Taxation for U.S. Multinationals: Anti-Deferral is Here, Don’t Be GILTI
September 13, 2018
International tax planning for outbound U.S. multinationals has been relatively stagnant over the past decade. Global structuring from a U.S. taxation perspective has focused on Subpart F income, foreign investment in US property, foreign tax credits, and transfer pricing. Beginning in tax year 2018, GILTI planning can be added to this list.
Effective for tax years beginning after December 31, 2017, the Tax Cuts and Jobs Act introduces a new anti-deferral regime, in addition to Subpart F, by creating a new foreign-sourced income category called Global Intangible Low-Taxed Income or “GILTI.” GILTI only applies to U.S. shareholders who own 10% or more of a controlled foreign corporation (CFC) and effectively enforces a limit on CFC income to a 10% return on tangible depreciable assets, forcing US shareholders to pick up the excess as taxable income.
For U.S. shareholders who are C corporations, the gross GILTI inclusion generally is reduced by a 50% deduction (reduced to 37.5% for taxable years after 2025), creating an effective 10.5% tax rate on GILTI. Foreign taxes paid on GILTI can be credited against the GILTI liability, limited to 80% of the foreign taxes paid. The unused portion of foreign taxes paid on GILTI may not offset other income categories and are forfeited if not used in the current year.
For example, if a U.S. C Corporation (USCo) wholly owns a CFC and its income is subject to GILTI, USCo would be taxed on 50% of the GILTI inclusion and could utilize up to 80% of the foreign taxes paid on GILTI as a foreign tax credit (FTC). If the effective foreign tax rate is equal to or exceeds 13.125% (10.5% tax rate / 80% FTC limit), no residual tax would be owed on GILTI (assuming further FTC limitations do not apply).
A key pitfall of GILTI for C Corporation U.S. shareholders resides in the restriction of the 50% deduction. The GILTI deduction, also referred to as the Section 250 deduction, is limited to the taxable income of the C corporation, without respect to GILTI and other certain foreign provisions. To the extent the C corporation has a net operating loss (NOL) to offset taxable income, the 50% deduction of GILTI is disallowed, forcing accelerated usage of NOLs to offset 100% of the GILTI inclusion. Additionally, no benefit will be received from foreign taxes paid on GILTI and unused taxes are forfeited. Using the previous example, if USCo had sufficient NOLs, USCo would utilize NOLs to the extent of 100% of GILTI inclusion and all associated foreign tax credits would be lost.
To the extent possible, managing your net CFC tested income and the location of income-producing assets can reduce the U.S. shareholders GILTI inclusion. Although a CFCs tested loss offsets another CFCs income for net CFC tested income purposes, only the tangible depreciable assets from the income-producing CFCs are considered for the 10% return limitation. If a disconnect exists between locations of income and depreciable assets, large GILTI inclusions may be triggered. Even a diminutive CFC loss can disqualify all the CFCs tangible assets from being included in the 10% limitation, severely increasing the potential GILTI inclusion. To prevent this situation, transfer pricing can be managed to ensure diminutive loss CFCs generate at least $1 of CFC tested income, qualifying the CFCs tangible depreciable assets for inclusion in the return on assets limitation.
If the majority of a U.S. shareholder’s GILTI inclusion is a result of a CFC holding large intangibles such as intellectual property (IP), electing the foreign entity to be disregarded for U.S. tax purposes could prevent the loss of foreign taxes which are subject to aggressive limitations under the GILTI provisions. This may be more attractive than the alternative option of moving IP onshore, which would entail strict compliance with BEPS regulations. The multinational should consider the regulatory, compliance, and tax implications before considering restructuring or moving IP.
The calculation of GILTI changes for U.S. shareholders not treated as a C corporation. For non-C corporation U.S. shareholders (i.e. an individual), the gross GILTI inclusion is not reduced by a special deduction and foreign taxes paid are generally disallowed. The income is also taxed at the higher ordinary individual tax rates.
To combat unfavorable individual tax rates on GILTI, a U.S. corporate blocker can decrease the GILTI impact. Assuming the substantial business purpose requirement is met, a U.S. individual shareholder could contribute its CFC stock into a newly formed domestic C corporation, benefiting from the 10.5% reduced tax rate and the ability to utilize foreign tax credits. If the majority of foreign tax credits are utilized and little residual tax is expected at the C corporation level, the 23.8% tax on the dividend distribution to an individual shareholder is substantially less than a 37% tax at the highest ordinary individual rate, not considering foreign taxes paid. Significant consideration should be given as other adverse consequences may result from such restructuring.
As new guidance and regulation are released, it is important to continually review and revise planning strategies. For more information, please contact us to discuss how your international structure can be further benefited.