The Global Intangible Low-Taxed Income (‘GILTI’) regime, enacted as part of Congress’s 2017 tax reform initiative, effectively subjects any US citizen, green card holder, and other US tax resident (a 'US Person') to US income tax on the worldwide earnings of any non-US corporation (i) in which the US Person himself or herself holds a material proportion of the shares, and (ii) which is majority-owned or controlled by one or more US Persons, each of whom owns a material proportion of such shares.
The aim of GILTI is apparently to thwart sophisticated offshoring schemes, particularly those involving the outbound transfer of intellectual property or other mobile assets, and to encourage major US-parented corporations to repatriate certain large offshore cash reserves back to the United States. Yet the GILTI rules reach much more broadly than their intended target, and hit individual US Persons much harder than their US corporate counterparts. As a consequence of the GILTI regime, US Persons owning shares even in conventional operating companies should consider restructuring or even divesting themselves of their share ownership if those companies are organized outside of the United States.
As a threshold matter, the GILTI tax applies only to ‘US Shareholders’ of ‘Controlled Foreign Corporations’ (‘CFCs’). A US Shareholder is a US Person, US corporation, or other US entity that owns or is treated as owning at least 10 percent of the stock of a non-US corporation by voting power or value. A CFC is a non-US corporation more than 50 percent of the voting power or value of the stock of which is owned by US Shareholders. The scope of the GILTI regime is therefore similar to its older and more well-established sister regime, ‘Subpart F.’
Like Subpart F, the GILTI regime requires the US Shareholder of a CFC to recognize on arising basis (as a ‘GILTI inclusion’) his, her, or its proportionate share of certain disfavoured income earned by that CFC—GILTI earnings—whether or not the CFC makes any actual distributions during the year in which the income is earned. GILTI inclusions are taxed to individual US Shareholders at 37 percent, and to domestic corporate US Shareholders at effective rates of between 10.5% and 13.125%, depending on the rate of non-US income tax paid on the CFC’s operating earnings.
What makes the GILTI regime particularly onerous is that it adopts a baseline presumption that virtually all of a CFC’s yearly earnings are disfavoured GILTI income, except for certain narrowly drawn categories of excluded income (generally, income that would already be subject to US income tax in some manner). If a CFC owns a substantial quantity of tangible, depreciable assets, the GILTI rules treat a commensurate portion of that company’s earnings as exempt from GILTI treatment. However, for businesses lacking such assets—for example, a services or consultancy business—it may be the case that every dollar of income earned by that CFC is treated as GILTI, thus giving rise to current, ‘dry’ income inclusions in the hands of the service business’s US Shareholders. Unlike its older sister Subpart F the GILTI system draws no distinction between active and passive income, between income earned in the CFC’s country of corporation and other earnings, or (ironically, considering its name) between income derived from intellectual property versus all other kinds of income.
The GILTI regime is at its most unforgiving in the case of individual US Shareholders who own CFC shares directly (i.e. without any intermediate US domestic corporate vehicle). As mentioned above, individual US Shareholders are subject to significantly higher effective tax rates on GILTI inclusions (up to 37%) when compared with corporate US Shareholders (between 10.5% and 13.125%). Moreover, while a corporate US Shareholder is generally entitled to credit 80% of CFC’s non-US operating-level taxes against its own GILTI inclusion, an individual US Shareholder cannot credit any such non-US taxes against its GILTI burden. If a CFC is organized or operated in a country with a significant operating-level income tax, an individual US Shareholder in that CFC may incur a combined US federal and non-US operating-level tax well in excess of 50%.
Fortunately, individual US Shareholders have potential solutions available to solve, or at least reduce, their GILTI problem. First, an individual US Shareholder might restructure his or her investment in a CFC through a wholly-owned US corporate investment vehicle, in order to take advantage of the lower GILTI rate imposed on corporate US shareholders, as well as the rules allowing a corporate US Shareholder to credit the CFC's non-US operating taxes against its own GILTI liability. Second, the individual US Shareholder might elect to treat the CFC as a partnership or disregarded entity for US tax purposes (i.e. make a ‘check-the-box’ election) in order to avoid GILTI altogether. Third, the individual US Shareholder could elect to be treated as if he or she were a US domestic corporation for the taxable year for certain (a so-called ‘section 962’ election). None of these solutions is likely to be perfect; entails a unique set of benefits and drawbacks. Nonetheless, any one of these three strategies has the potential to significantly improve the individual US Shareholder's GILTI position and avoid a potentially confiscatory US income tax charge.
The stark disconnect between the GILTI's regime full name — Global Intangible Low-Taxed Income — and its actual reach suggests that GILTI is the Holy Roman Empire of the US Internal Revenue Code — confined neither to intangibles-related income, income arising in low-tax jurisdictions, nor even income necessarily generated from non-US business operations. Accordingly, US taxpayers owning non-US corporate shares, or who own and operate a business in non-US corporate form, would be well-advised to take a close look at their tax structures to ensure that they are not ensnared by GILTI’s broad scope.
