In general – Good News For American Entrepreneurs Abroad …
On Friday June 14, 2019 US Treasury proposed in Notice 2019-12436 that any foreign income earned by Controlled Foreign Corporations be (subject to election) excluded from the definition of GILTI income. This will be particularly welcome to Americans living outside the United States, who are attempting to carry on business in their country of residence, through non-U.S. corporations.
For those who are concerned with understanding the hows and whys, I suggest you read Treasury’s Notice which includes a good history and description of the Subpart F rules, some Legislative History leading to the GILTI rules, and Treasury’s attempt to piece it all together. You will find it all here.
Treasury Notice 2019-12436
What Exactly Did Treasury Say? At The Risk Of Oversimplification (which this surely is) …
At page 24 of a long and detailed Notice, Treasury states:
For the foregoing reasons, the proposed regulations provide that an election may be made for a CFC to exclude under section 954(b)(4), and thus to exclude from gross tested income, gross income subject to foreign income tax at an effective rate that is greater than 90 percent of the rate that would apply if the income were subject to the maximum rate of tax specified in section 11 (18.9 percent based on the current rate of 21 percent). See proposed §1.951A-2(c)(6)(i). The election is made by the CFC’s controlling domestic shareholders with respect to the CFC for a CFC inclusion year by attaching a statement to an amended or filed return in accordance with forms,instructions, or administrative pronouncements.
This is the excerpt that will be of most interest to American Entrepreneurs abroad and will for some be welcome relief. A reading of the Notice reveals that Treasury paid close attention to the comments that were submitted as a result of their requests. Although there is nothing in the Notice that suggests that this relief was aimed specifically at Americans abroad, it is also clear that Americans abroad submitted many comments.
Bottom Line: For American entrepreneurs living in “some” high tax jurisdictions it seems likely that this will significantly mitigate your GILTI problem!
Relief will depend on the rate of taxation in your particular jurisdiction. It appears that it will be helpful to those who operate in a country where the tax rate on business income is at least 18.9% (90 percent of 21 percent). This may make the announcement less useful for Canadian residents (unless they want to forgo the small business deduction allowed under the Income Tax Act of Canada).
For The Second Time Treasury Adopts A Purposive Approach To Interpreting How The Section 951A GILTI Rules Are To Be Applied …
This gives me hope that all of the advocay efforts taking place on so many levels are slowly taking effect. This is the second time in 2019 that Treasury has intepreted the Section 951A GILTI rules in a way that assists INDIVIDUAL shareholders of CFCs.
First Time – Allowing Individuals To Have The Same 50% GILTI Income Deduction That Corporations Were Granted By Statute:
On March 12, 2019 Treasury interpreted Section 962 (in the context of the GILTI rules) to mean that individual shareholders were entitled to the same 50% discount on the GILTI income inclusion that corporations were entitled to by statute. Individuals are entitled to the same 50% discount provided that they are using the Section 962 election. You will find my discussion of this here.
The March 2019 decision by Treasury did NOT change the defintion of GILTI income. Rather, Treasury concluded that (whatever GILTI income is) both corporations and individuals are entitled to the same 50% deduction in determining what GILTI income is subject to U.S. tax. (Individuals are entitled to the 50% deduction in the context of the Section 962 election only.)
Second Time – Interpreting Subpart F Generally (with the assistance of the legislative history) To Mean That High Taxed Foreign Income Should NOT Be Considered To Meet The Definition Of GILTI Income
On June 14, 2019 Treasury interpreted Section 951A in the context of the Subpart F rules to mean that high taxed income should (subject to election) be excluded from the definition of GILTI income.
At page 22 of the Notice Treasury states:
II. GILTI High Tax Exclusion
A. Expansion to exclude other high-taxed income
In response to comments, the Treasury Department and the IRS have determined that the GILTI high tax exclusion should be expanded (on an elective basis) to include certain high-taxed income even if that income would not otherwise be FBCI or insurance income. In particular, the Treasury Department and the IRS have determined that taxpayers should be permitted to elect to apply the exception under section 954(b)(4) with respect to certain classes of income that are subject to high foreign taxes within the meaning of that provision.
Obviously the devil is in the details (and there are a lot of details). But, this is clearly good news and clear relief for American entrepreneurs abroad.
Treasury Should Be Congratulated For Taking a “Purposive Approach” To The Implementation of GILTI
Rather than interpreting Section 951A in the most literal way, Treasury has adopted a purposive approach. It has utilized: the history of the Subpart F regime, the legislative history leading to the TCJA in general, the GILTI rules in particular and how the GILTI rules are to be given effect as part of the Subpart F scheme. Furthermore, the views of Treasury have clearly been shaped by comments from the profession, comments from at least one government* and the public. In fact, the June 14, 2019 Notice from Treasury appears to address the submission from Arnold Porter from the Government of Israel which describes the “literal application” of the GILTI rules on Americans abroad living in Israel and subject to the Israeli tax regime. The submission is introduced as follows:
*On behalf of the Ministry of Finance of the Government of Israel, Arnold & Porter recommends, per the attached document, that the Treasury revise Prop. Reg. 1.951A-2(c)(1) to clarify that the “high tax kick out” exception of Section 954(b)(4) applies to GILTI so as to exclude from gross tested income and, therefore, from net CFC tested income, any item of income subject to an effective non-U.S. tax rate equal to, or in excess of, a prescribed rate.
For those who wish to read the submission (which provides some history of the Subpart F Regime):
It Takes A Village – The Collective Efforts Of Americans Abroad Are Beginning To Bear Fruit
As noted by Monte Silver, the collective advocacy efforts are beginning to bear fruit! Note that Treasury has achieved this result within the context of the language of Section 951A.
Treasury Should Now Consider The Section 965 Transition Tax As It Applies to Individuals
Treausury has proven that it can interpret the GILTI rules in ways that solve the problems of Americans abroad. Similarly, they should be challenged to interpret the Section 965 transition tax rules in a way that solves the problems of Americans abroad.
Futher Commentary …
John Richardson – Follow me on Twitter @Expatriationlaw