Perhaps it was a good enough joke at the moment of inception, but the term GILTI (global intangible low-taxed income) can be a source of confusion for those who have long since stopped laughing. Even once you get past the widely noted fact that the income in question might be neither low-taxed nor derived from intangible property, GILTI is just one income concept in the epic struggle to calculate U.S. tax on foreign income in what was supposed to be a territorial system. And although the code precisely defines it, the term GILTI is loosely thrown around, just like there is a city called Chicago with legal boundaries, but some people living in outlying jurisdictions such as Joliet and Des Plaines say they are from Chicago.
Suppose a U.S. corporation owns 100 percent of a single controlled foreign corporation that generates $200 of active profit, the CFC owns $1,000 of tangible depreciable property that helps generate that profit, and the CFC pays $20 of foreign income tax. After making a bunch of simplifying assumptions, under the gang of code provisions relevant to these circumstances — including new or revised sections 78, 250, 904, and 960(d) as well as the mother-ship section 951A — a U.S. corporate shareholder pays $2.50 of U.S. tax. Quiz: Is GILTI (a) the $200 of before-tax profit, (b) the $180 of after-tax profit, (c) the $100 after deducting 10 percent of deemed tangible return from before-tax profit, (d) the $80 after deducting 10 percent of deemed tangible return from after-tax profit, or (e) the $50 of income you eventually will include in U.S. taxable income?
For the answer to that and several other arithmetical questions about GILTI, please read on. Readers may download the GILTI Spreadsheet that contains the calculations used in this article.
Overview
Our goal is to calculate the U.S. tax that a U.S. shareholder of a CFC owes on the sum of (a) the GILTI amount included in the gross income of the U.S. shareholder plus (b) the related amount treated as a dividend received by the shareholder under section 78. This sum may be reduced by 50 percent if the shareholder is a C corporation. The deduction percentage is scheduled to decline from 50 percent to 37.5 percent after 2025. After calculating the shareholder’s taxable income, we calculate U.S. tax due after applying U.S. foreign tax credits.
Because of the redundancy of placing “allocable share” and “pro-rata share” before almost every amount to be mentioned, we highlight an example in Table 1 in which there is only one shareholder that wholly owns two CFCs, one profitable ($300 of income before any income taxes) and one not ($100 of loss before any income taxes). One of the rare forgiving aspects of the GILTI calculations is that for each shareholder, all components of profitable CFCs’ calculations can be aggregated, and so the single profitable CFC presented herein may be considered the aggregation of all pro-rata amounts of a shareholder’s profitable CFCs. And similarly, the single loss CFC may be considered an aggregation of all the shareholder’s loss CFC amounts.
| Example 1 |
|---|---|
U.S. shareholder gross domestic income | $500 |
U.S. deductions (some may be allocated to GILTI basket below) | $400 |
U.S. shareholder domestic income (used to calculate FTC limit) | $100 |
CFCs with tested income: | |
Gross income of CFC less 5 exceptions (section 951A(c)(2)(A)) | $300 |
Minus allocable deductions (except income tax) | $0 |
Minus foreign income taxes | $20 |
Tested income | $280 |
QBAI (only QBAIs of CFCs with tested income enter calculations) | $500 |
Interest expense of CFCs with tested income | $10 |
CFCs with tested loss: | |
Gross income of CFC less 5 exceptions (section 951A(c)(2)(B)) | -$100 |
Minus all allocable deductions | $0 |
Note: (10 percent of QBAI) - interest expense | $25 |
Tested loss | $100 |
Net tested income (section 951A(c)(1)) | $180 |
10 percent of QBAI of CFCs with tested income (section 951A(b)(2)(A)) | $50 |
Interest expense of CFCs with tested income (section 951A(b)(2)(B)) | $10 |
Net deemed tangible income return (NDTIR) (section 951A(b)(2)) | $40 |
GILTI = NTI - NDTIR (section 951A(b)(1)) (cannot be negative) | $140 |
Inclusion percentage = GILTI/(tested income) (section 960(d)(2)) | 50% |
Tested foreign income tax (only from CFCs with tested income) (section 960(d)(3)) | $20 |
Section 78 gross-up of GILTI | $10 |
Inclusion in taxable income | $150 |
Section 250 fraction (37.5 percent beginning in 2025) (only for corporate shareholders) | 50% |
Section 250 deduction (section 250(a)(1)(B)(i) and (ii)) | $75 |
Net inclusion in taxable income | $75 |
U.S. tax on (GILTI + gross-up) before credits | $15.75 |
Deemed paid foreign tax (section 960(d)(1)) (80% of gross-up) | $8 |
Net inclusion in taxable income (after section 250 deduction) | $75 |
Expenses allocated to GILTI | $50 |
Total worldwide income | $175 |
FTC fraction = (net inclusion - allocated expense)/worldwide income | 0.1429 |
Total U.S. tax before credits (21 percent of worldwide income) | $36.75 |
FTC limitation on GILTI basket (= FTC fraction * U.S. tax before credits) | $5.25 |
FTC (= minimum of deemed paid credit, FTC limit) | $5.25 |
U.S. tax on GILTI + GILTI gross-up | $10.50 |
ETR (foreign) on GILTI + GILTI gross-up | 6.7% |
ETR (U.S.) on GILTI + GILTI gross-up | 7% |
ETR (total) on GILTI + GILTI gross-up | 13.7% |
ETR (foreign) on GILTI + foreign tax + NDTIR | 10% |
ETR (U.S.) on GILTI + foreign tax + NDTIR | 5.3% |
ETR (total) on GILTI + foreign tax + NDTIR | 15.3% |
But it is important to remember that the amount of U.S. tax paid on the income generated by any CFC with GILTI depends on not only the characteristics of the CFC (that is, the quantity and categories of gross income, foreign income taxes, direct interest expense, parent expenses allocated to each of its categories of income, and quantity of depreciable capital), but also its owners’ characteristics, including the level of the shareholders’ taxable income, their taxpaying status (taxed as a C corporation or at the individual level), their amount of foreign-derived intangible income (FDII, under section 250), and the profitability and capital-intensity of any of their other CFCs with GILTI. Also, to the extent a CFC receives payments from its parent in the form of royalties, interest, or service payments, those payments may be subject to a new and separate base erosion antiavoidance tax (section 59A).
To keep matters simple, we look only at a single year’s calculation. But it is fascinating that many of these characteristics can change, perhaps dramatically, from year to year. And in a poor policy (but effective revenue-raising) move, Congress confined GILTI-related income and allocable taxes to its own FTC basket in which no carryforward or carrybacks of FTCs are allowed (section 904(c)). This heightens the importance of the FTC limitation because deemed paid taxes exceeding the credit limitation will never be credited.
Calculating Income
To calculate GILTI, we must first calculate a residual amount for each CFC for which the taxpayer is a shareholder. For each relevant CFC we start with gross income and then subtract five categories of exceptions to gross income: (1) the corporation’s effectively connected income under section 952(b); (2) any gross income taken into account in determining the corporation’s subpart F income; (3) any gross income excluded from foreign base company income or insurance income because of the high-tax exception under section 954(b)(4); (4) any dividend received from a related person (as defined in section 954(d)(3)); and (5) any foreign oil and gas extraction income (as defined in section 907(c)(1)). Then we subtract expenses allocable to that residual amount, including foreign income taxes (equal to $20 in Table 1). If the resulting net income is positive, the CFC has “tested income” (never to be confused with “net tested income” defined below). The tested income of all the shareholder’s CFCs with tested income is added together. In Table 1, tested income equals $280.
If after subtracting those five categories of income and allocable expenses, the resulting residual CFC income is negative, the CFC has “tested loss” equal to the absolute value of that number. The tested losses of all the shareholder’s CFCs with tested losses are added together. In Table 1, tested loss equals $100. The sum of tested incomes less the sum of tested losses is the taxpayer’s net tested income (NTI). In Table 1, NTI equals $180.
Calculated next is the bulk of the foreign-source income that escapes U.S. tax — the territorial part of the new U.S. international tax regime, net deemed tangible income return (NDTIR). (Foreign oil and gas extraction income is the other major component of foreign-source income not subject to U.S. tax.) NDTIR has two components. The first is an amount equal to 10 percent (often called the routine return) of qualified business asset investment (QBAI). QBAI is the basis of the CFC’s tangible depreciable property (called “specified tangible property”) calculated using the alternative depreciation system (slower than the more widely used modified accelerated cost recovery system). QBAI for any tax year is the average of the four end-of-quarter amounts. In Table 1, QBAI is $500 and 10 percent of that amount is $50. Under section 951A(d)(4), Treasury has the authority to prevent end-of-quarter shifting of ownership to minimize QBAI.
Importantly, only specified tangible property used in the production of (positive) tested income is included in the QBAI calculation. That creates a clumsy and unwieldy cliff effect. All specified tangible property of a CFC with one dollar of tested income is included in the QBAI calculation. But all specified tangible property of a CFC with one dollar of tested loss is disregarded. Also note that tangible depreciable property of a CFC not used in a trade or business that generates tested income (for example, used to generate subpart F income) is not included in the QBAI calculation.
The second part of NDTIR, to be subtracted from the first, is interest expense ($10) of the CFC that is not elsewhere generating any CFC interest income for the shareholder. For the most part, interest expense owed to unrelated parties is subtracted from NDTIR (and therefore adds to tested income). In other words, the routine return on debt-financed foreign investment is not exempt from U.S. tax. Because NDTIR cannot be negative, interest expense of CFCs with tested losses (along with, as noted above, the QBAI of CFCs with tested losses) is disregarded in calculating NDTIR. Of course, in practice you might not know if your CFC will have tested income or tested loss until after the end of the year, so you probably should do the calculations in any case. NDTIR in Table 1 is $40 ($50 minus $10).
In Table 1, GILTI is $140. It is a shareholder-level calculation equal to NTI ($180) minus (for CFCs with tested income only) NDTIR ($40). The answer to the question in the introduction is (d). Congratulations, you have calculated GILTI. Unfortunately, you are far from done.
The Section 78 Gross-Up
If all a shareholder’s CFCs have (positive) tested income and all CFC income is tested income, the section 78 gross-up considered a CFC taxable dividend paid to the parent would be all foreign income taxes paid by those CFCs. But more generally, under new section 960(d) the deemed paid tax is the product of the applicable percentage multiplied by tested foreign income taxes. The applicable percentage is a ratio (expressed as a percentage, here 50 percent) of GILTI ($140) divided by (positive) tested income ($280). Tested foreign income taxes are foreign taxes paid by CFCs with tested income ($20). Any income taxes paid by CFC with losses are disregarded in the calculation of the gross-up. The section 78 gross-up on GILTI is $10. Again, there is a troublesome cliff effect when a few dollars of income or loss pushing income into the positive or negative territory could add or subtract tax from the gross-up calculation.
One convenience resulting from the section 78 gross-up calculation is that when you multiply it by 80 percent, you obtain your deemed paid FTC amount ($8). (More on that below.)
The Section 250 Deduction
All shareholders add GILTI ($140) plus the section 78 gross-up ($10) to their taxable income. If you are a shareholder that is a C corporation, from 2018 through 2025, you may deduct 50 percent of GILTI plus the related section 78 gross-up from your taxable income (which, yes, means you may be able to simply add 50 percent of GILTI plus the related gross-up to your taxable income). If you have low levels of worldwide income (before the section 250 deduction) or high levels of FDII, you may be out of luck because the 50 percent GILTI deduction ($75) plus the 37.5 percent deduction for FDII (here assumed to be $0) cannot reduce taxable income below zero. The section 250 deduction percentage for GILTI is scheduled to decline to 37.5 percent in 2025. (The FDII percentage is reduced to 21.875 percent.) Remember, only C corporations are eligible for any section 250 deduction. That means CFC shareholders that are not C corporations and are in the top bracket may be paying 37 percent U.S. tax (before FTCs) on the full amount of GILTI plus section 78 gross-up.
Foreign Tax Credits
Our corporate shareholder has foreign-source income ($75) equal to 50 percent of the sum of GILTI ($140) plus the section 78 gross-up ($10). Let’s also assume the taxpayer has $100 of domestic net domestic-source income. Total income tax before tax credits ($36.75) is the corporate tax rate (21 percent) multiplied by worldwide income of $175.
As noted earlier, under section 960(d) the deemed paid credit for taxes properly attributable to tested income ($8) is 80 percent of tested foreign income taxes ($10).
The section 904 tax credit limitation for the GILTI basket is total income before tax credits ($36.75) multiplied by a fraction. The numerator is the excess of GILTI income plus section 78 gross-up subject to tax ($75) less any allocable expense (assumed to be $50 in Table 1). These allocable expenses — usually for interest, research, and administrative expenses incurred in the United States — are assigned to foreign-source income for purposes of calculating the FTC limitation under allocation and apportionment rules (which are likely to change under new regulations). The denominator is worldwide income of $175. The FTC limitation is $5.25 equal to total tax before credits of $36.75 multiplied by 0.1429 (equal to $25/$175).
Various effective tax rates are calculated at the end of Table 1. As has been widely noted, the combined effective tax rate on grossed-up GILTI (here 13.7 percent) can exceed the 13.125 percent rate discussed in the legislative history.
GILTI Characteristics
Table 2 presents similar calculations under different assumptions. Example 2 in Table 2 is the same as the example in Table 1 except instead of $50, zero dollars of expenses are allocated to GILTI. That expands the FTC limitation, and the effective tax rate on grossed-up GILTI declines from 13.7 percent to 11.8 percent.
One extremely annoying feature of new section 951A is that it doesn’t count the QBAI of CFCs with tested losses, so that NDTIR — the portion of CFC income totally exempt from U.S. tax — is suppressed. Example 3 is the same as Example 2, except the loss CFC is merged into the CFC with tested income. This allows the “lost” QBAI to get back in the game and increase the amount of income exempt from tax. U.S. tax as a percentage of the total before taxed CFC income is reduced from 3.9 percent in Example 2 to 1.6 percent in Example 3.
| Example 2 | Example 3 | Example 4 | Example 5 | Example 6 | Example 7 |
|---|---|---|---|---|---|---|
U.S. shareholder gross domestic income | $500 | $500 | $500 | $500 | $500 | $500 |
U.S. deductions | $400 | $400 | $400 | $400 | $400 | $400 |
U.S. shareholder domestic income | $100 | $100 | $100 | $100 | $100 | $100 |
CFCs with tested income: | ||||||
Gross income of CFC less 5 exceptions | $300 | $200 | $200 | $200 | $200 | $200 |
Minus allocable deductions (except tax) | $0 | $0 | $0 | $0 | $0 | $0 |
Minus foreign income taxes | $20 | $20 | $0 | $26.25 | $20 | $20 |
Tested income | $280 | $180 | $200 | $174 | $180 | $180 |
QBAI | $500 | $750 | $750 | $750 | $0 | $1,900 |
Interest expenses, CFCs with tested income | $10 | $10 | $10 | $10 | $0 | $10 |
CFCs with tested loss: | ||||||
Gross income of CFC less 5 exceptions | -$100 | $0 | $0 | $0 | $0 | $0 |
Minus all allocable deductions | $0 | $0 | $0 | $0 | $0 | $0 |
Note: (10 percent of QBAI) - interest expense | $25 | $0 | $0 | $0 | $0 | $0 |
Tested loss | $100 | $0 | $0 | $0 | $0 | $0 |
Net tested income | $180 | $180 | $200 | $174 | $180 | $180 |
10 percent of QBAI, CFCs with tested income | $50 | $75 | $75 | $75 | $0 | $190 |
Interest expenses, CFCs with tested income | $10 | $10 | $10 | $10 | $0 | $10 |
NDTIR | $40 | $65 | $65 | $65 | $0 | $180 |
GILTI = NTI - NDTIR | $140 | $115 | $135 | $109 | $180 | $0 |
Inclusion percentage = GILTI/(tested income) | 50% | 64% | 68% | 63% | 100% | 0% |
Tested foreign income tax | $20 | $20 | $0 | $26.25 | $20 | $20 |
Grossed-up GILTI | $10 | $12.78 | $0 | $16.43 | $20 | $0 |
Inclusion in taxable income | $150 | $127.78 | $135 | $125.18 | $200 | $0 |
Section 250 fraction | 50% | 50% | 50% | 50% | 50% | 50% |
Section 250 deduction | $75 | $63.89 | $67.50 | $62.59 | $100 | $0 |
Net inclusion in taxable income | $75 | $63.89 | $67.50 | $62.59 | $100 | $0 |
U.S. tax on grossed-up GILTI before credits | $15.75 | $13.42 | $14.18 | $13.14 | $21 | $0 |
Deemed paid foreign tax | $8 | $10.22 | $0 | $13.14 | $16 | $0 |
Net inclusion in taxable income | $75 | $63.89 | $67.50 | $62.59 | $100 | $0 |
Expenses allocated to GILTI | $0 | $0 | $0 | $0 | $0 | $0 |
Total worldwide income | $175 | $163.89 | $167.50 | $162.59 | $200 | $100 |
FTC fraction | 0.4286 | 0.3898 | 0.4030 | 0.3850 | 0.5000 | 0.0000 |
Total U.S. tax before credits | $36.75 | $34.42 | $35.18 | $34.14 | $42 | $21 |
FTC limitation on GILTI basket | $15.75 | $13.42 | $14.18 | $13.14 | $21 | $0 |
FTC | $8 | $10.22 | $0 | $13.14 | $16 | $0 |
U.S. tax on GILTI + GILTI gross-up | $7.75 | $3.19 | $14.18 | $0.00 | $5 | $0 |
ETR (foreign) on grossed-up GILTI | 6.7% | 10% | 0% | 13.125% | 10% | n.a |
ETR (U.S.) on GILTI + GILTI gross-up | 5.2% | 2.5% | 10.5% | 0% | 2.5% | n.a |
ETR (total) on grossed-up GILTI | 11.8% | 12.5% | 10.5% | 13.125% | 12.5% | n.a |
ETR (foreign) on GILTI + foreign tax + NDTIR | 10% | 10% | 0% | 13.125% | 10% | 10% |
ETR (U.S.) on GILTI + foreign tax + NDTIR | 3.9% | 1.6% | 7.1% | 0% | 2.5% | 0% |
ETR (total) on GILTI + foreign tax + NDTIR | 13.9% | 11.6% | 7.1% | 13.1% | 12.5% | 10% |
Example 4 shows that if there is zero foreign income tax, the effective U.S. tax rate on grossed-up GILTI is 10.5 percent. Example 5 shows that if the foreign tax rate is 13.125 percent (or above) and there are no allocated expenses reducing the FTC limitation, there is no U.S. tax imposed on grossed-up GILTI.
Examples 6 and 7 highlight the new role a CFC’s tangible depreciable property plays in U.S. taxation of foreign-source income. In Example 6, QBAI and NDTIR are assumed to be zero. In this case, no income is completely sheltered from U.S. income tax. With a 10 percent foreign tax rate, all CFC income is subject to U.S. tax at a 2.5 percent effective rate. Example 7 goes to the other extreme and assumes there is enough QBAI (less interest expense) to reduce GILTI to zero. In this case, there is no U.S. tax and the U.S. tax system for this lucky taxpayer is truly territorial.
The good news is that the Tax Cuts and Jobs Act (P.L. 115-97) in the most general sense has moved the United States in a positive direction with the elimination of the lockout effect and minimum taxation on some low-tax, foreign-source income. But calculations like these demonstrate that the details are especially devilish, and that neutrality, simplicity, and certainty are not features of our new international tax system.