Attorneys Seek Guidance on Foreign Corporation Dividends

March 30, 2018

The Honorable David J. Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable David J. Kautter
Acting Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

The Honorable William M. Paul
Principal Deputy Chief Counsel and Deputy Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Lafayette G. “Chip” Harter III
Deputy Assistant Secretary (International Tax Affairs)
Department of the Treasury

Douglas L. Poms
International Tax Counsel
Department of the Treasury

Re: Guidance with Respect to Section 78 Amount: GILTI “Category” for Purposes of Applying Section 904(d)

Dear Sirs:

We respectfully request guidance addressing the application of section 904(d), as amended by “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” P.L. 115-97 (the “TCJA”). Specifically, such guidance should clarify that the section 78 amount determined with respect to any amount included under section 951A will be treated as an item of income includible in the foreign tax credit limitation category described in section 904(d)(1)(A).

Many taxpayers are affected by the application of section 904(d) to GILTI generally, and in particular by the treatment of the section 78 amount determined by reference to foreign taxes imposed on GILTI income. We submit this letter on our own behalf, but we note that one or more of our clients may be affected by action or inaction in response to this request for guidance.

I. Background

Section 904(d)(1)(A) provides that the provisions of section 904(a) shall be applied separately to amounts included in income under section 951A (“GILTI” category income). Section 904(d)(1)(D)) provides that the provisions of section 904(a) shall be applied separately to “general category” income. The question has arisen among practitioners therefore whether a section 78 amount is a separate item of income to be treated as “general category” income or instead included as an item of GILTI category income.

As discussed below, section 78 was initially added to the Code in 1962 as a computational device to ensure that a foreign tax credit was not exaggerated as a result of providing, in effect, a deduction in the “multiplicand” of foreign tax on corporate earnings without a corresponding adjustment in the numerator of the limiting fraction under section 904. The correction to the “mathematical quirk” in the formula was to create a deemed dividend that would increase the multiplicand. That deemed dividend was not, however, a “real” dividend.¹ It was never conceived to be an item of income distinct from the underlying income on which foreign taxes were imposed.

The same Act introduced the first separate basketing regime for applying section 904. Then, as now, the important goal of introducing separate categories was to avoid targeted “cross crediting” of excess credits in one basket against excess limitation in another basket. As discussed below, although there was no specific statutory directive in the Revenue Act of 1962 to keep the “deemed dividend” created by section 78 in the same basket as the underlying income on which the foreign taxes were imposed, the obvious necessity of doing so to avoid unintended cross crediting was reflected in examples used in the committee reports accompanying the legislation.

In 1986 the separate basketing regime was refined and expanded. Although never discussed in any of the committee reports,² what appears to be a “belt and suspenders” or “clarifying” provision was added by the Conference Committee as a new last sentence in section 904(d)(3)(G). That new sentence referred to the section 78 amount as not a dividend for purposes of applying the look through rule in paragraph (3) of section 904(d) and directed that it instead be treated as an inclusion under section 951(a)(1).³ Thus, the tool of the computational deemed dividend was further, and unnecessarily in light of the practice for the preceding 24 years, “tweaked” to be sure that the intended consequences of the separate basketing regime were achieved: that the taxes on the underlying category of income, when that income was taken into account, and a section 78 amount added to the multiplicand of the limiting fraction, remained in the same basket.

In 2017 the TCJA created two additional special baskets under section 904(d): GILTI (relevant here) and foreign branch income (not relevant here). As in all prior legislation, the point of the separate basket was to prevent cross crediting of taxes on income in that basket against income in other categories, and of taxes on GILTI being used to offset U.S. tax on foreign income in another basket. Section 904(d)(3)(G) was not amended. The question has thus arisen whether, in the absence of an amendment to section 904(d)(3)(G) to refer to section 78 amount attributable to section 951A income, the section 78 amount that is based on foreign tax credits on inclusions under section 951A should be treated as a separate “dividend” income item that should somehow migrate to the newly named “general category” basket under section 904(d)(1)(G). While it may be tempting to indulge in criticizing the shortcomings of the draftsmen in failing to conform the “clarifying” belt and suspenders provisions added to section 904(d)(3)(G) in 1986, such an approach is neither technically justified nor required by section 904(d).

The fact that section 904(d)(3)(G) contains a clarifying reference to section 78 and section 951(a)(1)(A)⁴ does not mean that absent that clarifying statement in the Tax Reform Act of 1986 the resulting treatment of the right basket for the section 78 gross up would be any different if the clarification had not been added by the Conference Committee. Nowhere in the statute is there any suggestion that unintended cross crediting should be caused by separating the components of the limiting fraction under section 904(d). On the contrary, to do so would be to resurrect the “mathematical quirk” that section 78 was enacted to eliminate.

Guidance by the Treasury is required now because the view has evidently emerged among some or all of the major accounting firms that, absent such guidance, they cannot conclude that it is at least more-likely-than-not to treat the section 78 amount attributable to foreign taxes on GILTI income as pertaining to GILTI category income for foreign tax credit limitation purposes. It may be that the accounting firms are merely understandably cautious in applying new statutory language, although it is possible that their caution is also based in part on an incomplete consideration of the interpretive implications of the whole point of enacting and retaining section 78.

The point of section 78 is best understood by a review of the “mathematical quirk” in applying section 904(d) that led to enactment of section 78. The history, dating back at least to the American Chicle decision in 1942 may not be part of the regular knowledge base of those charged with making decisions about reasonable interpretations of section 904(d) when applied to the section 78 amount attributable to GILTI inclusions. Viewed within the context of that history, and the raison d'etre of section 78, the position if not corrected, will result in an absurd misapplication of the statute.

II. History: How and Why We Got to Now

A. Revenue Act of 1962 Created First Separate Basket Regime and Section 78 Gross Up

1. Statutory Amendments

The Code structure in place since 1962 (when section 904(d) was first added to section 904 in order to deal with the new concept of new “categories” of income for purposes of the foreign tax credit) provided essentially the same statutory language as section 904(d) as amended by the TCJA. In pertinent part, amended by the Revenue Act of 1962, section 904(f) of the Internal Revenue Code of 1954 provided as follows:

Section 904 Limitation on Credit

The Revenue Act of 1962 also added new section 78 to the Internal Revenue Code of 1954. As enacted, section 78 of the Internal Revenue Code of 1954 provided as follows:

Section 78. Dividends received from certain foreign corporations by domestic corporations choosing foreign tax credit.

If a domestic corporation chooses to have the benefits of subpart A of part III of subchapter N (relating to foreign tax credit) for any taxable year, an amount equal to the taxes deemed to be paid by such corporation under section 902(a)(1) (relating to credit for corporate stockholder in foreign corporation) or under section 960(a)(1)(C) (relating to taxes paid by foreign corporation) for such taxable year shall be treated for purposes of this title (other than section 245) as a dividend received by such domestic corporation from the foreign corporation.

The Revenue Act of 1962 made no amendments to section 7805 which continued to provide:

Section 7805. Rules and regulations.

Nothing in sections 78, 904 or 7805 of the Internal Revenue Code of 1964 or of the Revenue Act of 1964 purported to provide the Secretary or his delegate authority to prescribe “legislative” as distinguished from ordinary interpretive regulations with respect to how the deemed dividend under section 78 should be categorized under (then) section 904(f) for foreign tax credit limitation purposes.

2. Section 78 Was Enacted to Overturn, Prospectively, the Computational Anomaly Remaining After the 1942 Supreme Court decision in the American Chicle Case

When considering the application of then-proposed section 904(d), the Senate Finance Committee illustrated in 1962 the application in various examples that included the section 78 amount in the category to which belonged the income giving rise to the foreign tax credit and to the foreign tax on such income.⁵ Such a grouping was an obvious corollary to the point of adding section 78 as a means to modify the computational convention used to apply section 904 in order to overturn the result and reasoning in American Chicle Co. v. United States, 316 U.S. 450 (1942).⁶

Section 78 was enacted to ensure that the amount of foreign taxes to be credited against foreign source taxable income includible in the U.S. taxpayer's income would be added back in order to avoid accelerating the amount of credit under section 902 that would result from allowing a credit against U.S. tax on the net foreign source income remaining after deducting the foreign tax from accumulated earnings in measuring the amount of a taxable dividend. Section 78 was enacted as nothing more than a computational convention to overcome the problems that remained after the Supreme Court decision upheld certain IRS regulations that applied a partial fix to problems arising under the formula expressed in the predecessor provisions to the current section 902 regime.

The Supreme Court agreed that regulations adjusting the multiplicand of the limiting fraction were an appropriate reading of the statutory language:

The regulations sustained in American Chicle were an incomplete solution to the arithmetical problem under the statutory formula. A complete solution required an adjustment to the numerator of the limiting fraction discussed in the Supreme Court language quoted above. The utility of fixing a “mathematical quirk” so was noted in a seminal article by Stanley Surrey, “Current Issues in the Taxation of Corporate Foreign Investment,” 56 Columbia Law Rev. 815 (June 1956). He described the mathematical quirk, and a mathematical solution, at page 828:

Professor Surrey was, of course, the first Assistant Secretary for Tax Policy and the principal architect of the Revenue Act of 1962 that enacted, inter alia, Subpart F, section 1248, the section 904 separate limitation category for unrelated party interest and the gross up under section 78. His 1956 article correctly identifies the problem as a mathematical quirk and anticipates the mathematical “fix” by means of what he described as a gross up in income for foreign taxes for which a foreign tax credit has been claimed.

The mathematical “fix” was not intended to open the door to shifting the gross up amount into another basket and thereby accommodate unintended cross crediting. Assistant Secretary Surrey was undoubtedly still mindful of the pernicious effects of mathematical quirks he had described as Professor Surrey. The examples used to illustrate the use of section 78 amounts in calculating such things as “minimum distributions” confirm that those involved in creating the integrated overhaul of the U.S. regime for taxing income from cross border trade and investment correctly understood that separating the section 78 amount from the underlying income and foreign taxes on that income would result in at least as egregious a “mathematical quirk” as the mathematical quirk associated with the American Chicle reduction.

3. Treasury Exercised Interpretive and Not Legislative Authority to Retain Basketing of Section 78 Amount with Foreign Income On Which Associated Foreign Taxes Were Imposed

Within the context of what “the problem” was, there would have been no occasion to direct the obvious: that the deemed dividend under section 78 for deemed paid foreign taxes on the remaining “general” category of income, after taking into account the new “category” or basket of income, unrelated party interest, should remain in the general basket rather than be available to absorb any taxes properly associated with the other newly added basket.

Since 1962 it appears that both the Treasury and taxpayers correctly interpreted that the section 78 amount belonged to the same basket as the underlying income and taxes. Nevertheless, no actual guidance on this issue was promulgated until 1973 when the Treasury issued final⁷ regulations under sections 78, 904 and 960, exercising the general interpretive authority under section 7805, rather than any specific legislative authority to carry out the “purposes” of the 1962 legislation. Both the proposed regulations and final regulations expressly relied upon such general interpretive authority provided by section 7805.

In this regard, the 1973 regulations provided examples that reflected the section 78 amount associated with income includible resulting from actual dividends and from inclusions under the new Subpart F regime would be separately calculated and then combined, and not split off from the dividend in calculating the amount of U.S. tax that could be offset by foreign taxes.⁸ These examples in the regulations, however, did not rely on specific operative language in the regulations themselves to reach the results described in the examples (i.e., that the section 78 amount is to be in the same “basket” as the underlying dividend income). Nevertheless, by doing so in the examples, the regulations retained the integrity of precluding any excess foreign tax credits as so computed from being used to offset U.S. taxes otherwise due on the new separate category of interest income received from unrelated parties.

The Treasury today faces the same problem: if it interprets the provisions of sections 951A and 904 to direct that the section 78 amount attributable to foreign taxes on GILTI be placed in the “general category,” then the section 78 amount will end up supporting cross crediting against such section 78 amount foreign taxes otherwise causing excess credits in the “general category” basket. That anomalous result would be comparable to the mischief that could occur even after the original American Chicle decision that led to the very enactment of section 78 and its retention as a computational convention for the past 55 years.

4. The Revenue Act of 1962 Also Enacted a Provision Similar to GILTI: Section 963 and the “Minimum Distribution” Approach to Measuring Combined Foreign and Domestic Tax on Prescribed CFC Income.

Without digressing too much into the similarities and differences between the “minimum distribution” regime⁹ and the new GILTI regime, the description of the proper computation, including the associated section 78 gross up amount is clear evidence of the Congressional assumption that the section 78 amount would always remain in the basket for the income on which the foreign taxes were imposed (i.e., the section 78 amount). Section 963 established a regime designed to ensure that, after a “minimum distribution” the combined U.S. and foreign tax would be approximately the same as the U.S. rate if no foreign taxes had been imposed. The remaining undistributed earnings would then be excluded from inclusion under new section 951 (i.e., deferral of inclusion would be continued until a realization event such as an actual dividend or a section 1248 sale). In order to calculate the combined foreign and domestic rate on a hypothetical distribution, the section 78 amount had to be taken into account.

The Senate Finance Committee provided a Technical Explanation as part of its report on the proposed legislation illustrating the computational comparison of U.S. and foreign tax on hypothetical distributions.¹⁰

In doing so, the section 78 amount was assigned, without comment, to the same basket as the tested income in order to achieve the obviously intended result of measuring apples against apples: the combined foreign tax rate could not be reflected properly if the section 78 amount were disaggregated from the tentative U.S. tax on the tested foreign income. To disaggregate would be a revival of the computational flaws resulting from American Chicle that were intended to be corrected by enacting the computational convention in the contemporaneous section 78 proposal.

B. The Tax Reform Act of 1986 and Other Statutory Amendments to Section 904(d): Section 78 Gross Up Remained in Same Basket as Separate Category Income and Foreign Taxes on Such Separate Category Income

1. FOGI and FOREI

A new separate limitation for Foreign Oil and Gas Extraction income (FOGEI)/Foreign Oil Related Income (FORI) was added to the Code by the Tax Reduction Act of 1975.¹¹ The applicable separate limitation has consistently been interpreted to contemplate that any section 78 amount would be put in the same basket as the FORI/FOGEI taxes and income. The various iterations of the regulations applicable to section 907 did not rely on a special mandate to combine the section 78 amount for FOGI/FOREI taxes to the FOGI/FOREI basket(s).

For example, the regulations interpreting the separate limitation provisions under the 1984 versions of the section evidence the Treasury view that the section 78 gross-up amount was inherently classed as part of the same basket to which the tax credits were allocated. Section 907(c)(3) provided that dividends for which the taxpayer received a deemed-paid credit would be classed as FOGEI or FORI “to the extent such dividends, interest, amounts or distributive share is attributable to foreign oil and gas extraction income, or to foreign oil related income, as the case may be”. Treas. Reg. § 1.907(c)-2(d)(5), prior to amendment by TD 8240 on January 19, 1989, stated “The portion of a section 78 dividend that is FORI equals the amount of taxes deemed paid included in the dividend that is FORI taxes under § 1.907(c)-3(b) or (c).” Treas. Reg. § 1.907(c)-2(a) provided that this rule applied equally to FOGEI. Thus, Example 1 under Treas. Reg. § 1.907(c)-3(e) stated

As noted above, all that section 78 provided on the matter was that the gross up “shall be treated for purposes of this title . . . as a dividend received by such domestic corporation from the foreign corporation.” It did not say that such gross-up should be deemed to be attributable to anything in particular. Nevertheless, citing its authority under section 7805,¹² Treasury concluded that the section 78 deemed dividend must be treated as attributable to the basket to which the corresponding taxes were allocated, despite the fact that the earnings available for dividend were necessarily reduced by those same taxes.

Because the arithmetical function of section 78 is to produce the computation that would result if the foreign income was included in the U.S. return on a pre-tax basis¹³ (i.e. in the same basic manner as a branch inclusion), it automatically followed that the section 78 “dividend” must flow from the same class of pretax income to which the taxes were allocated.

2. DISC

Section 904(f) was amended in 1971 to add to section 904(f) new subsection 904(f)(1)(B) “(dividends from a DISC or former DISC (as defined in section 992(a)) to the extent such dividends are treated as income from sources without the United State”). Pre-existing section 904 “separate limitation interest” was retained as a separate category in renumbered section 904(f)(1)(A). The legislation did not amend section 78 or direct treatment of section 78 amounts as remaining in the separate limitation category for each kind of income in the section 904(f) baskets.

Treas. Reg. § 1.904-5, as it read between 1977 and 1988, defined such section 904(f) dividends as all income of the taxpayer for the taxable year consisting of qualifying dividends from a DISC or former DISC (as defined in section 992(a)(1) or (3), as the case may be). Without comment, Example 1 under Treas. Reg. § 1.904-5(c) treated the section 78 gross-up amounts relating to DISC-basket taxes as being included within the DISC income basket. Because DISC dividends qualified only to the extent that they were paid from qualifying export receipts, this classification effectively treated the section 78 gross-up as an addition to such receipts as otherwise defined by the statute. Again, Treasury cited section 7805 authority for this regulation.¹⁴

3. Separate Limitation Interest Amendment 1984

In 1984, section 122 of the Deficit Reduction Act (“DEFRA”)¹⁵ expanded the separate limitation for “separate limitation interest” as originally enacted in the 1962 Act.¹⁶ The expansion applied to the portion of dividends received by a U.S. shareholder attributable to such separate limitation interest income of the CFC (net of allocable deductions of the CFC) on a separate-limitation-first basis. The text of this provision made no mention of section 78. The statute, new section 904(d)(3), merely stated

This provision was applied under a set of ordering rules such that subpart F income inclusions and dividends from the foreign corporation were characterized as being in the separate limitation interest basket to the extent of the separate limitation interest income that the controlled corporation had received. Actual dividends were not further recharacterized once that aggregate amount had been reached (equal to separate limitation interest)

Congress understood and assumed that the section 78 amount should be added to the corresponding separate limitation basket as additional income above the amount of the separate limitation interest inclusion. The Conference Report states as follows:

Thus, while the applicable section 904(d) basket was defined in terms of the separate limitation interest income earned by the CFC, Congress stated its intent that section 78 should be applied in accordance with its computational role of creating an “as if” inclusion of pre-tax foreign income in the appropriate foreign income category for purposes of applying the section 904(d) limitation. Moreover, no special statutory language was considered to be necessary to cause this result to apply. That was so despite the fact that, under the separate-limitation-first method of characterization, an additional actual dividend in the amount of the section 78 inclusion would not have increased the separate limitation interest amount, all of which would have been already used up with respect to the CFC.

In enacting the Tax Reform Act of 1986 (“TRA 1986”)¹⁸ Congress did not provide a statutory provision addressing the combination of the income in a separate category, the foreign taxes thereon and the section 78 amount determined by reason of such taxes.

At the time of legislative examination, and upon enactment, the existing Treasury regulations provided that the section 78 gross-up amount would be assigned in the same manner as the underlying taxes. Congress undoubtedly recognized that the combination was inherent in the core Code architecture, and had expressly so stated two years previously when contemplating enacting DEFRA that the section 78 gross-up must be so treated.

The only potential problem that Congress apparently foresaw was that the section 78 gross-up on subpart F inclusions, which were deemed to flow directly from a lower-tier subsidiary to the U.S. shareholder under particular rules, could cause confusion if it were treated as being a dividend from the first-tier CFC. The Act therefore added section 904(d)(3)(G) providing that any “amount included in gross income under section 78 to the extent attributable to amounts included in gross income in section 951(a)(1)(A) shall not be treated as a dividend but shall be treated as included in gross income under section 951(a)(1)(A).”¹⁹

The Treasury regulations implementing this new legislation were based upon the assumption that the gross-up is automatically assigned to the basket to which the underlying taxes are allocated. This inherent assumption can be seen with regard to a simple illustration that applies the applicable regulation that applied to the amended provisions of section 904(d). The example illustrates that separating the section 78 amount could not result in the intended separate limitation results intended by the TRA 1986 amendments to section 904(d).

Assume that, under foreign law, a CFC wholly owned by the taxpayer had two classes of income subject to tax at different rates. $100 is High Withholding Tax (HWT) interest taxed at a 50% rate, and $100 is active business income taxed at a 30%. Out of the resulting E&P of ($100 x 50%) + ($100 x 70%) = $120, the CFC pays a dividend of $60. This includes HWT income of 50/120 x 60 = $25, and general limitation income of 70/120 x 60 = $35, with HWT credits of $50 x 25/50 = $25 and general limitation credits of $30 x 35/70 = $15, with corresponding section 78 gross-up amounts totaling $40.

TRA 1986 amended section 904(d)(3)(D), to provide that

In the example, if this language were to be applied on the assumption that the section 78 inclusion was an actual incremental dividend, the gross-up of $40 would be treated as HWT income in proportion to the earnings in such category of $50/$120, resulting in 42% of the gross-up, or $16.67, being in the HWT basket. The effective rate on income that basket would then be income of $25 + $16.67 = $41.67 with credits of $25 for an effective rate of 60%, rather than the actual 50%. The gross-up allocated to the general limitation income would be $23.33 with an effective rate computed as $35 + $23.33 = $58.33 of income and $15 of credits = 26%, rather than the actual 30%.

But that is not what the implementing interpretative regulations provided. T.D. 8214 (July 18, 1988), citing authority under section 7805 and section 904(d)(5), promulgated regulations that provided in Treas. Reg. § 1.904-6(b)(3) that

Under this formulation, the $25 of HWT credits would generate a $25 section 78 gross-up allocated to HWT, and the $15 in general limitation credits would generate a $15 gross-up allocable to general limitation. Total HWT income would then be $25 + $25 = $50 with credits of $25 for a 50% rate, while general limitation would be income of $35 + $15 = $50 with credits of $15 for a 30% rate, both corresponding to the actual effective rates that the CFC suffers on the relevant pretax income. This is a sensible result, but Treasury could only get there by using its interpretative powers to find that the section 78 inclusion could be treated that way without regard to the treatment of an actual dividend.

Nothing in the committee reports on the American Jobs Creation Act of 2004, which reduced the number of foreign tax credit baskets to two and changed the language of section 904(d)(3)(D) to refer only to passive income and general limitation income, indicates that Congress intended to change the way that section 78 interacts with section 904. Treasury was not required to, and did not, change the accompanying language of Treas. Reg. §§ 1.904-6(b)(3), 1.78-1, and/or 1.902-1(c)(2)(i). Given that, as explained above, Treasury did not rely on the language of section 904(d)(3)(D) in allocating the section 78 gross-up to the same basket as the underlying taxes, the change in the language under the American Jobs Creation Act of 2004 should have had no effect on the conclusion.

C. Specific Regulatory Authority for Treating the Section 78 Amount as GILTI Basket Income

As discussed above and in further detail below, a well-reasoned analysis of the applicable Code provisions and their legislative history support treating the section 78 deemed dividend attributable to foreign taxes under section 960(d) as an item of section 904(d) GILTI category income. To the extent that regulatory guidance is required to clarify this result, in addition to the authority under section 7805 to issue interpretative guidance (which, as discussed above, was relied upon to issue regulations under section 78 in 1965), the Treasury and the IRS have the regulatory authority to make this clear under section 904(d)(7), which provides as follows:

In addition, section 960(f) provides that “The Secretary shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section.” Application of this authority in the context of the section 78 deemed dividend attributable to foreign taxes under section 960(d) is further explained below.

III. The TCJA Clearly Assumes Integration of GILTI Income, GILTI Foreign Taxes and GILTI Section 78 Amounts in the Same Section 904 “Basket”

A. Background and Example 1

New section 960(d), enacted as part of TCJA, provides to a U.S. shareholder a tax credit equal to 80% of the foreign taxes attributable to GILTI. New section 78 treats that section 960(d) amount (unreduced by the 80% modifier) as a deemed dividend, the same treatment as deemed paid foreign taxes amounts under section 960(a). This section 78 treatment itself should be enough to get the income amount equivalent to the foreign taxes under section 960(d) as an amount of foreign source income includible in the section 904(d) GILTI category. Treating the section 78 deemed dividend amount for foreign taxes under section 960(d) as equivalent to GILTI itself is reflected by the equivalent treatment for those items of income in new section 250, which provides for a 50% (37.5% after 2025) deduction for the sum of the GILTI plus the section 78 deemed dividend amount attributable to GILTI. Further, Treas. Reg. § 1.904-6(a)(1)(i) clearly applies to treat the foreign taxes under section 960(d) as creditable against the U.S. tax liability attributable to income in the section 904(d) GILTI category. These rules are reflected/applied in the following example.

As the above example reflects, if the aggregate effective rate of foreign tax paid by a U.S. shareholder's CFCs is at least 13.125%, no incremental U.S. federal tax would be payable on the CFCs' net income. This is in accord with the following statement on pages 498-499 of the Joint Explanatory Statement of the Committee on Conference that accompanied the text of H.R. 1 (December 15, 2017) (the “Joint Explanatory Statement”):

The text of footnotes 1525-1527:

¹⁵²⁵ Due to the reduction in the effective U.S. tax rate resulting from the deduction for FDII and GILTI, the conferees expect the Secretary to provide, as appropriate, regulations or other guidance similar to that under amended section 965 with respect to the determination of basis adjustments under section 705(a)(1) and the determination of gain or loss under section 986(c).

¹⁵²⁶ 13.125 percent equals the effective GILTI rate of 10.5 percent divided by 80 percent. If the foreign tax rate on GILTI is 13.125 percent, and domestic corporations are allowed a credit equal to 80 percent of foreign taxes paid, then the post-credit foreign tax rate on GILTI equals 10.5 percent (= 13.125 percent × 80 percent), which equals the effective GILTI rate of 10.5 percent. Therefore, no U.S. residual tax is owed.

¹⁵²⁷ If the foreign tax rate on GILTI is zero percent, then the U.S. residual tax rate on GILTI is 13.125 percent. Therefore, as foreign tax rates on GILTI range between zero percent and 16.406 percent, the total combined foreign and U.S. tax rate on GILTI ranges between 13.125 percent and 16.406 percent. At foreign tax rates greater than or equal to 16.406 percent, there is no residual U.S. tax on GILTI, and the combined foreign and U.S. tax rate on GILTI equals the foreign tax rate.