Dateline: Bogota, Colombia
Tax reform in the United States is a dangerous business.
Before the highly anticipated “Trump Tax Reform” was finalized in 2017, there was talk of abandoning citizenship-based taxation and adopting the same residence-based system of taxation as most other western countries in the world. A lot of hope was in the air.
In the end, it was only talk.
The promising business outlook of Trump and proposals such as residence-based taxation turned into something that made international business ownership as a US person almost a nightmare.
Scratch that. It was a nightmare.
In an effort to flex the muscle of the US government and bring big corporations and their revenue back to US soil, the Trump Tax Reform – officially known as the Tax Cuts and Jobs Act (TCJA) – subjected anyone doing business offshore to the Global Intangible Low Tax Income tax, or GILTI.
Is it coincidence, irony, or a purposeful revelation of political opinion that the tax regulation aimed at folks doing business offshore sounds like “guilty”?
We don’t know, but we do know that it was introduced as an incentive to keep intellectual property (IP) in the United States rather than losing valuable IP and other intangible assets to offshore markets.
Before GILTLI, it was possible to defer all income tax by keeping your funds in a foreign corporation. Those days are long gone, but are there ways to still save on tax by going offshore?
In this article, you’ll learn about the GILTI tax, what it is, who it affects, and how you may be able to reduce your Global Intangible Low Tax Income tax rate and obligation with various offshore strategies.
What Is the GILTI Tax?
The Global Intangible Low Tax Income (GILTI) is a tax law introduced in 2017 as part of the Tax Cuts and Jobs Act (TCJA).
As mentioned, under the previous tax laws, US companies could defer the tax on the active business earnings of a foreign corporation unless those earnings were repatriated to the United States. Along with the Foreign Earned Income Exclusion, you could largely live tax-free as a US citizen offshore by having an offshore company.
Under the TCJA, the US now exempts (rather than defers) the active business earnings of foreign subsidiaries of US businesses even when repatriated. Sounds good, right? This was a big push to get companies like Google, Apple, and others to repatriate many of their offshore holdings back to the US to boost the US economy.
But there was a catch.
To discourage US multinationals from shifting their profits offshore to take advantage of this exception, the government also added a new 10.5% minimum tax on all global income from intangible assets that is not already taxed at a high rate in the source country.
These intangible assets include such things as patents, trademarks, and copyrights that are held offshore by US persons. The government hoped that this would keep US companies from using intellectual property transfer pricing with offshore entities in zero-tax and low-tax jurisdictions since IP is one of the easiest assets to shift offshore.
So now, any offshore company not paying enough overseas has to pay the GILTI tax at home too… if they qualify as a GILTI tax individual.
Who Counts as a GILTI Tax Individual?
An individual or entity is subject to GILTI if the following two factors apply:
- US Shareholder – US Person owning at least 10% (directly or indirectly) of the foreign corporation’s vote or value
- Controlled Foreign Corporation (CFC) – any foreign corporation of which more than 50% of the vote or value is owned by a US shareholder.
In the first case, GILTI is applied at the individual level to any US person who privately owns 10% of the vote or value of a foreign company. That 10% is based on the aggregate of the US person’s pro-rata share from all CFCs in which they are a shareholder.
What is a US person, you ask?
That wide umbrella includes not only US citizens but also residents, partnerships, corporations, estates, and trusts. Basically, any financial entity or person legally deemed to be a part of the US tax system.
The second GILTI factor opens the umbrella even wider and applies the tax regulations to foreign corporations as well… if they have enough US involvement.
If at least half of a foreign company is collectively owned by US persons, it is deemed a Controlled Foreign Corporation (CFC) and is considered a GILTI tax individual. This collective total is calculated by the shareholder’s basis rather than the company’s basis.
There are also certain requirements you must meet to qualify for the 10.5% tax rate. Just like previous tax deferrals, the lower GILTI tax rate can only be applied to international businesses that do not engage in US business or trade.
If you have operations such as an office or warehouse in the US, or a “dependent agent” that works for you exclusively, you have a US presence and cannot take advantage of the 10.5% GILTI tax rate.
What Is the GILTI Tax Rate and How Is It Calculated?
I already mentioned that the minimum GILTI tax rate is 10.5%, but that is only the minimum rate. The rate can go as high as 13.125% and that tax threshold is expected to rise to 18.9% in the next year.
But the GILTI tax calculation is much more complicated than merely applying a single rate to your company’s foreign income from intangible assets.
We already know that a US company must report GILTI in its annual gross income for any active offshore income that is equal to or more than 10% of the company’s assets. But how exactly do you calculate the tax owed?
Unfortunately, as with all things involving US tax laws, it is extremely complicated. Why? Well, there are other tax laws at play too, including complex foreign tax credit expense allocation rules. Thanks to these rules, US taxpayers are still liable for GILTI even if they have foreign tax obligations above 13.125%.
Generally, a US corporation can report GILTI with their corporate taxes and claim the 50% GILTI rate of 10.5% on all global intangible low-tax income compared to the regular 21% US corporate tax rate.
You can then claim a foreign tax credit for 80% of the foreign taxes paid or accrued on that income. If you are incorporated in a zero-tax country, you would owe the full 10.5% to the IRS. But if you paid anything to the offshore company jurisdiction, you can claim the foreign tax credit.
Let’s illustrate this.
Let’s say your company is located in a low-tax jurisdiction like Bulgaria where there is a 10% corporate tax rate. And to keep things simple, let’s say you have $1 million in active income from the intangible assets you hold in that company.
You will have to pay the full amount of tax due in Bulgaria on that income. In this case, that’s $100,000. If you own the foreign corporation directly, you can use the tax credit as a deduction against income. If a C Corp owns the foreign company, you take the amount you paid in tax to Bulgaria and use that as a tax credit via gross-up calculation.
The US tax on that same income would be $105,000 (with the GILTI tax rate of 10.5%) before the foreign tax credit. But since you already paid $100,000 to Bulgaria, you can claim a foreign tax credit of $80,000 and will then owe a total of $25,000 to the US government ($105,000 – $80,000).
In total, you would have paid $125,000 in taxes, an effective tax rate of 12.5%.
The calculations are usually much more complicated than this, but that’s the simplest explanation of how it works.
How Can I Reduce My GILTI Tax Obligations?
If the foreign tax rate is high enough, there is a GILTI high tax exception. If the tax rates in the country where your business is incorporated are 13.125% or more, the foreign tax credit will cancel out any tax owed to the IRS.
But until a company goes over that threshold, they will still be liable to some level of GILTI tax.
And now that the threshold is expected to go up to 18.9% in the coming year, there will be very little difference between the 18.9% or more you would be paying to a foreign country versus the 21% you would be paying in the US.
So, the question remains: Is there a better way to reduce your GILTI tax obligations?
The short answer is yes.
The long answer is that it’s even more complicated and could never fully be covered in a blog post that you found on the internet. That said, I can summarize the four different strategies available to you.
1. Convert GILTI to Subpart F income.
Subpart F income is something you’ll usually be trying to avoid when you go offshore because it applies to passive income that is taxed at ordinary tax rates and cannot be exempted under the Foreign Earned Income Exclusion.
But in this case, what you’ll have to pay through Subpart F is probably going to be much lower than the GILTI tax (again, depending on your unique situation).
This is particularly true for financial companies like banks that have a higher interest expense than companies in other industries which means they will have a higher GILTI inclusion.
2. Increase Qualified Business Asset Investments
If you are a shareholder in a CFC, you can lower your GILTI tax requirement by increasing your qualified business asset investments.
There are multiple ways you can increase qualified business asset investments. One option is purchasing equipment that has been previously leased.
This method won’t work if you don’t have enough control over the corporation to actually make these changes. And while it may be a good decision tax-wise, it may not have the best impact on your business.
3. Avoid CFC and Shareholder Status
Because GILTI tax applies to shareholders of CFCs, one way to avoid it would be to avoid CFC and shareholder status completely.
GILTI applies if you own 10% of the vote or value of a foreign corporation, so you can avoid it by owning less than 10%.
4. Put Shares of a CFC In a Private Placement Life Insurance Policy
You can put your assets into a life insurance policy and borrow from the death benefit while you are alive. Death benefits are tax-free, which means you’ve essentially avoided all income taxes — both federal and state.
The costs of this are high. It really only makes sense when you have about $10 million in assets.
Additionally, these are complicated structures that require you to be flexible and relinquish some control. Not many business owners and investors are willing to do that.
There’s Really Only One Way Out
As time goes on, the US is going to find even more ways to pull you into their tax net as taxes on the wealthy increase. GILTI is only one way they have already done this.
And they are already planning to increase the threshold for GILTI this year.
The only true way to avoid GILTI and whatever other wealth punishment the US government comes up with is to leave the US behind completely.
Not everyone is ready to renounce their US citizenship to get this type of relief, but there are ways like the ones discussed above that are still available to you that you can use in your tax planning to significantly reduce your GILTI tax.
If you are interested in getting help to create your holistic global tax plan – GILTI included – you can contact our Nomad Capitalist team here.