The GILTI High-Tax Exception (What You Should Know)
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The GILTI High-Tax Exception
As if international tax, Subpart F Income, and Controlled Foreign Corporation tax laws were not complicated enough – then came the TCJA (Tax Cuts and Jobs Act) and GILTI (Global Intangible Low-Taxed Income), which made foreign tax compliance even more complex. The idea behind Subpart F Income and GILTI is to avoid US Persons from moving (or keeping) money offshore in a low-tax jurisdiction. With Subpart F and GILTI, foreign income may be taxable even when it has not yet been distributed or repatriated. But, there are exceptions in scenarios where the income is in a high-tax jurisdiction. Let’s take an introductory look at the 26 USC 954 High Tax Exception:
26 USC 954 (4)
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For purposes of subsection (a) and section 953, foreign base company income and insurance income shall not include any item of income received by a controlled foreign corporation if the taxpayer establishes to the satisfaction of the Secretary that such income was subject to an effective rate of income tax imposed by a foreign country greater than 90 percent of the maximum rate of tax specified in section 11.
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Key Terminology from the code section
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shall not include any item of income
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received by a controlled foreign corporation
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that such income was subject to an effective rate of income tax imposed by a foreign country greater than 90 percent of the maximum rate of tax specified in section 11
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Thus, if the income received by a controlled foreign corporation was subject to an effective tax rate of at least 90% of the maximum tax rate specified in section 11, then it is exempt from GILTI.
26 USC Section 11
Section 11 refers to corporate taxation.
Section 11 provides in pertinent part:
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(a) Corporations in general
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A tax is hereby imposed for each taxable year on the taxable income of every corporation.
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(b) Amount of tax
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The amount of the tax imposed by subsection (a) shall be 21 percent of taxable income.
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Final Regulations
The final regulations involving high tax exceptions for GILTI are very dense. We have extracted a few of the important aspects of the regulations below:
Per CFC, Per QBU or Something Else?
The key concern as to how the final regulations would approach the competition is to ensure that companies cannot manipulate the total for an income in order to reduce GILTI. This could be done by having company structure around the low-taxed income countries in order to develop QBUs (Qualified Business Units) that exploited the outcome
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“For these reasons, the final regulations do not adopt a CFC-by-CFC approach. However, the final regulations replace the QBU-by-QBU approach with a more targeted approach based on “tested units” (as discussed in part III.A of this Summary of Comments and Explanation of Revisions), permit some additional blending of income under the tested unit combination rule (as discussed in part III.B of this Summary of Comments and Explanation of Revisions), and allow taxpayers additional flexibility by permitting the GILTI high-tax exclusion election to be made on an annual basis (as discussed in part IV.C of this Summary of Comments and Explanation of Revisions).
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Further, as noted in part I of this Summary of Comments and Explanation of Revisions, the separate notice of proposed rulemaking published concurrently with these final regulations conforms the rules implementing the subpart F high-tax exception with the GILTI high-tax exclusion, thereby eliminating the disparity between the two elections and the incentive for taxpayers to structure into the subpart F high-tax exception.”
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Effective Foreign Tax Rate
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“Consistent with section 954(b)(4), the 2019 proposed regulations apply the GILTI high-tax exclusion by comparing the effective foreign tax rate with 90 percent of the rate that would apply if the income were subject to the maximum rate of tax specified in section 11 (currently 18.9 percent, based on a maximum rate of 21 percent). See proposed §?1.951A-2(c)(6)(i)(B).”
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CFC Group Defined
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“Under the final regulations, a CFC group is an affiliated group, as defined in section 1504(a), with certain modifications that broaden the definition. See?1.951A-2(c)(7)(viii)(E)(2)(i). First, the affiliated group rules in section 1504(a) apply without regard to section 1504(b)(1) through (6) (which exclude certain corporations, such as foreign corporations, from the definition of an “includible corporation”). See id.
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Second, for purposes of determining whether a CFC is a member of a CFC group, the final regulations incorporate a “more than 50 percent” threshold instead of the “at least 80 percent” threshold in section 1504(a). See id. Stock ownership for this purpose is determined by applying the constructive ownership rules of section 318(a), with certain modifications. See id. These constructive ownership rules would, for example, cause two corporations owned directly by the same U.S. individual to be part of a CFC group.”
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GILTI High Tax Exclusion Annual Basis
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The Treasury Department and the IRS agree with these comments and have determined that, given that the final regulations adopt a tested unit-by-tested unit approach (in lieu of the QBU-by-QBU approach) and retain the consistency requirement set forth in the 2019 proposed regulations, the 60-month restriction is not necessary to prevent abuse. Accordingly, the final regulations do not include the 60-month restriction and, subject to the consistency requirement, taxpayers may elect the GILTI high-tax exclusion on an annual basis.
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The Treasury Department and the IRS agree that U.S. shareholders that are not controlling domestic shareholders of a CFC should be informed by the controlling domestic shareholders of the CFC if they make (or revoke) a GILTI high-tax exclusion election with respect to the CFC. Therefore, the final regulations clarify that the controlling domestic shareholders must provide notice of elections (or revocations), as required by §?1.964-1(c)(3)(iii), to each U.S. shareholder that is not a controlling domestic shareholder. See?1.951A-2(c)(7)(viii)(A)(1)(ii), (C) and (D).
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