As discussed in this related article, the calculation of Global Intangible Low-Taxed Income (GILTI) is highly complex. Accordingly, there are several issues whereby GILTI can impose a significant tax cost. In this article, we will examine five such possibilities:
- Where a domestic corporation has a net operating loss (NOL) carryforward
- Where a controlled foreign corporation (CFC) has an NOL
- Where a CFC takes advantage of incentives in a foreign country
- Where a domestic corporation takes advantage of domestic incentives
- Allocating and apportioning expenses against GILTI
Where a domestic corporation has an NOL carryforward, the GILTI deduction under Internal Revenue Code (IRC) Section 250 is limited to 50 percent of taxable income after the NOL. If the NOL completely wipes out taxable income, GILTI will eat into the NOL dollar for dollar—no 50 percent reduction. While losing the NOL may not trigger any immediate cash taxes, it would eat up the benefit from sheltering future income at a 21 percent tax rate. So where a domestic corporation has an NOL it will otherwise use, GILTI will effectively cost tax at a 21 percent rate—not the anticipated 10.5 percent, or less where the CFC has sufficient foreign tax credits (FTC) to eliminate the tax. Also note that GILTI income is its own basket for FTC purposes and no carryover is permitted from excess GILTI FTCs. So having GILTI when in a loss position in the U.S. can have a significant cost to a domestic corporation.
This aspect is not an issue for individuals who make the §962 election because the election affects only the deemed income and an individual NOL cannot offset the GILTI income.
It has become more relevant to understand how foreign countries will impose tax on a foreign subsidiary on an annual basis. For example, if a CFC has an NOL carryforward and uses it to wipe out taxable income, it may have GILTI for the current year with no deemed paid FTCs available. The benefit of the NOL in the foreign country used against the GILTI would be wiped out, with the U.S. assessing tax at a 10.5 percent rate—effectively eliminating the benefit of the foreign NOL.
Foreign Country Incentives
Consider a situation where a CFC conducts research in a foreign country and claims the local country’s tax credit to reduce its local country tax. Or assume new equipment is installed that can be written off rapidly, similar to bonus depreciation permitted in the United States. These incentives can drive down the tax burden incurred by a CFC. If these incentives or other temporary differences wipe out a tax liability, or reduce it below 13.125 percent, the U.S. government becomes the beneficiary of those incentives—not the company’s shareholders. This may be true even if the benefit is the result of a temporary item, such as depreciation, where more foreign taxes likely would be paid in future years when the depreciation deduction is lower. This also could be a problem for other differences between U.S. and foreign accounting, e.g., reserves for warranty or bad debts or pensions.
Consider a domestic company that builds a new plant in the U.S., or purchases an existing one. Under the revised bonus depreciation system, the depreciation could wipe out taxable income in the current year—and perhaps in immediately successive years as well. Again, in this situation, the GILTI will effectively be taxable at the full 21 percent rate, regardless of taxes paid in the foreign country.
Determining foreign source income in each FTC basket for the FTC limitation requires allocating expenses to the class of income to which they relate, along with apportioning expenses that relate to multiple classes of income, including an allocation of expenses that definitely do not relate to any class of income. Expenses such as stewardship, interest and research likely would need to be allocated in part against GILTI. The FTC may be reduced, triggering a tax cost to the U.S. shareholder. To continue with the example from the previously mentioned article, where the CFC had €400K of pretax income, €300K of tested income, €100K of taxes for the year and €100K of net deemed tangible income return, the taxes paid attributable to the earnings should be at a 25 percent rate, clearly well in excess of the 13.125 percent breakeven. To make the calculation simpler, let’s also assume the forex rate is $1 = €1. If the U.S. shareholder is required to allocate $150,000 of expenses against that income, the net foreign source income is now only $50,000 and the FTC limit would be $10,500, while the gross tax on the income would be $21,000, resulting in a net incremental cost of $10,500.
GILTI can have a significant tax cost to uninformed taxpayers. For taxpayers who own foreign subsidiaries, managing GILTI will become an exercise in financial management. Consideration will be given to book income projections, taxable temporary differences (both foreign and domestic), intercompany transfer pricing policies, foreign source income and FTCs, as well as the new export incentive for foreign derived intangible income. Taxpayers who are not managing these variables are likely to be in for a huge surprise when preparing their tax provisions and tax returns for the 2018 tax year.