IRS Proposes Expanding Highly Taxed Exclusions for GILTI Tested Income
Since the enactment of U.S. tax reform in December 2017, the exclusion of highly taxed subpart F income from GILTI tested income has prompted many U.S. shareholders to consider restructuring their CFC activities and supply chains to fall into subpart F to avail themselves of the previous highly taxed exclusion. By proposing a broad-based highly taxed exclusion from GILTI tested income, the IRS indicates the election may eliminate some of the needs for taxpayers to restructure their supply chains (to fall into subpart F for the purpose of claiming the highly taxed exclusion from GILTI-tested income).
If such an election is made for a CFC, the election applies to all of the CFC’s items of income for the tax year that meet the effective tax rate test. Moreover, the proposed regulations include a consistency requirement, by which each member of a “controlling domestic shareholder group” is subject to the election. CFCs are defined as “members” of a controlling domestic shareholder group, apparently requiring all CFCs held by a majority U.S. shareholder to be subjected to an election.
In the notice of proposed rulemaking, the IRS sets forth an effective date of CFC tax years beginning after the date final regulations are promulgated, so the exclusion may not apply prior to 2020 for U.S. shareholders holding only calendar-year CFCs.
The elective exclusion from GILTI treatment for highly taxed income may be beneficial for some taxpayers. However, it should be noted that GILTI foreign tax credits (FTCs) are computed on an aggregated basis (with no allowance for carryovers). Therefore, making the GILTI highly taxed exclusion election for all group members takes away the option of redesigning CFC activities and supply chains selectively, depending on particular CFCs’ anticipated operating results. More selective planning may be important for FTC purposes, especially since GILTI-basket FTCs may not be carried to other tax years.
As a result, electing U.S. shareholders holding CFCs with a mixture of highly taxed and low-taxed activities may actually find it more difficult to qualify for GILTI FTCs in the same proportions as would be available in the absence of making the election, assuming the election’s consistency rule is intended by the IRS to be applied to all group members. Therefore, it may be difficult to generalize in advance about FTC results, which may be highly dependent upon the allocation and apportionment of U.S. interest expense to the GILTI FTC basket.
Taxpayers should begin modeling their anticipated CFC-tested income and GILTI FTC limitation under a variety of potential scenarios in order to determine (1) whether or not the GILTI highly taxed exclusion election may be beneficial, and (2) whether CFC activities may be selectively redesigned to allow for better results than are available pursuant to the proposed election.
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