GILTI, FDII, and FTC Guidance and International Tax Planning: How to decipher this complex stew, replete with interesting ingredients.

• Author: Varma, Amanda
• Position: Part 2 - Global intangible low taxed income, foreign derived intangible income, foreign tax credit - Special Section on the Tax Cuts and Jobs Act

Prior to tax reform, multinational businesses often had similar strategies with respect to outbound international tax planning. Given the high U.S. corporate tax rates and worldwide system of taxation, many businesses sought to earn and keep profits offshore to defer U.S. tax. When it was important to repatriate profits, foreign tax credit planning could be helpful, while some turned to other creative approaches. Subpart F income was generally avoided.

Tax reform has required tax executives to reprogram their tax planning instincts. For outbound businesses, the need for a shift in thinking has been driven in significant part by the new global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII) rules, along with the redesigned foreign tax credit.

The proposed GILTI and foreign tax credit regulations provided critical guidance for tax executives adjusting to the new U.S. international tax paradigm. (1) Several aspects of the proposed regulations are generally helpful, such as the approach to expense allocation, foreign tax credit transition rules, guidance on the gross-up for taxes attributable to GILTI, and answers to numerous computational questions. Other aspects may be less welcome, such as the complexity of the regulations and the GILTI anti-abuse rules.

Because the new regime is still evolving, it is too early to formulate firm new outbound planning heuristics (and, given the complexity of the new rules, it will likely be more difficult to do so). Still, there are several emerging key issues and strategies for tax executives to consider. This article focuses on five key issues and strategies relating to GILTI, FDII, and the foreign tax credit and proposed regulatory guidance on these rules issued to date.

Overview

The GILTI rules, contained in new Section 951A, essentially subject ten-percent U.S. shareholders of controlled foreign corporations (CFCs) to current US. tax on certain CFC income exceeding a deemed routine return on the adjusted U.S. tax basis in tangible foreign business assets. The name "GILTI" is somewhat of a misnomer--GILTI can arise from income with little or no relation to intangibles where a CFC has few tangible assets with significant U.S. tax basis. A U.S. corporate shareholder is generally permitted a fifty percent GILTI deduction (reduced to 37.5 percent in 2026) under Section 250, resulting in a U.S. federal income tax rate on GILTI of 10.5 percent (in the absence of a foreign tax credit).

GILTI is calculated at the U.S. shareholder level as "net CFC tested income" over "net deemed tangible income return." Net CFC tested income is the excess of the U.S. shareholder's aggregate pro rata share of CFC tested income over CFC tested loss. Tested income is a CFC's gross income excluding several categories of income, including income already subject to U.S. tax under Subpart F or as effectively connected income, dividends received from a related person, foreign oil and gas extraction income, and income excluded from Subpart F because the high tax exception has been elected, over deductions allocable to such gross income. "Net deemed tangible income return" is essentially a deemed routine return on tangible assets, calculated as ten percent 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, over certain interest expense. QBAI is determined as the average of the adjusted U.S. tax basis (determined at the end of each quarter of a tax year) in "specified tangible property" that is used in the CFCs trade or business and subject to U.S. tax depreciation.

In light of the new participation exemption in Section 245A, tax reform eliminated the Section 902 indirect foreign tax credit and the pooling mechanism. Certain indirect foreign tax credits are still permitted, including where foreign taxes are imposed on income subject to U.S. tax under Subpart F or the GILTI rules. Under Section 960(d), the GILTI foreign tax credit is limited to eighty percent of the foreign taxes "properly attributable" to CFC tested income, multiplied by an "inclusion percentage" equal to GILTI divided by aggregate CFC tested income. There is a new GILTI foreign tax credit basket, and there is no carryover for taxes in the GILTI basket. A new foreign branch basket was also created in tax reform.

The FDII rules provide a reduced rate of U.S. tax on a portion of a U.S. corporation's intangible income derived from serving foreign markets. Through 2025, a U.S. corporation is generally allowed a deduction equal to 37.5 percent of its FDII, resulting in a U.S. federal income tax rate on FDII of 13.125 percent. For taxable years beginning after December 31, 2025, the deduction for FDII is reduced to 21.875 percent.

A U.S. corporation's FDII is determined under a formula: deemed intangible income multiplied by foreign-derived deduction-eligible income (FDDEI) over deduction-eligible income (DEI). Deemed intangible income is essentially an amount of income deemed to arise from the U.S. corporation's intangible assets. It is calculated as "deduction eligible income" minus ten percent of QBAI (which is calculated similarly to the GILTI QBAI calculation). "Deduction eligible income" is gross income, other than Subpart F income, GILTI, financial services income, dividends from CFCs, domestic oil and gas extraction income, and foreign branch income, minus deductions properly allocable to such gross income. "Foreign-derived" means from sales of property (including...