Global Intangible Low Tax Income (GILTI) Tested Income of US Persons
For many years, the US Subpart F rules caused controversy and confusion. The taxation of foreign corporations owned by US persons was a complex landscape to traverse even by the most skilled and experienced. Taxation of Effectively Connected Income further added to the complexity and tax consequences of US persons owning and operating a foreign corporation. With years of regulations and changes, many would be forgiven for being more confused than ever. The US Treasury department, however, were not as forgiving in collecting all which was owed to them in taxes via the Internal Revenue Service (IRS). In 2017, after many cries for change and improvements, the “Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” otherwise known as the Tax Cuts and Jobs Act (TCJA) 2017 delivered change!
That change came in the form of the TCJA 2017’s taxation of Global Intangible Low Tax Income, commonly known as GILTI. This change brought new and more complexity along with additional taxes. With GILTI, it would seem the US has entered the endgame in this long chess game. At Mithril Tax Law we embrace the complexity and turn it into simplicity for the benefit of our customers. In this article we will briefly explore a Controlled Foreign Corporation (CFC)’s tested income with respect to the calculation of GILTI.
For readers who are not familiar with GILTI or the US’s CFC regime, the following will provide some clarification and knowledge. Global Intangible Low Tax Income (GILTI) is a category of foreign income which was introduced in the Tax Cut and Jobs Act (TCJA) 2017. Taxation on GILTI is applied under section 951A, to US persons based on their pro rata share of a CFC or the aggregate GILTI based on their pro rata shares of multiple CFCs. Under section 957 a CFC is any foreign corporation where US shareholders own 50% or more of; the combined voting power of all classes of stock or the total value of stock or total value of the stock of such foreign corporation. US corporations are taxed on GILTI at the US corporate tax rate of 21%. A Florida corporation would be subject typically to 21% corporation tax and 5% sales tax on revenues. However, due to deductions such as the Section 250 deduction which includes the 50% of GILTI amount which is included in a US corporation’s gross income under section 951A (known as the 50% GILTI deduction) and the foreign-derived intangible income (FDII) deduction, the effective tax rates on GILTI are usually 10.5% to 13.125%. FDII deduction considers the US CFC’s Deemed Intangible Income, Foreign-Derived Deduction Eligible Income, and the Qualified Business Asset Investment (QBAI).
US individuals paying taxes on GILTI are subject to 37% income tax at the higher threshold. According to section 962 and the final regulations on “Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income” (TD 9901), US individuals can elect to be subject to tax corporate tax rates for GILTI. Being taxed at a corporate rate also allowed US individuals to have access to the section 250 deductions. For US individuals who own passthrough entities such as LLCs, S corporations and Trusts, the section 962 election is a useful tool in reducing their income taxes on GILTI. As noted before individuals can elect to be taxed as corporations.
With an effective tax rate of 10.5% to 13.125%, US persons will still be taxed significantly on their foreign income which falls under GILTI. Thus, Tested income is a vital component in of GILTI and in determining the amount of income or corporation taxes to be paid by the US person.
In order to fully appreciate the importance of tested income to GILTI we must explore the calculation of GILTI. The calculation for US taxation of a US corporation or US individual electing to be taxed at corporate rates for GILTI of a CFC is as follows;
US taxation on GILTI = 21% x (GILTI and related §78 gross-up – § 250 Deduction) – foreign tax credits.
- 21% = the US corporation tax rate according to section 11.
- GILTI = Net CFC Tested Income – Net Deemed Tangible Income; according to section 951A(b)
- Net CFC Tested income = Aggregate of CFC’s Tested income – Aggregate of CFCs’ Tested loss; according to section 951A(c).
- Tested income = Gross income of CFC – Allocable deductions; section 951A(c)(2)(A)
As seen above, CFC tested income is a vital component when calculating GILTI. One way of reducing GILTI would be to reduce CFC tested income. Less CFC tested income would mean a reduction in net CFC tested income. Lower net CFC tested income would result in a lower GILTI amount. The smaller GILTI is, the less income is exposed to US taxation which results in less US taxes!
Tested income of course includes the gross income of a CFC, however there are a few clear exclusions and deductions. According to section 951A, tested income is the gross income of a CFC without the inclusion of Effectively Connected income (ECI), Subpart F income, High taxed Subpart F income, Related Party Dividends and Foreign oil and gas extraction income as well as deductions (including taxes) properly allocable to such gross income under rules similar to the rules of section 954(b)(5).
Effectively connected income is already taxed under a separate regime and the tax is imposed on a non-resident alien or a foreign corporation not the US person as explained in Section § 864(c). Subpart F income of a CFC is subject to US taxes under Subpart F (section 951 to section 965. Taxation of income which has already been taxed is not the aim of GILTI. It can be argued that GILTI attempts to tax CFC income which previously would have avoided being taxed under Subpart F, essentially taxing active income of CFCs.
There are a few pieces of regulation not clearly outlined and not clearly understood by many our clients. It is important for taxpayers to understand all options which are available to them to manage their taxable income. One important item of income which is excluded from GILTI tested income, is CFC income which has been excluded from subpart F CFC income.
According to CFR §1.951A-2(c)(4)(iii)(A), “Gross income of a controlled foreign corporation for a CFC inclusion year described in section 951A(c)(2)(A)(i)(II) (Subpart F income)… includes any item of gross income that is excluded from subpart F income of the controlled foreign corporation for the CFC inclusion year”. Subpart F income is excluded from tested income under section 951A(c)(2)(A)(i)(II). If according to CFR §1.951A-2(c)(4)(iii)(A), subpart F income was already excluded from tested income, then any items of gross income which was excluded from the calculation of Subpart F income must be added to Subpart F income and then excluded from tested income. However, this provision is called the coordination with earnings and profits E&P limitation. This means that income which was excluded from the calculation of Subpart F due to the E&P limitation under section 952(c)(1) is also included in when calculating Subpart F income to be excluded from GILTI tested income.
According to CFR §1.951A-2(c)(4)(iii)(B) Coordination with E&P recapture, items of gross income which have been used to recharacterize earnings and profits as Subpart F income of a CFC is not included in Subpart F income for the calculation of GILTI tested income. Under CFR § 1.952-1(f)(2), if Subpart F income is reduced/limited by the CFC’s E&P in a previous tax year, then the excess income which was excluded from Subpart F income due to the E&P limitation, would be recharacterized as Subpart F income in a subsequent tax year and is considered to be included in a recapture account. However, under CFR §1.951A-2(c)(4)(iii)(A) recharacterized income is not included in the Subpart F exclusion for GILTI tested income. Thus, such recapture amounts will be included in tested income.
CFR §1.951A-2(c)(4)(iii)(B) Coordination with full inclusion rule and high tax exception, explains the exclusion of full inclusion foreign base company income from Subpart F income as well as high taxed Subpart F income with respect to the calculation of GILTI. Full inclusion foreign base company income which is excluded from a CFC’s Subpart F income under CFR § 1.954-1(d)(6) is not included in CFC’s Subpart F income nor will it be included in high taxed Subpart F income. Due to Subpar F income and high taxed subpart F income being excluded from GILTI tested income under section 951A, we can conclude that full inclusion foreign base company income is included in GILTI tested income.
Tested income is just a small part of GILTI; however, it has great impact on the outcome of taxable income under GILTI. While tested income is a broad pool of income it is vital taxpayers understand the limits of tested income to achieve fair taxation. At the end of the day GILTI is here to stay and all US persons subject to GILTI rules will have to navigate the complexity to determine their fair share of US taxation and avoid overpaying and losing money.
As seen in this article GILTI rules are very complex and tricky to navigate. However, US persons should not be hesitant to have CFCs in foreign countries such as Barbados. There are many benefits for US persons owning CFCs and owning a CFC should not be viewed as a hinderance, however this will be covered in a separate article later. For the few who can understand the GILTI rules and combine it with a knowledge of the Subpart F rules, taxation of a CFC can allow US persons to reduce their tax burdens and ease their worries.
Mithril Tax Law embraces the complexity of GILTI, Subpart F and many more US tax regulations. US persons who have CFCs or are interested in owning a CFC should acquire the services of experienced and knowledgeable international tax advisors who are also well versed in US international tax. As a final piece of advice, US persons who own or wants to own a US CFC should gain the services of a small boutique firm, such as Mithril Tax Law to work with you to achieve your goals. Small boutique firms will pay more attention to your needs and will provide you with the best service, which larger firms usually keep for their biggest clients.