Notes

Individual Us Taxpayers Eligible For Gilti Deduction If Electing Corporate Tax Treatment
In some cases, such use of corporate vehicles may also carry negative tax consequences in the jurisdiction of the CFC. The Proposed Regulations thus introduce not only a measure of fairness and simplification for individual US shareholders in the domestic context, but assist such investors in their investments internationally. For many individual US shareholders of non-US closely held businesses or with significant foreign holdings, the section 962 election is worth serious consideration as part of their tax and corporate planning.

This would however mitigate the benefits of the tax deferral currently enjoyed by Dr. Smith in respect of income retained in his corporation which is only subject to Canadian corporate taxes at rates of approximately 12%. In sum, the GILTI rules were written with large multinational corporate structures in mind. The rules for corporate US shareholders provide for LOWER US tax rates on non-US income than on US income. These corporate rules generally work as advertised to provide a minimum tax rate of 13.125% on CFC income classified as GILTI. However, individual US shareholders cannot take advantage of the provisions that reduce the US tax rate on GILTI below the corporate tax rate.

Rather, the Code goes one step further by allowing an individual, who is a “U.S. The final rules reverse course from the proposed FTC regulations and provide a different approach to this issue. First, taxpayers determine the adjusted basis of a 10% owned corporation for expense apportionment purposes as if they did not make the basis election .

Under GILTI, the rate on foreign profits is now at or below most tax rates in the developed world. This limits the incentive for U.S. multinationals to move their headquarters out of the U.S. The primary purpose of GILTI is to reduce the incentive for U.S.-based multinational corporations to shift profits out of the United States into low- or zero-tax jurisdictions.

Taxpayers are allowed the same deduction for Foreign Derived Intangible Income for Iowa purposes that they are allowed for federal purposes. Corporate taxpayers that file consolidated federal returns may have to make certain adjustments to both GILTI and the FDII deduction in order to properly report their income for Iowa purposes. Consider a situation where a CFC conducts research in a foreign country and claims the local country’s tax credit to reduce its local country tax. Or assume new equipment is installed that can be written off rapidly, similar to bonus depreciation permitted in the United States. If these incentives or other temporary differences wipe out a tax liability, or reduce it below 13.125 percent, the U.S. government becomes the beneficiary of those incentives—not the company’s shareholders.

Jack Brister Corporate taxpayers must also be aware of states not recognizing the IRC §250 deduction. This existing patchwork of state rules is made even more complex when one considers city and other local income taxes.

Shareholders of any CFCs, and other domestic partnerships that are related to the partnership (and their U.S. Shareholder partners) consistently apply the proposed regulations with respect to all CFCs in which the domestic partnership owns stock under section 958. The aggregate treatment of domestic partnerships under the final and proposed rules generally is limited to determining which persons have a GILTI, subpart F, or section 956 inclusion. The final and proposed rules continue to treat domestic partnerships as entities for purposes of determining whether a foreign corporation is a CFC, whether a U.S. person is a U.S. Shareholder is a controlling domestic shareholder of a CFC for purposes of making certain elections with respect to the CFC. U.S. corporations may be entitled under section 250 to a deduction of up to 50% of their GILTI inclusion and related section 78 gross-up.

However, any increase in the basis of the stock that results from the election would have been excluded for expense apportionment purposes. On February 5, 2019, the section 965 regulations were finalized and included a new “limited basis adjustment” election.

Making the §962 election means that the individual shareholder can look into the CFC and treat foreign taxes paid by the corporation as if the shareholder had paid those taxes directly. To understand what this means, consider a case where a CFC has $7 of GILTI that the shareholder must include in income and the CFC has already paid $3 of foreign tax on that income. The $7 of GILTI is computed after deducting the $3 of foreign tax, so in order to use that foreign tax as a credit, it must be added back to taxable income to get the $10 of pre-tax income that became GILTI. To recap, under the normal rules an individual US Shareholder of a CFC will include in their taxable income 100% of GILTI , and will pay US tax on the entire amount of GILTI at their marginal tax rate, up to 37%, with no credit for foreign taxes paid. This is the situation that was mentioned in the public comment made on behalf of the Israeli Ministry of Finance that I discussed in my first post.

As discussed below, the proposed regulation defines “high tax” to mean tax at a rate of 90% of the U.S. corporate income tax rate of 21%, or 18.9%. This would mean that U.S. shareholders of CFCS in countries with an effective corporate tax rate that is higher than 18.9% would generally not be subject to the GILTI tax. The provision requires that a US shareholder of a controlled foreign corporation include GILTI income on its return similar to Subpart F. Corporations and individuals making a Section 962 election, subject to certain limitations, could potentially lower the effective tax rate on this income to 10.5%. Making a section 962 election will not only reduce the tax liabilities of individual US shareholders but also their tax planning and compliance costs in many situations, providing an efficient and effective alternative to further corporate planning.

This would have significantly and adversely limited the impact of the 962 election. The tax rate on such distribution can generally be reduced to a maximum of 20% (plus 3.8% Obamacare tax) if the foreign corporation is located in a country that has an income tax treaty with the United States. Because the branch is not a CFC for U.S. tax purposes, neither the 50-percent deduction nor the 80-percent FTC, that are available for GILTI, may be used to reduce or even eliminate the U.S. income tax on the branch income. That being said, the U.S. owner of the branch generally may still claim a tax credit for the foreign taxes paid by the branch, thereby reducing their U.S. income tax liability attributable to the branch income.

Fundamentally, Section 951A imposes a 10.5% minimum tax on GILTI inclusions, subject to a partial GILTI deduction and foreign tax credit limitations. The GILTI inclusion is the deemed intangible income of a CFC which is essentially the excess of the foreign earnings above a 10% net deemed tangible income return. It is important to note, CFC’s deemed Intangible Income is not necessarily based on its intangible assets or its income derived from those assets. Therefore, due to the mechanics of the GILTI calculation, any CFC income may be considered deemed intangible income for the purposes of GILTI. For corporate consolidated taxpayers, the state GILTI calculation where the states do not recognize the full current US consolidate tax return regulations are particularly troublesome.

Similarly, special basis rules related to tested loss CFCs applicable to consolidated groups in the 2018 proposed regulations are not included in the final rules, and instead will be considered in a separate project. Shareholders that are members of a consolidated group after the publication of the final rules. The final rules also do not finalize certain related provisions of the 2018 proposed regulations that would have treated a member as receiving tax-exempt income immediately before another member recognizes income, gain, deduction, or loss with respect to a share of the first member’s stock. The preamble to the final rules explains that Treasury has become aware of fundamental flaws in the adjustment, and that taxpayers may not rely on the adjustment from the 2018 proposed regulations.

The problem for individual US shareholders of a CFC stems from the disparate treatment of individual and corporate taxpayers under the TCJA legislation in the application of relevant deductions, tax rates and credits. If an individual shareholder does not make the 962 election, GILTI will result in double taxation. This is because the foreign tax credit computation for GILTI is quarantined from foreign taxes paid on all other types of income. The only foreign tax that can possibly offset GILTI is the tax paid by the CFC – and without a §962 election an individual shareholder cannot use the tax paid by the CFC as a foreign tax credit.

Increasing the corporate tax rate to 28 percent would account for the largest revenue gain ($1.3 trillion over 10 years) in the plan. Adding other changes on the business side, such as the 15 percent corporate minimum tax and tax increases on international profits, Biden’s taxes on businesses account for about half of the revenue gains. Creates a minimum tax on corporations with book profits of $100 million or higher. The minimum tax is structured as an alternative minimum tax—corporations will pay the greater of their regular corporate income tax or the 15 percent minimum tax while still allowing for net operating loss and foreign tax credits. For the same reasons that a state is likely to include the DRTT “inclusion amount” in an individual’s federal adjusted gross income starting point, GILTI is also likely to enter into an individual’s state adjusted gross income starting point, but without offsetting deduction.

Similar state IRC conformity evaluations applicable to the DRTT will need to be applied by taxpayers that are individuals, including shareholders of S corporations or partners/members of other PTEs, and subject to the provisions of the new federal GILTI tax. The Act also imposes another special tax on global intangible low-taxed income .

This may be true even if the benefit is the result of a temporary item, such as depreciation, where more foreign taxes likely would be paid in future years when the depreciation deduction is lower. Individual shareholders of a CFC typically will pay a higher tax on the GILTI inclusion since they have higher tax brackets, are not eligible for the 50 percent deduction, and are not eligible for indirect foreign tax credits. However, there are tax planning considerations individuals should consider when contemplating their GILTI tax. Before the U.S. federal corporate tax rate was decreased from 35% to 21%, the possible tax savings arbitrage with the IRC section 962 election generally was not as effective to decrease the U.S. tax on CFC Subpart F income or an IRC section 965 transition tax inclusion. With the lower U.S. federal corporate tax rate currently in effect, the election can make a significant difference resulting in more favorable tax savings to a U.S. individual shareholder of a CFC.

For purposes of paying U.S. income tax on GILTI a corporate U.S. shareholder is allowed 80% of the foreign tax credits paid on such income. Based on the Tax Foundation General Equilibrium Model, we estimate that, on a conventional basis, Biden’s plan would increase federal tax revenue by $3.8 trillion between 2021 and 2030 relative to current law.

An individual that is a US Shareholder in a CFC can elect to pay the corporate tax rate on all subpart F income and use the corporate shareholder rules to receive FTC for taxes actually paid by the CFC. Prior to publication of the new proposed regulations, a 962 election would allow an individual CFC shareholder to “unlock” indirect foreign tax credits , but it was generally thought that the election would not “unlock” the 50 percent deduction under new Section 250 of the Code.

In the case of a U.S. individual owner of the branch – whether directly or through a partnership or S corporation – the foreign branch income will be subject to federal income tax at a maximum rate of 37 percent. In the case of an owner that is a C corporation, the foreign branch income will be subject to federal tax at the flat 21 percent rate applicable to corporations. Based on the interaction of the 50-percent deduction and the 80-percent FTC, the U.S. tax rate on GILTI that is included in the income of a domestic C corporation will be zero where the foreign tax rate on such income is at least 13.125 percent. In addition, for any amount of GILTI included in the gross income of a domestic corporation, the corporation is allowed a deemed-paid credit equal to 80 percent of the foreign taxes paid or accrued by the CFC with respect to such GILTI (the “80-percent FTC”). Beginning in tax year 2019, Global Intangible Low-Taxed Income is included in individual and fiduciary income taxpayers' Iowa net income, but under recent legislation GILTI is excluded from income for Iowa corporate income and franchise tax purposes.

The amount of this reduction would equal the amount of a taxpayer’s pro rata share of the section 965 specified deficit taken into account as a result of its ownership of the stock of the 10% owned corporation. This adjustment may reduce the basis of such stock below zero for purposes of determining the basis of the stock for expense apportionment purposes, but only if the value of the stock after adjustment for the “E&P bump” is not below zero. If the value of the stock would be less than zero after the addition of the “E&P bump”, then the final rules provide that the value of the stock for expense allocation purposes is zero for the year. To correct for these uneconomic effects and solely for purposes of valuing the stock of a 10% owned foreign corporation for expense apportionment purposes, the FTC proposed regulations would have treated the taxpayer as having made a section 965 basis adjustment election even if it had not done so.

The Act amends Subpart F of the IRC to include a new IRC § 951A to add the GILTI tax. Generally, the tax is at a 10.5 percent rate on a U.S. shareholder’s share of a CFC’s GILTI and, while similar to Subpart F income and treated as such for certain purposes, GILTI is not included in federal gross income under IRC § 951 nor included in the definition of “subpart F income” under IRC § 952. The amount of GILTI and corresponding federal tax is a complicated calculation, but generally impacts U.S. shareholders of CFC’s that have a heavy concentration of intangible assets compared to fixed/tangible assets . Like the DRTT, GILTI is included in the U.S. shareholder’s federal gross income under new IRC § 951A, and then a new deduction is provided under new IRC § 250 in an amount under a calculation that arrives at the 10.5 percent effective rate of tax on the GILTI. Unlike the DRTT, the GILTI tax is effective for taxable years beginning after December 31, 2017.

The proposed rules generally would apply to tax years of foreign corporations beginning on or after the date final regulations are published in the Federal Register, and to tax years of U.S. persons in which or with which such tax years of foreign corporations end. Pending final regulations, domestic partnerships may rely on the proposed regulations for tax years of CFCs that begin after December 31, 2017, provided the domestic partnership, its partners that are U.S.

Shareholder’s pro rata share of the CFC’s “net CFC tested income” over the shareholder’s “net deemed tangible income return” for the shareholder’s taxable year (which amounts are determined on an aggregate basis looking at all of the CFCs owned by a particular U.S. shareholder). The 10 percent qualified business asset investment exemption in GILTI attempts to target the provision at assets that return above-normal returns, which is a proxy for the returns to intellectual property. In addition, it exempts the returns to real investment, which should avoid distorting foreign investment decisions of U.S. multinational corporations.

This election was intended to minimize the gain recognized by taxpayers making the section 965 basis adjustment election. Taxpayers were, however, unsure of how to apply the special tax book value adjustment rule in the FTC proposed regulations as a result of the addition of the section 965 limited basis election. As noted above, the rules related to basis adjustments for tested loss CFCs have been reserved.

Under the newly enacted Section 951A, beginning in tax year 2018, each U.S. shareholder of a controlled foreign corporation is subject to current U.S. income tax on their share of global intangible low-taxed income . GILTI is defined as the excess of a U.S. shareholder’s net CFC-tested income over their net deemed tangible income return . In September 2018, Proposed Regulations under the GILTI provisions were issued. proposed just this week, Treasury and the IRS have significantly narrowed the scope of the GILTI tax, by adding a provision which excludes income of a CFC that is subject to “high tax” in the foreign company’s country of incorporation, whether such income is active or passive in nature.

For individual US Shareholders, the effective total tax rate on GILTI will be either their marginal US tax rate (if no §962 election is made), or the greater of 26.25% or their local tax rate (with a §962 election). This will be in addition to any tax paid on subsequent dividend distributions. The §962 election allows an individual US Shareholder to compute the tax on GILTI as if they were a corporation. On 4 March 2019, the US Treasury issued proposed regulations in which they changed their position on the availability of the 50% deduction to individuals making an election under §962. To ensure that this intent is respected, individuals making a §962 election will be allowed to take the 50% deduction allowed by §250.

Subject to certain limitations, U.S. citizens, resident individuals, and domestic corporations are allowed to claim a credit against their U.S. income tax liability for foreign income taxes they pay. In addition, for any amount of GILTI included in the gross income of a domestic corporation, the corporation is allowed a deemed-paid credit equal to 80 percent of the foreign taxes paid or accrued by the CFC with respect to such GILTI (“80-percent FTC”).

The Technical Appendix to this blog post has been updated to take the proposed regulations into account. With the §962 election, an individual US Shareholder owning a CFC that pays more than 13.125% of tax locally will end up in exactly the same position as under prior law – they will have no current US tax on their active business income, and no Previously Taxed Earnings and Profits .

This is done by placing a floor on the average foreign tax rate paid by U.S. multinationals of between 10.5 percent and 13.125 percent. The incentive to shift profits from one jurisdiction to another is the function of the difference between the countries’ statutory tax rates. Companies subject to GILTI would compare a 21 percent domestic rate with a 10.5 to 13.125 percent rate rather than a zero rate. The new tax law’s global intangible low-taxed income (“GILTI”) provision is triggering uncertainty among individual shareholders and non-C corporations that invest in controlled foreign corporations (or “CFCs”).
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