The tax reform of 2018 has created a real revolution – reducing the corporate tax rate, reducing the maximum marginal tax rate, providing tax exemption in the distribution of dividends of a foreign company, and much more. Despite these significant concessions, the tax reform imposed new tax obligations. Among these obligations is the GILTI provision.
In the article here before you, we will examine the main duties of the GILTI provision, the reasoning behind it, who it applies to, and whose condition it will improve or worsen. This and much more – in the following article.
The tax reform of 2018 – tax relief along with the imposition of new tax obligations
In 2018, President Trump’s tax reform came into effect, a reform that manifested itself in the law known as the Tax Cut and Jobs Act. On the one hand, the reform included reducing tax rates and changing the international tax system, but on the other hand, it included the imposition of new tax obligations, the abolition of deductions and credits, and the limitation of deduction of expenses. For example, the corporate tax rate and the maximum marginal tax rate were reduced, a dividend distribution tax was granted by a foreign company and tax benefits were granted to L.L.C.
However, the standard tax deductions were abolished, a one-time conceptual tax was established on the profits of foreign companies under American control, and the GILTI was imposed. It should be noted that these are only a few of the changes made by the reform.
The reasoning behind the GILTI tax
The GILTI tax is designed to manage the practice of American corporations and individuals holding foreign companies controlled, that is, companies incorporated under foreign law but effectively controlled by American stakeholders and operating through them. The foreign companies operate, of course, outside the United States, and therefore their income is not taxable.
Thus, the American entities effectively keep their income away and avoid paying taxes. This practice is especially common among the business activity of intangible assets – intellectual property, patents, etc.
In order to prevent the distribution of intellectual property outside the United States and to ensure tax payment for the profits of American controlled foreign companies, the U.S. government imposed the GILTI tax. As detailed below, this is a conceptual tax, which applies to the income of foreign companies managing intangible assets, even if the income was not distributed in dividends.
The main principles of the GILTI provisions
The GILTI provision applies to American entities and stipulates that an entity that holds more than 10% of a controlled foreign company will be liable to tax on the company’s income deducting expenses and 10% of the value of the company’s fixed assets.
We will clarify the different components in this act:
An American entity
The provision applies to U.S. citizens, people who hold a permanent resident status (green card holders), and local corporations (C-CORPORATION, L.L.D. companies, etc.).
An American controlled foreign company
A controlled foreign company is a corporation incorporated under foreign law and which is actually controlled by American entities. In order for a company to be designated as controlled, 50% of its shares must be held by U.S. citizens or companies incorporated under U.S. law. It is not enough that 50% of the shares will be held by American entities, but that each of these entities should hold at least 10% of the shares.
A controlled foreign company is a corporation incorporated under foreign law which is actually controlled by American entities. In order for a company to be defined as a controlled foreign company, 50% of its shares must be held by U.S. citizens or companies incorporated under United States law. It is not enough for 50% of the shares to be held by American entities, but it is necessary for each of these entities to hold at least 10% of the shares.
In a case where some of the holders hold less than 10% shares, but one of the subsidiaries is completely owned by the foreign company and is a company incorporated under U.S. law – the foreign company will be considered a controlled company. Moreover, once a company has been designated as a controlled foreign company, all of its subsidiaries under its full control will also be defined as controlled foreign companies.
The tax liability on the company’s income
The tax applies to the company’s revenues even before dividends are distributed, but with the deduction of expenses and another 10% of the company’s tangible asset value. In this way, it is guaranteed that the tax will apply primarily to income from intangible assets and will prevent the diversion of intellectual property outside the United States in the future. Out of this amount, which is the taxable profit, the tax rate will be calculated.
GILTI tax rates: Effects on C-CORP companies
As noted, the tax is calculated from the adjusted income (the company’s revenues after deducting expenses and 10% of the value of intangible assets). If the entity held by the controlled foreign company is C-CORPORATION, the tax rate on taxable profit should be 21% – the corporate tax rate.
However, the GILTI provisions stipulate a 50% discount on this rate and also stipulate the possibility of obtaining a tax credit at a rate of up to 80% for foreign tax paid on the company’s income. This means that as a matter of fact the tax rate as far as companies are concerned is only about 13.1%.
Therefore, as far as the American C-CORPORATION companies are concerned, the GILTI provisions entail somewhat of a benefit, since in other circumstances the distribution of income as a dividend would have required them to pay a higher tax rate.
GILTI and tax rates: effects on individuals and partnerships
If the entity held by the controlled foreign company is an individual, an L.LD or partnership, the tax rate on taxable profit should be a reduced tax rate applicable to a dividend (less than 20%). However, according to the GILTI provisions, the tax rate that will apply to such entities is the marginal tax rate applicable to the individual according to his income level, which is between 10-37%.
Moreover, for individuals, the provisions of the law do not set a 50% discount on the tax rate, nor do they determine the possibility of receiving a credit for the foreign tax paid on the company’s income. This means that for individuals the effect of GILTI may be extremely dramatic, reaching about 70% tax given the tax rule paid for the company’s income.
The good news is that the law allows an individual to request to be taxed on the income of the foreign company controlled by C-COR by applying section 962 of the Law.
The 2018 tax reform and its new tax obligations require organizing and rethinking the ways in which you carry out your economic activity.
The MasAmerica team has expertise and experience in accounting and law, in Israel and in the United States, and will be happy to find the best investment strategy for you.
This should not be seen as legal advice. It is recommended to consult with the team of MasAmerica before any action. The service is provided by a professional team, who speak English and Hebrew fluently, and includes lawyers and accountants with American licensees.