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This requirement to allocate domestic interest expense against foreign income has the effect of altering the fraction that limits the foreign tax credit. For example, a company, before the interest expense allocation, may earn half of its profits outside of the United States. This means the foreign tax credit would be limited to half of the U.S. tax liability. However, expense allocation may shift expenses out of the U.S. and into a foreign jurisdiction.
If/when the corporation determines that it has excess cash to distribute, it will declare a dividend, which will be taxed to the shareholder. In the first post I discussed a public comment made on behalf of the Israeli Ministry of Finance on the recentproposed GILTI regulations. The third post talked – https://www.Google.com/maps/place/International+Wealth+Tax+Advisors,+LLCfirstname.lastname@example.org,-73.980045,16z/data=!4m5!3m4!1s0x0:0xa13d6d09e95d825c!8m2!3d40.7510417!4d-73.9800451?hl=en about how GILTI was measured focusing on US domestic corporations, the target of these provisions in the first place. This post will look at how these rules, that were written for Apple and Google, play out for individuals owning small businesses in the “foreign” country where they live. For those who want to get into the detail, there’s a technical appendix on our wiki.
The GILTI system of taxation is similar in its design to an alternative minimum tax. At a very high level, because we no longer have deferral, GILTI will tax the operating income of controlled foreign corporations on an annual basis. Once the QBAI is calculated an entity calculates the net deemed tangible income return by multiplying the QBAI amount by 10 percent then subtract any interest expense paid to unrelated parties. The deemed tangible income return is the exclusion amount used to offset the amount of net tested income which results in the Global Intangible Low-Tax Income. The Global Intangible Low-Taxed Income tax was put in place to counter-act profit shifting to low-tax jurisdictions.
Under the statute, gross tested income excludes any gross income “taken into account” in determining subpart F income. The final rules adopt comments suggesting that the foreign base company “de minimis” and “full inclusion” rules be taken into account for this purpose. Accordingly, the final rules clarify that income excluded from FBCI under the de minimis rule and full inclusion amounts excluded from FBCI under the high-tax exception are included in gross tested income, while income included in FBCI under the full inclusion rule is excluded from gross tested income.
Prior to the Act, however, most foreign-source income that was earned by a U.S. person indirectly – as a shareholder of a foreign corporation that operated a business overseas – was not taxed to the U.S. person on a current basis. Instead, this foreign business income generally was not subject to U.S. tax until the foreign corporation distributed the income as a dividend to the U.S. person. The significant reduction in the corporate tax rate relative to the individual rate is likely enough of an incentive, by itself, to cause some individual USS to elect to be treated as a domestic corporation under Sec. 962. This election was added to the Code over 55 years ago, at the same time that the CFC rules under subpart F were enacted. According to its legislative history, Sec. 962 was enacted to ensure that an individual’s tax burden with respect to a CFC was no greater than it would have been had the individual invested in a domestic corporation that was doing business overseas.
The consolidated return rules in the 2018 proposed regulations adopted an aggregation approach to GILTI, whereby consolidated group members’ GILTI items were aggregated and then allocated to members in proportion to their share of the group’s tested income. In general, this had the effect of allowing tested losses or QBAI attributable to CFCs owned by one consolidated group member to offset tested income attributable to CFCs owned by another member of the group. The 2018 proposed regulations stopped short, however, of mandating that all GILTI computations occur as if members of a consolidated group were a single U.S.
This process goes through a calculation of reducing a CFC’s total tested income by the net deemed income from tangible assets. The variance can be considered income from a CFC’s intangible assets which is included in the shareholder’s income. Before the enactment of the TCJA in December 2017 entities with valuable intangible assets would set up a controlled foreign corporation in a low-tax foreign country to hold their intangible assets. The United States parent company would pay a licensing fee for use of the intangible property which resulted in shifting income from the US to the low-tax jurisdiction.
The problem is that many taxpayers and practitioners fail to properly test for these items. This can create a larger problem on audit where a tax
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