Modifications to the Global Intangible Low-Taxed Income (GILTI) provision could potentially lower tax liabilities and simplify Subpart F analysis for U.S. shareholders with international interests.
On July 20, the Treasury and the IRS issued final regulations that added a high-tax exclusion for purposes of calculating the amount of a U.S. shareholder’s GILTI. Concurrently, it released proposed regulations to align the Subpart F high-tax exception with the GILTI high-tax exclusion.
The Tax Cuts and Jobs Act (TCJA) included a provision on GILTI designed to reduce the incentive of multinational companies to shift profits offshore to lower tax jurisdictions. Under the GILTI regime, U.S. corporate shareholders of a controlled foreign corporation (CFC), and U.S. individual shareholders of a CFC who make a Section 962 election, are allowed a 50% deduction with respect to GILTI inclusions and a foreign tax credit for 80% of the foreign taxes related to that income. As a result, the U.S. shareholder is effectively taxed on GILTI inclusions at 10.5% and, absent any expense allocations, is exempt from the GILTI tax on foreign income subject to a foreign tax rate of 13.125% or higher.
Highlights of Final Regulations
The final regulations provide an election to exclude from GILTI tested income amounts that have been subject to foreign tax at an effective rate that exceeds 90% of the U.S. corporate rate (i.e., greater than 18.9%). This exclusion can be used for CFC tax years beginning on or after July 23, 2020, but can also be retroactively applied under certain conditions (see below)
In order to minimize the blending of income in a CFC that is subject to a different foreign tax rate (and more accurately identify high-taxed income), the final regulations provide that the calculation of the effective foreign tax rate is based on the income attributable to a “tested unit” of a CFC (rather than the CFC as a whole). For this purpose, a tested unit is comprised of three categories:
- A CFC,
- An interest in a pass-through entity held, directly or indirectly, by a CFC (such as a partnership or a disregarded entity), and
- A foreign branch.
Although tested units are determined independently of one another for purposes of calculating the effective foreign tax rate, tested units of a CFC are generally treated as a single unit if they are tax residents of, or located in, the same foreign country.
The final regulations also add a consistency requirement to ensure that U.S. shareholders do not strategically use foreign tax credits to offset some CFC holdings while using the GILTI high-tax exclusions for others. This consistency requirement stipulates that the GILTI high-tax exclusion election must be made for all CFCs that are members of a “CFC Group”, and it applies to all high-taxed income of the CFCs in that group.
Changes from Proposed Regulations
In a helpful departure from the proposed GILTI high-tax exclusion regulations, the final regulations allow taxpayers to retroactively apply the GILTI high-tax exclusion to tax years beginning after Dec. 31, 2017, which is another big change from the proposed regulations. Thus, under the final regulations, a GILTI high-tax exclusion election can be made on an amended return filed by the controlling U.S. shareholders. The amended return must be filed within 24 months of the un-extended due date of their original return, provided that each U.S. shareholder of the CFC files an amended return within a single six-month period (that is within the 24-month period) reflecting the effect of the election.
Proposed Changes to Subpart F
Under current law, U.S. shareholders of a CFC can make a high-tax election to exclude from their gross income an item of Subpart F income that is subject to tax at a rate greater than 90% of the highest U.S. corporate tax rate. Proposed regulations recently released would align the rules governing the Subpart F high-tax exception with the GILTI high-tax election. Accordingly, rather than applying the election at the CFC level as currently written, this Subpart F high-tax election would also be made at the tested unit level. To further harmonize the GILTI high-tax exclusion with the existing Subpart F high-tax exception, the proposed regulations provide for a single election for both GILTI and Subpart F.
The final regulations allowing for a GILTI high-tax exclusion and the proposed regulations for the Subpart F high-tax election are a welcome addition and can provide relief that is particularly helpful for taxpayers with overall high-taxed income in CFCs. Whether this election is beneficial (including on a retroactive basis) will require modeling the tax consequences with and without the election. For more information concerning the GILTI high-tax exclusion and the final and proposed regulations, please contact Don Reiser in the National Tax Office at email@example.com or 212.790.5724.
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