GILTI: Tax Reform Creates New Income Category for US Shareholders of CFCs
If you’re a U.S. shareholder of a controlled foreign corporation (CFC), you need to know that the Tax Cuts and Jobs Act has created a new category of income inclusion for you: the global intangible low-taxed income (GILTI). This new anti-deferral measure will affect your tax calculations for 2018 and beyond.
The objective of GILTI is to deter U.S. corporations from transferring intangible property to low-tax jurisdictions by subjecting the income to current U.S. taxation. Even though it targets intangible income it applies to any type of income that exceeds a routine return on net tangible assets. The GILTI provisions can be particularly detrimental to U.S. taxpayers (individuals, pass-through entities, and trusts) other than C corporations because the 50 percent deduction and deemed paid foreign tax credit are not available to them.
Calculating the GILTI amount
Generally, the GILTI amount is determined by first calculating a deemed return on the CFC’s tangible assets (net deemed tangible income return). The portion of the CFC’s tested income that exceeds the deemed return on tangible assets is then included in the U.S. shareholder’s GILTI amount.
Understanding the definitions of these terms can help you make sense of this:
- Net deemed tangible income — 10 percent of the shareholder’s aggregate pro rata share of the qualified business asset investment (QBAI) of each CFC, less the amount of interest expense taken into consideration of the CFC tested income
- Qualified business asset investment (QBAI) — The average of the adjusted bases in specified tangible and depreciable property used in its trade or business determined on a quarterly basis of the taxable year. Adjusted basis is determined by using Alternative Depreciation System (ADS) deprecation and allocating the depreciation deduction ratably to each day during the period.
- Tested income — The gross income of a CFC excluding subpart F income, effectively connected income, income excluded from foreign base company income or insurance income by reason of high-tax exception, dividends received from a related person, and foreign gas and oil income less deductions allocable to such gross income
- Tested loss — The excess of deductions allocable to the corporations disregarding the tested income exceptions over the amount of gross income
- Net tested income — The U.S shareholder’s aggregate pro rata share of excess of tested income over tested loss
U.S. shareholders owning less than 100 percent of a CFC will include only their pro rata shares of the CFC’s net deemed tangible income return and tested income in calculating the GILTI amount. U.S. shareholders owning an interest in more than one CFC must aggregate the net deemed tangible income return and tested income of each CFC.
The new provision requires that a U.S. shareholder of a CFC will include the GILTI amount in his or her gross income for the taxable year, regardless of whether distributions were received from the CFC.
Because the GILTI regime imposes income inclusion reduced for a deemed 10 percent return of a CFC’s tangible depreciable assets, a business with minimal tangible assets (such as a service provider) will have a significantly higher percentage of income subject to the inclusion than a business that relies heavily on such assets. CFCs operating in jurisdictions that provide tax incentives (such as tax holidays or enterprise zone tax benefits) will find that the income earned in such jurisdictions is vulnerable to the GILTI inclusion.
Deductions available to offset GILTI
The new tax law also adds a provision for a deduction to offset the GILTI inclusion for C corporations only, which is 50 percent (37.5 percent after 2025) of the GILTI inclusion. C corporations also receive a deduction equal to 37.5 percent (21.875 percent after 2025) of foreign-derived intangible income (FDII).
FDII is eligible income derived in connection with property sold or services provided by the taxpayer to a non-U.S. person. The taxpayer must establish that the property is foreign use property, and, in the case of services, the taxpayer must provide that the services are rendered to a non-U.S. person who is located outside of the United States.
Foreign tax credits are available
Only C corporation taxpayers can utilize the newly created deemed paid credit for taxes attributable to tested income (tested foreign income taxes). The corporation is deemed to have paid foreign income taxes equal to 80 percent of the product of the domestic corporation’s inclusion percentage, multiplied by the aggregate tested foreign income taxes paid or accrued by CFCs.
The tax reform law also amended the foreign tax credit provisions of the tax code by creating a new basket of income for determining the foreign tax credit attributable to GILTI. Excess foreign taxes paid cannot be carried back or forward under these rules or used to offset the tax liability for non-GILTI foreign source income.
Tested foreign income taxes are defined as foreign income taxes paid or accrued with respect to the tested income of that foreign corporation. The term net tested income is not used in the language of the law; therefore, tested losses cannot be used to offset U.S. tax owed on the GILTI inclusion.
How we can help
CLA’s international tax professionals can help you analyze the impact of GILTI on your tax obligations and craft a strategic plan that considers and accommodates its effects. This proactive planning will be particularly impactful to individuals and pass-through entities that own CFCs, which the GILTI provision will hit hardest.
Because it’s new and fairly complex, we can help you think things through from perspectives you might not otherwise take into account.