Global Intangible Low Tax Income (GILTI)was introduced as part of the Tax Cuts and Jobs Act that was signed into law in December 2017. Its purpose is to discourage US taxpayers from shifting corporate profits outside the US to low income tax or zero-tax jurisdictions. GILTI results in tax being imposed on the earnings of a controlled foreign corporation (CFC) that earns income on patents, other intellectual property or services that exceeds a 10% return on depreciable tangible assets. A CFC is a foreign corporation with more than 50% of the combined voting power or value being owned by US taxpayers. Each US shareholder that owns 10% or more of the voting power or value may be subject to a GILTI inclusion.
US shareholders that are US domestic corporations are able to deduct an amount equal to 50% of the GILTI income inclusion and entitled to a credit for 80% of their pro-rata share of the foreign taxes paid on the foreign income. This can result in the US corporation obtaining a full exemption from GILTI tax if the foreign corporation’s tax rate was at least 13.125%. However, the same treatment is not available if the US shareholder is a US individual. Therefore, double taxation can occur where the CFC earns income, but no dividend is paid during the year for a foreign tax credit to apply.
As an example, Mr. Appleby is a US citizen/resident of Canada that operates a Canadian corporation (“Serviceco”) that provides consulting services to other companies. His corporation has minimal tangible assets, which consist of computer equipment and office furniture with a value of $10,000. Each year the corporate earnings exceeds 10% of Serviceco’s tangible assets. In 2020, Serviceco earned $200,000 consulting income and paid Mr. Appleby a salary of $70,000. $129,000 ($200,000-$70,000 – ($10,000 x 10%)) of Serviceco’s income is subject to up to 37% tax on Mr. Appleby’s US personal tax return. This will result in double taxation.
For Canadian tax purposes Mr. Apply be will be subject to personal tax on the corporate earnings of Serviceco when the corporation pays a dividend. If the dividend is paid in a different year, then no foreign tax credit can be applied against the US personal GILTI income inclusion.
There are several options available to Mr. Appleby to avoid GILTI tax on his Canadian corporate earnings:
- File a special election with his US personal tax return
- Change his shareholding in Serviceco
- Change the legal structure of Serviceco
- Renounce his US citizenship
- Tax Serivceco at the higher Canadian corporate tax rate
File a special election with his US personal tax return
There is an election available to US individuals under Section 962 of the US tax code. If Mr. Appleby were to file this election with his US personal tax return it will allow him to be subject to GILTI as if he were a US corporation. This would entitle Mr. Appleby to a 50% deduction of the GILTI income inclusion and tax at the lower US corporate rate of 21% rather than the higher US personal tax rate of up to 37%. Using the example from above and assuming Serviceco incurred Canadian corporate tax totalling $15,600, Canadian corporate tax can be claimed as a foreign tax credit to reduce or eliminate the GILTI tax. The downside of this election is that it can result in Mr. Appleby’s being taxed at a higher US tax rate when dividends are eventually paid to him.
Change his shareholding in Serviceco
If Mr. Appleby has a spouse who is a Canadian citizen, he may consider changing his shareholdings of Serviceco so that he owns non-dividend paying shares and issue non-voting dividend shares to his spouse. Serviceco would pay Mr. Appleby a salary that reduces his GILTI income inclusion rather than dividends. Any dividends would be issued to his spouse; however, this dividend income could result in tax on split income rules being applied. This would result in the income being attributed back to Mr. Appleby. This income attribution would only be taxable on his Canadian tax return and not his US tax return.
Change the legal structure of Serviceco
Converting Serviceco into an unlimited liability company (ULC). This will allow him to apply the Canadian corporate tax paid against US income. However, the negative consequences of this option are that the change to an ULC may result in US tax because of any unrealized gains on the corporation’s assets. In addition, ULC’s do not have access to the small business deduction which will result in the Canadian tax rate being higher than if it remained a regular corporation.
Renounce his US citizenship
If Mr. Appleby has no intention of returning to the US, he may consider renouncing his US citizenship. Mr. Appleby will no longer having a US personal tax return filing requirement and thus would not be subject to GILTI tax. Renouncing his citizenship should not be taken lightly and could result in him being subject to expatriation tax if he is a covered expatriate. A covered expatriate is a taxpayer that meets one of the three requirements. (1) average annual net income tax for the period of 5 tax years ending on the date before relinquishing citizenship is greater than $168,000, for those expatriating in 2019 (this figure is adjusted annually). (2) net worth is at least $2 million on the date of expatriation. (3) failure to certify that 5 preceding tax years of returns have been filed. This certification is done by filing form 8854.
Tax Serivceco at the higher Canadian corporate tax rate
Private Canadian corporations that are controlled by Canadian resident shareholders with income under $500,000 can take advance of the small business deduction that reduces their Canadian corporate tax rate to 11% for BC corporations. This tax rate is less than the 13.125% tax rate threshold discussed above, resulting in the GILTI tax exemptions not applying. Mr. Appleby can consider reducing the small business deduction to increase the Canadian corporate tax rate to above the 13.125% threshold so the exemptions can apply.
Before any of these options are implemented careful consideration should be made. Contact Argento CPA today for advice on how to optimize your tax situation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.