Tax Proposals Target GILTI Rules

May 2021

BY

Michael Masciangelo, Senior Client Executive, International Tax Services Practice | Tiffany Ippolito, Senior Manager, International Tax Services Practice

U.S. tax policy and the fundamentals of the U.S. tax system have continued to be important partisan topics in recent years and, not surprisingly, a particular area of focus for President Biden’s administration since taking office in January. On March 31, 2021, the Biden administration released the American Jobs Plan (AJP) to primarily address the nation’s infrastructure needs. To pay for the potential expenditures, the AJP’s Made in America Tax Plan proposes significant changes to the current U.S. corporate tax system. These changes would modify several key international tax provisions introduced in the 2017 Tax Cuts and Jobs Act (TCJA), including the rules for taxing “global intangible low-taxed income,” also known as GILTI.
 

Overview of GILTI Rules

Under the existing GILTI rules, U.S. shareholders of “controlled foreign corporations” (CFCs) are required to include in income their pro rata share of most income (Tested Income) and losses (Tested Losses) generated by the CFCs (modest exceptions exist) on an annual basis, regardless of whether the income is repatriated to the U.S. The Tested Income and Tested Losses are aggregated to determine a net amount (Net Tested Income or Net Tested Loss). If there is Net Tested Income, such amount is then reduced by a deemed 10% economic return on qualified business asset investment (QBAI)[1] of CFCs generating Tested Income. The Net Tested Income less the QBAI return is the U.S. shareholder’s GILTI inclusion for the tax year.  If there is a Net Tested Loss, no GILTI inclusion is generated for that tax year.
 
U.S. shareholders that are domestic C corporations are eligible for up to a 50% deduction (Section 250 deduction) against GILTI income[2], thus subjecting GILTI inclusions to an effective U.S. tax rate as low as 10.5% (50% of the current 21% corporate tax rate). Subject to a set of very complex rules and calculations, domestic C corporations are also entitled to a foreign tax credit (FTC) to offset all or a portion of the U.S. tax on GILTI inclusions. If a domestic C corporation chooses to claim an FTC in a given year, it is required to include in income 100% of the deemed paid foreign taxes of Tested Income CFCs[3], and is entitled to an FTC of up to 80% of such deemed paid foreign taxes. Generally, if a domestic C corporation’s non-U.S. subsidiaries, in the aggregate, are subject to an average foreign cash tax rate of 13.125% (80% X 13.125% = 10.5%), the U.S. tax liability resulting from a GILTI inclusion could be entirely mitigated.[4]  
 
The AJP fact sheet released by the White House contains a summary of the proposed modifications to the GILTI rules, which include:
  •  Increasing the effective rate on GILTI inclusions for domestic C corporations from 10.5% (13.125% starting in 2026) to 21% by reducing the amount of Section 250 deduction to cause the GILTI effective tax rate to equal roughly 75% of the federal corporate income tax rate (currently proposed to be 28%);
  • Calculating GILTI and the associated FTC on a country-by-country basis rather than as a global aggregation; and
  • Eliminating the deemed 10% QBAI return.
On April 5, 2021, Democratic Senators Ron Wyden, Sherrod Brown and Mark Warner released the “Overhauling International Taxation” framework (Senate Framework), which also includes proposed changes to the GILTI rules including:
  • Increasing the effective rate on GILTI inclusions for domestic C corporations – potentially to between 60% and 100% of the federal corporate tax rate (also proposed as 28%);
  • Calculating GILTI, as well as FTCs, on a country-by-country basis or, alternatively, removing high-taxed income from the GILTI calculation, essentially taxing only income generated in low-tax jurisdictions; and
  • Eliminating the deemed 10% QBAI return.
 
As currently proposed, both the AJP and the Senate Framework would likely cause a significant increase in the reach of the GILTI rules, in terms of causing many more domestic C corporations to have increases in GILTI tax liabilities. A criticism from the Democratic party is that the current GILTI rules are not punitive to many U.S. corporations and, therefore, offshoring of income to international locations is still more advantageous than having that income directly earned in the U.S. Both the AJP and the Senate Framework seek to make the GILTI rules contain punitive features that result in an increase in the amount of tax revenue they generate.
 

How BDO Can Help

The complexity and detrimental impact of the U.S. rules related to taxation of earnings from non-U.S. subsidiaries are likely to increase significantly under the AJP or the Senate Framework.  While neither the AJP nor the framework are officially proposed legislation at this time, BDO is helping multinational companies proactively anticipate and address, from a strategic standpoint, what might be coming in terms of the potential changes, and what steps may be taken in anticipation of potential tax legislation.   
 
BDO can work with businesses to perform a comprehensive scenario analysis of the various proposals (in conjunction with the rest of the impactful proposals beyond changes to the GILTI rules). BDO can also help businesses identify proactive steps that should be considered now in advance of actual legislative proposals being issued, including:
 
Identifying favorable elections or method changes that can be made on 2020 tax returns;
Identifying method changes or other techniques to accelerate income subject to tax under the current GILTI rules or defer certain expenses to a later year when the tax cost of the GILTI rules could be higher;
Considering various FTC strategies under a country-by-country approach that could minimize the detrimental impact of the GILTI proposals; and
Considering other steps that should be taken in 2021 to maximize the relative benefits of existing GILTI and FTC rules.
 
For more information on the GILTI or other tax proposals that may affect you or your business, contact BDO.

 
[1] QBAI is generally the average quarterly depreciable tangible assets held by CFCs that generate Tested Income during the taxable year. For example, if QBAI is $100, a deemed return of $10 reduces the annual Net Tested Income amount. QBAI of Tested Loss CFCs is excluded from the calculation.
[2] The Section 250 deduction is 50% through 2025 and 37.5% thereafter (the effective rate of tax on GILTI under current law increases from 10.5% to 13.125% from 2026 onward). The amount of the deduction is limited by the taxable income of the domestic C Corporation – for instance, if a domestic C Corporation has net operating loss carryovers into the current year or is generating a current year loss, the Section 250 deduction may be reduced to as low as 0%, thereby having the effect of such income being taxed at the full 21%.
[3] The deemed paid foreign taxes are also entitled to a Section 250 deduction.
[4] Even if the offshore rate is 13.125% or greater, many domestic C corporations are limited in the amount of FTC they can claim in a given year because of the complexities of FTC expense allocation and apportionment, which could limit the amount of GILTI inclusion against which an FTC can be claimed.