On November 28, 2018, the US Department of Treasury (“Treasury”) and Internal Revenue Service (“IRS”) released proposed regulations (“Proposed Regulations”)1 on the determination of foreign tax credits, which is related to the global intangible low-taxed income (GILTI) regime and other changes made by last year’s tax reform legislation, known as the Tax Cuts and Jobs Act (TCJA). The TCJA repealed the Section 902 indirect FTC, in light of the enactment of new Section 245A, which provides a 100% dividends-received deduction for foreign-source dividends from 10%-owned foreign corporations.
The TCJA also created two new separate-limitation baskets – one each for GILTI and foreign branch income. These changes gave rise to a need for transition rules, and guidance on a number of issues, particularly in relation to the taxation of GILTI inclusions.
The preamble to the proposed regulations delineates five areas covered by the new rules:
- Allocation and apportionment of deductions and the calculation of taxable income for purposes of the FTC limitation
- Rules related to the TCJA’s addition of new separate limitation categories for GILTI and foreign branch income
- Rules related to the effect of foreign tax refunds in determining whether subpart F income is excludable as high-taxed income
- The determination of deemed-paid taxes under amended Section 960 (for subpart F and GILTI inclusions) and Section 78 (gross-up of inclusion to take deemed-paid taxes into account)
- Rules on the FTC effect of an election under Section 965(n) regarding net operating loss carryovers or carrybacks and Section 965 inclusions.
The GILTI Rules and the FTC
New Section 951A of the Internal Revenue Code (Code) requires US shareholders of controlled foreign corporations (CFCs) to include in taxable income their GILTI inclusion amount each year, which is based on a formula that includes CFCs’ income (subject to certain exclusions) in excess of 10% of investments in qualified business assets. The GILTI inclusion is reduced by 50% under Section 250 of the Code, resulting in an effective tax rate for corporate
US shareholders of 10.5% (until 2026 and later years, when the reduction will decrease from 50% to 37.5%, for an effective tax rate of 13.125%).
Generally, a corporate US shareholder can take as a credit against its GILTI tax liability up to 80% of its pro rata share of the foreign income taxes “properly attributable” to the portion of positive profits of its CFCs that it included in income as GILTI. No carryover or carryback of excess FTCs in the GILTI basket is allowed.
Unlike familiar subpart F income inclusions by US shareholders that are determined on a CFC-by-CFC basis, GILTI inclusions are determined based on a formula that aggregates at the shareholder level certain “CFC tested items” of all CFCs in which the taxpayer is a US shareholder. Thus, the GILTI rules do not fit neatly into the existing and familiar architecture of the otherwise similar subpart F provisions and the deemed-paid tax credit under Section 960 regarding subpart F income inclusions.
Treasury and the IRS simply did not acknowledge the possibility that allocating some US shareholder expenses, such as interest, to the GILTI basket for FTC limitation purposes would result in residual US tax liability.
Transition Rules
Prior to enactment of the TCJA, there were only two separate- limitation baskets – one for passive income and one for general income. The TCJA added two new baskets for GILTI and foreign branch income. Under the proposed regulations, taxpayers with carryovers of excess FTCs from prior years are allowed to assign those FTCs to the foreign branch income basket if the FTCs would have been in that basket if it had existed when the FTCs arose. In contrast, no excess FTC carryovers can be assigned to the GILTI basket.
Carrybacks of excess FTCs from post-2017 years to pre-2018 years, from either the foreign branch income basket or the general income basket, must go into the general income basket. No carrybacks are allowed from the GILTI basket.
The proposed regulations provide similar transition rules for the recapture of overall foreign loss accounts or separate limitation loss accounts, as well as for the recapture of an overall domestic loss that offset income in a pre-2018 separate basket prior to enactment of the TCJA.
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