The 2017 Tax Cuts and Jobs Act (TCJA) significantly impacted the taxation of U.S. multinational companies and their foreign profits. Prior to tax reform, the U.S. tax code provided for a worldwide taxing system of its residents.
This resulted in U.S.-domiciled corporations being taxed on worldwide income, upon repatriation irrespective of the income’s country of Subsequent to tax reform, the U.S. migrated to a quasi- territorial system and introduced a new regime which results in the immediate taxation foreign earnings, referred to as Global Intangible Low-Tax Income “GILTI”.
What’s in this article?
- What is the GILTI tax regime and what is its purpose?
- What are key GILTI-related concepts?
- What are the 2018 proposed regulations to Section 951A?
- How do I calculate GILTI?
- How do I calculate tested income?
- How does GILTI factor into the Section 250 deduction?
- How does GILTI affect foreign tax credits (FTCs)?
- How do I report GILTI?
- Need Help?
What is the GILTI tax regime and what is its purpose?
GILTI was introduced via the enactment Section 951A, which requires U.S. shareholders (i.e., 10% or more shareholders of a foreign corporation) of any Controlled Foreign Corporation (CFC) to include their foreign earnings as part of their gross income in the U.S. for the current tax year. Generally, GILTI is income derived from the deemed intangible assets of CFC’s. Deemed assets may include specifically identified assets such as patents, trademarks, copyrights, intellectual property but also encompasses unspecified assets.
GILTI is intended to serve as an outbound anti-base erosion provision. With a key objective of applying a global “minimum tax” to income earned overseas. Per the new provisions, GILTI income encompasses any foreign income that exceeds 10% of a foreign subsidiary’s Qualified Business Asset Investment (QBAI). Typically, a QBAI includes the fixed assets of each foreign subsidiary with U.S. tax depreciation rules applied. Due to the calculation of QBAI, GILTI is particularly burdensome to foreign entities with non-capital intense businesses. For example, a manufacturing plant that required considerable capital to start their business will have a high QBAI (i.e. fixed assets). Therefore, the implications of GILTI would lower.
Generally, GILTI is the excess of a U.S. shareholder’s aggregated “net tested income” from CFCs over a routine return on certain qualified tangible assets. This aggregated income approach allows loss entities to offset income generating entities with the same owner.
While GILTI is viewed as a punitive provision, the TCJA also instituted some relief via the enactment of Section 250. Section 250 provides U.S. corporate shareholders a 50% deduction on their GILTI income. This can result in a significant 10.5% U.S. effective tax on GILTI income, with partial foreign credits available to offset some or all of the U.S. tax liability on the GILTI amounts. (For taxable years beginning after December 31, 2025, the deduction decreases to 37.5%, resulting in a 13.125% U.S. tax rate.)
So, what is the purpose of GILTI?
The new definition of the GILTI foreign income intends to discourage companies from using intellectual or other intangible property to shift profits out of the United States into low-or zero-tax jurisdictions.
In order to achieve this, the government placed a floor on the average foreign tax rate paid by U.S. multinationals between 10.5% and 13.125%. Therefore, if the foreign tax rate is zero, the effective U.S. tax rate on GILTI will be 10.5% (half of the regular 21% corporate rate because of the 50% deduction). On the other hand, if the foreign tax rate is 13.125% or higher, there will be no U.S. tax after the 80% credit for foreign taxes.
The 10% QBAI exemption attempts to target the assets that return above-normal returns, which is, in turn, a proxy for the returns to intellectual property. This approach focuses on more mobile income. In addition, it exempts the returns to real investment, which should avoid distorting foreign investment decisions of U.S. multinationals. Under the GILTI provision, the rate on foreign profits is now at or below most tax rates in the developed world. As a result, there is less incentive for U.S. corporations to move their headquarters outside of the United States.
What are key GILTI-related concepts?
Tax reform expanded the definition of a U.S. shareholder to include either voting power or value, rather than solely voting power. More specifically, under the TCJA a U.S. shareholder is a U.S. person that holds at least 10% of the total voting power of all classes of stock entitled to vote in a foreign corporation or holds 10% of the total value of shares of all classes of stock of the foreign corporation. The expanded definition affects multinational corporations, such as a CFC, and their shareholders.
Controlled Foreign Corporations
A Controlled Foreign Corporation (CFC) is a registered corporate entity that conducts business in a foreign jurisdiction. The United States defines control of the foreign company according to the percentage of shares owned by U.S. shareholders. CFCs operate alongside tax treaties to determine how taxpayers declare their foreign earnings.
What are the 2018 proposed regulations to Section 951A?
Under the new Global Intangible Low-Taxed Income (GILTI) regime, the Treasury Department and Internal Revenue Service (IRS) proposed regulations to offer guidance on the new international tax landscape. The regulations package includes amendments and additions to the Subpart F income and consolidated return regulations.
The proposed regulations:
- Explain the calculations for the fundamental elements underlying the GILTI inclusion (e.g. “tested income” and “qualified business asset investment”)
- Revise the definition of “pro rata share” for purposes of inclusions of both GILTI and Subpart F income
- Outline anti-abuse rules in respect to specified basis step-up transactions for the GILTI regime
- Adopt a hybrid aggregate/entity approach to U.S. partnerships and their partners for purposes of the GILTI regime
- Generally require a consolidated group to compute its GILTI inclusion as a group rather than member by member
How do I calculate tested income?
Gross Tested Income
A CFC’s gross tested income is its gross income determined without regard to:
- Effectively connected income
- Gross income taken into account in determining Subpart F income
- Gross income excluded from foreign base company income or insurance income (because it is taxed at a foreign effective tax rate greater than 90% of the U.S. corporate tax rate)
- Dividends received from a related person
- Foreign oil and gas extraction income
A CFC’s tested income is the positive amount (if any) of its gross tested income minus deductions (including taxes) properly allocable to such gross income. The proposed regulations under the Treasury Department refer to CFCs with tested income as tested income CFCs.
A CFC’s tested loss is the positive amount (if any) of deductions (including taxes) properly allocable to the CFC’s gross tested income minus the amount of such gross income. The Treasury regulations refer to these CFCs as tested loss CFCs.
Note: U.S. shareholders may offset tested income with tested losses in computing GILTI; however, U.S. shareholders may not utilize other specified tested loss CFC tax attributes such as FTCs and QBAI.
Net CFC Tested Income
Net CFC tested income means, with respect to any U.S. shareholder for any taxable year, the positive amount (if any) of:
- The aggregate of the shareholder’s pro rata share of the tested income of each of its CFCs less
- The aggregate of its pro rata share of the tested loss of each of its CFCs
Net CFC Tested Income = Sum of CFC Test Income – Sum of CFC Tested Loss
Qualified Business Asset Investment (QBAI)
A CFC’s qualified business asset investment (QBAI) is the average of the aggregate of its quarterly adjusted bases in “specified tangible property” used in its trade or business. Specified tangible property, in this sense, means any property used in the production of tested income.
To calculate the depreciations deductions for QBAI purposes, you use an alternative depreciation system (i.e., the straight-line method).
Tested loss CFCs may have a business asset investment (BAI) but do not have tested income and, therefore, have no specified tangible property and no QBAI.
Net Deemed Tangible Income Return (DTIR)
A U.S. shareholder’s net deemed tangible income return (DTIR) is the positive amount (if any) of 10% of the aggregate of its pro rata share of the QBAI of each of its CFCs minus certain interest expense.
Net Deemed Tangible Income Return = [(10% x QBAI) – Certain Interest Expense]
How does GILTI factor into the Section 250 deduction?
Under Section 250(a)(1) a domestic corporation is entitled to a deduction equal to the sum of the following components:
- 5% of its FDII
- 50% of its GILTI inclusion and FTCs treated as deemed dividends attributable to GILTI under Section 78 (“Section 78 gross-up amount”)
Section 250(a)(2) explains that, if the sum of the corporation’s FDII, GILTI and Section 78 gross-up amount for the year exceeds its taxable income for the year (not taking the Section 250 deduction into account), its FDII, GILTI and Section 78 gross-up amount are proportionally reduced by that excess amount when calculating the deduction for the year.
Proposed Treasury regulations hold that individuals making a Section 962 election to be taxed as a corporation on Subpart F and GILIT inclusions can claim the 50% deduction for their GILTI and the Section 78 gross-up amount.
Additionally, the proposed regulations also provide that a corporate partner has the ability to claim the Section 250 deduction and adopt an aggregate approach for the partner’s FDII calculations.
How does GILTI affect foreign tax credits (FTCs)?
For any GILTI inclusion, U.S. shareholders are allowed a deemed-paid foreign tax credit equal to 80% of the aggregate tested foreign income taxes paid or accrued by their tested income CFCs, multiplied by their inclusion percentage. Tested foreign income taxes are taxes paid or accrued with respect to tested income, but not tested loss.
As a result, there are two limitations when determining the deemed-paid FTC with respect to GILTI.
- Multiply the aggregate tested foreign income taxes by 80% (partial credits) rather than the full 100% (full credits).
- Multiply the amount by the inclusion percentage to ensure that U.S. corporations do not get credit for tested foreign income taxes paid with respect to their net DTIR, which is “exempt” from tax.
How do I report GILTI?
The proposed regulations modify the existing rules to generally require each U.S. shareholder that directly or indirectly owns stock of a CFC to annually file a new IRS Form 8992, U.S. Shareholder Calculation of Global Intangible Low-Taxed Income. Typically U.S. shareholders file Schedule I-1, Information Return of U.S. Persons with Respect to Foreign Corporations, along with their annual Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations.
GILTI presented considerable changes to the international tax arena in the United States. It produced complex issues that require companies, tax directors and advisers to reassess their historic planning, global structures and transfer pricing. It’s a critical time for multi-national tax payers to recalibrate and reassess their global operating structures, and realign operations with change stemming from tax reform. Our International Tax Services team working closely with our Transfer Pricing team can guide you through the new international tax laws. We are ready to help you come up with a plan that best suits you and your business.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.