Mideast Peace Dividend May Be Eligible for GILTI Deduction and Foreign Tax Credit

In August 2020, the UAE issued a decree aimed at eliminating the UAE boycott of Israel. In September 2020, the UAE and Israel, and Bahrain and Israel, signed the Abraham Accords, designed to normalize their commercial relations. In October 2020, Sudan and Israel likewise announced an agreement towards normalizing commercial relations.

At the time of the Sudan agreement, President Trump indicated that Saudi Arabia and four other Arab countries are likewise moving towards normalizing relations with Israel. As a result of these intergovernmental accords and future Arab League country implementing laws, in the future, there may well be correspondingly fewer demands to companies to agree, and therefore fewer agreements by companies, to participate in or cooperate with the Arab League boycott against Israel as a condition of doing business within Arab League countries or with the government, a company, or a national of an Arab League country. Such agreements generally are characterized as participation or cooperation with an international boycott by tax code Section 999(b)(3).

Tax Implications

An agreement that constitutes participation or cooperation with an international boycott, by a foreign or U.S. member of a U.S. taxpayer’s controlled group, or a U.S. taxpayer itself, can trigger adverse U.S. income tax consequences. Most notably, Subpart F income can be triggered under Section 952(a)(3), and Section 901 direct foreign taxes and Section 960 deemed paid foreign corporate income taxes can be denied creditability under Section 908(a). However, Section 901 taxes are not denied deductibility, and no Section 78 gross-up is required for the disallowed Section 960 deemed paid taxes. Interest-charge-domestic international sales corporation (DISC) deferred income can also be triggered under Section 995(b)(1)(F)(ii), but any such acceleration is typically economically immaterial.

Of course, transactions potentially implicating the Arab League boycott of Israel may also raise non-tax U.S federal legal issues and U.S. state law issues. For example, U.S. legal prohibitions on Arab League boycott participation can arise under the U.S. Department of Commerce Regulations in 15 C.F.R. Part 760. These transactions may also raise foreign legal issues in foreign countries that either prohibit or enforce the boycott.

The Subpart F income inclusion and the foreign taxes denied creditability are both computed based on an “international boycott factor” described in Section 999(c)(1), or, if the taxpayer qualifies and so elects, the “specifically attributable” method described in Section 999(c)(2). The most recent IRS Statistics of Income Bulletin comparing the utilization of these methods shows that over the 9-year period reported, the Section 999(c)(2) specifically attributable method was utilized to compute 94% of the Subpart F inclusions and most of the foreign tax credit disallowances.

Under the specifically attributable method, a U.S. shareholder of a controlled foreign corporation (CFC) generally treats, as an addition to Subpart F income, the net income of the CFC which is attributable to the operations in which there was participation or cooperation with an international boycott. Similarly, the foreign taxes disallowed are those attributable to the operations in which there was participation or cooperation with an international boycott.

Section 951A(c)(2)(A)(i)(II) generally excludes from global intangible low-taxed income (GILTI) Subpart F income. Curiously, Treasury Regulation Section 1.951A-2(c)(4)(ii)(C), promulgated in 2020, excludes from GILTI the Subpart F income computed under the Section 999(c)(1) international boycott factor method. As noted above, the IRS Statistics of Income indicate that, historically, overwhelmingly, U.S. shareholders treat as Subpart F income arising from international boycott related transactions the presumably lower specifically attributable amount described in Section 999(c)(2). One suspects that Treasury did not intend that the excess of a CFC’s hypothetical Section 999(c)(1) amount over the included Section 999(c)(2) amount escapes both Subpart F income characterization under Section 999(c)(2) and GILTI characterization under Treas. Reg. Section 1.951A-2(c)(4)(ii)(C), but Treasury should clarify this point.

UAE Liberalization

In March 2020, the United Arab Emirates (UAE) released new foreign investment rules. The revised rules generally permit non-UAE parent corporations to own 100% of UAE subsidiaries which engage in enumerated activities in the UAE agricultural, manufacturing, and service sectors, subject to certain minimum capital and other criteria. The UAE advises that the UAE generally does not impose corporate income tax on such activities. Rather, the UAE generally only taxes mining and foreign banking activities.

The most recent IRS Statistics of Income publication, based on e-filed Forms 5713 for 2017, states that 42% of international boycott agreements related to the UAE. Nevertheless, it may be that the UAE has been the source of a smaller percentage of the Section 952(a)(3) Subpart F inclusions and Section 908(a) foreign tax credit disallowances. The U.S. Congressional Research Service (CRS) reported in 2020 that the UAE’s participation in the Arab League boycott from 1994 to 2020 had been limited to enforcing the primary boycott of Israel. The primary boycott generally prohibits companies of an Arab League member from buying from, selling to, or entering into a business contract with the Israeli government or an Israeli citizen . Under Sections 999(b)(4)(B) and 999(b)(4)(C), a company’s agreement to comply with a foreign law prohibition on importing Israeli-manufactured goods, or with a foreign law prohibition on exporting goods to Israel, will not be the basis of the loss of tax benefits although, under Q&A A-9 of the 1978 Treasury Guidelines, 43 Fed. Reg. 3454 (1/25/78), such agreement must be reported on Form 5713. CRS also noted that enforcement of the boycott was sporadic, especially in the Gulf States. As mentioned above, in August 2020, the UAE announced that it would no longer participate in the Arab League boycott of Israel.

In its October 2020 quarterly list of boycotting countries, the Treasury stated that in view of the UAE August 2020 announcement, the Treasury is monitoring the situation to determine if the UAE should favorably be removed from its long-standing place on Treasury’s list of Israel-boycotting countries adversely described in Section 999(a)(1)(A).

Removal of a country from the Treasury’s Section 999(a)(1)(A) boycott list does not necessarily prevent the adverse creation of Subpart F income under Section 952(a)(3) and the adverse loss of foreign tax credits under Section 908(a) by reason of participation or cooperation involving that country. Nevertheless, certain of the 1978 Treasury Guidelines, e.g. Q&A H-4, refer to agreeing to comply with the rules of a boycotting country as entering into a boycott-related agreement, triggering the potential application of Sections 952(a)(3) and 908(a). Any future removal of the UAE from the Treasury’s Section 999(a)(1)(A) list may bolster a taxpayer’s argument that the UAE is no longer adversely described in those Guidelines.

Conclusion

Companies will wish to monitor the position of the Treasury, as well as that of the Commerce Department and other regulators, on whether the ongoing normalization of relations between Israel and various Arab League members may eventually allow certain activities to no longer be described by U.S. anti-boycott legislation. For example, elimination of participation in the boycott of Israel by the UAE might lead a U.S. company to consider taking advantage of the March 2020 UAE foreign investment restrictions to form a non-UAE-taxed UAE subsidiary, whose net income may escape Subpart F income characterization under Section 952(a)(3).

Under Section 951A, low-tax CFC net income will nevertheless generally be included in the U.S. shareholder’s GILTI. However, GILTI is often, though not always, taxed to the U.S. parent at a lower effective U.S. corporate income tax rate than boycott-triggered or other Subpart F income. That is because Section 250(a)(1)(B) in some cases provides a U.S. parent a corporate income tax deduction of 50% of GILTI, whereas Subpart F inclusions do not receive the Section 250(a)(1)(B) deduction. The Biden tax plan, which includes a 28% general corporate income tax rate and 21% GILTI rate, may likewise create a lower tax rate for GILTI than Section 952(a)(3) Subpart F inclusions. Nevertheless, because of the interaction of the Section 250(a)(1)(B) deduction with such items as the U.S. parent’s foreign tax credit and net operating loss position, often modeling will be necessary to quantify whether, and, if so, how much, U.S. shareholder income tax will be saved.

This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Author Information

Alan S. Lederman is a shareholder at Gunster,Yoakley & Stewart, P.A. in Fort Lauderdale, Fla.