The Proposed GILTI Regulations: Only a First Step in Dealing with GILTI-Related Issues
November 01, 2018
By Charles Brezak, Chip Niculae and Harold Adrion
On September 13, 2018, the Treasury Department provided the first installment of the long-awaited section 951A proposed global intangible low-taxed income (“GILTI”) regulations. The GILTI provisions incorporated in Section 951A and Section 250 were enacted as part of Tax Cuts and Jobs Act at the end of December 2017. Similarly to the Subpart F income inclusion, the GILTI regime requires a U.S. shareholder of a controlled foreign corporation (“CFC”) to include in the U.S. shareholder’s gross income on an annual basis its share of the GILTI inclusion.
Although many in the industry were aware that this initial installment of GILTI guidance was going to focus on the mechanical application of the Section 951A inclusion, people were disappointed to learn that the proposed regulations did not address the following open items: basketing of the Section 78 gross-up, Section 250 deduction, GILTI foreign tax credit rules, interaction of Section 163(j) with GILTI and the Section 904 limitation. The Treasury indicated prior to the release of the proposed GILTI regulations and in the preamble of the aforementioned document that future guidance in the form of additional proposed regulations or/and notices should be forthcoming on the topics. Throughout the preamble, questions of the interplay of the GILTI rules with Subpart F rules and the differences between the two rules created dilemmas for the drafters. The considerations involved are manifested in many of the decisions, and some of the resolutions may not be totally satisfactory.
Our comments relative to special matters addressed by the proposed regulations and those that need further clarification are noted below.
Tested Income and Deductions Generally by Reference to the Existing Subpart F RulesThe regulations under Section 952 have specific rules which in certain cases represent a departure from the rules relating to domestic corporations. One of these exceptions is that there will be no net operating loss carryover or capital loss carryover. Moreover, the issue of the applicability of Section 163(j) to the CFC was deferred. It would have been helpful to specifically address the restrictions against net operating loss carryovers or capital loss carryovers beyond just referring to the Section 952 regulations which contain this restriction.
High Tax ExceptionProp. Reg. Sec 1.951A-2 confirms that gross tested income does not include a CFC’s income excluded from foreign base company income (“FBCI”) or insurance income due to an election to exclude the income under the high tax exception. No other income qualifies for the high-tax exception.
This is confirmation that there is no general “high-tax exception” to tested income; the election to exclude foreign base company income under Subpart F under the high-tax exception requires compliance with the formalities outlined in the Subpart F regulations, such as attaching a statement with the income tax return.
Tested loss CFC and QBAIProp. Reg. Sec 1.951A-3(c) makes it clear that the tangible property of a tested loss CFC cannot be characterized as specified tangible property. In other words, a tested loss CFC has no qualified business asset investment (“QBAI”).
The rule that a tested loss CFC has no QBAI is ultimately based on the legislative history, so the proposed regulation taking this position is not surprising. In view of this, taxpayers may find it beneficial to consider re-structuring using disregarded entities to avoid a stand-alone loss CFC. It is noted that the statute itself can be read to allow tested loss CFCs to have QBAI if they could ultimately produce tested income.
Anti-Avoidance ProvisionSection 951(a)(4) provides the Secretary with authority to issue regulations which deal with the avoidance of GILTI tax through certain transfers of property or through other transactions. However, after reviewing the proposed regulations, it is unclear whether long-standing “check the box” planning techniques would be challenged if they result in a transfer of property for tax purposes which has the effect of reducing GILTI tax -- for example, checking the box to combine CFCs to avoid the impact of losing QBAI because it is in a loss corporation. Such transaction would typically not result in a “stepped-up” basis for property but would be implemented to avoid the unduly harsh result that QBAI in a loss corporation could not be included. Similarly, re-structuring to create foreign base company income under Subpart F where the result would be better to the taxpayer than under GILTI should similarly be allowed.
U.S. Partnerships that own CFCsThe proposed regulations provide a “hybrid” approach in reporting GILTI, dependent on whether there are 10% partners. The approach in the proposed regulations illustrates how the GILTI and Subpart F rules basically differ and the resultant issues that had to be considered by Treasury. Under the Subpart F rules, as compared to GILTI, the US partnership owning at least 10% of the CFC reports the Subpart F income and it is apportioned to the partners in the U.S. partnership regardless of the ownership percentage of the partner. This treats the partnership as if it were a separate entity in all cases if the U.S. partnership is a U.S. shareholder. GILTI, on the other hand, makes the overall computation at the level of the partner where the partner is a U.S. shareholder (aggregate approach). However, where the partner is not a U.S. shareholder, the GILTI rules apply the entity approach.
The hybrid treatment of using an aggregate vs. entity approach dependent on whether there are 10% U.S. shareholders of a CFC or there are shareholders who are under that threshold is going to cause significant disparities in taxpayers reporting GILTI income. The Subpart F rules in this area affecting less than 10% shareholders prior to the Tax Cuts and Jobs Act did not have as great an impact because the CFC may not have had Subpart F income.
The proposed regulations leave a significant number of questions unanswered and could have provided more guidance in the preamble.
For example, while the legislative history indicates the intent to not tax the U.S. shareholder if the foreign tax rate is at least 13.125%, there is no commentary regarding whether this concept will be actually implemented, once the U.S. foreign tax credit limitation is applied. In other words, if there is a foreign tax credit limitation which reduces the opportunity to claim the full foreign tax credit against GILTI tax, will GILTI tax be imposed even though there is a foreign tax which is in excess of 13.125%? Admittedly, this is a subject for future section 904 regulations on GILTI, but it would be helpful to address this to some extent in the proposed regulations.
Not including Section 250 proposed regulations in this group also limited the utility of these proposed regulations. For example, the question of whether the Section 250 deduction is available in the context of a Section 962 election was not specifically addressed.
It also would have been helpful to articulate the reasoning for determining tested income by reference to Section 952 which is not based on earnings and profits. It is noteworthy that the question of the application of Section 163 to the computation of tested income was deferred. In the upcoming proposed regulations which would address that, perhaps there will be some commentary on this issue. To allow the full deduction for interest would be consistent with an earnings and profits computation.
In the final analysis, the Proposed Regulations were a bona fide attempt by the Treasury to reconcile various issues differences between GILTI and Subpart F, at the same time using the infrastructure of Subpart F to compute tested income. Once the additional regulations are issued, we will have a clearer picture of how GILTI operates.