Press Room: Tax Release
Proposed Regulations on GILTI Address Numerous Computational Issues Including Treatment of Consolidated Groups
IRS and Treasury have released much-anticipated guidance in the form of proposed regulations under the new Global Intangible Low-Taxed Income (GILTI) regime enacted as part of the Tax Cuts and Jobs Act (TCJA).
What is GILTI?
The GILTI regime requires U.S. shareholders of controlled foreign corporations (CFCs) to include in U.S. federal taxable income on an annual basis their respective share of net CFC tested income in excess of a net deemed routine return on certain CFC tangible property (i.e., 10% of quarterly average U.S. tax cost basis) in excess of aggregate CFC interest expense. Net CFC tested income is the excess in the aggregate of a U.S. shareholder's share of tested income over tested loss. Income of a CFC is subject to GILTI regardless of whether the business has any intangible property or whether it is subject to a low tax rate in the local jurisdiction. Therefore, for many CFCs, the GILTI rules are anticipated to result in the vast majority of a CFC’s earnings being included in the taxable income of their U.S. shareholders on an annual basis, even if there has been no actual distribution from the CFC.
Taxpayers who are domestic C corporations are allowed a 50% deduction of their GILTI inclusion and a deemed paid foreign tax credit (both of which are subject to certain limitations) to mitigate the net U.S. federal tax liability arising from GILTI. U.S. shareholders that are not C corporations are not entitled to the deduction or the deemed paid foreign tax credit. For all taxpayers, foreign tax credits (FTC) from taxable income other than GILTI are not allowed to be used against GILTI inclusions and there is no carry forward or carry back of unused credits. Thus, non-corporate shareholders face taxation of CFC earnings at full ordinary rates on an annual basis with minimal, if any, relief via FTC.
While GILTI is effective for tax years beginning after December 31, 2017, current year tax provision calculations and estimated tax payments have already needed to take GILTI into account during 2018.
The notice of proposed rulemaking and draft regulatory text is a lengthy 157 pages that only covers a subset of GILTI issues, which reflects the complexity of the GILTI calculation.
The proposed regulations address many computational issues associated with applying the GILTI rules, including:
- An aggregate approach for determining GILTI in a consolidated group context;
- A hybrid of entity and aggregate approach for determining GILTI for CFCs owned by domestic partnerships;
- Rules for determining tested income and loss;
- Rules for calculating a U.S. shareholder’s pro-rata share of various GILTI amounts;
- Use of a netting approach for determining specified interest expense;
- Basis adjustments for certain purposes in connection with tested losses;
- Rules for application of certain deduction limitations in the context of GILTI (e.g., Sec. 267(a)(3)(B)); and
- Various anti-abuse rules, including with respect to certain acquisitions of property that might otherwise be treated as increasing qualified business asset investment (QBAI).
The proposed regulations are the first of several new regulations packages to be released by IRS with respect to GILTI and related provisions. Specifically, the preamble to the proposed regulations states that rules relating to FTCs and the deduction under Sec. 250 (with respect to GILTI and foreign-derived intangible income (FDII)) will be included in separate notices of proposed rulemaking.
Additional guidance is also pending on other new international tax provisions that may affect the impact of GILTI, including the FDII deduction and the Base Erosion and Anti-Abuse Tax (BEAT).
The new GILTI regime creates an entirely new category of taxable income affecting all taxpayers who are U.S. persons. As a result of GILTI, income of a U.S. shareholder’s CFCs is now part of the U.S. shareholder’s annual U.S. federal income tax analysis. The effect of GILTI on non-corporate taxpayers who are U.S. shareholders of CFCs is particularly harsh. If such taxpayers have not already evaluated their exposure under GILTI and investigated planning and restructuring alternatives, they should do so immediately. For calendar year taxpayers, available planning options for GILTI will be extremely limited after December 31, 2018.
While the proposed regulations provide clarity with respect to some aspects of the GILTI calculation, they do not address important related issues, such as how FTCs and business expenses will impact the tax. Despite the open issues, all taxpayers affected by GILTI should promptly evaluate their GILTI exposure for compliance and planning purposes. GILTI cannot be considered in isolation and will need to be addressed in the context of other applicable TCJA provisions.