Brian Abbey, Managing Director, International Tax Services
Andrew Wai, Supervising Senior Tax Analyst, International Tax Services
30-Second Summary:
- The IRS recently released its much-anticipated regulations under Sec. 951A, finalizing the GILTI high-tax exception that was first introduced in proposed regulations published on June 21, 2019
- While the final regulations maintain the basic framework of the proposed high-tax exclusion, there are some significant changes, including the determination of the foreign effective rate of tax on a newly defined tested unit, rather than QBU-by-QBU, basis; the ability to elect the high-tax exclusion retroactively to the 2018 taxable year; and the ability to make the election on a yearly basis
- This article examines these changes, and will help you assess the impact of the final regulations on your company’s overall international tax profile
On July 21, 2020, the IRS released the much-anticipated regulations under Sec. 951A[1], finalizing the GILTI high-tax exception first introduced in proposed regulations published on June 21, 2019.[2] The final regulations maintain the basic framework of the proposed high-tax exception with the following significant changes:
- Determination of the foreign effective rate of tax on a newly defined tested unit, rather than QBU-by-QBU, basis;
- Ability to elect the high-tax exception retroactively to the 2018 taxable year; and
- Ability to make the election on a yearly basis.
The final regulations apply to tax years of foreign corporations that begin on or after July 23, 2020, and to tax years of U.S. shareholders in which or with which such tax years of foreign corporations’ end. Taxpayers may apply the final regulations retroactively to tax years of foreign corporations that begin after December 31, 2017 and before July 23, 2020, and to tax years of U.S. shareholders in which – or, with which – such tax years of the foreign corporations end, provided they consistently apply the final regulations to each year they elect the GILTI high-tax exception.
The IRS also issued proposed regulations under Sec. 954 that harmonize the Subpart F high-tax exception with the GILTI high-tax exception.[3] The proposed regulations generally are proposed to apply to taxable years of Controlled Foreign Corporations (CFCs) beginning after the regulations are finalized, and to taxable years of U.S. shareholders in which, or with which, such taxable years of foreign corporations end.
Final GILTI High-Tax Exception
The high-tax exception in Reg. §1.951A-2(c)(7) allows a taxpayer to elect to exclude from tested income, under Sec. 954(b)(4), a so-called tentative gross tested income item if that income was subject to an effective rate of foreign tax that is greater than 90% of the Sec. 11 rate (i.e. 18.9% = 21% * 90%).[4]
Unlike the proposed regulations, the final regulations calculate the foreign tax rate on a tentative tested income item on a tested unit basis[5], rather than a QBU-by-QBU basis. Broadly speaking, a tested unit includes a CFC; an interest held by a CFC in a pass-through entity that is a tax resident of any foreign country; and a branch, the activities of which are carried on by a CFC.[6] A same-country aggregation rule allows the tested units of a CFC (including the CFC itself,) which are residents of the same foreign country to be combined for purposes of determining whether the combined income is eligible for the
high-tax exception.[1] The tested unit is not quite as granular as a QBU, but it does not provide for the effective rate blending that a CFC would have. The same country combination may allow for limited blending, depending on the tax profiles of the same country tested units.
The tentative gross tested income of a tested unit is determined based on the items of income as reflected on the books and records of the tested unit and under general federal income tax principles. The final regulations apply the foreign branch income determination rules of Reg. §1.904-4(f)(2)(vi)[2] to adjust the gross income of a tested unit for disregarded payments. At a very high level, the disregarded payments rule provides that, if the disregarded payment is allocable to the foreign branch (or the foreign branch owner, as the case may be), then the foreign branch’s income is adjusted upward (or downward), and the branch owner’s income is correspondingly adjusted downward (or upward). Specifically, the income is redetermined by looking to see what income the deduction, if regarded, would reduce in applying the principles of reg. §1.861-8-14T and -17. As applied to the GILTI high-tax exception, the disregarded payments rule is applied by treating the CFC as the branch owner and the CFC’s other tested units as foreign branches. The exclusion for interest and interest equivalents from the disregarded payments rule in the Sec. 904 regulations[3] does not apply in determining tentative gross tested income to the extent the disregarded interest payment is deductible by the tested unit making the payment in its country of tax residence .[4]
Deductions are allocated to tentative gross tested income under the principles of Reg. § 1.960-1(d)(3) to calculate tentative tested income of a tested unit.[5] The principles of Reg. §1.904-6(a)(2) apply to allocate and apportion current year tax expense imposed by reason of disregarded payments to a tentative gross tested income item (i.e. withholding taxes imposed on disregarded payments which are reattributed under the disregarded payments rule are allocated and apportioned to the reattributed gross income).[6]
Under the final regulations, the GILTI high-tax election is made by the controlling domestic shareholders with respect to a CFC for a CFC inclusion year.[7] This yearly election is a significant, taxpayer-favorable departure from the proposed regulations, which generally imposed a 60-month waiting period on a subsequent high-tax election if a previous election had been revoked. A high-tax election applies with respect to each tentative gross tested income item of the CFC for the CFC inclusion year and is binding on all U.S. shareholders of the CFC.[8]
Like the proposed regulations, the final regulations require that the high-tax election be made or revoked for all CFCs which are members of a CFC group (i.e. the election cannot be made on a CFC-by-
CFC basis).[1] A CFC group is defined by reference to a Sec. 1504(a) affiliated group, without regard to the exclusions in Sec. 1504(b)(1)–(6) (i.e. foreign corporations are includable), lowering the 80% ownership threshold to more-than-50%, and modifying the “vote and value” test of Sec. 1504(a)(2) to be a disjunctive “or” test. Stock ownership is determined by applying the constructive ownership rules of Sec. 318(a) with certain modifications.[2] In an inbound context, for example, where a number of U.S. shareholders may have a common foreign parent, the GILTI high-tax election may have to be made (or revoked) in unison across the entire group.
If the controlling domestic shareholders of a CFC (or CFC group) wishes to make the high-tax election on an amended return, the amended return must be filed within 24 months of the unextended due date of the original return.[3] Therefore, for a taxpayer wishing to make a GILTI high-tax election retroactively for the 2018 tax year, it must file an amended return by April 2021 (assuming a calendar year-end). The 24 months from the unextended due date is a bit of an odd timing requirement and something taxpayers will need to keep in mind if seeking to make this election on an amended return.
Proposed Unified High-Tax Election
To reduce the ability of taxpayers to plan around the separate GILTI high-tax exception and Subpart F high-tax exception, the proposed regulations generally conform the Subpart F high-tax exception to the GILTI inclusion. Like the final GILTI high-tax exception, the proposed high-tax exception would apply on a tested unit basis instead of on a CFC basis.[4] More significantly, the proposed high-tax exception would be a year-by-year election applicable across an entire CFC group, removing the ability for taxpayers to elect in or out of the Subpart F high-tax exception at each CFC individually.
The proposed regulations would also make several changes to the calculation of the high-tax exception and coordination of the high-tax exception with other Subpart F provisions, which we do not address in this post.
Corporate Tax Implications
While the final GILTI HTE regulations are an improvement from the proposed regulations by allowing for a yearly election and testing at the “tested unit” rather than the QBU level, the regulations do not go so far as taxpayers wanted and allow for testing at a CFC by CFC level. Also, proposed Subpart F regulations will provide for one unified election. This approach removes some of the flexibility contained in the current Subpart F high-tax exception. Taxpayers will need to quantify what making the election does on a yearly basis, including the impact on the allocation and apportionment of expenses.
We hope that this quick overview of the GILTI high tax exclusion is helpful in assessing the impact of the final regulations on your company’s international tax profile. The international tax services group at GTM can assist to evaluate whether it may be beneficial to make the high tax election on 2018 (amended) and 2019 returns, as well as evaluate the impact going forward for ASC 740 and tax planning purposes. Contact Brian Abbey or Raymond Wynman, Managing Directors in GTM’s International Tax Services practice, to learn more.
[1] Reg. §1.951A-2(c)(7)(viii)(E).
[2] Reg. §1.951A-2(c)(7)(viii)(E)(2)
[3] Reg. § 1.951A-2(c)(7)(viii)(A)(2).
[4] Prop. Reg. §1.954-1(d)(1)(i)(A).
[1] Reg. §1.951A-2(c)(7)(iv)(C)(1).
[2] For a detailed discussion of these rules in the Sec. 904 context, see Abbey, Brian “U.S. Foreign Branch Basket Regulations: Taxpayer Considerations,” Tax Notes International, Vol. 97, No. 4 (1/27/2020).
[3] described in Reg. §1.904-4(f)(2)(vi)(C)(1)
[4] Reg. §1.951A-2(c)(7)(ii)(B)(2).
[5] Reg. §1.951A-2(c)(7)(iii)(A).
[6] Reg. §1.951A-2(c)(7)(iii)(B).
[7] Reg. §1.951A-2(c)(7)(viii)(A)(1).
[8] Reg. § 1.951A-2(c)(7)(viii)(B).
[1] T.D. 9902.
[2] REG-101828-19.
[3] REG-127732-19.
[4] Reg. §1.951A-2(c)(7)(i).
[5] Reg. §1.951A-2(c)(7)(ii)(A).
[6] Reg. §1.951A-2(c)(7)(iv)(A)(1)–(3).
