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GILTI (But it is not a “bad” status, under the TCJA, having GILTI income for certain US domestic corporations is “good”)
The must-awaited guidance on new section 951A was recently issued on September 13, 2018 by the Treasury and the Internal Revenue Service in the form of proposed regulations (REG-104390-18). Section 951A, an important provision in the Tax Cuts and Jobs Act, P.L. 115-97, requires certain U.S. shareholders to include their share of global intangible-low taxed income (GILTI) derived by controlled foreign corporation to be included in their gross income. Under section 250(a)(1)(B)(i) a U.S. domestic corporation which is a U.S. shareholder in a controlled foreign corporation is entitled to a deduction equal to 50% of the amount of GILTI required to be included in gross income. This deduction drives down the corporate income tax rate from 21% to 10.5% reduced further by a certain percentage of otherwise allowable foreign tax credits (FTCs). The GILTI provision, section 951A, applies to taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end.
The GILTI rule, which, as mentioned will subject a U.S. domestic shareholder, to current taxation on active business income conducted overseas by a 10% or more controlled foreign affiliate, may, under prior law, have been able to defer US income tax on the same income under an exception to foreign based sales or services company income or other exception found in subpart F of the Code.
Prior to the TCJA, a U.S. shareholder was defined in section 951(b) as a United States person (“U.S. person”) owning at least 10% of the total combined voting power of all classes of stock entitled to vote in a foreign corporation. The TCJA amended this definition to include a U.S. person that holds at least 10% of the total value of shares of all classes of stock of the foreign corporation. The TCJA further eliminated language in former section 951(a)(1) that required that the foreign corporation must be a CFC for an uninterrupted period of 30 days or more in order to give rise to an inclusion under section 951(a)(1).
The TCJA also added two foreign tax credit (FTC) provisions relating to the new GILTI provision. New section 960(d) provides a FTC to a US domestic corporation with respect to its so-called “tested income” which is required to be taken into account under section 951A, and section 904(d)(1)(A) provides that any amount included in gross income under section 951A (other than passive category income) is treated as a separate category of income for purposes of section 904 (FTC limitation). Moreover, as mentioned, the TCJA added section 250(a)(1)(B)(i) providing domestic corporations a deduction equal to a percentage of their GILTI inclusion amount and foreign-derived intangible income, subject to a taxable income limitation. The recently issued proposed regulations do not include any rules relating to FTCs or the deduction under section 250. The Treasury and IRS announced in the proposed rule-making that rules relating to FTCs and the deduction under section 250 will be included in separate notices of proposed rulemaking. It is anticipated that the proposed regulations relating to FTCs will provide rules for assigning the section 78 gross-up attributable to foreign taxes deemed paid under section 960(d) to the separate category of income described in section 904(d)(1)(A).
An Overview of GILTI Within the Context of the Foreign Tax Reforms Introduced in the Tax Cuts and Jobs Act
The most significant reforms in the foreign tax area made by the TCJA were the repatriation of accumulated foreign earnings and profits (post-1986) with respect to certain specified foreign corporation, e.g., CFCs, under section 965, and the 100% dividends received deduction from a foreign corporation allowable in computing taxable income by certain U.S. corporations under section 245A.
Section 965 (as revised by the TJCA) was intended to repatriate several trillion dollars of deferred foreign income accumulated offshore that was not reduced or taxed under the Bush Administration’s version of foreign accumulated earnings repatriation in 2004 which had to be linked with actual cash dividends. As to section 245A, it is forward looking in its approach and provides U.S. corporations with a participation exemption in investing in overseas corporations which many our treaty partners’ domestic tax laws had in place for years. Not to have the benefit of a participation exemption, and further burdened by the former 35% corporation income tax rate, advantaged foreign multi-national enterprises over U.S. corporations and U.S. multi-national enterprises.
While Congress was clear in making US corporate competitiveness a priority of the new law, on the other hand, it did not want the U.S. to become or perceived as a giant “base erosion” monster to our treaty partners and other countries where substantial US investment has been made. Congress recognized that without any base protection measures, the participation exemption system could incentivize taxpayers to allocate income — in particular, mobile income from intangible property — that would otherwise be subject to the full U.S. corporate tax rate to CFCs operating in low- or zero-tax jurisdictions. One major reform was the imposition of a 10% tax on the worldwide taxable income, as adjusted, for economically substantial (greater than $500M in average annual gross receipts for a 3 year period) US domestic corporations in accordance with section 59A. Discussion of the BEATs tax is beyond the scope of this post.
As to GILTI, Congress was aware that it would be considered to have developed its own version of the “patent box” that several foreign countries have enacted . As such Congress attempted to limit the benefit of GILTI income rate reduction to U.S. corporations having a threshold ownership position in a foreign corporation and that the benefit related to “intangible income”. It is possible that the legislation is much wide than simply a receptacle for licensing fees and royalty income as indeed it is much broader than those items.
Section 951A(a) provides that a U.S. shareholder of any CFC for a taxable year must include in gross income its GILTI for that year as another species of subpart F income of a CFC but the rule itself is determined in a manner that is fundamentally different from that of an inclusion under section 951(a)(2). Subpart F income is determined at the level of a CFC, and then a U.S. shareholder that owns stock directly or indirectly in each CFC generally includes in gross income its pro rata share of the CFC's subpart F income.
Under GILTI, a U.S. shareholder does not compute a separate GILTI inclusion amount with respect to each CFC for a taxable year, but instead computes a single GILTI inclusion as to the net amount of its net CFC tested income for the year over the shareholder’s net deemed tangible income return (DTIR). Again, GILTI is by no means limited to income from intangible property.
The proposed regulations contain computational, definitional, and anti-avoidance guidance regarding section 951A. Obviously, the regulations, as expected, tell us how to determine a U.S. shareholder’s amount of GILTI to include in gross income and the separate computations that are required. and how to compute the components of GILTI. The proposed regulations under sections 951A, 1502, and 6038 provide details for taxpayers (including members of a consolidated group) in computing required amounts of “tested income, tested loss, qualified business asset investment, net DTIR and specified interest expense”. Coverage is provide as to the consequences of a GILTI inclusion for other sections of the Code and describe the reporting requirements associated with GILTI. Anti-abuse rules are set forth to prevent taxpayers from taking measures to inappropriately reduce their GILTI through some transfers of property as well as a duplication of loss rule.
More to Follow Of Course
The recently issued proposed regulations can be viewed as analyzing the bare essentials of applying the statute and providing needed definitions. More guidance is needed and is sure to be on the Treasury’s agenda. There are questions outstanding on whether the legislation itself should be clarified in certain instances by technical corrections. This would include FTC gross-up issues, expense allocations, and other matters, such as why small business owners are not provided the same tax reduction benefits for GILTI income as provided to larger domestic corporations.