One of the primary policy goals of the Tax Cuts and Jobs Act (TCJA) was to put an end to the practice of U.S. taxpayers migrating their intangible property offshore, in an effort to shift significant income derived by such IP outside of the U.S. tax net.
One of the primary policy goals of the Tax Cuts and Jobs Act (TCJA) was to put an end to the practice of U.S. taxpayers migrating their intangible property offshore, in an effort to shift significant income derived by such IP outside of the U.S. tax net.
The TCJA introduces incentives for companies that leave their valuable IP in the U.S., and at the same time penalizes taxpayers that have migrated IP offshore to a CFC.
The Incentive: Foreign Derived Intangible Income
Foreign Derived Intangible Income (FDII) is a category of income that is not specifically traced to intangible assets, rather TCJA assumes a fixed rate of return on business assets and the residual income is the income deemed to be generated by the IP.
Particularly, FDII is income that is more than 10% of a taxpayer’s Qualified Business Asset Investment or QBAI. A taxpayer’s QBAI are the assets used by the taxpayer in a trade or business that are depreciable under Section 167. Income in excess of 10% of the QBAI is the Deemed Intangible Income of that taxpayer and to the extent this income is foreign sourced it is the taxpayer’s FDII.
FDII earned by U.S. C corporations are taxed at the beneficial rate of 13.125%.
This is a great incentive for C Corporations in the service or technology industry or any other industry that does not have significant amounts of fixed assets.
The Penalty: Global Intangible Low Taxed Income
Global Intangible Low Tax Income (GILTI) is a new category of income that is similar to subpart F in that it is deemed repatriated in the year earned.
Global Intangible Low Tax Income (GILTI) is a new category of income that is similar to subpart F in that it is deemed repatriated in the year earned.
GILTI is the income of a Controlled Foreign Corporation (CFC), reduced for certain adjustments such as U.S. Effectively Connected Income or other Subpart F income, that exceeds 10% of the CFC’s QBAI. See here for a more detailed description of GILTI.
An individual shareholder or an investor in a flow-through entity with GILTI is taxed at the highest ordinary income tax rate applicable to such individual.
A corporation with GILTI receives a 50% deduction of GILTI and consequently pays an effective tax of 10.5% on its GILTI. An indirect foreign tax credit is allowed to reduce the GILT Income, but only 80% of the standard deemed paid credit is allowed, while the Section 78 gross is 100% of what the standard deemed paid credit.
GILTI has its own separate foreign tax credit limitation basket. Carrying forward excess foreign tax credits for GILTI is disallowed, consequently, credits that aren’t used in the year of inclusion are lost.
Effective Date
Both the GILTI and FDII provisions are effective for tax years beginning after December 31, 2017.
What can you do to benefit from the carrot and avoid the stick?
- Taxpayers should consider leaving IP onshore to generate the beneficially taxed FDII
- Taxpayers need to assess how the new GILTI provisions will impact them by comparing the income earned by CFCs to the CFCs’ QBAI
- If significant amounts of GILTI are anticipated restructuring should be considered including but not limited to possibilities such as using a C Corp structure in the U.S. or electing to treat the CFCs as Foreign Disregarded Entities
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