Final GILTI Regulations: Planning Concerns and Considerations

On June 14 Treasury and the IRS issued final global intangible low-taxed income regulations, published in the Federal Register June 21,¹ just in time to have retroactive effect to the Tax Cuts and Jobs Act enactment. The final regulations improve upon the September 2018 proposed GILTI regulations² by appropriately lessening GILTI inclusions in many situations. Let’s explore the stuffing of specified tangible property and the removal or washing of intangible returns to reduce or eliminate GILTI inclusions and the new ownership rules that may allow for decontrolling a controlled foreign corporation.

Reducing GILTI

Introduced in the TCJA, section 951A provides that each U.S. shareholder of a CFC is subject to tax on GILTI. A U.S. shareholder’s net deemed tangible income return (DTIR) under GILTI equals the excess of 10 percent of their share of the qualified business asset investment, with some adjustments. A CFC’s QBAI for a tax year means the average of its aggregate adjusted basis in any “specified tangible property” used by the CFC in a trade or business and for which a section 167 deduction is permitted. The QBAI specified tangible property is the adjusted basis measured at the end of each quarter in the tax year. Overall, these provisions are designed to tax approximated excessive returns on what may be intangible income, with the justification that intangible income is easily movable. But many tangible assets are also movable, which allows for transfers to increase QBAI and reduce GILTI.

Section 951A(d)(4) authorizes the issuance of regulations or other guidance that the secretary determines are appropriate to prevent the avoidance of the purposes of section 951A(d), including regulations or other guidance that provide for the treatment of property that is transferred, or held, temporarily. The old proposed GILTI regulations included a 12-month per se rule and also provided that if a tested income CFC (1) acquired specified tangible property with a principal purpose of reducing the GILTI inclusion amount of a U.S. shareholder; and (2) holds the property temporarily, but over at least the close of one quarter, then the specified tangible property is disregarded in determining the acquiring CFC’s average adjusted basis in specified tangible property for purposes of determining the acquiring CFC’s QBAI under prop. reg. section 1.951A-3(h)(1).

The final GILTI regulations, T.D. 9866, responded to concerns and comments that the antiabuse rule on parking assets was overbroad and explained that “the final regulations also modify the 12-month per se rule to make it a presumption rather than a per se rule. Therefore, under the final regulations the temporary ownership rule is presumed to apply only if property is held for less than 12 months. See reg. section 1.951A-3(h)(1)(iv)(A). This presumption may be rebutted if the facts and circumstances clearly establish that the subsequent transfer of the property was not contemplated when the property was acquired by the acquiring CFC and that a principal purpose of the acquisition of the property was not to increase the DTIR [on QBAI] of the applicable U.S. shareholder.”

The new rebuttable presumption expands the opportunities to mitigate GILTI and the possibilities for tax-efficient QBAI increases through the outbound transfer of qualifying tangible assets, or stuffing, and decreases of tested income through transfers and washing, possibly below the 10 percent threshold. With DTIR increases and CFC tested income decreases through a plethora of possibilities, including outbound and foreign outlays, GILTI inclusions should be in line with American taxpayer expectations of the TCJA. While seemingly generous, a quarter of a year may be viewed as well within the time frame in which courts have viewed temporarily held assets as worthy of being respected.

In Compaq,³ a dividend-paying stock of a corporation was acquired right before the corporation declared a dividend, and then the stock was sold all within roughly an hour. The dividend created ordinary income and the availability of large foreign tax credits. While the IRS argued there was no business purpose for the transaction apart from obtaining the foreign tax credits, the court explained that the benefits and burdens of stock ownership would be respected when “there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached, the government should honor the allocation of rights and duties effectuated by the parties.” In Penn-Dixie Steel Corp. v. Commissioner, 69 T.C. 837 (1978), and Griffin Paper Corp. v. Commissioner, T.C. Memo. 1997-409, the Tax Court examined additional factors for respecting stock ownership.

The final GILTI regulations create a safe harbor for temporarily held qualified tangible property between related CFCs. Also, section 250 permits a corporate U.S. shareholder a deduction equal to 50 percent of any remaining GILTI inclusion, resulting in an effective U.S. federal income tax rate of 10.5 percent, with further potential for section 901 foreign tax credits subject to a 20 percent haircut under section 960(d).

In addition to the flexibility described above, taxpayers were alleviated from some penalizing provisions. Because comments “raised many significant issues with respect to these rules,” the final regulations did not adopt the basis reductions of the proposed regulations relating to the stock of tested loss CFCs under reg. section 1.951A-6(c).

Decontrolling CFCs

Decontrolling a potential CFC has long been a common planning technique that the TCJA was intended to eliminate. It did so by replacing a voting threshold with a vote or value threshold for U.S. shareholders. It also eliminated the rule that a CFC have a U.S. shareholder for 30 days for its subpart F earnings to be taxed.

The GILTI regime follows the updated subpart F control thresholds for U.S. shareholders and CFCs and has some additional control rules of its own. Section 951A(e)(2) requires ownership of stock of a foreign corporation on the last day of its tax year in order to be counted for CFC status. To fully appreciate this one-day rule, it must be considered with the updated U.S. shareholder threshold enacted in the same legislation.

Before 1986 the concept of control for CFC status was entirely based on the total combined voting power of all classes entitled to vote. The Tax Reform Act of 1986 amended subpart F to provide that CFC status is determined by total combined voting power or total value of the stock held. Although the law added a value test for CFC status, the code’s definition of a U.S. shareholder in section 951(b) continued to be based solely on voting power. In 2017 the section 951 control threshold to be a U.S. shareholder was updated to align with the section 957 control threshold for CFC status.

Under new section 951A(a), U.S. shareholders of CFCs must include their yearly GILTI inclusion in gross income. Section 951(b) now defines a U.S. shareholder as a U.S. person (as defined in section 957(c)) that owns directly, indirectly, or constructively, under section 958(a) and (b), 10 percent or more of the total combined voting power of all classes of stock entitled to vote or 10 percent or more of the total value of shares of all classes of stock of a CFC. The TCJA’s updated provision expands the definition of U.S. shareholder under subpart F beyond voting control to include any U.S. person that owns 10 percent or more of the total value of the CFC stock. This may weaken planning for corporations with low-vote stock and expand the number of U.S. shareholders and CFCs.

Section 957(a) continues to define a CFC as any foreign corporation with more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of the stock owned, under section 958(a) and (b), by U.S. shareholders on any day during its tax year.

Under section 951A(e)(2), a person is treated as a U.S. shareholder of a CFC only if that person owns stock in the foreign corporation on the last day in the tax year of the foreign corporation. A corporation can’t be a CFC if its owners aren’t U.S. shareholders.

For a good discussion of taxpayers that avoid the reg. section 1.957-1(b) principal purpose test, designed to eliminate or avoid CFC status (referred to as decontrolling) through a recapitalization, check out a 1992 field service advice (FSA 1998-720). The 1986 and 2017 mechanical control threshold updates for CFCs and U.S. shareholders, respectively, and the general factors of stock ownership discussed above will be accorded weight in similar determinations.