This is a thought leadership article by PrimeGlobal member firm Katz, Sapper & Miller which looks at how new international regulations provide additional guidance on tax reform.
The IRS recently issued a new set of final and proposed regulations impacting many international tax concepts introduced as part of the Tax Cuts and Jobs Act (TCJA). As a refresher, the TCJA enacted section 951A, often known as Global Intangible Low-Taxed Income (GILTI), and requires a U.S. shareholder of a Controlled Foreign Corporation (CFC) to include certain income earned by a CFC in taxable income annually. The shareholder’s GILTI inclusion is the sum of the shareholder’s aggregate tested income in excess of tested loss, with certain modifications, calculated based on the proportional interest in all CFCs in which the shareholder held during the tax year.
Below are details regarding final and proposed regulations with respect to the international impact of the business interest limitation (section 163(j)), the expansion of guidance surrounding the section 250 deduction and regulations regarding GILTI income subject to a high effective tax rate in a foreign jurisdiction.
Business Interest Limitation Interplay With International Activities
The TCJA amended section 163(j) in its entirety and created a new interest limitation that limits the amount of deductible business interest expense for a given year to the sum of:
- The taxpayer’s business interest income for the year
- 30% of the taxpayer’s adjusted taxable income for the year
- The taxpayer’s floor plan financing interest expense for the year
One additional change to note is that the proposed regulations included a recommendation that excess deductions (allocated and apportioned deductions in excess of foreign income) be carried forward to future tax years to allow for an FDII recapture when foreign revenue is profitable. The IRS determined that the purpose of the section 250 deduction is an annual determination and thus a carryforward or carryback would be inconsistent with the purpose of the law and did not include this suggestion in the final regulations.
The final regulations require the annual section 250 deduction must still be substantiated and contemporaneous documentation must be available to the IRS upon request. However, the relaxed documentation requirements ease the administrative burden and compliance costs associated with these two very important deductions.
The final regulations are applicable for tax years beginning on or after Jan. 1, 2021; however, taxpayers can elect to apply the regulations for taxable years beginning on or after Jan. 1, 2018 (as long as they apply the regulations in their entirety).
GILTI High-Tax Exclusion
As noted above, the TCJA implemented a new deemed foreign income regime under section 951A known as GILTI. Although GILTI stands for “global intangible low-taxed income,” the actual calculation has very little to do with intangibles. Section 951A requires a U.S. shareholder of any CFC to include in income the amount of tested income (a modified taxable income concept) in excess of 10% of the adjusted basis in the CFC’s assets and net interest expense. This inclusion is an annual inclusion and is an aggregate calculation that includes all of the U.S. shareholder’s CFCs.
In July 2020, final regulations were issued that allows a U.S. shareholder to make an election to exclude any income earned by the CFC that was subject to a foreign effective tax greater than 90% of the U.S. statutory C corporation rate (currently 18.9%) from the CFC’s gross tested income calculation.
The election for a specific CFC is made by the controlling domestic shareholders of such CFC. However, once made, the election applies to all U.S. shareholders of such CFC – not just the controlling shareholders that made the election. Furthermore, a controlling domestic shareholder that makes the election with respect to a CFC must make the election with respect to all CFCs under their control.
The election is an annual election (which is a change from the proposed regulations where the election was binding unless revoked, leading to a 60-month lockout period). The final regulations also include a combination rule, where tested units within the same foreign country must be combined to determine the foreign effective tax rate.
There have been many changes to the complex international tax regime over the last three months. Some of the changes have helped to reduce complexity and administrative burden and some of the changes have resulted in more uncertainty and complications. It is important to stay on top of and in front of these new and complex regulations. Please reach out to your KSM tax advisor for more information or assistance.
Katz, Sapper & Miller
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