December 7, 2018
U.S. Shareholders of Foreign Corporations Still Await IRS Guidance on GILTI and Section 962
Almost a year ago, the U.S. Congress enacted a new tax on so-called “Global Intangible Low-Taxed Income” (GILTI). The new tax affects, (among others), many U.S. citizens and U.S. residents who live in Canada or other foreign countries, and who own shares in non-U.S. corporations. It applies for corporate tax years beginning after December 31, 2017.1
WHO IS SUBJECT TO THE GILTI TAX?
The tax applies to “U.S. Shareholders” of foreign (non-U.S.) corporations that are “controlled foreign corporations” (CFCs).
What is the Meaning of “U.S. Shareholder”?
A “U.S. Shareholder” (U.S. Shareholder) is any U.S. person (a U.S. citizen, U.S. green card holder or resident, or U.S. entity) that “owns” 10% or more of the voting power, or value, of a CFC.2 Complex rules describe, and expand, the meaning of “ownership”. For purposes of GILTI, a person is treated as a U.S. shareholder only if the person owns stock in the corporation on the last day the corporation’s tax year in which the corporation is a CFC.3
HOW DOES THE GILTI TAX WORK?
In the case of an individual who is a U.S. Shareholder, the individual is taxed on his/her portion of the CFC’s operating profit in excess of a hypothetical return on the CFC’s foreign assets. This taxable amount is referred to as “Global Intangible Low-Taxed Income” (GILTI). The tax rate for an individual on GILTI is a graduated federal tax rate up to the maximum 37%, and it applies even if the GILTI is not distributed to him/her. The example below sets out an extremely simplistic description of the application of the tax, absent tax planning or other action.
Example: Steve is a U.S. citizen living in Canada and he owns 100% of SteveCorp, a Canadian corporation. The corporation is a service corporation and it owns no physical assets. SteveCorps’ profits in calendar year 2018 are $300,000 and it pays no dividends and makes no distributions to Steve, other than some salary to Steve which is already deducted in arriving at $300,000 profit above. On these very simple facts Steve may be taxable personally in 2018, on the GILTI ($300,000) at U.S. tax rates up to 37%, even though he does not receive it.
All Eyes are on the Section 962 Election
In the above example, Steve has the right to elect to pay tax at U.S. federal corporate tax rates (a flat 21%) on the $300,000 GILTI, instead of paying tax at graduated rates up to 37%.4 This election also gives Steve the right to take a personal current foreign tax credit in the U.S. for up to 80% of the corporate income tax which SteveCorp pays in Canada.5 The CFC’s relevant foreign corporate tax is “grossed up” on the GILTI. However, this may not be a complete panacea. When the GILTI income is distributed to Steve as a dividend, there will be additional income to Steve, in the amount of the GILTI distributed to him less the U.S. tax he has already paid on it. However, at that time there will be additional foreign tax credits available to Steve, which could reduce, or even eliminate, any additional U.S. tax to Steve on the GILTI portion of the dividend.
The New Section 250 GILTI Deduction
Now comes the issue of the GILTI deduction. The tax code permits a “U.S. Shareholder” that is a “domestic corporation”, a deduction of 50% of the GILTI in computing its tax on GILTI.6 As of this date, December 7, 2018, it is unclear whether the 962 election by an individual referred to above, will permit that individual to also take the 50% GILTI deduction.
If the IRS decides to permit such a deduction, the maximum current tax rate to the individual would be 10.5%. The current tax could be further reduced, perhaps eliminated, by the 962 electing individual’s ability to claim a foreign tax credit for up to 80% of the CFC’s foreign corporate tax. The CFC’s relevant corporate tax is grossed up on the GILTI, but more U.S. tax may arise on a subsequent distribution from the CFC. Several months ago, the IRS indicated informally that it would issue regulations on section 250 by the end of 2018. None has been issued as of this date, December 7, 2018.
Domestic (U.S.) corporations that are U.S. Shareholders of CFCs are much better off than individuals. Their U.S. federal corporate tax rate is already 21%, they are automatically entitled
to the 50% GILTI deduction thus reducing the tax on GILTI to 10.5%, and they are automatically entitled to a current foreign tax credit for up to 80% of the foreign tax paid by the CFC. Thus, if the foreign corporate tax rate for the CFC exceeds 13.125%, there should be no GILTI tax for the domestic corporation and, generally, no further U.S. tax on a distribution of GILTI from the CFC to the domestic corporation.
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1 IRC §951A
2 IRC §951(b)
3 IRC §951A(e)(2)
4 IRC §962
5 IRC §960
6 IRC §250(a)(1)(B)