On June 14, the U.S. Department of Treasury (Treasury) and the IRS released final regulations on Global Intangible Low Taxed Income (GILTI), a provision included in the 2017 tax reform law commonly known as the Tax Cuts and Jobs Act (TCJA). Concurrently, the Treasury and IRS released proposed regulations on Subpart F inclusions to partners of domestic partnerships.
GILTI is one of the more complex provisions in the new tax reform law, and the IRS had already issued proposed regulations in September 2018. Those proposed regulations helped U.S. shareholders of controlled foreign corporations (CFCs) to calculate their GILTI inclusion and clarified the law’s anti-avoidance principles. The final regulations generally adopt the provisions contained in the proposed regulations, but unlike the proposed regulations, provide significant relief to investors in private equity and other domestic partnerships that own interests in CFCs.
Brief Overview
The intent of the GILTI provision is to discourage U.S. entities and individual taxpayers from shifting profits out of the U.S. into lower tax jurisdictions. To prevent this base erosion, a U.S. shareholder’s GILTI, a new category of foreign income, is currently included in taxable income, levying what is essentially a worldwide minimum tax of 13.125%.
The Problem
The earlier proposed regulations had adopted a hybrid approach for purposes of applying GILTI to domestic partnerships by treating the partnership as an entity on behalf of non-U.S. shareholder partners (i.e., less than 10% ownership) and as an aggregate for partners that are themselves 10% U.S. shareholders of a CFC owned by the partnership. This could have led to situations where the partnership had to calculate its GILTI inclusion amount for each CFC and allocate it to partners who are not themselves U.S. shareholders of that CFC. The result was that partners in domestic partnerships were treated differently than partners in foreign partnerships holding the same investments.
Proposed and Final Regulations
The new guidance reduces this disparate treatment of domestic and foreign partnerships for purposes of the GILTI and Subpart F inclusions. The final and new proposed regulations adopt an aggregate approach for domestic partnerships to determine partner-level Subpart F and GILTI inclusions with respect to CFCs owned by the domestic partnership. However, the new guidance does not affect whether a domestic partnership or its partners are treated as a U.S. shareholder for determining whether a foreign corporation is a CFC and whether a domestic partnership is a controlling domestic shareholder; the entity approach will continue to apply for those purposes. It may still be beneficial to hold investments in foreign corporations through a foreign partnership in situations where an investor indirectly owns at least 10% of the foreign corporation, assuming that such foreign corporation would not be considered a CFC if owned by the foreign partnership.
The final GILTI regulations are effective for taxable years of foreign corporations beginning after Dec. 31, 2017. The proposed Subpart F regulations are anticipated to apply to taxable years of foreign corporations beginning on or after the publication of these rules as final regulations in the Federal Register. However, for a foreign corporation’s taxable year that begins before the finalization date but after Dec. 31, 2017, a domestic partnership may apply these rules retroactively, provided certain conditions are satisfied. A partnership that has already filed its 2018 return will need to amend or correct its tax return if it decides to apply these rules before the proposed regulations are finalized.
Other Changes
The new guidance also made it clear that the TCJA did not intend for GILTI to create such a burden on taxpayers. Treasury and IRS acknowledge that income taxed at high rates in foreign jurisdictions does not contribute to base erosion here in the U.S. Accordingly, if the proposed regulations are finalized, taxpayers can elect out of the GILTI provision if their foreign-earned income is taxed at 18.9% or higher. This election is made by the controlling shareholders of a CFC, and once made is binding for all subsequent years unless revoked.
This election was available to taxpayers even before the proposed regulations were released, but it was more restrictive. Under current law, the high tax exclusion is only available for income that was considered foreign base company income (a major category of Subpart F income) or insurance income. The IRS proposes to expand this exclusion to “any item of income received by a controlled foreign corporation.”
Final Thoughts
While these proposed regulations will help many taxpayers, there are still some concerning aspects of the current provisions. First, the 18.9% tax rate is tested at the qualified business unit level rather than at the CFC level, which will be difficult to calculate. Second, these changes will not be retroactive. They will apply only after the final regulations are published.
The new proposed guidelines will be open for public comment through September 19. If you have any questions about GILTI and how the new provisions will impact your business, please contact us.
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