POSSIBLE TAX PLANNING IN CASE OF GILTI TAX (IRC 951A)

PRE-AMBLE:

When the Donald Trump has introduced TCJA in the year 2017, most of the US Taxpayers started feeling guilty while making investment in the foreign corporations. Getting confused? The reason behind the same is through TCJA, US Government has introduced new category of tax in the name of GILTI. GILTI stands for “Global Intangible Low Taxed income”. Yes, obviously along with GILTI, govt. has also introduced Territorial Tax system and FDII which are beneficial provisions for the US Taxpayers. However, US Govt. has made sure that if any of the US persons don’t consider tax provision of GILTI, they will really feel guilty at the end of the year while making the tax payments.

In this article, we will understand some of the Tax planning aspects which any US person should consider while making investment in any foreign corporation or while calculating the GILTI Taxes at the end of the year. We will also understand the basic reporting requirements but our main focus would be on the Tax planning aspects so that it will help in minimizing the tax exposure.

Let’s start this with the basic understanding about the GILTI Tax and its history.

WHAT IS GILTI AND WHY IT WAS INTRODUCED?

GILTI was introduced through “TCJA” in 2017 under section 951(a) and it is applicable from the Tax Year 2018. It was introduced because of implementation of “Territorial Tax system” in the USA. In 2017, when Trump led US Government has decided not to tax US Domestic corporation’s foreign dividend income (under section 245 (a) ), most of all the US persons has silently decided in mind to earn the profit in low taxed country and repatriate to USA in the form of Dividend. To curb this kind of Tax evasion aspect, GILTI was introduced to tax the income of “Controlled Foreign Corporation” (CFC) in case CFC is earning return over and above reasonable rate of Return.

In general as per the Internal Revenue Service (IRS), the reasonable rate of return is 10%. So, in case any US persons is earning income (“Tested Income”) over and above 10% of their investments in tangible assets (“QBAI”), the excess profit of CFC is treated as GILTI ?by the IRS.

TAX RATES ON GILTI:

In general in case of C Corporation, 21% of corporate Tax rate is applicable on the GILTI Income. We will discuss about effective tax rate in case of C-Corp. later in this article.

Whereas in case of any other entity (i.e., partnership & S-Corp.) and individual, tax rate can go as high as 37% because of the fact that those are flow-through entity and there is marginal rate taxation applicable in case of individual against the flat rate taxation in case of C-Corporation.

So, now the major question comes in the mind of any US Taxpayer is how to reduce this Tax exposure of GILTI? What are the tax planning aspects to be considered while investing in any foreign corporation? To understand the same in a better way, let’s bifurcate the same in the two broad categories:

1)?????Tax Planning strategies at the time of making investment in foreign corporations

2)?????Tax Planning strategies at the end of year while calculating actual GILTI income.

?

?

1)????Tax Planning strategies at the time of making investment in foreign corporations:

??You can avoid owning 10% or more directly, indirectly or constructively in the foreign corporation because GILTI is applicable to US Shareholder who is owning 10% or more in CFC.

??You can also try to avoid status of your foreign corporation from “CFC” because GILTI only applies to a 10% US Shareholder of CFC. In general, CFC is any foreign corporation in which more than 50% of combined voting power of all classes of stocks are owned by US Shareholders.

??If you are already doing trade or business in the USA through C-Corp., make sure you do the investment in the foreign corporation through C-Corporation only.

??In case you want to make investment in foreign corporation as an individual, make sure you make the foreign investment through “Blocker Corporation”.?Blocker Corporation is nothing but a C-Corp that can work as a bridge in between investor & foreign corporation and can block the adverse tax exposure for the ultimate individual investor.

??Below are the benefits in case of GILTI income taxation while making the investment through C-Corporation:

·???????Tax rate is lower (21%) in case of C-Corp compared to individual (Can be up to 37%).

·???????Under section 250, by taking 50% exclusion in case of C-Corp, effective GILTI Tax Rate can be reduced to 10.5% which is not possible in case of Individual.

·???????In case of C-Corp., FTC can also be taken for the 80% of the foreign taxes paid by the CFC on its foreign income which is not possible in case of individual.

??Instead of investing in foreign corporation, make investment into “Private Placement Life Insurance”. However, this option is only designed for certain high net worth individuals as this comes with the cost.

??Plan in advance to convert your CFC income into “Subpart-F Income” as “Sub-part F” income is taxed at lower rate compared to GILTI income and it is to be deducted while calculating the GILTI base.

?

?

2)????Tax Planning strategies at the end of year while calculating actual GILTI income:

Now let’s consider the scenario where any US person did not think about high tax exposure due to GILTI while making the investments in foreign corporation. So, now we are standing at the year end and we need to think about the strategies to be applied while calculating the GILTI income on the Tax Return? Let’s understand the same for the different types of US Taxpayers:

?

??????I.?????????C-Corporations:

??At the year end, when you are working on calculating GILTI Taxes, make sure that first you check the tax rate of “CFC”. In case you identify that CFC has paid more than 90% of US Corporate Tax rate, i.e., more than 18.9% (90% *21%), than you can fall under “high tax exception” designed by the IRS and because of that you may be exempt from GILTI Taxes as you have already paid higher taxes in the foreign jurisdiction [IRC 954(b) (4)].?However, in case this is not the scenario, please think about below mentioned tax strategies to have minimum tax exposure.

??Make sure to take the benefit of 50% deduction under Section 250 by reporting the same on the form 8993.by this way, we can reduce the effective tax rate of GILTI to 10.5%. Please note that, after 2025 the deduction is going to reduce to 37.5% from 50% and because of that, effective tax rate will be 13.125% after the year 2025.

??In case of corporation, make sure to take the credit for 80% of foreign taxes paid in the foreign jurisdiction to reduce the tax exposure.?While doing so, make sure you first include IRC 78 gross up income on your Tax return and then take the credit for the foreign taxes. In other words, please add the foreign taxes paid as your income first and then take the credit for the foreign taxes.

??In case after considering all the above tax planning tools, there are still significant tax exposure due to GILTI, kindly make sure you have taken the net tested income of the CFC into the calculation. i.e., you should deduct the income of CFC which is having net loss from the income of CFC which is having net profit. In other words, GILTI base has to be calculated on a net level and not at a gross level.

????II.?????????Individual:

Kindly note that all the taxpayer favorable provisions related to GILTI mentioned above are only applicable for the C-Corps and not to the Individuals.?Also, the tax rate can go high in case of Individuals. So, now are you trapped by making the foreign corporation investment at Individual level? Typically, the answer would be “Yes”, but technically I would say the answer is “No”. So, let’s understand some of the helpful tax planning strategies for individual Taxpayers:

??IRC 962 election gives an option to all the individual taxpayer to be treated as a “corporation” for the subpart F purposes and GILTI. So, make sure you consider this alternative and make this election in case you feel that your GILTI Tax exposure is high at the individual level.

??Please note that, by making this election an individual would be able to claim the benefit of section 250 exclusion, FTC and corporate tax rate. Theoretically, it looks very simple and easy in terms of understanding.?But, I know the question in most of your mind right now is –how to implement it practically? So, let’s understand this as well.

??First of all, we need to make an election at an individual level and prepare a dummy corporate tax return to calculate GILTI income by taking all the tax provisions applicable to C-Corps as most of the Tax software are not that smart to do this calculation on the individual tax returns.

??Enter all the sec. 962 Taxes and credits manually on the individual tax return through sec. 962 worksheet and file dummy 1120 Tax return manually or as an e-filing attachment to 1040.

Conclusion:

It is very critical to consider the impact of GILTI while making the investment into foreign corporations. Otherwise, taxpayer can really feel guilty at the time of filing the annual tax return/paying the taxes. However, in case any US Taxpayer missed this opportunity at the time of making the foreign investment, you as a tax professional should guide them in the right way for other possible planning opportunities at the time of filing the Tax return/calculating the GILTI Taxes.

I hope this article helps you in understanding all the crucial aspects related to possible ways for minimizing the tax exposure in case of GILTI. In case of any feedback, please feel free to reach out to me on [email protected].