By James J. DeLuca, CPA, MST
Senior Tax Manager
The acronym GILTI sounds more like a phrase from the James Cagney movie “Public Enemy” than a section of the Internal Revenue Code (IRC), but it is, indeed, a code section that U.S. business owners with foreign operations need to understand.
Global Intangible Low-Taxed Income is a category of income that is earned abroad by controlled foreign corporations (CFCs) and is subject to special treatment under the U.S. tax code. CFCs are foreign corporations in which more than 50% of the vote or value is owned by U.S. shareholders who each own 10% or more of the entity.
Why GILTI?
The tax on GILTI is intended to discourage multinational companies from shifting their profits on “easily moved assets” from the U.S. to foreign jurisdictions with tax rates below U.S. rates. Generally, GILTI is foreign income earned by CFCs from intangible assets such as copyrights, trademarks and patents.
Created by the Tax Cuts and Jobs Act (TCJA) of 2017, the GILTI tax was intended to slow the erosion of the U.S. tax base by removing the incentive to locate operations and assets in low-tax countries. At the time, TCJA was promoted as shifting the U.S. to a territorial tax system rather than a system that taxed U.S. taxpayers on their worldwide income, as it had always been. However, the GILTI tax does subject U.S. taxpayers to taxation on worldwide income by requiring them to include their ownership percentage of foreign-derived income in their taxable income.
History
To understand the purpose of GILTI one needs to understand the history behind it. Although it was part of TCJA, it has roots extending back six decades to President John F. Kennedy’s administration. The Kennedy administration was concerned that U.S. corporations were exporting jobs overseas to foreign-owned corporations in low-tax countries and avoiding U.S. taxation until the income was repatriated back to the U.S. as dividends. To curtail this tax avoidance, lawmakers instituted what is known as the Subpart F regime, whereby certain kinds of foreign income would be deemed to be repatriated back to the U.S., along with related foreign tax credits, and subject to current taxation at ordinary income tax rates.
Over time, due to abuse, exceptions and changes in economic circumstances, the Subpart F income rules became inadequate in taxing CFCs. Concerned once again about the erosion of the U.S. tax system, Congress drafted the GILTI provision to tax all income associated with intangible assets of controlled foreign corporations.
How GILTI Works
GILTI income is includible in the income of U.S. shareholders if all of a CFC’s gross income (exclusive of income associated with a U.S. trade or business and Subpart F income) exceeds 10% of the corporation’s adjusted tax basis of tangible depreciable property assets used in the trade or business, less allocable deductions.
For U.S. corporate shareholders the deemed inclusion amount is further reduced by 50%, thereby subjecting the income to an effective tax rate of 10.5% through 2025, and 13.125% thereafter. This deduction is not available to U.S. individual shareholders.
If a company pays foreign taxes, it can claim 80% of the value of those taxes as a credit against GILTI liability.
Further, there are exceptions to the GILTI tax. If the CFC is organized in a foreign country where the effective tax rate is greater than 90% of the U.S. tax rate it is assumed that tax avoidance is not the motive for organizing overseas and the GILTI tax does not apply.
With an effective tax rate of 10.5% for corporate shareholders of U.S.-owned CFCs, the GILTI tax may, in certain circumstances, provide shareholders with an effective way to lower their tax bills.
If you would like to discuss how the GILTI tax may affect you, contact your G.T. Reilly adviser.
