One of the central features of the Tax Cuts and Jobs Act (TCJA) passed in December 2017 is the reformation of the U.S. system for taxation of international taxpayers and their activities. In so doing, Congress created a new category of taxable income: Global Intangible Low Taxed Income (affectionately known in the tax practitioner community as “GILTI”, pronounced “guilty”). The title of the tax, though, is misleading. While it appears to target intangible income held in low tax foreign jurisdictions, it may actually apply to any type of income earned in many jurisdictions.
GILTI Tax: General Rule
The law essentially dictates a regular rate of return that U.S. shareholders owning 10% or more of a Controlled Foreign Corporation (CFC) can earn on their overseas business assets without having this income subject to current U.S. taxation. The GILTI imposes a tax on income earned above this regular rate of return - generally, 10% - in a similar manner to Subpart F income; that is, on a current basis on U.S. Shareholders on their pro rata share of GILTI.1
The GILTI tax primarily affects shareholders of CFCs with low levels of depreciable assets as compared to their income. This can include technology companies, companies with a low adjusted asset base, and service providers with significant intangible assets and low levels of fixed and depreciable assets.
Even though GILTI adds to the punitive regime of Subpart F income, planning opportunities can minimize its impact.
The formula for GILTI is:
GILTI = net CFC tested income – [(10% x QBAI) – Interest Expense]
More precisely, GILTI equals “net CFC tested income” (defined below) minus the shareholder’s “net deemed tangible income return” (net DTIR). The shareholder’s net DTIR equals the excess (if any) of:
Every 10% U.S. Shareholder of a CFC, whether an individual or an entity, is required to include its pro rata share of GILTI in its current income in the applicable tax year. The calculation of GILTI follows three basic steps and is calculated in the aggregate for U.S. persons or entities with respect to the CFCs for which they are a 10% U.S. Shareholder (each a “relevant CFC”):
Step 1 – Calculating Net Tested Income: “Net tested income” is the gross income of the CFC less allowable deductions. Gross income for this purpose EXCLUDES:
If the allocable deductions exceed the CFC’s gross income, the CFC has a “tested loss.” If the CFC holds an interest in a partnership, net tested income includes the CFC’s distributive share of the partnership’s current year income or loss. The U.S. Shareholder’s “net CFC tested income” is the amount by which the aggregate “tested income” of all its CFCs exceeds the aggregate “tested loss” of all its CFCs. If the U.S. Shareholder does not wholly own the CFCs, the amount of the shareholder’s “net CFC tested income” is determined by taking into account only their pro rata share.
Step 2 – Calculating the Net Deemed Tangible Income Return (net DTIR): A shareholder’s “net DTIR” is 10% of the adjusted tax basis of the Qualified Business Asset Investment (QBAI) less an interest expense amount. QBAI is the CFC’s quarterly average aggregate adjusted bases of specified tangible property. Specified tangible property generally includes any tangible property used in the production of tested income,2 but must be used in a trade or business of the CFC and must be depreciable under U.S. tax rules. In addition, if the CFC holds an interest in a partnership at the end of the tax year, the CFC must include its distributive share of the aggregate of the partnership’s adjusted basis in tangible property used in the partnership’s trade or business. The interest expense component of net DTIR is interest expense included in the calculation of tested income, but only to the extent interest income attributable to that expense is not factored into the tested income calculation.
Step 3 – Calculating GILTI: A U.S. shareholder computes GILTI in the aggregate for all its CFCs. Therefore, companies with losses can offset companies with income.
Domestic Corporations Can Benefit as U.S. Shareholders Under GILTI
GILTI and FDII Deductions
As an incentive to keep intangible assets in the states, U.S. corporations are now entitled to a deduction equal to their “Foreign-Derived Intangible Income” (also known as FDII). FDII equals the portion of a U.S. corporation’s income attributable to its intangible income – determined on a formulaic basis – derived from serving foreign markets. This means income earned by the domestic corporation in connection with property or service sold to any unrelated person who is not a U.S. person to the extent that property or service is for foreign use, consumption or disposition. For this purpose, “sold” includes any lease, license, exchange, or other disposition.
In addition to the FDII deduction, U.S. corporations that have GILTI income are eligible for a corresponding deduction. For tax years beginning after Dec. 31, 2017 and before January 1, 2026, this deduction is generally equal to the sum of:
For tax years beginning after December 31, 2025, the deduction for FDII is reduced to 21.875% and the GILTI deduction is reduced to 37.5%. The GILTI and FDII deduction is limited to taxable income. To the extent that total GILTI and FDII exceeds taxable income, FDII is first reduced by the proportion of the excess of taxable income equal to the proportion of FDII to total GILTI and FDII, and the remainder reduces GILTI.
Foreign Tax Credits
Additionally, for corporate U.S. Shareholders, foreign tax credits (FTCs) are allowable for foreign income taxes paid with respect to GILTI, but they are limited to 80% of the foreign income taxes paid in the current tax year. Neither carryback nor carry forward of these foreign tax credits is permitted. Moreover, GILTI is a separate basket for FTC limitation purposes, so foreign taxes in excess of 10.5% of GILTI may never offset US tax liability.4
U.S. individuals and pass-through entities are at a significant disadvantage because they are not entitled to the FDII or GILTI deductions or foreign tax credits and thus can be taxed on GILTI income up to a maximum 37% federal tax rate. Without factoring in foreign taxes, and with the ability to deduct 50% of GILTI, C corporation shareholders effective tax rate on GILTI would be 10.5% on this income (21% corporate tax rate times 50%).
Considering some of the following planning options could potentially reduce the impact of GILTI.
It is clear that the GILTI is another tax provision that is virtually impossible for taxpayers to understand and apply without guidance from an informed tax professional. Berdon advisors are constantly analyzing evolving law and its interpretation and are ready to assist you with the GLITI or other aspects of the TCJA. If you have questions, please contact Lisa Goldman 212.699.8808 | lgoldman@BERDONLLP.com or reach out to your Berdon advisor.
Berdon LLP New York Accountants
1 A CFC is any foreign corporation in which more than 50% of the total vote or value of all classes of stock is owned, directly or indirectly, by U.S. shareholders. A U.S. shareholder is a U.S person who owns, directly or indirectly, 10% or more of the voting stock in a foreign corporation
2 The calculation excludes assets generating tested losses.
3 This example ignores, for purposes of simplicity, any “gross up” for indirect foreign taxes attributable to the GILTI amount.
4 Foreign taxes above 13.125% theoretically eliminate US liability on GILTI (10.5%/80%), but taxes above this percentage may be lost because of the no carryforward/carryback rule.