When U.S. tax reform passed into law in the last days of 2017, significant changes were made to how U.S. citizens and residents owning Canadian companies are taxed. That reform package included a tax on global intangible low-taxed income (GILTI), which is applicable for 2018 and subsequent tax years. The scope of GILTI is very broad and does not necessarily relate to intangibles—or even to Canadian companies doing business globally.
To add insult to injury, this additional U.S. tax could result in double tax on the affected Canadian resident individual due to differences in the timing of U.S. and Canadian taxation of corporate profits.
Are you impacted? If so, what planning do you need to consider to mitigate or avoid increased liability for U.S. tax for 2018 and beyond?
Who is impacted by these changes?
These changes impact U.S. taxpayers who control any non-U.S. corporation (such as Canadian corporations). U.S. taxpayers include not only U.S. corporations and U.S. resident individuals, but also U.S. citizens and Green Card holders living in Canada.
Any U.S. taxpayer who owns as little as 10% of the shares of non-U.S. companies can be impacted by this new tax on GILTI.
More specifically, GILTI applies to U.S. shareholders of controlled foreign corporations (CFCs). A CFC is generally a non-U.S. corporation of which more than 50% of the stock (based on aggregate voting power or value) is owned by U.S. shareholders. A U.S. shareholder is a U.S. taxpayer who owns shares representing at least 10% of the votes or value of all stock of the corporation. Such shares can be owned directly or indirectly—even constructively, based on shares owned by certain related parties.
What are the significant risk factors for GILTI?
Factors that increase the risk of your Canadian corporation exposing you to significant tax on GILTI include:
- Significant corporate after-tax net income in the current year;
- Lack of significant dividends received from CFCs subject to GILTI;
- Minimal depreciable assets used in the business—typically the case for professional corporations and other service businesses; and
- Depreciable assets held in a CFC generating a loss, while profits are being generated in a related CFC.
What tax planning is available to limit tax on GILTI?
There are potential planning measures to mitigate or eliminate tax on GILTI.
- Pay management bonuses: Deductible shareholder remuneration will decrease the corporate profits subject to GILTI. However, for U.S. tax purposes, rules for deducting unpaid compensation are more restrictive than in Canada, so accruing bonuses at year end may not necessarily reduce GILTI.
- Declare dividends: Canadian tax on dividends from CFCs is generally eligible to be claimed as a foreign tax credit to reduce tax on GILTI, whereas Canadian tax on other sources of income is not eligible. Furthermore, there is no ability to carryforward or carryback Canadian tax paid on dividends in past or future years to offset tax on GILTI. This means sufficient Canadian tax would need to be generated based on dividends in the current year to offset tax on GILTI in the same year.
- Make a Section 962 election: A special election is available on an annual basis to have GILTI taxed at the maximum U.S. corporate tax rate (21% for 2018). This also provides an opportunity to claim 80% of the Canadian corporate taxes paid as a foreign tax credit. It might also permit a deduction of 50% of GILTI to be claimed, but current guidance is unclear. The downside of this election is that subsequent distributions of GILTI will be taxed as dividends subject to U.S. income tax (generally limited to 20%), plus the net investment income tax will apply.
- Reduce or eliminate U.S. ownership: CFC shares can be sold or gifted by U.S. shareholders to non-U.S. persons, or redeemed by the CFC. However, caution should be exercised because the disposition of the shares may give rise to immediate tax: income tax in Canada, income tax in the U.S., and/or gift tax in the U.S.
- Convert CFC into an unlimited liability corporation (ULC): This would avoid the GILTI rules altogether by making the corporation a flow-through entity for U.S. tax purposes, much like a partnership. The drawbacks of this conversion could include the reduced ability to effectively defer tax on corporate income, potential U.S. income tax being triggered at the time of conversion, and non-tax issues due to the loss of limited-liability protection for shareholders.
Certain actions (above) can be taken into consideration when doing owner-manager remuneration planning for 2018 and future years. The new GILTI rules are highly complex, and further regulatory guidance is expected to be forthcoming in 2019.
How is GILTI calculated and taxed?
The mechanics of the computation of GILTI are complex.
Broadly speaking, GILTI represents ‘excess' profits earned on the depreciable tangible assets of CFCs.
More specifically, GILTI is the excess of net CFC-tested income over net deemed-tangible income return for the year. Net CFC tested income is generally non-U.S. net business income after tax, with such net income and losses aggregated across all of a U.S. shareholder's CFCs. Net deemed-tangible income return is 10% of the depreciated cost basis of tangible capital assets of CFCs that generate tested income, less related interest expense.
GILTI does not include non-business income and income from U.S. business activities of the CFC, which are subject to U.S. tax via other existing means.
GILTI must be computed on a calendar-year basis, which can be particularly burdensome for CFCs with an off-calendar fiscal year for Canadian tax purposes. Furthermore, GILTI is based on the calculation of business profits under U.S. tax rules, which differ in certain respects from Canadian tax rules.
The U.S. shareholder's proportionate share of GILTI is included in their taxable income in the year the income is earned by the corporation, even if that income is not distributed to them via dividend in that year. GILTI is subject to ordinary federal graduated income-tax rates. The top rate for 2018 is 37%. Subsequent distributions of GILTI via dividend are not subject to future U.S. income tax, but may be subject to an additional 3.8% net investment income tax.
This can result in double taxation to the extent that U.S. tax is payable in the year the corporate profits are generated, but the related Canadian tax is not paid until a future year when those profits are distributed to the U.S. shareholder via dividend.
This is a complex area of tax, and careful consideration of your specific situation will be needed to arrive at the best result for you and your business. If you have questions regarding the new tax on GILTI and what you can do to minimize its impact on you and your business, please contact a member of our U.S. Personal Tax service team or your personal BDO advisor.