In theory, the Global Intangible Low-Taxed Income policy, known as GILTI, was expected to prevent companies from moving intangibles offshore into low-tax jurisdictions in order to take advantage of favorable tax rate differentials. Congressional committee reports for the 2017 Tax Cuts and Jobs Act suggested that foreign companies paying taxes in jurisdictions with an effective tax rate of 13.125 percent or more would be not be subject to this new tax regime.
In practice, the implementation of GILTI created a tangled web for many U.S. companies as they navigate the interconnectedness of this provision with expense allocations, the haircut of foreign tax credits and domestic net operating losses (NOLs) that reduce the ability to take advantage of Section 250 deductions. While qualified business asset investment (QBAI) rules favored companies with large real property investments in foreign subsidiaries, active service companies have also found themselves tied up in this GILTI web.
The yearly snapshot calculation of GILTI also stands in contrast with much of the rest of the tax code that allows for the pooling of earnings and profits and tax pools for Subpart F and dividends or the carryforward of foreign tax credits and NOLs. This has produced in unexpected results for cyclical businesses.
As part of the September 13, 2021 Ways and Means Committee tax proposal, the House appears to be trying to return GILTI to its original intention while also increasing the tax for companies operating in low-tax jurisdictions. Here is an overview of the international tax provisions included in this bill.
Country-by-Country and the High Tax Exclusion
This bill takes the bulk of the GILTI calculation to a country-by-country basis, which is bound to increase the complexity of the calculation for many taxpayers. The bright side is that the House is also proposing carryover of net losses on a country-by-country basis, thereby granting relief to companies that have not been able to take advantage of high tax exclusions due to local country NOLs.
It remains to be seen how the House or the IRS would extend these rules to the high tax exclusion going forward and whether these exclusions would also change to a country-by-country test or stay at a tested unit level.
Changes to Section 250 Deductions
The House Ways and Means committee has proposed a reduction of the Section 250 deduction to 37.5 percent, which would already be the effective rate when the current 50 percent deduction sunsets after December 31, 2025. Paired with the top-end corporate rate of 26.5 percent, this change increases the effective GILTI rate from 10.5 percent to 16.5625 percent before considering foreign tax credits or the impact of losses.
For companies in a loss-making position, the Section 250 deduction related to GILTI has been limited. It appears that the House is responding to this struggle for companies with domestic losses and foreign income through its proposed repeal of this limitation, which would allow the Section 250 deduction to create or add to an NOL. This provision would give relief to companies who have found their domestic NOLs offset by inflated GILTI income. (Note: Foreign Derived Intangible Income (FDII) would similarly also have a reduced 250 deduction, going from a 37.5 percent deduction to 21.875 percent. This deduction would also not have a taxable income limitation.)
In determining the amount of foreign tax credit allowed against GILTI, current regulations require the allocation of certain domestic expenses against GILTI income before determining the foreign tax credit limitation. The House proposal would reduce expenses allocated to GILTI income, which would decrease the amount of double taxation against this type of income.
Change in Qualified Business Asset Investment
GILTI currently allows for a safe amount of foreign income based on a percentage of a foreign corporation’s tangible property at an original rate of 10 percent. Net foreign income above this 10 percent threshold would be subject for inclusion into U.S. income. The House proposal would decrease this threshold to five percent of QBAI.
Foreign Tax Credits
As originally proposed, foreign taxes allowed were limited to 80 percent of available credits. The House bill increases the allowances of foreign taxes by allowing 95 percent of foreign tax credits available. Additionally, while previously left out of inclusion, foreign income taxes on companies with tested losses would also be available for use as a foreign tax credit against other tested income.
While the GILTI regime only allowed current taxes to offset current year GILTI inclusions in a “use it or lose it” situation, the House bill would allow for GILTI foreign tax credits to be carried forward to the succeeding taxable year.
It is still uncertain how many of these international tax provisions will survive in the Senate or in final reconciliation. RKL’s International Tax team will continue to monitor and provide updates. In the meantime, please reach out to your RKL advisor or use the contact form below to request more information on how these proposals may impact your company’s current GILTI inclusion.