Global Intangible Low-Taxed Income (GILTI) and Foreign-Derived Intangible Income (FDII) Provisions Under the Tax Cuts and Jobs Act
Several Key International Tax Provisions Were Enacted Under the Tax Cuts and Jobs Act (“Tcja”) Of 2017. Notably, These Provisions Included Global Intangible Low-Taxed Income (“Gilti”), A New Category of Subpart F Income, and the Foreign-Derived Intangible Income (“Fdii”) Deduction.
A summary of the rules and potential tax impact to U.S. multinational companies under these provisions are discussed below.
GLOBAL INTANGIBLE LOW-TAXED INCOME (“GILTI”)
GILTI is essentially foreign income earned in the current year by a Controlled Foreign Corporation (“CFC”) in excess of an amount deemed to be a routine rate of return (i.e., 10%) on the CFC’s business assets. A CFC is a foreign corporation in which U.S. shareholder(s), in the collective, own more than 50% interest (vote or value) in such foreign corporation. For purposes of GILTI, the current year foreign income is reduced by any U.S. effectively connected income, other subpart F income, and deductions allocable to the CFC income, among other items. The resulting amount is referred to as the Net CFC Tested Income, and the excess of this amount over the Net Deemed Intangible Income Return, described below, constitutes the GILTI inclusion that is included in a U.S. shareholder’s gross income pro rata in the year earned. A U.S. shareholder is generally defined as a U.S. person with at least a 10% ownership (vote or value) in a foreign corporation.
The deemed rate of return mentioned above is termed as the Net Deemed Tangible Income Return under the GILTI provisions and is equal to 10% of the U.S. shareholder’s pro rata share of the CFC’s Qualified Business Asset Investment (“QBAI”). QBAI is defined as the quarterly average of the CFC’s tax basis in depreciable property used in a trade or business, over the amount of interest expense taken into account in determining such U.S. shareholder’s Net Tested CFC Income.
U.S. shareholders that are C-corporations are allowed a 50% deduction on their GILTI inclusion, resulting in a 10.5% effective tax rate (50% of the 21% corporate tax rate as of January 1, 2018). Additionally, corporate U.S. shareholders are also allowed a foreign tax credit on the GILTI inclusion, equal to 80% of such shareholder’s pro rata share of foreign income taxes attributable to the CFC income taken into account in determining the Net Tested CFC Income. As such, where the effective foreign tax rate on GILTI is 13.125% or higher, the corporate GILTI tax liability may be fully offset by the allowable foreign tax credits. It should be noted that foreign tax credit rules apply separately to foreign taxes paid on the GILTI and cannot be carried forward or carried back.
Starting with the 2018 tax year, U.S. shareholders of CFCs that do not have substantial amounts of depreciable assets as compared to their income, such as service companies and technology companies, may face a material tax burden as a result of the GILTI inclusion. Moreover, individual shareholders and pass-through entities owning stock in CFCs are not afforded the benefit of the 50% GILTI deduction or the reduced corporate tax rate of 21%. However, there may be planning strategies for mitigating such implications. It is highly advisable that the tax profile of each U.S. taxpayer be carefully reviewed to determine the most efficient strategy for U.S. tax purposes and to avoid unexpected adverse consequences.
FOREIGN-DERIVED INTANGIBLE INCOME (“FDII”)
In addition to the GILTI rules discussed above, the international tax provisions enacted under the tax reform also included the FDII deduction. In a sense, the mechanics of determining the FDII deduction operate in a similar manner as the GILTI calculation; however, while a GILTI inclusion is generally a tax cost, a FDII deduction serves as a tax benefit.
The FDII deduction is available only to domestic corporations taxed as C-corporations for tax years beginning on or after January 1, 2018. It is essentially a deduction given on income earned by a domestic C-corporation selling property to foreign persons for foreign use, or for providing services to persons located outside the U.S. For purposes of determining FDII, “foreign use” means any use, consumption, or disposition which is not within the U.S. It should be noted that where the sale of property or the provision of services is to a related party, different rules may apply for purposes of the FDII deduction.
For purposes of calculating the FDII deduction, the first step is to determine the amount of income earned by the domestic C- corporation from the sale of property to foreign persons for foreign use, or the provision of services to persons located outside the U.S. FDII excludes from the calculation certain types of income such as GILTI and other types of subpart F income, dividends received from CFCs, and any foreign branch income, among other items, and applies allocable deductions. Then the excess of this amount over the QBAI (10% of the corporation’s depreciable tangible property used in a trade or business, similar to GILTI) is multiplied by 37.5% to yield the FDII deduction amount in connection with the current year. The applicable rate for the FDII deduction is 37.5% for taxable years beginning after December 31, 2017, and before January 1, 2026, then will decrease to 21.875% for taxable years beginning after December 31, 2025.
- For GILTI:
- Individual U.S. shareholders may consider holding foreign entities through a domestic C-corporation to qualify for the 50% deduction on GILTI inclusion.
- For individual U.S. shareholders with controlled foreign entities in jurisdictions with high income tax rates, consider treating the foreign entities as pass-through entities to the extent possible, as this may maximize the use of foreign tax credits, resulting in a lower overall effective income tax rate.
- Please note there are certain types of entities in each foreign jurisdiction which are not eligible to be treated as pass-through entities for U.S. federal income tax purposes.
- Individual U.S. shareholders may consider making an annual election under IRC Section 962. Under this election, an individual would be treated as a corporation, enabling a foreign tax credit to be taken against any GILTI inclusion. However, the 50% GILTI deduction would not be available even with a Section 962 election, though the election may still be beneficial, provided the foreign income tax rates are high enough and profits are not repatriated regularly nor is there a plan for regular repatriation.
- It is recommended that a financial analysis be conducted to determine the potential tax impact of planning alternatives, as it relates to GILTI and other relevant considerations.
- For FDII:
- Domestic C-corporations should examine transactions with foreign customers (for sales) and customers located outside the U.S. (for services) to determine the availability of the FDII deduction and to properly identify deductions allocable to this type of income.
- It is recommended that a financial analysis be conducted to determine the potential tax impact of planning alternatives, as it relates to the FDII deduction and other relevant considerations.