GILTI High-Tax Exclusion

We have written about GILTI before –

The IRS published final regulations (T.D. 9902) on July 23, 2020, to address the application of the high-tax exclusion from global intangible low-taxed income (GILTI) under Sec. 951A(c)(2)(A)(i)(III). Sec. 951A, which contains the GILTI rules, was added to the Internal Revenue Code by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.Under the high-tax exclusion, taxpayers may make an election to exclude certain highly taxed income of a controlled foreign corporation (CFC) when computing their GILTI.The final regulations on the GILTI high-tax exclusion mostly follow the 2019 proposed regulations (REG-101828-19) but with some modifications. Some of the highlights of the final regulations include:

The high-tax exclusion applies only if the GILTI was subject to foreign income tax at an effective rate greater than 18.9% (90% of the highest U.S. corporate tax rate, which is 21%). This threshold is unchanged from the proposed regulations.

  • The effective foreign tax rate for purposes of the high-tax exclusion is calculated on a tested-unit basis.
  • This differs from the proposed regulations, which used a qualified business unit (QBU)-by-QBU basis. The high-tax exclusion election can be made on an annual basis.
  • This differs from the proposed regulations, which contained a more restrictive election rule.

The following discussion explores some of the key aspects of the final regulations on the GILTI high-tax exclusion.

Tested units

For purposes of calculating the effective foreign tax rate, the final regulations replace the QBU-by-QBU approach in the 2019 proposed regulations with a more targeted approach based on “tested units” (Regs. Sec. 1.951A-2(c)(7)(ii)). The tested unit approach applies to the extent an entity, or the activities of an entity, are actually subject to tax of a foreign country as a tax resident or permanent establishment (or similar taxable presence).

The final regulations define three categories of tested units:

  • A CFC;
  • An interest that the CFC holds directly or indirectly in a passthrough entity that: (1) is a tax resident of a foreign country, or (2) is not subject to tax as a resident but is treated as a corporation (or as another entity that is not fiscally transparent) for purposes of the CFC’s tax law;
  • A branch of the CFC that either (1) gives rise to a taxable presence in the country in which the branch is located, or (2) gives rise to a taxable presence under the owner’s tax law, and the owner’s tax law provides an exclusion, exemption, or other similar relief (such as a preferential rate) for income attributable to the branch (Regs. Sec. 1.951A-2(c)(7)(iv)(A)).

Transparent interest is defined as an interest in a passthrough entity (or the activities of a branch) that is not a tested unit (Regs. Sec. 1.951A-2(c)(7)(ix)(C)).
In addition, the final regulations provide that tested units of a CFC (including the CFC), other than certain nontaxed branches, are regarded as a single tested unit if the tested units are tax residents of, or located in, the same foreign country (Regs. Sec. 1.951A-2(c)(7)(iv)(C)(1)).

Effective foreign tax rate

Consistent with the 2019 proposed regulations, the final regulations apply the GILTI high-tax exclusion by comparing the effective foreign tax rate with 90% of the rate that would apply if the income were subject to the maximum U.S. corporate tax rate — or in other words 18.9%, based on the maximum rate of 21%.The effective foreign tax rate that is compared to 18.9% takes several steps to determine. It is calculated by dividing the U.S. dollar amount of foreign income taxes paid or accrued (with respect to each respective tentative tested income item) by the U.S. dollar amount of the tentative tested income item increased by the U.S. dollar amount of the relevant foreign income taxes (Regs. Sec. 1.951A-2(c)(7)(vi)).

Tentative gross tested income: To calculate the tentative tested income item, the tentative gross tested income of each tested unit must first be determined. The final regulations retain the general approach set forth under the 2019 proposed regulations that items of gross income of a CFC are attributable to a tested unit of the CFC to the extent they are properly reflected on the separate set of books and records of the tested unit (Regs. Sec. 1.951A-2(c)(7)(ii)(B)). However, if a separate set of books and records is not prepared, items required to apply the GILTI high-tax exclusion that otherwise would be reflected on the book set must be determined (Regs. Sec. 1.951A-2(c)(7)(v)(B)). In addition, tentative gross tested income of a tested unit is adjusted by disregarded payments made between tested units of the CFC under the principles of Regs. Sec. 1.904-4(f)(2)(vi). Also, if gross income is attributable to more than one tested unit, the item is considered attributable only to the lowest-tier tested unit (Regs. Sec. 1.951A-2(c)(7)(iv)(B)).

Tentative tested income:  The final regulations provide that a tentative tested income item is determined by allocating and apportioning current-year deductions for the CFC (including current-year taxes) to the tentative gross tested income item under the principles of Regs. Sec. 1.960-1(d)(3). As defined in Regs. Sec. 1.960-1(b)(4), current-year tax is a foreign income tax paid or accrued by a CFC in a current tax year; therefore, the U.S. dollar amount of the CFC’s current-year taxes can be allocated and apportioned to the tentative tested income.

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