The Verdict Is In: The High-Tax Exclusion Final Regulations are GILTI

On July 23, 2020, the U.S. Treasury and IRS released final regulations on the global intangible low-taxed income (“GILTI”) high-tax exclusion. The final regulations retain the basic approach of the June 14, 2019, proposed regulations with certain revisions as described below.

GILTI income, subject to various exceptions, is essentially a foreign corporation’s net earnings and profits (known as tested income) less a 10% return on the CFC’s (controlled foreign corporation) tangible depreciable assets.

What does this mean for U.S. corporate and non-corporate taxpayers going forward?

A U.S. taxpayer may avoid U.S. tax on their foreign corporation’s earnings classified as GILTI, depending on (1) the taxpayer’s global tax structure; (2) domestic and applicable foreign tax laws; and (3) the effective foreign tax rate (“EFTR”) on each tested unit.

Past to Present

Once the Tax Cuts and Jobs Act was enacted on December 22, 2017, all U.S. shareholders (i.e., 10% owners) of a CFC, (a foreign corporation that is controlled by U.S. shareholders) were required to be taxed on the allocable portion of the CFC’s GILTI income (i.e., post-2017 annual earnings, which exceeded a 10% return on the CFC’s qualified depreciable assets). Congress intended GILTI to discourage the erosion of valuable intangible assets from leaving the U.S. as well as to deter the accumulation of offshore earnings in low tax jurisdictions.

The U.S. permitted corporate taxpayers to take a: (1) 50% deduction on their total CFC earnings exposed to GILTI (i.e., 50% of the 21% ordinary corporate tax rate); and (2) an 80% foreign tax credit (“FTC”) on foreign income taxes associated with such earnings. (Non-corporate taxpayers would have to make an IRC § 962 election to receive similar corporate benefits.) This effectively meant a U.S. taxpayer could, in many cases, avoid U.S. tax on GILTI if the CFC’s foreign tax rate on GILTI income exceeded 13.125% (i.e., 10.5% divided by the 80% FTC haircut mentioned above).

The GILTI proposed regulations released on June 14, 2019, allowed (1) the GILTI high-tax exclusion on an elective basis, and (2) the EFTR of a CFC’s net tested income to be attributed to a single qualified business unit (“QBU”) (QBU being defined as a separate and clearly identifiable unit of a trade or business that maintains separate books and records).

The GILTI final and proposed regulations released on July 23, 2020, set forth to conform the rules for implementing the high-tax exclusion for Subpart F and GILTI to a single election, with certain differences described below. (Subpart F includes specific type of income of a CFC. When a CFC has Subpart F, the U.S. shareholders may have to pay tax on the earnings.)

Application

The main differences between the high-tax exclusion for Subpart F income (income related to another set of anti-deferral rules requiring U.S. shareholders to pick-up income from CFCs on a current basis, regardless of distribution) and the new GILTI high-tax exclusion is that the former follows a CFC-by-CFC approach, while the latter was proposed to follow a QBU-by-QBU approach. Having said that, as finalized, the final regulations now use a “tested unit” approach instead of a QBU approach for the high-tax exclusion to GILTI. The tested unit approach is applied to CFCs, but separately to the activities of a CFC that are subject to tax in a foreign country as either a:

1. Tax resident; or
2. Permanent establishment

Below are the three categories of tested units:

1. A CFC
2. A partnership or disregarded entity, held directly or indirectly by a CFC, which is meet the following requirements:
   1. Is a tax resident of a foreign country;
   2. Is regarded as a corporation or different from a transparent entity for CFC tax purposes; or
   3. Is not a transparent interest.
3. A branch or portion of a branch, which activities are on carried by the CFC, provided the following:
   1. The branch’s activity generates a taxable presence in the country of location; or
   2. The branch generates a taxable presence under the owner’s tax law, which provides an exclusion, exception, or similar relief for income attributed to the branch.

The tested units approach will require referencing foreign countries’ tax laws, statues, regulations and tax treaties. U.S. shareholders are allowed to combine certain tested units to reduce their compliance burden, but an analysis of each tested unit would be required. The following is a list of a U.S. taxpayer’s future considerations concerning GILTI high-tax exclusion:

1. Identify tested units in each country based on U.S. and foreign country standards.
2. Analyze whether combining the tested units would reduce global EFTR and compliance burden.
3. Consider if an amended return or future high-tax exclusion revocations would generate unwanted tax and compliance burdens.

Other changes made to the GILTI final regulations from the proposed regulations include an annual election (instead of 60 months, as originally proposed) to bring it more in line with the Subpart F high tax exclusion. Marcum LLP can provide a detailed analysis of a taxpayer’s GILTI tax exposure and the applicability of the finalized GILTI high-tax exclusion to their effective global structure.

Contact your Marcum International Tax advisor for your global GILTI tax exposure analysis or other international matters.