The addition of a new tax on global intangible low-taxed income (GILTI) in the Tax Cut and Jobs Act dealt taxpayers a new hand, with both opportunities and costs. The government released final and proposed regulations dealing with the GILTI high-tax exception (HTE) in late June 2019. The GILTI HTE could provide a generous benefit because taxpayers would be able to remove GILTI CFCs from their calculation of GILTI, and therefore lower their GILTI inclusion.
The proposed regulations expand the scope of this exception, thereby providing further relief to taxpayers as the exception becomes more broadly applicable. This article discusses the statutory framework, the final regulations’ treatment of the HTE, and how taxpayers should analyze the proposed regulations when taking the GILTI HTE.
THE FLOP (STATUTORY FRAMEWORK)
New tax code Section 951A, GILTI, introduced as a new regime to tax intangible income that was not captured under the Subpart F regime.
Similar to the HTE contained in tax code Subpart F, the GILTI HTE would give some taxpayers the ability to reduce their GILTI inclusion by excluding tested income items for controlled foreign corporations (CFCs) that have an effective tax rate above 18.9% (90% of the U.S. statutory corporate tax rate of 21%). Section 951A(c)(2)(A)(i)(III) provides that the HTE described in Section 954(b)(4) includes GILTI along with Subpart F HTE (substituting “tested income” for “Subpart F income”). Since Subpart F has laid much of the framework for how GILTI gets included for inclusion purposes, it is not a surprise that GILTI and Subpart F would share the same deck in tax law when it comes to the HTE.
THE RIVER CARD (FINAL AND PROPOSED REGULATIONS)
Under the final regulations, foreign base company income and insurance income are the only types of income excluded as part of the GILTI HTE. As a result, GILTI could tax other high-taxed income such as active business income or financing income. The proposed regulations expand the scope of income sources to elect to exclude all high-taxed income, not only foreign base company income or insurance income. Although GILTI may share the same deck in Section 954(b)(4), there are differences that do make the GILTI HTE a different card in the same suit. Taxpayers should know and understand these differences when looking to apply the GILTI HTE.
A DIFFERENT CARD IN THE SAME SUIT
There are both potential benefits and drawbacks of making the HTE provided by the proposed regulations, the below factors should be considered in making the decision:
Pros (hit me with another card):
• Taxpayers can exclude tested items for CFCs with tax rates above 18.9% and lower their GILTI inclusion.
• The GILTI HTE election is made annually, so you aren’t stuck with it forever if you decide to make it in one year.
• Even though the election can be revoked, there are consequences stacked against you. If the election is revoked, there is a waiting period of 60 months (5 years) before the election can be made again. That is a long time to wait to get this potential benefit.
• This is an “all or nothing” election applied to all CFCs in the consolidated group. The application of the election would be for all CFCs that are above the given high taxed rate of 18.9%. As a result, a downside of the GILTI HTE election is that a HTE CFC that had high-tax foreign tax credits (FTCs) previously netted against GILTI liability would be excluded from the consolidated calculation of GILTI liability, resulting in a higher net GILTI liability.
While the election in the proposed regulations is not currently available and will probably not be retroactive, taxpayers should be analyzing the impact that making this election will have on their tax position, should the proposed election (or something similar) be adopted by future final regulations. There are several steps to this analysis that cannot be missed to be able to claim the election. Below are important steps that should be followed when doing the calculation:
• prepare gross income separately for each qualified business unit (QBU) to assess gross tested income items on a separate basis (i.e. on an income by income basis),
• allocate and apportion the QBU deductions to get net tested income items,
• allocate taxes based on the complementing foreign tax credit basket methodology,
• calculate the effective tax rate (ETR) for each net tested income item by QBU,
• exclude CFCs that are above an 18.9% effective tax rate; and
• compare group taxable income with and without the election.
SHOW OR FOLD
As mentioned, the election in the proposed regulations cannot be applied to tax returns currently. Nevertheless, some taxpayers are already including the GILTI HTE election in their current GILTI modeling exercises. Below are a list of some potential questions that have been asked by taxpayers while we wait to hear about the proposed regulations being final:
• Is the HTE retroactive to apply to the first GILTI inclusion year in the 2018 tax return?
• Will an all-or-nothing approach be revised so that the election can be made CFC-by-CFC?
• Can the HTE put me in a worse answer in GILTI?
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
David Flores is a senior manager at True Partners Consulting in Long Island, N.Y. David provides tax compliance, provision, and consulting services to large multinational clients. He can be emailed at David.Flores@TPCtax.com.