Revise Proposed GILTI High-Tax Exclusion Regs, Firm Says

September 19, 2019

The Honorable David J. Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable Michael J. Desmond
Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

The Honorable Charles P. Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Comments on Section 951A Proposed Regulations (Internal Revenue Service REG-101828-19) — GILTI High Tax Exclusion

Dear Messrs. Kautter, Rettig, and Desmond:

On June 21, 2019, regulations were published implementing the provisions of the Tax Cuts and Jobs Act of 2017 (the “TCJA") addressing global intangible low-taxed income (“GILTI"). Those regulations included proposed regulations (the “Proposed Regulations") that provide guidance on the application of section 954(b)(4) in the case of income that is generally subject to the GILTI rules.¹ Specifically, the Proposed Regulations permit taxpayers to exclude, on an elective basis, certain high-taxed income from the scope of “tested income" (as defined in section 951A(c)(2)(A)), and thus the GILTI provisions (the “GILTI high tax exclusion"). The inclusion of the GILTI high tax exclusion in the Proposed Regulations is important and helpful in assisting taxpayers as they operate under the new GILTI regime. We appreciate the opportunity to submit comments on the Proposed Regulations.

I. Background

A. GILTI High Tax Exclusion

The GILTI high tax exclusion under sections 954(b)(4) and 951A(c)(2)(A)(i)(III) excludes from tested income “any gross income excluded from the foreign base company income (as defined in section 954) and the insurance income (as defined in section 953) of such corporation by reason of section 954(b)(4).”² The Proposed Regulations implement the GILTI high tax exclusion by providing an election to exclude under section 954(b)(4), and thus to exclude from a controlled foreign corporation's (“CFC”) tested income under section 951A(c)(2)(A)(i)(III), income that is subject to foreign income tax at an effective rate that is greater than 90 percent of the maximum corporate income tax rate (currently 90 percent of 21 percent, or 18.9 percent).³ The effective rate of foreign income tax imposed on an item of income for this purpose is determined based on the amount of taxes that are properly attributable to the item, and thus would be deemed paid under section 960.⁴ When made, the election applies to exclude from tested income all of the CFC's items of income for the taxable year that meet the effective rate test.⁵ The election, if made, applies to each CFC in a group of commonly controlled CFCs (the “all-or-nothing rule").⁶ The Preamble requests comments on whether the all-or-nothing rule should be modified, such as by allowing the election to be made on an item-by-item or a CFC-by-CFC basis.⁷

The preamble to the Proposed Regulations (the “Preamble”) notes that its implementation of the GILTI high tax exclusion is consistent with legislative intent because “[t]he legislative history evidences an intent to exclude high-taxed income from gross tested income.”⁸ Moreover, the election results in the “same treatment” for high-taxed tested income and high-taxed foreign base company income (“FBCI”) and insurance income, “and thus eliminates an incentive for taxpayers to restructure their CFC operations in order to convert gross tested income into FBCI for the sole purpose of availing themselves of section 954(b)(4) and, thus, the GILTI high tax exclusion."⁹ The Preamble includes as an example that a taxpayer could restructure its operations to have a CFC purchase personal property from, or sell personal property to, a related person without substantially contributing to the manufacture of the property in its country of incorporation, with the result that the CFC's income from the disposition of the property would be foreign base company sales income, and therefore FBCI.¹⁰

Application of the GILTI high tax exclusion is elective, and an election is effective for a CFC for the CFC inclusion year for which it is made and all subsequent CFC inclusions years of the CFC unless revoked.¹¹ Although an initial election may be made or revoked at any time, if a U.S. shareholder revokes an election with respect to a CFC, the U.S. shareholder cannot make a “subsequent election” for five years after the revocation (the “lock-out rule”).¹² Similarly, a subsequent election cannot be revoked (a “subsequent revocation”) for at least five years after the subsequent election was made (the “lock-in rule”).¹³ An exception to the lock-out and lock- in rules may be permitted by the Commissioner for a CFC if the CFC undergoes a change of control.¹⁴ The Preamble requests comments on whether the limitations with respect to revocations should be modified.¹⁵

The effective rate test is applied by treating all items of tested income attributable to a qualified business unit (“QBU”) as a single item of income.¹⁶ A single CFC may have multiple QBUs.¹⁷ The tested income attributable to a QBU is determined by reference to the items of income reflected on the books and records of the QBU, determined under U.S. federal income tax principles, except that income attributable to a QBU must be adjusted to account for certain disregarded payments.¹⁸ The Preamble requests comments on whether: (i) additional rules are needed to properly account for other instances in which the income base upon which foreign tax is imposed does not match the items of income reflected on the books and records of the QBU determined under U.S. federal income tax principles; (ii) all of a CFC's QBUs located within a single foreign country should be combined for purposes of performing the effective rate test; and (in) the definition of QBU should be modified for purposes of the GILTI high tax exclusion.¹⁹

The Preamble discusses various approaches that were considered for implementing section 954(b)(4) in the case of high-taxed income that would otherwise be tested income. Specifically, Treasury and the IRS considered three alternative approaches that could be used to determine whether an item of income meets the effective rate test: (1) applying the test on an item-by-item basis; (2) applying the test on a CFC-by-CFC basis; or (3) applying the test on a QBU-by-QBU basis.²⁰ The first option (item-by-item) was rejected because it would be “complex and difficult to administer.”²¹ The second option (CFC-by-CFC) “would minimize complexity and would be relatively easy to administer,” but was ultimately rejected because it “could permit inappropriate tax planning, such as combining operations subject to different rates of tax into a single CFC” to effective blend the rates of foreign income tax imposed on the income, “which could result in low- or non-taxed income being excluded as high-taxed income by being blended with much higher-taxed income.”²² Treasury and the IRS determined that this would be inappropriate because “[t]he low-taxed income in this scenario is precisely the sort of base erosion-type income that the legislative history describes section 951A as intending to tax.”²³ The third option (QBU-by-QBU) “may be more complex and administratively burdensome under certain circumstances” than the CFC-by-CFC approach, however, it was selected because “it more accurately pinpoints income subject to a high rate of foreign tax and therefore continues to subject to tax the low-taxed base erosion-type income that the legislative history describes section 951A as intending to tax.”²⁴

In addition to removing high-taxed income from the scope of tested income, and thus the GILTI rules, certain additional tax consequences follow from the election and its treatment of high-taxed income. First, foreign income taxes that are properly attributable under section 960 to items of income excluded from tested income by the GILTI high tax exclusion are no longer considered properly attributable to tested income, and thus those taxes are not allowed as a deemed paid credit under section 960.²⁵ In addition, the property used to produce that income does not qualify as specified tangible property and therefore the adjusted basis in the property is not taken into account in determining qualified business asset investment (“QBAI”).²⁶

The election to apply the GILTI high tax exclusion is proposed to be available for taxable years of foreign corporations beginning on or after the date that final regulations are published in the Federal Register.²⁷

B. History of Subpart F High Tax Exception

As noted above, the GILTI high tax exclusion is an implementation of the section 95(b)(4) high tax exception.²⁸ Although section 954(b)(4) has used an objective test based on the rate of foreign tax since 1986, it is the successor to the original exception that was enacted in 1962 to exclude from the subpart F rules income that was earned abroad for valid business reasons. Prior to its amendment in the Tax Reform Act of 1986 (the “1986 Act”), the provision was captioned an “[e]xception for foreign corporations not availed of to reduce taxes” and included a subjective “significant purpose” test. Under this subjective test, income was excluded from subpart F if the taxpayer established to the satisfaction of the Secretary that neither the creation of the CFC that earned the income nor the effecting of the transaction giving rise to the income had as “one of its significant purposes” a substantial reduction of taxes. Even though the statutory language was not explicitly elective, it effectively was elective in that it did not apply unless the taxpayer decided to establish, to the satisfaction of the Secretary, that a portion of a CFC's income was high-taxed, which the taxpayer was under no obligation to do.

Section 954(b)(4) was then revised and took its current form in 1986. The legislative history to the 1986 Act explained the shift of section 954(b)(4) from a subjective “substantial purpose” test to an objective test:

The committee intends, by making the operation of this rule more certain, to ensure that it can be used more easily than the subjective test of present law. This is important because it lends flexibility to the committee's general broadening of the categories of income that are subject in the first instance to current tax under subpart F. The committee's judgment is that because moveable income could often be as easily earned through a U.S. corporation as a foreign corporation, a U.S. taxpayer's use of a foreign corporation to earn that income may be motivated primarily by tax considerations. If, however, in a particular case no U.S. tax advantage is gained by routing income through a foreign corporation, then the basic premise of subpart F taxation is not met, and there is little reason to impose the subpart F tax. Thus, since the scope of transactions subject to subpart F will be broadened, and may sweep in a greater number of non-tax motivated transactions, the committee expects that the flexibility provided by a readily applicable exception for such transactions will become a substantially more important element of the subpart F system.²⁹

Although the amended statutory text of section 954(b)(4) does not expressly reference an election, the Bluebook for the 1986 Act confirms that the provision “was intended to apply solely at the taxpayer's election,”³⁰ and thus was a continuation of the practice under section 954(b)(4) as it had been applied prior to the adoption of the objective test in 1986. The Bluebook for the 1986 Act further confirms this elective approach, noting that “[t]he Secretary may not apply the provision without the taxpayer's consent.”³¹

Consistent with this legislative history and the operation of its predecessor, the regulations promulgated under section 954(b)(4) permit taxpayers to elect whether to apply the subpart F high tax exception, and to do so on an item of income-by-item of income basis.³² The preamble to those proposed regulations noted, "[t]o minimize the additional administrative burdens imposed by these rules, they rely to the greatest extent possible on calculations already required for purposes of the foreign tax credit limitation under section 904.”³³ Similarly, the preamble to the final regulations under section 954(b)(4), published in 1995, notes that Treasury and the IRS sought to avoid “undue complexity” in designing rules for the subpart F high tax exception, including by relying on computations already required by other provisions of the Code.³⁴

II. General Recommended Approach: Conformity with Subpart F

As a general approach, we respectfully request that the Proposed Regulations be revised to more closely conform the GILTI high tax exclusion to the subpart F high tax exception of section 954(b)(4) when the Proposed Regulations are finalized. As discussed in the Preamble, the Proposed Regulations provide that income is excluded from tested income under the GILTI high tax exclusion if it meets the terms of section 954(b)(4). Consistent with the operation of section 954(b)(4), and its implementing regulations, we respectfully request that, when the GILTI high tax exclusion is finalized, the Proposed Regulations be modified to provide a similar approach regarding the flexibility available for taxpayers making the election.

Conforming the GILTI high tax exclusion to the existing subpart F high tax exception would preserve a single set of integrated rules that mitigates substantially the incentives for planning that would otherwise affect the manner in which taxpayers' foreign business operations are conducted. If the GILTI high tax exclusion is more restrictive than the subpart F high tax exception, the rules will continue to provide an incentive to restructure CFC operations in order to plan into subpart F, thus encouraging activity the Proposed Regulations were intended to address, including “restructuring [that] may be unduly costly and only available to certain taxpayers,” and the predominance of tax over business considerations in determining business structures which may “lead to higher compliance costs and inefficient investment.”³⁵

Most importantly, adopting rules for the GILTI high tax exclusion that conform to the existing rules for the subpart F high tax exception would not only be consistent with the intent of Congress when it amended section 954(b)(4), but it would also give effect to the policy choices made by Congress in the TCJA. Before the TCJA's enactment, foreign income was divided into favored income (generally active income, the taxation of which was deferred until repatriation) and disfavored income (generally subpart F, which was subject to immediate taxation). Subpart F sometimes operated by defining a broad category of suspect income and then providing exceptions for certain favored income in order to identify the appropriate scope of income that was disfavored and thus subject to the subpart F regime. For instance, while rents and royalties were generally considered foreign personal holding company income,³⁶ the active rents and royalties exception provided that certain rents and royalties derived in the conduct of a trade or business were excluded from subpart F income.³⁷

The TCJA revised the international tax system from one with either subpart F or deferred income to a new system where all income is either immediately subject to tax or exempt. The new category of exempt income is, in the first instance, comprised of a routine return on tangible assets (i.e., net deemed tangible income return).³⁸ In addition, Congress specifically carved out foreign oil and gas extraction income (which is typically high-taxed) from GILTI, placing it instead in the exempt category.³⁹ The final category of exempt income is high- taxed income that taxpayers have elected to exclude under section 954(b)(4).⁴⁰ Moreover, “taxable” foreign income is further subdivided into subpart F income (taxed at 21 percent with a full foreign tax credit) and GILTI (taxed at 10.5 percent with a significantly restricted foreign tax credit). Thus, the post-TCJA system now has three categories of foreign income: subpart F, GILTI, and exempt. While the TCJA retained the subpart F rules nearly unchanged, Congress generally shifted deferred (favored) income to GILTI.

Treating income excluded from subpart F by reason of section 954(b)(4) as exempt represents a conspicuous policy choice by Congress. Subpart F includes a number of exceptions, including the active rents and royalties exception, the exceptions for certain related party income in section 954(c)(3), and the look-thru rule for related CFCs in section 954(c)(6). These categories, as well as all other deferred income, were treated consistently under the TJCA and became tested income that is subject to the GILTI rules under the new system. However, Congress treated income excluded by reason of section 954(b)(4) differently than other deferred income, including income under every other exception from subpart F income. High-taxed income was instead treated as exempt. Moreover, this treatment presumably was intended to provide the same flexibility of section 954(b)(4) and the accompanying regulations, as the TCJA adopted section 954(b)(4) as the measure of high-taxed income without modification.

Thus, each taxpayer was given the election whether to leave high-taxed income as taxable income and benefit from applying the associated foreign tax credits against the taxpayer's other GILTI, or instead to exclude it and receive the resulting benefits (and offsetting detriments, discussed below).

The following sections discuss individual aspects where the GILTI high tax exclusion is more restrictive than the subpart F high tax exception and the advantages to conforming the former to the latter in each instance.

III. Five-Year Limitation on Subsequent Elections and Revocations

The Proposed Regulations generally provide that, if a taxpayer revokes an election to apply the GILTI high tax exclusion, the taxpayer cannot make the election again for five years — the lock-out rule — and any subsequent election cannot be revoked for another five years — the lock-in rule. We respectfully request that, consistent with the rules of the subpart F exception, the election be made on an annual basis.

Eliminating the five-year limitation on subsequent elections and revocations would maintain consistency with the subpart F high tax exception and the long history of current section 954(b)(4) and its predecessor provision, which have never contained a lock-in or lock-out rule since their inception in 1962.

This flexibility is also critical to ensure that the election in the Proposed Regulations provides its intended relief. As with the subpart F high tax exception post-TCJA, in any given year, the election to apply the GILTI high tax exclusion could either help or harm a taxpayer. In the case of subpart F income, a taxpayer may benefit more from either the ability to cross-credit excess foreign tax credits or exempt the underlying income. In any given year, taxpayers are permitted to elect whichever of those two alternatives is more effective, including doing so with respect to only a portion of the CFCs' high-taxed income. Most importantly, taxpayers are permitted to assess the relative impact of either approach at the end of the year and only at that time decide to what extent to make the election. Because this is an annual election, a decision in one year does not bind a taxpayer in subsequent years as the election in a later year could be detrimental to the taxpayer. These considerations are even more relevant in the case of GILTI, given its scope and the fact that the potential negative consequences of the GILTI high tax exclusion are broader. The exclusion of high-taxed income from tested income not only results in the loss of excess foreign tax credits but also has other collateral effects such as the loss of QBAI and the related exempt return on the assets producing the high-taxed income. Thus, a taxpayer may benefit or be worse off applying this relief provision. The five-year limitation of the Proposed Regulations thus can lock taxpayers into an election that harms them in future years. And because of the magnitude of GILTI income for most taxpayers, especially when compared to subpart F income, the harm could be significant and could occur in each of the four remaining years under the lock-in rule.

This makes projecting the impact of the GILTI high tax exclusion in future years crucial to the initial decision of whether to make the election. Even a taxpayer who may benefit from the election in a particular year may decide not to make it if they project significant cost, or even the potential for significant cost, to the election in future years. To the extent there is uncertainty about the future impact, this will itself decrease the number of taxpayers that can make the election as even taxpayers that would have actually benefitted from the provision may well forego this relief unless there is a sufficient level of certainty concerning any downside risk in future years.

Further, the task of quantifying the benefit — and offsetting costs — of the election is formidable, especially when combined with the all-or-nothing rule of the Proposed Regulations. To begin, taxpayers are not simply deciding whether to make the election at the end of a taxable year, but instead must predict their tax circumstances for the succeeding four taxable years. Relevant tax attributes that must be projected include the amount of taxable income, foreign income taxes, and QBAI, each of which must be projected at the level of the QBU. Of course, these attributes vary each year, as the taxpayer's business results and the tax environment fluctuate. The Proposed Regulations thus impose a significant burden on taxpayers, requiring them to conduct a predictive exercise annually across a five-year period and to do so at the granular QBU-by-QBU level.⁴¹ While businesses often project operating results, these projections are always speculative, and are not made on a QBU-by-QBU basis.

The projections necessary for assessing whether to make an election also introduce significant challenges. Not only must taxpayers project the performance of all of their QBUs over the five-year period, they also need to assess the likelihood of any extraordinary transactions, such as the acquisition or disposition of any foreign operations, as these nonrecurring transactions may dramatically shift the costs and benefits of an election. Moreover, in addition to the challenge of predicting these types of major corporate events, acquisitions necessarily entail including operations in the projections without any of the information necessary to perform this exercise. In practical terms, it is not enough for taxpayers to predict an acquisition three or four years in the future (which they cannot do), they would need the same granular detail about the target's foreign operations as they have on their own operations, and this is information that only the target would have. And if the target is a foreign company, then it will have never performed any of these projections itself; thus, not only can the U.S. acquiror not predict the impact of an election over the five-year term, even the target could not.

And, as challenging as predicting business results are for companies, it at least is something they have experience with, although never in the detail required here or on a QBU-by-QBU basis. But projecting the impact of an election also requires taxpayers to predict changes in foreign tax law, and to do so at a particularly dynamic period in the level of taxation on foreign operations given a number of trends evolving around the globe. Assessing the risk of future tax law changes is not something that is generally within the competence of a company to undertake. Nevertheless, taxpayers would be tasked with assessing the likelihood of such foreign tax law changes over the next five years. If the foreign tax rate on a particular QBU rises, a QBU that did not meet the effective rate test when the election was made may become subject to the GILTI high tax exclusion in later years. Conversely, if a tax rate falls, the income of a QBU that was excluded by the GILTI high tax exclusion when the election was made may no longer be excluded in subsequent years. And foreign tax law changes other than a change in the statutory tax rate may produce the same results, for example if a foreign country imposes new limits on interest deductibility or changes its net operating loss rules in a way that increases the effective rate of tax on the QBU's income.⁴²

Fortunately, we have not identified any potential for abuse that would suggest a need for restrictions on a taxpayer's ability to elect or revoke the election. There are two broad categories of elections. Some elections are freely available every year. Electing between the standard deduction and itemized deductions is one example of an annual election with no restrictions on a taxpayer's ability to change from year to year. This can be contrasted with a second class of elections that are appropriately subject to limitation, because an unrestricted election would provide taxpayers with benefits that are unrelated to the policy that supported providing relief on an elective basis, or because the election imposes burdens on the government in administering the law.

An example is the check-the-box election regime, the entity classification regulations that permit most legal entities to elect to be treated as either a corporation or a pass-through entity. The purpose of the regulations was to provide elective entity classification and eliminate the cumbersome rules of the prior law four factor approach, but the rules also gave taxpayers the ability to effect significant corporate transactions, such as liquidations, through a check-the-box election that may present planning opportunities in certain cases. While an unfettered election may provide too much flexibility to taxpayers, the underlying purpose of the election — simplification of entity classification — could be achieved even if taxpayers are limited in the frequency with which they can change their election. Thus the regulations include a limitation targeted to restricting planning opportunities that also preserves the purpose of the rule: taxpayers can freely make an entity classification election at any time, but then have a 60-month waiting period before the classification can be changed.⁴³

By contrast, the flexibility under the existing section 954(b)(4) rules is at least as appropriate for the new context of GILTI as it was when the current subpart F high tax exception rules were enacted. First, unlike a check-the-box election, an annual election does not provide unrelated tax planning opportunities, it simply allows taxpayers the ability to make the election at a time when the information to assess the impact is available, and thus avoids taxpayers projecting future income and law changes, analysis that they do not perform for any other U.S. tax purpose. Further, when section 954(b)(4) was amended in the 1986 Act to be more easily used by taxpayers, the concern was that the expansion in the scope of subpart F income presented the danger that the expansion “may sweep in a greater number of non-tax motivated transactions,” creating conditions under which taxpayers would need relief through the subpart F high tax exception; this danger is significantly greater in the case of GILTI.⁴⁴

Thus, flexibility in the GILTI context is even more important for taxpayers and several aspects of the GILTI regime should mean that flexibility here is even less of a concern than in the case of subpart F income. In 1986, when the current form of section 954(b)(4) was enacted, the high tax exception simply permitted taxpayers to either include high-taxed income, and the foreign tax credits that could be cross-credited against low-taxed foreign source income, immediately or defer that cross-crediting benefit to a future year, presumably because they did not need excess credits in the current year. Post-TCJA, a section 954(b)(4) election imposes actual costs on taxpayers, as the election does not simply provide flexibility for when a taxpayer decides to use the excess credits from high-taxed income, but instead those excess credits are lost as the income becomes exempt. Electing the GILTI high tax exclusion has additional detrimental consequences when compared to electing section 954(b)(4) in the subpart F context. These collateral consequences effectively serve as a counterbalance to the benefits that taxpayers can obtain from the election and thus mitigate the opportunities for tax planning.

Excluding income under the GILTI high tax exclusion results not only in a loss of foreign tax credits properly attributable to such income, it also reduces the taxpayer's QBAI. In addition, taxpayers are generally allowed foreign tax credits for withholding taxes imposed on distributions on foreign earnings that were previously included in income as GILTI. However, if a taxpayer applies the GILTI high tax exclusion to such earnings, those earnings are instead treated as exempt and no foreign tax credit is allowed for any withholding or other taxes that are imposed when the exempt earnings are distributed.⁴⁵

There are also second-order collateral consequences as well.⁴⁶ Where a single CFC contains multiple QBUs, the exclusion of one or more high-taxed QBUs can cause the entire CFC to become a tested loss CFC. Consider a single CFC with three QBUs: one profitable and high- taxed, one low-taxed but profitable, and the third running a loss. If the high-taxed QBU is excluded and the two remaining QBUs cumulatively have a loss, the CFC will become a tested loss CFC by reason of the GILTI high tax exclusion. Thus, applying the high tax exclusion will cause the taxpayer to not only forfeit foreign tax credits and QBAI with respect to the excluded QBU, but also the foreign taxes and QBAI attributable to the remaining QBUs.

Finally, and in addition to these collateral consequences, the benefits from the GILTI high tax exclusion are diffuse and therefore the election is not easily susceptible to tax planning. First, the primary benefit of the GILTI high tax exclusion is a reduced cost from the allocation of expenses of the U.S. members of a multinational global group to the group's foreign operations. Accordingly, the operation of the rules results in any tax planning with respect to any specific CFC or QBU being limited as it likely forms a small portion of any multinational's global operations. And even then, tax planning options to “create” high-taxed income are limited. Simply increasing foreign taxes imposes an actual cash cost to the taxpayer, which is not offset by the resulting foreign tax credit as the election generally makes sense only for a taxpayer that is in an excess credit position in the GILTI basket, and that cost will almost always be greater than any expense allocation benefit Even efforts to shift foreign taxes between periods may provide a benefit in one year at the expense of other years. And in all these cases, the diffuse impact of any planning with respect to one QBU when spread across the group's global operations significantly limits the ability of taxpayers to inappropriately plan into the exclusion.

The flexibility for taxpayers to decide whether to exclude high-taxed income on an annual basis is fundamental to how the section 954(b)(4) election has operated for the past 60 years. Additional flexibility simply allows taxpayers to mitigate the impact of expense allocation on high-taxed income, and high-taxed income, of course, was never the target of the GILTI rules. Thus, allowing flexibility in the election is not at odds with, but instead fully consistent with, the policies of the GILTI high tax exclusion. Allowing relief for high-taxed income to be applied at the taxpayer's election on an annual basis ensures that taxpayers are never worse off in a future taxable year simply from having high-taxed income. Instead, taxpayers should be permitted to make the election at a time when they will have the necessary information, and avoid the burden of projecting the future income, foreign taxes, and QBAI of the group's worldwide operations for a five-year period, consistent with the policy that supports the election in the first instance.

IV. The All-or-Nothing Rule

The Proposed Regulations provide that an election to apply the GILTI high tax exclusion applies to all high-taxed income of every CFC in the same group of commonly controlled CFCs. Taxpayers thus are given a choice between excluding all of their high-taxed tested income or none of it. We respectfully request that this all-or-nothing rule be modified consistent with the subpart F high tax exception, so that taxpayers are allowed to elect on an annual basis which high-taxed items of income to exclude.

For the past 33 years, taxpayers have been permitted to make the election under section 954(b)(4) separately on an item-by-item basis. Even before that, since 1962 under the original subpart F high tax exception, taxpayers were permitted, but not required, to show that a particular item of income qualified for the exception. This approach is also consistent with the competing considerations reflected in the TCJA's revisions to the international tax system and would significantly reduce the compliance burdens required for taxpayers that would like to use the election.

First, the revisions to the international tax rules departed from similar reform efforts by other countries in recent years. Rather than moving to a traditional territorial tax system, like Japan or the UK, the TCJA adopted a modified approach. One significant component of that approach was the GILTI regime to ensure taxation of low-taxed foreign income and reduce the incentives to shift income outside the United States when compared to a more traditional exemption-based territorial tax system. A second aspect of the TCJA was a decision to allow taxpayers to offset residual tax on that low-taxed income with excess foreign tax credits from high-taxed foreign income. But this reliance on the foreign tax credit to eliminate double taxation also preserved the impact of expense allocation, albeit only for taxpayers whose overall effective tax rate on their foreign operations exceeded 13.125 percent. Although the rules generally use the foreign tax credit to avoid double taxation, the statute also excepted high-taxed subpart F income from GILTI, and thus from the impact of expense allocation. This exception is applied on an item of income-by-item of income basis allowing taxpayers to retain excess credits as needed, and then to exempt other income and avoid the impact of expense allocation. Adopting a similar degree of flexibility for the GILTI high tax exclusion would provide similar results and thus balance these two structural features of the TCJA. Taxpayers would be permitted to use excess credits on high-taxed tested income to eliminate the residual tax on their low-taxed tested income. And to that extent, the impact of expense allocation would apply. But beyond that, applying the GILTI high tax exclusion more flexibly would allow those taxpayers to mitigate the unexpected consequences of expense allocation in precisely the same manner the TCJA provides in the case of high-taxed subpart F income.

Moreover, for the reasons discussed in Section III, a flexible election is both important for taxpayers and provides more safeguards than in the case of subpart F income. Flexibility is necessary to ensure that taxpayers, across an array of circumstances, can avail themselves of relief with respect to their high-taxed income. This is due to several negative consequences of excluding high-taxed income from tested income, including the loss of QBAI and foreign tax credits, which do not similarly apply in the subpart F context. Taxpayers cannot mitigate those consequences unless they can designate which high-taxed income to exclude. Especially when coupled with the five-year limitation discussed above, an all-or-nothing rule will limit the number of taxpayers that can avail themselves of the GILTI high tax exclusion, significantly diminishing the relief from expense allocation offered by the Proposed Regulations. On the other hand, the planning opportunities for taxpayers from a more flexible election are already limited by the diffuse nature of the benefit and the negative collateral consequences that offset that benefit. In light of these limitations, further restrictions on taxpayer flexibility, including the all-or-nothing rule, should not be necessary.

In addition to these policy considerations, there are practical concerns to be considered as well. Imposing an all-or-nothing approach across a controlled group, or even a single U.S. shareholder, exponentially increases the compliance burden. In analyzing the effect of the election, and whether to make it, taxpayers must engage in a resource-intensive, multi-step analysis, involving an array of tasks and computations, most of which are not required for any other U.S. tax purpose. As discussed above, taxpayers must first identify every QBU in the global group. This alone is a complicated, fact-based determination involving issues for which there is limited guidance under existing law. Second, taxpayers must identify and allocate all tax items (income, gain, loss, and deductions) attributable to each QBU. Third, taxpayers must determine which taxes are “properly attributable” to a specific QBU as opposed to a CFC, and then also compute the effective tax rate for each QBU. Fourth, taxpayers must allocate QBAI among the QBUs of a CFC, including cases in which tangible business assets may be shared between QBUs, in order to determine what QBAI will be removed from the computation of deemed tangible income return if the QBU is high-taxed.

This all-or-nothing approach requires that taxpayers engage in this QBU-level analysis for every single QBU across their entire global operations, regardless of the size of the QBU or the CFC in which it resides, and regardless of the local marginal tax rate, as even jurisdictions with very low tax rates may nonetheless have high foreign effective tax rates in any given period due to differences in U.S. and foreign tax systems.⁴⁷ This analysis is necessary even in the simple case of a single CFC with two QBUs in the same country that is subject to the same foreign income tax rate with respect to all of its income, as illustrated in an example in Appendix A to this letter. In that example, due to differing accounting rules between the U.S. and the foreign country, one QBU has an effective tax rate that is higher than 18.9 percent and the other QBU has an effective tax rate that is lower (even though the differences otherwise offset each other such that there is no effect on the CFC's overall foreign effective tax rate). In order to determine which QBUs would be excluded under the GILTI high tax exclusion, taxpayers must conduct the multi-step analysis discussed above for each QBU, even if it may seem from a high- level examination of statutory tax rates or book income that the particular QBU would not meet the effective rate test.

By contrast, if the GILTI high tax exclusion were not subject to the all-or-nothing rule, a taxpayer could make targeted decisions about what income to examine and potentially exclude, expending the resources to conduct this analysis only to the extent necessary to obtain a reasonable level of relief. Similarly, in auditing a taxpayer that has elected to apply the GILTI high tax exclusion, the government would only need to examine the income that a taxpayer designated as being subject to the election, rather than poring through data for every single one of a U.S. multinational's CFCs and QBUs.

Thus, moving from an all-or-nothing rule to the flexible approach of the subpart F high tax exception would be fully consistent with the structural approach of the TCJA, allow more taxpayers to avail themselves of the relief offered by the GILTI high tax exclusion, and greatly reduce the burdens faced by taxpayers in determining the effect of a potential election.

V. Application of the Exclusion on a QBU-by-QBU Basis

The Proposed Regulations provide that the effective rate test for the GILTI high tax exclusion is applied by treating all items of tested income attributable to a QBU as a single item of income. Treasury and the IRS have explained that a motivation in proposing this QBU-level approach rather than calculating foreign effecting income tax rates at the CFC-level was to avoid “inappropriate tax planning, such as combining operations subject to different rates of tax into a single CFC.”⁴⁷ While we understand this concern, we respectfully request Treasury and the IRS consider alternations to this QBU-level determination in order to simplify its operation and mitigate its administrative burden, especially in light of the interaction with the five-year limitations and all-or-nothing rule discussed above. Specifically, given the significance of the administrative burdens, we request that the final regulations shift the approach and apply on a CFC-by-CFC basis, or alternatively, if a CFC-by-CFC approach is not adopted, we respectfully request that one or more rules be adopted to mitigate the burden of a QBU-by-QBU approach.

The policy concerns about inappropriate tax planning should be balanced against the significant administrative burden imposed by a QBU-by-QBU approach, in order to implement the GILTI regime in a manner that reaches the right result without unduly burdening taxpayers who seek to comply with the rules. In many instances, the reduction of administrative burdens may not represent a compelling reason for adopting a particular rule. Here, though, given the specific concerns identified below, a QBU-by-QBU determination would impose administrative and compliance burdens on taxpayers to an extent that they may not realistically be able to meet.

First, taxpayers are not required to conduct this type of QBU-level analysis for any other U.S. tax purpose. Accordingly, taxpayers may lack the systems, data, or personnel to do so. By contrast, a CFC-level computation can be accomplished using the same information and analysis that is already required under the GILTI rules and thus avoids imposing a new burden on taxpayers.

Second, a QBU-by-QBU approach does not simply change the level at which the analysis is performed, it adds an additional (and significantly more complicated) level to the analysis. The GILTI high tax exclusion analysis cannot take place solely at the level of the QBU. Rather, taxpayers must also aggregate up from the QBU level to the CFC level to determine the effect that excluding one or more QBUs has on the remaining income of the CFC. For example, and as discussed above, excluding a profitable, high-taxed QBU may result in a tested loss for the remainder of the CFC, a result that can only be determined through conducting analysis at both the QBU and CFC levels.

Third, a QBU-level analysis would have a larger number of collateral consequences that make it particularly difficult to apply when coupled with the all-or-nothing consistency rule and the five-year limitation on subsequent elections and revocations. As discussed in Section IV, above, combining an all-or-nothing rule with a QBU-by-QBU approach significantly increases the administrative and compliance costs of the GILTI high tax exclusion. Taxpayers would be required to separate the income, taxes, and assets of every QBU they own, regardless of the size of the QBU or the CFC to which it belongs and regardless of the local tax rate that generally applies. Again, this analysis and the related calculations are processes that taxpayers are not currently required to perform for any other tax purpose.

Fourth, the added complexity from a QBU-level analysis is especially burdensome when combined with the five-year limitation that will require taxpayers to project their future tax circumstances when deciding whether to make or revoke the election.

As an additional consideration, the QBU concept was not designed for this purpose and, as such, may require modification for this new context, as recognized in the Preamble.⁴⁹ Any such modification would produce rules that, by definition, would apply only for the single purpose of the GILTI high tax exclusion. For example, if a different definition of QBU were applied, taxpayers would need to reevaluate all of their foreign operations to determine which operations constitute a QBU under this new definition. In addition, taxpayers may have difficulty, and would certainly incur added costs, if certain payments that are generally disregarded for U.S. income tax purposes are regarded for purposes of the effective rate test. While adopting existing QBU rules whole cloth may be ill-suited for particular aspects of the GILTI high tax exclusion, crafting modified QBU rules for this one purpose may be inefficient and impose additional burdens on taxpayers.

The burdens identified above would also impact the government in administering the GILTI high tax exclusion. Treasury and the IRS would potentially need to write new regulations to adapt the QBU rules for this particular purpose, and, going forward, the IRS, if it intends to ensure the GILTI high tax exclusion is used appropriately, would be faced with requesting and analyzing exponentially more data in audits, in order to determine the effective tax rate of each QBU and the amount of QBAI of each excluded QBU, in addition to engaging in the highly fact- specific inquiry into whether particular operations rise to the level of a QBU.

The burdens imposed by a QBU-by-QBU approach could be mitigated in different ways. Most simply, a CFC-level approach would allow taxpayers to take advantage of data and calculations that are already being produced for purposes of other tax provisions. Alternatively, while many of the complexities identified above would still remain, allowing taxpayers an election to aggregate QBUs of a CFC within a single country would allow taxpayers to reduce some of the burden of a separate QBU approach, including significantly reducing the instances when disregarded payments need to be identified and adjustments made when computing the foreign effective tax rate. This same-country aggregation would also reduce the variance that would otherwise occur from an annual computation of an effective tax rate at the QBU-level, especially in the case of individual QBUs with a relatively small amount of income. Differences in the business cycle and differences in U.S. and foreign taxation can produce fluctuation in the effective tax rate across different taxable years of a single QBU. Applying the effective tax rate computation across a broader set of operations, along with increasing the likelihood of offsetting items, may ameliorate these variations.

In addition, one or more simplifying rules could be adopted. Under a de minimis rule, at a taxpayer's election, CFCs with income below a threshold level could be treated as a single QBU. Another de minimis rule could, at a taxpayer's election, aggregate QBUs that have a small amount of tested income (measured either in absolute terms or as a percentage of the CFC's tested income) within the same CFC. Either of these simplifying rules could reduce the number of QBUs that need to be analyzed in detail, reducing burdens to taxpayers and the government significantly, while producing only negligible effects on a taxpayer's overall tax picture.

VI. Retroactive Effectiveness

The Proposed Regulations propose to allow taxpayers to elect to apply the GILTI high tax exclusion to taxable years of foreign corporations beginning on or after the date that final regulations are published in the Federal Register. We respectfully request that the election to apply the GILTI high tax exclusion instead be available retroactively to the effective date of section 951A.

As an initial matter, the policies cited in the Preamble as supporting the proposed GILTI high tax exclusion are equally applicable to earlier periods and thus the policy justifications for creating an elective GILTI high tax exclusion fully support making it available retroactively to the 2018 taxable year to which GILTI first applied. Because the GILTI high tax exclusion is by its terms elective, the Proposed Regulations can be applied retroactively without negative impact on any taxpayer. Moreover, retroactivity is expressly permitted by section 7805(b)(7).

Applying the Proposed Regulations retroactively also should not add to the administrative burden of either taxpayers or the government. Retroactive application will be elective and thus there will be a burden on taxpayers only in situations where taxpayers affirmatively decide to avail themselves of such relief. Further, taxpayers already routinely weigh the benefits of filing an amended return with the administrative burden of doing so. And from the government's perspective, there should be little or no increase in the number of taxpayers filing amended returns for the 2018 taxable year in order to apply the GILTI high tax exclusion for that year because it is already the case that many (and potentially all) of the taxpayers affected by the rule will be required to file amended returns for 2018 for other reasons, including due to section 905(c) and foreign tax redeterminations.

In any event, but especially if retroactive application is not permitted, unresolved questions regarding effective tax rate calculations should not delay finalization of the GILTI high tax exclusion. To the extent the Proposed Regulations' new approach of calculating effective tax rates at the QBU-level surfaces new unresolved questions, such as how to define a QBU for this purpose and how to treat disregarded payments between QBUs, this is a further reason not to adopt a QBU-level approach.

* * * * *

We appreciate the opportunity to submit these comments for your consideration, and would welcome the opportunity to discuss this submission at your convenience.

Sincerely,

Michael J. Caballero
Covington
Washington, DC

cc:
U.S. Department of the Treasury

Lafayette “Chip” G. Harter III, Deputy Assistant Secretary (International Tax Affairs)

Douglas L. Poms, International Tax Counsel

Wade Sutton, Senior Counsel, Office of International Tax Counsel

Jason Yen, Attorney-Advisor, Office of International Tax Counsel

Internal Revenue Service

William M. Paul, Deputy Chief Counsel (Technical)

Drita Tonuzi, Deputy Chief Counsel (Operations)

Peter Blessing, Associate Chief Counsel (International)

Daniel M. McCall, Deputy Associate Chief Counsel (International — Technical)

Jeffery G. Mitchell, Branch Chief, Office of Associate Chief Counsel (International)

Jorge M. Oben, Office of Associate Chief Counsel (International)

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Appendix A

In this example, a CFC has two QBUs in the same country, each subject to foreign tax at a rate of 30 percent. For both U.S. and foreign tax purposes, the income of the CFC is 150. However, the income of each QBU is different for U.S. and foreign tax purposes, for example, due to differing tax accounting rules for U.S. and foreign tax purposes, even though in the example the amount of these differences offset each other. While QBU 1 has income of 50 for foreign purposes, its income for U.S. tax purposes is 100. Conversely, QBU 2 has income of 100 for foreign tax purposes, but income of 50 for U.S. tax purposes.

The effective foreign income tax rate is calculated by comparing the amount of foreign income taxes paid by the QBU — which is a function of the QBU's income for foreign income tax purposes — to the amount of income of the QBU as determined under U.S tax principles. QBU 1 thus has a foreign effective tax rate of 15 percent, calculated by dividing 15 in foreign taxes by 100 in income. QBU 2 has a foreign effective tax rate of 60 percent, calculated by dividing 30 in foreign taxes by 50 in income.

Therefore, even though the CFC is subject to foreign tax at a rate of well over 18.9 percent, the GILTI high tax exclusion excludes only the income (and QBAI, etc.) of QBU 2, not QBU 1. In order to identify this result, the taxpayer must, regardless of the size of the CFC and the local tax rate, separate all of its QBUs and compute the foreign effective tax rate of each individually.