
If the US shareholder was a C-Corporation in this example, there would be a deduction allowed for $12,000 (assuming this didn’t result in a loss for the owner), resulting in a net income inclusion of only $12,000 ($24,000 x 50%). In addition, a foreign tax credit would be allowed to the extent taxes had been paid for the CFC.
Conclusion
All US shareholders of CFCs are subjected to the new GILTI regime and non C-Corporate shareholders are particularly vulnerable to having this new anti-deferral regime result in an increase in taxable income. There are some planning opportunities related to restructuring that may reduce the potential of a tax implication of the GILTI tax.
If you have any questions or would like additional information on how this change could affect you or your business please contact your Lurie advisor.
Loma B. Ince, CPA
Director, Tax Services
612.381.8777
lince@luriellp.com
FOOTNOTES
[i] Types of income that are subtracted from the gross income of the CFC: Effectively Connected Income, Gross Income of Subpart F, Gross income excluded due to the High Tax Exception, Dividend income from a related party, Foreign oil and gas extraction income, and Deductions (including taxes) properly allocable under IRC 954(b)(5)
[ii] Effective for tax years after 2025 the deduction is reduced to 37.5%.