The Global Intangible Low-Taxed Income (GILTI) provisions that were enacted as part of the Tax Cuts and Jobs Act (TCJA) of 2017 brought substantial changes to international tax provisions in the U.S.—and it also brought some unintended consequences for U.S. investors in controlled foreign corporations (CFCs).
Fortunately, the U.S. Department of the Treasury and the IRS finalized regulations for a GILTI high tax exception. This exception creates tax planning opportunities, and all U.S. shareholders of CFCs should analyze the costs and benefits of this useful tax election.
What Is GILTI?
GILTI sought to discourage multinational corporations from using intangible property to shift profits out of the U.S. by immediately taxing the net income of a CFC that exceeds 10% of the net tax value of its depreciable assets. Under pre-TCJA law, those earnings may have been tax deferred.
GILTI is reported on the owner’s return, and there are some potential foreign tax credits that can offset some of the tax due on GILTI income. However, these rules are complex and vary depending on the legal structure of the CFC owner.
Although the intent of Section 951A was to discourage companies from holding intangible property offshore, many taxpayers who had ownership interests in CFCs became liable for the new GILTI tax regardless of their intangible property holdings due to the 10% of assets threshold.
What Is the GILTI High Tax Exception?
On July 20, 2020, the IRS finalized regulations for the GILTI high-tax exception, which allows a complete exclusion of GILTI tested income from the federal taxable income of a U.S. shareholder that owns a CFC.
If the CFC earns income from a foreign jurisdiction with a high tax rate, the high tax exception rules acknowledge that intangible property allocated to that country may be there for purposes other than tax avoidance. Thus, U.S. shareholders of CFCs can exclude global income earned in high tax jurisdictions from their GILTI inclusion.
Among the key points of the final regulation:
- Election – The controlling domestic shareholders of the CFC make the election to use the GILTI high tax exception by attaching a statement to the shareholder’s federal tax return. That election is binding for all U.S. shareholders, and the controlling domestic shareholders must provide notice of the election to all non-controlling shareholders. The election is made on an annual basis.
- All or nothing – The election applies to all qualifying CFCs in the group; it cannot be made on a CFC-by-CFC basis. CFCs are considered to be part of a group if they share more than 50% common ownership. If made for GILTI, the election also applies to any Subpart F income inclusions of the U.S. shareholders.
- Definition of high tax – The GILTI high tax exception applies only if the CFC’s effective foreign rate on GILTI gross tested income exceeds 18.9% (i.e., more than 90% of the U.S. corporate income tax rate of 21%) and the U.S. shareholder elects for that year to exclude the high-taxed income.
- Effective date – Taxpayers can elect the GILTI high tax exclusion for the taxable years of CFCs beginning on or after July 23, 2020, and for the tax years of U.S. shareholders in which the tax year of the CFC ends. The IRS also allows taxpayers to amend prior year tax returns for foreign corporations with tax years beginning after December 31, 2017 (2018 and 2019 calendar years) to make the election.
- Annual lection – This election is made annually so taxpayers should carefully consider each year the benefits of making the election.
What Should Companies Do Before Electing the High Tax Exception?
The GILTI high tax exception can be a useful planning tool, but there are disadvantages in certain situations. For example, the high tax election:
- Affects the amount of qualified business asset investment (QBAI) the taxpayer can use to reduce their GILTI inclusions
- Can impact foreign tax credits, as GILTI gross income is excluded from gross income
- May impact current and future net operating loss (NOL) utilization
For these reasons, it’s important to closely evaluate whether this exception is useful, which generally requires tax modeling. As always, if you have questions about electing the GILTI high tax exception or any other international tax arrangements, contact your Warren Averett advisor or ask a member of our team to reach out to you.