Final GILTI Regulations Provide Taxpayers Mixed News

| 6/27/2019
On June 21, the U.S. Department of the Treasury and the IRS published final regulations related to IRC Section 951A, which provides for an inclusion of global intangible low-taxed income (GILTI).

Background

The Tax Cuts and Jobs Act of 2017 introduced a new kind of income inclusion under Subpart F, GILTI. The conceptual justification for the GILTI inclusion was to tax U.S. shareholders that had shifted intangible assets and the streams of income they generate offshore. Each controlled foreign corporation (CFC) in which a U.S. shareholder has an interest calculates its tested income or loss. The tested income and losses of all CFCs are aggregated at the shareholder level, and GILTI is defined as net aggregate tested income minus 10% of aggregate tangible depreciable assets or qualified business asset investment (QBAI) from each CFC with tested income minus net interest. Comprehensive proposed regulations were released on Sept. 13, 2018.

Final GILTI regulations

The final regulations largely adopt the regulations as proposed. The preamble to the final regulations justify and confirm several issues that have been the subject of much debate, including the exclusion of tested loss CFC assets from aggregate QBAI, the inclusion of Subpart F income recovered under the earnings and profits (E&P) limitation in tested income, and the confirmation that net tested losses cannot be carried forward. The preamble also includes a lengthy amount of text clarifying that depletable assets are not included in QBAI. The final regulations contain several significant clarifications and modifications that are not entirely unfavorable to taxpayers.

One modification that might benefit taxpayers is the abandonment of the hybrid treatment of partnerships with respect to GILTI. The proposed regulations treated domestic partnerships as foreign partnerships with respect to partners that carried a 10% ownership in underlying CFCs. Affected partners were considered owners of their proportionate share of partnership assets under the aggregate theory and, consequently, included their share of partnership GILTI attributes in an independent GILTI calculation. For U.S. partners that did not hold a 10% interest in underlying CFCs, a domestic partnership retained its domestic characterization, making the partnership a U.S. shareholder computing its own GILTI inclusion and requiring U.S. partners owning less than 10% of the underlying CFCs to include their distributive share of the partnership GILTI inclusion. The final regulations abandon the hybrid treatment and provide that domestic partnerships always are treated as foreign partnerships and all partners will compute their GILTI inclusion independently based on their share of partnership GILTI attributes. Partners holding less than 10% ownership of any lower-tier CFC will not have the requisite ownership for a GILTI inclusion. The preamble emphasizes that this treatment is for GILTI purposes only and will not have an impact on other Subpart F income, but proposed regulations published the same day would extend the treatment to Subpart F, and though not effective, taxpayers can rely on them for years after 2017.

The final regulations also provide a bit of relief with respect to tested loss CFCs. While they cannot contribute to QBAI, each tested loss CFC’s pro rata QBAI amount can be used to offset net interest expense from the CFC, thereby preserving the amount of tangible return and decreasing GILTI. Furthermore, the final regulations allow downward basis adjustments to push stock basis below zero if E&P brings it back up to or above zero. Conversely, the final regulations serve bad news to CFCs that develop software, film, television, or theatrical productions, clarifying that property to which Section 168(k) applies does not generate QBAI.

The final regulations include other important clarifications that bring administrative ease. When a CFC ceases to be a CFC, the GILTI inclusion is attributed to shareholders that owned the CFC on the last day it was a CFC, but the inclusion does not occur until the end of the CFC’s tax year. For example, assume a CFC has a tax year that ends on Nov. 30, the shareholder’s tax year ends on Dec. 31, and the CFC is sold on Dec. 15. The measurement of GILTI is based on the tested income attributed to the period between Dec. 1 and Dec. 15, but that amount cannot be computed until Nov. 30 of the following year. Previously, the amount would have been included in the U.S. shareholder’s tax return for the year ending Dec. 31, but the amount could not be computed until Nov. 30 of the following year. Now the inclusion is deferred until the U.S. shareholder’s following year, although the measurement remains the same.

The final regulations also clarify how tested loss, QBAI, and other GILTI attributes are allocated among U.S. shareholders, clarify how to address CFC investment in partnerships for GILTI purposes, and soften some anti-abuse provisions. Finally, although the final regulations decline to broaden the GILTI high-tax exception, proposed regulations published on the same date expand the traditional Subpart F exception to include GILTI for years beginning after the finalization of those proposed regulations.

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