GILTI High-Tax Exclusion: What You Should Know

November 30, 2020

The global intangible low-tax income (“GILTI”) regime was introduced under the Tax Cuts and Jobs Act of 2017 (“TCJA”). Under the old regime, US shareholders were not taxed on income earned by their controlled foreign corporations (“CFC”s) until those amounts were repatriated back to the US entity. This deferral system incentivized companies to keep their profits offshore. The TCJA introduced a more territorial system of taxation, doing away with the existing deferral system; but also added the GILTI regime to discourage US taxpayers from shifting profits to low-tax jurisdictions. Conceptually, Congress intended to ensure that there would not be incentive for US intellectual property to be kept in a low-tax offshore jurisdiction by taxing income generated by it in the US GILTI calcualation. However, the way that the calculation works created additional complexity and some unintended consequences, taxing the income of foreign subsidiaries who are not necessarily in low-tax juridictions.

Effective as of the 2018 tax year, both C Corporation and noncorporate shareholders are required to determine the amount of the CFC's GILTI inclusion to be taxed on an annual basis. A model prepared by the Wharton School of Business projects that US multinationals could generate about $4.6 trillion in GILTI income over the ten years from 2021-2030. However, functionally the GILTI regime tends to erroneously apply to multinational businesses who are not actually operating in low-tax jursidictions.

To mitigate the impact of GILTI, taxpayers have had to revisit their organizational structures. In many cases, this involves modeling scenarios to find a way to limit tax liability while maintaining operational and administrative effectiveness.

GILTI High-Tax Exclusion

In July of this year, Treasury and the IRS published final regulations on the GILTI high-tax exclusion. This much-anticipated planning tool provides US shareholders with the ability to exclude GILTI tested income subject to a foreign tax rate in excess of 18.9% from its GILTI determination. It seems that a Company would always want to elect to use this exclusion, however, this election may reduce the ability to use corresponding tax attributes, like foreign tax credits. Therefore, planning is still required as the GILTI inclusion is determined on a net basis, aggregating all CFCs, and the election cannot be made on a entity-by-entity basis; it applies to all commonly controlled CFCs. Below are the noteworthy highlights of the legislation.

The GILTI high-tax election can be made annually.
By making the election, the taxpayer can exclude gross income from the GILTI calculation that is subject to foreign income tax at an effective rate that is greater than 90% of the maximum corporate US tax rate (currently 21%).
The GILTI high-tax exclusion can be applied retroactively to taxable years of a foreign corporation that begin after December 31, 2017, and before July 23, 2020.
In computing the effective foreign tax rate, the taxpayer has to look at the gross income of each "tested unit." In general, a tested unit can consist of a CFC itself, interests in pass-through entities that are residents of any foreign country, and branches of the CFC.
Each year the election is made, it applies to every member of a commonly controlled CFC.
The GILTI high-tax election precludes the taxpayers from using foreign taxes and qualified business asset investment (QBAI) associated with the excluded income.

As is often the case with new legislation, to truly understand whether the GILTI high-tax exclusion is a beneficial planning option, a modeling exercise is needed to determine the overall tax impact. The GILTI regime has even more onerous rules in application for noncorporate US shareholders (individuals and flow-through entities), so determining a strategy of using this exclusion, the Section 962 election, or restructuring altogether can be even more important in mitigating its negative tax consequences.