Expense Apportionment to GILTI
Following tax reform, domestic corporate taxpayers are required to include in gross income the amount of a CFC’s income in excess of its Subpart F income and 10 percent of depreciable tangible property (referred to as GILTI). The corporate taxpayer generally can deduct 50 percent of the amount of GILTI (10.5 percent US tax rate), and claim a foreign tax credit for 80 percent of foreign taxes paid or accrued on the GILTI (subject to limitation).
The Conference Report states: “At foreign tax rates greater than or equal to 13.125 percent, there is no residual US tax owed on GILTI, so that the combined foreign and US tax rate on GILTI equals the foreign tax rate.”
Many taxpayers are finding—to their surprise—that, if pre-tax reform expense allocation and apportionment principles apply, the foreign tax credit limitation can result in a significantly higher overall tax rate than 13.125 percent. For example, assume a domestic corporation has $10 million of GILTI that was subject to a 25 percent foreign income tax rate. Further assume that, under existing expense allocation and apportionment rules, $3 million of expenses (e.g., interest) would be apportioned to the income. Under these facts, $630,000 of US tax would be paid on the GILTI because of the foreign tax credit limitation, resulting in an overall effective tax rate of 31.3 percent.
The US Department of Treasury has been open to discussions with taxpayers to explore potential approaches to expense allocation and apportionment that would address the adverse impact of the pre-tax reform rules. Taxpayers should consider taking the opportunity to discuss their concerns and issues with Treasury through in-person meetings, comment letters or by endorsing comment letters that support your position. Treasury and the IRS are currently working on proposed regulations on GILTI and are targeting issuance of such guidance in late summer of 2018. Thus, the window to provide comments on this guidance is soon closing.