There have been many changes in the last 12 months for US taxation of foreign entities. US shareholders of controlled foreign corporations (CFCs) have already felt the pinch of transition tax for 2017. Unfortunately, the pinch of foreign taxation changes is going to continue in 2018 and onwards thanks in part to GILTI. As the acronyms connotation implies, it is a less than popular tax change. Let us look together at some significant points related to the ominous GILTI:
- I keep hearing the phrase GILTI and seeing worried looks, what does it mean and what is it?
GILTI is the acronym for the mouthful of Global Intangible Low-Taxed Income. There is an increased worldwide thrust to stop base erosion and incentivize entities and people not to locate their business in low-tax jurisdictions. The major idea behind it is that in taxing the profits in low-tax jurisdictions, US shareholders will be less likely to relocate their CFCs to those jurisdictions in an effort to circumvent higher tax rates. Basically, it imposes a tax on income earned in jurisdictions with tax rates below a certain threshold. Many who were affected by the transition tax now need to turn their gaze towards GILTI to determine 1) if it applies to them and 2) how this alters their tax planning for the future.
- How do I know if I need to consider GILTI? Am I a US shareholder of a CFC for GILTI?
In order to be a US shareholder of a CFC for purposes of GILTI, you must be a US person that directly, indirectly, or constructively owns at least 10% of the CFC stock (by value or vote) on the last day in the CFC’s taxable year. If you are a US shareholder of a CFC for purposes of GILTI, you should begin to calculate if GILTI tax exists for you.
Example A: Colin Cogswell (US person) owns Solar Sprockets (a corporation organized outside the US). Under CFC rules, more than 50% of Solar Sprockets ownership is by US shareholders. Colin Cogswell owns 15% on the last day of the taxable year of Solar Sprockets. As a result, Colin Cogswell is a US shareholder for purposes of GILTI. Rosie Jetson (US person) owns only 5% of Solar Sprockets on the last day of the taxable year of Solar Sprockets and therefore is not a US shareholder for purposes of GILTI.
- I have heard there is a deduction for GILTI, does that apply to me?
Unfortunately, the GILTI deduction is only available to domestic C corporations who own at least 10% of the stock of the CFC.
Example B: Sun Sprickets Inc. is a US C corporation. Sun Sprickets owns 30% of Solar Sprockets from Example A. Sun Sprickets is allowed a GILTI deduction in 2018 of 50% of the GILTI inclusion and can also potentially use the foreign tax credit. However, Colin Cogswell is a US individual and is not able to use the GILTI deduction.
- How do you calculate the GILTI inclusion amount?
Now, hold onto your hats because it is about to get complicated. GILTI inclusion is Net CFC tested income less 10% of Qualified Business Asset Investment (QBAI) and less interest expense.
What is Net CFC Tested Income? Essentially, you take the CFC’s gross income and subtract exclusions. Such exclusions would be comprised of income included in determining subpart F, income that is effectively connected with a US trade or business, and dividends from related persons. Then this is reduced by the deductions allocable to the gross income.
QBAI is trickier. QBAI is the aggregate adjusted bases as of the close of each quarter of tangible property used to produce tested income in the CFC’s trade or business and of a type that a depreciation deduction would be allowable.
Example C: Elroy’s Widgets Inc (domestic C-corp.) owns 100% Galaxy Widgets (a CFC). Galaxy Widgets has specified tangible property of $25 million each quarter of 2018. Galaxy Widgets also has $17.5 million of gross income, allocable deductions of $14 million, and interest expense of $0. The tested income is $3.5 million (17.5M-14M). The QBAI is $2.5 million (10% of the $25 million quarterly average of specified tangible property). GILTI inclusion income is $1 million. Because Elroy’s Widgets is a domestic C-corporation, it may take a 50% deduction in 2018.
- What tax rates will result in GILTI inclusion tax?
As a domestic C-Corporation shareholder of a CFC, the tax will apply for effective foreign tax rates less than 13.125% for years 2018-2025. The rate increases for years after 2025.
Example D: Continuing from example C, Elroy’s Widgets has a US tax rate of 21%, and Galaxy Widgets has a foreign tax rate of 15%. Galaxy Widgets has paid $150,000 of taxes on the $1 million of GILTI inclusion. Elroy’s Widgets is able to take an 80% foreign tax credit of $120,000 (80% x $150,000 foreign taxes). GILTI inclusion less GILTI deduction is $500,000 ($1 million GILTI inclusion x50% deduction for 2018). The tax on the shareholder would be $105,000, but the foreign tax credit of $120,000 offsets the GILTI liability.
Say the foreign tax rate was 10%. The foreign tax credit would have been $80,000 ($1M inclusion x 10% tax x 80% allowed), and therefore the GILTI tax liability would have been $25,000. So, you can see first hand how the foreign tax rate impacts the GILTI calculation.
- What are some issues related to GILTI?
Some of the main issues are related to how this applies to non-C corporation shareholders. Particularly with regards to the deductions, credits, and rates. For example, a US person who owns 100% of a CFC could face up to 37% tax on the whole GILTI inclusion on top of the foreign tax paid. This is due to not being able to take the GILTI deduction and generally not being able to take a foreign tax credit. Also, individuals will potentially have higher rates than a corporation. Another big area of consideration is how this will play out on a state level. Many states utilize the federal income for determining state tax. State taxes could be affected by GILTI too, making it not just a federal matter.
As you can probably tell, this is a complicated subject matter. If you own part of a CFC you should strongly consider seeking out a qualified tax professional. It is very important to engage qualified tax professionals to assist with these calculations especially as more comments are submitted by CPAs and more guidance is issued by the IRS.
The International Tax Team at Ryan & Wetmore is well-versed in foreign informational filings and complicated tax matters related to foreign activity. For questions or concerns regarding your international accounts, entities, and assets click here to email our foreign tax team. Please be aware that tax issues are complicated and may vary based on the details of your situation. For this reason, an initial phone call is generally required to obtain the facts and address the questions.
Bethany Bouw CPA, is a manager at Ryan & Wetmore and has been with the firm for over eight years. She has experience with offshore voluntary compliance and assisting taxpayers with foreign asset and entity reporting requirements.
Traci Getz CPA, is a partner with Ryan & Wetmore, P.C. Traci has over fifteen years of experience providing accounting, tax, and consulting services to small and medium-sized business owners. She works with clients to understand their accounting and tax issues while specializing in international tax, healthcare, and construction.
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