GILTI: Eliminating Tax Holidays and use of NOLs
GILTI (Global Intangible Low-Taxed Income) went into effect in 2018. The purpose of GILTI was to not allow tax deferral on offshore intangible earnings. However, as we have detailed many times, a formula that seeks to tax intangible income that does not have intangible income in the calculation causes many problems. Recently, we have had clients encounter even more issues as the practical application of GILTI is fully flushed out.
Net Operating Losses
Foreign corporations can sometimes run net operating losses. There are many reasons a valid business can have a loss. This could be the nature of the business as with a startup or tech company, or it can be based on tax planning. The problem is that GILTI is a year-to-year calculation. If a foreign corporation has income in the current year but a carryforward loss that negates the income it won’t have any current taxable income. Nevertheless, for the yearly GILTI calculation there will be positive income since the prior losses are not considered. Furthermore, since there is no taxable income, no taxes will be paid in the home country. Without any taxes paid in the home country there won’t be an opportunity for foreign tax credits to be used. Therefore, when a foreign corporation has prior losses offsetting current year income it will usually mean that there will be GILTi tax payable in the U.S.
Sometimes when clients are investing abroad, they can negotiate a tax holiday as the foreign country tries to entice inbound investment. Recently, we had a client negotiate a multi-year 0% tax holiday in an Asian country to setup a manufacturing facility. Once again, GILTI came in to cause problems. Despite a decent level of fixed assets, the manufacturing plant was very successful and profitable and went well beyond the GILTI allowable 10% return on assets. However, due to the tax holiday the business did not have to pay local tax. This means that it had plenty of income for GILTI and no taxes for foreign tax credits. Unfortunately, the result was that the tax holiday became a complete waste. Even worse, the client didn’t need to spend the time, energy, and possible public relations hit to get the tax holiday. It would have been better off to just pay taxes, look like a boost to the local economy, get in good with the government, and take a credit on the U.S. return to have a net zero increase for those taxes.
Overall, while well intentioned and good in theory, the poor planning and application of GILTI continues to cause problems. Before moving operations abroad or investing in foreign corporations it is important to look at the tax consequence and effects of GILTI. While it may not be avoidable, it may show you that certain planning in the foreign country is irrelevant and you can save some time and money.