Introduction
The authors of the essay “Differences in the Consequences of GILTI and Subpart F Inclusions” are Stephanie Wu and B. Anthony Billings. The article analyzes and compares the tax effects of Subpart F income inclusions and Global Intangible Low-Taxed Income (GILTI) for U.S. multinational firms. The article explains that the Tax Cuts and Jobs Act of 2017 introduced GILTI to prevent U.S. multinationals’ perceived abuse of low-tax jurisdictions.
Subpart F Income
In accordance with Internal Revenue Code (IRC) sections 250 and 951A, which mandate that U.S. shareholders include the pro rata share of the subpart F income and GILTI of the controlled foreign corporation (CFC) in their gross income, this article provides an overview of subpart F income and the global intangible low-taxed income (GILTI) regime. Foreign personal holding company income, foreign base company sales revenue, and foreign base company services income are all included in the subpart F income. Certain guidelines and restrictions can be applied when calculating the revenue for each subpart F category.
The GILTI regime aims to deter U.S. businesses from moving earnings to other countries with low taxes. The GILTI and subpart F regimes are now applicable primarily to U.S. companies. The high-tax election and the same-country exemption, which exclude some subpart F income inclusions, are also covered in the article. The review argues that U.S. shareholders may be eligible for a foreign tax credit for income taxes paid on subpart F income and that subpart F income of any CFC for any tax year cannot exceed the corporation’s earnings and profits for the year.
GILTI
GILTI is the difference between the shareholder’s pro rata share of the CFC’s net CFC-tested income and the CFC’s net deemed tangible income return. The net considered tangible income return is 10% of each U.S. shareholder’s pro rata share of each CFC’s qualifying business asset investment that exceeds the interest costs used to determine the shareholder’s net CFC tested income. The net CFC tested income is the difference between the U.S. shareholder’s pro rata portion of each kind of CFC’s tested revenue and its pro rata share of each CFC’s tested loss. Taxpayers can exclude foreign base company income and insurance income from gross tested income if the effective foreign tax rates on that income exceed 90% of the highest U.S. corporate tax rate.
According to the article, subpart F revenue comprises earnings from various sources, including insurance earnings, profits from foreign-based companies, earnings from unlawful kickbacks and bribes, earnings from international boycott factors, and revenues from some countries. Subpart F income, effectively connected income (ECI), dividends paid from a related party, and overseas oil and gas extraction revenue are all excluded from GILTI. Allocable deductions and 10% of the return on eligible physical assets are deducted from the remaining gross tested income.
The high-tax exemption, which is a limitation on subpart F income, is also discussed in the article. The share of foreign base company revenue or insurance income subject to an effective foreign rate exceeding 90% of the maximum U.S. corporation rate of 21% is excluded from subpart F income under this exemption. The part of the net income eligible for the high-tax exception is subtracted from the adjusted net foreign base business income or adjusted net insurance income.
The article then discusses the final regulations published by the Treasury Department in July 2020 to address the GILTI high-tax exception. The regulations used a CFC’s gross tested income attributable to a tested unit to assess the GILTI high-tax exemption. A CFC, an interest directly owned by a CFC in a passthrough corporation or a branch whose operations are managed by a CFC, is an example of a tested unit. Moreover, if their owners are tax residents of the same nation as the CFC, the final regulations mandate that a CFC’s tested units be handled as a single tested unit. Branch-tested units that are not taxed are not included. Like subpart F, the rules also let taxpayers choose the GILTI high-tax exclusion annually.
This article also covers the proposed subpart F regulations that align the subpart F high-tax exemption with the high-tax exception in the final GILTI regulations. The proposed subpart F regulations change the guidelines for implementing the subpart F high-tax exemption. The subpart F election will no longer be available to taxpayers for each line item. It needs to be clarified why, in the final GILTI rules, the subpart F exemption conforms to the GILTI exception rather than vice versa.
Examples
The Calculation of Subpart F Income
The example demonstrates the calculation of subpart F income. It uses the case study of Maxtan Inc., a U.S. company in the car industry. Zero Corp., a Singapore-based affiliate of Maxtan, is controlled by the company to the tune of 85%. In 2020, Taxman Inc., an Irish building contractor that is a 90%-owned affiliate of Maxtan, hired Zero to perform engineering work for it in Ireland.
Moreover, Zero offered engineering support in Singapore to Singatan Corp., a Maxtan affiliate owned 90%. In 2020, Zero generated $5.1 million in revenue and $6 million in E&P. Because Zero is held more than 50% by American stockholders who control more than 10% of its shares, the example illustrates that Maxtan will probably have $1.275 million in subpart F income for the services income Zero received from Taxman.
However, according to the same-country exemption, which exempts revenue from subpart F classification if obtained in the same country as the CFC, the $2 million in engineering services Zero provided for Singatan are not considered subpart F income. Given that Zero paid Singaporean taxes on the $1.275 million in subpart F income, Maxtan is entitled to an FTC if it is within the section 904 time period for claiming one. This example shows how combining technical rules like subpart F and GILTI can result in challenging calculations and difficulties for U.S. businesses conducting business abroad.
The Calculation of GILTI
Global Intangible Low-Taxed Income (GILTI) calculation for an automobile business with a U.S. domicile, Maxtan, and its overseas partner, Zero, with a Singaporean domicile, is demonstrated in Example 2. The scenario considers that Taxman, an Irish construction company 90% owned by Maxtan, obtained $1.5 million worth of engineering services from Zero during the 2020 fiscal year. Moreover, Zero reported $5.1 million in revenue and $900,000 in operational costs, of which $700,000 pertained to sales revenue and $200,000 to engineering work done for Taxman in Ireland. Zero’s tangible assets have an adjusted average basis of $3.5 million. Zero owes $714,000 in taxes on its $4.2 million taxable revenue in Singapore.
Zero’s net CFC-tested income is calculated using the GILTI methodology, which takes gross income and subtracts certain exceptions (in this example, subpart F income) from deductions. Operating costs and income tax are deducted from the gross revenue of $3.6 million ($5.1 million—$1.5 million), which is utilized to calculate GILTI. The income tax that should be deducted is $493,000, which is determined by multiplying the total tax by the proportion of net pretax tested income by total net pretax income.
Zero’s net CFC tested income is $2.407 million ($3.6 million – $1.193 million). The net is considered tangible income return, which is determined as 10% of Zero’s qualifying business assets, or the average adjusted basis of Zero’s $3.5 million in utilized tangible assets, which is $350,000. As a result, Maxtan has recognized GILTI for $1,748,450 (($2.407 million – $350,000) * 0.85), where only 85% of the GILTI determined may be attributed to Maxtan as it owns 85% of Zero. The example illustrates how to calculate GILTI and include it in subpart F revenue. It highlights the importance of understanding the interplay between U.S. tax law and foreign jurisdictions’ tax laws when determining U.S. taxpayers’ tax liability with foreign affiliates.
The Calculation of the Effective Foreign Rate
The GILTI high-tax exclusion is affected by the practical foreign tax rate calculation, as shown in Example 3. By dividing Zero’s net CFC tested income’s income tax by the total of its net CFC tested income and the income tax attributable to it, the effective foreign tax rate is determined. In this instance, the effective foreign tax rate for Zero is 17 percent, which is less than the threshold rate of 18.9 percent. As a result, Maxtan is unable to use the GILTI high-tax exclusion and is forced to factor Zero’s net-tested income into its calculation of the GILTI tax at the U.S. shareholder level.
This example emphasizes how crucial it is to determine the effective foreign tax rate to see if the GILTI high-tax exclusion applies. The effective foreign tax rate is a crucial consideration if a foreign tax is deemed high enough to offset the GILTI tax. The GILTI high-tax exclusion cannot be used, and the U.S. shareholder must include the CFC’s net tested income in its GILTI tax calculation if the effective foreign tax rate is lower than the threshold rate.
The example also emphasizes the significance of staying current with regulatory changes. The high-tax exemption in the proposed subpart F regulations is aligned with the high-tax exception in the final GILTI regulations. In the future, taxpayers will not be allowed to make the subpart F election item by item. This modification shows that the Treasury now prefers to apply for a high-tax exemption per the GILTI guidelines. Hence, taxpayers must keep up with regulatory changes to ensure compliance with the most recent regulations and prevent fines.
Conclusion
In conclusion, this article explores the connection between subpart F and GILTI regimes, highlighting the difficulties multinational U.S. corporations face. High-tax exemptions are available for both subpart F income and GILTI. However, under each regime, a different effective foreign rate determines how much income should be excluded from gross income. While GILTI requires each tested unit’s tentatively tested income item and the attributable foreign tax to be calculated to determine the effective foreign rate, Subpart F requires each income and attributable foreign tax.