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Treasury Releases Final GILTI High-Tax Exclusion Regulations

by Jon Davies, Surbhi Bordia
July 22, 2020

Updated August 11, 2022


On July 20, the U.S. Treasury finalized the much-awaited global intangible low-taxed income (GILTI) high-tax exception rules. In response to the comments received on the 2019 proposed regulations [REG-101828-19 under sections 951, 951A, 954, 956,958, and 1502 in the Federal Register (84 FR 29114, as corrected at 84 FR 37807)], the final regulations allow companies to choose to apply the GILTI high-tax exclusion to taxable years of foreign corporations that begin after December 31, 2017, and before July 23, 2020.

The final regulations now provide that GILTI high-tax exclusion is an annual election and have eliminated the 60-month restriction to revoke or make changes to the election, which was put in the proposed regulations to prevent abuse.

The GILTI high-tax exclusion applies if the effective foreign tax rate is 90% of the rate that would apply if the income were subject to the maximum rate of tax specified in section 11 (currently 18.9%, based on a maximum rate of 21%).

If GILTI high-tax exclusion applies and is availed, such income will not be subject to U.S. federal income tax.

Calculations for GILTI Inclusion Amount

The calculations for GILTI inclusion amount are primarily driven by this formula:

GILTI inclusion amount = net CFC tested income – NDTIR

There are many defined terms and other supporting formulas in order to understand how to use this primary formula. The supporting formulas are used to determine a U.S. shareholder’s pro rata share of the relevant CFC’s “test items.” The CFC tested items include many defined terms such as tested income, tested loss, qualified business asset investment (QBAI), etc.

The calculation of the GILTI tax can be summarized by the following steps:

  1. Determine the U.S. shareholder’s CFC tested items of each CFC
  2. Determine the U.S. shareholder’s pro rata share of each of its CFC’s tested items
  3. Determine the U.S. shareholder’s GILTI inclusion amount
  4. Determine the U.S. shareholder’s GILTI related foreign taxes paid, if applicable
  5. Determine the U.S. shareholder’s GILTI tax liability
  6. Adjust relevant CFC’s E&P and stock basis

Step 1 includes calculation of the CFC-tested items at each CFC level in U.S. dollars using the appropriate foreign exchange rates. A CFC with tested income is called a tested income CFC while a CFC with tested loss, a tested loss CFC. QBAI, a new defined term for GILTI, is the aggregate of all tested income CFCs’ average quarterly adjusted bases of specified tangible property determined under special rules. A CFC with a large amount of specified tangible property, generally tangible fix assets used in the production of tested income, may need to go back many years to figure out the tax bases under the GILTI rules. It is important to note that only a tested income CFC has QBAI. A tested loss CFC has no QBAI, even if the CFC is a tested income CFC in other tax years.

Step 2 determines the U.S. shareholder’s pro rata share of each of its CFC’s tested items, generally based on the U.S. shareholder’s ownership percentage in the CFC. Calculations may become complicated for a CFC with multiple classes of stock including preferred stock. Rules are different for a partner’s distributive share of GILTI inclusion amount from a domestic partnership that is a U.S. shareholder of a CFC (a “partnership CFC”), depending whether the partner of the domestic partnership is also a U.S. shareholder of the partnership CFC.  Special rules are provided for tiered U.S. shareholder partnerships.  New reporting requirements are provided for U.S. shareholder partnerships to report relevant information to their partners with schedule K-1.

In Step 3, the U.S. shareholder’s pro rata CFC-tested items from all its CFCs are aggregated, netted or multiplied, as relevant, according to the formulas described above, so that the GILTI inclusion amount is determined under the primary formula:

GILTI inclusion amount = net CFC tested income – NDTIR

Step 4 determines foreign tax credits (FTCs) that are generally available only to a corporate U.S. shareholder. However, an election is available to an individual U.S. shareholder to claim FTC, discussed below.

Step 5 determines the tentative GILTI tax by multiplying the relevant tax rate and the U.S. shareholder’s GILTI inclusion amount. Corporate U.S. shareholders are entitled to a Section 250 deduction, which permits a deduction equal to 50% (37.5% after 2025) of its GILTI inclusion amount. Since the corporate tax rate is 21%, the effective U.S. federal income tax rate on GILTI is 10.5% before the FTC. This tentative GILTI tax could be reduced by the deemed paid FTCs determined under the GILTI rules. This means that for certain U.S. shareholders, the GILTI tax liability could be reduced to zero.

Finally, in Step 6, the Proposed Regulations determine how to allocate the GILTI inclusion amount back to tested income CFCs. There are also a complex set of rules to determine the adjustment of the stock basis in a tested loss CFC by a corporate U.S. shareholder.

Key Takeaways

Below are the key takeaways of the final regulations:

  1. Modify application of high-tax exclusion (i.e., determination of the effective foreign tax rate) based on a qualified business unit by qualified business unit (QBU by QBU) approach to a tested unit approach. Did not adopt a controlled foreign corporation by controlled foreign corporation (CFC by CFC) approach as requested under numerous comments.
    1. QBU is defined under section 989(a) as any separate and clearly identifiable unit of a trade or business of a taxpayer that maintains separate books and records.
    2. In contrast, the tested unit approach generally applies to the extent an entity, or the activities of an entity, are actually subject to tax, as either a tax resident or a permanent establishment (or similar taxable presence), under the tax law of a foreign country. In principle, the final regulations provide three categories of tested unit: (a) a CFC itself; (b) a pass-through entity held directly or indirectly by a CFC; and (c) a branch – (i) resulting in a CFC’s taxable presence in the country in which the branch is located, or (ii) giving rise to taxable presence under the owner’s tax law and that owner’s tax law provides an exclusion, exemption or other similar relief (such as a preferential rate) for income attributable to the branch.
  2. Conform GILTI high-tax exclusion rules with the rules implementing the subpart F high-tax exception and thereby eliminate the disparity between the two elections and the incentive for taxpayers to structure into the subpart F high-tax exception.
  3. Retain the 2019 proposed regulations that effective foreign tax rate be determined by referencing the amounts of income and taxes at the CFC level, rather than the amount of taxes that would be deemed paid, under section 960, at the U.S. shareholder level.
  4. Require the reallocation of gross income attributable to disregarded payments between the tested units, to appropriately associate the income with the tested unit in which it is subject to tax. There are additional rules on ordering of reallocation with respect to multiple disregarded payments.
  5. Do not consider the comments that allow taxpayers to elect to adjust either the numerator or denominator of the effective foreign tax rate fraction to take into account foreign net operating loss carryforwards and other similar items.
  6. Allow, in general, combination rule pursuant to which the tested units of a CFC (including the CFC tested unit), other than certain nontaxed branch tested units, are treated as a single tested unit if the tested units are tax residents of, or located in, the same foreign country.
  7. Retain consistency requirements pursuant to which a GILTI high-tax exclusion election is either made with respect to each member of the CFC group or is not made for any member of the CFC group. CFC group is defined under the final regulations as an affiliated group under section 1504(a), with certain modifications.

Allow U.S. shareholders to make (or revoke) the GILTI high-tax exclusion election with an amended income tax return. Provide special rules in the event a CFC has multiple U.S. shareholders; in that case, requires all U.S. shareholders rather than controlling U.S. shareholders to make (or revoke) such election.

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For a detailed discussion on how these provisions may apply to your organization’s specific facts, contact our international tax team.

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Author
Jon Davies - Partner, Tax - San Jose CA | Armanino
Partner
Surbhi Bordia, Tax
Partner
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