Tax Reform Goes International – New “GILTI” Provisions
By Kayla Lau, Manager, Tax & Business Services
When the Tax Cuts and Jobs Act became law on December 22, 2017, most taxpayers were focused on the individual and business tax reform changes. However, international taxpayers may have overlooked the less televised international tax provisions included in this bill, which could have a significant impact on these taxpayers. Some of these provisions include a new transition tax, a “participation exemption” for foreign dividends, deemed repatriation of foreign earnings and profits, a base erosion minimum tax, and a minimum tax on undistributed income of controlled foreign corporations (CFCs).
One significant portion of international tax reform is the introduction of a new category of income. Under the old law, U.S. shareholders were not required to recognize income earned by a foreign corporation until that income was distributed to the U.S. shareholder as a dividend. Global intangible low-taxed income, or GILTI, is a new category of income that requires the recognition of a percentage of previously deferred foreign earnings. Under this provision, many multinational U.S. corporations would be subject to additional foreign tax for this additional income, albeit at a lower rate. GILTI income only applies to foreign corporations owned 10% or more (directly or indirectly) by a U.S. shareholder, or a controlled foreign corporation (CFC). Once calculated, the income is included in the income of the U.S. shareholders, and certain shareholders will be eligible for a deduction and reduced foreign tax credit.
The GILTI calculation is complicated, but is necessary for certain multinational corporations. The main calculation is as follows:
- Net CFC tested income
- Less: Net deemed tangible income return
- GILTI amount to be included in the U.S. shareholder’s income
Net CFC tested income is similar to Subpart F income. It is the gross income of a CFC less allocable deductions, including foreign taxes. Not all CFC income is considered in the GILTI calculation however. Exceptions are available for certain types of income, including effectively connected income (ECI), subpart F income, and foreign oil and gas related income.
Net deemed tangible income return is generally the excess of 10% of the shareholder’s qualified business asset investment (QBAI) of each CFC over the amount of interest expense allocated to the CFC (if not already included in the net CFC tested income calculation). Basically, this calculation is a deemed 10% return on the CFC’s basis in depreciable tangible property, less the CFC’s allocated interest expense.
The net amount will be included in the U.S. shareholder’s income for that tax period, similar to subpart F income, and taxed at a rate of 10%.
The inclusion of GILTI may cause a significant tax liability for U.S. shareholders. To mitigate this, the new tax law introduces a few deductions related to GILTI. A U.S. domestic corporation shareholder is eligible for a GILTI deduction in addition to a reduced foreign tax credit. For tax years 2018 through 2025, such corporations are allowed a deduction of 50% of the GILTI amount, limited to taxable income. This deduction is reduced to 37.5% starting in 2026. When combined with the new lower corporate income tax rate of 21%, the effective tax rate on GILTI is 10.5% for tax years 2018 through 2025, and 13.125% for 2026 and beyond.
In addition to the GILTI direct reduction, corporations are also allowed a reduced foreign tax credit on deemed paid foreign income taxes related to GILTI. The GILTI-related foreign tax credit is limited to 80% of the foreign income taxes paid. However, unlike normal foreign tax credits, GILTI-related credits cannot be carried back or forward to other tax years. Additionally, this foreign tax credit is considered a Section 78 gross-up and included in income. The gross-up is included at 100% and the foreign tax credit is limited to 80%.
The above GILTI provisions are effective for tax years of foreign corporations beginning after December 31, 2017.
The GILTI provisions can be cumbersome to understand and prepare for, but they will have a significant impact on foreign corporations. Furthermore, states may not necessarily conform to the federal GILTI provisions, adding another layer of complexity to this calculation.