As a U.S. person, grappling with the intricate realm of international taxation is an inevitable challenge. Among the concerns is the Global Intangible Low-Taxed Income (GILTI) tax on Canadian-Controlled Private Corporations (CCPCs). This article aims to furnish a comprehensive comprehension of GILTI tax, elucidate its ramifications, and present effective strategies to circumvent its impact successfully.
Briefly, US citizens who are the owners of foreign corporations, which includes CCPCs, are required to include in their annual US taxable income the Subpart F income of a controlled foreign corporation (“CFC”) in which they have 10% or more ownership by vote or value. In turn, passive income (interest, dividends, and capital gains from the sale of assets which earn passive income), is normally considered Subpart F income. This results in both a potential loss of deferral and a double tax risk. However, there is a key exception from Subpart F income for income that is subject to a minimum amount of Canadian tax. Income that would normally be classified as Subpart F income is exempted from this classification if the corporation pays tax on its income to the country where the CFC operates at a rate of at least 90% of the US federal corporate tax rate. The technical term for this is the high tax exclusion, and it is found in section 954(b)(4) of the Internal Revenue Code. With the reduction of the US federal corporate tax rate to 21%, the 90% threshold is now reduced to an 18.9% rate. That means that passive income earned by a CCPC, which is subject to tax at a higher rate than this, will not be considered Subpart F income. The effect of this is that US citizens that own CCPCs that earn passive income should no longer have any Subpart F risk
UNDERSTANDING CCPCS AND GILTI TAX
A CCPC eligible for the small business deduction, coupled with active business income, stands to benefit from a lower corporate tax rate. The small business rate offers a substantial tax deferral avenue by retaining earnings within the corporation and leveraging the $500,000 exemption—a cornerstone in Canadian private company tax strategy. This results in the shareholder only contending with a corporate income tax of 11.5%, a noteworthy saving compared to the individual marginal tax rate of 54% (utilizing Nova Scotia data).
However, the GILTI regime is designed to defer U.S. tax on foreign-earned earnings, necessitating proactive measures to mitigate its impact. GILTI punishes the retention of earnings within the corporation by taxing them to the shareholder as individual income, termed GILTI income.
STRATEGIES TO AVOID GILTI TAX
Several strategies can be deployed to alleviate the risk of double taxation imposed by GILTI.
- BONUSES
Some business owners opt for bonuses up to the GILTI amount. However, this plan lacks tax deferral as bonuses are subject to immediate taxation. Incorporated professionals may find operating as sole proprietorships advantageous to sidestep onerous Controlled Foreign Corporation (CFC) reporting requirements. A check-the-box election to establish it as a disregarded entity is also a viable consideration.
- ELECTION UNDER SECTION §962
Under Section §962, individual taxpayers can opt to be taxed as U.S. corporations. This choice yields advantages such as reducing the U.S. tax on GILTI from the maximum individual rate of 37% to the U.S. corporate tax rate of 21%, claiming an 80% foreign tax credit for Canadian corporate taxes paid on GILTI profits, and utilizing the section 250-authorized deduction for 50% of the GILTI. The cumulative benefits result in an effective tax rate of 13.125%, negating U.S. tax on GILTI if the Canadian corporate tax rate is 13.125% or higher.
- HIGH TAX EXCLUSION
Taxpayers can exclude GILTI income if the Canadian corporate tax rate on GILTI revenue surpasses 90% of the U.S. corporate tax rate. The Canadian company tax rate must exceed 18.9% (compared to the current U.S. corporate tax rate of 21%) to qualify for this exception. This option may be viable for Canadian CFC owners earning over $800,000, contingent on factors such as the taxing province and eligibility for the small company tax rate.
- UNLIMITED LIABILITY COMPANIES (ULCS)
ULCS in certain Canadian provinces, like Nova Scotia, Alberta, and British Columbia, are treated as disregarded entities for U.S. tax purposes. While a ULC’s income is exempt from GILTI, the conversion from a limited liability company to a ULC may be impractical for established businesses due to its classification as a liquidation transaction in Canada. A check-the-box election allows businesses to retain limited liability while benefiting from disregarded entity treatment.
In summary, planning approaches for GILTI tax on CCPCs are expected to align with either section 962 planning for smaller CFC owners or transitioning to a non-CFC structure. Owners of large CFCs may leverage the high-tax exception.
Navigating the intricacies of GILTI tax on CCPCs may pose challenges, but armed with the right knowledge and guidance, you can effectively manage your tax obligations.
Remember, individual tax situations vary, and this article offers general information. For personalized advice, consult a tax professional.
At Expat Tax Relief, we are committed to providing expert tax advice to those in need. Understanding international taxation complexities can be a challenge, and we’re here to help.