On July 23, the U.S. Department of the Treasury and the IRS published final regulations regarding global intangible low-taxed income (GILTI) under Section 951A of the IRC. The final regulations provide an election to exclude high-taxed income from a taxpayer’s GILTI calculation (high-tax exclusion). Proposed regulations were published on the same day to conform the Subpart F high-tax rules with the final regulations.
The final regulations generally provide that U.S. shareholders of a controlled foreign corporation (CFC) can elect to exclude from the GILTI calculation certain income of the CFC that is subject to a sufficiently high effective foreign tax rate as determined under U.S. tax principles. In many cases, income that is excluded from the GILTI calculation will escape U.S. taxation permanently.
Determination of high-taxed income
The final regulations adopt a calculation of high-taxed income based on the concept of a “tested unit,” which broadly is an integrated collection of activities conducted or owned by a CFC. A tested unit includes 1) a CFC, 2) interests in certain pass-through entities held directly or indirectly by a CFC, and 3) certain branches of the CFC or the portion of a branch whose activities are carried on directly or indirectly by a CFC. Tested units within a CFC, including the CFC itself, that are located or tax resident in the same foreign country are treated as a single combined tested unit.
Whether income of a CFC qualifies for the high-tax exclusion is determined separately for each tested unit. If a CFC as a whole is the tested unit and the tested unit qualifies for the high-tax exclusion, the high-tax exclusion effectively is applied with respect to all gross tested income (with certain modifications) of the CFC. If a CFC has multiple tested units, tested income attributable to some tested units might qualify for the high-tax exclusion, and tested income attributable to others might not. Disregarded payments (payments made by a branch or disregarded entity to its owner or vice versa) are taken into account when computing gross tested income attributable to a tested unit.
When determining the effective foreign tax rate for the gross tested income attributable to a tested unit, deductions (including current year taxes) must be allocated and apportioned to the gross tested income using the regulation principles under Section 960 (which incorporate Section 861 principles). Generally, the effective foreign tax rate is determined by dividing the foreign income taxes paid or accrued with respect to each tested unit’s net tested income by the net tested income before income taxes. All amounts must be computed in U.S. dollars. If the effective foreign tax rate of a given tested unit exceeds 90% of the maximum rate specified in Section 11 (presently 18.9%, based on a maximum corporate rate of 21%), the tested unit’s income is high-tax income and eligible for the GILTI high-tax exclusion election.
