In the first edition of the ongoing series on tax reform’s most memorable acronym, GILTI, Alvarez and Marsal, Taxand USA, discussed how expense allocation under IRC Sec. 861 could leave many unsuspecting taxpayers exposed to incremental tax on their foreign earnings. Despite paying a high effective rate of tax overseas that would seemingly offer a full foreign tax credit offset against US tax on GILTI, every dollar of expense allocation may cause an incremental $0.21 of tax, an issue similarly identified in a letter sent by the US Chamber of Commerce to the Treasury Department last week.
Whether this is an intentional part of the new law, or simply a side effect of the quick process of drafting and passing the law, many tax professionals are now scrambling to revisit their GILTI estimates and evaluate their potential exposure. Critically, this exercise involves examining how expenses, particularly interest, are meant to be allocated against GILTI for foreign tax credit purposes.
Allocating Interest to Statutory Groupings of Income
The “low-taxed” portion of the GILTI name comes from the presumption that any U.S.-based multinational paying an aggregate effective rate of tax on their foreign earnings of at least 13.125 percent through 2025, and 16.4 percent thereafter, should be able to claim a foreign tax credit to fully offset the resultant U.S. tax. However, as we’ve seen often with the new reform bill, these provisions were designed within the framework of existing law, and are subject to a long-standing body of related rules. For example, the GILTI foreign tax credit mechanism was established via a new income basket under the existing Sec. 904 foreign tax credit limitation rules. Meaning, GILTI is subject to a largely unchanged body of law, including expense allocation rules for Sec. 904 purposes.
Discover more: GILTI and interest allocation: how the foreign minimum tax attracts expenses
For similar content to our Global Guide, subscribe to our mailing list and keep up to date.
Many companies will be required to first report the tax effect of GILTI on their first quarter financials in a few short weeks. For those expecting a full foreign tax credit offset against the U.S. tax on GILTI, the expense allocation rules could prove to be an unwelcome surprise. Therefore, taxpayers should be revisiting their expense allocation procedures and identifying whether their CFCs have tax basis in any assets that give rise to GILTI. In the absence of clear guidance from either the Treasury Department or IRS, Sec. 861 expense allocations must be modelled out by every taxpayer subject to the new GILTI rules.
