What is the Global Intangible Low-Taxed Income (GILTI)?

Global Intangible Low-Taxed Income (GILTI) is a tax provision introduced under the U.S. Tax Cuts and Jobs Act of 2017, aimed at reducing profit shifting by U.S. multinational corporations to low-tax foreign jurisdictions. It applies to income earned by Controlled Foreign Corporations (CFCs) that exceeds a deemed return on their tangible assets. GILTI is calculated as the excess of a CFC's tested income over 10% of its Qualified Business Asset Investment (QBAI).

The resulting income is included in the U.S. parent company's taxable income, with partial deductions and foreign tax credits available to mitigate double taxation. GILTI ensures that profits, including those generated from intangible assets, are subject to a minimum level of U.S. taxation, even if earned in low-tax countries.

Purpose of GILTI

The primary aim of the GILTI regime is to prevent U.S. corporations from avoiding U.S. taxes by shifting their profits to foreign subsidiaries located in low-tax jurisdictions. Before GILTI, many companies exploited differences between U.S. and foreign tax systems to reduce their overall tax liability. They would locate valuable intangible assets, such as patents or trademarks, in subsidiaries in countries with low or no corporate income taxes. The income generated from these assets would then be subject to minimal foreign taxes, allowing corporations to reduce the amount of tax owed in the United States.

GILTI is intended to capture this income and ensure that it is taxed at a reasonable rate by the U.S. government, regardless of where it is earned. It applies to all income of controlled foreign corporations (CFCs) that exceeds a certain threshold, not just income from intangible assets. This broad application was meant to prevent companies from sidestepping the rules by reclassifying income or using other loopholes.

How GILTI Works

GILTI is calculated based on the income of a U.S. company’s foreign subsidiaries—specifically, the income that exceeds a "normal" return on the subsidiaries' tangible assets. Here’s a step-by-step breakdown of how it works:

1. Controlled Foreign Corporations (CFCs)

GILTI applies to income earned by Controlled Foreign Corporations (CFCs). A CFC is any foreign corporation in which more than 50% of the total combined voting power or value is owned by U.S. shareholders. GILTI calculations aggregate income across all CFCs owned by a U.S. shareholder.

2. Tested Income

GILTI begins with what is known as “tested income.” Tested income refers to the gross income of a CFC, excluding certain types of income such as:

• Effectively connected income (ECI) with a U.S. trade or business
• Subpart F income (another category of income subject to immediate U.S. taxation)
• Foreign oil and gas extraction income
• High-taxed income that is subject to a foreign tax rate of more than 90% of the U.S. corporate rate Once these exclusions are applied, the CFC’s remaining income is classified as tested income.

3. Net Deemed Tangible Income Return (NDTIR)

To calculate the portion of a CFC’s income that will be subject to GILTI, the U.S. parent company can subtract a deemed return on its tangible assets. This is referred to as the Net Deemed Tangible Income Return (NDTIR). The formula for NDTIR is:

NDTIR = 10% of the CFC’s Qualified Business Asset Investment (QBAI)

QBAI is the average adjusted basis of the CFC’s tangible property used in the production of its tested income. This property typically includes machinery, equipment, and other depreciable assets.

4. GILTI Inclusion

After subtracting the NDTIR from the tested income, the remaining amount is the Global Intangible Low-Taxed Income (GILTI). The U.S. shareholder must include this amount in its U.S. taxable income, whether or not the income is distributed as dividends.

5. Section 250 Deduction

U.S. corporations are entitled to a deduction under Section 250 for a portion of their GILTI. As of 2023, this deduction allows corporations to reduce the GILTI inclusion by 50%, effectively lowering the tax rate on GILTI to 10.5%. The deduction rate is set to decrease to 37.5% in 2026, which would raise the effective tax rate on GILTI to 13.125%.

6. Foreign Tax Credits (FTCs)

To avoid double taxation, U.S. companies can claim a Foreign Tax Credit (FTC) for foreign taxes paid on GILTI. However, there are limitations. Only 80% of the foreign taxes paid on GILTI income are eligible for the credit, and any unused credits cannot be carried forward or back to other tax years. This limitation increases the likelihood of residual U.S. tax on GILTI, particularly for companies operating in countries with low corporate tax rates.

Key Terms Related to GILTI

1. Controlled Foreign Corporation (CFC):
   A foreign corporation in which U.S. shareholders own more than 50% of the combined voting power or value.
2. Tested Income:
   The income of a CFC subject to GILTI after excluding certain types of income like Subpart F income and effectively connected income (ECI).
3. Qualified Business Asset Investment (QBAI):
   The average adjusted basis of tangible property used in the production of tested income. QBAI determines the amount of NDTIR that can be subtracted from tested income.
4. Net Deemed Tangible Income Return (NDTIR):
   The 10% deemed return on QBAI that is excluded from the GILTI calculation.
5. Foreign Tax Credit (FTC):
   A credit that U.S. taxpayers can claim for foreign taxes paid. For GILTI purposes, only 80% of foreign taxes paid are eligible, and unused credits cannot be carried forward.

Compliance and Reporting Requirements

The GILTI regime significantly increases the compliance burden for U.S. multinational companies. Corporations must now track, report, and calculate GILTI for all of their foreign subsidiaries, which involves gathering detailed financial information about each CFC's income and assets.

Moreover, companies must maintain records on:

• The amount of tested income generated by each CFC
• The value of QBAI and the calculation of the NDTIR
• The foreign taxes paid on GILTI income, to determine FTC eligibility

Failure to accurately report and calculate GILTI can result in significant penalties, making compliance a critical issue for multinational companies.

Policy Considerations and Criticisms

While GILTI was designed to reduce profit shifting, it has faced criticism for a number of reasons:

1. Residual U.S. Taxation

Even though the GILTI regime allows U.S. corporations to claim a Foreign Tax Credit, the 80% limitation and the inability to carry forward unused credits often result in residual U.S. tax. This residual tax occurs even when corporations pay substantial foreign taxes on their GILTI income, leading some to argue that GILTI creates an unfair tax burden for companies operating in high-tax foreign jurisdictions.

2. Broad Application

GILTI applies to more than just intangible income, despite its name. The broad application means that any income earned by a CFC above the NDTIR threshold is subject to U.S. tax, even if it is not derived from intangible assets. This has led to complaints that GILTI unfairly penalizes companies that earn profits from tangible business activities in foreign markets.

3. Competitive Disadvantage

Some U.S. companies argue that the GILTI regime puts them at a competitive disadvantage compared to foreign competitors. Foreign companies that do not have U.S. shareholders are not subject to GILTI-like rules, potentially allowing them to benefit from lower tax rates in foreign jurisdictions.

The Bottom Line

Global Intangible Low-Taxed Income (GILTI) is a provision of the U.S. tax code that was introduced to combat profit shifting by U.S. multinational corporations. It requires companies to include foreign earnings in their U.S. taxable income if the income exceeds a threshold tied to the tangible assets of foreign subsidiaries. While GILTI was intended to reduce tax avoidance, it has increased the compliance burden for U.S. companies and created potential tax liabilities even for income earned in high-tax foreign jurisdictions.