On September 13, 2018, the US Treasury and Internal Revenue Service (IRS) released proposed regulations under Internal Revenue Code (IRC) section 951A (the proposed regulations), relating to a US shareholder’s “global intangible low-taxed income” (GILTI).
The GILTI regime, which applies for taxation years of controlled foreign corporations (CFCs) beginning after December 31, 2017, was enacted as part of the Tax Cuts and Jobs Act (the Act) on December 22, 2017. The proposed regulations are the first administrative guidance released under this new regime.
If you are a US citizen or resident or have US family members involved in your Canadian business, consider how the GILTI regime impacts the taxation of your company’s income in 2018. Although these rules apply to both US corporate and individual shareholders, this Tax Insights focuses on US individual shareholders of a private Canadian company.
The GILTI regime applies to US shareholders of CFCs. A CFC is a non-US corporation if more than 50% of its stock (by votes or value) is owned by US shareholders.
The Act expanded the definition of a US shareholder, effective 2018, to include US persons who own at least 10% of the voting power or value of a CFC. The previous definition required at least 10% voting power and not value, and therefore, a US individual may not have been treated as a US shareholder if that person owned only non‑voting shares.
As well, other changes in the Act may also attribute ownership to the US shareholder if there is a US corporation in the corporate group.
As a result, it is likely that more companies will be considered CFCs starting 2018.
The following information is based on the proposed regulations and may change when the regulations are finalized and published in the Federal Register.
GILTI is computed for taxation years beginning after December 31, 2017. The application of GILTI means that if you are a US shareholder, you may be subject to US federal income tax on certain income earned in the Canadian company, reduced by 10% of the CFC’s tax basis in certain tangible assets. Therefore, if your company has minimal depreciable assets, or if those assets are fully depreciated, all of its business profits may be subject to this new tax in the hands of the US shareholder.
The GILTI amount is calculated as the excess of each US shareholder’s “tested income” over the shareholder’s “net deemed tangible income return.”
Tested income is calculated as the gross tested income, less allocable deductions. A CFC’s tested income is generally determined under US federal tax principles. If a taxpayer is considered a US shareholder of multiple CFCs, net CFC tested income takes into account the tested income of all CFCs reduced by the tested loss of all CFCs for the taxation year.
The reduction of tested income by the net deemed tangible income return is calculated as 10% of the adjusted basis of specified tangible assets that meet the definition of a “qualified business asset investment.”
The GILTI for individuals can be significantly higher than the GILTI for a US corporate shareholder, because the GILTI will be subject to tax at ordinary income tax rates of up to 37% for individuals, with no corresponding deductions or foreign tax credits that may otherwise be available to US corporate shareholders.
Individuals can elect under IRC section 962 to be taxed as a corporation for certain purposes. The election is generally due with the filing of the US federal income tax return. The section 962 election:
As a result, this election may benefit the US individual shareholder if the CFC is paying sufficient income taxes in Canada.
However, if this election is filed, future dividends will not be viewed as previously taxed income for US federal income tax purposes. This means that any future dividend distributions attributable to the earnings that gave rise to GILTI may be taxable as dividend income to the individual shareholder upon distribution. Nevertheless, this may not be a concern if the dividend is also subject to Canadian tax.
Before making this election, an individual must consider all relevant factors, including those discussed above.
While the proposed regulations provide some guidance, additional clarity from the IRS is still required for the following key considerations related to tax planning for GILTI:
The proposed anti‑abuse rules may also be interpreted to be overly broad and potentially apply to “any transaction or arrangement.”
Before the end of 2018, you should:
The implications of GILTI will have a significant impact on US shareholders of Canadian private companies. It is important that you contact your PwC adviser to identify all situations where GILTI may apply to you and to evaluate your options.