High-Tax Exception to Global Intangible Low-Taxed Income

  • Global expansion
  • 9/8/2020
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Treasury released final regulations that govern the high-tax exception to global intangible low-taxed income (GILTI). Be aware of the benefits — and potential pitfalls — when you elect this exception.

Key insights

  • Taxpayers who elect to apply the high-tax exception in a tax year are not locked into that election in subsequent tax years.
  • Consult your tax advisor before you make the high-tax exception election, since financial modeling may help you realize the overall benefit of the election.
  • The election may be available to U.S. shareholders of controlled foreign corporations with tax years ending after December 31, 2017.

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The IRS and Department of the Treasury released final regulations under the global intangible low-taxed income (GILTI) provision. The regulations expand the high-tax exception to include certain high-taxed income under GILTI, even if that income would not otherwise be considered foreign base company income (FBCI) or insurance income under Subpart F.

Therefore, the GILTI high-tax exception:

  • Excludes income from the controlled foreign corporation (CFC) that would have been included in the U.S. shareholder’s income under GILTI
  • Would not include income excluded under a high-tax exception made for FBCI and insurance income under section 954(b)(4)
  • May reduce or eliminate a current year GILTI inclusion for taxpayers operating in higher-tax foreign jurisdictions

GILTI high-tax exception mechanics

The final regulations on GILTI:

  • Provide for an elective high-tax income exclusion (i.e., high-tax exception).
  • Apply to gross tested income subject to foreign tax at an effective tax rate that is higher than 90% of the applicable highest U.S. tax rate imposed on a corporation, or 18.9% (90% x 21%).
  • Apply to each “item of income” for each tested unit of a CFC (note, a CFC is deemed to be a tested unit)
  • Result in the exclusion of each gross tested income item of a CFC that meets the effective rate test from gross tested income for the tax year (if we assume the high-tax election is made)

An item of income is defined as each separate limitation category for foreign tax credit purposes under Section 904(d) (i.e., GILTI, foreign branch income, passive income, general income). Taxpayers must allocate and apportion foreign income taxes to each item of income to determine the effective tax rate. Taxes assigned to the GILTI separate limitation category are not eligible for the foreign tax credit (if the GILTI inclusion meets the high-tax exception).

Further, for an item of income excluded from gross tested income under the GILTI high-tax exception, the property used to produce that income does not qualify as specified tangible property since it wasn’t used in the production of gross tested income. Therefore, the adjusted basis in the property is not taken into account to determine the qualified business asset investment (QBAI).

Here’s an example to illustrate the exception:

Assume a U.S. corporation owns 100% of two CFCs: CFC1 generates tested income subject to an effective local income tax rate of 15% and CFC2 generates tested income subject to a 25% effective local income tax rate. The GILTI high-tax exception would apply separately to each CFC, with only the tested income generated by CFC2 meeting the high-tax exception threshold, since the effective tax rate on its tested income exceeds 18.9%.

However, the QBAI of CFC2 would be excluded to calculate the U.S. corporation’s GILTI inclusion. CFC2 could not claim as a deemed paid credit any foreign income taxes paid or accrued with respect to its tested income, if the related tested income is excluded under the GILTI high-tax exception. If we assume the U.S. shareholder of the CFC is a U.S. C corporation, the income excluded under the GILTI high-tax exception may be eligible for the 100% dividends received deduction (DRD) under Section 245A when these earnings are distributed.

GILTI high-tax exception election

The election is made by U.S. shareholders who collectively own, directly or indirectly, more than 50% of the CFC’s stock (i.e., controlling domestic shareholders). The election excludes from gross tested income all the CFC’s items of income for the taxable year that meet the effective rate test and is binding on all U.S. shareholders of the CFC.

The GILTI high-tax election applies to each item of income of each CFC in a group of commonly controlled CFCs that meets the effective rate test. So, if the same U.S. shareholders own a majority of the stock of two or more CFCs, an election to apply the GILTI high-tax exception to one CFC — or to revoke such an election — would apply to all the CFCs. The election is effective for a CFC for the CFC inclusion year for which it is made.

Effective date

U.S. shareholders of CFCs that generate high-taxed tested income can elect the high-tax exception for such CFCs’ tax years ending after December 31, 2017. However, if a U.S. taxpayer intends to amend a prior year return to elect the high tax exception, all U.S. shareholders of such CFC must amend their U.S. federal income tax returns to consistently apply the election. Additionally, amended federal income tax returns for all U.S. shareholders of the CFC for the CFC inclusion year must be filed within a single six-month period.

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