The United States Treasury Issues GILTI Final Regulations
The primary purpose of the Global Intangible Low Taxed Income regulation (GILTI) is to provide a disincentive for US-based multinational corporations to shift profits to relatively low-tax countries. GILTI creates a minimum tax increment on foreign taxes rates by US multinationals of between 10.5 percent and 13.125 percent. This effectively reduces the tax savings on every dollar shifted to low-tax jurisdictions. GILTI is intended to reduce the incentive to shift corporate profits out of the United States, particularly by using intellectual property (IP) as a tax-shifting vehicle.
Some low-tax countries have marginal corporate tax rates that approach zero. GILTI creates a tax regime where corporations must pay between 10.5 percent and 13.125 percent, making profit shifting less attractive.
On June 14, 2019, the Treasury Department issued section 951A Global Intangible Low Taxed Income (GILTI) final regulations and proposed regulations related to stock ownership and excluding foreign hightaxed income from GILTI. Final rules reject the hybrid approach and adopt the aggregate approach for determining a partner’s GILTI inclusion amount due to CFC stock owned by a domestic partnership. GILTI final regulations also contains modifications to the pro rata share rules, clarification of anti-abuse rules, foreign tax applicability to direct or indirect share ownership of CFC, clarification of “allocable earnings and profits”, and clarification of the rule requiring appropriate adjustments to the allocation of allocable E&P that would be distributed in a hypothetical distortion.
Proposed regulations address allowing an election to exclude certain high-taxed foreign income from the calculation of tested income in determining GILTI. In the same publication, authorities discuss treatment of domestic partnerships for the purpose of section 958 (stock ownerships) and section 951A (GILTI).
These regulations are scheduled to be published in the Federal Register on June 21, 2019. Below is a summary of key provisions of the final and proposed regulations. If you would like to obtain further information on these rules, please contact our attorneys.
Background of the Section 951A
The Tax Cut and Jobs Act of 2017 (the “Act”) updated the international tax provisions by adding section 951A. Section 951A also known as Global Intangible Low Taxed Income (GILTI) introduced a new tax regime which is similar to the existing subpart F regime. Under section 951A, each U.S. shareholders of a controlled foreign corporation (CFC) should include their proportionate share of GILTI in the U.S. shareholder’s gross income. GILTI is defined as the excess of its pro rata share of “net tested CFC income”, over a 10 percent return on its pro rata share of the depreciable tangible property of each CFC.
Final rules adopt an “aggregate” approach to partnerships for GILTI purposes.
The Internal Revenue Code (IRC) at certain points treats partnerships as either an entity separates from its partners or as an aggregate of its partners.
GILTI proposed Treasury Regulations published on October 10, 2018, provided a hybrid approach for a domestic partnership that is a U.S. shareholder of one or more CFC and for partners of the partnership who are not U.S. shareholders of the CFC.1 Under this approach, the U.S. shareholder partnership shall determine its GILTI inclusion amount and the partners who are not U.S. shareholder shall take into account their distributive share of the partnership’s GILTI inclusion amount (entity approach). Partners that are U.S. shareholders do not take the distribute share of the partnership’s GILTI inclusion but instead treated as owning proportionately owning CFC shares (within the meaning of section 958(a)) and will include pro-rata share of CFC’s GILTI (aggregate approach).
Final GILTI rules published in the Federal Register (REG-101828-19), the Treasury Department and the IRS reject the idea of hybrid treatment and adopt the aggregate approach to determine the GILTI inclusions of domestic partnerships. One of the main reasons cited by the authorities for this change is to obtain consistent treatment across section 951A (GILTI) and section 951 (Subpart F regimes).
Under the aggregate approach, for section 951 or section 951A purposes, a domestic partnership is not treated as owning stocks of a foreign corporation within the meaning of section 958(a). Instead of treating partners of a domestic partnership are proportionately owning the stocks of CFCs that owned by the domestic partnership (same treatment as if the partnership would be a foreign partnership).2 The aggregate approach addressed in the final regulations only limited to determination of GILTI inclusion amount. This treatment does not apply for purposes of determining whether a U.S. person is a U.S. shareholder and to determine foreign corporation’s CFC status.
GILTI final regulations apply to taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of the U.S. shareholder in which or with such taxable years of foreign corporations end.
Proposed new election to exclude certain high-taxed income from GILTI
Proposed regulation issued in 2018 did not pave a path to a GILTI high-tax exclusion. The preamble indicated that taxpayers may not use GILTI high-tax exclusion to exclude any item other than FBCI or insurance income from gross tested income. In determining “Tested income” of a CFC, section 951A(c)(2)(A)(i)(III) requires to exclude Foreign Base Company Income (FBCI) (as defined in section 954) and the insurance income (as defined in section 953) of the CFC by reason of electing the exception under section 954(b)(4) (“high tax exemption”) from the gross income of the CFC.
Many tax professionals have submitted comments letters on this application and scope of the GILTI high-tax exclusion. In response to these comments, the IRS and the Treasury issued a new set of GILTI proposed regulations outlining the exclusion of certain CFC’s high-tax income from tested income in calculating GILTI.
The Proposed rules issued on June 14, 2019, cites to Senate Committee explanation for the deviation from previous explanation where the IRS did not allow a high-taxed exception outside the section 954(b)(4) high-tax exclusion. “The Committee believes that certain items of income earned by CFCs should be excluded from the GILTI, either because they should be exempted from U.S. tax as they are generally not the type of income that is the source of base erosion concerns or are already taxed currently by the United States.” The Proposed rules also state that allowing an election to exclude a CFC’s high-taxed income from tested income eliminates taxpayer incentives to structure CFC operations that convert tested income to FBCI just to get the section 954(b)(4) high tax exclusion.
The new GILTI Proposed Regulations, expand the GILTI high tax exclusion to include certain high-taxed income even if that income is not otherwise be FBCI or insurance income. As a result, a domestic shareholder of CFC can elect to exclude gross income subject to foreign income tax at an effective rate that is greater than 18.9% (90% of the U.S. corporate tax rate, which is currently at 21%) from gross tested income.3
The election has to be made by the CFC’s controlling domestic shareholders by attaching a statement on an original or amended return for a CFC inclusion year.4 If the election applies, then it is binding on all the U.S. shareholders of the CFC.5 The election applies to all CFCs within the controlling domestic shareholder group6 . 7 The election can only be revoked by the controlling domestic shareholders of the CFC.8 Unless revoked, the election is effective for the CFC inclusion year and all subsequent CFC inclusion years.9 Upon revocation, a new election cannot be made for another 60 months (lock-out period), and any subsequent election cannot be revoked for 60 months after the close of the CFC inclusion year which the subsequent election was made.10 The Treasury and the IRS are requesting further comments on these proposed rules, thus these proposed rules are subject to modification. All items of gross tested income attributable to a Qualified Business Unit (QBU) are treated as relevant items of income in regard to the election to exclude high-tax foreign income from GILTI.11 This means election eligibility analysis is made on a QBU by QBU basis, not at the CFC level or analyzing each item of income. In regard to foreign income taxes and obtaining deemed paid foreign tax credit under section 960, any items of income that elected to be excluded under the GILTI high-tax exclusion will not get the deemed paid foreign tax credit. 12 The high-tax exclusion for CFC tested income under section 954(b)(4) and section 951A is available taxable years beginning on or after the date that final regulations are published in the Federal Register.
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1 See Prop. Reg. § 1.951A(b).
2 Treas. Reg. § 1.951A-1(e)(1) and IRC § 958(a)(2)
3 See Prop. Reg § 1.95
4 See Prop. Reg. § 1.951A-2(c)(6)(v)(A).
5 See Prop. Reg. § 1.951A-2(c)(6)(v)(B).
6 A “controlling domestic shareholder group” is defined as two or more CFCs if more than 50 percent of the stock
(by voting power) of each CFC is owned (within the meaning of section 958(a)) by the same controlling domestic
shareholder (or persons related to such controlling domestic shareholder) or, if no single controlling domestic
shareholder owns (within the meaning of section 958(a)) more than 50 percent of the stock (by voting power) of
each corporation, more than 50 percent of the stock (by voting power) of each corporation is owned (within the
meaning of section 958(a)) in the aggregate by the same controlling domestic shareholders and each controlling
domestic shareholder owns (within the meaning of section 958(a)) the same percentage of stock in each CFC. See
Prop. Reg. § 1.951A-2(c)(6)(v)(E)(2).
7 See Prop. Reg. § 1.951A-2(c)(6)(v)(E)(1).
8 See Prop. Reg. § 1.951A-2(c)(6)(v)(C).
9 See Prop. Reg. § 1.951A-2(c)(6)(v)(C).
10 See Prop. Reg. § 1.951A-2(c)(6)(v)(D)(2)(i).
11 See Prop. Reg. § 1.951A -2(c)(6)(ii)(A)(1).
12 See Treas. Reg. § 1.960-1(e).