The Importance of The Qualified Business Asset Investment (QBAI) To the Reduction of GILTI.
As US Taxation of CFCs becomes more complex, US business owners want to accumulate more capital and grow their businesses faster, in order to deal with mounting uncertainty and the local impact of global markets. US Persons who own or are a shareholder of US Controlled Foreign Corporations (CFC) must pay US taxes on their Subpart F income and their Global Intangible Low-Tax Income (GILTI). US business owners and their CFCs are exposed to various methods of taxation. CFCs will usually be exposed to, corporation tax in the foreign jurisdiction in which the CFC is incorporated.
US taxes on Subpart F income and GILTI. Exemptions, credits, and deductions enable US Persons and their CFCs to either lower their effective tax rates or to reduce the amount of taxable income of the CFC that is immediately subject to US corporation or income tax.
In this article we will take a brief journey through the Qualified Business Asset Investment (QBAI) and its impact on GILTI. We will assume that all US persons are taxed at the US corporation tax rate of 21%. Individuals can make an election under section 962. The section 962 election allows US individuals who own CFC using pass through entities such as limited liability companies (LLCs), S corporations or trust to be taxed at the US corporate tax rate and have access to the section 250 deductions.
Global Intangible Low-Tax Income (GILTI)
Global Intangible Low Tax Income (GILTI) is a category of foreign income which was introduced in the “Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” otherwise known as the Tax Cuts and Jobs Act (TCJA) 2017. Taxation on GILTI is applied under section 951A, to US persons based on their pro rata share of a CFC or the aggregate GILTI based on their pro rata shares of multiple CFCs. Under section 250 there are two deductions which reduce GILTI, the 50% of GILTI amount which is included in a US corporation’s gross income under section 951A (known as the 50% GILTI deduction) and the section 250 foreign-derived intangible income (FDII) deduction.
Qualified Business Asset Investment (QBAI)
Qualified Business Asset Investment as defined under section 951A (d)(1) means, the average of such corporation’s aggregate adjusted basis as of the close of each quarter of the taxable year in question, in specified tangible property. The tangible property must be used in a trade or business (section 162) of the corporation and be of a type with respect to which a deduction is allowed via depreciation under section 167. Specified tangible property is defined under section 951A (d)(2)(A) as any tangible property used in the production of tested income, except as outlined in section 951A (d)(2)(A). Tangible property means property for which the depreciation deduction provided by section 167(a) is eligible to be determined under section 168 without regard to section 168(f)(1), (2), or (5), section 168(k)(2)(A)(i)(II), (IV), or (V), and the date placed in service.
Tested income is defined under section 951A(c)(2)(A) as the gross income of a CFC without the inclusion of Effectively Connected income (ECI), Subpart F income, High taxed Subpart F income, Related Party Dividends and Foreign oil and gas extraction income as well as deductions (including taxes) properly allocable to such gross income under rules similar to the rules of section 954(b)(5).
Specified tangible property is mainly limited by the dual use property rules. Specified tangible property includes but is not limited to real property, vehicles and equipment as well as any other items of property which qualify as depreciable under section 167 and is eligible to be determined by section 168 “the alternative depreciation system (ADS)” according to CFR § 1.951A-3(c)(1) and CFR § 1.951A-3(c)(2)
According to 951A (d)(2)(B) dual use property means property used both in the production of tested income and income which is not tested income. Only the depreciable portion of the dual use property will be used for specified tangible property. To calculate the portion of dual use property to be use for QBAI we must take the average of the tested income CFC’s adjusted basis in the property and multiply it by the dual use ratio with respect to the property for the CFC inclusion year (CFR § 1.951A-3(d)(1)).
GILTI and QBAI
QBAI actually impacts the GILTI calculations on two fronts. QBAI is involved in both the calculation of GILTI and the FDII calculations used in determining US taxes to be paid on GILTI. First, we will explore QBAI with respect to the calculation of GILTI.
| GILTI | = | Net CFC Tested Income | – | Net Deemed Tangible Income | according to section 951A(b) |
Where:
| Net CFC Tested income = | Aggregate of CFC’s Tested income | – | Aggregate of CFCs’ Tested loss | according to section 951A(c). |
| Net Deemed Tangible Income = | 10% x aggregate of US shareholder’s pro rata share of each tested income CFC’s Qualified Business Asset Investment (QBAI)) | – | certain interest expenses | according to section 951A(b)(1)(B). |
| QBAI = | CFC’s adjusted basis in specified tangible property | according to section CFR § 1.951A-3(b). | ||
| Adjusted basis = | basis in specified tangible property adjusted using the Accelerated cost recovery system | According to (IRC §951A(d)(3)) |
As we can see QBAI plays a vital role in the reduction of GILTI. Net deemed tangible income is subtracted from net CFC tested income (Tested income is explained in a previous article) larger portion of taxable income under GILTI.
QBAI is the adjusted basis in specified tangible property. Adjusted basis, according to the ADS is calculated using the straight-line method without regard to Salvage value (section 168(b)(3)).
Therefore,
the adjusted basis of specified tangible property = the basis of the specified tangible property divided by the recovery period (useful life) of the property. An increase in the value of a CFC’s specified tangible property or an increase in the CFC’s assets which qualify as specified tangible property a CFCs tangible property which qualifies under section 951A (d)(2)(A) will result in an increase in QBAI and thus a reduction in GILTI. However, there is a small draw back to having a large QBAI in a CFC.
FDII and QBAI
We will now turn our attention to the section 250 deduction. The calculation for US taxation on GILTI is as follows:
| US taxation on GILTI of US Corporations | = | 21% | x | (GILTI and related §78 gross-up – § 250 Deduction) | – | foreign tax credits. |
Under section 250, there are two deductions; 50% of GILTI amount which is included in a US corporation’s gross income under section 951A (known as the 50% GILTI deduction) and the foreign-derived intangible income (FDII) deduction. Together, these deductions reduce the effective tax on GILTI from 21% to tax rates between 10.5% to 13.125%.
FDII itself is defined under section 250(b)(1) as:
| Deemed intangible income (DII) | x | (Foreign-derived deduction-eligible income (FDDEI) | ÷ | Deduction-eligible income (DEI)) |
Where:
| Deemed intangible income (DII) (section 250(b)(2)(A)) | = | Deduction-eligible income (DEI) | – | (10% × Qualified business asset investment (QBAI)) |
Thus, it can be seen that 10% of QBAI reduces the DII, which in turn means FDII will be reduced and have less impact on reducing CFC’s taxable income under GILTI. This does not mean the benefits of QBAI has been reduced drastically, as only 37.5% of FDII is considered when calculating the section 250 deduction.
It can be seen clearly that QBAI plays a vital role in the reduction of the impact of GILTI on the immediate taxation of CFC taxable income which would otherwise be deferred, despite a minor setback in the section 250 deductions.
If a US CFC has high value specified tangible property, even with reduction due to depreciation each taxable year, the GILTI for the US shareholders of the CFC will be reduced. With the taxable income under GILTI reduced by 10% of QBAI and with the section 250 deductions reducing the GILTI, US shareholders of CFCs will be paying their fair share of taxes without being disadvantaged by increased current taxation due to GILTI.
US Shareholders of CFCs must ensure their International Tax advisors are knowledgeable and skilled in the US GILTI rules to allow them to operate their foreign businesses and enable US business owners to take advantage of international business opportunities with peace of mind.
Mithril Tax law and Mithril International will continue our exploration of the GILTI rules and comb through the complexity to ensure our clients are taxed fairly but effectively so they can operate and grow their businesses comfortably.
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