On Sept. 13, 2018, the Treasury and IRS released proposed regulations related to the enactment of the tax on global intangible low-taxed income (“GILTI”). GILTI was included as part of the 2017 tax reform law introduced as the Tax Cuts and Jobs Act (TCJA). The proposed regulations address several areas, including computational, definitional and anti-avoidance rules for GILTI. The guidance includes provisions applicable to partnerships as well as consolidated groups, but leaves open many questions related to look-through treatment for foreign tax credits, and the interaction with other newly enacted code sections.
The new Section 951A requires a U.S. shareholder of any controlled foreign corporation (CFC) to include in gross income the shareholder’s GILTI for the taxable year. The GILTI inclusion is required for taxable years of CFCs beginning after Dec. 31, 2017, and to taxable years of U.S. shareholders in which or with which such taxable years of the CFCs end. The GILTI inclusion is generally calculated as the excess of the U.S. shareholder’s pro-rata share of the CFC’s tested income, reduced by the aggregate pro-rata share of the CFC’s tested loss, over a notional return on the CFC’s qualified tangible property.
Private equity and venture capital firms are going to be particularly interested in the guidance set forth in proposed Section 1.951A-5 that addresses issues related to domestic partnerships and their partners. As Section 951A itself does not contain any specific rules for these types of taxpayers, the proposed regulations are the first indication of how the IRS intends to apply the principles of the tax on GILTI to domestic pass-through entities.
The proposed regulations adopt a hybrid of the entity and aggregate approaches when it comes to determining the amount of the GILTI inclusion of domestic partnerships and their partners. The proposed regulations treat the partnership as an entity with respect to partners who are not considered U.S. shareholders of any CFC owned by the partnership because they do not own, directly or indirectly, at least 10 percent of the value or voting power of the CFC’s stock. These partners will be required to include in their income their share of the partnership’s total GILTI inclusion amount. However, the proposed regulations treat the partnership as an aggregate for purposes of partners who are the U.S. shareholders with respect to one or more CFCs owned by the partnership. Those partners would compute their GILTI inclusion amount for the taxable year by taking into account their proportionate share of the partnership’s pro-rata share of the relevant items – tested income, tested loss, qualified business asset investment, tested interest income, and tested interest expense – of such CFC.
The proposed approach could result in small partners of U.S. partnerships with foreign investments being taxed on their share of the partnership’s GILTI inclusion amount even if they are not considered to be U.S. shareholders under the tax code’s definitions.
Furthermore, the proposed approach creates new complexities for private equity and venture capital firms, potentially requiring them to track the computational inputs for each of their CFC’s GILTI inclusion amounts on a partner-by-partner basis so that these partners can appropriately determine their own GILTI inclusion amount with respect to these CFCs.
These consequences may lead some U.S. partnerships with CFC investments to consider converting from pass-through entity to corporate status or separating those CFC investments into separate corporate structures.
A 60-day comment period on the proposed regulations will begin once the proposed regulations are published in the Federal Register. It remains to be seen whether the final regulations will differ substantially from the proposed hybrid approach. Private equity and venture capital firms should consider the impact of these proposed regulations on their funds, investors, and compliance process and develop strategies to address the challenges that arise from the proposed regulations.
For more information about the proposed GILTI regulations or if you have any questions, please contact us.
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