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Section 962 Election of The Corporate Tax Rate by Individuals For Global Intangible Low-Taxed Income ( GILTI) And Subpart F Income Inclusions

TUESDAY , JULY 10, 2018, 1:00-2:50 pm Eastern

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TUESDAY , JULY 10, 2018

Section 962 Election of The Corporate Tax Rate by Individuals For Global Intangible Low-Taxed Income ( GILTI) And Subpart F Income Inclusions

Thomas M. Giordano-Lascari, Atty Karlin & Peebles, Los Angeles tgiordano@karlinpeebles.com William K. Norman, J.D., LL.M. (Taxation), Partner Ord & Norman, Los Angeles

• ntaxla@yahoo.com

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

Section 962 Election of The Corporate Tax Rate by Individuals For Global Intangible Low-Taxed Income ( GILTI) And Subpart F Income Inclusions

Thomas M. Giordano-Lascari Karlin & Peebles, LLP 5900 Wilshire Boulevard, Suite 500 Los Angeles, CA 90036 Telephone: (323) 648-4649 Facsimile: (310) 388-5537 tgiordano@karlinpeebles.com William K. Norman Ord & Norman 11377 West Olympic Boulevard, 5th Fl. Los Angeles, CA 90064 Telephone: (310) 473-8067 Facsimile: (310) 473-8140

• ntaxla@yahoo.com

Introduction

• Fundamentally, IRC § 962 allows a non-corporate US shareholder of a CFC to elect to be taxed on subpart F

inclusions at the same rate as a corporate US shareholder.

• Prior to the TCJA, § 962 was not significantly utilized.
• The TCJA gave new importance to § 962:

– First, the corporate tax rate was reduced from 35% to 21% making the differential between the highest individual tax rate (39.6%) and the corporate rate much more substantial. – Second, the introduction of GILTI drastically reduced the ability to defer foreign earnings from US tax by causing all but a modest amount of foreign income to be includible in a US shareholder’s income on an annual deemed basis (similar to traditional subpart F inclusions).

• Why not just interpose a US C corporation?

– Not ideal if future sale of CFC stock anticipated – Adverse foreign country consequences of transfer of CFC stock to domestic corporation – Likely not viable solution for US persons (not citizens) that will be exiting the United States in the future – Also likely not viable for US persons (including citizens) resident in foreign country where foreign country tax will be prohibitive if CFC held through a US corporation

Global Intangible Low Taxed Income (GILTI) § 951A

Effective for TYs of foreign corps. beginning after 12/31/17 and the TYs of U.S. Shareholders in which or with which the TY

• f the foreign corp. ends. P.L. 115-97, § 14201(a)

7

GILTI (Cont)

“U.S. Shareholder” of any CFC includes in its gross income the shareholder’s “Global Intangible Low Taxed Income” (GILTI). § 951A(a)

8

GILTI (Cont)

Foreign corp. is a “Controlled Foreign Corporation” (CFC) only if it was a CFC at any time during the TY. See § 957 for definition of CFC.

§ 951A(e)(3)

9

GILTI (Cont)

A U.S. Person is a “U.S. Shareholder” if the person owns (w/in meaning of § 958(a) i.e., directly or indirectly through foreign entities) stock in the foreign corp. on the last day in the taxable year of the foreign corp. on which it is a CFC. See § 951(b) for definition of U.S. Shareholder. § 951A(e)(2)

10

GILTI (Cont)

GILTI = “Net CFC

• “Net

For Any Tested Income” Deemed U.S. Shareholder

• f the U.S.

Tangible For Any TY Shareholder Income

• f the Shareholder

Return” (NDTIR”) of the U.S. Shareholder >0 § 951A(b)(1)

11

GILTI (Cont)

“Net CFC Tested Income” of a U.S. Shareholder for any TY of the Shareholder nCFC nCFC = Ʃ Aggregate of Prorata Share of

• Ʃ Aggregate of Prorata Share of

1 “Tested Income” of all CFCs 1 “Tested Loss” of all CFCs wrtw wrtw the shareholder which is a the shareholder which is a U.S. U.S. Shareholder for TY Shareholder for TY of the CFC

• f the CFC that ends with or w/i

that ends with or w/in the TY the TY of the shareholder

• f the shareholder

>0

§ 951A(c)(1)

12

GILTI (Cont)

“Tested Loss” of a CFC for any TY of the CFC = Deductions Gross Income of the including taxes CFC computed w/o allocated to GI

• regard to excluded
• f the CFC under

items in rules similar to § 951A(c)(2)(i) § 954(b)(5) w/o (I) through (V) excluded items in § 951A(c)(2)(i) (I) through (V)

< 0

§ 951A(c)(2)(B)(i)

13

GILTI (Cont)

“Tested Income” of a CFC for any TY of the CFC = Gross Income of the CFC Deductions Except: including taxes

• ECI (952(b))

allocable to

• Subpart F income (954) - GI of the CFC
• GI excluded from

under rules subpart F income as similar to high taxed (954(b)(4)) § 954(b)(5)

• Dividends from “related

w/o excepted persons” (954(d)(3) items < 0

§ 951A(c)(2)(A)

14

GILTI (Cont)

NDTIR of n U.S. Shareholder = .10 Ʃ QBAI Interest expense allocable to For Any TY 1 of all

• “Net CFC Tested Income” to

CFCs extent interest income attributable wrtw to the expense is not taken into SH is account in determining Net CFC a U.S. SH Tested Income of the shareholder used to produce Tested Income >0

§ 951A(b)(2)

15

GILTI (Cont)

QBAI 4 Aggregate adjusted tax basis

• f a CFC

=

¼ Ʃ under ADS (§168(g) as of the close of each

for TY 1 quarter of “Specified Tangible Property” used in t or b of CFC of a type wrtw deduction is allowable under §167

§ 951A(d)(1)

16

GILTI (Cont)

Specified tangible property (STP) of a CFC is (except for “dual use property”) any tangible property used in the production of “tested income”

§ 951A(d)(1)

17

GILTI (Cont)

“Dual use property” is tangible property used by the CFC for production of both “tested income” and income which is not tested income.

§ 951A(d)(2)(B)

18

GILTI (Cont)

Specified Tangible Adjusted base of Shareholder’s Property Allocable = tangible property pro rata share to a CFC in used in t or b by the X

• f “tested

dual use CFC for which income” of the deduction is allowed CFC wrt under §167 tangible property Total gross income of the CFC produced by the tangible property

§ 951A(d)(2)(B)

19

GILTI (Cont)

Allocation of CFC’s distributive Adjusted Adjusted basis = share of income basis of

• f STP of a
• f the partnership as

X items of partnership to a percentage wrt STP held CFC partner the STP by partnership

• f which the

CFC is a partner

§ 951A(d)(3)

20

GILTI (Cont)

Deemed Paid GILTI * Aggregate Credit for = .80 Aggregate Tested Foreign GILTI Inclusion Tested X Income Tax

• f a U.S. Shareholder

Income

• f CFCs
• f CFCs

*Fraction is called “inclusion percentage”.

§ 960(d)(2)

21

GILTI (Cont)

See 78 = GILTI * X Aggregate Gross Up Aggregate Tested Foreign Related Tested Income Income Tax to GILTI

• f CFCs
• f CFCs

Inclusion

• f a U.S.

Shareholder *Fraction is called “inclusion percentage”. § 960(d)(2)

§ 78 and § 960(d)

22

GILTI (Cont)

“Tested Foreign Income Taxes” of a domestic (C) corporation which is a U.S. Shareholder of one or more CFCs is the sum of:

Foreign income taxes paid or accrued by each CFC with “tested income” that are “properly attributable” to the “tested income”

• f the CFC included in GILTI.

§ 960(d)(3)

23

GILTI (Cont)

GILTI (except for passive category income) is assigned to a separate basket for FTC limitation purposes.

§ 904(d)(1)(A)

24

GILTI (Cont)

Foreign Tax Credit = .50 (GILTI + Gross Up) X U.S. Federal Limitation Entire Taxable Income Income Tax for the GILTI - .50(GILTI + Gross Up) Before FTC Basket (Category) Other than Passive

§§ 904(a), (d)(1)(A) and 861(b)

25

GILTI (Cont)

GILTI allocated GILTI from U.S. S/H’s to a U.S. = all CFCs pro rata share of Shareholder wrtw the X “tested income”

• f a CFC for

shareholder is

• f the CFC

purposes of a U.S. Shareholder Ʃ aggregate of §951A(f)(1) “tested income”

• f all CFCs

wrtw the shareholder is a U.S. Shareholder

§ 951A(f)(2)

26

GILTI (Cont)

GILTI Is Generally Treated In the Same Manner as Subpart F Income for Purposes of:

951(a)(1)(A) – Subpart F inclusion 996(f)(1) – E and P of IC DISC 168(h)(2)(B) – not tax exempt prop. 1248(b)(1) – limitation on dividend treatment 535(b)(10) - deduction for AET 1248(d)(1) – exclusion for E & P 904(h)(1) - resourcing 6501(e)(1)(C) – 6 year S of L 952(c)(1)(A) – E & P limitation 6654(d)(2)(D) – estimated tax 959 – PTI stock and ordering 6655(e)(4) – estimated tax 961 – adjustments to basis 962 – election of corporate rates 993(a)(1)(E) – dividends and inclusions wrt foreign export corporations

§ 951A(f)(1)

27

IRC § 962

• A US shareholder of a CFC who is an individual

(including a trust or estate (see treas. reg. § 1.962-2(a)) can make a 962 election, which provides:

– Tax imposed on subpart F inclusions of said individual, including GILTI inclusions (see § 951A(f)(1)), will be subject to tax as calculated under section 11 (i.e., taxes imposed on corporations). – A deemed paid credit under IRC § 960 shall be allowed on such amounts. – Basis step-up under § 961 allowable to the extent of tax paid

29

IRC § 962 – Legislative History (S. Rep.

• No. 1881, 87th Cong., 2d Sess. (1962))
• “The purpose of this provision is to avoid what

might otherwise be a hardship in taxing a U.S. individual at high bracket rates with respect to earnings in a foreign corporation which he does not receive. This provision gives such individuals assurance that their tax burdens, with respect to these undistributed foreign earnings, will be no heavier than they would have been had they invested in an American corporation doing business abroad.”

30

IRC § 962 – Application

• Application of section 11 for inclusions subject to a 962

election (treas. reg. § 1.962-1(b)(1)):

– Section 11 is limited under 962 and the above cited regulation. Specifically, for 962 purposes, “taxable income” means the sum

• f:
• The amounts required to be included in gross income as traditional

subpart F income and GILTI; plus

• The section 78 “gross-up” with respect to those amounts.

– “such sum shall not be reduced by any deduction of the United States shareholder even if such shareholder’s deductions exceed his gross income”

• “Taxable Income” under Section 11 refers to section 63,

which provides taxable income means gross income minus allowable deductions

31

IRC § 962 – Foreign Tax Credit (Treas.

• Reg. § 1.962-1(b)(2)
• Allowance of foreign tax credit:

– There shall be allowed a foreign tax credit under § 960(a)(1) for amounts which are the subject of a § 962 election (subject to the applicable limitation

• f § 904)
• To the extent the foreign tax credit exceeds the § 904

limitation, the excess can be carried back or carried forward, except can only offset other income for which a 962 election is in place

32

IRC § 962 – Treatment of Actual Distributions (IRC § 962(d); Treas. Reg. § 1.962-3

• § 962 E&P less Excludable § 962 E&P are included in gross

income

– § 962 E&P = the E&P of a foreign corporation that were included in the gross income of a the taxpayer under § 951(a) in a prior year and for which a § 962 election is in effect; includes Excludable § 962 E&P and Taxable § 962 E&P – Excludable § 962 E&P = the amount of income tax paid by the taxpayer with respect to the § 962 election in the prior year – Taxable § 962 E&P = the excess over Excludable § 962 E&P.

• Source of distributions:

– § 962 E&P generally is distributed after regular PTI

• Excludable § 962 E&P is distributed first and then Taxable § 962 E&P

33

IRC § 962 – Procedure (Treas. Reg. § 1.962-2)

• Only individuals, trusts or estates may make the election.
• Election made by filing a statement with taxpayer’s return:

– Name, address, and taxable year of each CFC with respect to which the electing shareholder is a US shareholder and all other corporations, partnerships, trusts, or estates in any applicable chain of ownership described in § 958(a) – The amounts, on a corporation-by-corporation basis, which are included in such shareholder’s gross income for his taxable year under § 951(a) – Taxpayer’s pro rata share of E&P of such CFC with respect to which the taxpayer as an inclusion under § 951(a) and the foreign taxes with respect to such E&P – The amount of distributions received by the taxpayer from each CFC which are (1) excludable § 962 E&P; (2) taxable § 962 E&P; and (3) E&P other than § 962 E&P, showing the source of such amounts by taxable year

• Effect of election

– A § 962 election when made is applicable to all CFCs owned by the taxpayer and is binding for the taxable year for which the election is made – An election may be revoked with the approval of the Commissioner. Approval will not be granted unless a material and substantial change in circumstances occurs which could not have been anticipated.

34

IRC § 962 – Areas of Uncertainty

• Can individuals who own CFC through an S

corporation or partnership make a § 962 election?

• Availability of § 250 Deduction for GILTI

Inclusions

• Are subsequent distributions qualified

dividends if distributed from a foreign corporation not located in a treaty jurisdiction?

35

36

Comparative Examples

• GILTI -

Prepared By: William K. Norman Ord & Norman Los Angeles Tel: 310-473-8067 Email: ontaxla@yahoo.com

37

GILTI Comparative Examples:

US Co USI Case 1 Facts: For Co Domestic net income θ Tested income 1,150 Foreign income taxes θ Adjusted basis of QGAI 1,500

38

Analysis of Case 1

Calculation of GILTI Inclusion Tested Income 1,150 Net deemed tangible income return (NDTIR) (.10 * 1,500) <150> GILTI inclusion 1,000

39

Analysis of Case 1 (cont.)

Calculation of Tax Liability of USCO: GILTI inclusion 1000 Dividend of NDTIR 150 1,150 GILTI deduction <500> 650 Taxable income corp tax rate .21 136.5

40

Analysis of Case 1 (cont.)

Calculation of Tax Liability of Ultimate Shareholder:

E & P of USCO: Distribution of GILTI 1000 Dividend of NDTIR 150 1,150 Less Corp. tax <136.5> E & P available for dividend to Ultimate Shareholder 1,013.5 Combined ordinary and unearned rate .238 Ultimate Shareholder tax 241.2

• Corp. level tax

136.5 Total tax burden 377.7 Effective tax rate 377.7/1,150 32.8%

41

GILTI Comparative Examples:

USI Case 1A Facts: For Co Domestic net income θ Tested income 1,150 Foreign income taxes θ Adjusted basis of QGAI 1,500

42

Analysis of Case 1A (cont.)

Calculation of Tax Liability of Ultimate Shareholder: GILTI inclusion 1000 Dividend from For Co 150 Taxable income 1,150 Combined ordinary and unearned rate .408 Ultimate shareholder tax to Ultimate Shareholder 469.2 Effective tax rate 469.2/1,150 40.8%

44

GILTI Comparative Examples:

USI Case 1B – Section 962(b) election Facts: Domestic net income θ Tested income 1,150 Foreign income taxes θ Adjusted basis of QGAI 1,500

§ 962(a) fictional domestic corporation

For Co

45

Analysis of Case 1B (cont.)

Calculation of Tax on Gifts Inclusion at Fictional Corporation Level With §250(a) deduction Without §250(a) Deduction GILTI inclusion 1000 GILTI deduction <500> 500 1000 .21 .21 §962(a) Corp. Tax on GILTI inclusion 105 210

46

Analysis of Case 1B (cont.)

Calculation of Tax Liability of Ultimate Shareholder:

With §250(a) Deduction Without §250(a) Deduction E & P fictional US Co 895 (1000-105) 790 (1000-210) Dividend from fictional US Co 895 790 Direct dividend from For Co 150 150 Applicable ordinary and unearned tax rate .408 .238 .408 .238 61.2 238 238 61.2 188.0 188 274 249 Ultimate Shareholder Tax

• Corp. level tax

105 210 Combined tax burden 379 459 Effective tax rate 379/1,150 or 459/1,150 33% 39.9%

47

GILTI Comparative Examples:

US Co USI Case 2 Facts: For Co Domestic net income θ Tested income less foreign taxes 1,150 Foreign income taxes 275 Effective fringe tax rate 23.9% Adjusted basis of QBAI 1,500

48

Analysis of Case 2

Calculation of GILTI Inclusion for US Co:

Tested income before foreign taxes 1,500 Foreign income taxes <275> NDTIR (.10 * 1,500) <150> GILTI inclusion 725

Calculation of Foreign Tax Credit Amounts: DPTTC = 725 1,150 - 275 .80 275 = 182 Gross Up = 275 = 227.9 725 1,150 - 275 .875 .875

49

Analysis of Case 2 (cont.)

Calculation of Tax Liability of US Co: GILTI inclusion 725 Gross Up 227.9 952.9 GILTI deduction <476.45 > 476.45 .21

• Corp. tax before FTC

100.1 FTC as limited <100.1>

• Corp. Tax

Receipt of distribution of NDTIR net of allocated foreign income taxes is eligible for participation exemption. §245A

50

Analysis of Case 2 (cont.)

Calculation of Tax Liability of Ultimate Shareholder: Available E & P for distribution: Tested income before foreign tax 1,150 Foreign income taxes <275> Dividend to Ultimate Shareholder 875 .238 Ultimate Shareholder tax 208.25 Foreign income taxes 275.00 Total tax burden 483.25 Effective tax rate 483.25/1,150 42%

51

GILTI Comparative Examples:

USI (Case 2A Facts: For Co Domestic net income θ Tested income before foreign taxes 1,150 Foreign income taxes 275 Effective foreign tax rate 23.9% Adjusted basis of QBAI 1,500

52

Analysis of Case 2A

Calculation of GILTI Inclusion for USI: Total income before foreign taxes 1,150 Foreign income taxes <275> N D T I R (-.10* 1,500) <150> GILTI Inclusion 725

53

Analysis of Case 2A (cont.)

Calculation of Tax Liabilities of Shareholder: GILTI inclusions 725 Dividend of NDTIR 150+(150/1150) 275 35.9 185.9 910.9 Combined ordinary and unearned rate .408 Ultimate shareholder tax 371.6 Foreign tax 275.0 Total tax burden 646.6 Effective tax rate 646.6/1,150 56.2%

54

GILTI Comparative Examples:

USI Case 2B Facts: Domestic net income θ Tested income before foreign taxes 1,150 Foreign income taxes 275 Effective foreign tax rate 23.9% Adjusted basis of QBAI 1,500

§ 962(a) fictional domestic corporation

For Co

55

Analysis of Case 2B

Calculation of GILTI Inclusion of Fictional USCO: Tested income before foreign taxes 1,150 Foreign tax <275> NDTIR (.10 * 1,500) <150> GILTI inclusion 725 Calculation of Foreign Tax Credit Amounts: Same as Case 2 DPFTC = 182 Gross up 227.9

56

Analysis of Case 2B (cont.)

Calculation of Tax Liability of Shareholders: E&P and Tax Pool Allocations -- E&P of ForCo PTI Other Total 725* 150 875 Allocation of tax pool 725/875 X 275 228 47 275 *Gross up is excluded from E&P . Regs §1.78-1(a)

57

Analysis of Case 2B (cont.)

Calculation of Tax Liability of Fictional USCO:

With §250(a) Deduction

GILTI inclusion 725 Gross up 227.9 952.9 GILTI deduction <476.45 > Taxable income 476.5 .21 Corporate Tax before FTC 100.1 FTC as limited <100.1>

• Corp. tax

58

Analysis of Case 2B (cont.)

Calculation of Tax Liability of Shareholder (cont.):

Dividend from GILTI (inclusion of fictional USCO) 725 Dividend from ForCo 150 Tax rate on distribution from fictional USCO .238 Tax rate on actual distribution for ForCo .408 Partial Tax 172.6 61.2 61.2 Shareholder Tax Total 233.8 Foreign Tax 275 Total of U.S. and foreign taxes 508.8 Effective tax rate 508.8 / 1,150 44.2%

Comparative Examples – GILTI – Summary of Results

Case 1 Case 1A Case 1B Case 2 Case 2A Case 2B

Combine Effective Tax Rate at various levels ForCo

23.9% 23.9% 23.9%

Immediate Shareholder 136.5/1.180 = 11.9%

+ 40.8%

With W/O $250 $250 10.5% 21% 275/1150 = 23.9%

+ 56.2%

With W/O $250 $250 23.92% 23.9% Ultimate Shareholder

+ 32.8% + 40.8%

With W/O $250*+ $250*+ 33% 39.9%

+ 42% + 56.2%

With W/O $250*+ $250*+ 33% 39.9%

1 3 2

* Assumes qualified dividend rate available for distribution from fictional domestic C corporation + Assumes qualified dividend rate not available for distribution from ForCo.

USI USI USI USI USI USI ForCo USCo ForCo ForCo ForCo ForCo ForCo USCo Foreign Tax = 0 Foreign Tax = 23.9% Foreign Tax = 23.9% Foreign Tax = 23.9% Foreign Tax = 0 Foreign Tax = 0

59

Comparative Examples – GILTI Comments on Summary of Results

Case 1 Case 1A Case 1B Case 2 Case 2A Case 2B

ForCo

23.9% 23.9% 23.9% 1 Row 1 ▪ This row merely states the foreign tax rate for each case. Because of a U.S. Shareholder in every case, the combined U.S. foreign tax rate with or without a distribution is reflected in Row 2.

60

Comparative Examples – GILTI Comments on Summary of Results

Case 1 Case 1A Case 1B Case 2 Case 2A Case 2B

Immediate Shareholder 136.5/1.180 = 11.9%

+ 40.8%

With W/O $250 $250 10.5% 21% 275/1150 = 23.9%

+ 56.2%

With W/O $250 $250 23.92% 23.9%

2 Row 2 ▪ The results under Cases 1 and 1B, assuming the § 250 deduction is allowed, are essentially the same. The reason the effective tax rate in Case 1 is higher than Case 1B (11.9% v. 10.5%) is that in Case 1 we assume the earnings attributed to NDTIR are distributed. If the § 250 deduction is not allowed in Case 1B, the tax burden in Case 1B is almost double the result in Case 1. ▪ The results in Cases 2 and 2B at the domestic corporation level reflect only the foreign tax burden of 23% which completely offsets the domestic corporate tax. ▪ The results in Cases 1A and 2A reflect the disadvantage of an individual U.S. shareholder under the GILTI regime.

61

Comparative Examples – GILTI Comments on Summary of Results

Case 1 Case 1A Case 1B Case 2 Case 2A Case 2B

Ultimate Shareholder

+ 32.8% + 40.8%

With W/O $250*+ $250*+ 33% 39.9%

+ 42% + 56.2%

With W/O $250*+ $250*+ 33% 39.9%

3 Row 3 ▪ Essentially, Case 1 and Case 1B, with the § 250 deduction are the same. ▪ Without a § 250 deduction, Case 1B and Case 1A are comparable in results. ▪ Case 2 is only marginally better than Case 2B with, or, surprisingly, without the § 250 deduction. ▪ Case 2A provides the higher tax burden of the ultimate individual shareholder.

62