updated 6:36 PM CET, Mar 18, 2023

Proposed IRS tweaks to GILTI regs seen giving break to American taxpayers resident in high-tax countries

Proposed rule changes to the way “foreign income” earned by “Controlled Foreign Corporations” would be taxed by the U.S. would be good news for American taxpayers living in high-tax countries, tax experts have said.

The proposed rule changes, issued on Friday (June 14), would expand a high-tax exclusion for multinationals that have been unintentionally hit by an international provision meant to ensure that companies pay a minimum tax on offshore profits in low-tax countries, the so-called GILTI (Global Intangible Low Tax Income) tax.

The GILTI tax was introduced by President Trump’s Tax Cuts & Jobs Act (TCJA) in December, 2017, and came into force on Jan. 1 of the following year. It requires companies to pay a 10.5% tax on any of their offshore profits that aren’t already taxed at a rate of at least 13.125%.

The tax applies to income that U.S. shareholders earn from controlled foreign corporations (CFCs) – those that are more than 50% owned by U.S. shareholders who own 10% or more of the total stock in the entity.

Under the GILTI provisions, it has emerged, some companies with CFCs that were paying more than 13.125% overseas were still getting caught by GILTI.

As reported here in March, American expat groups have been campaigning vigorously for changes in the way the TCJA generally and the GILTI tax in particular is written, as they argue that it unfairly hits American taxpayers living outside of the U.S., with owners of small overseas businesses particularly hard-hit. 

The proposed regulations (REG-101828-19) include new guidance under tax code Section 958 for determining stock ownership, as well as under Section 951, with respect to GILTI income.

Tax experts say the proposed changes will be particularly welcome to Americans living outside the United States who are attempting to carry on business in their country of residence, through non-U.S. corporations.

Among the tax experts celebrating the publication of the proposed rule changes issued by the IRS has been Monte Silver, a U.S. tax attorney resident in Israel who, in February, filed a lawsuit in U.S. District Court against the IRS and U.S. Treasury, in which he challenged key elements of the TCJA, including the way it treated owners of small non-U.S. businesses owned by Americans. 

"Of course, the new relief is still only a proposed regulation, and we must wait for the final regs to be issued," Silver said on Sunday, in a posting on a Facebook page for American expats.

"But it is safe to say that if you live in a country where the corporate tax is at least 18.9%, then you can smile a very big smile today."

John Richardson, a Toronto-based tax and citizenship lawyer, also said the news was a potentially important victory for crusaders against certain aspects of the TCJA. What's more, he pointed out today, the latest IRS statement with respect to GILTI represented the second time thus far this year that the U.S. Treasury has proposed a fresh interpretation of the GILTI rules that has been "favorable to individual owners of CFCs."

The first time was in March, when it determined that individuals using the Section 962 election were entitled to the same 50% discount that corporations were entitled to, by statute, he noted; now, in proposing that the Section 954 "high tax exclusion" should apply to all the foreign income earned by a CFC, the Treasury is effective saying "that income earned by foreign corporations with a tax rate of at least 18.9% would not be [classified as] GILTI," Richardson, who recently published a blog on the matter, added.

"Treasury should be congratulated for interpreting the legislation in a purposive manner, and should now turn its attention to interpreting the Section 965 transition tax in a way that is [as] so damaging to individuals as it currently is."

‘High-tax exclusion should be expanded’

In a statement issued on Friday alongside the proposed regulations, the IRS and  U.S. Treasury said that “in response to comments” they had “determined that the GILTI high-tax exclusion should be expanded, on an elective basis, to include certain high-taxed income even if that income would not otherwise be FBCI [foreign-based company income] or insurance income.”

“In particular, the Treasury Department and the IRS have determined that taxpayers should be permitted to elect to apply the exception under section 954(b)(4) with respect to certain classes of income that are subject to high foreign taxes within the meaning of that provision,” they went on.