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Can Holding or Blocker Company be Used to Reduce GILTI Tax Liability?

Can Holding or Blocker Company be Used to Reduce GILTI Tax Liability?

By Anthony Diosdi

The GILTI or “global intangible low-taxed income regime under Internal Revenue Code Section 951(a) captures a significant amount earned by a controlled foreign corporation (“CFC”). The U.S. federal income tax liability associated with GILTI is dramatically different to an individual CFC shareholder compared to domestic subchapter C corporation. Individual CFC shareholders are subject to GILTI tax at federal rates of up to 37 percent (plus 3.8 percent medicare tax, applicable state and local taxes). Absent planning, individual CFC shareholders cannot claim indirect foreign tax credit to reduce U.S. federal income tax liability. On the other hand, domestic C corporations are typically only subject to tax on GILTI inclusions at a Federal rate of 10.5 percent. In addition, a domestic C corporation may utilize an indirect foreign tax credit of 80 percent of the amount of foreign taxes paid to reduce GILTI inclusions for U.S. federal tax purposes.

Because the U.S. federal liabilities are so excessive on GILTI inclusions, many individual CFC shareholders have taken an “if you can’t beat them, join them” mentality and have established domestic holding or blocker companies to hold CFC shares to reduce GILTI inclusions. Establishing a domestic holding or blocker company to hold CFC shares has a number of benefits. But with those benefits come some downsides. This article will discuss GILTI planning opportunities associated with transferring CFC shares into a holding company. 

Summary of GILTI Tax Regime

Similar to Subpart F, GILTI is an anti-deferral regime applicable to U.S. shareholders of CFCs. GILTI is the excess of a U.S. shareholder’s net CFC tested income for such a taxable year over its net deemed tangible income return. Net CFC tested income is any excess of the U.S. shareholder’s pro rata share of the tested income of each CFC for which it is a U.S. shareholder over its pro rata share of such CFC’s tested loss. A U.S. shareholder’s net deemed tangible income is 10 percent of the shareholder’s pro rata share of the CFC’s tax basis in tangible personal property used by its CFC in the production of the tested income (reduced by certain interest expense).

As its name suggests, Congress presumably intended that GILTI apply only to income that is subject to a low rate of tax in the source country. Unfortunately, the mechanisms that were created to ensure this result are only applicable to U.S. shareholders that are domestic corporations. That is, a domestic corporation can make a Section 250 deduction equal to 50 percent of the GILTI inclusion. This deduction effectively reduces the current 21 percent federal corporate rate to 10.5 percent on a GILTI inclusion. Second, a domestic C corporation may elect to use a foreign tax credit equal to 80 percent of the foreign taxes paid on GILTI income. This credit effectively ensures that a CFC that pays an effective rate of foreign tax of 13.125 percent or more would pay no additional U.S. federal tax liability on a GILTI inclusion. A 50 percent deduction under Section 250 of the Internal Revenue Code is not available to individual CFC shareholders. As a result, individual CFC taxpayers are subject to tax on a GILTI inclusion at federal rates of up to 37 percent.

Contributing CFC Shares to a Domestic C Corporation

In order to reduce the sting of a GILTI inclusion, an individual CFC shareholder may contribute his or her shares to C corporation. This would result in the C corporation becoming a U.S. shareholder of the CFC. The short-term benefits of this strategy are clear. The contribution, when structured properly, should qualify as a tax-free Section 351 contribution. (Shareholders in an incorporation transaction will not recognize any gain or loss on the exchange if they satisfy three requirements of Internal Revenue Code Section 351(a)). First, there must be a contribution of property. Second, the contribution must be solely in exchange for stock and, third, the contributors must control the corporation immediately after the exchange).

GILTI earned by a C domestic corporation should receive the benefits of the Section 250 deduction and flow-through of foreign tax credits. In addition, a distribution of the CFC’s previously taxed earnings and profits (“PTEP”) should not be subject to further U.S. federal tax. Moreover, if the CFC has any E&P (that is not otherwise PTEP) a distribution of such an amount from the CFC to a domestic corporation may qualify for the Section 245A participation exemption. Internal Revenue Code Section 245A allows an exemption for certain foreign income of a domestic C corporation that is a U.S. shareholder by means of a 100 percent dividends received deduction for the foreign-source portion of the dividends. Proper planning may also result in dividend distributions from the C corporate holding company qualifying for reduced qualified dividend rate of 20 percent (plus medicare, state, and local taxes).

However, anyone considering transferring CFC shares into a domestic C corporate holding company must understand there are significant long term costs. First, typically, if an individual were to sell CFC shares, the gain on such sale would likely be classified as long-term capital gain for federal tax purposes. Long-term capital gains are subject to federal income tax at a preferential 20 percent rate. To the extent that the CFC has E&P, then some or all of this gain may be recharacterized as a dividend under Section 1248. Under Section 1248(a) of the Internal Revenue Code, gain recognized on a U.S. shareholder’s disposition of stock in a CFC is treated as dividends to the extent of relevant E&P accumulated while the person held the stock. With respect to individual U.S. shareholders who sell shares of a C corporation holding CFC shares, recharacterization is significant due to the rate differential between long-term capital gains, (maximum 20 percent) and ordinary income (maximum 37 percent).

In addition, on the sale of the CFC stock by a domestic C corporation, the shareholder of the domestic C corporation is subject to two layers of tax. First, the sale of CFC stock by the domestic C corporation would be subject to 21 percent federal corporate tax rate. A second layer of tax is assessed when the C corporation makes a distribution of the CFC gains to its shareholders. Planning opportunities may be used to reduce or even eliminate the 21 percent corporate rate on the sale of CFC shares. This could be done by making an election under Section 338(g) of the Internal Revenue Code. When a Section 338(g) election is made, the target CFC is deemed to sell its assets and must recognize any gain resulting from the deemed asset sale. If the seller is a domestic C corporation, the CFC target’s gain on non-trade or business assets typically is classified as Subpart F income, and the remaining gain (with respect to trade or business assets) instead is classified as tested income for GILTI purposes. The CFC’s tax year closes, and its Subpart F income and GILTI through the date of sale are included in the gross income of the domestic C corporate seller.

With a Section 338(g) election, the domestic seller also will be taxed on the gain from the sale of the CFC stock, with the basis of such stock being increased to account for any inclusions under Subpart F or GILTI for the year (including the Subpart F and GILTI income generated by the deemed asset sale). Subject to holding period requirements, the stock gain will be recharacterized as a dividend under Section 1248 and generally will be deductible under Section 245A to the extent of the CFC’s prior year untaxed earnings and profits and current year earnings that are not Subpart F income or tested income, as well as earnings arising from gain on deemed sale of assets that are not subject to Subpart F or GILTI. Because of the dividends received under Section 245A, there may be a preference for C corporate sellers toward dividend characterization under Section 1248 (i.e., a stock sale), which may be exempt from U.S. tax under Section 245A, as compared to gain that may be classified as GILTI income (i.e., an asset sale), which would trigger a 10.5 percent corporate tax. However, if sufficient E&P exists, corporate sellers will likely prefer stock sales over asset sales. In this case, utilizing a Section 338(g) election will convert gains to GILTI tax which will be taxed 10.5 percent.

The liquidation or distribution of the sale proceeds of CFC would be subject to an additional tax at the shareholder level. As discussed above, this may be reduced to 20 percent for federal income tax purposes. A word of caution when using C corporate structure to hold CFC shares. Some holding corporations are developed to avoid shareholder level tax by simply failing to make corporate distributions. In these cases, the Internal Revenue Service (“IRS”) may assess penalty taxes under the provisions of the accumulated earnings tax and the personal holdings company tax.

The accumulated earnings penalty tax is imposed upon corporations “availed of for the purpose of avoiding the income tax with respect to its shareholders…by permitting earnings and profits to accumulate instead of being divided or distributed.” See IRC Section 532(a). Once the IRS determines that a corporation is subject to the accumulated earnings penalty tax, a tax imposed upon “accumulated taxable income” at the 37 percent top marginal tax rate imposed on individuals. See IRC Sections 532, 535. Under the personal holding company tax provisions of the Internal Revenue Code, a penalty tax is imposed upon undistributed personal holding company at the top individual marginal tax rate of 37 percent. See IRC Section 541.

Contributing CFC Shares to a Partnership or S Corporation

CFC shareholders may also contribute CFC shares to flow-through structures such as partnerships or S corporations through tax-free transactions. Compared to utilizing a C corporate corporation, placing  CFC shares through flow-through structure does not result in a second layer of tax. Individuals that place CFC shares into flow-through structures may also be able to foreign tax credits without an 80 percent limitation. However, flow-through structures are not likely eligible to utilize the Section 250 deduction. Thus, a flow-through structure may not be an optimal structure if the CFC is operating in a zero or low tax country. There still remains some under certainty regarding S corporations holding CFC shares with accumulated E&P and PTEPs. As a result, the IRS intends to issue regulations addressing these issues in the near future.


There is no one size fits all solution when it comes to GILTI planning.Careful modeling should be done by a qualified international tax attorney prior to proceeding with a GILTI tax reduction plan. 

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.

He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or 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.