GILTI AS CHARGED: THE BENEFITS AND …...corporations had large sums of money in banks overseas that...

GILTI AS CHARGED: THE BENEFITS (AND DRAWBACKS) OF THE NEW U.S. INTERNATIONAL TAX REGIME

Panelists: S&W Tax Briefings Joseph B. Darby III One Post Office Square Joseph X. Donovan Boston, MA 02109 Douglas S. Stransky November 14, 2018


Materials in Part I (c) 2018

by Joseph B. Darby III, Esq. Sullivan & Worcester LLP One Post Office Square

Boston, MA 02109 (617) 338-2985

Materials in Part II

(c) 2018 by Joseph Donovan, Esq. Sullivan & Worcester LLP One Post Office Square

Boston, MA 02109 (617) 338-2860

© Sullivan & Worcester LLP 2


PART I INTERNATIONAL TAX CHANGES

INTRODUCED BY 2017 TAX ACT

THE “GILTI” REGIME


I. A. The 2017 Tax Act

• The 2017 Tax Act (the “Act”) introduced desperately needed revisions to the provisions of the U.S. Internal Revenue Code (the “Code”) that deal with international income taxation

• How do we know the revisions were desperately needed? Because for about the last twenty years U.S. multi-national companies had been leaving the United States—a process referred to as “inversion”—for other jurisdictions

• These inversions occurred because the U.S. had the highest corporate tax rate in the industrialized world and one of the very highest corporate tax rates in the entire world



• The problems with the U.S. international income tax regime were described in extensive detail by the Author in an article entitled “Building the New Berlin Wall,” published May/June 2016 issue of Business Entities

• The U.S. government’s tax policy in recent years, perversely, was not to make U.S. corporate income tax rates competitive with the rest of the world but rather to prevent U.S. companies from leaving the U.S., not unlike the strategy of the Soviet Union when it built the Berlin Wall back in the 1960s



• My article suggested that imposing high taxes and then telling people they were not allowed to leave the U.S. was likely to be just about as successful as building the Berlin Wall

• The 2017 Tax Act modified two things that absolutely had to change

› First it brought the U.S. federal corporate tax rate down to 21%, which puts the U.S. in the mainstream of the rest of the industrialized world’s corporate income tax regimes

› Second, the U.S. converted to a (modified) territorial system such that the U.S. no longer applies full U.S. corporate income taxation on a worldwide basis to corporations solely because the parent corporation of a multi-national corporate group is incorporated in the United States



• Over the past 30 years, many U.S. companies that remained in the U.S. moved their (often extremely valuable) intangible assets offshore, and structured business operations such that the profits from activities outside the United States were taxed in low-tax jurisdictions, such as Ireland

• This, in turn, lead to the conundrum that these U.S. corporations had large sums of money in banks overseas that could not be brought back to the United States without being subject to the then 35% corporate tax

• As a result, huge amounts of money—literally in the trillions of dollars—sat in the offshore accounts of U.S. corporations in recent years



• As a result of the dysfunctional features of the U.S. international income tax rules, by late 2017, the U.S. not only needed to reduce its U.S. corporate tax rate in to be competitive with the rest of the world, but it also had to “fix” the problem of large accumulations of earnings and profits held offshore in controlled foreign corporations (“CFCs”)

• Significantly, the United Kingdom had a similarly counter-productive tax regime during the early 2000s that produced in an inversion crisis similar to that of the U.S. loans

• The UK responded by reducing corporate tax rates to 20% (and even lower after that) and stopped trying to tax the income of CFCs earned outside the UK (unless there was an artificial diversion of profits from the UK to the CFC)



• This seminar addresses at a relatively high level, but also with significant specificity on certain issues, the dramatic changes introduced by the 2017 Tax Act

• The U.S. tax overhaul is similar to, but ultimately less clear cut and decisive than, the UK international income tax revisions of 2010

• There are three basic areas where the 2017 Tax Act fundamentally changed U.S. international income tax principles



• It triggered a one-time automatic “deemed” distribution of the earnings and profits of CFCs, which for U.S. corporations meant that all the offshore earnings over many years were suddenly deemed distributed as a dividend, albeit at favorable tax rates

• On a forward-looking basis, U.S. adopted what was nominally a “territorial” tax regime, which basically starts with the premise that dividend distributions from controlled foreign corporations are no longer subject to tax

• The single biggest change, and an absolutely necessary change, was a reduction in the U.S. corporate tax rate from 35% to 21%


I. B. Reduced U.S. Income Tax Rates

• This change obviously benefits U.S. C corporations with substantial domestic operations but it also has an impact on international tax because income earned by a U.S. corporation from foreign activities (e.g., a branch in a foreign country) is subject to a significantly lower tax rate than before

• Individual tax brackets and tax rates were modified in favorable ways, and now reach a maximum tax rate of 37% (down from 39.6%)

• As a result, the income tax cost for “pass through” taxation structures was also reduced, although no where near as dramatically as the tax reduction for C corporations


I. C. Deemed Repatriation Rules

• A key provision of the 2017 Act provided a one-time “deemed” repatriation of all of the accumulated deferred foreign earnings and profits held in certain foreign corporations and attributable all periods through November 2, 2017 or December 31, 2017 (whichever date produced a larger amount)

• The deemed repatriation tax applied to “U.S. shareholders,” meaning any U.S. person who was a 10% owner of a “specified foreign corporation” that had “accumulated post-1986 deferred foreign income.” These specified foreign corporations with deferred income were known as “deferred foreign income corporations”



• The term “specified foreign corporation” meant a CFC or a foreign corporation in which at least one U.S. domestic corporation held a 10% interest

• The amounts calculated under Code Section 965 were includible in the 2017 Subpart F income of the U.S. Shareholder, and were taxed to U.S. domestic corporations at a 15.5% tax rate (8% for non-cash assets)

• For U.S. individual taxpayers who were U.S. Shareholders, the deemed repatriation was taxed at a somewhat higher rate of 19.22%



• The C corporation tax rate of 15.5% was actually calculated based on a deduction, which in turn is based on the maximum corporate tax rate (35%) at the time of the inclusion

• The maximum corporate tax rate was 35% in 2017, and a C corporation would calculate the allowable deduction for cash as [1-(15.5/35)] or 55.71%. See Code §965(c)(2)(B). Thus, an inclusion of $100 of cash would be eligible for a deduction of $55.71, leaving $44.29 to be taxed at a corporate tax rate of 35%. This makes the effective rate 15.5%



• A similar calculation applied for individuals who are U.S. Shareholders of a CFC

• On a $100 deemed cash distribution the individual U.S. Shareholder can claim the same deduction of $55.71, leaving $44.29 taxed at a 43.4% tax rate (39.6% plus the NIIT of 3.8%) or 19.22%

• The deemed repatriation amount included in 2017 income was the greater of a CFC’s post-1986 deferred foreign income as of (i) November 2, 2017, or (ii) December 31, 2017, and that was not previously subject to U.S. tax



• A U.S. Shareholder could elect (and almost all probably did elect) to pay the resulting tax in eight annual installments, without interest, with 5% of the liability reported in each of the first five years, then 15%, 20%, and 25%, respectively, in the final three years

• Special (and extremely favorable) rules applied under Code Section 965(i) to shareholders of S corporations, and basically allowed S shareholders to elect to defer payment of the net tax liability with respect to such S corporation until the shareholder’s taxable year which includes the relevant “triggering event,” such as death, sale of the S corporation stock, liquidation of the S corporation of termination of S status


• The 15.5% rate was higher than many anticipated – a similar, one-time repatriation of offshore profits in 2005 was taxed at just 5% – but the higher rate, in addition to generating a LOT of U.S. revenue in 2018, seems fair in light of the very long deferral in taxing all those offshore profits

• In all events, a deemed repatriation concept was necessary in order to “reset” the U.S. international income tax regime to a new starting line beginning in 2018



I. D. Territorial Tax Regime

• The second major change is that the Act converts the U.S. taxation of domestic corporations from a worldwide tax system to a territorial tax regime with a participation exemption. . . sort of

• Territorial taxation in the purest sense means a country taxes the activities that occur within its borders, but does not tax income earned by its tax residents outside its borders

• The UK adopted a relatively pure territorial system in 2010, and generally does not tax income earned by the controlled foreign corporations (CFCs) of a UK corporation except where there is an artificial diversion of profits to the CFCs


I. D. Territorial Tax Regime New Code Section 245A(a) provides: “In the case of any

dividend received from a specified 10-percent owned foreign corporation by a domestic corporation which is a United States shareholder with respect to such foreign corporation, there shall be allowed as a deduction an amount equal to the foreign-source portion of such dividend”

No foreign tax credit is allowed under Code Section 901 for foreign taxes paid or accrued with respect to any dividend for which a 100% dividend received deduction is allowed under new Code Section 245A. See Code Section 245A(d)


I. E. GILTI Regime However, the new tax regime then proceeds to more or less

override the “territorial tax” concepts contained in Code Section 245A by creating special provisions under new Code Section 951A and related sections that apply to “Global Intangible Low-Tax Income” (with the wonderfully pejorative acronym of “GILTI”)

GILTI income sounds like it is a tax on income earned on intangibles, but in fact it is a U.S. income tax on the income of CFCs that earn high profits (defined as the income above a 10% return on the adjusted tax basis of the CFC in its tangible assets) in “low tax” jurisdictions


I. E. GILTI Regime The excess offshore profits are called “Global Intangible

Low-Tax Income,” or “GILTI,” whether or not the income actually has anything to do with intangible assets

Effective for the first tax year of a Controlled Foreign Corporation (“CFC”) after December 31, 2017, each U.S. taxpayer who is a “U.S. shareholder” (meaning a 10% or greater shareholder) of a CFC will be subject to current U.S. income taxation to the extent that the CFC is deemed to have GILTI income under new Code §951A


I. E. GILTI Regime GILTI income is basically the portion of the income of a CFC

called the “Net CFC Tested Income,” minus an allowable amount called the “Net Deemed Tangible Income Return,” which, in turn, is an amount equal to 10% of the adjusted tax basis of the CFC depreciable tangible personal property (called the “Qualified Business Asset Investment” of “QBAI”), all with further adjustments for interest income and interest expense

The GILTI regime starts with the premise that some portion of a CFCs earnings is attributable to its investment in tangible business assets, specifically tangible personal property as opposed to its intangibles


I. E. GILTI Regime

• The law allows a 10% return per year, based on the CFCs adjusted tax basis of the tangible personal property (the QBAI)

• Note that the tangible property amounts used to calculate QBAI generally include adjusted tax basis in equipment, manufacturing plants, and other similar investments in tangible business assets, but do not apply to tax basis in either real property or intangibles

• The U.S. imposes a special tax only on the “GILTI income,” which it views as a proxy for the higher revenues and returns that are attributable to intangible assets that have been moved offshore or that are otherwise owned offshore by a U.S. corporation


I. E. GILTI Regime • The actual GILTI tax on a domestic U.S. C corporation, as we

will see below, is remarkably low and reasonable, and is effectively a “minimum tax” imposed of a CFC is owned by a U.S. domestic C corporation

GILTI tax imposed on a non-corporate taxpayer is dramatically higher, and suggests that major restructuring will be needed for individuals who currently hold an interest in a CFC, whether directly or through a disregarded or pass-through entity

The GILTI tax is imposed on the applicable U.S. Shareholder with respect to the GILTI income of the applicable CFC


I. E. GILTI Regime • One-half (50%) of this amount (grossed up by the adjustment

for foreign taxes under Code Section 78) is excluded for C corporations by an allowable deduction under Code Section 250

• Since the U.S. federal corporate tax rate has been reduced to 21%, this effectively amounts to a 10.5% tax on the GILTI income (which itself is the portion of the CFC income that is above a 10% return on its adjusted tax basis in business assets)

• This is already be a fairly reasonable tax rate, even if the CFC is in a jurisdiction with a zero corporate rate

• Note again, by comparison, the tax regime in Ireland currently imposes a 12.5% tax on business profits, and the regime in Malta imposes a 10% tax, and both of these jurisdictions are considered “tax havens”


I. E. GILTI Regime • Code Section 250 provides as follows:

› In general. In the case of a domestic corporation for any taxable year, there shall be allowed as a deduction an amount equal to the sum of

• 37.5% of the foreign-derived intangible income of such domestic corporation for such taxable year, plus

• 50% of

• The global intangible low-taxed income amount (if any) which is included in the gross income of such domestic corporation under section 951A for such taxable year, and

• the amount treated as a dividend received by such corporation under section 78 which is attributable to the amount described in clause i.


I. E. GILTI Regime

• The 50% deduction under Code Section 250 is only available for domestic U.S. C corporations, and so any non-C corporation U.S. shareholder will be taxed on 100 percent of any GILTI income

• However, the GILTI rules get even better for C corporations. A credit is available under Code Section 960(d) such that a domestic U.S. C corporation is deemed to have paid a pro rata share of up to 80 percent of the foreign income taxes imposed on the CFC’s GILTI

• The Section 960 deemed-paid tax-credit rules do not apply to non-C corporation U.S. shareholders


I. E. GILTI Regime The credit for 80 percent of the taxes paid to a foreign

jurisdiction, coupled with the 50% deduction under Code Section 250, dramatically reduce the incremental GILTI tax owed by a U.S. domestic C corporation, especially if foreign taxes are paid in any significant amount

Although the math can be relatively complicated, a relatively simplistic explanation is that if the GILTI income of a domestic U.S. C corporation is taxed in a foreign jurisdiction at a tax rate of 13.125% or higher, and if 80% of the foreign taxes are creditable against U.S. tax (13.125 X 80% = 10.5%), then no further U.S. tax will apply


I. E. GILTI Regime • Again, given that Ireland’s current tax rate on corporate

income is 12.5%, operating a CFC business in Ireland and paying tax in Ireland would likely result in a minimal amount of additional U.S. taxation for a domestic U.S. C corporation parent under the GILTI regime

• Since the Section 960(d) credit equals 80% of any foreign taxes paid by the CFC on the GILTI income, the mathematical effect of this credit is that if the tax rate in a foreign jurisdiction on CFC income is at least 13.125%, (80% of 13.25% equals 10.5%), then there will be (approximately) a full credit against all U.S. (Variations in this “simplistic” observation can arise because of the impact of interest deductions and other factors.)


I. E. GILTI Regime • In summary, the GILTI regime in complicated but the basic

concept is relatively straight forward • The U.S. will tax the U.S. shareholders of CFCs that have excess

offshore profits (i.e., GILTI) on all or a portion of that income if no other jurisdiction taxes the income at a specified minimum threshold rate

• The tax rate imposed on U.S. domestic C corporations is very reasonable –the equivalent of just 10.5% even if a U.S. C corporation pays zero tax on its GILTI to any foreign jurisdiction


I. E. GILTI Regime • On the other hand, tax rate imposed on all U.S. shareholders

other than C Corporations is not even remotely reasonable – basically, individuals are taxed (and sometimes double-taxed) at full (or almost full) U.S. income tax rates

• Thus, it is important to recognize that the GILTI regime is far more favorable to U.S. C corporations than to other U.S. taxpayers


I. F. Simplified GILTI Calculations Example 1. Simplified U.S. C Corporation Example

• U.S. C corporation (“U.S.C”) is the 100% owner of a CFC, which earns $100 of GILTI income, and pays foreign tax at a rate of 10 percent on that income (resulting in $10 of foreign tax)

• U.S.C can claim a 50 percent deduction under Section 250 on the $100 of GILTI income (a $50 deduction), reducing the taxable amount of GILTI to $50. At a 21% U.S. corporate tax rate, the U.S. tax on $50 is $10.50

• U.S.C can further claim a foreign tax credit under Section 960(d) equal to 80 of foreign taxes paid ($10 × 80% = $8)


I. F. Simplified GILTI Calculations • Thus, U.S.C has net U.S. income tax liability of $2.50 ($10.50

U.S. tax - $8 tax credit) on the GILTI income

• The total tax paid by U.S.C on $100 of foreign income is therefore $12.50 ($10 of foreign tax + $2.50 of U.S. tax), for a combined effective tax rate of 12.5%


I. F. Simplified GILTI Calculations Example 2: Simplified Non-C Corporation Example

• Same facts as Example 1, except that the shareholder in the CFC is U.S. individual taxpayer (herein “X”) rather than a C corporation

• X cannot take advantage either of the 50% deduction under Code Section 250 or the 80% tax credit under Code Section 960(d)

• X can, however, deduct the $10 in foreign taxes paid in calculating the amount of GILTI income subject to tax


I. F. Simplified GILTI Calculations

• Assuming that X is taxable at the maximum individual rate of 37% on $90 ($100 of GILTI income - $10 foreign taxes paid), this results in U.S. income tax of $33.30 (37% × $90)

• Therefore, total taxes paid by X on the $100 of GILTI income comes to $43.30 ($10 of foreign tax + $33.30 of U.S. tax) for an effective tax rate of 43.3% on the GILTI income. OUCH!

• Although these examples are greatly simplified for purposes of illustration, Examples 1 and 2 generally demonstrate how the GILTI regime can be very favorable for U.S. domestic C corporations with CFCs, while at the same time producing strikingly adverse tax consequences for individuals and pass-through entities.


G. More Complicated GILTI Calculations

Similar to the subpart F provisions, GILTI imposes a current tax on income of CFCs, but with a difference:

• Subpart F is an “additive” regime – income of a CFC is not taxable unless it runs afoul of one of the subpart F rules

• GILTI is a “subtractive” regime – all income of the CFC is taxable, after subtracting 1) subpart F income and 2) the product of 10% multiplied times QBAI to calculate the Net Deemed Tangible Income Return


I. G. More Complicated GILTI Calculations

Under the GILTI provisions, the U.S. shareholder of a CFC is taxed on all of the CFC’s income except:

• Income which was already taxed (either as subpart F income under Subpart F, as U.S. trade or business income, or other tax regime)

• A relatively modest amount of income, equal to 10% of the adjusted tax basis in tangible assets, called the Net Deemed Tangible Income Return, which will be subject to territorial regime (and not subject to tax thanks to the deduction under Code Section 245A)



Complex calculations under Code Section 951A are required at two levels, both for the CFC and for the U.S. shareholder:

• At the CFC level, calculations are made for each CFC to determine the following:

› “Tested income” or “tested loss” – Code section 951A(c)(2)A)

› Qualified Business Asset Investment (QBAI) – Code section 951A(d)

› Interest income/interest expense – Code section 951A(b)(2)(B)



• At the U.S. shareholder level, the calculations are based on CFC-level calculations from all CFCs netted together:

› Net tested income

› Net Deemed Tangible Income Return

› GILTI inclusion amount (net of deductions Under Sections 245A and 250)

› Foreign Tax Credit (under Section 960(d))



• CFC tested income is calculated under section 951A(c)(2)(A):

› Start with gross income (revenues less CGS)

› Subtract (back out) certain items:

• Gross subpart F income

• Dividends from “related persons”

• Gross income from U.S. trade or business

• Income excluded under high-tax exception

• Foreign oil and gas extraction income



• Then, deduct expenses and taxes allocable to the remaining

• Section 951A – certain key calculations are carried out at U.S. shareholder level based on information from all underlying CFCs:

Net CFC tested tested income/loss – section 951A(c)(1)

Net deemed tangible income return – section 951A(b)(2)

GILTI – section 951A(a)

GILTI deduction – section 250

Federal Tax Credit on GILTI inclusion – section 960



• The maximum U.S. tax rate on GILTI income is at a 10.5% rate -- half the U.S. corporate rate, and in fact a very low rate in most international contexts.

• Ireland, for example, currently has a 12.5% tax rate and Malta has a 10% tax rate.


Item Federal State

1. Net CFC Tested Income $500,000,000 2. Tested Foreign Income Taxes $80,000,000 3. Qualified Business Asset Investment $1,500,000,000 4. Net Deemed Tangible Income Return (10% of Line 3) $150,000,000 5. Interest Expense Reducing Tested Income $50,000,000 6. Excess of Line 4 over Line 5 $100,000,000 7. GILTI (Excess of Line 1 Over Line 6) $400,000,000 $400,000,000

8. Inclusion Percentage (Line 7 Divided by Line 1) 80% 9. Deemed Credit Paid (Line 8 Multiplied by Line 2) $64,000,000 10. IRC Section 78 Gross-Upa $64,000,000 11. GILTI Plus Section 78 Gross-Up (Line 7 Plus Line 10) $464,000,000 12. 50% Deduction Under Section 250 (37.5% Beginning in 2026) (Line 11 Multiplied by 0.5)

12a. State: 50% Deduction Under Section 250 (37.5% Beginning in 2026) (Line 7 Multiplied by 0.5)b

$232,000,000 $200,000,000

13. Net Inclusion in Taxable Income (Line 11 Minus Line 12)

13a. State: Net Inclusion in Taxable Income (Line 7 Minus Line 12a)

$232,000,000 $200,000,000

14. U.S. Federal Tax on GILTI (Net Inclusion) Before Credits, at 21% $48,720,000 15. Less: Foreign Tax Credit (80% of Line 9) ($51,200,000) 16. Net Federal Tax on GILTI (Unused Foreign Tax Credits Do Not Carry Forward) $0 Federal Tax 17. Unapportioned State Tax on GILTI – Line 13a Multiplied by 7% Tax Rate

17a. State Tax on GILTI Without Section 250 Deduction – Line 7 Multiplied by 7% Tax Rate

$14,000,000

$28,000,000

18. State Tax on GILTI, Assuming 20% Apportionment, With Section 250 Deduction

18a. State Tax on GILTI, Assuming 20% Appointment, Without Section 250 Deduction

$2,800,000 State Tax

-or-


a Line 10 assumes that a state including GILTI in its tax base subtracts the IRC Section 78 gross-up in conformity with pre-existing treatment at the state level of IRC Sec. 78 gross-up.

b Line 12a assumes that a state that conforms to the IRC Section 250 deduction subtracts any IRC Section 78 gross-up added for federal purposes.

Bold font reflects items generally not affecting the state tax calculation. This example is intended to provide a conceptual framework for the GILTI calculation and is not intended to show how the calculation will be reflected on federal and state corporate tax forms.



I. H. GILTI Tax Planning for U.S. Taxpayers other than C Corporations

• In general, there were two basic strategies for structuring international operations under a U.S. parent corporation prior to 2018:

› If the U.S. entity (and its owners) wanted to bring the money back to the U.S. within a reasonable period of time, it made sense to structure the business group as a “flow through” structure so that all income was taxed one time, generally at U.S. individual income tax rates, and with a full credit under Code Section 901 for foreign taxes paid



• Prior to 2018, if the U.S. entity (and its owners) did not intend to bring the money back to the U.S., then structuring all the foreign operations under a regarded foreign holding company (typically a wholly owned CFC of the U.S. C corporation parent) made sense, and the strategy was to plan around the inclusion rules of Subpart F to avoid Subpart F income and have the foreign income taxed in a low tax jurisdiction and then keep the retained earnings offshore indefinitely

• It worked!



• The 2018 strategies for addressing the GILTI Regime are actually similar to the pre-2018 strategies, but with one further option

› if the individual U.S. owners of a CFC intend to bring the foreign income back to the U.S. and distribute it to themselves within a relatively short time frame, then a “pass through” structure still makes sense, so that income is taxed one time at U.S. tax rates with a direct tax credit available for foreign taxes paid



• If the income earned offshore is intended to be kept offshore and reinvested, then it makes sense to insert a “blocker,” except that instead of using a foreign CFC as the “blocker” to trap all foreign income offshore (and avoid U.S. income taxation), the new and better strategy would be to create an “onshore” blocker, namely, a U.S. C corporation that holds all the foreign CFCs beneath it. This will allow the U.S. taxpayers to pay the minimum amount of U.S. tax on GILTI income and leave the income offshore indefinitely

• A third alternative – and unique to the GILTI regime -- is for an individual to election be taxed as a corporation under Code Section 962



This third alternative has some, but not all, of the benefits of inserting a C corporation blocker. However, the good news is that it can be elected for a year where no blocker was in fact inserted


• Example 4 – Simplified Example of Section 962 Election

• Same facts as Example 2, except that individual Taxpayer X elects under Code Section 962 to be taxed at corporate rates with respect to income includable under Code Section 951(a) (including GILTI income)

• Section 962 allows an individual shareholder to elect to be taxed on amounts included in their gross income under Section 951(a) at corporate rates and to get the benefit of Section 960 foreign tax credits with respect to such income




• The GILTI rules expressly provide that GILTI is treated as included in Section 951(a) for purposes of Section 962, so this rule should apply to GILTI as well as to regular Subpart F income

• However, it is presently unclear the whether 50 percent deduction under Code Section 250 is available to an individual who makes a Section 962 election. At the moment, some commentators suggest yes, while others say no. The weight of opinion at the moment is “no”



At WORST, making a Section 962 election would provide Taxpayer X with the following benefits:

GILTI income is taxed currently at the 21% corporate rate rather than at the 37% individual rate. Therefore, Taxpayer X pays U.S. tax on the GILTI income amount of $100 at a 21% tax rate (this example assumes no 50% deduction under Section 250), or $21 of tax. The credit for 80% of foreign taxes under Code Section 960(d) is available, so the $10 of foreign tax paid in Example 2 produced an $8 tax credit ($10 × 80% = $8)


• Thus, the net U.S. GILTI tax due and payable in the current year by Taxpayer X is $13 ($21 - $8 = $13). Thus, the total amount of income tax paid by Taxpayer X in the current year on $100 of GILTI income is $23 ($13 U.S. GILTI tax + $10 foreign tax), for a 23% effective tax rate




However, there is still a deferred dividend tax to be paid by Taxpayer X in the future, whenever X actually receives a distribution of GILTI income from the CFC. Since $23 has so far been paid in tax, X will be taxable on a $100 dividend distribution in the amount of $77 ($100 - $23). This amount does not qualify as previously taxed income (PTI) and will likely be taxed as a dividend. Assuming the dividend is a qualified dividend (it may not be) taxed at 20%, plus being subject to the 3.8% NIIT, the resulting tax amount is $18.33 ($77 × 23.8%)



• Thus, the total tax paid with respect to the Section 962 election (Example 4) is therefore $23 + 18.33 = $41.33 or the equivalent of 41.33% combined tax rate

• However, if the dividend is NOT a qualified dividend, the distribution is taxed at the taxpayer’s marginal rate (e.g., up to 37%) plus 3.8% NIIT. Tax is as high as 40.8% x $77 = $31.42, with total tax of $23 + $31.42 = $54.42, or a 54.42% combined tax rate

• Compare this to Example 2, where the GILTI tax due and payable by Taxpayer X in the current year was paid at an effective tax rate of 43.3%



• The election under Code Section 962 is available to individual U.S. taxpayers, including estates and trust.

• The election can be made for each separate tax year, and does not automatically carry over. For any year in which the election is made, it applies to all CFCs in which the electing individual is a U.S. shareholder.



Example 5 – The Pass-Through Tax Model

• A variation on this theme would be to consider using “check the box” elections to convert all of the CFC entities into disregarded or “pass through” entities, in which case the U.S. individual taxpayer would be able to claim a foreign tax credit for all foreign taxes paid.

• Assume the same facts as in Example 2, except that the CFC is an “eligible entity” and the owners elect to “check the box” and treat the entity as a pass-through entity for U.S. federal income tax purposes.



• Based on $100 of foreign income earned by the CFC, Taxpayer X will report both the $100 of foreign income and the related foreign tax credits on the Form 1040 return

• The U.S. income tax on $100 of foreign income is $37 (37% × $100) but a full foreign tax credit under Section 901 (as opposed to an 80% credit under 960(d)) is available, and so the “net” U.S. income tax (assuming the foreign tax credit is fully available and ignoring the weird results that sometimes arise on foreign tax credit calculations under Form 1116) will result is $27 of U.S. tax ($37 of U.S. tax - a $10 foreign tax credit) and total tax will be $37 ($27 + $10) or the equivalent of a 37% tax rate



Note that all tax is due in the year the foreign income is reported, without deferral, but the effective tax rate is the U.S. individual tax rate of 37%. This alternative is particularly beneficial if most or all of the foreign income will be repatriated currently or relatively soon



Example 6 – Simplified Example of Inserting C corporation Blocker

• Same facts except that Taxpayer X, planning ahead, inserts a U.S. domestic C corporation as the owner of the CFC and thereby enjoy the favorable tax treatment accorded domestic U.S. C corporations under the GILTI Regime.

• Assume the same facts as Example 2, except that Taxpayer X contributes all the shares in the applicable CFC into a U.S. domestic C corporation.



The tax results are now the same as Example 1! The U.S. domestic C corporation pays $12.50 of current tax ($10 foreign tax + $2.50 U.S. Tax)

When the domestic C corporation later distributes the retained earnings and profits of $87.50 in the future to Taxpayer X, and assuming this is a qualified dividend, X will pay 23.8% (20% dividend + 3.8% NIIT) on $87.50, or an additional $20.83 ($87.5 x 23.8%). Total tax is $33.33 ($12.50 + $20.83), or a combined effective rate of 33.33%

This structure both allows for significant tax deferral and produces the best after-tax result for Taxpayer X


I. I. State Tax Considerations

• Many U.S. states tax their individual residents based on the computation of federal income taxation, and so the effect of the GILTI regime at the state income tax may vary quite widely from state to state

• In particular, some states include the current federal tax code, while other states operate on a delayed basis, and some states do not base state taxation on the federal definition of taxable income

• Still other states do not have an individual income tax or (less common) do not have a corporate income tax regime


I. I. State Tax Considerations

• Another interesting question is whether the GILTI income will be considered net investment income subject to the so-called NIIT tax of 3.8%. If the income is ultimately converted into a dividend, then definitely yes, but pass through of GILTI to an individual taxpayer will likely depend on specific facts

• The 2017 Tax Act made corresponding changes to the foreign tax credit rules – mostly changes that conform with the other modifications introduced by the Act

• The indirect foreign tax credit under Code Section 902 was repealed, since the “general” rule is that the U.S. allows a 100% deduction for foreign dividends under Code Section 245A

• Tax credits for domestic C corporations are available under Code Section 960(d) (at 80% of foreign tax paid) with respect to GILTI income


I. J. Changes in Tax Credits

• Code Section 960, which provides a credit for inclusions of Subpart F income, was modified to provide that such credits are determined on annual (non-pool) basis

• Code Section 960 provides that is Subpart F income is included in taxable income of a U.S. domestic corporation that is a United States shareholder in a CFC, the domestic corporation is deemed to have paid so much of such foreign corporation's foreign income taxes as are properly attributable to the included income


I. K. Summary of Changes

The GILTI regime is a very dramatic change from prior U.S. tax law and it is worth stopping to compare the changes. For the corporate U.S. corporations, under prior law, a repatriation of foreign profits by a CFC to the U.S. parent company would have been taxed at a 35% rate, and so the current GILTI regime, reducing the tax rate to at most 10.5% U.S. tax (and literally zero tax if the CFC is already taxed at a tax rate at or above approximately 13.125%). The effect of this is that U.S. corporations owning CFCs are now subject to a very favorable regime


I. K. Summary of Changes

• By contrast, for individual or pass-through U.S. taxpayers, the current regime is significantly worse. Under the old regime, the foreign earnings could be deferred indefinitely, and upon repatriation they would be subject to tax at a dividend rate, which would be 20% if the dividend was a “qualified” dividend, pursuant to a U.S. tax treaty, and worst-case scenario was taxed at the individual rate.

• Under the current regime, the active business income of CFC that “checks the box” is now subject to full U.S. taxation at a 37% rate, with no deferral.



PART II STATE TAX CONSEQUENCES

OF

GILTI INCOME


Item Federal State

1. Net CFC Tested Income $500,000,000

2. Tested Foreign Income Taxes $80,000,000

3. Qualified Business Asset Investment $1,500,000,000

4. Net Deemed Tangible Income Return (10% of Line 3) $150,000,000

5. Interest Expense Reducing Tested Income $50,000,000

6. Excess of Line 4 over Line 5 $100,000,000

7. GILTI (Excess of Line 1 Over Line 6) $400,000,000 $400,000,000

8. Inclusion Percentage (Line 7 Divided by Line 1) 80%

9. Deemed Credit Paid (Line 8 Multiplied by Line 2) $64,000,000

10. IRC Section 78 Gross-Upa $64,000,000

11. GILTI Plus Section 78 Gross-Up (Line 7 Plus Line 10) $464,000,000

12. 50% Deduction Under Section 250 (37.5% Beginning in 2026)

(Line 11 Multiplied by 0.5)

12a. State: 50% Deduction Under Section 250 (37.5% Beginning in 2026)

(Line 7 Multiplied by 0.5)b

$232,000,000 $200,000,000

13. Net Inclusion in Taxable Income (Line 11 Minus Line 12)

13a. State: Net Inclusion in Taxable Income (Line 7 Minus Line 12a)

$232,000,000 $200,000,000

14. U.S. Federal Tax on GILTI (Net Inclusion) Before Credits, at 21% $48,720,000

15. Less: Foreign Tax Credit (80% of Line 9) ($51,200,000)

16. Net Federal Tax on GILTI (Unused Foreign Tax Credits Do Not Carry Forward) $0 Federal Tax

17. Unapportioned State Tax on GILTI – Line 13a Multiplied by 7% Tax Rate

17a. State Tax on GILTI Without Section 250 Deduction –

Line 7 Multiplied by 7% Tax Rate

$14,000,000

$28,000,000

18. State Tax on GILTI, Assuming 20% Apportionment,

With Section 250 Deduction

18a. State Tax on GILTI, Assuming 20% Appointment,

Without Section 250 Deduction


-or-


a Line 10 assumes that a state including GILTI in its tax base subtracts the IRC Section 78 gross-up in conformity with pre-existing treatment at the state level of IRC Sec. 78 gross-up.

b Line 12a assumes that a state that conforms to the IRC Section 250 deduction subtracts any IRC Section 78 gross-up added for federal purposes.

Bold font reflects items generally not affecting the state tax calculation. This example is intended to provide a conceptual framework for the GILTI calculation and is not intended to

show how the calculation will be reflected on federal and state corporate tax forms.



III. Speaker Bios


Joseph B. Darby III

Joseph B. Darby III is a partner in Sullivan & Worcester's Boston office, focusing his practice on business and transactional tax law. Jay advises a wide variety of corporations and high-net-worth individuals on tax and legal aspects of business and real estate activities and represents these taxpayers before federal and state taxing authorities. He also works with high-net-worth individuals and business owners to organize their personal income tax and estate planning affairs in order to maximize wealth preservation and minimize tax on transfers to family members, charities and other recipients. Jay has represented and advised numerous public and private companies, as well as private equity and venture capital firms, on investment and acquisition transactions and on the disposition of business interests, in transactions ranging from early-stage investments in high-tech startups to acquisitions and sales of mature, late-stage companies and publicly traded corporations.

617 338 2985 [email protected]


Joseph X. Donovan

Joseph X. Donovan joined the state and local tax practice of Sullivan & Worcester LLP in 2006 after having spent three years as Deputy General Counsel of the Massachusetts Department of Revenue, where he was responsible for working with the General Counsel to manage the Department’s Legal Division – the group responsible for developing public written statements of departmental policy, litigating tax cases in the Massachusetts Appellate Tax Board and drafting and providing comments on proposed tax legislation. From 1984 to 2003, Joe held various positions in the state tax consulting practice of PricewaterhouseCoopers LLP and its predecessor firm Coopers & Lybrand, including leader of its Northeast Region state tax practice. Joe is the author of the Massachusetts Sales and Use Tax Manual and co-author, with J. Gary Dean, of the BNA Multistate Tax Portfolio on Formulary Apportionment Methods. He has been an adjunct faculty member in tax programs at Suffolk University, Northeastern University and New York University. In April of 2007, Joe was appointed by Governor Deval Patrick to a special commission charged with studying Massachusetts corporate taxation.



Douglas S. Stransky Douglas S. Stransky is a partner in the Tax Department of our Boston office and the leader of the International Tax Practice Group. Doug concentrates his practice on international tax planning for clients in a wide range of industries with a particular emphasis on U.S.-based clients investing in foreign jurisdictions. Doug is a former co-chair of the International Tax Committee of the Boston Bar Association, a member of the Board of Advisors for Practical U.S./International Tax Strategies, a contributing author for Lexis Practice Advisor and a member of the adjunct faculty at Boston University School of Law.

In addition, Doug is a frequent speaker at various conferences and webinars on international tax topics for Bloomberg Tax, Financial Executives International, Boston Bar Association and the International Fiscal Association.

Before joining Sullivan & Worcester, Doug was the Director of International Tax Services and a member of the National Outbound Team at PricewaterhouseCoopers LLP. Previously, he held various management positions in the hospitality industry.



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