My last four posts were an attempt at a broad overview of the Global Intangible Low-Taxed Income (GILTI) provisions that were part of the US Tax Reform enacted in December 2017. I started with a discussion of a comment made on behalf of the Israeli Ministry of Finance. This comment is quite unusual because most countries refrain from commenting on domestic regulations in another country. Following on from that post, I explained the underlying rationale behind GILTI, the mechanics of GILTI for corporate US shareholders and how the rules differ for individual US shareholders. This post provides a high level summary to tie the series together.
The idea behind GILTI is to ensure that multinational corporations are no longer able to move easily portable income into tax havens to avoid paying tax on that income at all. Under the GILTI provisions, a US Shareholder of a Controlled Foreign Corporation (CFC) is taxed currently on 50% of the active business income of that CFC that exceeds 10% of the book value of the CFC’s fixed assets. US tax on this income can be offset by 80% of the taxes paid by the CFC in the current year. Of course, the rules are more complex than that to deal with the complex web of CFCs that many MNCs have developed and to ensure that there have not been any tax-motivated reallocations of expenses between parent and subsidiaries.
For non-corporate shareholders, however, GILTI is much worse: the 50% deduction is disallowed; and foreign tax credits to offset GILTI are only available if a §962 election is made. As noted by the Israeli Ministry of Finance, individual US Shareholders of CFCs may be subject to double taxation and extremely high effective tax rates due to GILTI.
If we consider those individual US Shareholders of CFCs who are tax residents of high tax countries (where they are running a local business that the US treats as a CFC), GILTI is particularly egregious. Under prior US tax rules, while they would have had a US tax reporting requirement, US tax would have been fully offset by foreign tax credits most of the time. Active business income would have been taxed locally as it was earned, and would have shown up on a US tax return when distributed. However, in many high-tax countries the income tax paid locally on dividends would have been available as a foreign tax credit to offset any US tax on the dividend. This means that any tax on GILTI is tax on income that would never have generated a US tax liability under the old rules. For individual shareholders who are residents of other countries, GILTI is a clear expansion of the US tax base.
One of the problems individual shareholders face is that Congress amended the FTC limitation rules to create a separate FTC limitation for GILTI. The interaction of this separate limitation with foreign taxes paid on subsequent distributions is not adequately addressed in the recent proposed regulations (published in the Federal Register on 7 December). Further guidance from the IRS is needed if individual shareholders are to have any hope of complying with these new laws. Future blog posts will address the implications of these confusing regulations for individual shareholders.
The expansion of the US tax base, combined with the fact that GILTI almost guarantees double taxation of individual shareholders, raises the question of whether GILTI violates tax treaties. While treaty partners have traditionally turned a blind eye to US taxation of undistributed passive CFC income, GILTI is different both in character and degree. In particular, allowance of only 80% of foreign taxes paid while denying the 50% GILTI deduction to non-corporate shareholders is a clear instance of double taxation, and treaty partners should object. This is doubly true when the affected individual shareholders are tax residents of the same country as the CFC.