Under section 951A, the TCJA introduced the anti-deferral concept of GILTI. GILTI is sort of a misnomer, in that it does not only apply to “intangible” income in the general sense of the word. Rather, GILTI assumes if a foreign company is able to generate more than a 10 percent return on its foreign business assets (defined as Qualified Business Asset Investment, QBAI), the excess must be from intangibles and should be included in the gross income of U.S. shareholders in the year earned. This 10 percent return on assets definition creates a very wide net and will mean the majority of foreign businesses will be captured under GILTI.
Example 1. Consider a U.S. shareholder who owns a foreign-based service business which generates no passive income (i.e., service income only). Prior to the TCJA, this foreign company may not have been subject to the Subpart F or PFIC rules because it did not earn dividends, interest, rents, or royalties; therefore, the foreign earnings were not subject to immediate U.S. taxation.
After the TCJA, we must consider GILTI. If laptops and office furniture comprise the majority of the foreign business assets (QBAI), then net income as little as $20,000 could likely exceed the adjusted basis of the QBAI, and subject the U.S. shareholder to GILTI (i.e., immediate U.S. taxation on foreign earnings not yet received).
Example 2. Consider a U.S. shareholder who owns a foreign-based manufacturing business which does generate passive income above the de minimis thresholds (e.g., generates royalty income related to a machine process). Prior to the TCJA, this foreign company may not have been subject to the Subpart F or PFIC rules because it met an active-type business exception for the royalty income.
After the TCJA, there are no active-type exceptions to GILTI. Therefore, the same foreign manufacturing business will likely be subject to the new GILTI anti-deferral regime if such business generated more than a 10 percent return on its QBAI.
If you own a foreign business, consult with an experienced international tax advisor to help make the needed changes to your existing structure, or help structure a new foreign business after tax reform. International Tax Advisors, Inc. builds easy-to-understand Excel models to help calculate your potential tax liability based on your specific facts and numbers.