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Section 962 Election of The Corporate Tax Rate by Individuals For Global Intangible Low-Taxed Income ( GILTI) And Subpart F Income Inclusions TUESDAY, JULY 10, 2018 Thomas M. Giordano-Lascari, Atty Karlin & Peebles, Los Angeles tgiordano@karlinpeebles.com William K. Norman, J.D., LL.M. (Taxation), Partner Ord & Norman, Los Angeles ontaxla@yahoo.com
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Section 962 Election of The Corporate Tax Rate by Individuals For Global Intangible Low-Taxed Income ( GILTI) And Subpart F Income Inclusions William K. Norman Ord & Norman 11377 West Olympic Boulevard, 5th Fl. Los Angeles, CA 90064 Telephone: (310) 473-8067 Facsimile: (310) 473-8140 ontaxla@yahoo.com Thomas M. Giordano-Lascari Karlin & Peebles, LLP 5900 Wilshire Boulevard, Suite 500 Los Angeles, CA 90036 Telephone: (323) 648-4649 Facsimile: (310) 388-5537 tgiordano@karlinpeebles.com
Introduction Fundamentally, IRC 962 allows a non-corporate US shareholder of a CFC to elect to be taxed on subpart F inclusions at the same rate as a corporate US shareholder. Prior to the TCJA, 962 was not significantly utilized. The TCJA gave new importance to 962: First, the corporate tax rate was reduced from 35% to 21% making the differential between the highest individual tax rate (39.6%) and the corporate rate much more substantial. Second, the introduction of GILTI drastically reduced the ability to defer foreign earnings from US tax by causing all but a modest amount of foreign income to be includible in a US shareholder s income on an annual deemed basis (similar to traditional subpart F inclusions). Why not just interpose a US C corporation? Not ideal if future sale of CFC stock anticipated Adverse foreign country consequences of transfer of CFC stock to domestic corporation Likely not viable solution for US persons (not citizens) that will be exiting the United States in the future Also likely not viable for US persons (including citizens) resident in foreign country where foreign country tax will be prohibitive if CFC held through a US corporation
Global Intangible Low Taxed Income (GILTI) 951A Effective for TYs of foreign corps. beginning after 12/31/17 and the TYs of U.S. Shareholders in which or with which the TY of the foreign corp. ends. P.L. 115-97, 14201(a) 7
GILTI (Cont) U.S. Shareholder of any CFC includes in its gross income the shareholder s Global Intangible Low Taxed Income (GILTI). 951A(a) 8
GILTI (Cont) Foreign corp. is a Controlled Foreign Corporation (CFC) only if it was a CFC at any time during the TY. See 957 for definition of CFC. 951A(e)(3) 9
GILTI (Cont) A U.S. Person is a U.S. Shareholder if the person owns (w/in meaning of 958(a) i.e., directly or indirectly through foreign entities) stock in the foreign corp. on the last day in the taxable year of the foreign corp. on which it is a CFC. See 951(b) for definition of U.S. Shareholder. 951A(e)(2) 10
GILTI (Cont) GILTI = Net CFC - Net For Any Tested Income Deemed U.S. Shareholder of the U.S. Tangible For Any TY Shareholder Income of the Shareholder Return (NDTIR ) of the U.S. Shareholder >0 951A(b)(1) 11
GILTI (Cont) Net CFC Tested Income of a U.S. Shareholder for any TY of the Shareholder ncfc ncfc = Ʃ Aggregate of Prorata Share of - Ʃ Aggregate of Prorata Share of 1 Tested Income of all CFCs 1 Tested Loss of all CFCs wrtw wrtw the shareholder which is a the shareholder which is a U.S. U.S. Shareholder for TY Shareholder for TY of the CFC of the CFC that ends with or w/i that ends with or w/in the TY the TY of the shareholder of the shareholder >0 951A(c)(1) 12
GILTI (Cont) Tested Loss of a CFC for any TY of the CFC = Deductions Gross Income of the including taxes CFC computed w/o allocated to GI - regard to excluded of the CFC under items in rules similar to 951A(c)(2)(i) 954(b)(5) w/o (I) through (V) excluded items in 951A(c)(2)(i) (I) through (V) < 0 951A(c)(2)(B)(i) 13
GILTI (Cont) Tested Income of a CFC for any TY of the CFC = Gross Income of the CFC Deductions Except: including taxes -ECI (952(b)) allocable to -Subpart F income (954) - GI of the CFC -GI excluded from under rules subpart F income as similar to high taxed (954(b)(4)) 954(b)(5) -Dividends from related w/o excepted persons (954(d)(3) items < 0 951A(c)(2)(A) 14
GILTI (Cont) NDTIR of n U.S. Shareholder =.10 Ʃ QBAI Interest expense allocable to For Any TY 1 of all - Net CFC Tested Income to CFCs extent interest income attributable wrtw to the expense is not taken into SH is account in determining Net CFC a U.S. SH Tested Income of the shareholder used to produce Tested Income >0 951A(b)(2) 15
GILTI (Cont) QBAI 4 Aggregate adjusted tax basis of a CFC = ¼ Ʃ under ADS ( 168(g) as of the close of each for TY 1 quarter of Specified Tangible Property used in t or b of CFC of a type wrtw deduction is allowable under 167 951A(d)(1) 16
GILTI (Cont) Specified tangible property (STP) of a CFC is (except for dual use property ) any tangible property used in the production of tested income 951A(d)(1) 17
GILTI (Cont) Dual use property is tangible property used by the CFC for production of both tested income and income which is not tested income. 951A(d)(2)(B) 18
GILTI (Cont) Specified Tangible Adjusted base of Shareholder s Property Allocable = tangible property pro rata share to a CFC in used in t or b by the X of tested dual use CFC for which income of the deduction is allowed under 167 CFC wrt tangible property Total gross income of the CFC produced by the tangible property 951A(d)(2)(B) 19
GILTI (Cont) Allocation of CFC s distributive Adjusted Adjusted basis = share of income basis of of STP of a of the partnership as X items of partnership to a percentage wrt STP held CFC partner the STP by partnership of which the CFC is a partner 951A(d)(3) 20
GILTI (Cont) Deemed Paid GILTI * Aggregate Credit for =.80 Aggregate Tested Foreign GILTI Inclusion Tested X Income Tax of a U.S. Shareholder Income of CFCs of CFCs *Fraction is called inclusion percentage. 960(d)(2) 21
GILTI (Cont) See 78 = GILTI * X Aggregate Gross Up Aggregate Tested Foreign Related Tested Income Income Tax to GILTI of CFCs of CFCs Inclusion of a U.S. Shareholder *Fraction is called inclusion percentage. 960(d)(2) 78 and 960(d) 22
GILTI (Cont) Tested Foreign Income Taxes of a domestic (C) corporation which is a U.S. Shareholder of one or more CFCs is the sum of: Foreign income taxes paid or accrued by each CFC with tested income that are properly attributable to the tested income of the CFC included in GILTI. 960(d)(3) 23
GILTI (Cont) GILTI (except for passive category income) is assigned to a separate basket for FTC limitation purposes. 904(d)(1)(A) 24
GILTI (Cont) Foreign Tax Credit =.50 (GILTI + Gross Up) X U.S. Federal Limitation Entire Taxable Income Income Tax for the GILTI -.50(GILTI + Gross Up) Before FTC Basket (Category) Other than Passive 904(a), (d)(1)(a) and 861(b) 25
GILTI (Cont) GILTI allocated GILTI from U.S. S/H s to a U.S. = all CFCs pro rata share of Shareholder wrtw the X tested income of a CFC for shareholder is of the CFC purposes of a U.S. Shareholder Ʃ aggregate of 951A(f)( 1) tested income of all CFCs wrtw the shareholder is a U.S. Shareholder 951A(f)(2) 26
GILTI (Cont) GILTI Is Generally Treated In the Same Manner as Subpart F Income for Purposes of: 951(a)(1)(A) Subpart F inclusion 996(f)(1) E and P of IC DISC 168(h)(2)(B) not tax exempt prop. 1248(b)(1) limitation on dividend treatment 535(b)(10) - deduction for AET 1248(d)(1) exclusion for E & P 904(h)(1) - resourcing 6501(e)(1)(C) 6 year S of L 952(c)(1)(A) E & P limitation 6654(d)(2)(D) estimated tax 959 PTI stock and ordering 6655(e)(4) estimated tax 961 adjustments to basis 962 election of corporate rates 993(a)(1)(E) dividends and inclusions wrt foreign export corporations 951A(f)(1) 27
IRC 962 A US shareholder of a CFC who is an individual (including a trust or estate (see treas. reg. 1.962-2(a)) can make a 962 election, which provides: Tax imposed on subpart F inclusions of said individual, including GILTI inclusions (see 951A(f)(1)), will be subject to tax as calculated under section 11 (i.e., taxes imposed on corporations). A deemed paid credit under IRC 960 shall be allowed on such amounts. Basis step-up under 961 allowable to the extent of tax paid 29
IRC 962 Legislative History (S. Rep. No. 1881, 87th Cong., 2d Sess. (1962)) The purpose of this provision is to avoid what might otherwise be a hardship in taxing a U.S. individual at high bracket rates with respect to earnings in a foreign corporation which he does not receive. This provision gives such individuals assurance that their tax burdens, with respect to these undistributed foreign earnings, will be no heavier than they would have been had they invested in an American corporation doing business abroad. 30
IRC 962 Application Application of section 11 for inclusions subject to a 962 election (treas. reg. 1.962-1(b)(1)): Section 11 is limited under 962 and the above cited regulation. Specifically, for 962 purposes, taxable income means the sum of: The amounts required to be included in gross income as traditional subpart F income and GILTI; plus The section 78 gross-up with respect to those amounts. such sum shall not be reduced by any deduction of the United States shareholder even if such shareholder s deductions exceed his gross income Taxable Income under Section 11 refers to section 63, which provides taxable income means gross income minus allowable deductions 31
IRC 962 Foreign Tax Credit (Treas. Reg. 1.962-1(b)(2) Allowance of foreign tax credit: There shall be allowed a foreign tax credit under 960(a)(1) for amounts which are the subject of a 962 election (subject to the applicable limitation of 904) To the extent the foreign tax credit exceeds the 904 limitation, the excess can be carried back or carried forward, except can only offset other income for which a 962 election is in place 32
IRC 962 Treatment of Actual Distributions (IRC 962(d); Treas. Reg. 1.962-3 962 E&P less Excludable 962 E&P are included in gross income 962 E&P = the E&P of a foreign corporation that were included in the gross income of a the taxpayer under 951(a) in a prior year and for which a 962 election is in effect; includes Excludable 962 E&P and Taxable 962 E&P Excludable 962 E&P = the amount of income tax paid by the taxpayer with respect to the 962 election in the prior year Taxable 962 E&P = the excess over Excludable 962 E&P. Source of distributions: 962 E&P generally is distributed after regular PTI Excludable 962 E&P is distributed first and then Taxable 962 E&P 33
IRC 962 Procedure (Treas. Reg. 1.962-2) Only individuals, trusts or estates may make the election. Election made by filing a statement with taxpayer s return: Name, address, and taxable year of each CFC with respect to which the electing shareholder is a US shareholder and all other corporations, partnerships, trusts, or estates in any applicable chain of ownership described in 958(a) The amounts, on a corporation-by-corporation basis, which are included in such shareholder s gross income for his taxable year under 951(a) Taxpayer s pro rata share of E&P of such CFC with respect to which the taxpayer as an inclusion under 951(a) and the foreign taxes with respect to such E&P The amount of distributions received by the taxpayer from each CFC which are (1) excludable 962 E&P; (2) taxable 962 E&P; and (3) E&P other than 962 E&P, showing the source of such amounts by taxable year Effect of election A 962 election when made is applicable to all CFCs owned by the taxpayer and is binding for the taxable year for which the election is made An election may be revoked with the approval of the Commissioner. Approval will not be granted unless a material and substantial change in circumstances occurs which could not have been anticipated. 34
IRC 962 Areas of Uncertainty Can individuals who own CFC through an S corporation or partnership make a 962 election? Availability of 250 Deduction for GILTI Inclusions Are subsequent distributions qualified dividends if distributed from a foreign corporation not located in a treaty jurisdiction? 35
Comparative Examples - GILTI - Prepared By: William K. Norman Ord & Norman Los Angeles Tel: 310-473-8067 Email: ontaxla@yahoo.com 36
GILTI Comparative Examples: USI US Co For Co Case 1 Facts: Domestic net income Tested income 1,150 Foreign income taxes Adjusted basis of QGAI 1,500 θ θ 37
Analysis of Case 1 Calculation of GILTI Inclusion Tested Income 1,150 Net deemed tangible income return (NDTIR) (.10 * 1,500) <150> GILTI inclusion 1,000 38
Analysis of Case 1 (cont.) Calculation of Tax Liability of USCO: GILTI inclusion 1000 Dividend of NDTIR 150 1,150 GILTI deduction <500> 650 Taxable income corp tax rate.21 136.5 39
Analysis of Case 1 (cont.) Calculation of Tax Liability of Ultimate Shareholder: E & P of USCO: Distribution of GILTI 1000 Dividend of NDTIR 150 1,150 Less Corp. tax <136.5> E & P available for dividend to Ultimate Shareholder 1,013.5 Combined ordinary and unearned rate.238 Ultimate Shareholder tax 241.2 Corp. level tax 136.5 Total tax burden 377.7 Effective tax rate 377.7/1,150 32.8% 40
GILTI Comparative Examples: USI For Co Case 1A Facts: Domestic net income Tested income 1,150 Foreign income taxes Adjusted basis of QGAI 1,500 θ θ 41
Analysis of Case 1A (cont.) Calculation of Tax Liability of Ultimate Shareholder: GILTI inclusion 1000 Dividend from For Co 150 Taxable income 1,150 Combined ordinary and unearned rate.408 Ultimate shareholder tax to Ultimate Shareholder Effective tax rate 469.2/1,150 469.2 40.8% 42
GILTI Comparative Examples: USI Case 1B Section 962(b) election Facts: 962(a) fictional domestic corporation Domestic net income θ Tested income 1,150 Foreign income taxes θ Adjusted basis of QGAI 1,500 For Co 44
Analysis of Case 1B (cont.) Calculation of Tax on Gifts Inclusion at Fictional Corporation Level With 250(a) deduction GILTI inclusion 1000 GILTI deduction <500> Without 250(a) Deduction 500 1000.21.21 962(a) Corp. Tax on GILTI inclusion 105 210 45
Analysis of Case 1B (cont.) Calculation of Tax Liability of Ultimate Shareholder: With 250(a) Deduction E & P fictional US Co 895 (1000-105) Without 250(a) Deduction 790 (1000-210) Dividend from fictional US Co 895 790 Direct dividend from For Co 150 150 Applicable ordinary and unearned tax rate.408.238.408.238 61.2 238 Ultimate Shareholder Tax Corp. level tax 105 238 61.2 188.0 274 249 210 Combined tax burden 379 459 188 Effective tax rate 379/1,150 or 459/1,150 33% 39.9% 46
GILTI Comparative Examples: USI US Co For Co Case 2 Facts: Domestic net income Tested income less foreign taxes 1,150 Foreign income taxes 275 Effective fringe tax rate 23.9% Adjusted basis of QBAI 1,500 θ 47
Analysis of Case 2 Calculation of GILTI Inclusion for US Co: Tested income before foreign taxes 1,500 Foreign income taxes <275> NDTIR (.10 * 1,500) <150> GILTI inclusion 725 Calculation of Foreign Tax Credit Amounts: DPTTC = 725.80 275 = 182 1,150-275.875 725 Gross Up = 275 = 227.9 1,150-275.875 48
Analysis of Case 2 (cont.) Calculation of Tax Liability of US Co: GILTI inclusion 725 Gross Up 227.9 GILTI deduction 952.9 <476.45 > 476.45.21 Corp. tax before FTC 100.1 FTC as limited <100.1> Corp. Tax 0 Receipt of distribution of NDTIR net of allocated foreign income taxes is eligible for participation exemption. 245A 49
Analysis of Case 2 (cont.) Calculation of Tax Liability of Ultimate Shareholder: Available E & P for distribution: Tested income before foreign tax 1,150 Foreign income taxes <275> Dividend to Ultimate Shareholder 875.238 Ultimate Shareholder tax 208.25 Foreign income taxes 275.00 Total tax burden 483.25 Effective tax rate 483.25/1,150 42% 50
GILTI Comparative Examples: USI For Co (Case 2A Facts: Domestic net income θ Tested income before foreign taxes 1,150 Foreign income taxes 275 Effective foreign tax rate 23.9% Adjusted basis of QBAI 1,500 51
Analysis of Case 2A Calculation of GILTI Inclusion for USI: Total income before foreign taxes 1,150 Foreign income taxes <275> N D T I R (-.10* 1,500) <150> GILTI Inclusion 725 52
Analysis of Case 2A (cont.) Calculation of Tax Liabilities of Shareholder: GILTI inclusions 725 Dividend of NDTIR 150+(150/1150) 275 185.9 35.9 910.9 Combined ordinary and unearned rate.408 Ultimate shareholder tax 371.6 Foreign tax 275.0 Total tax burden 646.6 Effective tax rate 646.6/1,150 56.2% 53
GILTI Comparative Examples: USI Case 2B Facts: 962(a) fictional domestic corporation Domestic net income θ Tested income before foreign taxes 1,150 Foreign income taxes 275 Effective foreign tax rate 23.9% Adjusted basis of QBAI 1,500 For Co 54
Analysis of Case 2B Calculation of GILTI Inclusion of Fictional USCO: Tested income before foreign taxes 1,150 Foreign tax <275> NDTIR (.10 * 1,500) <150> GILTI inclusion 725 Calculation of Foreign Tax Credit Amounts: Same as Case 2 DPFTC = 182 Gross up 227.9 55
Analysis of Case 2B (cont.) Calculation of Tax Liability of Shareholders: E&P and Tax Pool Allocations -- E&P of ForCo PTI Other Total 725* 150 875 Allocation of tax pool 725/875 X 275 228 47 275 *Gross up is excluded from E&P. Regs 1.78-1(a) 56
Analysis of Case 2B (cont.) Calculation of Tax Liability of Fictional USCO: With 250(a) Deduction GILTI inclusion 725 Gross up 227.9 952.9 GILTI deduction <476.45 > Taxable income 476.5.21 Corporate Tax before FTC 100.1 FTC as limited <100.1> Corp. tax 0 57
Analysis of Case 2B (cont.) Calculation of Tax Liability of Shareholder (cont.): Dividend from GILTI (inclusion of fictional USCO) 725 Dividend from ForCo 150 Tax rate on distribution from fictional USCO.238 Tax rate on actual distribution for ForCo Partial Tax 172.6 61.2 Shareholder Tax Total 233.8.408 61.2 Foreign Tax 275 Total of U.S. and foreign taxes Effective tax rate 508.8 / 1,150 508.8 44.2% 58
Comparative Examples GILTI Summary of Results Case 1 Case 1A Case 1B Case 2 Case 2A Case 2B Combine Effective Tax Rate at various levels USI USI USI USI USI USI USCo USCo ForCo ForCo ForCo ForCo ForCo ForCo 1 Foreign Tax = 0 Foreign Tax = 0 Foreign Tax = 0 Foreign Tax = 23.9% Foreign Tax = 23.9% Foreign Tax = 23.9% ForCo 0 0 0 23.9% 23.9% 23.9% 2 Immediate Shareholder 136.5/1.180 = 11.9% + 40.8% With W/O $250 $250 10.5% 21% 275/1150 = 23.9% + 56.2% With W/O $250 $250 23.92% 23.9% 3 Ultimate Shareholder + 32.8% + 40.8% With W/O $250*+ $250*+ 33% 39.9% + 42% + 56.2% With W/O $250*+ $250*+ 33% 39.9% * Assumes qualified dividend rate available for distribution from fictional domestic C corporation + Assumes qualified dividend rate not available for distribution from ForCo. 59
Comparative Examples GILTI Comments on Summary of Results 1 Case 1 Case 1A Case 1B Case 2 Case 2A Case 2B ForCo 0 0 0 23.9% 23.9% 23.9% Row 1 This row merely states the foreign tax rate for each case. Because of a U.S. Shareholder in every case, the combined U.S. foreign tax rate with or without a distribution is reflected in Row 2. 60
2 Immediate Shareholder Comparative Examples GILTI Comments on Summary of Results Case 1 Case 1A Case 1B Case 2 Case 2A Case 2B 136.5/1.180 = 11.9% + 40.8% With W/O $250 $250 10.5% 21% 275/1150 = 23.9% + 56.2% With W/O $250 $250 23.92% 23.9% Row 2 The results under Cases 1 and 1B, assuming the 250 deduction is allowed, are essentially the same. The reason the effective tax rate in Case 1 is higher than Case 1B (11.9% v. 10.5%) is that in Case 1 we assume the earnings attributed to NDTIR are distributed. If the 250 deduction is not allowed in Case 1B, the tax burden in Case 1B is almost double the result in Case 1. The results in Cases 2 and 2B at the domestic corporation level reflect only the foreign tax burden of 23% which completely offsets the domestic corporate tax. The results in Cases 1A and 2A reflect the disadvantage of an individual U.S. shareholder under the GILTI regime. 61
3 Ultimate Shareholder Comparative Examples GILTI Comments on Summary of Results Case 1 Case 1A Case 1B Case 2 Case 2A Case 2B + 32.8% + 40.8% With W/O $250*+ $250*+ 33% 39.9% + 42% + 56.2% With W/O $250*+ $250*+ 33% 39.9% Row 3 Essentially, Case 1 and Case 1B, with the 250 deduction are the same. Without a 250 deduction, Case 1B and Case 1A are comparable in results. Case 2 is only marginally better than Case 2B with, or, surprisingly, without the 250 deduction. Case 2A provides the higher tax burden of the ultimate individual shareholder. 62