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American Taxation: Watch for the GILTI Tax Update

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A tax update is planned on U.S. GILTI tax system. Here’s what U.S. shareholders of a Canadian corporation need to know.

Joe Biden’s arrival in the White House may increase the tax burden on U.S. shareholders of Canadian corporations that are subject to the U.S. GILTI (global intangible low-taxed income) tax system.

If the new U.S. President’s tax proposals are implemented, the U.S. corporate tax rate will increase from 21% to 28% and the GILTI tax rules will be tightened.

For U.S. shareholders of a U.S.-controlled Canadian corporation (which includes certain Canadian entrepreneurs with dual citizenship), these changes could restrict access to a new tax relief measure introduced in the summer of 2020 called the GILTI high-tax exclusion (GILTI HTE).

What is GILTI?

The GILTI tax regime was introduced by the Trump administration as part of the December 2017 tax reform.
Under the GILTI plan, a U.S. shareholder who owns at least 10% (by number of votes or by share value) of a non-U.S. corporation controlled (more than 50%, as defined) by Americans may be required to include its share of such a corporation’s net income in its gross income. (Note that net income is calculated according to the special rules of the GILTI plan).

This share is equal to the U.S. shareholder’s share of the foreign corporation’s net income based on the U.S. shareholder’s ownership percentage less 10% of the value of certain tangible assets of the foreign corporation (pro-rated based on the U.S. shareholder’s ownership percentage).

The amount so determined is included in the U.S. shareholder’s gross income even if the foreign corporation has not made any distributions.

This additional income is subject to U.S. personal income tax (currently up to 37%, but which Joe Biden wants to increase to 39.6%). A foreign tax credit is not available, since this income is not subject to personal income tax on dividends in the foreign country.

New tax relief

Following the enactment of the GILTI HTE measure, a U.S. shareholder of a Canadian corporation can now claim a high foreign tax exception if the Canadian corporation is subject to an effective tax rate that exceeds 90% of the U.S. corporate tax rate.

Currently, this rate is 21%. This means that if the effective Canadian tax rate is above 18.9% (as is generally the case), a U.S. shareholder subject to GILTI tax can benefit from GILTI HTE. Therefore, the U.S. shareholder will not have to include the additional income in its taxable income under the GILTI Plan.

However, be careful, as the measure refers to the concept of effective tax rate. The effective tax rate could be less than 18.9% for certain Canadian corporations, including those that have a high refundable dividend tax (RDT) for the year or those that benefit from certain tax credits, such as research and development related credits.

Access restricted to new measure

In his tax reform package, President Biden proposes to increase the U.S. corporate tax rate to 28% and to double the GILTI tax rate from 10.5% to 21%.

As a result, if such measures are implemented, the effective Canadian tax rate would have to be higher than 25.2% (90% of 28%) instead of 18.9% (90% of 21%) in order to benefit from GILTI HTE. With Democrats having a majority in both houses, it is possible that these tax changes could be passed within two years, before the mid-term elections.

It should be noted that Biden’s tax changes would also restrict access to another means of eliminating the GILTI tax. This alternative, which is more complex to implement than the GILTI HTE, is the tax election under section 962 of the Internal Revenue Code (IRC). With this alternative, to eliminate the GILTI tax, the effective foreign tax rate would have to be higher than 26.25%, instead of the current threshold of 13.125%.

In conclusion, the GILTI tax may be an additional tax burden for our Canadian entrepreneurs with dual citizenship, especially if the measures proposed by Biden are adopted. For this reason, it is important to consult a cross-border tax expert who can assess the present and future risks of the GILTI tax system and suggest solutions to mitigate the impact of this additional tax.

Our team of international tax experts offers personalized advice based on the specific considerations of each case. Contact us to speak with one of our specialists.

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