The GILTI is a type of income that is received outside the United States by U.S.-controlled foreign companies (CFCs) and is given preferential treatment by the Internal Revenue Service (IRS) of the United States. The tax on GILTI that the United States levies are designed to discourage multinational corporations from moving their profits on efficiently movable assets, including such intellectual property (IP) rights, from the United States to foreign jurisdictions that have tax rates that are lower than those in the United States to stop the erosion of the tax base in the United States. Before the Tax Cuts & Jobs Act (TCJA) was passed in 2017, businesses and people in the United States were required to pay income taxes to the United States on all their income, regardless of where it originated.
But U.S. firms were only required to pay taxes on the international earnings of their foreign subsidiaries when such earnings were distributed as dividends in the United States. The Tax Cuts and Jobs Act (TCJA) altered the tax regulations that apply to multinational organizations by providing a broad exemption from U.S. corporate taxes for the earnings of foreign subsidiaries' active enterprises, even if the revenues were repatriated.
Understanding GILTI
Even though the Tax Cuts and Jobs Act (TCJA) reduced the maximum rate of corporate income tax from 35% to a flat rate of 21% beginning in 2018, the corporation tax rate in the United States is still higher than the rate in many other nations. Yet certain tax havens, such as Jersey, Guernsey, and the Isle of Man, usually did not charge any corporate tax at all, with only a few low-rate exceptions for specific types of revenue derived from real estate, natural resources, and financial services.
Compared to establishing ownership of a valuable patent in the United States, establishing ownership of that patent in a foreign company located in a country with a lower tax rate or no tax at all might nevertheless result in significant tax savings for a multinational corporation. The Tax Cuts and Jobs Act (TCJA) included provisions, most notably the tax on GILTI, to discourage multinational corporations from shifting profits overseas to avoid paying taxes in the United States. This was done in response to concerns that multinational corporations might try to avoid paying taxes by shifting profits overseas.
GILTI refers to the foreign income CFCs produce through intangible assets like copyrights, trademarks, & patents. This type of revenue is derived from outside the country. CFCs, also known as controlled foreign companies, are foreign corporations in which U.S. stockholders own more than 50% of the vote or value combined and individually own at least 10% of the CFC.
The GILTI Tax System in Action
The tax on GILTI is not levied on profits made by CFCs per se but instead acts as a minimum tax on all earnings made by those CFCs, regardless of where they were earned. Determining what percentage of a CFC's revenue is GILTI is complicated. Global intangible low-taxed income (GILTI) is the amount of a CFC's taxable income that is more than the net considered tangible income return of a CFC, equal to 10% of a CFC's investment in depreciable, substantial business assets less specified interest expenditure.
According to this approach, CFCs' tangible investment returns of 10% are essentially free from U.S. corporation taxation. If a CFC earns more than the exemption threshold, the excess is taxed as GILTI since it is assumed to represent income from investments in intangible assets. Therefore, CFCs whose profits are disproportionately high about one's investment in tangible or fixed assets, such as service provisioning, logistics, purchasing, distribution, and the development of technological infrastructure and applications, will be hit particularly hard by the tax on GILTI. In addition, GILTI is subject to the special decreased foreign tax credit restrictions.
When income is subject to elevated foreign tax rates, the GILTI formula might result in tax rates greater than 13.125% due to the complex nature of allocating expenses and credits. To determine how GILTI should be treated and calculated, the Treasury Department and the Internal Revenue Service published rules. To address the unanticipated high rates of U.S. tax on income subject to very high foreign tax rates, they have also suggested restrictions on the tax treatment of CFC income.
