The Treasury Department published final regulations under Sections 951A and 954 on July 23, 2020. These regulations finalize proposed regulations governing income subject to a high rate of foreign tax. In addition to these regulations, a separate notice of proposed rulemaking will provide rules conforming the subpart F high-tax exception to the global intangible low-taxed income (GILTI) high-tax exception and will provide for a single election for both subpart F income and tested income.
The final regulations will be effective on September 21, 2020 and are generally applicable to tax years of foreign corporations beginning on or after July 23, 2020 and to taxable years of US shareholders in which or with which the foreign corporations tax year ends. However, the final regulations may be applied by taxpayers to taxable years of foreign corporations that begin after December 31, 2017 and before July 23, 2020 (and to taxable years of US shareholders in which or with which the foreign corporations tax year ends). If a taxpayer applies the GILTI high-tax exclusion retroactively, the taxpayer is required to consistently apply the rules to each taxable year that the taxpayer applies the GILTI high-tax exclusion.
In general, the final regulations provide for an exception to GILTI where the income is subject to a high rate of foreign tax and retain the basic approach and structure of the proposed regulations with certain modifications and clarifications. A few highlights include:
To apply the GILTI high-tax exception, an election must be made – specific rules are provided as to how to make the election. The election can be made on an annual basis.
Election is made by the controlling domestic shareholders (generally, more than 50% of vote). Notices are generally required to be provided to non-controlling domestic shareholders.
Election is made or revoked with respect to all controlled foreign corporations that are members of a CFC group which is generally a CFC connected through ownership of more than 50% (vote).
The election or revocation can be made on an amended return provided specific requirements are met, including that all US shareholders of the CFC file an amended return. Special rules apply to domestic partnerships.
Calculating the Effective Tax Rate
GILTI high-tax exception applies where the effective tax rate is greater than 18.9% (90% of the highest corporate income tax rate which is currently 21%).
Calculation of the effective tax rate based on a “tested unit” approach. For this purpose there can be multiple tested units of one CFC for which the GILTI high-tax exclusion has to be applied to each tested unit separately. Multiple tested units are treated as a single tested unit (this is mandatory) if the tested units are tax residents of, or located in, the same foreign country.
Determining gross income attributable to a tested unit is generally based on a separate set of books and records (as defined under Treas. Reg. §1.989(a)-1(d)) of the tested unit. There are special rules related to transparent interests (i.e., an interest in a pass-through entity that is not a tested unit).
The gross income is generally determined under U.S. federal income tax principles and adjusted for disregarded payments. Deductions are generally allocated and apportioned based on federal income tax principles.
No special adjustments are allowed for foreign net operating losses or other timing differences.
Generally, there are three categories of a tested unit:
- A Controlled Foreign Corporation (CFC)
- An interest in a pass-through entity held (directly or indirectly) by a CFC if it meets these requirements: Pass-through entity is a tax resident of a foreign country and is not subject to tax as a resident but is treated as a corporation.
- A branch (or portion of a branch) where the activities are carried on directly or indirectly by a CFC provided that either the branch gives rise to a taxable presence in the country where the branch is located or under the owner’s tax law, and the owner’s tax law provides an exclusion, exemption, or similar relief.
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