GILTI Tax & Does it Apply to You? Here’s What You Need to Know

GILTI Tax: Are you a small business owner, or perhaps the CFO of a multinational corporation with its origin and headquarters based in the USA? If so, do you have foreign subsidiaries outside of the United States?

If your answer is yes to any of these questions, you need to have an in-depth understanding of the latest addition to the corporate income tax law, the GILTI tax.

What is the GILTI tax?

The GILTI tax or Global Intangible Low Tax Income is defined as a corporate tax designed to “discourage companies from using intellectual property to shift profits out of the United States.” It was initially “introduced as an outbound anti-base erosion provision.” It is a new category of foreign income added to annual corporate taxable income. In effect, it is a tax on earnings that is greater than 10% of the company’s invested foreign assets.

Before the advent of the 2017 Tax Cuts and Jobs Act, the United States used to tax American companies and residents on their worldwide income. However, companies could defer the tax on their foreign subsidiaries’ active earnings until these monies were brought back into the USA as shareholder dividends. Now that this act has been signed into law, any foreign-controlled company’s annual profits in the form of dividends paid out to American residents will be taxed to the shareholder directly. It does not matter whether the money has been withdrawn from its offshore-based and brought into the USA; it will be taxed irrespective of where it is located in the world.

However, the caveat here is that, in practice, it does not work in the way it was initially expected to work.

Therefore, the most critical part of this discussion is not only to understand the ins and outs of GILTI but to know if GILTI applies to you.

How does GILTI Tax apply to your business?

Succinctly stated, GILTI applies to every business, irrespective of industry and size, that has offshore subsidiaries or branches outside of the United States. Consequently, the question that must be asked and answered is how does this corporate tax apply? Or how should you apply it to your corporate annual income tax calculations?

By way of answering these questions, let’s consider the following scenario. 

You are the sole shareholder of an offshore company, and your annual 2019 profit was $1 000. The mandatory 23% foreign corporate tax has already been paid. As the sole shareholder, you must report this figure on your personal income tax return and pay about 37% additional tax on this amount. It makes no difference that you have already paid the 23% or $230 on this profit. 

However, you can elect Section 962, which translates into being taxed at lower US corporate rates, and receive a 50% deduction and an 80% tax credit for the foreign taxes (the 23% foreign corporate tax) paid at the Controlled Foreign Company (CFC) level. 

Note:  The Section 962 election is only available to individuals and certain trusts that are American CFCs’ shareholders. 

When we redo the tax calculation, the results are as follows. 

You get 50% off the $1000, so you are only taxed on $500. The US corporate tax rate is currently 21%, which means you are taxed 21% of $500, or $105. Lastly, you receive an 18.4% foreign tax credit, calculated by multiplying 23% times 80%. As a result, you would end up not paying any tax on this original $1000. 

Final thoughts

While this calculation is a simplified version of the actual tax calculation, it highlights the crucial point that it is advisable to hire a tax consultant to complete your tax returns, especially if you are a Foreign Controlled Company shareholder.