Practical considerations from the GILTI and subpart F high-tax exception regulations

Overview

The Treasury Department and the IRS (Treasury), on July 20, 2020, released Final Regulations and Proposed Regulations under Section 951A, as enacted by the 2017 tax reform legislation (the Act), and Section 954, relating to the treatment of income that is subject to a high rate of foreign tax under the global intangible low-taxed income (GILTI) and subpart F income regimes. 

The Final Regulations generally adopt, with certain modifications, the rules in the 2019 Proposed Regulations (defined below) under Sections 951A and 954, including the high-tax exclusion for GILTI purposes. The Final Regulations retain the approach of applying the high-tax exclusion on a CFC group-wide basis, but vary from the 2019 Proposed Regulations with respect to certain aspects—notably, the use of the ‘tested unit’ standard (rather than the ‘qualified business unit’ (QBU) standard) and the ability to elect the high-tax exclusion on an annual basis. 

The Final Regulations may be applied retroactively to tax years beginning after December 31, 2017, subject to certain requirements. However, such retroactivity was provided with a short amended return date. Taxpayers should immediately consider the application of the Final Regulations to 2018 tax years before being time-barred pursuant to the applicable statute of limitations. The conformity rule from the 2019 Proposed Regulations was retained whereby a controlling domestic shareholder must apply the election to all members of the CFC group. 

The Proposed Regulations generally conform the high-tax exception under the subpart F regime with the high-tax exclusion under the GILTI regime (thus departing from the manner in which the subpart F high-tax exception is applied in certain key respects), and adopt a single election under Section 954(b)(4) applicable for purposes of both subpart F income and tested income (the High-Tax Exception).

The takeaway

The Final Regulations provide additional guidance related to taxpayers’ ability to exclude gross income from tested income of CFCs by reason of a high tax election. The complex tested unit calculations take into account disregarded transactions, as well as whether a tested unit’s gross income is subject to tax in more than one jurisdiction. As a result, the statutory income tax rate in the foreign country may not be indicative of whether income is subject to a sufficiently high rate of tax. Accordingly, taxpayers should model the application of these rules to determine eligibility. 

Taxpayers also should note the short time period to file an amended return if seeking to apply these rules retroactively. 

The Proposed Regulations adopt a unified election for subpart F and tested income that applies the rules of the GILTI High-Tax Exclusion for both tested income and subpart F income. This approach represents a substantial departure from the current final subpart F high-tax regulations (e.g., by applying the ETR test on a tested-unit basis and the election, if made, consistently to a CFC group). Accordingly, taxpayers should examine their organizational structure and consider the extent to which this change may affect them. Taxpayers should also note the proposal of the applicable financial statement standard and the contemporaneous documentation requirement, and consider what, if any, changes in computational approaches or substantiation protocols may be required.