The Tax Cuts and Jobs Act, passed in December 2017, contains a new requirement that a “United States Shareholder”1 of a controlled foreign corporation (“CFC”) include its proportionate share of a CFC’s global intangible low-taxed income (“GILTI”) in such shareholder’s annual income. The Internal Revenue Service (“IRS”) recently proposed regulations interpreting the GILTI provisions of the U.S. federal income tax law.
Generally, GILTI is determined by subtracting the deemed tangible income return (“DTIR”) of a CFC from the CFC’s net tested income (i.e., tested income minus tested loss). DTIR means 10% of the aggregate average adjusted basis in tangible, depreciable property that is used in a trade or business.
Tested income means gross income minus deductions and certain items of excludable income. Excludable items of income for this purpose includes, among other items, income that is already included in the United States Shareholder’s income as subpart F income and income that is effectively connected to a United States trade or business. Therefore, GILTI should not have a material impact on United States Shareholders that invest in offshore investment funds because most, if not all, of the fund’s income would be treated as subpart F income (and U.S. taxable persons generally do not invest in offshore corporate feeder funds). However, GILTI could affect private equity investments in non-U.S. portfolio companies.
Although the GILTI acronym suggests that income that is subject to a high rate of foreign taxation would not be included in a United States Shareholder’s GILTI inclusion, this is not the case. Test income excludes income subject to the high-tax exception from subpart F income. The proposed regulations clarify that this exclusion only applies to subpart F income (and not all income) that is subject to a rate of foreign income taxation greater than 18.9%. Therefore, it is possible that a CFC in a high-tax jurisdiction with no subpart F income could generate a significant amount of GILTI to its U.S. owners.
A corporate United States Shareholder of a CFC’s equity is entitled to a 50% deduction with respect to any GILTI included in its income. Thus, corporate United States Shareholders of a CFC are taxed at an effective U.S. federal income tax rate of 10.5% on their share of GILTI from CFCs. The IRS does not address this deduction in the recent set of proposed regulations and will publish guidance separately with respect to this deduction.
The proposed GILTI regulations clarify that U.S. taxpayers that have elected to treat subpart F income as “net investment income” for purposes of the so-called Medicare tax on net investment income should also treat GILTI as net investment income.
The proposed regulations leave open the possibility that GILTI could be characterized as unrelated business taxable income (“UBTI”) with respect to tax-exempt organizations. While this potential treatment remains under consideration, we expect that future guidance will clarify that GILTI should not be treated as UBTI. Our view is based in part on the above-described possible treatment of GILTI as “net investment income”.
Finally, the proposed GILTI regulations provide for a new IRS reporting obligation with respect to calculating and reporting GILTI. Form 8992 (U.S. Shareholder Calculation of Global Intangible Low-Taxed Income (GILTI)) will be created by the IRS and may need to be filed by U.S. Shareholders of CFCs.
The IRS anticipates finalizing these regulations by June 2019. Seward & Kissel will continue to actively monitor regulatory developments with respect to changes to the United States federal income tax law. For additional information on recent tax developments, please contact Jonathan P. Brose (212-574-1615), James C. Cofer (212-574-1688), Ronald P. Cima (212-574-1471), Peter E. Pront (212-574-1221), Daniel C. Murphy (212-574-1210) or Brett R. Cotler (212-574-1269).
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1 A “United States Shareholder” means a United States person that owns directly or constructively 10% or more of the equity (by vote or value) in a foreign corporation.
