GILTI High-Tax Exclusion Election for US Individual Taxpayers
What is GILTI?
In December of 2017, expansive US tax reform was introduced under the Tax Cuts and Jobs Act (TCJA). Much of this tax reform was focused on the international tax code, in particular the taxation of offshore earnings. As a result of this tax reform, a minimum tax was imposed on foreign company earnings, more specifically, the foreign earnings which are derived from, or deemed to be derived from, intangible assets. This new minimum tax introduced in 2018 was called the Global Intangible Low-Taxed Income, or “GILTI”.
Unlike the Subpart F regulations which already impose a tax on passive foreign earnings directly, GILTI imposes a tax on earnings in excess of a 10 percent return threshold on tangible business depreciable assets, known as the Qualified Business Asset Investment, or “QBAI”. This means that the GILTI tax ultimately relies on the assumption that the earnings in excess of the 10 percent exemption are derived from intangibles, such as patents and other intellectual property, and that US companies move such intangibles offshore to low-tax jurisdictions to avoid paying US taxes. However, in practice, the GILTI tax is often imposed on earnings that are not directly related to intangible assets and that are already subject to taxation in a high-tax jurisdiction. As a result, many US shareholders of foreign corporations may face an additional tax burden in the US. This is in direct contradiction to the original objective of the GILTI tax legislation, which was the taxation of offshore low-tax income.
Given this contradiction, there was much push-back and debate from tax experts about the reasonability of this new tax burden. In response, the US Department of the Treasury and the IRS released the GILTI Final Regulations (Federal Register, 85 FR 44620) in July 2020 which provided taxpayers with the ability to exclude such high-tax earnings from GILTI. The new GILTI High-Tax Exclusion, or “GILTI HTE”, election is similar to the already existing Subpart F high-tax exception, which allows foreign income that is already taxed at or above 90% of the US tax rate of 21% (or 18.9%), to avoid taxation in the US.
Main Factors of the GILTI High-Tax Exclusion Election
For US taxpayers with interests in foreign corporations, the GILTI HTE election may prove to be a beneficial tax-saving strategy against additional taxes in the US. However, before electing to exclude GILTI high-taxed income, several factors must be considered in order to determine if the entity or entities are eligible for the election and if the election is ultimately beneficial for the taxpayer in the current tax year. These factors include the following:
The definition of a tested unit under the final regulations varies from the previous approach found in the proposed regulations from 2019, which utilized the previously understood concept of the qualified business unit as the determining factor. However, under the final regulations, for purposes of determining the applicability of the GILTI High-Tax Exclusion, a tested unit is more concretely defined as: a controlled foreign corporation (CFC), the interest a CFC holds in a passthrough entity, or a branch of the CFC. Moreover, tested units of a CFC are regarded as a single tested unit if they are located in the same foreign country (Treas. Reg. Sec. 1.951A-2(c)(7)(ii)).
Tested Unit Example
A US Taxpayer, who is an individual US citizen, has a greater than 10 percent ownership in three CFCs: one in Germany, one in the Netherlands, and one in Italy. Each of these CFCs is a separate tested unit.
CFC 1, a German CFC is the parent entity to a Polish foreign branch. The Polish foreign branch is also a tested unit if it has a taxable presence in Poland.
The Belgian entity owned by the Dutch CFC 2 is treated as a partnership for both US tax purposes and under the laws of Belgium. The partnership files all the required tax returns in Belgium and therefore has a taxable presence in Belgium, making it a tested unit.
Lastly, CFC 3 in Italy holds an interest in another Italian entity, which a foreign disregarded entity for US tax purposes. Under the GILTI final regulations, the tested units of a CFC are to be regarded as a single tested unit if the entities are located in the same foreign country or are tax residents of the same foreign countries. Therefore, CFC 3, together with the foreign disregarded entity, are treated as one tested unit.
The entities determined to be tested units are outlined in red in the organization structure below. Whether or not each of these various tested units is eligible for the GILTI High-Tax Exclusion election depends on the effective tax rates of each respective entity.
CFC Group Consistency
Under the Final GILTI Regulations, the GILTI HTE election cannot be made on a CFC-by-CFC basis, but rather is applicable to all of the qualifying CFCs in the group. This all-or-nothing approach considers CFCs that share common ownership of more that 50 percent, by either vote or value, to be a part of a group. The 50 percent ownership determination includes stock that is owned directly, indirectly, or constructively (Treas. Reg. Sec. 1.951A-2(c)(7)(viii)(E)(2)(i)).
The group consistency requirement extends beyond the GILTI HTE election as well. If the election is made for the group for GILTI, then the election is deemed to also apply to the Subpart F income as part of a unitary election.
Effective Foreign Tax Rate
In order to elect the GILTI High-Tax Exclusion, the effective foreign tax rate for the tested unit must be at or above 90% of the applicable maximum US corporate tax rate that would apply if the income were subject to tax in the US. The maximum US corporate tax rate is currently 21%. Therefore, in order to be eligible for the high-tax income exclusion, the effective foreign tax rate must be at least 18.9%. The effective foreign tax rate must be computed after the foreign income and tax amounts are converted to US Dollar amounts (Treas. Reg. Sec. 1.951A-2(c)(7)(vi)(A)-(B)).
The GILTI High-Tax Exclusion election is applicable for tax years beginning on or after July 23, 2020, and for tax years of US Shareholders in which the tax year of the CFC ends on or after this date.
However, for foreign corporations with tax years beginning after December 31, 2017, the election can also be made retroactively in order to include the election on previously filed returns on which tax was imposed as result of a GILTI inclusion. The retroactive election is made by amending the prior year return(s) within 24 months of the original due date (not including extensions) of the controlling US domestic shareholder (Treas. Reg. Sec. 1.951A-2(c)(7)(viii)).
In order to make the election after determining that it is beneficial, the controlling domestic shareholders attach a statement under § 1.964-1(c)(3)(ii) to their federal tax returns for the applicable tax year. The election is binding for all US shareholders. As such, the controlling shareholders must give notice to both minority and noncontrolling shareholders of the decision to make the election (Treas. Reg. Sec. 1.951A-2(c)(7)(viii)).
The election is made annually and must be reconsidered each year. Should the election be made in following years, the election statement must be attached again to the US shareholder’s tax returns. Additionally, minority and noncontrolling shareholders must be informed of the decision again each year for which the election is made.
If you have any questions or would like more information about the GILTI High-Tax Exclusion election and whether it may be beneficial as a tax-saving strategy for you, please be sure to contact us. Our experts are available to help with all your corporate foreign tax issues and more.
Sanders US Tax Services specializes in US corporate reporting. We have multilingual teams in the US as well as various European countries. We’re therefore able to work alongside your German, Dutch or Swiss accountant and enhance collaboration and facilitate a smoother exchange of information.