There is a tremendous shift in U.S.-Canadian cross-border tax affairs, owing to the recent enactment of the U.S. tax reform – the initial wave having come into effect on January 1, 2018. This move represented a complete renovation of the taxation system. One of the changes that had far-reaching implications was the Tax Cuts and Jobs Act (TCJA) – an initiative that drastically reshaped decades-old conventions. As with the enactment of most landmark legislations, this one comes with its fair share of growing pains. To know more about the growing significance of GILTI planning and whether or not it will be beneficial for you to claim indirect foreign tax credits on GILTI provisions by making Section 962 elections, keep reading!
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There are two major regimes that come to light with the TCJA – the annual GILTI (Global Intangible Low-Taxed Income) rules and the one-time mandatory repatriation tax. The enactment of the former makes it complicated for American expatriates to conduct business from outside the United States, as there is a strong chance that their income may be deemed GILTI. These provisions are considered by tax experts to be so complex for the average citizen that many U.S. business owners may be tempted to renounce their citizenship.
Under the latest corporate tax regime introduced by the U.S., American companies are solely taxed on their own earnings and not the dividends that they receive from foreign subsidiaries – as the latter is tax-free. A great start to understanding the inner workings of this legislation is to explore the primary catalyst that triggered the introduction of the GILTI rules in the first place. GILTI was introduced as a preventative measure to combat against the possibility of companies attempting to shift their profits to subsidiaries in low-tax countries and then repatriating those same profits to the U.S. to gain tax-free incentives. While this move is largely beneficial when applied to multinationals, it may not bode very well for you if you’re a U.S. taxpayer living abroad.
So what does GILTI entail exactly? To begin with, if a U.S. citizen accrues any profits through a CFC (Controlled Foreign Corporation), they must classify whether those are GILTI or not. Anything in excess of 10% of the return on depreciable tangible assets owned by the company will be considered GILTI. While a majority of companies do not own a lot of equipment or other tangible assets, these developments are not without justification. For instance, a medical professional who is a citizen of the United States and conducts his operations from Canada, might not necessarily own heavy equipment save for small apparatus and computers. Nevertheless, the profits earned through the business will be considered GILTI income should they be in excess of 10% of the company’s overall investment in depreciable tangible assets.
Is GILTI a blessing or a bane? Early reactions suggest an inclination toward the latter. The undesirable impact of the GILTI regime has already reverberated across the taxation system – leaving most with a bad aftertaste. This is manifested through the fact that the income regulations are personally taxed to the U.S. business owner, even though it is not personally distributed to them. Furthermore, to add insult to injury, the option of offsetting the Canadian tax paid with the GILTI inclusion is extremely limited.
Another downfall for the already cumbered taxpayer is that the costs associated with determining whether or not profits are GILTI are expected to be astronomical, owing to the fact that the rules themselves are intricate and complex. Additionally, a U.S. citizen who conducts their operations via a foreign firm enjoys only a restricted ability to defer income arising from personal tax. Double tax risks may emerge as a result of the restrictions applied on foreign tax credits.
While all possibility appears bleak, there is one technical exception, albeit quite narrow, accommodated by the GILTI rules. Profits arising from your company’s operations may be classified as not GILTI if one of the following cases is applicable: If the income is deemed to fall under Subpart F (essentially, a U.S. term applied to specific types of income earned by a foreign company) If the income is applicable for corporate-level tax in Canada for no less than 18.9%. Suffice it to say, that only a few types of income will align with the above criteria. Additionally, it may entail forgoing the Canadian small business tax rate. While this strategy does help to preserve some of the deferrals, it will elevate the comprehensive tax costs in the U.S. and Canada associated with making money through a corporation.
Call it Divine Providence, but there is yet another respite for the weary taxpayer. The U.S tax code allows you to make a section 962 election, the mechanics of which are unsurprisingly complicated. To put it simply, if you are an individual U.S. shareholder, you may opt to be taxed as a corporation to become eligible to tax the Subpart F income at foreign rates. This shareholder will be regarded as a “phantom” corporation, solely for the purpose of this income. The overriding benefits? – Access to foreign tax credits and lower tax rates! Additionally, the individual may also have access to a 50% deduction on tax, the same that is applied to U.S. corporations with GILTI income – however, as this is not entirely confirmed, there is a significant risk attached; such as paying a lot more tax than would be applicable with other options.
Given that the tax reform changes reshaped several founding and lon-standing tenets of the law, the complete impact of the reform is yet to be witnessed. Needless to say, these alterations present a whole new side of the matter – namely, the kind of opportunities that emerge in terms of the structuring, capitalization and operation of cross-border investments and businesses. Since the new reform is already in effect, taxpayers aren’t afforded all that much time to dwell on contingencies, but rather are compelled to act quickly in their best interests to take short-term decisions and lay the groundwork for future planning.
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