March 7, 2018 / North America
We are nearly two months into the new tax regime, and we in the tax community are still wrapping our heads around the complex and far-reaching new provisions. The Republicans’ goal of a simplified, territorial system was clearly lost on the drafters, as we now live under an even more complicated set of rules that may be more akin to a pure worldwide tax system, largely thanks to one provision: Global Intangible Low-Taxed Income, or GILTI.
U.S. taxpayers are now subject to current tax on their share of their foreign subsidiaries’ GILTI. GILTI includes any income over and above a 10 percent return on the tax basis of tangible assets, subject to certain exceptions (earnings generating other forms of Subpart F, effectively connected income, etc.). Corporate shareholders of foreign corporations generating GILTI are generally entitled to a 50 percent1 deduction against such income, lowering the effective rate of tax from 21 percent to 10.5 percent. Further, those shareholders are able to recognize a foreign tax credit for 80 percent of local taxes paid on GILTI income (subject to the foreign tax credit limitation). Therefore, so long as the foreign structure’s average effective tax rate is 13.125 percent2 or more, the tax associated with GILTI should be fully offset by foreign tax credits. Or so that was the idea. The problem is that most companies will not be able to fully offset the tax, and many will have significant exposures, primarily due to the legacy foreign tax credit limitation rules. In this first installment in our TAW series on GILTI, we discuss how the expense allocation rules within the foreign tax credit limitations can result in GILTI exposure to many unsuspecting companies.
Revisiting the Foreign Tax Credit Limitation
In enacting GILTI, Congress carved out a new separate foreign tax credit limitation category…