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Economic Analysis: A New GILTI Spreadsheet for Policy and Planning

Posted on July 29, 2019

Imagine some smart, upstart member of Congress proposing to repeal the new international provisions, replacing them with a flat 5 percent tax on all foreign profits from active business activities. No bells, whistles, or foreign tax credits included. And then imagine this tax as a stopgap measure left in place as an alternative to our current taxation of global intangible low-taxed income until some rational minimum tax on foreign profits can be enacted. And talk about good timing. Right now the OECD, with substantial input from the Treasury Department, is working on just such a tax.

But, you say, such a flat tax would be rough justice that is too rough. U.S. multinationals would still have considerable incentive to shift investment and profits into tax havens. And while some multinationals would be provided with undue relief, other U.S. multinationals that are paying high foreign taxes would unjustifiably be subject to double tax.

Your objections are well taken. Unfortunately, they also apply to the current system. Under current law, investment in a tax haven can still attract zero U.S. tax (through the wonders of cross-crediting), while some high-taxed U.S. multinationals can be subject to additional U.S. tax (through heavy-handed expense allocation rules that squeeze the FTC limitation and subject the allocated expenses of high-foreign-tax U.S. multinationals to a 21 percent tax).

So given the low standard set by current law, our hypothetical flat tax on foreign profit may not be so objectionable under the usual efficiency rationales. This leaves administrative and compliance issues as criteria for policy assessment. Here, the foreign flat tax shines. It is as breathtakingly simple as our current international tax rules are complex. That complexity is absurd, but it might be acceptable if it fine-tuned some lofty policy objective. But no, while seemingly providing the precision of a guided missile, it really is just driving us around town in bewildering circles, arbitrarily dropping us off in unexpected places.

Back to reality. Forget about the foreign flat tax or any alternative to current law. You are unlikely to obtain relief from Congress soon. So in the meantime, we provide a spreadsheet as a tool to help with the complexity. It doesn’t have the detail that commercially available models provide. It doesn’t have the detail necessary for real-world tax planning. But perhaps it can help tax policymakers and tax planners better understand the basics of taxing GILTI as they take on the unavoidable monumental tasks before them. Policymakers eventually must fix GILTI. Planners have no choice but to deal with it. (The GILTI 2.0 July 2019 spreadsheet is available here.)

Figure 1: Simplest Case

Let’s begin by looking at some charts the spreadsheet can produce. Figure 1 depicts the taxation of GILTI that may be familiar to readers. It is the plain-vanilla case in which a controlled foreign corporation has no tangible capital and no expenses are allocated to the GILTI category. (In the worksheet, see the “Charts” tab to produce the calculations underlying the four figures discussed here.)

The effective U.S. and combined (U.S. plus foreign) tax rates are on the vertical axis. The average foreign tax rate on CFC income is on the horizontal axis. The two lines shown are kinked when the average foreign rate is 13.125 percent. Below this rate, a taxpayer is below the FTC limit (an excess-limit position). Above this tax rate, the taxpayer is subject to the FTC limit (an excess-credit position). The rate where the kink occurs — the rate that divides excess limit from excess credit, which will change a lot depending on conditions — is referred to here as the crossover rate.

In Figure 1, the maximum effective rate of U.S. tax is 10.5 percent when the foreign rate is zero. For the excess-limit taxpayer to the left of the crossover rate, U.S. tax declines by 80 cents for every additional dollar of foreign tax. In other words, using the terminology of professor Daniel Shaviro of New York University Law School, the marginal reimbursement rate (MRR) is 80 percent. In the diagram, the MRR is depicted by the -0.8 slope of the line. The U.S. effective tax rate continues its decline until it reaches the crossover rate of 13.125 percent, where its value is zero.

The crossover rate is a key point of reference because, as under prior law, the incentives for investment and tax planning for excess-credit taxpayers can be vastly different than those for excess-limit taxpayers. For example, as the spreadsheet calculations show, the incentive to invest in low-tax countries and to shift profit into low-tax countries can be much greater for excess-credit taxpayers than for excess-limit taxpayers.

Figure 1. U.S. and Combined (U.S. plus foreign) Tax Rate of CFC Income,  No Exclusions (from tested income), No QBAI, and No Allocated Expenses

Excess-credit taxpayers are in effect on a territorial system. FTCs are not available to provide relief against high foreign taxes. Each dollar of allocated expense raises U.S. tax by 21 cents. The MRR equals 0 percent. Excess-credit taxpayers are far more common than under prior law because the statutory corporate tax was cut from 35 percent to 21 percent and the effective rate of U.S. tax on foreign active income in the GILTI category is further cut in half to 10.5 percent (if the 50 percent section 250 deduction is not limited).

Excess-limit taxpayers are U.S. minimum taxpayers. Assuming the section 250 deduction isn’t limited, the maximum effective U.S. minimum tax rate is 10.5 percent. Unlike prior law, and unlike income in the other three FTC baskets in current law (passive, branch, and general), the MRR is not 100 percent, but is equal to 80 percent or, depending on circumstances, less.

Figure 2: Allocate Expenses

Under prior and current law, expenses incurred in the United States (for which foreign governments will not provide deductions) are allocated to foreign-source income in the calculation of the FTC limit. Figure 2 shows what happens when U.S.-incurred expenses — like those for interest, administration, and research — are allocated to the GILTI basket. The allocation shrinks the FTC limitation. The crossover rate shifts to the left. This means that taxpayers can be in excess-credit positions even when their average foreign tax rate on GILTI is in single digits. It also means that as long as there is any allocated expense, U.S. residual tax on foreign profit will be due, no matter how high the average foreign tax rate may be. For the taxpayers with an average foreign tax rate below the crossover rate, expense allocation has no effect.

Figure 2. The Effect of Allocating Expenses to the GILTI Basket

Figure 3: Increase Tangible Capital

Only CFC income that exceeds qualified business activity income (less specified interest, which we will ignore here) is GILTI that is subject to U.S. tax. QBAI is equal to 10 percent of basis on tangible capital that is used in the generation of tested income. (Here, before-tax tested income is equal to CFC before-tax income, with the assumption that none of the five statutory exceptions to tested income apply to CFC income.) The reduction of taxable income attributable to QBAI affects before-credit U.S. tax liability. It also reduces what is called the inclusion percentage, which is equal to 1 minus the ratio of QBAI to tested income.

Under current law creditable, deemed paid taxes in the GILTI basket are equal to CFC foreign taxes multiplied by 80 percent, multiplied by the inclusion percentage. So increases in QBAI, which reduces the inclusion percentage, also reduce the FTC for excess-limit taxpayers (to the left of the crossover rate). This reduces the MRR below 80 percent and reduces the (absolute value of) the slope of the line in Figure 3.

Figure 3. The Effect of Increasing QBAI

Figure 4: The 20 Percent Haircut

One notable innovation of the Tax Cuts and Jobs Act (also included in an Obama administration proposal for a foreign minimum tax) is the elimination of dollar-for-dollar U.S. compensation (through the provision of FTCs) for foreign taxes paid. Probably inserted into the law for the purpose of raising revenue, it also serves the admirable goal of providing an incentive for U.S. multinationals to minimize foreign taxes. Under section 960(d), this haircut to the FTC is 20 percent (implemented by multiplying creditable, deemed paid tax by 80 percent).

If this percentage were changed, the intercept on the vertical axis would remain unchanged (10.5 percent, if QBAI equals zero), but the slope of the line depicting the U.S. tax rate would move and the crossover rate would move with it. Figure 4 depicts elimination of the haircut, which steepens the slope of the line and reduces the crossover rate. Lawmakers could consider increasing the haircut. This would reduce the slope of the line, reduce the MRR, and increase the crossover rate.

Figure 4. The Effect of Eliminating the 20 Percent “Haircut” of Deemed Paid Foreign Income Taxes

Mechanics

The following description will be too complex for the newcomer to GILTI taxation and too imprecise for the high priests and priestesses of international tax. But if you have come this far, you are probably somewhere in between, and hopefully it doesn’t stray too far in either direction from what is useful to you. This description generally follows the calculations in the sheet under the “EnterValues” tab. The inputs chosen in this tab are also used in the calculations in the “ChartCalc” tab, which in turn is used to produce the diagram shown in the “YourChart” tab. A sample of the calculations from ChartCalc is shown in the table. The calculations needed to determine the taxation of GILTI are here divided into five parts.

1. Calculate foreign tax (easy).

Usually, this will be assumed to be the foreign statutory rate multiplied by before-tax CFC income. If there is more than one CFC, total tax is assumed to be the sum of products of rate times base in each country. Matters could become more complicated, for example, if activities conducted in the United States were moved to a foreign location in an effort to eliminate double taxation (more precisely, double nondeductibility of expenses). But that is an exercise for a future article because deductions for these domestically incurred expenses are effectively denied to excess-credit taxpayers. In our diagrams, the horizontal axis is the average foreign tax rate, so the effect of changes in average foreign tax rate (whether attributable to new foreign investment in jurisdictions above or below the average rate, shifting of foreign profit between jurisdictions through adjustments in transfer pricing, or through other means of foreign tax planning) can be seen by simply moving along the horizontal axis.

2. Calculate GILTI tax before any FTCs (relatively straightforward).

This amount is net (after deductions for costs) income minus net deemed tangible income return (NDTIR) minus a section 250 deduction. NDTIR is a crude proxy for return on tangible capital. It is set equal to 10 percent of the basis of tangible capital minus specified interest. After subtracting NDTIR, corporate shareholders of CFCs (or noncorporate shareholders that elect to be taxed as corporations under section 962) may be able to deduct 50 percent of that amount. For taxpayers that can get the full 50 percent deduction, the effective tax rate becomes 50 percent of 21 percent. But the section 250 deduction is subject to a limit, so if a taxpayer has a loss or net operating loss carryforwards on its U.S. return, the section 250 deduction may be eliminated. Taxpayers that cannot get a section 250 deduction will almost always prefer their CFC income to be taxed as subpart F income.

3. Calculate deemed paid credit (easy).

Because no-tax FTCs should be allowed on exempt income (as a result of NDTIR), the amount of potentially creditable foreign tax is reduced by an inclusion percentage that becomes smaller as NDTIR becomes larger. That reduced amount is then multiplied by 0.8, as required by section 960(d).

4. Calculate the FTC limitation (complex).

In the simpler times before the TCJA, the FTC limitation was basically the U.S. statutory rate multiplied by foreign-source income, where foreign income was generally adjusted downward because interest, research, stewardship, and administrative expenses incurred in the United States were allocated to foreign-source income. Although individual situations vary, the limit generally was less of an issue because the U.S. corporate rate of 35 percent was generally greater than effective foreign rates.

Post-TCJA, most CFC active income is in the GILTI basket. Tax-exempt income arises as a result of the section 250 deduction (when the U.S. shareholder is profitable and has no carryforwards) and as a result of NDTIR (when the CFC has tangible income). Under the regulations, tax exemption that results from the section 250 deduction is treated as tax-exempt income was treated under prior law. Assets related to the generation of tax-exempt income are removed from the numerator and denominator of the allocation fraction (which, multiplied by allocable expenses, yields expenses allocated to that basket).

So, for example, suppose a U.S. parent has 100 of CFC stock and 100 of U.S. assets. If there was no tax-exempt income, the allocation fraction for the GILTI base would be ½. For example, 50 percent of U.S.-incurred interest expense would be allocated to the GILTI basket, reducing foreign-source taxable income by that amount and the FTC limitation by 21 percent of that amount. With a 50 percent section 250 deduction, 50 percent of the CFC stock is removed from the numerator and from the denominator, and the allocation fraction becomes 50/150, equaling ⅓. One-third of allocable expenses are allocated to the GILTI basket. That is what the reg writers provided as partial relief for the onerous effects of FTC limitation expense allocation rules.

To account for the tax exemption that is provided by income sheltered from U.S. tax by NDTIR, the TCJA provides an entirely different mechanism in section 904(d)(4). Expenses allocable to income exempt because of NDTIR are added back to worldwide income in the denominator of all the FTC fractions (and to the numerator of the general basket fraction). To obtain this addback, the expenses related to NDTIR must be calculated. That amount is the product of allocable expense multiplied by a fraction in which the numerator is assets related to the generation of NDTIR and the denominator is total assets (remembering that total assets must exclude assets that are excluded under a section 250 tax exemption).

5. Calculate U.S. tax on GILTI.

With those four building blocks in place, U.S. tax on GILTI (plus the section 78 gross-up) is simply U.S. tax before credits (computed in step 2) less the FTC. The FTC is the minimum of the deemed paid credit (step 3) and the FTC limitation (step 4).

Many details were breezed over here. Rather than asking readers to follow what would only be excruciatingly detailed text, we suggest that those seeking more precision consult the spreadsheet.

A Policy Example

For any given set of input values inserted in the “EnterValues” tab, a base case is created with a figure similar to those appearing with this article. This might be of interest in and of itself, but further insight can be drawn by looking at the effects of changes from this base case. Changes in policy parameters can be computed on a separate sheet (that is, in a separate tab in the worksheet), and the results from the base case and the policy change sheet can be compared. More generally, each policy issue can be examined in a separate sheet and compared with the base case.

A key policy issue is how the taxation of GILTI affects the incentive for U.S. multinationals to invest in foreign jurisdictions. That will depend on many details in the law as well as taxpayer characteristics, many of which can be summarized in a marginal effective tax rate. So, for example, the spreadsheet contains a tab that examines the marginal effective tax rate on high-margin investment (that is, a return on tangible assets that exceed 10 percent) in a low-tax country. As described in that tab, the additional investment has several effects that must be incorporated into the calculation. CFC income increases. CFC tax increases. QBAI increases. The difference in tax before (in the “EnterValues” tab) and after (in the “Policy” tab) the new investment is divided by change in income to calculate the marginal effective tax rates on investment. For excess-limit taxpayers, marginal effective tax rates increase with the foreign rate imposed on the marginal investment. For excess-credit taxpayers, marginal effective tax rates are equal to the foreign rate imposed on the marginal investment.

A Planning Example

Mathematically speaking, policy is about changing exogenous variables (that is, stuff in the law) so that the tax system generates revenue and achieves efficiency as well as other objectives. Tax planning is about changing endogenous variables (stuff the company adjusts) to reduce tax.

The planning example in the current version of the spreadsheet examines the effect of shifting foreign profit from a jurisdiction with a 25 percent tax rate to a jurisdiction with a 5 percent rate. For excess-limit taxpayers, profit shifting to a low-tax jurisdiction reduces foreign tax, but that reduction is offset by an increase in U.S. tax. For excess-credit taxpayers, profit shifting to low-tax jurisdictions reduces foreign tax with no offsetting increase in U.S tax.

Table. Sample of Calculations in Spreadsheet

input:

U.S.-source revenues

500

500

500

input:

U.S. expenses (some component may be allocable to foreign-source income)

400

400

400

input:

CFC before-tax profit

100

100

100

 

Foreign tax rate

7.22%

7.88%

8.53%

input:

CFC tangible capital

250

250

250

input:

CFC “specified” interest

0

0

0

input:

Section 250 deduction percentage

50%

50%

50%

input:

U.S. statutory rate

21%

21%

21%

input:

Allocable expense (in dollars)

60

60

60

input:

Section 960(d) percentage (1 - “haircut”)

80%

80%

80%

input:

U.S. assets

1,000

1,000

1,000

input:

CFC stock

1,000

1,000

1,000

 

Foreign tax: 

 

CFC taxable income under foreign income tax

100

100

100

 

Statutory foreign tax rate (existing income)

7%

8%

9%

 

Foreign tax

7.22

7.88

8.53

 

U.S. tax on foreign-source income before FTC:

 

CFC before-tax profit

100

100

100

 

5 exclusions from tested income

0

0

0

 

Before-tax tested income

100

100

100

 

Foreign tax (allocable to tested income)

7.22

7.88

8.53

 

Tested income

92.78

92.13

91.47

 

Basis of CFC tangible capital

250

250

250

 

QBAI (using 10 percent from statute)

25

25

25

 

Specified interest

0

0

0

 

NDTIR

25

25

25

 

GILTI

67.78

67.13

66.47

 

Inclusion percentage (= GILTI/tested income)

73.1%

72.9%

72.7%

 

Foreign tax

7.22

7.88

8.53

 

Section 78 gross-up

5.27

5.74

6.20

 

Section 951 inclusion

73.05

72.86

72.67

 

Section 250 percentage

50%

50%

50%

 

Section 250 deduction

36.53

36.43

36.33

 

CFC taxable income under U.S. tax

36.53

36.43

36.33

 

U.S. tax rate

21%

21%

21%

 

U.S. tax on foreign-source income before FTC

7.67

7.65

7.63

 

Deemed paid credit

 

Section 78 gross-up

5.27

5.74

6.2

 

Section 960(d) fraction (“haircut”)

80%

80%

80%

 

Deemed paid credit

4.22

4.59

4.96

 

FTC limitation 

 

A. Allocate stock (assume simple asset method)

 

U.S. assets

1,000

1,000

1,000

 

CFC stock

1,000

1,000

1,000

 

Inclusion percentage (= GILTI/tested income)

73.1%

72.9%

72.7%

 

Section 951A stock (use inclusion percentage) (negative function of QBAI)

730.5

728.6

726.7

 

General (residual) category stock

269.5

271.4

273.3

 

GILTI (non-section 245A)

365.3

364.3

363.3

 

Section 245A (treated as exempt) (positive function of section 250 deduction)

365.3

364.3

363.3

 

Section 245A stock removed from numerator and denominator

 

 

 

 

B. Allocation fractions and expenses for each basket

 

GILTI basket numerator

365.3

364.3

363.3

 

GILTI basket denominator

1,634.7

1,635.7

1,636.7

 

GILTI basket allocation fraction

22.3%

22.3%

22.2%

 

Allocable expense (in dollars)

60

60

60

 

Expense allocated to GILTI basket (above line subtracted from numerator of FTC fraction)

13.4

13.4

13.3

 

General basket numerator

269.5

271.4

273.3

 

General basket denominator

1,634.7

1,635.7

1,636.7

 

General basket allocation fraction

16.5%

16.6%

16.7%

 

Allocable expense (in dollars)

60

60

60

 

Expense allocated to general basket (above line will be added back to denominator: section 904(b)(4))

9.89

9.95

10.02

 

C. FTC limitation

 

GILTI numerator

 

(CFC taxable income less allocated expense) * tax rate

 

CFC taxable income

36.53

36.43

36.33

 

Expense allocated to GILTI basket

13.41

13.36

13.32

 

Foreign-source income for FTC limit (numerator)

23.12

23.07

23.01

 

GILTI denominator (worldwide taxable + addback)

 

U.S.-source taxable income

100

100

100

 

Foreign-source taxable income

36.53

36.43

36.33

 

Addback (section 904(d)(4))

9.89

9.95

10.02

 

Denominator

146.42

146.39

146.35

 

Fraction

0.158

0.158

0.157

 

Worldwide taxable income

136.5

136.4

136.3

 

Worldwide U.S. tax before credits

28.67

28.65

28.63

 

FTC limit

4.53

4.51

4.5

 

Final tax calculations:

 

Foreign tax

7.22

7.88

8.53

 

U.S. tax on foreign-source income before FTC

7.671

7.651

7.63

 

Deemed paid credit

4.219

4.59

4.96

 

FTC limit

4.527

4.515

4.502

 

FTC

4.219

4.515

4.502

 

U.S. tax on U.S. income

21

21

21

 

U.S. tax on CFC income

3.45

3.14

3.13

 

Total tax on CFC income

10.67

11.01

11.66

 

Total tax on worldwide income

31.67

32.01

32.66

 

U.S. tax rate on CFC income

3.45%

3.14%

3.13%

 

Total tax rate on CFC income

10.67%

11.01%

11.66%

 

Excess foreign tax credit

-0.308

0.076

0.458

 

Excess credit or limit?

excess limit

excess credit

excess credit

 

Stuff that may be useful:

 

Allocable expense as percentage of CFC before-tax income

60%

60%

60%

 

Expense allocated to GILTI as percentage of CFC before-tax income

13.4%

13.4%

13.3%

 

NDTIR as percentage of CFC before-tax income

25%

25%

25%

 

Output from spreadsheet shown in chart:

 

Foreign tax rate

7.22%

7.88%

8.53%

 

U.S. tax rate on CFC income

3.45%

3.14%

3.13%

 

U.S. + foreign tax rate on CFC income

10.67%

11.01%

11.66%

 

Calculate MRR

 

Total U.S. tax

24.452

24.136

24.128

 

Foreign tax

7.219

7.875

8.531

 

Change in U.S. tax

-0.393

-0.316

-0.008

 

Change in foreign tax

0.656

0.656

0.656

 

MRR

0.6

0.482

0.012

More to Come

The spreadsheet described here will be updated with more features (such as computation of the crossover rate and addition of loss CFCs); more complete documentation and cross-references to the code and regulations; and any necessary corrections.

Issues that can be explored with the spreadsheet will be examined in future articles. Those include the effect of adjusting transfer prices for transactions between a U.S. parent and a CFC, the effect of moving expenses from the United States to foreign locations, the effect of new business investment that does not affect QBAI (but may affect allocable expenses), and — most challenging of all — the conditions under which the high-tax kickout suggested in proposed regulations will be favorable to the taxpayer.

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