Much of the news relating to The Tax Cuts and Jobs Act (TCJA) is about domestic tax activities, such as limitations on state and local taxes, Sec 199 deduction and individual and corporate rates. However, little has been provided a little known but very critical parts in the international area.
If you have a foreign operation that is considered a controlled foreign corporation (“CFC”), then there may be a new tax regime that may affect you – Global Intangible Low Taxed Income (“GILTI”). This tax is designed to tax profits of your CFC even if the profits have not been distributed. A CFC is a foreign corporation that is controlled 50% or more by a US person (individual or entity).
If this applies to your situation, you may be taxed on your foreign profits even if they have not been repatriated. However, under the right kind of structure, you may reduce substantially or eliminate this tax completely. This article shows you how.
First, lets review how to compute GILTI.
GILTI is equal to net CFC tested income less 10% of Qualified Business Asset Investment (“QBAI”). Net CFC tested income in simplistic terms is your foreign net income after foreign taxes. QBAI is the fixed or depreciable assets used to produce the income (specifically excluded are intangibles such as goodwill, copyrights, computer software and related items).
An example of this is as follows:
CFC Tested Income
Net Income = $1,100,000
Less Foreign Income Tax Paid = $100,000
CFC tested Income = $1,000,000
QBAI = $2,000,000
GILTI = $1,000,000 – 10% of $2,000,000 = $800,000
How this GILTI is taxed will depend on how the CFC is owned – and this is the really important part. Individuals and flow through entities (i.e. LLC/partnerships and S-corps) are taxed at their highest ordinary income tax rate (maximum of 37%) while c-corporations are taxed completely different. If the CFC is held by a Corporation, the tax rate is 50% of the US corporate rate (21.0%) or 10.5% PLUS they get a foreign tax credit deduction of 80% of the tax paid. So, watch what happens:
|US Tax Rate||37.0%||10.5%|
|Preliminary US Tax||$296,000||$84,000|
|Less 80% of Foreign Tax Paid||$0||$80,000|
|US Tax Inclusion||$296,000||$4,000|
So, you can see very clearly, that if you are not holding your CFC in a corporation, you will incur substantial tax liability.
The other item to note is if the foreign corporate tax rate is over 13.125%. you may not have any GILTI to pay (assuming you are holding the entity in a corporation). That is because the foreign tax credit allowed is 80% of the foreign tax rate – thus, 80% of 13.125% is 10.50%.; not so if the CFC is held differently, because there is no foreign tax credit available.
How to Determine if This will Apply To You
The first step in determining how GILTI may apply to your situation is to determine if you have a CFC. Remember a CFC is a foreign corporation (not a foreign partnership or trust) that is owned directly, indirectly and/or constructively by 50% or more of US persons. US persons are individuals, entities, and trusts. The specific rules and application of ownership is beyond the scope of this article.
If it is determined that you have a CFC, then the next step is how is it held? The GILTI will only apply to direct ownership in the CFC. This is somewhat different than determining if you have a CFC. Yes, you read that right – the rules for determining if you have a CFC is different than how the GILT is applied.
|Determination of CFC||Subject to GILTI|
As we have already discussed, if the direct ownership is held by other than a c-corporation, then the tax rate applied to the GILTI will be the highest ordinary rates, currently 37%.
What To Do If You Are Looking at GILTI
There are several concepts that might be applicable to your situation to either reduce or avoid GILTI. Here are some that might work:
Create a US corporation and transfer the ownership of the foreign entity.
This strategy will allow you take advantage of the reduced tax rates and the indirect foreign tax credit. The downside is that to the extent the foreign corporation has earnings and profits, it must include these as income. However, if this is not an issue or you are going through a foreign acquisition, then now is a great time to structure yourself in this way.
Check the Box Election.
This strategy allows you to change the character of the CFC to either taxed as a partnership or disregarded entity. If you do this, all of the income is reported in the current year (i.e. no deferral of income) and thus you would not be subject to CFC rules. The foreign taxes paid under this scenario can be used by the taxpayer. Thus, you may have to include the income in your tax return at your ordinary income tax rates, but to the extent you paid or accrued foreign taxes, you have a credit to apply.
Section 962 Election.
This strategy allows you to elect as an individual to be taxed as a corporation with respect to GILTI. This means that you will pay 21% on the GILTI and not the highest ordinary rate. So, if your ordinary income tax rate is above 21%, then this might be a good way to reduce the tax under GILTI. The taxpayer does get to include the foreign tax credit. The election is made annually.
Structure Foreign acquisitions as Asset Purchases.
This strategy allows you to allocate basis to tangible assets purchased. Increases in tangible assets reducing the income subject to GILTI. The depreciation write off also reduces the tested income of the CFC.
The TCJA has made a renewed emphasis on how your foreign entities are held and taxed. GILTI is one of the changes in the tax law that needs reviewing. Please contact us at firstname.lastname@example.org to discuss your situation. Let’s find a solution that works for you.
This article carries no official authority, and its contents should not be acted upon without professional advice. For more information about this topic, please contact our office.