Advising International Business Ventures: Tax Reform’s New GILTI Tax
Freeman Law frequently advises international business ventures. International operations often give rise to unique (and sometimes unanticipated) compliance obligations and complex reporting requirements. Recent tax reform rules and regulations have imposed a number of new requirements. The IRS and Treasury Department have elaborated on these new rules through proposed regulations and other guidance. This post focuses on, and provides a short introduction to, the new GILTI tax.
The new GILTI tax will impact many businesses, particularly those that have a high profit margin compared to their fixed asset base. For example, service companies, software and other technology companies, distribution companies, and companies that typically realize a significant international return on intangible assets may be particularly impacted by the Code’s new GILTI provisions.
The Tax Cuts and Jobs Act, Pub. L. 115- 97 (2017) (“the TCJA”) enacted new section 951A, which imposes the new tax on Global Intangible Low-Taxed Income (the “GILTI tax”)—a central part of the new international tax regime. The TCJA largely shifted the U.S. corporate tax system from a worldwide tax system to a “quasi-territorial” system. (See our Insight here on the shift.) However, like the existing Subpart F regime, the GILTI tax creates an important category of income that is subject to current taxation. (See our Insight on Subpart F income here.)
The proposed regulations require that taxpayers annually file a new Form 8992, U.S. Shareholder Calculation of Global Intangible Low-Taxed Income, as well as a new Schedule I-1, Information for Global Intangible Low-Taxed Income, with their annual Forms 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations.
The General Rule
Section 951A (the GILTI provision) requires a United States shareholder (“U.S. shareholder”) of any controlled foreign corporation (“CFC”) for any taxable year to include the shareholder’s GILTI in gross income. The TCJA provides that section 951A applies to taxable years of foreign corporations beginning after December 31, 2017.
Notably, section 250 of the Code provides domestic corporations with a deduction equal to a percentage of their GILTI inclusion amount and foreign-derived intangible income (“FDII”), subject to a taxable income limitation.
The TCJA established a “participation exemption” system that allows certain earnings of a foreign corporation to be repatriated to a corporate U.S. shareholder without U.S. tax. That general system is established by new section 245 of the Internal Revenue Code.
Congress enacted section 951A (the GILTI provision) to impose tax on a current basis on “intangible income” earned by a CFC in a manner that is similar to the treatment of a CFC’s subpart F income under section 951(a)(1)(A). However, a corporate U.S. shareholder’s GILTI is taxed at a reduced rate. That reduced rate is accomplished through a deduction under section 250.
“Intangible income” (and thus GILTI) for purposes of section 951A is determined using a formulaic approach. Under this formula, all income exceeding a “normal return” on the tangible assets of a foreign corporation is considered GILTI. In order to accomplish this, the proposed regulations assume that a “normal return” would be equal to a 10-percent return on certain tangible assets (“qualified business asset investment” or “QBAI”). Each dollar of certain income above this “normal return” is effectively treated as “intangible income.”
The GILTI Inclusion
Section 951A(a) provides that a U.S. shareholder of any CFC must include its GILTI in gross income. For many purposes, a GILTI inclusion is treated similarly to a section 951(a)(1)(A) inclusion of a CFC’s subpart F income. However, the manner in which a GILTI inclusion is determined is fundamentally different from inclusions under section 951(a)(1)(A).
A U.S. shareholder’s GILTI inclusion amount begins with the calculation of certain items of each CFC owned by the shareholder, such as tested income, tested loss, or QBAI. A U.S. shareholder must next determine its pro rata share of each of these CFC-level items in a manner similar to a shareholder’s pro rata share of subpart F income under section 951(a)(2).
However, unlike section 951(a)(1)(A) inclusions under the CFC/Subpart F rules, the U.S. shareholder’s pro rata shares of these GILTI items are not simply included in gross income, but rather are taken into account by the shareholder in determining the GILTI included in the shareholder’s gross income. The U.S. shareholder aggregates (and then nets or multiplies) its pro rata share of each of these items into a single shareholder-level amount – for example, aggregate tested income reduced by aggregate tested loss becomes net CFC tested income and aggregate QBAI multiplied by 10 percent becomes deemed tangible income return. A shareholder’s GILTI inclusion amount for a taxable year is then calculated. This calculation is performed by subtracting one aggregate shareholder-level amount from another – the shareholder’s net deemed tangible income return (“net DTIR”) is the excess of deemed tangible income return over certain interest expense, and, finally, its GILTI inclusion amount is the excess of its net CFC tested income over its net DTIR.
Notably, a U.S. shareholder does not compute a separate GILTI inclusion amount with respect to each CFC. Rather, it computes a single GILTI inclusion amount by reference to all its CFCs. The effect is to generally ensure that a U.S. shareholder is taxed on its GILTI wherever (and through whichever CFC) derived.
For other related Insights, see Advising International Business Ventures: Tax Reform and a Quasi-Territorial Tax System, Advising International Business Ventures: Passive Foreign Investment Companies (PFICs), Advising International Business Ventures: Controlled Foreign Corporations and Subpart F.