Global Intangible Low-Taxed Income (GILTI): What it is, how it works & examples
This article is for informational purposes only and does not constitute legal or tax advice.
Always consult with a tax professional for your specific circumstances.
In the ever-evolving landscape of international taxation, the introduction of the Global Intangible Low-Taxed Income (GILTI) has been a significant development.
Designed to prevent US corporations from shifting profits to low-tax jurisdictions, GILTI has become a focal point for multinational corporations and tax pros alike.
In this article, we'll delve deep into what GILTI is, how it operates, and provide real-world examples to clarify its implications.
Understanding GILTI
GILTI, an acronym for Global Intangible Low-Taxed Income, was introduced as a measure to ensure that US corporations pay taxes on income derived from intangible assets held by their controlled foreign corporations (CFCs).
These intangible assets, often elusive in nature, include but are not limited to:
- Patents: Legal rights granted for inventions, allowing exclusivity for a certain period.
- Copyrights: Protection for original works of authorship, including literature, music, and art.
- Trademarks: Symbols, words, or phrases legally registered to represent a company or product.
The primary objective behind GILTI is to discourage US corporations from shifting their profits to low-tax jurisdictions by exploiting these intangible assets.
GILTI is designed to reduce the incentive for US multinational corporations to shift profits out of the US into low or zero-tax jurisdictions
How does GILTI work: The mechanics of GILTI
1. Calculation
GILTI is more than just a simple subtraction; it's a comprehensive formula designed to capture the essence of a corporation's foreign earnings.
Where:
- Total CFC Income: This represents the entirety of the income earned by the Controlled Foreign Corporation. It encompasses revenues from sales, services, and any other business operations, minus associated expenses.
- Tangible Assets: These are the physical and measurable assets that are used in a company's operations. Examples include machinery used in manufacturing, buildings housing operational activities, and land owned by the corporation.
- Specified Interest Expense: This is the interest expense of the US shareholder. It represents the cost of borrowing and other related financial charges.
2. Tax rate
The tax implications for GILTI vary based on the nature of the shareholder:
| Shareholder Type | Initial Tax Rate | Effective Tax Rate (Post Deductions) |
|---|---|---|
| Corporate | 21% | 10.5% – 13.125% |
| Individual | 10% – 37% | Based on marginal tax rate |
NOTE! While corporate shareholders benefit from a 50% GILTI deduction, bringing their effective tax rate down, individual shareholders are taxed at their regular marginal rates.
Examples of GILTI in action
Understanding GILTI becomes clearer with practical examples.
Let's delve into a few scenarios to grasp its implications better:
Example 1: Corporate shareholder in a low-tax jurisdiction
Scenario: A US corporation owns a CFC in a low-tax jurisdiction like Bermuda. The CFC has a successful year, earning $1 million, of which $200,000 is attributed to tangible assets like machinery and real estate.
- GILTI = Total Income - 10% of Tangible Assets GILTI = $1,000,000 - ($200,000 * 10%)
- GILTI = $1,000,000 - $20,000
- GILTI = $980,000
Implication: The corporation would need to include $980,000 as GILTI in its US taxable income.
Example 2: Individual shareholder with a minority stake
Scenario: An individual US shareholder owns 15% of a CFC. Over the year, the CFC earns $500,000, with the majority of this income stemming from intangible assets like patents.
- Individual's Share of Income = Total CFC Income * Ownership Percentage
- Individual's Share of Income = $500,000 * 15%
- Individual's Share of Income = $75,000
Implication: The individual's GILTI would be $75,000, which would then be taxed at their US marginal tax rate.
Example 3: CFC with high foreign taxes
Scenario: A US corporation owns a CFC in a high-tax jurisdiction like Germany. The CFC earns $2 million, with $400,000 coming from tangible assets. Additionally, the CFC pays $300,000 in foreign taxes.
- GILTI = Total Income - 10% of Tangible Assets
- GILTI = $2,000,000 - ($400,000 * 10%)
- GILTI = $2,000,000 - $40,000
- GILTI = $1,960,000
Implication: While the GILTI amount is $1,960,000, the corporation can claim a foreign tax credit for 80% of the $300,000 foreign taxes paid, potentially reducing its US tax liability on the GILTI.
These examples underscore the varying impacts of GILTI based on factors like the jurisdiction of the CFC, the nature of its income, and the foreign taxes it pays.
Pro tip: Proper planning and understanding can help in optimizing the tax outcomes.
Mitigating GILTI's impact
With the right strategies, US shareholders can significantly reduce their tax burden.
Here are some of the most effective methods:
1. Section 962 election
Overview: The Section 962 election allows individual US shareholders to elect to be treated as a corporation for GILTI tax purposes.
Benefits: By making this election, shareholders can avail themselves of the 50% GILTI deduction, effectively reducing the GILTI tax rate to 10.5%.
Additionally, they can claim foreign tax credits, further reducing their US tax liability.
Considerations: While this strategy offers immediate tax relief, it's essential to understand the long-term implications.
When the foreign earnings are eventually distributed as dividends, they might be subject to additional US tax.
2. Salary compensation
Overview: Instead of retaining earnings in the CFC, US shareholders can draw a salary or bonus from their CFC.
Benefits: This strategy reduces the CFC's retained earnings, thereby decreasing the GILTI amount. The compensation is deductible by the CFC, reducing its taxable income.
Considerations: While this method can effectively reduce GILTI, the compensation received by the shareholder is subject to US income tax.
Pro Tip: It's crucial to balance the benefits of reduced GILTI with the US tax on the compensation.
3. Foreign Tax Credit
Overview: To prevent the double taxation of the same income, the US offers a foreign tax credit to its corporations.
Benefits: Corporations can offset their GILTI by claiming a credit for 80% of the foreign taxes they've paid on that income. This significantly reduces the US tax liability.
Considerations: The foreign tax credit comes with its own set of rules and limitations. For instance, the credit cannot exceed the US tax liability on the foreign income.
Additionally, any unused foreign tax credits can be carried back one year and forward ten years. Given the intricacies, it's highly recommended for corporations to seek expert advice to ensure they're maximizing their benefits and staying compliant.
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The Future of GILTI
With ongoing discussions about international tax reforms and the potential for changes in US tax policy, the future of GILTI remains uncertain.
Pro Tip: It's essential for multinational corporations and shareholders to stay informed and adapt to any changes that may arise.
FAQ
No, GILTI is not tax-exempt. It was introduced to ensure that U.S. corporations pay taxes on certain types of income earned by their controlled foreign corporations (CFCs).
However, U.S. corporations can claim a foreign tax credit for 80% of the foreign taxes associated with GILTI, which can offset some of the U.S. tax liability.
The Tax Cuts and Jobs Act (TCJA) provided a 50% deduction for GILTI, effectively reducing the tax rate for corporate shareholders to 10.5%.
However, this deduction is set to decrease to 37.5% in 2026, which will increase the effective tax rate on GILTI to 13.125% for corporations. It's essential to monitor legislative changes as the date approaches.
One of the primary criticisms of GILTI is its complexity and the compliance challenges it presents for U.S. corporations with foreign operations. Additionally, while GILTI aims to prevent profit-shifting to low-tax jurisdictions, it can sometimes result in double taxation, especially for corporations operating in high-tax countries.
This can lead to a higher effective tax rate on foreign income than on domestic income, which some argue is counterproductive.