As 2021 draws to a close, the future of the Build Back Better Act (BBBA) – the Biden administration’s successful $ 1.75 trillion spending plan – hangs in the balance. The measure, which was passed by the House on November 19e, is currently being debated in the Senate, but there is little indication that it will pass by Christmas as Democrats had hoped.
The future of the BBBA is important to taxpayers and tax practitioners, as the law contains several important tax changes, including substantial revisions to the Global Low Tax Intangible Income Tax (GILTI), which was enacted in 2017 in under the Tax Cuts and Jobs Act (TCJA) (creating a new Section 951A of the Internal Revenue Code).
The GILTI tax applies to U.S. shareholders of controlled foreign corporations (CFCs) and imposes a minimum rate of 10.5% to 13.125% on their income from intellectual property and other assets held abroad. This way it works like a minimum tax. The House version of the Build Back Better Act (HR 5376) seeks to increase the GILTI tax in several key ways.
Deduction under section 250
U.S. persons (citizens, residents, substantial presence or green card holders, domestic entities) are treated as U.S. shareholders of a controlled foreign corporation (CFC) if those individuals directly or indirectly own at least 10% shares or voting securities of a foreign company. . A CFC is any foreign company in which more than 50 percent of the votes or the value of the shares are held by US shareholders on any day of a given year.
The TCJA has created significant tax savings opportunities for domestic US corporations through deductions created under IRC Section 250 for GILTI and the Foreign Derived Intangible Income provision ( FDII). Taxpayers can calculate these deductions by filling out Form 8993. But the Build Back Better Act seeks to reduce some of these savings opportunities.
Currently, US CFCs can claim a 50 percent deduction rate on their GILTI, under IRC Section 250 deduction. BBBA intends to lower the IRC Section 250 deduction rate to 28.5%, which would increase the effective tax rate of GILTI to 15%.
GILTI works in tandem with FDII, which the BBBA would also modify. The FDII entitles U.S. corporations to a separate deduction, also under section 250 of the IRC, on income from the sale of goods and services to foreign customers for foreign use. The current IRC Section 250 deduction rate for the FDII is 37.5%, which generates an effective tax rate of 13.125. But the BBBA intends to reduce the FDII deduction rate to 24.8%, which would generate an effective tax rate of 15.8%.
Both would apply to tax years that begin after December 31, 2022.
On the plus side, the BBBA would allow taxpayers whose IRC Section 250 deductions exceed taxable income to use the excess to calculate their net operating losses, which could result in additional NOL carryforwards. This new treatment under IRC Section 951A (c) would apply to tax years beginning after December 31, 2022.
Exemption from investment in qualifying business assets
Another savings opportunity for taxpayers that is set to change is the Qualified Business Asset Investment Exemption, which currently allows taxpayers to exclude a ten percent return on foreign tangible assets from their GILTI base. . Under BBBA, the exclusion would be halved under Section 951A (b) (2) (A), at a yield of five percent.
Average country by country
Under the current GILTI rules found in Section 951A of the IRC, tax is calculated by averaging the income and foreign taxes of a U.S. taxpayer around the world to determine liability. Critics argue that this averaging approach is ineffective because taxpayers can use income from their operations in low-tax jurisdictions to offset income earned in higher-tax jurisdictions.
The Build Back Better Act plans to remove the GILTI average and calculate the tax country by country to avoid potential abuse. Under this plan, the income of foreign branches (which are taxable business units under the laws of the foreign country in which they operate) would be included in this calculation. It also means taxpayers are likely to face additional compliance costs.
Small haircut GILTI
One of the most controversial aspects of the GILTI regime is a limitation on the amount of foreign tax credits (FTC) that can be used to offset the GILTI obligation under section 960 (d) of the IRC. Taxpayers who calculate their FTC can do so on Form 1118, Foreign Tax Credit, under IRC Section 951. Under current law, taxpayers can use 80% of their foreign tax credits to offset their GILTI obligation. This is called the discount of the GILTI foreign tax credit. Some taxpayers were hoping the haircut would be removed so they could use all of their foreign tax credits for offsets, but the BBBA is keeping the haircut.
That said, the BBBA offers more generous treatment. Under the law, taxpayers would be allowed to use 95% of their foreign tax credits as compensation. Given the additional complexities and increased tax burdens envisioned by the BBBA, if a taxpayer does not have voting rights and has never wanted to participate in the management of the SEC, one of the options to avoid the complexity of l The GILTI tax is to form a foreign trust and invest the CFC Shares held by said foreign trust. This eliminates the calculation and reporting of GILTI taxes.
The foreign trust strategy has some drawbacks, as already discussed in a previous article. There are potential gift tax implications, additional tax filing fees, and the taxpayer may be required to calculate Net Distributable Income (DNI), which is reported on Form 3520 and potentially on Form 3520. -AT.
Overall, these changes, if implemented, will significantly reshape the GILTI regime. They could also create new complexities and tax burdens for taxpayers that will require careful and thoughtful attention from an experienced tax practitioner.