Freeman Law frequently advises international business ventures. International operations often give rise to unique (and sometimes unanticipated) compliance obligations and complex reporting requirements. Recent tax reform rules and regulations have imposed a number of new requirements. The IRS and Treasury Department have elaborated on these new rules through proposed regulations and other guidance. This post provides a short introduction to the concept of “tested income” under the new GILTI tax regime.
As described in our prior Insight post, Tax Reform’s New GILTI Tax, the new GILTI tax will impact many businesses, particularly those that have a high profit margin compared to their fixed asset base. For example, service companies, software and other technology companies, distribution companies, and companies that typically realize a significant international return on intangible assets, may be particularly impacted by the Code’s new GILTI provisions.
The Tax Cuts and Jobs Act, Pub. L. 115- 97 (2017) (“the TCJA”) enacted new section 951A, which imposes the new tax on Global Intangible Low-Taxed Income (the “GILTI tax”)—a central part of the new international tax regime. The TCJA largely shifted the U.S. corporate tax system from a worldwide tax system to a “quasi-territorial” system. However, like the existing Subpart F regime, the GILTI tax creates an important category of income that is subject to current taxation.
The proposed regulations require that taxpayers annually file a new Form 8992, U.S. Shareholder Calculation of Global Intangible Low-Taxed Income, as well as a new Schedule I-1, Information for Global Intangible Low-Taxed Income, with their annual Forms 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations.
The concept of “tested income” plays an important role in calculating GILTI. For purposes of calculating GILTI, “tested income” is generally defined as the gross income of a CFC, but without regard to certain specifically excluded categories of income. Tested income is defined at §1.951A-2(b)(1) of the proposed regulations.
The proposed regulations technically define “tested income” as “the excess (if any) of a controlled foreign corporation’s gross tested income for a CFC inclusion year, over the allowable deductions (including taxes) properly allocable to the gross tested income for the CFC inclusion year.”
The term “gross tested income” is defined as the gross income of a controlled foreign corporation for a CFC inclusion year determined without regard to–
(i) Items of income described in section 952(b),
(ii) Gross income taken into account in determining the subpart F income of the corporation,
(iii) Gross income excluded from the foreign base company income (as defined in section 954) or the insurance income (as defined in section 953) of the corporation solely by reason of an election made under section 954(b)(4) and §1.954-1(d)(5),
(iv) Dividends received by the corporation from related persons (as defined in section 954(d)(3)), and
(v) Foreign oil and gas extraction income (as defined in section 907(c)(1)) of the corporation.
The proposed regulations further provide that the allowable deductions that offset the “gross tested income” in order to arrive at “tested income” are determined by applying the rules set forth in regulations under §1.952-2 for determining the subpart F income of a controlled foreign corporation. Thus, as in other contexts, GILTI is calculated by leveraging the existing regulatory infrastructure related to Subpart F.
For more topics related to International tax reform, see other Insights such as: Advising International Business Ventures: Tax Reform’s Section 245A Participation Exemption Regime; Advising International Business Ventures: Tax Reform’s “Transition” Tax; Advising International Business Ventures: Tax Reform’s New GILTI Tax; Advising International Business Ventures: Controlled Foreign Corporations and Subpart F; and Advising International Business Ventures: Passive Foreign Investment Companies (PFICs).