5 things to know about the GILTI high-tax exclusion

The global intangible low-taxed income (GILTI) provisions enacted as part of the Tax Cuts and Jobs Act of 2017 aimed to immediately tax intangible income from a controlled foreign corporation (CFC) rather than allow deferral of the tax. Under Subpart F, which also is an anti-deferral regime, income taxed at an effective rate higher than 18.9% in a local jurisdiction is not subject to deemed repatriation and remains untaxed by the U.S. until actual repatriation occurs, assuming IRC Section 245A does not apply.

Comments on the proposed GILTI regulations recommended that a high-tax exception similar to the one under Subpart F should be provided for GILTI. The U.S. Department of the Treasury and the IRS agreed and added the GILTI high-tax exclusion (HTE) when the final GILTI regulations were released in July 2020. Portions of the regulations, including the GILTI HTE, were made retroactive to the 2018 tax year, the first year GILTI was applicable. Following are five things taxpayers should understand about making the GILTI HTE.

1. If the election is made, the exclusion applies to all U.S. shareholders. The election to use the GILTI HTE is made by the controlling domestic shareholder(s) of the CFC and is binding on all U.S. shareholders. The controlling domestic shareholder(s) makes the election by attaching a statement to the shareholder’s federal tax return and must provide notice of the election to the other affected shareholders. When the controlling domestic shareholder of the CFC is a partnership, the partnership makes the election and notice is given to the partners. While the election can be beneficial to a particular shareholder, it might not benefit all shareholders.
2. The election applies to all CFCs in the group. If a controlling shareholder makes the HTE election for one CFC in the group, the election must be made for all CFCs in the group that qualify. It cannot be made on a CFC-by-CFC basis. CFCs are considered to be in a group if they share more than 50% common ownership. Taxpayers cannot pick and choose which CFCs are taken into account for purposes of the election; all CFCs must be tested for qualification. The CFCs that do not qualify to make the election are subject to GILTI.
3. Loss CFCs may be considered high-taxed. CFCs are required to compute their tested income using U.S. tax concepts for purposes of determining their GILTI income, which includes taking into account expenses for local tax paid or accrued during the testing period. Computing taxable income under U.S. tax principles can create a situation in which there is a tested loss for GILTI purposes but income and tax under the local tax law. If the local jurisdiction tax expense exceeds the tested loss, the result will be a disproportionately high tax rate. For example, if a CFC has a $20 loss under U.S. tax concepts, which includes a $30 expense for paid or accrued under local tax, the effective tax rate is 300% ($30/ $30+-$20). While the loss otherwise would reduce the overall income from other CFCs in the group in computing GILTI, the CFC’s tested loss is excluded from the calculation and no longer reduces the GILTI inclusion if an HTE election is made for the group.
4. Model, model, model. For most, but not all, taxpayers with net operating losses, it generally makes sense to make the HTE election and preserve their U.S. losses. However, for other taxpayers, making the election might create some unintended and unfavorable results. For example, removing all high-taxed CFCs from the calculation will leave only low-taxed entities, which could reduce foreign tax credits and create additional U.S. tax liability. Additionally, if a CFC is removed from the GILTI calculation, the benefit of its fixed assets also is removed from the GILTI qualified business asset investment calculation, which will increase the portion of a profitable CFC’s tested income included in income. Finally, making the HTE also affects the apportionment of expenses like interest, which could reduce the ability to use foreign tax credits against other kinds of foreign sourced income. Accordingly, taxpayers will need to model the effect of the election to determine if there is a benefit to making the HTE election, which likely will require substantial modeling.
5. Amending 2018 returns to make the election. Taxpayers who wish to amend their 2018 tax return to take advantage of the HTE election must do so within the 24-month period of the original unextended due date for their 2018 tax return. For calendar year corporate and individual taxpayers, that means the amended return must be filed by April 15, 2021. Furthermore, all U.S. shareholders must amend their returns within the same time period. The short window leaves taxpayers who have not yet made the election for 2018 with little time to prepare the required analysis and file amended tax returns.