What are the long-term implications of electing the GILTI high tax exception?

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The GILTI high tax exception (HTE) presents U.S. shareholders of controlled foreign corporations (CFCs) with a potent tool to manage international tax exposure and limit potential issues of double taxation. The short-term benefit is the exclusion of high-taxed foreign income from the Global Intangible Low-Taxed Income (GILTI) provision. However, it’s essential also to consider the longer-term trade-offs that come with this powerful tool.

Let’s start with the mechanics. Under current law, if a CFC’s GILTI tested income is taxed at a foreign rate higher than 90% of the U.S. corporate rate (21%), it qualifies for exclusion from GILTI. That threshold is currently 18.9%. By electing the GILTI high tax exception, a taxpayer avoids recognizing that income in their U.S. taxable income, thus potentially lowering their GILTI tax rate to near zero for those tested units.

However, this isn’t a decision to be taken lightly. The election is made annually and must be applied consistently across all eligible CFCs. Additionally, as a taxpayer making this election, you must consider the Subpart F income from the same controlled foreign corporation group.  Any flip-flopping could have ripple effects on your tax strategy, making it a decision that requires careful consideration.

When income is excluded from GILTI under the high-tax exception, the foreign taxes paid on that income are also excluded from the GILTI foreign tax credit basket. If you’ve been relying on excess credits from high-tax jurisdictions to offset U.S. tax on low-taxed GILTI income, this election could potentially backfire. The GILTI tax rate on remaining low-taxed income might be higher without those credits to cushion it.

Then there’s the issue of QBAI (Qualified Business Asset Investment). Excluded income also means excluded QBAI, which reduces the deemed tangible income return (DTIR) that shelters other GILTI income. So, ironically, using the HTE can sometimes lead to a larger inclusion from other CFCs.

The election also doesn’t create previously taxed earnings and profits (PTEP). The simple fact that you aren’t paying tax on the excluded income means you haven’t previously paid U.S. tax on said income. That means when the income is eventually repatriated as a dividend, it won’t be automatically exempt from U.S. tax unless the distribution qualifies under the C Corporation setting for the Section 245A deduction—and not all states follow that rule.

From a compliance standpoint, the high tax exception adds complexity. You’ll need to calculate effective foreign tax rates on a tested-unit basis and document them meticulously. That means more coordination across jurisdictions and more work for your tax team every year. A common pitfall noted with this election is that the concept of high-tax income is determined on a CFC’s net tested income, rather than its local country taxable income. For example, a CFC in the UK faces a 25% statutory corporate tax rate, and at first glance you would think this could qualify for the high tax exception. However, as a taxpayer you must calculate that CFCs effective tax rate on its GILTI tested income. Due to unfavorable U.S. tax adjustments, that effective tax rate in the year could be lower than 18.9%, and therefore not eligible for the election.

Bottom line: the GILTI high tax exception is not a permanent shield; it’s a timing decision. You’re deferring tax, not eliminating it. If foreign tax rates drop or rules change, you could lose the protection midstream. It’s a smart move for many companies, but only if the rest of your tax position can handle the consequences.

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