Multinational businesses face unique complexities as a result of certain features under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act was signed into law March 27, and includes temporary federal income tax relief measures for businesses such as net operating loss (NOL) carryback deductions and enhanced deductions for business interest. These temporary measures could impact significantly the amount of Global Intangible Low Taxed Income (GILTI), Foreign Derived Intangible Income (FDII), and Base Erosion Anti-abuse (BEAT) Tax that an international business must recognize.
Recap of Certain Temporary Measures under CARES Act
The CARES Act provides $2.2 trillion of tax and economic relief measures that include a restoration of deductions for NOL carrybacks. Specifically, the CARES Act allows businesses to carryback NOLs that arise in taxable years beginning in 2018 through 2020 to the five previous tax years without limitation. The CARES Act also allows businesses to deduct more business interest expense during taxable years that begin in 2019 through 2020, where the amount of business interest expense that is in excess of business interest income is deductible up to an amount that is 50% of adjusted taxable income (ATI). For this purpose, businesses may reference the 2019 ATI amount for the calculation of the 2020 business interest limitation if it produces a more favorable result. The beneficial changes to the business interest limitation are somewhat more restricted for a partnership’s interest expenses allocated to partners.
As mentioned before, each of these changes could significantly interact with the determination of GILTI, FDII, and BEAT tax for international businesses.
GILTI and FDII
GILTI pertains to the income of a controlled foreign corporation (CFC) that is in excess of its Subpart F income and a 10% return on its own tangible depreciable property. GILTI generally is taxed each year to the CFC’s U.S. shareholders under IRC Section 250, but in the case of corporate shareholders (or individual shareholders who make a Section 962 election), currently it is reduced by a 50% deduction under Section 250, so the effective tax rate is 10.5% (rather than 21%). This tax can be further reduced by foreign tax credits, up to 80% of foreign income taxes imposed on GILTI, but without carryover of excess credits to other years.
Somewhat similarly, FDII of a U.S. corporation generally is defined as income from the sale of property to a non-U.S. person for foreign use or from services provided to any person, or with respect to property, located outside the U.S. The amount of FDII currently is reduced by a 37.5% deduction under Section 250, so the effective tax rate is 13.125%. FDII can be further reduced by normal foreign tax credits.
However, these Section 250 deductions are limited by a taxpayer’s pre-deduction taxable income for the year. Thus, if deductions are increased under the CARES Act for business interest expenses and/or NOL carrybacks that cause the sum of GILTI and FDII to exceed taxable income, then the GILTI and FDII amounts are reduced pro rata. This can reduce and/or eliminate the benefit of such foreign income’s lower tax rates and foreign tax credits. Taxpayers that are adversely impacted in this manner may want to consider an election under Rev. Proc. 2020-22 to waive the CARES Act benefits to the business interest deduction limitation, or an election under Rev. Proc. 2020-24 to waive the CARES Act benefits for NOL carryback deductions.
The BEAT currently imposes a 10% tax on a corporation with at least $500 million in average annual gross receipts if its deductions paid or accrued to related non-U.S. persons exceed 3% of its total deductions. This operates as a new alternative minimum tax, so if the corporation’s regular income tax liability (adjusted for certain credits) is less than the BEAT rate that is applied to its so-called modified taxable income (including by adding back its payments to related non-U.S. persons), then the excess is owed as BEAT.
Under final regulations, reductions in the corporation’s modified taxable income for BEAT purposes can include only a portion of NOL carryovers, and in any event these cannot reduce such income below zero. As a result, deductions that are increased under the CARES Act may increase NOL carryovers, and this can increase a corporation’s BEAT liability in carryover years. Taxpayers that are adversely impacted in this manner may want to consider the elections out of certain CARES Act benefits that were mentioned previously.
Taxation of Pre-2018 Accumulated Foreign Profits under Section 965
The tax reform law commonly known as the Tax Cuts and Jobs Act (TCJA) imposed a one-time transition tax on a 10%-or-greater U.S. shareholder’s portion of most accumulated and previously untaxed foreign earnings and profits after 1986 (E&P). The transition tax applies only to such E&P of a CFC (or of another foreign corporation having a U.S. corporate shareholder with at least 10% ownership), and applies regardless of whether such profits were actually repatriated. For corporate shareholders, the tax rate was 15% of earnings held in cash or cash equivalents, and 8% if the E&P pertained to illiquid assets. For individual shareholders, the applicable tax rates were generally 17.5% and 9%, respectively. U.S. shareholders could elect to pay this one-time tax in installments over a period of eight years.
The CARES Act contains two generally favorable provisions impacting this inclusion. First, taxpayers with Section 965 inclusions in 2017 and 2018 and who carryback NOLs under the CARES Act to those years will be deemed to have made a Section 965(n) election for those years. Pursuant to this election, these taxpayers will not use NOL carrybacks to offset the Section 965 inclusion amount (which was taxed at a lower rate than regular taxable income). This election preserves the NOL for future use against taxed income that is subject to higher tax rates.
Second, taxpayers that carry back NOLs under the CARES Act may elect to exclude from the five-year carryback period any year in which an amount is includable in gross income under Section 965. If this election is made, the NOL can be carried back five years and then forward, while skipping over the year of a Section 965 inclusion (thereby preserving an extra year for the NOL). This election may also be beneficial if foreign tax credits can be used to offset other non-Section 965 income in those inclusion years.
The interplay of the various business provisions under the CARES Act and the determination of a taxpayer’s GILTI, FDII, and BEAT tax amounts requires careful consideration. Certain situations may warrant a waiver of the CARES Act benefits for businesses. For more information on how these nuances may affect your business, please contact your local CBIZ tax advisor. Up-to-date information is also available through our COVID-19 Resource Center.
Published on April 16, 2020