By Anthony Diosdi
The Internal Revenue Code provides that a United States shareholder (a “U.S. shareholder”) of a controlled foreign corporation (“CFC”) is subject to tax on the foreign corporation’s global intangible low taxed income (“GILTI”). A U.S. shareholder is a U.S. person (A U.S. person is defined as a U.S. citizen, resident alien, corporation, partnership, trust, or estate) who owns, or is considered owning at least 10 percent of the total combined voting power of all classes of shares of stock entitled to vote of such foreign corporation, or 10 percent or more of the total value of shares of all classes of stock of suh foreign corporation. In determining whether a person is a U.S. shareholder and whether the foreign corporation is a CFC, the Internal Revenue Code looks at direct ownership, indirect ownership, and constructive ownership. This means, that for classification purposes, a U.S. person is constructively treated as owning stock in a foreign corporation that is owned by certain entities or individuals that are related to the U.S. person. For example, if a U.S. tax resident father owns 7 percent of a foreign corporation and his U.S. resident son owns another 6 percent of the same foreign corporation, they each will be considered U.S. shareholders, because they are treated as constructively owning the shares of the other. In the CFC context, Section 958(b) provides that the constructive ownership rules of Section 318(a), with certain modifications, apply for the purposes of determining whether: 1) a U.S. person is a U.S. shareholder is a U.S. shareholder (within the meaning of Section 951(b); 2) a foreign corporation is a CFC under Section 957; 3) the stock of a domestic corporation is owned by a U.S. shareholder of a CFC for purposes of Section 956(c)(2); and 4) a corporation or other person is related to the CFC for purposes of Section 954(d)(3).
These rules have also been broadened to include the definition of a CFC if more than 50 percent of either the value of all of the outstanding stock or the total combined voting power is owned by U.S. shareholders.
The Mechanics of GILTI
Similar to subpart F, GILTI is an anti-deferral regime applicable to U.S. shareholders of CFCs. GILTI is the excess of a shareholder’s net tested income for such 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 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 return is 10 percent of the shareholder’s pro rata share of the CFC’s tax basis in tangible personal property used by its CFCs in the production of the tested income. This amount is reduced by certain interest expenses.
Determination of U.S. Shareholder’s Pro Rata Share of GILTI
A U.S. shareholder’s pro rata share of GILTI is determined by going through a hypothetical dividend distribution of the CFC’s GILTI on the last day of its tax year on which it meets the CFC definition. Specifically, a U.S. shareholder’s pro rata share of GILTI is the amount of the distribution that the U.S. shareholder would have received with respect to the stock owned in the CFC if, on the last day of its tax year on which it was a CFC, the corporation had distributed pro rata to all of its shareholders a dividend in an amount equal to the GILTI for the tax year. However, if the corporation was a CFC for only part of its tax year, the U.S. shareholder’s pro rata amount is reduced proportionately. For example, if a foreign corporation is a CFC for only 100 days during a taxable year with 365 days, its U.S. shareholders will have to include only 100/365 of their pro rata shareholders of the corporation’s GILTI income for the year.
Furthermore, if the U.S. shareholder acquired the stock in the CFC during the year of the GILTI inclusion, the pro rata amount is reduced by a portion of the dividends received by the U.S. shareholder’s predecessor in interest during that year. This latter amount includes a portion of any gain by the predecessor in interest on the disposition of the CFC’s stock that was treated as a deemed dividend under Internal Revenue Code Section 1248.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. As a domestic and international tax attorney, Anthony Diosdi provides international tax advice to individuals, closely held entities, and publicly traded corporations. 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.