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GILTI’s Design Flaws Vex Practitioners

Posted on May 13, 2019

If the Tax Cuts and Jobs Act is like an amusement park filled with assorted attractions, shows, and exhibits, then the global intangible low-taxed income provision is like the fun house — filled with distortions, surprises, and mazes.

Except the challenges posed by GILTI — including its antiabuse rules, treatment of high-tax income, and basis adjustment concerns — aren’t particularly “fun” for taxpayers, as has been elucidated in numerous written comments to the Treasury Department over the past few months. The distortions in the GILTI fun house run deep, all the way to the foundation, according to practitioners at the April 16 NYU/KPMG Tax Symposium. On one hand, GILTI is a minimum tax regime that also ensnares high-tax income. On the other hand, it is an intangible income tax that captures more than intangibles.

Taxpayers caught in the GILTI crosshairs are finding that they must pay more tax than expected. As Treasury continues to work on a slate of GILTI-related regulations, practitioners are questioning whether tightening the regime and shifting it more clearly toward either a minimum tax regime or an intangible income tax regime would eliminate some of the surprises. At the very least, some would like to see GILTI move toward a traditional minimum tax and reduce its reliance on the foreign tax credit system, the combination of which has bedeviled the GILTI regime with complexity.

Conceptually Clunky

GILTI was placed on top of the IRC’s existing subpart F rules, but the two regimes do not fit neatly together. Subpart F requires U.S. shareholders of controlled foreign corporations to include their pro rata share of the corporation’s earnings and profits in their taxable income under various circumstances. GILTI, on the other hand, does not look to E&P but rather to tested income and losses. Tested income is the excess of a CFC’s income (minus subpart F income and other exclusions) over certain deductions. Tested losses are the excess of a CFC’s properly allocable deductions over its income (minus the same subpart F income and other exclusions).

“You have what I have described before as building a Ford F150 truck chassis and putting it on a Mustang wheel base. And Treasury tried very hard to come up with welding devices to make sure it could go down the road, but it is pretty clunky as it moves forward because the framework within which it’s been put doesn’t necessarily fit GILTI,” said panel moderator Paul Oosterhuis of Skadden, Arps, Slate, Meagher & Flom LLP.

Oosterhuis views the regime as a conceptual hybrid — a minimum tax on foreign earnings and a low-rate tax on intangible earnings — that doesn’t make conceptual sense and has created a confusing mishmash for taxpayers and practitioners alike. How is GILTI like an intangible income tax? It focuses on extraordinary returns — specifically, the excess of a taxpayer’s net CFC tested income, over its net deemed tangible income return. That net deemed tangible income return is the excess of 10 percent of a shareholder’s pro-rata share of its qualified business asset investment, minus certain interest expenses. But it’s not a perfect intangible tax because it ensnares more than just intellectual property. Any amount above the rate of return is GILTI income, regardless of its origin.

Although GILTI’s minimum tax attributes are clear — the regime sets a 10.5 percent minimum tax rate (13.125 percent as of 2026) on eligible taxpayers, for example — it is not a traditional minimum tax. GILTI income is fully includable, while a true minimum tax would not require inclusion in the United States if the foreign income is appropriately taxed locally, said Robert Wilkerson, a principal in KPMG LLP’s Washington National Tax practice.

From a tax design perspective, GILTI’s tax rate and base move in different directions, according to KPMG principal Ron Dabrowski. While the 10.5 percent minimum tax rate points to a narrower antiabuse regime, the GILTI base is very broad, imposed on mostly all CFC income, he said. Meanwhile, ordinary income is based on QBAI, which is relatively narrow. All in all, many companies are finding the GILTI base to be quite broad. The effects have been outlined in numerous writings, from Treasury correspondence to The Wall Street Journal.

There are also downward attribution concerns caused by the TCJA’s repeal of IRC section 958(b)(4). The new law creates a crop of unintended or accidental CFCs that previously were not characterized as such and are now potentially subject to GILTI.

“Our original subpart F rules . . . said unrelated U.S. shareholders can get you into CFC status. In the corporate context, it ought to be corporate control by related corporations can create CFC status,” Dabrowski said. “And then after that, once you have control, then you can extend to other shareholders. But having unrelated U.S. shareholders all owning less than 50 percent and creating CFC status, [that’s an] interesting design choice. [It’s] something that could be revisited in other forms or for round 2 of GILTI,” he said.

Foreign Tax Credits, Expense Allocation

Since GILTI is not a true minimum tax and requires full inclusions, taxpayers trying to square their income with the existing foreign tax credit rules are facing expense allocation issues. The rules subject taxpayers to a 20 percent “haircut” on the amount of foreign taxes they can use to offset GILTI.

“The existing system is encouraging taxpayers to try to sort of in a [perverse] way to restructure operations to try to get subpart F income, the less favored category of income to get a better tax answer, and it’s hard to see that as anything other than a pure flaw in the system,” Wilkerson said.

In the meantime, several taxpayers have asked Treasury to make a high-tax exception for GILTI income that’s not eligible for the subpart F high-tax exception under 954(b)(4). But such a move could spur interesting results, according to Dabrowski.

“If you create the exemption based on general high tax, under the current thinking, you create much more exempt assets, your expense allocation changes, [foreign-derived intangible income] policy starts to come into play,” Dabrowski added. “All that interest starts to look for what’s nonexempt. That goes back onto FDII, which is an interesting sort of trade-off.”

Relatedly, the 954(c)(6) look-through rules for tax-free reinvestments of CFC earnings are set to expire at the end of this year, and it’s unclear whether Treasury will extend them. Companies are split on whether the rules should be extended, but Wilkerson believes that if Treasury provides an effective high-tax exception for GILTI income, companies might change the way they think about 954(c)(6).

“I would rather see the regime move more toward the minimum tax, have less inclusions and less reliance on the [foreign tax credit] system,” Dabrowski said. “If you make the regime much more antiabuse, say it’s a minimum tax at a 10 percent level . . . the argument for having an FTC becomes just that — an argument; it becomes more tenuous.”

Wilkerson agreed. “When I think of a minimum tax, it strikes me that once you have identified your appropriate rate of tax, there’s no reason to apply the FTC rules. That just gets you back into sort of dealing with U.S. shareholders on [net operating losses] and other attributes inconsistent with the purpose of a minimum tax,” he said.

Losses and Timing

GILTI’s reliance on the section 250 deduction to attain a lower rate instead of a separate schedule or tax is another design decision that practitioners are questioning, particularly regarding the treatment of losses. Under GILTI, the section 250 deduction competes with onshore losses but loses to them, because onshore losses are used against GILTI income first, driving out the benefit of the deduction.

“The other way to go in the loss space is that if I have a loss in the CFC, or overall amongst all CFCs, should I have a rule like section 172 that carries the losses forward, so it’s more of a normative tax base over time? We didn’t go there,” Dabrowski said. “I would think more separate and [a section] 172 notion offshore would make more sense than where we are today.”

Wilkerson concurred, saying a regime that doesn’t allow NOL carryforwards seems inconsistent with a regime that also doesn’t allow FTC carryovers in the United States.

“There are timing differences that are pervasive in the U.S. versus foreign taxation, and those get reflected. I think that those sorts of timing differences, the problems of those are exacerbated with the GILTI rules as they are written now,” Wilkerson said.

This is one area in which GILTI’s hybrid nature is particularly frustrating. It’s not purely a CFC deemed distribution regime like subpart F because there are several shareholder attributes that must be deemed up, Oosterhuis said.

“QBAI, your interest income expense, your foreign taxes, your losses are all taken into account at the shareholder level, so it has elements of the passthrough regime, with respect to those items, but it’s not a passthrough regime beyond that,” he said. “So you’re left into this kind of mishmash that we tax lawyers are not used to because it takes elements of both.”

The Next Act?

Pillar 2 of the OECD’s consultation on the digital economy considers the utility of a global minimum corporate income tax in the flavor of GILTI. The OECD’s discussions are preliminary, but the effort could have ramifications in the United States, particularly as GILTI matures. Whatever the outcome, the OECD’s effort will likely address some key design questions that could be incorporated in the future.

“How that comes out will be important because a lot of these issues I think are going to be on the table legislatively in this country sometime between 2021 and 2024 and what the OECD says about a minimum tax like this compared to GILTI . . . will inform the legislative debate as it happens in this country,” Oosterhuis said.

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