By Anthony Diosdi
The Tax Cuts and Jobs Act, created a new global minimum tax on certain foreign income of U.S. shareholders or global intangible low-taxed income (“GILTI”). The Congressional intent of GILTI is to discourage U.S. multinational corporations from shifting the income of foreign subsidiaries into foreign countries with low tax rates. Although GILTI’s intent was to discourage U.S. multinationals from shifting income of foreign subsidiaries into foreign jurisdictions with low tax rates, the mechanical nature of the GILTI’s calculations means it impacts most foreign corporations (“CFCs”) and CFC shareholders. GILTI also triggers unexpected results that may catch unsuspecting practitioners by surprise.
GILTI is calculated by including in the income of a CFC shareholder of a CFC the excess of a “deemed tangible return” on its tangible fixed assets. This is determined by computing a shareholder’s “net CFC tested income” for the taxable year over that shareholder’s pro rata share of the “tested loss” for each CFC. See IRC Section 951A(c).
This article focuses on the computation of tested income or loss and uncovers mistakes that may catch unsuspecting practitioners by surprise who have little experience navigating the GILTI provisions.
Computation of Tested Income/Loss and Common Mistakes
Probably the most common mistake computing tested income or loss is that it is based on the calculation of the CFC’s earnings and profits (“E&P”). The author has even witnessed Internal Revenue Service (“IRS”) “International Specialists” compute compute tested income and tested loss on a CFC’s E&P. This is incorrect, tested income and tested loss of GILTI income requires the categorization tracking of income and adjustments made to income. For example, when determining tested income or loss, the following items of income are excluded:
1. Any item of income described in Internal Revenue Code Section 952(b) (this typically includes income effectively connected with a trade or business within the United States);
2. Any gross income taken income account in determining subpart F income;
3. Any gross income excluded from the foreign base company income, certain insurance income, and income excluded as a result of the high-tax exception under Internal Revenue Code Section 954.
Another common mistake is that the computation of tested income or tested loss is only necessary if a CFC shareholder is required to pay a federal tax liability or realizes a loss. A CFC shareholder must compute its tested income or loss regardless of the fact a federal tax liability is owed or if the CFC suffered losses. In addition, some practitioners erroneously assume GILTI permits a CFC shareholder a net operating loss under Section 172(a) of the Internal Revenue Code. The GILTI rules do not permit a Section 172(a) net operating loss deduction. This means that tested loss cannot be carried forward or backward to offset current year tested income.
CFCs Are Typically Only Entitled Claim 80% of Foreign Taxes Paid and Cannot Carry Excess Foreign Tax Credits to Other Years
Besides mistakes calculating tested income and tested loss, in our practice, we have noticed that practitioners have difficulties computing foreign tax credits associated with GILTI inclusions. Practitioners should keep in mind that a U.S. corporation is typically not entitled to claim a 100% deduction for foreign taxes paid associated with GILTI inclusions. Instead, a GILTI inclusion is treated as having paid foreign income taxes equal to 80% of the product of its “inclusion percentage” and the aggregate “tested foreign income taxes” paid or accrued by a CFC. Expressed formulaically:
80% x inclusion percentage x aggregate tested foreign income taxes paid or accrued =
80% x [GILTI inclusion / aggregate tested income] x [Foreign income tax properly attributable to the tested income of such CFC].
While foreign tax credits deemed paid are only 80% of the the product determined, 100% of such product are treated as dividends from the relevant CFCs for the purposes of Internal Revenue Code Section 78. Once the deductible foreign tax credits are determined, it is important to remember that for GILTI purposes, any excess foreign tax credits do not carry back or forward to other taxable years.
Conclusion
The computation of tested income or loss is complicated and time-consuming. U.S. shareholders of CFCs and their practitioners should plan well ahead of time to make sure that GILTI inclusions and any associated foreign tax credits can be properly calculated.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. As an international tax attorney, Anthony Diosdi has substantial experience advising U.S. multinational corporations and other international tax practitioners plan for and calculate GILTI inclusions.
Diosdi Ching & Liu, LLP has offices in San Francisco, California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in international tax matters throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.