Written by Justin K. Hoffman | Cross Boarder Tax Services, Davis Martindale LLP
In December 2017, the U.S. introduced sweeping tax reforms that included the introduction of a new tax on international income called the “Global Intangible Low-Taxed Income” (GILTI).
Beginning in 2018, this tax would require U.S. shareholders of controlled foreign corporations (CFC) to include on their personal U.S. tax returns any income earned by the corporation in excess of a 10% return on the corporation’s tangible depreciable capital property. In future years practitioners must carefully plan for the impact of this tax.
Who May Face the Tax?
For the tax to potentially apply two conditions must be present:
1) The corporation must be a CFC
To be a CFC, MORE than 50% of votes OR value of the foreign corporation (i.e. a Canadian company) must be owned U.S. citizens, U.S. permanent residents or other U.S. resident entities.
2) The shareholder must qualify as a “U.S. Shareholder”
To be a U.S. shareholder, a person must own directly, indirectly or constructively at least 10% of the votes OR value of the foreign company.
Options to Mitigate the Tax
1) Payment of a Bonus
The simplest but perhaps least tax efficient option for eliminating GILTI is to eliminate the income of the corporation by fully distributing it as a wage. This will align the U.S. and Canadian taxation of the income and create sufficient foreign tax credits (FTC) to fully offset the U.S. tax owing.
2) Payment of a Dividend
On November 28, 2018 the IRS released proposed regulations that provided for the allocation of FTCs to specific “baskets” of income. The result was that all of a corporation’s pre-2018 retained earnings must be distributed before any tax on dividends can be allocated against GILTI. As such, using dividends to create an offsetting FTC will only be viable in cases of corporations with insignificant pre-2018 retained earnings.
3) Adjustments to Ownership
For family-owned corporations, it may be advantageous to restructure the ownership of the company so that U.S. persons own no more than 50% of the votes or value of the corporation. By limiting ownership to 50%, the company will cease to be a CFC and the GILTI provisions won’t apply.
4) Utilization of a 962 Election to be Taxed as a Corporation
For U.S. tax purposes, an individual can elect under Section 962 to be taxed as a corporation for the purposes of determining income from a CFC.
This has several benefits:
1) A reduced 21% tax rate on the GILTI inclusion.
2) An entitlement to an offsetting 50% deduction against any GILTI inclusion.
3) An ability to claim 80% of the Canadian corporate taxes as an indirect foreign tax credit.
With these benefits, provided that the corporation pays Canadian tax of at least 13.125%, in making the 962 election, the shareholder will be able to defer all immediate U.S. tax on their corporate income. Should the taxes paid in Canada be lower than 13.125% any taxes remaining in the U.S. after the 962 election will represent a true double-tax.