GILTI high-tax exclusion final regulations

| 8/13/2020
GILTI high-tax exclusion final regulations

On July 23, the U.S. Department of the Treasury and the IRS published final regulations regarding global intangible low-taxed income (GILTI) under Section 951A of the IRC. The final regulations provide an election to exclude high-taxed income from a taxpayer’s GILTI calculation (high-tax exclusion). Proposed regulations were published on the same day to conform the Subpart F high-tax rules with the final regulations.

The final regulations generally provide that U.S. shareholders of a controlled foreign corporation (CFC) can elect to exclude from the GILTI calculation certain income of the CFC that is subject to a sufficiently high effective foreign tax rate as determined under U.S. tax principles. In many cases, income that is excluded from the GILTI calculation will escape U.S. taxation permanently.

Determination of high-taxed income

The final regulations adopt a calculation of high-taxed income based on the concept of a “tested unit,” which broadly is an integrated collection of activities conducted or owned by a CFC. A tested unit includes 1) a CFC, 2) interests in certain pass-through entities held directly or indirectly by a CFC, and 3) certain branches of the CFC or the portion of a branch whose activities are carried on directly or indirectly by a CFC. Tested units within a CFC, including the CFC itself, that are located or tax resident in the same foreign country are treated as a single combined tested unit.

Whether income of a CFC qualifies for the high-tax exclusion is determined separately for each tested unit. If a CFC as a whole is the tested unit and the tested unit qualifies for the high-tax exclusion, the high-tax exclusion effectively is applied with respect to all gross tested income (with certain modifications) of the CFC. If a CFC has multiple tested units, tested income attributable to some tested units might qualify for the high-tax exclusion, and tested income attributable to others might not. Disregarded payments (payments made by a branch or disregarded entity to its owner or vice versa) are taken into account when computing gross tested income attributable to a tested unit.

When determining the effective foreign tax rate for the gross tested income attributable to a tested unit, deductions (including current year taxes) must be allocated and apportioned to the gross tested income using the regulation principles under Section 960 (which incorporate Section 861 principles). Generally, the effective foreign tax rate is determined by dividing the foreign income taxes paid or accrued with respect to each tested unit’s net tested income by the net tested income before income taxes. All amounts must be computed in U.S. dollars. If the effective foreign tax rate of a given tested unit exceeds 90% of the maximum rate specified in Section 11 (presently 18.9%, based on a maximum corporate rate of 21%), the tested unit’s income is high-tax income and eligible for the GILTI high-tax exclusion election.

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Making the election

If made, the GILTI high-tax exclusion election must be made for all CFCs that are members of the CFC group. A CFC group generally is an affiliated group as defined in Section 1504(a) with certain modifications that broaden the definition, such as including foreign corporations.

The election is made annually by the controlling domestic shareholders by filing a statement with a timely filed original or amended tax return for the applicable year. An election made on an amended return must be filed within 24 months of the unextended due date of the original return. As the election is binding on all U.S. shareholders, the controlling domestic shareholders making the election must provide notice of the election to each U.S. shareholder that is not a controlling domestic shareholder. Similar rules apply for revoking the GILTI high-tax exclusion election.

Applicability dates

The final regulations apply to tax years of foreign corporations beginning on or after July 23, 2020, and to taxable years of U.S. shareholders in which or with which such taxable years of the foreign corporations end. Taxpayers can elect to apply the final regulations retroactively to tax years of foreign corporations that begin after Dec. 31, 2017, and before July 23, 2020, and to taxable years of U.S. shareholders in which or with which such taxable years of the foreign corporations end, provided the final regulations and certain other regulations under Section 954 are applied consistently.

Looking forward

In addition to the prospective planning opportunities these regulations offer, retroactive application could provide refund opportunities by amending prior returns. The 24-month limitation for amended returns does not leave much time to evaluate making the retroactive election for 2018 returns. Due to the complexity of the final regulations, taxpayers should carefully assess the impact of either a prospective or retroactive election in order to minimize unintended consequences.

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