The final GILTI verdict for individual US shareholders

GILTI was implemented in 2017 as the latest addition to a set of anti-avoidance rules seeking to ensure a quasi-minimum tax on foreign earnings of US-owned businesses. Where US tax on income from foreign corporations is ordinarily deferred until the point at which it is repatriated (e.g. via salary/dividends to a US shareholder), these rules accelerate the US tax point on certain items of income to the year in which they are received by the CFC. 

Prior to 2017, these rules more narrowly targeted specific income including income that was passive in nature (under the Subpart F regime) or invested in US property (under Section 956). Supplementing these rules with GILTI broadened the base of foreign earnings for which deferral of US tax was potentially denied until extraction.

At a high level, GILTI captures the income earned by CFCs which is considered to be ‘excess’ returns on tangible assets and therefore derived from intangible assets. That is to say, a deduction is available for the deemed return on tangible assets, albeit limited to 10 percent of the CFC’s investment in tangible business assets.

Absent any elections, GILTI inclusions are taxable annually for individual US shareholders at personal ordinary income rates (up to 37 percent), irrespective of actual distributions. To mitigate the annual US tax burden on inclusions under the anti-avoidance regimes, certain elections are available to individual US shareholders of CFCs.

Notwithstanding the increased risk of double taxation caused by GILTI, the TCJA was not all doom and gloom for US shareholders of CFCs. Indeed, delivery of the GILTI ‘verdict’ was somewhat mitigated by the concomitant reduction of US corporation tax from 35 percent to 21 percent. This significant reduction made the use of corporations more attractive than passthrough entities, for US tax purposes, whilst at the same time giving new meaning to section 962 of the Internal Revenue Code.

Under 962, individual US shareholders can elect to be taxed as if they are a domestic corporate shareholder. As such, corporate income tax rates apply in lieu of the aforementioned personal rates (up to 37 percent). In addition, a 962 election renders the individual eligible for certain deductions and foreign tax credits (FTCs) otherwise exclusively available for US corporate shareholders. Prior to 2017, this election offered limited reduction in the overall tax rate applicable to CFC inclusions as the effective corporation tax rate was similar to the top rate of personal tax. When considered in conjunction with the potential for a second layer of personal tax upon receipt of a dividend, this election was rarely used, if ever. By contrast, the post-TCJA combination of increased CFC income attribution under GILTI, lower corporation tax rates and access to corporate deductions/FTCs, made this election far more attractive and prevalent.

In numerical terms, a 962 election after 2017 meant a maximum 21 percent tax rate on GILTI further reduced to 10.5 percent after taking the deduction for 50 percent of the GILTI inclusion available to domestic corporate shareholders. The election also enables a credit for 80 percent of foreign taxes paid by the CFC, otherwise inaccessible to individual shareholders, against US liability arising on GILTI inclusions. As GILTI inclusions are calculated net of foreign taxes, claiming an FTC against the tax thereon requires the inclusion to be adjusted accordingly to prevent benefitting from the taxes twice. The overall result of these interactions is that an effective foreign corporate tax rate of 13.125 percent was generally sufficient to eliminate a residual US tax charge on the income as it arises in the CFC.

Following the OBBBA, the days of GILTI-based puns are numbered. Effective for tax years of foreign corporations starting after 31 December 2025, GILTI has been renamed Net CFC Tested Income (NCTI). As well as abolishing the attention-grabbing acronym of its predecessor, the OBBBA modifies the way in which inclusions under NCTI are calculated and taxed. By scrapping the deduction for income deemed to arise from tangible assets, the OBBBA further widens the tax base by bringing more foreign income into the scope of US tax. US shareholders whose exposure to GILTI was mitigated by the deduction allowed for income derived from the CFC’s tangible assets, may therefore face greater exposure to US tax on NCTI.

Given the broader base of CFC income encompassed by NCTI, more US shareholders may make use of the various elections available to mitigate their exposure to US tax and avoid cash flow issues. Changes to deductions and credits available to US corporate shareholders may thus have implications for individuals making a 962 election. To date, a 962 election allowed for a 50 percent GILTI deduction, resulting in an effective tax rate of 10.5 percent (based on 21 percent corporate tax rate). As the OBBBA reduces the deduction to 40 percent, the effective rate will increase to 12.6 percent. Where a claim is made for FTCs, the OBBBA increases the percentage of creditable foreign corporation taxes from 80 percent to 90 percent and modifies the corresponding gross-up of the inclusion accordingly to eliminate double benefit for those taxes. Overall, the marginal increase in the effective rate of foreign tax required to eliminate a residual US charge (from 13.125 percent to circa 14 percent) is unlikely to materially alter the US tax burden for most US shareholders of CFCs making a 962 election.

By way of summary, the modifications to the GILTI regime will widen the US tax net over CFC’s foreign earnings and in doing so, bring more US shareholders into the scope of the anti-avoidance regimes applicable to CFCs. That said, elections remain available to potentially mitigate the annual tax burden faced by US shareholders of CFCs. Effective planning and expert advice from those well-versed in navigating the CFC landscape will therefore continue to be of critical importance for these individuals.

For further information please contact:

• James Murray
• Helena Heyndrickx