United States Provides New Guidance on Excluding High-Taxed Foreign Income from GILTI and Subpart F Income
The US Treasury Department and Internal Revenue Service (IRS) have issued final regulations (TD 9902) and proposed regulations (REG-127732-19) that provide guidance on the exclusion of certain income that is subject to a high rate of foreign tax ("high-taxed income") from the income of a controlled foreign corporation (CFC) for purposes of computing the global intangible low-taxed income (GILTI) and subpart F income of the US shareholders. The regulations were announced by the IRS in News Release IR 2020-165 dated 20 July 2020. Both the final and proposed regulations are scheduled to be published in the Federal Register on 23 July 2020.
The final regulations
The final regulations were issued pursuant to section 951A of the Internal Revenue Code (IRC), which was enacted as part of the US international tax reform implemented by Tax Cuts and Jobs Act (TCJA) on 22 December 2017. In general terms, the GILTI rules of section 951A require a US shareholder of a CFC to include in gross income each year the excess of such US shareholder's pro rata share of the net tested income of the CFC over such US shareholder's pro rata share of a deemed 10% return on the CFC's qualified business asset investment (QBAI). GILTI must be included by the US shareholders in addition to the regular subpart F income of the CFC.
The final regulations retain the basic approach and structure of proposed regulations that were issued on this topic in 2019, with certain revisions. The preamble to the final regulations addresses the public comments that were received by the Treasury and IRS in response to the 2019 proposed regulations.
The GILTI rules permit US shareholders to exclude income that is subject to a high rate of foreign tax from the tax base used to compute GILTI.
The definition of "high-taxed" under the final regulations continues to be based on a comparison of the effective foreign tax rate with 90 percent of the maximum US corporate tax rate (currently 21%) i.e. 18.9%. If the effective foreign tax rate on the income exceeds the 90% measure, an election may be made to exclude such income from GILTI.
The final regulations also address the computation of the effective foreign tax rate. The final regulations rejected public comments that the computation should be made using a CFC-by-CFC approach, rather than a "qualified business unit" (QBU) approach, i.e. QBU-by-QBU, as in the originally proposed 2019 regulations, but adopt a more targeted approach to the foreign income that is taken as the basis for the computation, specifically using a "tested unit" approach rather than a QBU approach.
In response to a number of public comments, the final regulations provide that the GILTI high tax exclusion can be elected annually, subject to the consistency requirement ("all-in or all out") set out in the regulations, and eliminated the 60-month re-election restriction that applied under the proposed regulations if the election was revoked.
The final regulations will be effective from 21 September 2020, and the GILTI high-tax exclusion applies to taxable years of foreign corporations beginning on or after 23 July 2020, and to taxable years of US shareholders in which or with which the taxable years of such foreign corporations end. Subject to certain conditions, taxpayers may also choose to apply the exclusion to taxable years of foreign corporations that begin after 31 December 2017, and before 23 July 2020, and to taxable years of US shareholders in which or with which the taxable years of such foreign corporations end.
The final regulations do not finalize the portions of the 2019 proposed regulations under IRC sections 951, 956, 958, and 1502 regarding the treatment of domestic partnerships. The Treasury Department and the IRS plan to finalize those regulations separately.
The proposed regulations
The proposed regulations were issued at the same time as the final regulations and are intended to conform a similar exclusion of high-taxed income that applies to subpart F income under IRC section 954(b) to the rules applicable to GILTI in the final regulations. This is intended to prevent inappropriate tax planning and reduce complexity.
The proposed regulations provide for a single high-tax election for purposes of both GILTI and subpart F income. In addition, to facilitate administration of the rules regarding these elections, the proposed regulations include a contemporaneous documentation requirement that requires US shareholders to maintain specific contemporaneous documentation that substantiates their high-tax exception computations. The proposed regulations also include an anti-abuse rule to address actions undertaken with a significant purpose of avoiding the purposes of the subpart F and GILTI provisions.
The IRS has requested comments on the new proposed regulations. Comments should be received by 21 September 2020.