As you may know, the Tax Cuts and Jobs Act (TCJA) introduces several complex, hard to understand international tax provisions. Specifically, the TCJA introduces incentives for companies exporting goods and services and, at the same time, provides a new unfavorable category of income controlled foreign corporations need to be aware of.
The Good: Foreign Derived Intangible Income Deduction (FDII)
Let’s talk about the good first! A new deduction, the foreign derived intangible income deduction, is available for C Corporations. Take note that intangible income is defined in the Act as income in excess of 10% of a taxpayers Qualified Business Asset Investments (QBAI). For reference, taxpayer’s QBAI are depreciable assets used in a trade or business. QBAI does not include intangible property, such as patents, trademarks, or other amortizable property. Therefore, the definition of intangible income for purposes of this deduction is much different than the traditional definition of intangible income. Any C Corporation exporting goods or services should take the time to go through the mechanics of the calculation to determine whether they qualify for this deduction.
How to Calculate FDII
Step 1: Determine Deduction Eligible Income (Gross income less foreign branch income, Subpart F income, Dividends from CFCs and less taxes)
Step 2: Determine Foreign Portion of deduction eligible income
Step 3: Determine Deemed Intangible Income = Deduction Eligible Income – (QBAI * 10%)
Step 4: Calculate FDII Deduction = (Deemed Intangible Income * (Foreign Derived Deduction Eligible Income/Deduction Eligible Income) * 37.5%
The deduction is such that FDII will be taxed a beneficial rate of 13.125%. This incentive will likely provide a great incentive for C Corporations in industries without significant amounts of fixed assets.
The Bad: Global Intangible Low Taxed Income (GILTI)
Now, for the bad news. As the acronym suggests, GILTI is a new unfavorable category of income for US shareholders of a controlled foreign corporation (CFC). At first glance a taxpayer may think, “I don’t have intangible income so this new regulation doesn’t apply to me.” However, similar to FDII, GILTI has nothing to do with the traditional definition of intangible income and, instead, is defined as income that exceeds 10% of a CFC’s QBAI. GILTI uses the same definition of QBAI as FDII.
While the mechanics of the FDII calculation are relatively straight-forward, the GILTI calculation is certainly not. And, while FDII is only available for C Corporations, GILTI is applicable to any 10% US shareholder of a CFC. Additionally, a C Corporation is allowed certain deductions and foreign tax credits which may help to reduce the burden of GILTI. Such preferences are not allowed for non C Corporate shareholders of a CFC.
How to Calculate GILTI
The formula for GILTI at the shareholder lever: Net Tested Income – [(10% of QBAI) – interest expense]
Step 1: Calculate the Tested Income or loss for each CFC
Tested income/loss of a CFC is gross income less deductions (including taxes). Gross income excludes:
Subpart F income (income which would have been Subpart F is the high-tax exception had not been elected), income taxed as effectively connected with a US trade or business, and dividends received from a related party.
Step 2: Calculate the Net Tested Income for the US shareholder
Net Tested Income is a US shareholder’s aggregate amount of its pro rata share of Tested Income/Loss from each CFC combined.
Step 3: Calculate aggregated QBAI for all CFCs
Step 4: Calculate GILTI: Net Tested Income – (10% of QBAI – interest expense)
Non-Corporate shareholders are taxed at ordinary income tax rates. As mentioned earlier, C Corporations are allowed a deduction against GILTI in an amount equal to the sum of:
- 37.5% of FDII for the tax year plus
- 50% of the GILTI amount
The deductions allowed against GILTI are meant to bring the effective tax rate down to 10.5% for a C Corporation. An 80% indirect foreign tax credit is allowed to be applied against the tax on GILTI income, which will further reduce the burden.
There are many questions still unanswered surrounding these computations. For instance, the Internal Revenue Code has long provided that a US individual could make an election to be taxed as a C Corporation for certain items of income. It is possible such an election could be made in this instance to reduce the burden GILTI through the use of indirect foreign tax credits.
The Subpart F regime has long provided an exception for high taxed income. The new legislation was written as such that income which would be Subpart F, except for the high tax exception, is excluded from GILTI, does not exclude non Subpart F income, but is considered high-taxed. The result could be that corporations with significant interest expense could find the mechanics of the calculation leave them with some US tax liability on GILTI, even if the CFC pays local tax at a rate similar to the US tax rate.