It cannot be stressed enough how wide-ranging and game-changing the Tax Cuts and Jobs Act (TCJA) has been for individual taxpayers and businesses in all industries. This legislation represents the most significant overhaul of the Internal Revenue Code in 30 years, requiring businesses, estates, trusts and exempt organizations to analyze their present tax profiles, address issues both old and new along with new exposures, as well as take key steps and adjust their tax planning efforts.
Certainly, multinational businesses are part of this mix and many are closely examining the impact of tax reform on their organizations, particularly because of the many additional complexities arising from cross-border activity. For example, the TCJA contains a provision that addresses the treatment of global intangible low-taxed income (GILTI). This new provision requires a 10 percent U.S. shareholder of a controlled foreign corporation (CFC) to include in current income their share of the CFC’s GILTI. The intention of this provision was to discourage the erosion of the U.S. tax base that results when taxpayers move or keep valuable intangible property and its related income outside the United States. The reach of GILTI, however, is not limited to earnings on intangible assets. In fact, the GILTI rules result in a current U.S. tax on earnings that exceed a routine return on foreign tangible assets as well.
Furthermore, while some assume that the GILTI tax provision only affects entities with valuable intangible property in low tax jurisdictions, many businesses have discovered their operations in relatively high tax-rate jurisdictions, and with little to no intangible assets, are affected by these very broad rules.
GILTI impact depends on type of taxpayer
Suffice to say, the new GILTI rules apply to all taxpayers who are U.S. shareholders in a CFC; however, the ultimate tax impact varies greatly depending on the type of taxpayer type. For instance, the TCJA provides certain advantages to C corporations as opposed to individuals and pass-through businesses. Eligible C corporations that are U.S. shareholders may deduct 50 percent of any GILTI inclusion, reducing the effective rate on GILTI to 10.5 percent, before taking into account any eligible indirect foreign tax credit. For tax years after 2025, the deduction is reduced to 37.5 percent, resulting in an effective tax rate on GILTI of 13.125 percent. The GILTI deduction is subject to a limitation if the sum of GILTI and foreign-derived intangible income exceeds taxable income. In addition, the recently released proposed section 250 regulations have extended the 50 percent deduction against GILTI for individuals, estates and trusts that are U.S. shareholders in a CFC if they make a section 962 election.
Claiming foreign tax credits is another way businesses are addressing GILTI tax liability. U.S. corporate shareholders can claim an indirect foreign tax credit under section 960 for 80 percent of the foreign tax paid by the shareholder’s CFC that is allocated to GILTI income. This amount is calculated by multiplying an “inclusion percentage” by the foreign income taxes paid that are attributable to the GILTI inclusion. Available GILTI foreign tax credits have their own separate foreign tax credit basket, which means they can be used only against GILTI and not other foreign income. Furthermore, these foreign tax credits cannot be carried forward or back. However, because the calculation includes all foreign income taxes attributable to “tested income”, foreign taxes paid by one CFC on GILTI may be used to offset GILTI earned by another CFC.
There are additional applications and nuances to the GILTI provision that businesses and taxpayers must consider. For example, multinationals in the manufacturing, life sciences, technology and software sectors should be especially diligent in reviewing the GILTI provisions because the GILTI rules generally produce harsher results to cross border businesses in these sectors. Of course, businesses should also weigh individual state tax considerations as well, including whether GILTI is taxable for state purposes. For instance, both Massachusetts and New Jersey have adopted legislation addressing the GILTI provision and state income tax treatment.
One thing is certain: the GILTI rules present a significant change in the law that will require companies, tax directors and advisers to reexamine their historic planning, global structures, related risks and transfer pricing. As part of this review, we recommend the following:
- Review foreign subsidiaries for potential high returns and consider consequences or possible changes to the business structure or transfer pricing to address the new tax on GILTI.
- Assess state and local taxation of GILTI inclusions; this will vary greatly among jurisdictions.
- Determine your estimated annual GILTI inclusion, section 250 deduction, foreign tax credit and residual U.S. tax—given current revenue projections and current structure.
- Consider implications of intercompany debt in existing structures or future foreign acquisitions.
- Assess transfer pricing strategies.
- Evaluate any historic international tax strategies.
- If needed, consider a structural or entity classification change (for example, S versus C corporation), to address GILTI inclusions and other impacts of the TCJA.
- Reach out to your tax professional for further GILTI guidance. This provision is complex and may require the help from professionals who have studied GILTI, have experience addressing it and can provide perspective. Work with a professional who understands your industry, business and goals.