Under the newly enacted Section 951A, beginning in tax year 2018, each U.S. shareholder of a controlled foreign corporation (CFC) is subject to current U.S. income tax on their share of global intangible low-taxed income (GILTI). GILTI is defined as the excess (if any) of a U.S. shareholder’s net CFC-tested income over their net deemed tangible income return (NDTIR). In September 2018, Proposed Regulations under the GILTI provisions were issued. The IRS expects to finalize the regulations soon.
The calculations for GILTI inclusion amount are primarily driven by this formula: GILTI inclusion amount = net CFC tested income – NDTIR.
There are many defined terms and other supporting formulas in order to understand how to use this primary formula. The supporting formulas are used to determine a U.S. shareholder’s pro rata share of the relevant CFC’s “test items.” The CFC tested items include many defined terms such as tested income, tested loss, qualified business asset investment (QBAI), etc.
The calculation of the GILTI tax can be summarized by the following steps:
Step 1. Determine the U.S. shareholder’s CFC tested items of each CFC
Step 2. Determine the U.S. shareholder’s pro rata share of each of its CFC’s tested items
Step 3. Determine the U.S. shareholder’s GILTI inclusion amount
Step 4. Determine the U.S. shareholder’s GILTI related foreign taxes paid, if applicable
Step 5. Determine the U.S. shareholder’s GILTI tax liability
Step 6. Adjust relevant CFC’s E&P and stock basis
Step 1 includes calculation of the CFC-tested items at each CFC level in U.S. dollars using the appropriate foreign exchange rates. A CFC with tested income is called a tested income CFC while a CFC with tested loss, a tested loss CFC. QBAI, a new defined term for GILTI, is the aggregate of all tested income CFCs’ average quarterly adjusted bases of specified tangible property determined under special rules. A CFC with a large amount of specified tangible property, generally tangible fix assets used in the production of tested income, may need to go back many years to figure out the tax bases under the GILTI rules. It is important to note that only a tested income CFC has QBAI. A tested loss CFC has no QBAI, even if the CFC is a tested income CFC in other tax years.
Step 2 determines the U.S. shareholder’s pro rata share of each of its CFC’s tested items, generally based on the U.S. shareholder’s ownership percentage in the CFC. Calculations may become complicated for a CFC with multiple classes of stock including preferred stock. Rules are different for a partner’s distributive share of GILTI inclusion amount from a domestic partnership that is a U.S. shareholder of a CFC (a “partnership CFC”), depending whether the partner of the domestic partnership is also a U.S. shareholder of the partnership CFC. Special rules are provided for tiered U.S. shareholder partnerships. New reporting requirements are provided for U.S. shareholder partnerships to report relevant information to their partners with schedule K-1.
In Step 3, the U.S. shareholder’s pro rata CFC-tested items from all its CFCs are aggregated, netted, or multiplied, as relevant, according to the formulas described above, so that the GILTI inclusion amount is determined under the primary formula: GILTI inclusion amount = net CFC tested income – NDTIR.
Step 4 determines foreign tax credits (FTCs) that are generally available only to a corporate U.S shareholder. However, an election is available to an individual U.S. shareholder to claim FTC, discussed below.
Step 5 determines the tentative GILTI tax by multiplying the relevant tax rate and the U.S. shareholder’s GILTI inclusion amount. Corporate U.S. shareholders are entitled to a Section 250 deduction, which permits a deduction equal to 50% (37.5% after 2025) of its GILTI inclusion amount. Since the corporate tax rate is 21%, the effective U.S. federal income tax rate on GILTI is 10.5% before the FTC. This tentative GILTI tax could be reduced by the deemed paid FTCs determined under the GILTI rules. This means that for certain U.S. shareholders, the GILTI tax liability could be reduced to zero.
Finally, in Step 6, the Proposed Regulations determine how to allocate the GILTI inclusion amount back to tested income CFCs. There are also a complex set of rules to determine the adjustment of the stock basis in a tested loss CFC by a corporate U.S. shareholder.
The GILTI Relief for Individual U.S. Shareholders
Internal Revenue Code Section 962 provides an election for individual U.S. shareholders so that their Subpart F income including GILTI is subject to federal income tax at the corporate tax rate of 21% rather than individual tax rate of up to 37%. This election is also available to an individual U.S. shareholder of a passthrough entity. Under this election, individual U.S. shareholders can claim FTCs under the GILTI rules, which would not otherwise be available to them. This could significantly reduce or even eliminate the individual U.S. shareholder’s GILTI tax liability.
However, it should be noted that when an actual distribution is received in later years from the relevant CFC, part of the income will be taxable at the individual’s marginal tax rate. This could potentially result in an overall higher tax rate for the U.S. shareholder. Therefore, an election under Section 962 should be considered and planned carefully based on each taxpayer’s unique tax situations.
The Tax Warriors® at Drucker & Scaccetti highly recommend taxpayers who may be subject to GILTI engage an experienced and skilled advisor in the area of international tax. This new tax code section adds yet another layer of complexity to an already confusing law. Call on us if your international tax situation has increased in complexity. We are always prepared to help.