On July 23, 2020, the Treasury Department and IRS issued final regulations (T.D. 9902, the “Final Regulations”) under IRC § 951A to finalize the elective high-taxed income exclusion for GILTI. Proposed regulations were also issued (REG-127732-19) to modify the existing subpart F high-taxed income exception rules and to coordinate with T.D. 9902 (the “Proposed Regulations). Both regulations are detailed and complex; this blog will discuss the most important parts of these pronouncements.
Final Regulations Relating to GILTI Exclusion
The Final Regulations allow taxpayers to elect to exclude from a CFC’s (controlled foreign corporation) tested income items subject to an effective foreign tax rate over 90% of the highest corporate tax rate, i.e., current tax rates over 18.9% (= 21% current corporate rate X 90%). If the corporate rate were to be increased to 28%, the exclusion would kick in at an effective rate higher than 90% of 28%, i.e., greater than 25.2%.
The election is made on an annual basis. The general effective date for the election is for years of the foreign corporation beginning on or after July 23, 2020, but the election may be made retroactively for any tax year of a CFC beginning after December 31, 2017, provided that is applied consistently to each year for which the election is made. The election is made by the controlling domestic shareholder(s), who must give notice to all U.S. shareholders of the CFC -- the election is binding on them.
The election is made on a timely-filed original return, or on an amended return. In the latter case, the amended return must be filed within 24 months of the unextended due date, and each U.S. shareholder of the CFC must file an amended return within a six-month period included in the 24-month period.
Under the Final Regulations, the high-taxed income test is conducted based on grouping of income. First, the “CFC group” must be identified. The election is subject to consistency rules for each CFC group. Under the consistency rules, the GILTI high-tax exclusion election must be made with respect to each member of a CFC group, or not at all. A CFC group consists of CFCs that are members of the same affiliated group under § 1504(a) (the Code section used to determine eligibility for corporate consolidation), with the following modifications:
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- Instead of a 80% vote and value ownership threshold, apply a “more than 50%” threshold, by vote or value;
- Do not consider exclusions from group membership under § 1504(b) (including foreign corporation); and
- Use modified § 318(a) rules to determine ownership.
Second, the amount of income to be tested is determined based on gross tested income attributable to a “tested unit.” A tested unit is either:
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- A CFC;
- An interest in a passthrough entity held directly or indirectly by a CFC if one of two tests are met with respect to the passthrough entity --
- It is a tax resident of any foreign country, or
- It is not treated as fiscally transparent under the tax laws of the CFC’s tax resident country; or
- A branch whose activities are carried on directly or indirectly by the CFC.
The tested units of a CFC are generally combined into a single tested unit if the tested units are tax residents of, or located in, the same foreign country.
Third, tentative gross tested income items for each CFC are determined. These are the items attributable to a CFC’s tested unit, that are reflected on the tested unit’s separate books and records. Adjustments are made for disregarded payments to associate the gross income with the tested unit where the income is subject to foreign tax.
Fourth, CFC deductions, including current year taxes, are allocated and apportioned to the tentative tested income items. There are special rules for interest expense and current year taxes.
Finally, the effective tax rate (“ETR”) of the tentative tested income items attributed to a tested unit is determined, as follows.
ETR = Foreign income taxes / Tentative tested income items + foreign income taxes
Proposed Regulations on high-taxed income exception under subpart F
In general, the Proposed Regulations:
- Conform the rules of the high-taxed income exception of subpart F to the principles of the Final Regulations;
- Combine the two elections into one election that applies to both GILTI and subpart F;
- Apply the GILTI CFC group and election rules to the subpart F exception;
- Generally apply to tax years after filing of final regulations in the Federal Register;
- Shift identification of gross income based on the tested unit’s “applicable financial statements,” rather than its books and records;
- Allocate and apportion deductions based on tested unit’s “applicable financial statements,” but amounts and timing of deductions are determined under U.S. tax principles; and
- Include certain anti-abuse rules.
Conclusion
It is certainly beneficial that Treasury created a general high-taxed income exclusion election within the GILTI regime. However, not all taxpayers may qualify for the GILTI exclusion or subpart F exception. Consequently, in order to take advantage of the opportunity for a permanent deferral of their CFC’s foreign income, affected taxpayers should model the tax effects of making the election on both GILTI and subpart F income.
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