Tax Insights: US tax reform – Proposed GILTI regulations and implications for US shareholders of a Canadian business

October 29, 2018

Issue 2018-39

In brief

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.

In detail

US shareholders and GILTI

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.

How GILTI is calculated

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.

Filing a section 962 election

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:

  • allows an individual to claim a deemed paid foreign tax credit for Canadian corporate taxes paid by the CFC
  • subjects the GILTI of an individual shareholder to US corporate tax rates for federal income tax purposes (generally 21% for 2018), which may be substantially lower than ordinary income rates for the individual

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.

Key considerations

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:

  • Anti-abuse rules: The proposed regulations include anti-abuse rules that may limit tax planning opportunities with respect to the GILTI tax. Specifically, the proposed anti-abuse rules will disregard any transaction or arrangement that has a principal purpose of avoiding US federal income tax

The proposed anti‑abuse rules may also be interpreted to be overly broad and potentially apply to “any transaction or arrangement.”

  • Foreign tax credit (FTC): The tested income of a CFC will be included as a separate income basket for calculating FTCs. The IRS has not yet addressed whether FTCs from other income baskets (i.e. general income or passive income) can be used to reduce taxes on GILTI.

Next steps

Before the end of 2018, you should:

  • review the shareholdings of your US persons to determine if the expanded definition of US shareholder and ownership attribution changes will impact the classification of your Canadian company
  • review your company’s distribution strategy to see if it should be adjusted for 2018 and future years
  • consider if electing to be treated as a corporation under IRC section 962 is a viable option
  • consider the impact of additional reporting if your company does not have a December 31 year-end, because GILTI reporting is generally done on a calendar year basis 

The takeaway

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. 

 

Contact us

Beth Webel

National Personal Tax Leader, PwC Canada

Tel: +1 905 815 6400

Nadja Ibrahim

Calgary Private Company Services Leader, Partner, Tax, PwC Canada

Tel: +1 403 509 7538

Kaye Bland

Senior Manager, PwC Canada

Tel: +1 905 418 3439

Kim Maiatico

Senior Manager, PwC Canada

Tel: +1 905 815 6354

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