One of the central features of the Tax Cuts and Jobs Act of 2017 (TCJA) is its reformation of the U.S. system for taxation of international taxpayers and their activities. In so doing, Congress created a new category of taxable income: global intangible low-taxed income (GILTI). The title of the tax, though, is misleading. While it appears to target intangible income held in low-tax foreign jurisdictions, it may actually apply to any type of income earned in many jurisdictions.
GILTI Tax: General Rule
The law essentially dictates a regular rate of return that U.S. shareholders owning 10% or more of a controlled foreign corporation (CFC) can earn on their overseas business assets without having this income subject to current U.S. taxation. GILTI imposes a tax on income earned above this regular rate of return—generally, 10%—in a similar manner to Subpart F income; that is, on a current basis on U.S. shareholders on their pro rata share of GILTI. (A CFC is any foreign corporation in which more than 50% of the total vote or value of all classes of stock is owned, directly or indirectly, by U.S. shareholders. A U.S. shareholder is a U.S person who owns, directly or indirectly, 10% or more of the voting stock in a foreign corporation.)
The GILTI tax primarily affects shareholders of CFCs with low levels of depreciable assets as compared to their income. This can include technology companies, companies with a low adjusted asset base, and service providers with significant intangible assets and low levels of fixed and depreciable assets.
Although GILTI adds to the punitive regime of Subpart F income, planning opportunities can minimize its impact.
The formula for GILTI is as follows:
GILTI = net CFC tested income − [(10% × QBAI) − Interest Expense]
More precisely, GILTI equals “net CFC tested income” (defined below), minus the shareholder’s “net deemed tangible income return” (net DTIR). The shareholder’s net DTIR equals the excess (if any) of:
- 10% of the aggregate of its pro rata share of the qualified business asset investment (QBAI) of each CFC in which it is a U.S. shareholder, over
- the amount of interest expense taken into account in determining its net CFC tested income for the year (but only to the extent that the interest expense exceeds the interest income included in CFC tested income).
Every 10% U.S. shareholder of a CFC, whether an individual or an entity, is required to include its pro rata share of GILTI in its current income in the applicable tax year. The calculation of GILTI follows three basic steps and is done in the aggregate for U.S. persons or entities with respect to the CFCs for which they are a 10% U.S. shareholder (each a “relevant CFC”):
Step 1: Calculating net tested income.
“Net tested income” is the gross income of the CFC, less allowable deductions. Gross income for this purpose excludes the following:
- Income that is effectively connected with a U.S. trade or business;
- Subpart F income (certain narrowly defined categories of income from specified activities, usually involving related parties or passive type income);
- Income that is excluded from Subpart F income because it is subject to an effective foreign income tax rate greater than 90% of the maximum U.S. corporate income tax rate;
- Dividends received from related persons; and
- Certain foreign oil and gas income.
If the allocable deductions exceed the CFC’s gross income, the CFC has a “tested loss.” If the CFC holds an interest in a partnership, net tested income includes the CFC’s distributive share of the partnership’s current year income or loss. The U.S. shareholder’s “net CFC tested income” is the amount by which the aggregate tested income of all its CFCs exceeds the aggregate tested loss of all its CFCs. If the U.S. shareholder does not wholly own the CFCs, the amount of the shareholder’s net CFC tested income is determined by taking into account only the pro rata share.
Step 2: Calculating the net deemed tangible income return (net DTIR).
A shareholder’s net DTIR is 10% of the adjusted tax basis of the QBAI, less an interest expense amount. QBAI is the CFC’s quarterly average aggregate adjusted bases of specified tangible property. Specified tangible property generally includes any tangible property used in the production of tested income (the calculation excludes assets generating tested losses), but it must be used in a trade or business of the CFC and must be depreciable under U.S. tax rules. In addition, if the CFC holds an interest in a partnership at the end of the tax year, the CFC must include its distributive share of the aggregate of the partnership’s adjusted basis in tangible property used in the partnership’s trade or business. The interest expense component of net DTIR is interest expense included in the calculation of tested income, but only to the extent that the interest income attributable to that expense is not factored into the tested income calculation.
Step 3: Calculating GILTI.
A U.S. shareholder computes GILTI in the aggregate for all its CFCs; therefore, companies with losses can offset companies with income.
Domestic Corporations Can Benefit as U.S. Shareholders
As an incentive to keep intangible assets in the states, U.S. corporations are now entitled to a deduction equal to their foreign-derived intangible income (FDII). FDII equals the portion of a U.S. corporation’s income attributable to its intangible income—determined on a formulaic basis—derived from serving foreign markets; that is, income earned by the domestic corporation in connection with property or service sold to any unrelated person who is not a U.S. person to the extent that property or service is for foreign use, consumption, or disposition. For this purpose, “sold” includes any lease, license, exchange, or other disposition.
In addition to the FDII deduction, U.S. corporations that have GILTI income are eligible for a corresponding deduction. For tax years beginning after December 31, 2017, and before January 1, 2026, this deduction is generally equal to the sum of 37.5% of FDII, plus 50% of GILTI.
For tax years beginning after December 31, 2025, the deduction for FDII is reduced to 21.875% and the GILTI deduction is reduced to 37.5%. The GILTI and FDII deduction is limited to taxable income. To the extent that total GILTI and FDII exceeds taxable income, FDII is first reduced by the proportion of the excess of taxable income equal to the proportion of FDII to total GILTI and FDII, and the remainder reduces GILTI.
A domestic corporation has $3,000 of FDII, $2,000 of GILTI, and total other taxable income of $4,000. The sum of the corporation’s FDII and GILTI is $5,000, exceeding total other taxable income by $1,000. The amount of FDII for which a deduction is allowed is reduced by $600 ($1,000 × $3,000/$5,000), to $2,400. The amount of GILTI for which a deduction is allowed is reduced by the remainder of the excess ($400) to $1,600. Applying the statutory rates, the corporation’s GILTI and FDII deduction equals $1,700, the sum of $900 ($2,400 × 37.5%) and $800 ($1,600 × 50%). The resulting taxable income, then, is $2,300 ($4,000 less the $1,700 GILTI and FDII deduction). This example ignores, for purposes of simplicity, any “gross up” for indirect foreign taxes attributable to the GILTI amount.
Foreign Tax Credits
In addition, for corporate U.S. shareholders, foreign tax credits (FTC) are allowable for foreign income taxes paid with respect to GILTI, but they are limited to 80% of the foreign income taxes paid in the current tax year. These foreign tax credits cannot be carried forward or back. Moreover, GILTI is a separate basket for FTC limitation purposes, so foreign taxes in excess of 10.5% of GILTI may never offset U.S. tax liability. Foreign taxes above 13.125% theoretically eliminate U.S. liability on GILTI (10.5%/80%), but they may be lost due to the no carryforward/carryback rule.
U.S. individuals and pass-through entities are at a significant disadvantage, because they are not entitled to the FDII or GILTI deductions or foreign tax credits and thus can be taxed on GILTI income up to a maximum 37% federal tax rate. Without factoring in foreign taxes, and with the ability to deduct 50% of GILTI, C corporation shareholders’ effective tax rate on GILTI would be 10.5% on this income (21% corporate tax rate times 50%).
For those taxpayers that will be negatively affected, some of the following planning options could potentially reduce the impact of GILTI.
Creating parity between corporate taxation and individual taxation.
The IRC section 962 election allows individuals investing in CFCs to receive the same tax treatment they would have had if they had invested through domestic corporations. By making this election, individual shareholders, including shareholders who own CFCs through trusts, partnerships, and S corporations, are treated as corporations eligible to claim the foreign tax credits associated with GILTI inclusions. Similar to corporations, individuals making this election are subject to a second tax on subsequent distributions of corporate earnings. It is unclear whether this election will entitle individuals to claim the deduction described above on GILTI income.
Holding CFCs through a domestic C corporation.
Individual shareholders or pass-through entities may want to hold their CFCs through a C corporation. This will allow taxpayers to claim credits and deductions associated with GILTI inclusions that they would not ordinarily be permitted to take. Taxpayers should take care, however, to avoid the personal holding company rules that could potentially subject this strategy to additional U.S. tax. Moreover, actual shareholder distributions of earnings will subject the dividend itself to a second tax.
Check the box.
The GILTI tax only applies to income earned by foreign entities considered corporations under U.S. tax rules. U.S. taxpayers can elect to treat eligible foreign entities as pass-through entities or disregarded entities for U.S. tax purposes. This strategy, however, requires careful planning to avoid any unforeseen negative consequences and should not be undertaken without input from a knowledgeable advisor.
Consider an asset purchase.
When acquiring another foreign corporation, a CFC may consider purchasing an asset or electing a step-up in the basis of assets on stock acquisitions, in order to increase the tax basis of foreign tangible depreciable assets.
Following the enactment of the TCJA, state legislatures and taxing authorities are considering how their jurisdiction will tax GILTI income and if they will accept the GILTI or FDII deductions. States currently differ in their treatment of Subpart F income and deemed or actual dividends from CFCs, and it is likely that the GILTI tax will lead to a wide variety of outcomes.