The 2017 Tax Cut and Jobs Act (TCJA) had many provisions, which we will be discussing over the next few months, and they include good, bad, and ugly. Some are two-faced, with aspects that at first seem bad but may actually turn out to be a blessing depending on your situation. One such provision is the GILTI regime, a new category of “Subpart F” income intended to prevent inappropriate deferral of foreign source income by U.S. taxpayers. The provision applies to all 10% or more U.S. shareholders of controlled foreign corporations (CFC’s), which is any foreign corporation owned OR controlled by vote OR value more than 50% by U.S. persons. The regime requires the U.S. shareholder to include their pro rata share of the GILTI for a given year regardless of whether cash is distributed or not, similar to other Subpart F provisions.
Some definitions first (from Code Sec. 951A):
GILTI: with respect to any United States shareholder for any taxable year of such United States shareholder, the EXCESS (if any) of "(A) such shareholder's net CFC tested income for such taxable year, over "(B) such shareholder's net deemed tangible income return for such taxable year.
Net Deemed Tangible Income: with respect to any United States 10% shareholder for any taxable year, an amount equal to 10 percent of the aggregate of such shareholder's pro rata share of the qualified business asset investment (QBAI) of each controlled foreign corporation with respect to which such shareholder is a United States shareholder for such taxable year.
QBAI: The average of the corporation's aggregated adjusted bases as of the close of each quarter of that tax year in specified tangible property: (A) used in a trade or business of the corporation, and (B) of a type with respect to which a deduction is allowable under Code Sec. 167 (depreciation).
Or said another way GILTI = Net Tested Income – [(10% of QBAI) – interest expense].
Basically, the income inclusion is the net income of the CFC minus 10% of fixed assets minus interest expense. This is, of course, an oversimplification but provides a good starting point for understanding it.
This at first seems bad but if the U.S. shareholder is a C Corporation the corporation is entitled to a deduction equal to the sum of 37.5% of Foreign Derived Intangible Income (FDII, a topic for another time) plus 50% of the GILTI amount. In addition, they are entitled to a foreign tax credit up to 80% of their share of the foreign taxes paid with respect to this income. This results in a possible effective tax rate of 10.5% on this income with the new 21% corporate tax rate. The FDII is also only subject to tax at 13.125%. Overall, not a bad result if you are a corporate shareholder.
Individuals and pass-through entities (PTE’s) are not so lucky. Individuals and PTE’s are not entitled to a foreign tax credit on GILTI nor are they allowed the deduction, instead they are subject to tax on GILTI at ordinary income rates for the full amount. This has caused many taxpayers to question their existing structure and/or whether they should elect to be taxed as a U.S. corporation with respect to their CFC. No so fast, C Corporations still carry a double level of tax for their U.S. shareholders and the overall effective rate must be examined before structuring decisions are made. Depending on the tax rates in the foreign jurisdiction and the intentions for cash flow it may be a good idea, but only after some number crunching.
The above is a simplified discussion of a new and complicated topic, careful consideration and analysis with your tax advisor is strongly recommended before taking any action. Please contact us for further information.