Key Considerations of GILTI High Tax Exclusion Final Regulations

December 11, 2020

By Chip Niculae

Back in July, the Treasury Department and IRS issued final regulations concerning the Global Intangible Low-Taxed Income (GILTI) “high tax exclusion” that were effective on September 21, 2020.  The final regulations allow taxpayers to elect the GILTI high tax exclusion to taxable years of foreign corporations beginning on or after July 23, 2020, and to tax years of U.S. shareholders in which the taxable year of the foreign corporation ends.  Under the new regulations, the taxpayer has the option of retroactively applying the GILTI high tax exclusion to the taxable years beginning after December 31, 2017 and before July 23, 2020.  In short, electing the high tax exclusion eliminates the need to include GILTI on a U.S. parent company from its adjusted controlled foreign corporation (CFC) earnings.

How the High Tax Exclusion Works

The measure to determine qualification of the high tax exclusion is if a CFC‘s gross tested income is subject to a foreign effective tax rate greater than 90% of the maximum U.S. corporate tax rate (currently 21%).  Consequently, GILTI income subject to a foreign effective tax rate in excess of 18.9% should qualify for the GILTI high tax exclusion.  However, the new regulations applies the GILTI high tax exclusion on a separate basis to each tested unit of a CFC.  A tested unit includes a CFC, an interest held directly or indirectly by a CFC in a foreign pass-through entity (which is not fiscally transparent under local law), and/or a branch operated by a CFC.  Tested units are determined independently from one another, but are consolidated if located within the same foreign jurisdiction.  Finally, the regulations require all tested units to maintain separate books and records similar to qualified business units.

Making the High Tax Exclusion Election

Taxpayers are required to make an annual election in order to utilize the GILTI high tax exclusion.  The GILTI high tax exclusion election is made by attaching a statement to a timely-filed income tax return.  The final regulations also give taxpayers the option of making a GILTI high tax exclusion election with an amended income tax return as long as all U.S. shareholders of the CFC file the amended return within 24 months of the due date of the original income tax return.  The regulations further require that the amended returns of the individual U.S. shareholders must be filed within six months of each other that is within a 24-month period.  Next, the GILTI high tax exclusion election applies to all items of income of all CFCs in which a U.S. taxpayer holds majority equity interest, and will be binding on all U.S. shareholders of the CFCs.  Finally, the regulations adopted a “consistency” rule that apply the GILTI high tax exclusion on a CFC group wide basis, and limits the opportunity to pick and choose certain entities for the election. 

Considerations for High-Tax Exclusion:

While the high tax exclusion election protects the U.S. shareholder from not being subject to the GILTI rules and their complexities, there are disadvantages in certain situations and a thorough analysis is advisable to determine making the election would be beneficial.  Such a review should consider the following questions and aspects:

  1. Whether a taxpayer has CFCs with operations in countries that are high taxed and low taxed. The benchmark rate is 18.90% percent presently, but the effective rate calculation is not that simple.  Moreover, the analysis utilizes a targeted approach based on the “tested unit” standard, rather than on the basis of CFCs.  For example, a tested unit may be a permanent establishment of a CFC.
  2. Has the taxpayer modeled out the effect of the new high tax exception for GILTI purposes? The tax modelling needs to take into account such factors as U.S. net operating losses (NOLs), foreign tax credits (FTCs), and expense allocation against foreign source income for the foreign tax credit limitation.  
  3. Has the taxpayer considered how the high tax exclusion election might affect their FTC position?  For example, there is cross-crediting for GILTI purposes if taxpayers also have high taxed and low taxed GILTI income.  However, cross-crediting is limited where the high tax exclusion election is made.
  4. Has the taxpayer considered how the high-tax exception election might affect the amount of qualified business asset investment (QBAI) they can use to reduce their GILTI inclusions? GILTI inclusions are generally computed as the amount of tested income in excess of 10% of the QBAI aggregated from all CFCs.  The high tax exclusion election will prevent a taxpayer from using the QBAI that generates the excepted income.
  5. Has the taxpayer considered a CFC grouping election under the interest deduction limitations of IRC Sec. 163(j)? Such grouping election can be beneficial in avoiding being subject to the 30% limitation of IRC Sec. 163(j) on intercompany debt. 
  6. Does the taxpayer have projections of CFC income for the next three to five years? One of the dynamics is the effect on current and future NOL utilization where there is the opportunity to make the election and avoid reporting GILTI income.  Such a consideration is especially relevant due to the financial circumstances arising from COVID-19 and the CARES Act.
  7. It is important to note that the factors and considerations involving retailers and manufacturers versus technology companies may be different.   For example, retailers and manufacturers may have substantial QBAI overseas and supply chain issues, whereas the tech companies may be highly impacted by the allocation of research and development expenses.
  8. Has the taxpayer considered the impact of the high tax exclusion election on their future repatriation of foreign earnings?   With proper planning, the related income may be repatriated without U.S. federal income tax under the new rules of IRC Sec. 245A.

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About Chip Niculae

Chip Niculae is a Tax Director in the International Services Group with experience in international tax structuring, cross border transactions, tax structuring, mergers and acquisitions, entity formation, global restructurings and liquidations.