Will We Feel GILTI under Tax Reform? by Andre Benayoun, JD
Posted on September 01, 2018
In an effort to prevent U.S. businesses from shifting profits offshore to low-tax countries, the Tax Cuts and Jobs Act imposes an annual tax on foreign income that exceeds 10 percent of a taxpayer’s return on all foreign depreciable assets, including plants, equipment and real estate. However, under this Global Intangible Low Taxed Income (GILTI) regime, U.S. owners of foreign corporations may exclude from this calculation some items of income, including income that is considered “high-taxed” (i.e., income subject to a local tax rate above 18.9 percent). While this can be a very powerful tool to avoid GILTI, the language used in the current version of the law does not exempt all income subject to high-tax. Rather, the exemption applies only to income subject to high-tax that would have otherwise been picked up on a pre-existing anti-deferral regime known as Subpart F.
As the IRS continues to issue guidance to help taxpayers apply the new law, it is possible that the agency will interpret the language contained in the TCJA to mean that only high-tax income already exempt from Subpart F income should be exempt from GILTI. At this point in time, it appears that this interpretation is very likely to be the correct one. The reason for this exemption is that if the IRS does not allow taxpayers to exempt from GILTI high-taxed income that would have been Subpart F, then the pre-existing exception to Subpart F would be rendered meaningless. This is because taxpayers would simply pick up that same income by the new tax law’s GILTI anti-deferral regime after exempting it under the older Subpart F rules.
Keeping this exception in mind, will more businesses feel GILTI under the new law? Maybe, maybe not.
U.S. C corporation taxpayers receive a credit against GILTI inclusions for foreign taxes they paid at the level of their foreign corporate subsidiaries (albeit a reduced benefit of 80 percent). They also receive a 50 percent deduction on GILTI income that reduces their corporate rate from 21 percent to 10.5 percent. In essence, if a U.S. C corporation has foreign entities that pay taxes locally, in a foreign jurisdiction, at a rate of 13.125 percent (20 percent more than the U.S. rate charged on GILTI of 10.5 percent), then, the foreign tax credits allowed against GILTI should theoretically eliminate the corporation’s U.S. tax liability. However, this is not always the case. For example, if a C corporation has interest expense at the U.S. level, it may allocate and apportion some of that amount in such a way as to reduce the entity’s foreign tax credit, and subsequently leave the entity with some additional U.S. tax liability.
What about U.S. individual taxpayers who may be taxed as high as 37 percent on GILTI income? They neither receive the 10.5 percent tax rate on GILTI inclusions, nor do they benefit from the possibility of getting credit for foreign taxes paid by foreign-owned subsidiaries. However, eligible taxpayers may be able to reduce their GILTI liability by making Section 962 elections to be treated similar to C corporations. When this occurs, a U.S. individual taxpayer may receive a credit for foreign taxes paid at the corporate level to be used against his or her individual GILTI liability.
Yet, the law does not yet make clear whether a Section 962 election would also allow an individual taxpayer to take advantage of all of the tax benefits afforded to C corporations. For example, it is yet to be seen if the IRS will permit an individual to apply the 50 percent deduction against GILTI inclusions that a C corporation may use to reduce its effective tax rate to 10.5 percent, rather than the 21 percent rate that a corporation would otherwise have on GILTI inclusions. Even without this deduction, a 21 percent tax rate would still be better than the maximum 37 percent that could apply to U.S. individuals. Currently, it appears that an individual making a Section 962 election will only be entitled to the 21 percent rate and will not receive the 50 percent deduction afforded to corporate taxpayers.
Are there any other options that a U.S. individual could employ to reduce or eliminate the GILTI inclusion? Since many foreign jurisdictions effectively tax income at a rate greater than 18.9 percent, U.S. individual taxpayers may be able to use the new tax law’s high-tax exception to avoid the GILTI inclusion. However, the language used in the new tax law relevant to the GILTI provision allows this exception only for income that would otherwise have been picked up as Subpart F income.
As an example, consider that a U.S. individual owns a foreign distribution business carried out by two foreign subsidiaries, CFC1 and CFC2. Both subsidiaries are located in different jurisdictions and subject to effective tax rates that are greater than 18.9 percent in their local countries. If CFC1 and CFC2 buy widgets from suppliers and then sell each widget in their local markets, the income on these transactions would not be considered Subpart F, regardless of the high local taxes the subsidiaries paid. Therefore, neither CFC1 nor CFC2 would be eligible for the GILTI exception to include income that would have been treated as Subpart F income, but for the high-tax exception. What if the operations change and, instead, CFC1 and CFC2 can treat their foreign income as Subpart F income (but for the high tax)? Presumably, this type of a change in operation would allow for an exemption from the GILTI inclusion.
No matter what the circumstances, taxpayers with offshore earnings should engage in careful advanced planning under the guidance of experienced international tax advisors to maximize their exemptions from GILTI. Under some circumstances, it may behoove taxpayers to restructure their international operations to avoid or minimize feeling GILTI in the future.
About the Author: Andre Benayoun, JD, is an associate director of International Tax Services with Berkowitz Pollack Brant, where he works with inbound and outbound multinational businesses and nonresident aliens on a variety of matters, including structuring for mergers, acquisitions and liquidations; planning for repatriation of profits; treaty analysis; tax-efficient debt financing; and pre-immigration tax planning. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.