Final GILTI Regulations Provide Some Relief to Taxpayers
The Tax Cuts and Jobs Act of 2017 added a new anti-deferral rule known as Global Intangible Low-Taxed Income (GILTI). The GILTI provisions impact taxpayers that own an interest in certain foreign corporations that are classified as controlled foreign corporations (CFC). Below is a brief background on the basic GILTI rules as well as highlights of significant developments in the final regulations that were issued in June 2019.
Generally, a taxpayer is not subject to U.S. taxation on the earnings of a foreign corporation until they receive an actual distribution from such corporation (i.e., a dividend). However, a U.S. Shareholder of a CFC is subject to U.S. taxation on certain amounts of the CFC’s earnings whether they receive an actual distribution or not. The new GILTI inclusion rules are among the anti-deferral provisions that result in current taxation of the GILTI inclusion amount even though actual distributions are not received. Note that only U.S. Shareholders of a CFC are subject to the GILTI inclusion rules.
There are a few key phrases in the above paragraph that require a brief definition. The following definitions are basic and simplified. The intent is to provide a summarized overview for U.S. taxpayers who may be affected by these rules.
- U.S. Shareholder – A U.S. person who owns, or is considered as owning, 10% or more of the total combined voting power or 10% or more of the total value of the stock of a foreign corporation.
- Controlled Foreign Corporation (CFC) – A foreign corporation with more than 50% of the total voting power or total value of the stock of such corporation owned by U.S. Shareholders.
- GILTI Inclusion Amount – The amount by which the CFC’s net tested income exceeds 10% of the CFC’s adjusted basis in specified tangible property (i.e., Qualified Business Asset Investment, or QBAI), reduced by the tested interest expense. The net tested income is the CFC’s taxable income subject to certain modifications.
Proposed and Final Regulations
The Internal Revenue Service (IRS) issued proposed regulations implementing the new GILTI inclusion rules in September 2018. The IRS subsequently issued final regulations in June 2019. The final regulations made several important changes to the proposed regulations, particularly with respect to indirect GILTI inclusions through domestic partnerships. In addition to issuing final regulations, the IRS issued new proposed regulations addressing additional comments provided with respect to high-taxed foreign income. When finalized, these new proposed regulations will be effective for future tax years.
Domestic Partnerships and GILTI
The proposed regulations issued in September 2018 established a hybrid method for partners in a domestic partnership. Partners that indirectly owned less than 10% of the CFC (through ownership in the domestic partnership) were required to pick up their share of the GILTI inclusion amount that was calculated at the partnership level. Partners that indirectly owned 10% or more of the CFC were required to calculate their GILTI inclusion amount as if they were direct shareholders of the CFC.
The final regulations adopted an approach in which all partners of a domestic partnership are treated as directly owning their pro rata share of the foreign corporation’s stock in determining their GILTI inclusion amount. Thus, a domestic partnership does not have a GILTI inclusion amount, and no partner has a distributive share of the partnership’s GILTI inclusion. The domestic partnership is treated as an aggregate of its partners for purposes of determining each partner’s GILTI inclusion. Accordingly, partners who do not indirectly own 10% or more of the CFC owned by the partnership will not be subject to the GILTI inclusion rules with respect to such CFC.
This change is effective for calendar year 2018 tax returns. Thus, there may be refund opportunities available for taxpayers who originally filed their 2018 tax return under the hybrid method of the proposed regulations.
Subpart F and High-Tax Exception
The GILTI inclusion rules specifically exclude certain types of gross income from the tested income of a CFC for purposes of computing the GILTI inclusion amount. These exclusions include income that is already recognized under Subpart F, as well as income excluded from Subpart F as a result of the high-tax exception. The GILTI regulations proposed in September 2018 provided that the high-tax exception for GILTI only applied to income that would otherwise be foreign-based company income or foreign insurance income under the Subpart F rules. Any other income that was subject to a high foreign tax would still have been subject to the GILTI inclusion rules. This rule still applies for tax years 2018 and 2019.
The new proposed regulations provide a much broader high-tax exclusion. Specifically, a CFC is able to make an election to exclude from gross tested income any items of gross income that are subject to tax that is greater than 90% of the maximum U.S. corporate tax rate (effective rate test). This election will be available and effective for taxable years beginning on or after the date the final regulations are published and will not be retroactive. This change is very good news for taxpayers. However, it is disappointing that the effective date is being deferred to 2020 at the earliest.
Other Notable Changes in the Final Regulations to the Prior Proposed Regulations
- Anti-Abuse Rule Narrowed – Transactions with the principal purpose of avoiding federal income taxation will only be disregarded in determining the appropriate adjustments to the allocable earnings and profits for certain hypothetical distributions.
- Determining Adjusted Basis – The final regulations allow certain CFCs to make an election to use a non-ADS depreciation method in determining the adjusted basis in specified tangible property.
- Depreciation Accounting Method – The final regulations clarify that the determination of adjusted basis for QBAI purposes is not a method of accounting change. However, a change from ADS to another depreciation method for purposes of computing tested income or tested loss is a change in method of accounting and would require a Form 3115 to be filed.
- Interest Expense of Tested Loss CFC – The final regulations allow the tested interest expense of a tested loss CFC to be reduced by an amount equal to 10% of the CFC’s adjusted basis in specified tangible property (i.e., QBAI).
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