New International Tax Provisions for 2018 and Beyond
With the recently enacted tax reform two new terms have been introduced into the international tax arena: global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII).
We’re going to spend a few minutes wrapping our heads around what these new provisions are and their potential impact on taxpayers.
Are You GILTI Beyond a Reasonable Doubt?
With the new tax reform, there may be an incentive to shift profits abroad since income earned by a domestic corporation’s foreign subsidiary will now be able to be paid back as a dividend to the US without generating any US tax. GILTI is a provision which aims to discourage this by imposing tax on foreign sourced intangible income.
Global intangible low-taxed income (or GILTI) provisions can be found in new IRC Section 951A. Each person who is a US shareholder of any controlled foreign corporation (CFC) must include their share of GILTI in gross income for the tax year. For C-Corporation shareholders, this ultimately results in an effective US tax rate of 10.5% on the GILTI income. US individual shareholders are subject to GILTI at their regular individual marginal tax rates.
How is GILTI Calculated?
GILTI is the excess of a US shareholder’s net CFC tested income for the tax year over the US shareholder’s net deemed tangible income return for the tax year.
Net CFC tested income is the excess of the aggregate of the shareholder’s prorata share of the tested income of each CFC of the US shareholder over the aggregate of the shareholder’s prorata share of the tested loss of each CFC. Tested income of the corporation is the gross income of the corporation less the following: deductions properly allocable to that gross income, Effectively Connected Income, Subpart F income, dividends received from related parties, foreign oil and gas extraction income, and gross income excluded due to exception for high foreign taxes. In essence, Net CFC tested income is the aggregate annual foreign sourced earnings of your foreign corporations, with some exceptions and adjustments.
Net deemed tangible income return is the excess of 10% of the aggregate of the shareholder’s prorata share of the qualified business asset investment of each CFC over the amount of interest expense taken into account in determining your Net CFC tested income. The qualified business asset investment is the average of the corporation’s aggregate adjusted bases as of the close of each quarter of the tax year in specified tangible property used in a trade or business of the corporation and which is allowed a deduction under Section 167 (which is determined using ADS depreciation).
Easy enough right?
A GILTI Example
Let’s look at a somewhat basic example.
First we have to figure out the net CFC tested income. In this example, US C-Corp owns 100% of CFC 1 and CFC 2 which have gross income of $10,000,000 and $8,500,000 and deductions allocable of $6,000,000 and $10,000,000, respectively. This results in net tested income of $2,500,000 ($10,000,000 - $6,000,000 plus $8,500,000 - $10,000,000).
Now we need to figure out the net deemed tangible income return. The quarterly average of CFC 1 and CFC 2’s specified tangible property is $10,000,000 and $12,000,000. 10% of the qualified business asset investment is therefore $1,000,000 and $1,200,000. We end up with a net deemed tangible income return of $2,200,000.
Since GILTI is calculated as the excess of the net CFC tested income over the net deemed tangible income return, we end up with GILTI income of $300,000.
If the US shareholder were an individual or S-Corporation we would stop here and include an additional $300,000 of GILTI income which would be taxed at the individual’s regular marginal tax rates. However, if the US shareholder is a domestic C-Corporation, there is a foreign tax credit and/or deduction available to offset some of the GILTI income.
80% Deemed Paid Foreign Tax Credit for GILTI
If a domestic corporation has an amount includible for GILTI, the corporation is deemed to have paid foreign income taxes equal to 80% of the product of the domestic corporation’s inclusion percentage by the aggregate tested foreign income taxes paid or accrued by CFCs.
To try to keep this post somewhat simple we won’t get into the specifics of calculating the foreign tax credit, but let’s just point out a few key take away points with regard to this credit:
- The credit is limited to 80% of the foreign taxes paid
- The taxes deemed to have been paid are treated as an increase in GILTI income for purposes of Code Sec.78.
- A new separate foreign tax credit basket is used for the GILTI credit
- There is no carryback or carryforward for taxes paid or accrued in the GILTI basket
Deduction for GILTI
A domestic corporation is allowed a deduction equal to the sum of (i) 50% of the GILTI amount included in gross income and (ii) the amount treated as a dividend under Code Sec. 78 attributable to the amount in item (i). The 50% deduction will be reduced to 37.5% after December 31, 2025.
So, at the end of the day, with the new US federal corporate tax of 21%, the effective US tax rate on GILTI is 10.5%. If the foreign tax rate is 0%, then the US residual tax rate is 10.5%. Once the foreign tax rate is at least 13.125%, there should be no residual US tax owed (80% x 13.125% = 10.5%).
The Foreign-derived Intangible Income Deduction (FDII)
The second new provision to touch on is the foreign-derived intangible income (FDII) deduction.
Where GILTI income and the corresponding deduction looks to CFC income, the FDII deduction is sort of opposite of this whereby it looks to the foreign-derived income of a US corporation in order to determine the corresponding deduction. Please note that any foreign derived intangible income is already included within the US taxable income of the corporation.
So this provision is not looking to add any additional income to the return, but rather can just potentially provide a deduction based on the foreign-derived income. The deduction is 37.5% of the foreign-derived intangible income of a domestic corporation for the tax year. (Note that this deduction will decrease to 21.875% after December 31, 2025). We won’t get into the technical computation of the deduction, but in a nutshell it ends up being a deduction of 37.5% of the computed FDII and the deduction is computed similarly to the GILTI computations.
Part of computing the FDII involves determining the foreign derived eligible income of the corporation. Foreign derived eligible income of a taxpayer is deduction eligible income that is derived in connection with property sold to any person who is not a US person for foreign use or services provided to any person not located within the US. Foreign use is any use, consumption, or disposition which is not within the US.
So, under this provision a US corporate taxpayer could receive a tax deduction for exports of property used in foreign jurisdiction or for providing services to any person, or with respect to any property, not located in the U.S.
Cutting Through the Complexities of GILTI and FDII
Even though I’ve used shortened examples for purposes of this article, there is no doubt that the computations of GILTI and FDII are often going to be much more complex. They are going to be time intensive and will require a lot of additional work and information gathering that the taxpayer and their CPA typically haven’t had to do in the past.
If you have any questions or concerns about how GILTI or FDII may impact you please reach out to the International Tax Team at Freed Maxick for a complementary Tax Situation Review. Call
If you have any questions or concerns, call the Freed Maxick Tax Team at 716-847-2651 to discuss your tax situation or start the process of setting an appointment by clicking here and submitting your contact information.