The Senate Finance Committee Chairman’s Mark (Senate Mark) released last Thursday includes a provision that effectively imposes a foreign minimum tax on 10% U.S. shareholders of controlled foreign corporations (CFCs) to the extent the CFCs are treated as having “global intangible low-taxed income” (GILTI). Under a related provision, corporate U.S. shareholders generally would be entitled to a deduction equal to 37.5% of any GILTI plus other foreign-derived intangible income, as described further below. Combined, these provisions amount to a 12.5% “patent box” that would impose current taxation on net income of a CFC that generally exceeds a routine rate of return on the CFC’s tangible depreciable business assets.
GILTI Inclusion. Under the Senate Mark, each 10% U.S. shareholder of a CFC is required to include currently in its income its GILTI in the applicable tax year.
- The GILTI is the excess of the U.S. shareholder’s “net CFC tested income” over a deemed return equal to 10% of the shareholder’s pro rata share of the “qualified business asset investment” (QBAI) of each CFC with respect to which it is a U.S. shareholder.
- The determination of “net CFC tested income” generally follows the House bill (described here), except that a number of exclusions from tested income in the House bill do not appear in the Senate Mark (certain items expressly excluded from subpart F income and commodities income). The Senate Mark also adds an exclusion for certain foreign oil and gas income.
QBAI is, generally, a CFC’s quarterly average tax bases in depreciable tangible property used in the CFC’s trade or business to produce tested income or loss. Because (similar to the determination of the “high return threshold” in the House bill) QBAI is determined with respect to bases in tangible property, a CFC that holds mostly depreciated or intangible assets may have a very low QBAI.
Deduction for Foreign-Derived Intangible Income. A domestic corporation is allowed a deduction under the Senate proposal equal to 37.5% of the lesser of:
- (1) its foreign-derived intangible income (FDII) and its GILTI or
- (2) its taxable income, determined without regard to the proposal.
To determine its FDII, a domestic corporation must first identify its “deduction eligible income” (DEI), which is generally the gross income of the corporation without regard to net Subpart F income, GILTI, dividends received from 10%-owned CFCs, domestic oil and gas income, and foreign branch income. FDII can then be calculated as the product of:
- (x) DEI less 10% of the domestic corporation’s QBAI and
- (y) the percentage of DEI that is “foreign-derived” DEI (i.e., foreign-derived DEI/DEI).
A domestic corporation’s QBAI is calculated (similarly to a CFC’s QBAI) as the corporation’s average tax bases in depreciable tangible property used in its trade or business to produce DEI.
DEI is considered “foreign-derived” DEI if it is derived in connection with:
- (i) property sold to a non-U.S. person for a foreign use or
- (ii) services provided to any person (or with respect to property) outside of the United States.
Special rules apply with respect to certain intermediaries and related parties.
As an example, assume a U.S. corporation has an $80x GILTI inclusion, no foreign-derived DEI (so its FDII is $0) and taxable income in excess of $80x. Under the formula above, the U.S. corporation would be allowed to deduct 37.5% of the $80x of GILTI, or $30x, for a net $50x inclusion. Applying a 20% tax rate, the resulting tax liability is $10x. The effective tax rate on the GILTI is therefore 12.5%.
Foreign Tax Credits. Corporate 10% U.S. shareholders will be entitled to a tax credit for 80% of the foreign taxes paid by CFCs attributed to the GILTI amount. Like the House bill, a separate provision of the Senate Mark would expand the CFC and 10% U.S. shareholder categories beginning January 1, 2018 by changing the attribution rules to require downward attribution from non-U.S. persons.