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GILTI Rules for Americans in Canada
The U.S. Tax Cuts and Jobs Act (TJCA) can create complications for American citizens living in Canada to run businesses through Canadian corporations. One of the complex tax provisions to consider is GILTI (Global Intangible Low-Taxed Income).
What Is GILTI?
GILTI rules were enacted to address American-owned businesses that have corporate structures which result in profits being earned in foreign subsidiaries located in low-tax countries and repatriating then these earnings to the U.S. tax-free. While these rules were primarily put in place to address large U.S. multinationals, they also impact U.S. citizens in Canada who own Canadian corporations.
GILTI High-Tax Exception
In 2020 the U.S. Treasury Department implemented a high-tax exception for the GILTI inclusion. Income that qualifies under the high-tax exception is not included in the net tested income of the Controlled Foreign Corporation (CFC).In order to benefit from the high-tax exception, a CFC’s income must be subject to an effective tax rate imposed by a foreign country that is greater than 90% of the U.S. corporate tax rate of 21% – that is, 18.9%.
The 2020 Final Regulations are effective for tax years of foreign corporations beginning on or after July 23, 2020, and for tax years of U.S. shareholders in which or with which such tax years of foreign corporations year-end. Taxpayers are permitted to apply the 2020 Final Regulations for tax years beginning after December 31, 2017, and before July 23, 2020, as long as certain consistency requirements are satisfied. Note that the U.S. shareholder must claim the high-tax exemption for both GILTI and Sub-part “F” income for the CFC.
Americans who own Canadian corporations are subject to the U.S. GILTI rules. The high-tax exception could assist in avoiding a GILTI income inclusion in many scenarios. However, in cases where the corporate tax rate is below 18.9% due to the application of loss carry-forwards, high tax credits (such as SR&ED credits), high RDTOH refunds, etc. the high-tax exception will not apply.
The GILTI inclusion could also represent an additional tax for Canadian shareholders. For example, consider a corporate structure where a Canadian parent corporation has a controlled foreign affiliate in the US (“US Sub”) that wholly owns a CFC (“Foreign Sub”). The Foreign Sub generates active income that should translate to tested income for GILTI purposes. As a result, US Sub should have a GILTI inclusion in its taxable income with respect to Foreign Sub for US tax purposes.
From a Canadian tax perspective, the active income should be excluded from FAPI and included in Foreign Sub’s exempt surplus. The active income that leads to the GILTI inclusion is not active income earned by US Sub. The foreign Sub’s active income is only one of the elements used to determine the GILTI inclusion. As such, the GILTI inclusion should have an impact on US Sub’s surplus calculation.
Section 962 Election
Another GILTI planning option available for U.S. taxpayers is to make a section 962 election, but this may not eliminate the GILTI generated taxes if the Canadian corporate taxes are low.
A section 962 election is designed to ensure an individual U.S. taxpayer is not subject to a higher rate of tax on the earnings of a directly-owned foreign corporation than if he or she had structured the business through a U.S. C corporation.
A section 962 election may be made on an annual basis with respect to all CFCs owned by a U.S. shareholder, including those owned through pass-through entities.
Individuals who make a section 962 election are taxed as if there was an imaginary domestic corporation interposed between them and the foreign corporation. A section 962 election may be an effective method of reducing or deferring double-tax scenarios.
At UHY Victor, we have expertise in helping Americans living in Canada navigate the complex GILTI regulations to minimize their cross-border tax situation. Contact our cross-border tax experts for a free consultation:
UHY Victor LLP Canada U.S. Tax Team
Disclaimer: UHY Victor assumes no responsibility or liability for any errors or omissions of this site. The information used in this site is provided for general guidance. This article is not a substitute for professional legal advice.