Global Intangible Low-Tax Income – Working Example. Executive Summary
Does your Corporation own greater than 50% of a business established in a foreign country?
Beginning January 1, 2018, US entities will be subject to a tax on Global Intangible Low-Tax Income (GILTI) of their subsidiary controlled foreign corporations (CFC).
The income and tax associated with GILTI is eligible for certain deductions and foreign tax credits for US Corporations only.
Do you or your pass-through entity own greater than 50% of a business established in a foreign country?
Pass-through entities and individuals are subject to the new GILTI tax and do not receive the same deductions and tax credits as Corporations.
However, there is an election to have their CFC income taxed at the corporate level which provides them a 21 percent flat tax rate along with offsetting foreign tax credits.
Corporations, pass-through entities, and individuals should be starting to speak with their tax advisor as soon as possible since 2018 is already half-way. Asset acquisitions and entity elections need to be established before year-end in order to reduce your overall tax liability associated with these new laws.
The 2017 Tax Cuts and Jobs Act (TCJA) enacted a specific tax on Global Intangible Low-Tax Income (GILTI) to discourage United States (US) persons from building wealth in low-tax jurisdictions through controlled foreign corporations which begins January 1, 2018
Before the enactment of the TCJA in December 2017 entities with valuable intangible assets would set up a controlled foreign corporation (CFC) in a low-tax foreign country to hold their intangible assets. The United States parent company would pay a licensing fee for use of the intangible property which resulted in shifting income from the US to the low-tax jurisdiction. The US government did not like the idea of easily avoiding US income tax on this intangible revenue so they decided to make a change by enacting a tax on Global Intangible Low-Tax Income, IRC §951A.
GILTI Tax Example- US Corporation
The Global Intangible Low-Taxed Income tax was put in place to counter-act profit shifting to low-tax jurisdictions. This process goes through a calculation of reducing a CFC’s total tested income by the net deemed income from tangible assets. The variance can be considered income from a CFC’s intangible assets which is included in the shareholder’s income.
To begin, there are a few key terms which need to be defined to better understand the GILTI calculation:
Controlled Foreign Corporation: Any foreign corporation of which more than 50% of its stock by vote of value is owned by US shareholders.
e. A foreign corporation that has 3 US shareholders that own 20% each and one foreign shareholder that owns 40% would be considered a CFC since greater than 50% of the outstanding stock is owned by US shareholders.
Tested Income: The gross income of a CFC excluding the following:
-Subpart F income
-US effectively connected income
-Subpart F income that is excluded due to the high tax exception
-Dividends received from a related person
-Foreign gas and oil income less deductions attributable to such income.
Qualified Business Asset Investment (QBAI): The average of the adjusted bases in specified tangible property subject to depreciation used in a trade or business determined on a quarterly basis of the taxable year. The adjusted bases is determined using the Alternative Depreciation System (ADS) and allocates the depreciation ratable to each day during the taxable period.
Global Intangible Low-Tax Income:
GILTI = Net CFC Tested Income – (10 percent x QBAI) – Interest Expense)
Example: ABC Company is a US Corporation that owns 100% of two manufacturing plants located in a foreign country. CFC 1 distributes its products to both the US and foreign countries while CFC 2 strictly sells their products to foreign consumers.
Since ABC Company owns 100% of both foreign manufacturing plants these entities are considered controlled foreign corporations for US tax purposes. CFC 1 has net tested income for the current year and CFC 2 has a net tested loss resulting in a combined net tested income of $2,200,000. IRC §951A(c).
As a check a company can use the GILTI formula defined in the key terms listed above:
2,200,000 – (10% x 1,300,000) – 10,000) = $910,000
CFC 1 owns the manufacturing facility while CFC 2 leases their facility and each CFC. Additionally, each CFC has recalculated their depreciation based on Alternative Depreciation System (ADS) rules. IRC §951A(d)(3). The ADS depreciation recalculation offers a higher exclusion base for the QBAI since it typically has longer lives for certain assets and calculates on the straight-line method of depreciation.
An entity is also required to use the aggregate quarterly average adjusted bases for their CFC assets. This means that entities who plan to purchase a significant amount of assets at year-end to decrease their GILTI tax will be subject to averaging those assets with the first three quarters adjusted bases which means less of a tangible asset exclusion from the total tested income.
Once the QBAI is calculated an entity calculates the net deemed tangible income return by multiplying the QBAI amount by 10 percent then subtract any interest expense paid to unrelated parties. The deemed tangible income return is the exclusion amount used to offset the amount of net tested income which results in the Global Intangible Low-Tax Income.
There are three different types of US shareholders of controlled foreign corporations, Corporations, pass-through entities, and individuals. Under IRC §250 only Corporations are eligible for the 50 percent GILTI deduction and indirect foreign tax credits associated with GILTI. The 50 percent deduction is taken directly from the amount of GILTI included on the parent corporations US tax return as a result of IRC §951A.
Additionally, under IRC §960(d) there is a deemed foreign tax credit (FTC) based on the tax paid or accrued by a controlled foreign corporation attributable to the tested income calculated under IRC §951A. The FTC is calculated by calculating an inclusion percentage (GILTI divided by total tested income) which in this example would be 41.36 percent ($910,000/2,200,000). The aggregate foreign taxes paid or accrued on the tested income is $125,000 ($2,500,000 x 5%) which multiplied by the inclusion percentage results in net foreign tax paid or accrued by the CFC of $51,705. The last part of this calculation is to limit the foreign tax paid or accrued by 80% resulting in a net foreign tax credit of $41,364 which can be used to offset the GILTI tax. The above example uses a 5 percent tax rate which results in a balance due of $54,186 from GILTI in addition to tax the US parent corporation owes from their US operations.
If the local tax rate of the CFC were higher (i.e. 12.5 percent) then the result would be much different as the total foreign tax credit of $103,409 would be higher than the total US tax on GILTI. The GILTI provisions created a new bucket when calculating the FTC called the “GILTI” bucket. The provision states a corporation cannot carryforward or carryback any excess foreign tax credit that is directly related to GILTI.
GILTI – Considerations for Individual Shareholders
Individual shareholders of a CFC typically will pay a higher tax on the GILTI inclusion since they have higher tax brackets, are not eligible for the 50 percent deduction, and are not eligible for indirect foreign tax credits. However, there are tax planning considerations individuals should consider when contemplating their GILTI tax.
IRC §962 defines a special rule which allows an election for individual shareholders to be taxed at corporate rates on the earnings of their CFC. This means that the GILTI will be eligible for the new corporate tax rate of 21% along with eligibility for foreign tax credits to reduce the overall tax burden.
Global Intangible Low-Tax Income inclusion under the Tax Cuts and Jobs Act is something that every owner of a controlled foreign corporation should be analyzing during 2018 in order to make the best tax planning decisions before year-end. Certain corporations may find it beneficial to increase the amount of tangible property in their CFC while others may decide to restructure their CFC all-together. Individual shareholders should pay close attention to their amount of GILTI because making an election to have their CFC income taxed at the corporate level could result in significant tax savings.
At MKS&H, we have the experience and knowledge to guide you through these complex tax calculations and provide individualized tax planning to help create you a more profitable future.
Article Contributed by Shawn Burman, CPA
Senior Tax Accountant