On June 14, the U.S. Department of Treasury (Treasury) and the IRS released final regulations for the tax on Global Intangible Low Taxed Income (GILTI), a provision that came from the tax reform law commonly known as the Tax Cuts and Jobs Act (TCJA). Concurrently, the Treasury and IRS released proposed regulations on Subpart F inclusions.
GILTI provision is one of the more complex provisions in the tax reform law, and the IRS had already issued proposed regulations, released in September 2018. The first round of provisions helped taxpayers calculate their GILTI inclusion and clarified the law’s anti-avoidance principles. The recent guidance is expected to provide significant relief to investors in private equity and other domestic partnerships owning interests in controlled foreign corporations (CFCs).
The GILTI tax’s intent was to discourage U.S. entities and individual taxpayers from shifting profits out of the United States into low tax jurisdictions. To prevent this base erosion, the law taxes taxpayers’ GILTI, a new category of foreign income, levying what is essentially a worldwide minimum tax of 13.125%.
The earlier proposed regulations had adopted a hybrid approach for domestic partnerships by treating the partnership as an entity on behalf of non-U.S. shareholder partners and as an aggregate for partners that are themselves U.S. shareholders of a CFC owned by the partnership. This could have led to situations where the partnership had to calculate its GILTI inclusion amount for each CFC and allocate it to partners who are not themselves U.S. shareholders of that CFC. The result was that partners in domestic partnerships were being treated differently than partners in foreign partnerships holding the same investments.
Proposed and Final Regulations
The new guidance reduces this disparate treatment of domestic and foreign partnerships for purposes of the GILTI and Subpart F inclusions. The final and new proposed regulations adopt an aggregate approach for domestic partnerships to determine partner-level Subpart F and GILTI inclusions with respect to CFCs owned by the domestic partnership. However, the new guidance does not affect whether a domestic partnership or its partners are treated as a U.S. shareholder for determining whether a foreign corporation is a CFC and whether a domestic partnership is a controlling domestic shareholder; the entity approach will continue to apply. It may still be beneficial to hold investments in foreign corporations through a foreign partnership in situations where an investor indirectly owns at least 10% of the foreign target corporation, assuming the foreign corporation would not be deemed to be considered a CFC if the fund is organized as a foreign partnership.
These proposed Subpart F regulations are anticipated to apply to taxable years of foreign corporations beginning on or after the publication of these rules as final regulations in the Federal Register. However, for a foreign corporation’s taxable years that begin before the finalization date but after Dec. 31, 2017, a domestic partnership may apply these rules retroactively. The proposed rules also permit a domestic partnership to retroactively apply the rules for taxable years in which such taxable years of the foreign corporation end, provided certain conditions are satisfied. A partnership that has already filed its 2018 return will need to amend its tax return if it decides to apply these rules before the proposed regulations are finalized.
The new guidance also made it clear that the law did not intend for the GILTI tax to create such a burden on taxpayers; legislators know that income taxed at high rates in foreign jurisdictions does not contribute to base erosion here in the U.S. If the proposed guidance is adopted, taxpayers can elect out of the GILTI provisions if their foreign-earned income is taxed at 18.9% or higher. This election is made by the controlling shareholders of a CFC and is made only once. It remains valid until the taxpayers revoke their election.
This election was available to taxpayers even before the proposed regulations were released, but it was more restrictive. As the law was originally written, the high tax exclusion was only available for income that was considered foreign base company income (a major category of Subpart F income) or insurance income. The IRS proposes to expand this exclusion to “any item of income received by a controlled foreign corporation.”
While these proposed regulations will help many taxpayers, there are still some concerning aspects of the provisions as they are written. First, the 18.9% tax rate is tested at the qualified business unit level rather than at the CFC level, which will be difficult to calculate. Second, these changes will not be retroactive. They will apply only once the final regulations are published.
The new proposed guidelines will be open for public comment through September 19. If you have any questions about GILTI and how the new provisions will impact your business, please contact us.
Barret Pinto is a Tax Director and is a member of the Private Equity & Venture Capital Practice. He can be reached at 401.626.3237 or firstname.lastname@example.org.
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