The Implications of the Global Intangible Low Tax Income on Transfer Pricing Documentation and Decision Making
Overview of GILTI
The recently enacted Tax Cuts and Jobs Act (“TCJA”) introduced the concept of global intangible low tax income (“GILTI”). GILTI is a new category of Subpart F income defined as returns earned by a controlled foreign corporation’s (“CFC”) qualified business asset investment (“QBAI”) above the initial 10% return -- that is to say, any income earned on a CFC’S QBAI after an initial 10% return, per year. QBAI is defined as the CFC’s depreciable fixed assets that are under IRC Section 167 and does not include intangible assets such as copyrights and goodwill that are amortizable under Section 197. To put it simply, if a CFC’s QBAI is valued at $50,000, any income above $5,000 would be GILTI income. This computation is done at the shareholder level, meaning the gains of one CFC can be offset by losses in a related CFC. U.S. shareholders are also permitted to claim a foreign tax credit (“FTC”) of up to 80% on foreign taxes paid by the CFC. The minimum GILTI tax rate is set at 10.5%, rising to 13.125% starting in 2025.
Transfer Pricing Implications of GILTI
Onshore to U.S.
The language involved in the OECD’s Base Erosion Profit-Shifting (“BEPS”) code requires some form of evidence for the development, enhancement, maintenance, protection or exploitation (“DEMPE”) of intangibles in order to be justified as being taxable in the given jurisdiction. This makes it much harder for companies to simply choose a tax haven jurisdiction for its intangible assets to be taxed in; they must now prove through the presence of DEMPE functions that their intangible asset ought to be based in said location. Given that the establishment of facilities or faculties necessary to fulfill the DEMPE requirement may require large investments by the given company, in both capital and time values, it may be a better use of resources to instead reallocate those intangible assets to the U.S., particularly given the beneficial tax rate of foreign derived intangible income (“FDII”). This is especially alluring to corporations with less tangible fixed assets, such as many in the technology industry, and thus a lower QBAI.
Invest in Tangible Assets Offshore
The other option is to instead invest in tangible assets in the offshore CFC. This will necessarily increase the CFC’s QBAI, thus allowing a greater total return in income before being subject to GILTI taxation. For example, a firm increasing from $80,000 in tangible assets to $120,000 would in turn see a growth of potential non-GILTI income of $4,000. This investment would not only allow for greater production but would also effectively act as a tax-shield.
Reduce BEPS transfer pricing exposure in conjunction with GILTI
By staying up-to-date with BEPS Action 13 requirements, companies can reduce the taxes and fines required due to non-compliance and imperfect intercompany transfer pricing policies. Action 13 requires a demonstrated and tangible interaction with the intangible asset to be taxed. Companies which are unaware or noncompliant with this new policy may face penalties. Companies would be benefitted by updating their transfer pricing documentations and policies. They can reduce their transfer pricing exposure and benefit from the lower 21% corporate tax in the U.S. and avoid unnecessary charges.
Thus, companies looking to prepare for GILTI implications, whether that is to onshore assets to the U.S. or to keep assets abroad, should pay close attention to BEPS Action 13 regulations in structuring their foreign and domestic investments.