Lisa Goldman, CPA, TEP, M. Tax and Rebeccah Fontaine, J.D., LL.M.
8.8.19 | Client Alert
Part 2 – High-Tax Exclusion
In our ongoing examination of new IRS guidance on Global Intangible Low-Taxed Income (“GILTI”), we turn to one of the most significant changes in the proposed regulations, the GILTI “high-tax exclusion.” When finalized, the regulation would exclude, from a U.S. shareholder’s GILTI amount, certain items of income of its Controlled Foreign Corporations (CFCs) that are subject to a foreign effective tax rate of at least 18.9% (90% of the U.S. corporate tax rate, currently 21%). The initial proposed GILTI regulations permitted high-tax income to be excluded from GILTI only if the income was excluded from the Subpart F regime due to qualifying for the high-tax exception. Therefore, CFCs that had high-taxed income, but did not have Subpart F income were still subject to GILTI.
This proposed rule is significant because the statute did not specify the above exception. Moreover, many taxpayers argued to the IRS that, per the legislative history, Congress intended that income of a CFC should be taxed as GILTI only if it was subject to a low rate of foreign tax. In response, the IRS determined that the GILTI high tax-exclusion should be expanded (on an elective basis) to include certain high-taxed income even if that income would not otherwise be taxed under Subpart F.
This exclusion is applied on an elective basis to all tested gross income subject to an 18.9% minimum effective tax rate. The election is made by the CFC’s controlling domestic shareholders with respect to the CFC (U.S. shareholders that collectively own, directly or indirectly, more than 50% of the CFC’s stock). Once made, the election applies for the CFC’s subsequent tax years unless revoked. If revoked, the election would not be available to that CFC for 60 months. Any subsequent elections cannot be revoked for 60 months.
If the same U.S. shareholders own a majority of the stock of two or more CFCs, an election to apply this high-tax exception to one CFC would apply to all CFCs. If an election is made for a CFC, the election would be binding on all U.S. shareholders of the CFC. Going further, per the preamble to the regulations, “if a CFC is a member of a controlling domestic shareholder group, the election applies with respect to each member of the controlling domestic shareholder group”.
This new exclusion is available to individuals and trusts as well as entities.
If this election is made, any foreign income taxes paid or accrued with respect to a CFC’s items of income that are excluded under the GILTI high-tax exception would be excluded from the deemed paid taxes foreign tax credit calculation under IRC Section 960.
Potential Relief Comes with a But
The proposed GILTI high-tax exclusion could provide much needed relief for certain taxpayers. However, as drafted, the election could also produce unfavorable results for other taxpayers. For example, if a taxpayer has a high-taxed CFC and a low-taxed CFC, the election would exclude the income of the high-taxed CFC from tested income. Without this exclusion, the high-taxed CFC’s income would have otherwise carried credits that could have shielded some or all of the low-taxed CFC’s income from incremental U.S. tax.
The high-tax exclusion will not be available until the proposed regulations are finalized and effective. Currently, the 2018 tax year is not included the language of the regulations and retroactive application of the exception is not permitted.
If you have questions or need advice regarding GILTI and the high-tax exclusion, contact Lisa Goldman at 212.699.8808 | firstname.lastname@example.org or reach out to your Berdon advisor.
Berdon LLP New York accountants