There is certainly a great deal of buzz around the new Global Low Tax Intangible Income (GLTI) and Foreign Derived Intangible income (FDII) rules enacted as part of the Tax Cuts and Jobs Act (TCJA) in late 2017. At this same time, there is a lack of understanding amongst many practitioners and taxpayers as to what this means for them. What follows here is a general explanation of how these new rules work.
The TCJA has introduced newly enacted IRC Code §951A as well as the catchy new acronym pronounced as “guilty” by those who want to be hip and cool in tax circles. GLTI requires U.S. CFC shareholders to include in income its GLTI income in a very similar manner to our old friend Subpart F. The entire GILTI amount is included in a U.S. shareholder’s income in a manner similar to Subpart F. Corporate shareholders are allowed a deduction equal to 50% of GILTI for 2018 through 2025, which is reduced to 37.5% in 2026. As a result of the 50% deduction, the effective tax rate will be 10.5% until 2026 and increasing to 13.125% when the deduction is reduced in 2026.
The GLTI deduction is limited when the GILTI inclusion and FDII (described below) exceed the corporation’s taxable income determined without regard to the GILTI and FDII deductions. Because the GILTI deduction is limited by taxable income, net operating losses are used first against the gross GILTI amount before any GILTI deduction is allowed. Further, there is no carryforward for the lost portion of the GILTI deduction due to the taxable income limitation.
It is very important to understand who GLTI applies to. In general, when a U.S. person is (i) a 10% U.S. shareholder of a CFC, under the Subpart F constructive ownership rules, on any day during the CFC’s tax year during which the foreign corporation is a CFC; and (ii) the U.S. person owns a direct or indirect interest in the CFC on the last day of the foreign corporation’s tax year on which it is a CFC without regard to whether the U.S. person is a 10% shareholder on that date, then the U.S. person will be required to include in its own income its pro-rata share of the GILTI amount allocated to the CFC for the CFC’s tax year that ends with or within its own tax year. The U.S. shareholder will increase their basis in the CFC stock for the GILTI inclusion, which generally would be treated as “previously taxed income” for Subpart F purposes. This may be a little hard to follow but it is absolutely critical to understand who GLTI applies to.
Individual and noncorporate shareholders are generally subject to full U.S. tax on GILTI inclusions. However, qualifying U.S. shareholders may make an IRC Code §962 election with respect to GILTI inclusions where the electing shareholder is subject to tax on the GILTI inclusion based on corporate rates and may claim foreign tax credits on the GLTI inclusion as if the noncorporate shareholder were a corporation. This is intended, in theory, to place corporate and noncorporate shareholders with a similar tax burden.
GILTI is calculated at the U.S. shareholder level as the excess of the CFCs’ net income over a deemed return on tangible assets. The GILTI inclusion is calculated as the excess of a U.S. shareholder’s “net CFC tested income” over its “net deemed tangible income return,” which is 10% of the CFC’s “qualified business asset investment” (QBAI) reduced by certain interest expense.
“Net CFC tested income” is the excess of the U.S. shareholder’s aggregate pro rata share of the tested income of each CFC for which the shareholder is a U.S. shareholder for such taxable year over the aggregate pro rata share of the tested loss of each such CFC. For this purpose, “tested income” of a CFC generally is described as the CFC’s gross income other than (i) effectively connected income; (ii) Subpart F income; (iii) amounts excluded from subpart F income under the IRC §954(b)(4) high-tax exception; (iv) dividends received from a related person (as defined in Code section 954(d)); and (v) foreign oil and gas extraction income, over deductions allocable to such gross income under rules similar to IRC Code §954(b)(5) or to which such deductions would be allocable if there were such gross income. “Tested loss” is defined to mean the excess of deductions allocable to such gross income over the gross income itself.
“Net deemed tangible income return” is the excess of 10% of the aggregate of each CFC’s QBAI over the interest expense taken into account in determining the shareholder’s net CFC tested income to the extent the interest income attributable to the expense is not taken into account in determining the shareholder’s net CFC tested income. QBAI is determined as the average of the adjusted bases, determined at the end of each quarter of a tax year, in “specified tangible property” that is used in the production of tested income and that is subject to IRC §167 depreciation. The conference explanation states that specified tangible property would not include property used in the production of a tested loss, so a CFC that has a tested loss in a taxable year would not have any QBAI for that year.
If GILTI is includible in a U.S. corporate shareholder’s income, the new law provides for a limited deemed paid credit of 80% of the foreign taxes attributable to the CFC’s tested income as defined above. The foreign taxes attributable to the tested income are determined using a U.S. shareholder level calculation as the product of (i) the domestic corporation’s “inclusion percentage,” multiplied by (ii) the aggregate foreign income taxes paid or accrued by each of the shareholder’s CFCs that are properly attributable to tested income of the CFC that is taken into account by the U.S. shareholder under IRC §951A.
The inclusion percentage is the ratio of the U.S. shareholder’s aggregate GILTI amount divided by the aggregate U.S. shareholder’s share of the tested income of each CFC. This ratio seeks to compare the amount included in the U.S. shareholder’s income to the amount upon which the foreign taxes are imposed, i.e., the tested income, to determine the percentage of foreign taxes that should be viewed as deemed paid for purposes of the U.S. foreign tax credit.
The IRC Code §78 gross-up is calculated traditionally by including 100% of the related taxes rather than the 80% that are allowable as a credit. Although the gross-up amount is included in income as a dividend, it is not eligible for the IRC Code §245A 100% dividend received deduction but is eligible for the GILTI deduction.
There is also now a new separate basket for the GLTI deemed paid taxes to prevent them from being credited against U.S. tax imposed on other foreign-source income. Additionally, any GLTI deemed-paid taxes cannot be carried back or forward to other tax years.
These rules are effective for tax years of foreign corporations beginning after December 31, 2017 and for tax years of U.S. shareholders in which or with which such foreign corporation’s tax years end.
In connection with the new GLTI tax regime on excess returns earned by a CFC, the TCJA provides a 13.125% effective tax rate on excess returns earned by a U.S. corporation from foreign sales, including licenses, leases, and services, which increases to 16.406% starting in 2026. For tax years 2018-2025, a U.S. corporation may deduct 37.5% of its “foreign-derived intangible income” (FDII). Starting in 2026, the deduction percentage is reduced to 21.875%. The FDII deduction is limited when the GILTI inclusion and FDII exceed the corporation’s taxable income determined without regard to the GILTI and FDII deductions. The deduction is not available for S corporations or domestic corporations that are RICs or REITs.
Generally, a U.S. corporation’s FDII is the amount of its “deemed intangible income” attributable to sales, or leases or licenses, of property to foreign persons for use outside the United States or the performance of services to persons, or with respect to property, located outside the United States. A U.S. corporation’s deemed intangible income generally is its gross income that is not attributable to a CFC or foreign branch reduced by (i) related deductions including taxes and (ii) an amount equal to 10% of the aggregate adjusted basis of its tangible depreciable assets other than assets that produce excluded categories of gross income, such as branch assets.
Thus, a domestic corporation is subject to the now standard 21% corporate tax rate to the extent of a fixed 10% return on depreciable assets and a 13.125%, increased to 16.406% as of 2026, tax rate on any excess return that is attributable to exports of goods or services.
There are special rules for foreign related-party transactions. A sale of property to a foreign related person does not qualify for FDII benefits unless the property is ultimately sold to an unrelated foreign person, or is used by a related person in connection with sales of property or the provision of services to an unrelated foreign person for use outside the United States. A sale of property is treated as a sale of each of the components thereof.
The provision of services to a foreign related person does not qualify for FDII benefits if the services are substantially similar to services provided by the foreign related person to persons located in the United States.
The FDII provisions are effective for tax years beginning after December 31, 2017.
The GLTI and FDII rules in connection with the new territorial income rules are a seismic shift in the international tax landscape for those who have learned and practiced international tax under the post-1986 international tax regime. This article is really only a primer of these evolving rules. Once official guidance is produced, we will be able to deliver clearer client guidance on these important new rules.
Frank J. Vari, JD, MTax, CPA is the practice leader of FJV Tax which is a CPA firm specializing in complex international and U.S. tax planning. FJV Tax has offices in Wellesley and Boston. The author can be reached via email at firstname.lastname@example.org or telephone at 617-770-7286/800-685-2324. You can learn more about FJV Tax at fjvtax.com.