We have described in past US Tax Tips the
recently enacted, Global Intangible Low Taxed Income (GILTI) provisions and the
potential impacts on United States persons in Canada who own enough shares in
Canadian corporations such that those Canadian corporations would be a
controlled foreign corporations (CFC) for U.S. tax purposes.
GILTI is treated as a new form of subpart F
income meaning that the United States shareholder must include their pro-rata
share of GILTI on their U.S. income tax return even though it may not be
taxable personally in Canada. Even
worse, where the United States shareholder is a natural person, there is no
credit for the underlying corporate tax paid by the Canadian corporation.
GILTI is also subject to being included in
its own foreign tax credit basket. As
such the inclusion of GILTI can result in an actual tax liability for United
States shareholders. An election, under
IRC §962, may be made by the taxpayer to address the potential double tax
Under this election, a United States
shareholder, who is an individual, can elect that certain income of the
Canadian corporation, be taxed as if the shareholder was a United States
corporation as opposed to an individual. This allows the corporate income to be
(i) taxed at the U.S. corporate rate of 21% (instead of at the individual’s
marginal tax rate which may be as high as 37%) and (ii) by doing so the
underlying actual corporate taxes are eligible to be claimed as a foreign tax credit. If the IRC §962 election is being made with
respect to GILTI, however, the eligible foreign taxes are reduced by 20% in
computing the foreign tax credit.
Other potential relief, however, appears to
be on its way.
In determining what income is subject to
the GILTI provisions, the corporation’s gross income is reduced for certain
items of income that are already subject to U.S. tax under other provisions of
the Internal Revenue Code. Such
exceptions include U.S.-source effectively connected income, passive income
subject to the subpart F inclusion provisions and other passive investment
income that would be subpart F income except for the high tax kick out
provision. In general, foreign source
active business income would be caught under the GILTI provisions.
On June 14th, 2019 the U.S.
Treasury and the IRS released Notice 2019-12436 entitled “Guidance under
Section 958 (Rules for Determining Stock Ownership) and Section 951A (Global
Intangible Low-Taxed Income).”
What is being proposed is a new exception
in determining what gross income would be classified as gross tested income (GILTI). The CFC’s controlling shareholder(s) would
make an election to exclude, from gross tested income, gross income that is
subject to foreign tax at an effective rate that is greater than 90% of the
maximum U.S. corporate rate. The maximum
U.S. corporate rate is currently 21% so the threshold would be 18.9% (21% x
90%). If the Canadian effective tax rate
is in excess of 18.9% then that income will not be subject to a GILTI inclusion
on the U.S. return.
Canadian corporate tax rates vary depending
on whether the corporation is a CCPC or not.
If the corporation is not a CCPC (or if a CCPC the active business
income is well above the Small Business Deduction (“SBD”) threshold
such the effective tax rate on Active Business Income (“ABI”) exceeds
18.9%) the 2019 general corporate tax rate varies from a low of 26.5% (Ontario
and the Northwest Territories) to a high of 31% (Nova Scotia and Prince Edward
Island). The lowest general corporate
rate of 26.5% is in excess of 18.9% so any ABI subject to these rates would be
excluded from GILTI under these provisions.
This particular item of relief, however,
would not assist CCPCs which take advantage of Small Business Deduction. The 2019 small business rates vary from 9%
(Manitoba) to 15% (Quebec). These
rates, by themselves, are below the current threshold of 18.9%.
For CCPCs, the shareholders may consider making the IRC §962 election. The IRS, however, had previously ruled that a United States shareholder, who is an individual, may claim the 50% deduction, under IRC §250, for any GILTI or Foreign-Derived Intangible Income (FDII) when an IRC §962 election is being made. As such, the effective U.S. corporate tax rate, on the GILT inclusion would 10.5% (1/2 of 21%). 80% of eligible foreign taxes paid may be claimed as a foreign tax credit against the GILTI U.S. tax. For a CCPC in Manitoba 80% of 9% equals 7.2%. Using this example, there would U.S. tax of 3.3% (10.5% – 7.2%) as the CCPC has not paid enough Canadian corporate tax to eliminate the U.S. tax. As such, small Canadian business may still be subject to a small level of double taxation under GILTI.
United States persons who are Canadian
residents, generally, did not establish their Canadian corporations to defer or
eliminate U.S. tax. They did so, because
they live and work in Canada, invest in Canada, they plan and conduct their
affairs as Canadians, which they are.
In our opinion, many provisions of the TCJA
failed to address how these changes would impact U.S. persons who live
abroad. These individuals are simply not
on the U.S. Congress’ radar.
Canada applies a de minimis threshold in
regard to many of its foreign reporting requirements. For example, a T106, “Information Return of Non-Arm’s Length Transactions with Non-Residents”,
is not required to be filed unless the reportable transactions exceed Cdn
The U.S. could easily include such a de
minimis threshold. There could even be
recapture provisions to clawback the de minimis threshold for larger taxpayers
(those who are the real targets of these provisions) such that Treasury does
not lose any tax revenue to which they are entitled. Such a provision would eliminate a
significant number of foreign small businesses from these far reaching and,
frankly, intrusive provisions. Something
to consider (in our opinion anyway).
Obviously the GILTI provisions rules are
extremely complex. Cadesky U.S. Tax Ltd.
is a full service firm providing U.S. consulting, planning and compliance
services. We monitor U.S. tax news that
may be of interest to our readers and share our thoughts in U.S. Tax Tips. If you require our assistance please do not
hesitate to reach out to us.
“An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (Public Law 115-97 a.k.a. the Tax Cuts and Jobs Act H.R.1) introduced, into the United States Internal Revenue Code (IRS) new section 951A, “Global Intangible Low-Taxed Income Included in Gross Income of United States Shareholders” a.k.a. “GILTI”.
Many U.S. multi-national entities (MNEs) have, historically, held their patents and other intellectual property in low tax foreign jurisdictions, Ireland being an example. The GILTI provisions are viewed as imposing a minimum tax on the MNE’s foreign earnings generated by these off-shore assets. Under these rules, the amount of GILTI will be included, annually, in the United States shareholder’s gross income whether the income is actually distributed or not. It is an expansion of the U.S. subpart-F rules.
The problem, however, is that these rules go far beyond this as they will impact all “United States shareholders” (a defined term under the Internal Revenue Code) of controlled foreign corporations (CFC) not only U.S. based MNEs. So if you are a U.S. citizen, resident in Canada and own shares in a Canadian company these rules may impact you. It would appear that either the U.S. congress did not think about the impact on U.S. citizens living abroad or simply didn’t care.
The new law also changed the definition of when a U.S. person is a “United States shareholder” for these purposes. Prior to January 1, 2018, “… the term “United States shareholder” means, with respect to any foreign corporation, a United States person…who owns…10 percent or more of the total combined voting power of all classes of stock entitled to vote of such foreign corporation.”
As such, if the U.S. person only held non-voting preferred shares (say equating to 80% of the value of the Canadian company), and assuming there is no share attribution, they would never be a “United States shareholder” for CFC purposes and would not be subject to these rules.
The Act, however, expands this definition, as of January 1, 2018, to also include any U.S. person that owns 10% of the value of the stock in a foreign corporation. The test is now a ≥ 10% votes or a ≥10% value test. This change accordingly expands the circumstances in which a foreign corporation will be treated as a CFC including situations where a U.S. person owns “low vote” stock that represents at least 10% of the value of the foreign corporation. In the hypothetical example above, the U.S. person would now be a “United States shareholder” since the non-voting preferred shares represent ≥10% of the value of the company. As such, Canadian corporations should review their share registry to determine whether any shareholders have now become “United States shareholder” for U.S. tax purposes.
How do the GILTI provisions work?
“GILTI” is defined as the excess of the United States shareholder’s net CFC tested income over a net deemed tangible income return.
“Net CFC tested income” generally means the CFC’s gross income, other than income that is subject to U.S. tax as effectively connected income, Subpart F income (including income that would be Subpart F income but for the application of certain exceptions), and foreign oil and gas extraction income, less allocable deductions. The exceptions, in general, represent types of income that are already subject to specific U.S. tax rules. The remaining income represents foreign source income that, historically, has been deferred for U.S. tax purposes.
The “net deemed tangible income return” generally is an amount equal to (i) 10% of the aggregate of the United States shareholder’s pro rata share of a CFC’s qualified business asset investment (generally, a quarterly average of the CFC’s tax basis in depreciable property used in its trade or business) over (ii) the amount of interest expense taken into account to determine such U.S. shareholder’s net CFC tested income.
Where the United States shareholder is a U.S. domestic corporation, two other provisions arise. First, the company may deduct an amount equal to 50% of the GILTI inclusion (per above). This reduces the -new U.S. corporate effective tax rate to 10.5% [(100%-50%) x 21%]. As of 2026, the GILTI deduction will be reduced from 50% to 37.5%. This will have the impact of increasing the effective U.S. corporate tax rate to 13.185% [(100%-37.5%) x 21%].
Second, the U. S. domestic corporation, is entitled to a credit for 80% of its pro rata share of the foreign corporate income taxes attributable to the income of the CFC that is taken into account in computing its net CFC tested income. The foreign tax credit limitation rules apply separately to such taxes, and any taxes that are deemed paid under these rules may not be carried back or forward to other tax years.
These two provisions do NOT apply if the United States shareholder is not a U.S. domestic corporation, i.e., a U.S. citizen. For these taxpayers there will only be the GILTI inclusion and the “normal” foreign tax credit provisions will apply. That is, absent any planning, there could be a timing mismatch for Canadian and U.S. tax purposes.
U.S. citizens, who are United States shareholders as defined under the IRC, who have established Canadian corporations may now have to include in U.S. gross income their share of GILTI. Any type of service corporation, whether a provincially allowed Professional Corporation or not, will probably have GILTI as their “net deemed tangible income return” may be nominal. 10% of zero is still zero.
The Cadesky U.S. Tax team can help determine whether the GILTI provisions are applicable to you and can assist in planning to mitigate any impact.