On June 14 the Internal Revenue Service (IRS) released the Final and Proposed Regulations REG-101828-19.
The proposed regulations provide an expanded high tax exception to the Global Intangible Low Taxed Income (“GILTI”) regime. GILTI was enacted as part of the Tax Cuts and Job’s Act of 2017 as a “stick” in order to reduce the incentive to US multinationals from shifting income from intangibles, such as patents, to subsidiaries in low-tax jurisdictions (a rate below 13.125%). The provision, however, unintentionally resulted in corporations and individuals being subject to the GILTI tax on active foreign income that is subject to tax in a foreign jurisdiction well in excess of 13.125%.
The proposed regulations mitigate this unintended result by allowing US taxpayers to elect out of the tax’s levy on GILTI income if they are paying foreign taxes on such income of at least 18.9%. The election is made by the controlling domestic shareholders of the CFC and is binding on all shareholders for the tax year to which it relates. An election is effective for the election year and all subsequent years unless revoked by the controlling domestic shareholder of the CFC. The high tax test is applied at the Qualified Business Unit (QBU) level by allocating and apportioning foreign expenses to QBU’s gross income.
Even though the exclusion may be viewed as a well-received relief, applying the high-tax exclusion on the basis of a QBU rather than the CFC as a whole is more complex and administratively burdensome. Also, the proposed regulations were not made effective on a retroactive basis and only apply after the date that final regulations are published in the Federal Register. The delayed effective date will negatively impact the 2018 and 2019 tax filing as it appears that in most cases the high-tax exclusion will begin to apply only for 2020 tax returns.
The final regulations also contain, with certain modifications, anti-abuse provisions that were included in the proposed regulations and revise the proposed regulations’ domestic partnership provisions to adopt an aggregate approach for purposes of determining the amount of GILTI included in the gross income of a partnership’s partners under I.R.C. § 951A with respect to CFCs owned by the partnership. The regulations also provide guidance related to certain foreign tax credit provisions applicable to persons that directly or indirectly own stock in foreign corporations.