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11.10 Branch operations, subpart F income, and GILTI
Publication date: 31 Dec 2023
us Income taxes guide
This section addresses the special considerations related to the accounting for branch operations, subpart F income, and GILTI.
11.10.1 Income tax accounting for branch operations
A branch operation generally represents the operations of an entity conducted in a country that is different from the country in which the entity is incorporated. Accordingly, for a US entity, a branch represents the portion of the US entity's operations that are located in and taxed by a foreign jurisdiction. For US entities, a branch can also take the form of a wholly-owned foreign corporation that has elected for US tax purposes to be treated as a disregarded entity of its parent corporation.
Branch operations are often subject to tax in two jurisdictions: (1) the foreign country in which the branch operates and (2) the entity's home country. Accordingly, we would expect the entity to have two sets of temporary differences that give rise to deferred tax assets and liabilities: one for the foreign jurisdiction in which the branch operates and one for the entity's home jurisdiction. The temporary differences in the foreign jurisdiction will be based on the differences between the book basis and the related foreign tax basis of each related asset and liability. The temporary differences in the home country jurisdiction will be based on differences between the book basis and the home country tax basis in each related asset and liability.
To mitigate the effects of double taxation that can result from branch operations being taxed in both the home tax return and in the foreign jurisdiction tax return, the US tax law allows for US corporations to take a foreign tax credit or deduct the foreign income taxes paid in the foreign jurisdiction. Therefore, in addition to recording deferred taxes in the foreign jurisdiction and the entity’s home country, the entity should also record deferred taxes in its home country for the effects the foreign deferred tax assets and liabilities would be expected to have on the home country’s future FTCs. When a deferred foreign tax liability is settled, it increases foreign taxes paid, which may decrease the home country taxes paid as a result of additional FTCs or deductions for the additional foreign taxes paid. As a result, deferred tax liabilities of foreign branches may generate deferred tax assets in the US jurisdiction. Conversely, when a deferred foreign tax asset in the foreign jurisdiction is recovered, it reduces foreign taxes paid, which may increase the home country taxes as a result of lower foreign tax credits or deductions for foreign taxes paid. See ASC 740-10-55-20, which describes a similar concept in the context of deductible state income taxes.
For branch operations, this generally means there are three deferred tax items:
- The deferred taxes in the foreign country in which the branch operates;
- The deferred taxes in the entity's home country; and
- The home country deferred tax effect of the foreign deferred taxes.
11.10.1.1 Home country deferred tax effect of foreign branch deferred taxes
In considering the amount of deferred taxes to record in the home country related to foreign deferred tax assets and liabilities, an entity must consider how those foreign deferred taxes, when paid, will interact with the tax computations in the home country tax return.
In the US, for example, a taxpayer makes an annual election to either deduct foreign taxes paid or claim them as a credit against its US tax liability. Although the deduction of foreign taxes paid is less beneficial than claiming a credit, there are limitations on the use of foreign tax credits, and unutilized FTCs have a limited carryforward period. Also, in deciding whether to deduct or credit foreign taxes paid, a taxpayer will need to consider the interaction of the income and taxes of the foreign branch with the income and taxes of the entity’s other branches.
If the taxpayer expects to take a credit for the foreign taxes to be paid, it should record a home country deferred tax asset or liability for the related foreign deferred tax liability or asset for the amount of the foreign deferred taxes that are expected to be creditable. When determining the amount of any foreign taxes that will be creditable, tax law limitations should be considered. If the foreign taxes that will be paid as the deferred taxes reverse are not expected to be fully creditable, further analysis is necessary. In the US, the federal US corporate tax rate of 21% and FTC limitations for foreign branch income may limit an entity’s ability to claim an FTC for the foreign taxes paid by the foreign branch. For example, FTC availability may be limited when the foreign tax rate exceeds the US tax rate and the company does not have other foreign branch source income to utilize the FTC.
If a US deferred tax asset has been recorded for future FTCs, it may be appropriate to reduce it for the portion of any net foreign deferred taxes that, when paid, are expected to generate FTCs that will expire unutilized. When the aggregate tax rate on foreign branch income exceeds the US corporate tax rate, this would result in the US deferred tax asset being capped at the US corporate tax rate since FTCs would not be available for more than the US tax rate. Other limitations may also continue to impact the amount of the deferred tax asset. For example, the allocation of expenses to the branch basket of income could reduce the amount of FTCs that can be utilized.
A similar situation can occur when there is a deferred tax asset that exists in the foreign jurisdiction. The foreign deferred tax asset signifies a reduction in future foreign taxable income, which inherently will result in the foreign entity paying less tax in the foreign jurisdiction. In this fact pattern, the foreign deferred tax asset is representative of the fact that the US company will forego an FTC that would otherwise have been available had more tax been paid in the foreign jurisdiction. As a result, companies also need to consider whether US deferred tax liabilities should be recorded for the forgone FTCs resulting from foreign branch deferred tax assets based on the aggregate tax rate of its foreign branches. Similar to US deferred tax assets, to the extent the aggregate tax rate on foreign branch income exceeds 21%, the US deferred tax liability should not exceed the 21% US corporate tax rate and should reflect only the forgone FTCs that could have actually been utilized had they been generated.
If the entity expects to deduct (rather than take a credit for) foreign taxes paid, it should establish deferred taxes in the home country jurisdiction on the foreign deferred tax assets and liabilities at the home country enacted rate expected to apply in the period during which the foreign deferred taxes reverse. In some fact patterns, scheduling the reversal of the foreign deferred taxes may be required if the company’s ability to utilize FTCs would be affected by the timing of these reversals.
Generally, a deferred foreign tax asset of a branch is a taxable temporary difference for US tax purposes, and a deferred foreign tax liability is a deductible temporary difference for US tax purposes. But the applicable rate may be:
- 100% of the US tax rate on a post-tax basis if foreign taxes are expected to be fully creditable for US tax purposes;
- Less than 100% of the US tax rate on a post-tax basis if FTCs are expected to be limited; or
- Equal to the US tax rate (currently 21%) if foreign taxes are expected to be deducted.
Example TX 11-5 and Example TX 11-6 illustrate how to account for inside basis differences of a foreign branch.
EXAMPLE TX 11-5
Deferred tax accounting on inside basis differences of a foreign branch – higher home country rate
Deferred tax accounting on inside basis differences of a foreign branch – higher home country rate
Company P is a US entity with a branch in Country X where the statutory tax rate is 20%. In the current year, the branch has pre-tax income of $10,000. For Country X and US tax purposes, the branch has a $3,000 deductible temporary difference for inventory reserves that are not currently deductible for tax purposes and a $5,000 taxable temporary difference for PP&E due to tax depreciation in excess of book depreciation. For US purposes, income from the branch is taxed at 25%. Taxes paid to Country X will be claimed as a foreign tax credit. No expenses have been allocated to the branch income basket.
How and for which jurisdictions should deferred taxes be recorded on the inventory and PP&E temporary differences?
Analysis
Because the branch is taxed in both Country X and the United States, the taxable and deductible temporary differences in each jurisdiction must be computed. A deferred tax asset (DTA) and deferred tax liability (DTL) in Country X should be recorded as follows:
Country X |
||
|---|---|---|
Inventory reserves DTA
|
$600 |
($3,000 × 20%) |
PP&E DTL
|
(1,000) |
($5,000 × 20%) |
Branch DTA/(DTL), net
|
($400) |
The same temporary differences exist in the US; however, the deferred taxes are recorded at the US rate of 25%. The net deferred tax liability of $400 in Country X will increase foreign taxes paid when settled, resulting in an increase in future FTCs in the US. In this case, the FTCs would not be limited based on the tax rate or expense allocation because the US tax rate is higher than the tax rate of Country X and no expenses have been allocated to the branch income basket. In addition to the temporary differences for the PP&E and inventory reserves, a $400 deferred tax asset should be recorded in the US to reflect the future FTCs related to the foreign deferred taxes. Deferred taxes in the US should be recorded as follows:
US |
||
|---|---|---|
Inventory reserves DTA
|
$750 |
($3,000 × 25%) |
PP&E DTL
|
(1,250) |
($5,000 × 25%) |
Future branch FTCs
|
400 |
($400 x 100%) |
US DTA/(DTL), net
|
($100) |
If there were more than one branch in this example, Company P would need to consider the branches in the aggregate when determining the impact of any limitations on the applicable rate used to measure any anticipatory or foregone FTCs.
EXAMPLE TX 11-6
Deferred tax accounting on inside basis differences of a foreign branch – lower home country rate
Deferred tax accounting on inside basis differences of a foreign branch – lower home country rate
Company P is a US entity with a branch in Country X where the statutory tax rate is 30%. In the current year, the branch has pre-tax income of $10,000. For Country X and US tax purposes, the branch has a $3,000 deductible temporary difference for inventory reserves that are not currently deductible for tax purposes and a $5,000 taxable temporary difference for PP&E due to tax depreciation in excess of book depreciation. For US purposes, income from the branch is taxed at 25%. Taxes paid to Country X will be claimed as a foreign tax credit. No expenses have been allocated to the branch income basket.
How and for which jurisdictions should deferred taxes be recorded on the inventory and PP&E temporary differences?
Analysis
Because the branch is taxed in both Country X and the United States, the taxable and deductible temporary differences in each jurisdiction must be computed. Deferred taxes in Country X should be recorded as follows:
Country X |
||
|---|---|---|
Inventory reserves DTA
|
$900 |
($3,000 × 30%) |
PP&E DTL
|
(1,500) |
($5,000 × 30%) |
Branch DTA/(DTL), net
|
($600) |
The same temporary differences exist in the US; however, the deferred taxes are recorded at the US rate of 25%. The net deferred tax liability in Country X of $600 will increase foreign taxes paid when settled, resulting in an increase in future FTCs in the US. In this case, the FTCs will be limited because the US tax rate is lower than the tax rate of Country X. Only $500 of the FTCs can be utilized on the US tax return (25% US rate divided by 30% foreign rate times $600 net branch deferred tax liability). If expenses were allocated to the branch basket of income, further limitations would also need to be considered in determining the applicable rate. In addition to the temporary differences for the PP&E and inventory reserves, a $500 deferred tax asset should be recorded in the US to reflect the future FTCs related to the foreign deferred taxes. Deferred taxes in the US should be recorded as follows:
US |
||
|---|---|---|
Inventory reserves DTA
|
$750 |
($3,000 × 25%) |
PP&E DTL
|
(1,250) |
($5,000 × 25%) |
Future branch FTCs
|
500 |
($600 x 83.33%) |
US DTA/(DTL), net
|
– |
If there were more than one branch in this example, Company P would need to consider the branches in the aggregate when determining the impact of any limitations on the applicable rate used to measure any anticipatory or foregone FTCs.
Example TX 11-7 illustrates the complexity that could arise as a result of having multiple branches.
EXAMPLE TX 11-7
US deferred taxes for a loss related to one of multiple foreign branches
US deferred taxes for a loss related to one of multiple foreign branches
Company A is a US entity with branches in two separate foreign tax jurisdictions. Assume that there are no temporary differences prior to the current year in either jurisdiction. The tax rate is 25% in both the United States and in foreign jurisdiction B. The tax rate in foreign jurisdiction C is 20%.
Company A has domestic income of $800, Foreign Branch B has income of $300, and Foreign Branch C has a loss of ($100), resulting in $1,000 of consolidated income for Company A.
Company A claims US foreign tax credits for its foreign taxes paid. The US tax law limits the FTC claimed to an amount equal to the US taxes on the branch income before consideration of the FTCs (FTC limitation percentage in chart below). With regard to Foreign Branch B and C, there is no carryback potential, but both loss and credit carryforwards are allowed in each foreign jurisdiction.
How should deferred taxes be recorded in relation to the branch operations?
Analysis
US federal tax, based on $1,000 consolidated income at the 25% tax rate, is $250.
The following illustrates the calculation of FTC availability:
Net income |
Tax paid |
|||
|---|---|---|---|---|
Branch B
|
$300 |
$75 |
||
Branch C
|
(100) |
0 |
||
Total
|
$200 |
$75 |
||
Total Company A income
|
$1,000 |
|||
FTC limitation percentage ($200 / $1,000)
|
20% |
|||
US federal tax
|
$250 |
|||
FTC limitation ($250 tax * 20% limitation)
|
$50 |
Although Branch B paid $75 of foreign taxes, only $50 can be claimed as a tax credit in the current year’s return based on the FTC limitation. The remaining $25 would be carried forward. Given that excess FTCs have limited carryforward potential in the United States and have limitations under US tax law, the carryforward needs to be assessed for realizability. Further income in Branch B will generate additional FTCs, so realization of the FTC would need to be based on the generation of income in Branch C, which is in a lower tax jurisdiction. If, for example, losses are anticipated in Branch C through the US FTC carryforward period, a valuation allowance may be necessary on the $25 of excess FTCs.
Also, with respect to the Branch C’s deferred tax asset of $20 related to its $100 NOL, Company A will need to consider whether a valuation allowance should be established on the foreign country deferred tax asset. If a valuation allowance is not recorded, a corresponding deferred tax liability of $20 for the future FTC impact should be recorded in the US jurisdiction taking into account all relevant considerations (e.g., tax rate and expense allocation).
11.10.2 US subpart F income
Subpart F of the Internal Revenue Code was enacted to discourage US companies from forming a foreign subsidiary to defer the US taxation of certain types of foreign earnings. Under subpart F, certain types of income are currently taxable to the extent of the foreign subsidiary's current tax basis earnings and profits. Subpart F income, when taxable, is treated as a deemed dividend, followed by an immediate contribution of the deemed dividend to the foreign subsidiary. The contribution increases the US parent's tax basis in the foreign subsidiary. If a subsequent distribution is made from the foreign subsidiary, the amounts that have already been subjected to tax under the subpart F rules can be repatriated without further taxation (other than potential withholding taxes and any tax consequences applicable to foreign currency gains or losses). The subsequent distribution would reduce the US parent's tax basis in the subsidiary.
A controlled foreign corporation (CFC) is a foreign corporation where greater than 50% of the voting power or value of the foreign corporation’s stock is owned by a US shareholder. A CFC may have certain temporary differences that, upon reversal, will represent subpart F income. US deferred taxes may need to be recorded for such foreign temporary differences that will impact subpart F income (and thus US taxes) when they reverse.
In some circumstances, all of a foreign subsidiary’s income may be subject to subpart F. Foreign subsidiaries with subpart F income that represents more than 70% of the entity’s gross income are considered “full inclusion” entities (meaning, all of their income is considered subpart F income). Foreign subsidiaries engaged in certain financing activities may also be subject to current US taxation on their entire income in the absence of a statutory exception for “active” financing activities. In circumstances when a company expects to consistently be a full inclusion entity, recognition of US deferred taxes for temporary differences of the subsidiary is appropriate since the subsidiary is effectively the tax equivalent of a branch. Because a “full inclusion” subsidiary is analogous to a branch, the temporary differences for US tax purposes should be based on the differences between the US E&P tax basis and book basis in the assets and liabilities of the subsidiary. In circumstances when a company does not expect to consistently be a full inclusion entity, an inside basis or outside basis unit of account should be selected and applied in measuring subpart F deferred taxes. This expectation should be consistently reassessed as a change in expectations, or a reality that is different from initial expectations (e.g., the foreign subsidiary is consistently a full inclusion entity), can significantly impact the accounting for deferred taxes.
Some reporting entities may assert that earnings of their foreign subsidiary are indefinitely reinvested. To utilize the indefinite reversal exception in ASC 740-30-25-17, the parent must have the ability and intent to indefinitely defer the reversal of the temporary difference with a tax consequence. To the extent that activities occurring at the foreign subsidiary level or below will cause the recognition of subpart F income by the US parent, the underlying facts and circumstances must be examined to determine whether recording US deferred taxes is appropriate.
With respect to foreign subsidiaries that are not full inclusion and for which an indefinite reversal assertion is made, it is important to determine the unit of account to be applied in measuring subpart F deferred taxes. We believe either of the following views is acceptable:
View A (an inside basis unit of account): Under this view, deferred taxes would be recorded regardless of whether an outside basis difference exists and regardless of whether the outside basis is in a book-over-tax or tax-over-book position. The reversal of applicable temporary differences at a foreign subsidiary will create subpart F income when the underlying assets and liabilities are recovered. Therefore, the equivalent of an inside basis US taxable temporary difference exists for which a US deferred tax liability should be recognized.
Similarly, deferred subpart F income would create the equivalent of an inside basis US taxable temporary difference. Therefore, a temporary difference exists for deferred subpart F income as it would for other deferred taxable income. While future losses at the foreign subsidiary could further delay the taxation of subpart F income, the concepts underpinning ASC 740 do not allow companies to avoid the recognition of a deferred tax liability because of anticipated losses.
View B (an outside basis unit of account): Subpart F income (both unrealized and realized but deferred for US tax purposes), as a component of the subsidiary’s book earnings, is encompassed in the outside basis of the parent’s investment. Therefore, outside basis would be the unit of account for purposes of determining the relevant temporary difference. Unlike other portions of the outside basis difference for which the US parent may be able to control the timing of taxation simply by avoiding repatriations of cash, a company may not be able to delay the taxation of subpart F income. Therefore, under this view, deferred taxes would be recorded when subpart F income is recognized in book income, but only to the extent that subpart F income does not exceed the parent’s book-over-tax outside basis difference. In effect, deferred taxes recorded are limited to the hypothetical deferred tax amount on the portion of the parent’s outside book-over-tax basis difference that cannot be avoided as a result of the indefinite reinvestment assertion. Whichever view is selected by the company should be applied consistently.
If a CFC has no current E&P, the subpart F income may be deferred for US tax purposes. In this case, the deferred subpart F income would be recognized in taxable income when the CFC generates current E&P. We believe the accounting consequences of subpart F income are the same whether the income is (1) realized but deferred for US tax purposes or (2) unrealized (e.g., unrealized gains on AFS debt securities that will create subpart F income when realized). Example TX 11-8 illustrates the US deferred taxes that may be required to be recorded due to foreign temporary differences that will result in subpart F income.
EXAMPLE TX 11-8
Foreign temporary differences that will give rise to future subpart F income
Foreign temporary differences that will give rise to future subpart F income
A French subsidiary of a US company holds an appreciated available-for-sale debt security that is accounted for under ASC 320, Investments—Debt Securities. When sold, the gain on the sale of the debt security will constitute subpart F income in the United States. The US parent company has a book-over-tax outside basis difference in the French subsidiary that is greater than the unrealized gain in the security; however, it has asserted indefinite reversal as it does not intend to repatriate any of the subsidiary’s undistributed earnings.
Should US deferred taxes be recorded on the potential subpart F income resulting from the appreciated debt security?
Analysis
Yes. To the extent subpart F income is expected to be generated on the reversal of the temporary difference associated with the debt security, US deferred taxes should be provided even when the company has made an assertion of indefinite reversal related to its overall outside basis difference. This is because the company is not able to control or indefinitely defer the reversal of the related portion of its outside basis difference.
11.10.2.1 Subpart F qualified deficit
As noted in TX 11.10.2, when a foreign subsidiary has a current-year earnings and profit deficit (i.e., a loss measured under applicable tax law), subpart F taxation is deferred until there is current-year E&P. A qualified subpart F deficit is the amount of a current-year E&P deficit attributable to activities that, when profitable, give rise to certain types of subpart F income. The qualified deficit is available to reduce income from activities in the future that would otherwise be taxable under the subpart F rules.
Consistent with our discussion of the unit of account considerations in TX 11.10.2, we believe a consistent approach should be used to determine whether a US deferred tax asset should be recorded for a subpart F qualified deficit. We believe either of the following views is acceptable:
View A (inside basis unit of account): Under this view, a qualified deficit creates an inside basis difference for which a US deferred tax asset would be recorded. This view considers a qualified deficit to be a tax attribute akin to a carryforward or deductible temporary difference that can reduce income of the same category in the future that would otherwise be taxable under the subpart F rules.
View B (outside basis unit of account): Under this view, a qualified deficit is considered a component of the subsidiary's book earnings, and therefore inherent in the outside basis of the parent's investment. Accordingly, the recognition requirement applicable to a deductible outside basis difference would apply. A deferred tax asset would be recorded only if it is apparent that reversal of the qualified deficit is anticipated to occur in the foreseeable future (ASC 740-30-25-9) and only to the extent of the parent's tax-over-book outside basis difference. If subpart F income is anticipated in future periods and the qualified deficit is expected to eliminate the associated US tax cost (cash or utilization of a loss or credit carryforward), a deferred tax asset would be recognized based on the amount of subpart F loss that does not exceed the parent's tax-over-book outside basis difference.
Under either View A or View B, a valuation allowance may be required if it is more-likely-than-not that some portion or all of the recognized deferred tax asset will not be realized.
11.10.2.2 Indefinite reversal and previously taxed income
Previously taxed income (PTI) occurs when foreign earnings and profits have been subject to US federal taxation prior to an actual distribution to the US. Subpart F income, as well as the one-time "toll tax" on unremitted E&P as part of the 2017 Act and global intangible low-taxed income inclusions, may give rise to PTI. A US parent can generally receive distributions of PTI without incurring further US federal income tax. Such distributions, however, may be subject to the tax consequences applicable to any foreign currency gain or loss as well as state taxes, foreign withholding taxes, and potential US foreign tax credits. Therefore, management still needs to declare its intentions with respect to whether PTI is indefinitely reinvested.
TX 13.4 on branch operations and deferred taxes related to CTA discusses the rationale for an indefinite reversal assertion applied to PTI. When a company analyzes its intentions under ASC 740-30-25-17, which will often include the tax consequences of remitting undistributed earnings, it may be more difficult to overcome the presumption that the undistributed earnings that underlie the PTI are indefinitely reinvested because the earnings have already been taxed and the impact of translation and withholding taxes may be minimal.
11.10.3 GILTI
Under the 2017 Act, a US shareholder of a controlled foreign corporation is required to include its global intangible low-taxed income in US taxable income. At a high level, the amount of GILTI included in US taxable income is based on the relationship between two elements: (1) the US company’s aggregate share of the net tested income of its CFCs and (2) a net deemed tangible income return.
Tested income is the total gross income of a CFC reduced by certain exceptions and allocable deductions. Net tested income is the US shareholder’s pro rata share of all of its CFCs’ tested income in excess of their tested losses. The net deemed tangible income return is generally equal to 10% of the US shareholder’s aggregate share of qualified business asset investment (QBAI), which is defined as the company’s basis in tangible depreciable business property of the CFCs that generated tested income, adjusted for certain expenses. If the aggregate share of net CFC tested income exceeds the net deemed tangible income return, that excess is the amount of GILTI included in US taxable income (the GILTI inclusion).
The US tax cost of GILTI may be reduced by 50% (the Section 250 deduction, reduced to 37.5% for tax years beginning after December 31, 2025). However, the Section 250 deduction may be limited based on the level of US taxable income.
Additionally, there is a foreign tax credit of up to 80% of foreign taxes attributable to the GILTI inclusion that may reduce the US tax cost. These GILTI FTCs can only reduce US taxes owed on GILTI and are not eligible for carryforward.
The FASB staff issued a Q&A in response to the Tax Cuts and Jobs Act (FASB Staff Q&A #5), which indicated they do not believe ASC 740 is clear as it relates to the accounting for GILTI. Therefore, the FASB staff concluded that reporting entities can make an accounting policy election to either: (1) treat GILTI as a period cost (i.e., recognized as incurred); or (2) record deferred taxes for basis differences that are expected to reverse as GILTI in future years. FASB Staff Q&A #5 also indicates that an entity must disclose its accounting policy related to GILTI in accordance with ASC 235, Notes to Financial Statements.
Reporting entities with a GILTI inclusion in their US taxable income may realize reduced (or no) cash tax savings from NOLs due to the mechanics of the GILTI calculation. Regardless of the accounting policy chosen for whether or not to measure deferred taxes considering GILTI, reporting entities must make a separate accounting policy election as to whether to consider the potential reduction/loss in cash tax savings from their NOLs due to GILTI as part of their valuation allowance assessments (see TX 5.7.3.5).
11.10.3.1 GILTI deferred tax election
For reporting entities electing to recognize deferred taxes for basis differences that are expected to have a GILTI impact in future years (GILTI deferred taxes), we believe the approach set forth herein is one acceptable model based on the broad principles of ASC 740. The approach begins with a two-step model: (1) “looking-through” each CFC to the underlying assets and liabilities and (2) considering any residual outside basis differences. The impacts of the net deemed tangible income return, the Section 250 deduction, and FTCs should also be considered. The subsections that follow provide additional details on the two-step model and additional considerations.
Recording GILTI deferred taxes
GILTI is measured on a US shareholder basis. The US shareholder’s pro rata share of its CFCs’ net tested income in excess of its tested losses is included in its taxable income.
We anticipate that a reporting entity will only recognize GILTI deferred taxes if it expects to have a GILTI inclusion in the future. Otherwise, any basis differences that might exist would not have a GILTI impact upon reversal. Situations when a GILTI inclusion may not be expected to occur in the future include:
- Net deemed tangible income return will routinely exceed CFCs net tested income
- CFCs are expected to consistently produce tested losses
- CFCs are not expected to have tested income because their net income is already taxed in the US on a current basis (e.g., effectively connected income, subpart F income)
Two-step model for measuring GILTI deferred taxes
When recording GILTI deferred taxes, a reporting entity must consider both the inside and outside basis differences of its CFCs.
Step 1: “Look-through” each CFC to the underlying assets and liabilities
Similar to accounting for branch operations (as discussed in TX 11.10.1), the assets and liabilities of CFCs may result in two sets of temporary differences that give rise to deferred tax assets and liabilities: one for the foreign jurisdiction and one for the GILTI impact in the US.
Foreign deferred taxes recorded for temporary differences in the local jurisdiction in which the CFC operates would follow the provisions of ASC 740. For GILTI deferred taxes, the US shareholder should “look through” each CFC and compare the book basis of its assets and liabilities to the US tax basis determined under the GILTI provisions (GILTI basis) to determine if basis differences exist. If the GILTI basis differences will impact tested income/loss of the CFC upon reversal, they should be included in the measurement of GILTI deferred taxes. GILTI deferred taxes should be recorded for inside basis differences regardless of whether the total outside basis difference is in a book-over-tax or tax-over-book position or whether an outside basis difference exists at all.
Example TX 11-9 illustrates the application of Step 1.
EXAMPLE TX 11-9
Application of GILTI deferred tax model Step 1 – “Look-through” each CFC
Application of GILTI deferred tax model Step 1 – “Look-through” each CFC
Company A (US shareholder) has one CFC (CFC1). CFC1 has intellectual property (IP) with a book basis of $1,500 that will be amortized over 10 years. The IP has a tax basis in the foreign jurisdiction of $1,000 that will also be amortized over 10 years. In determining the tested income of CFC1 under US tax law, the intellectual property has a GILTI basis of $600 that will be amortized over 15 years.
Which bases are relevant in the measurement of GILTI deferred taxes related to CFC1’s IP?
Analysis
Company A should “look-through” CFC1, noting that a $900 basis difference exists between the book basis ($1,500) and the GILTI basis ($600). As this inside basis difference reverses, it will have an impact on tested income. For example, assuming no other book-tax differences in the first year, CFC1’s tested income will be equal to pre-tax income plus $110 [book amortization of $150 compared to US GILTI tax amortization of $40].
Additionally, there is a $500 basis difference between book and tax basis in the foreign jurisdiction that will give rise to a deferred tax liability for CFC1. Upon reversal, the deferred tax liability will result in additional foreign taxes that might be creditable in the calculation of GILTI and may reduce the GILTI tax cost in the year in which the deferred tax liability reverses (i.e., anticipatory FTCs). US deferred taxes for anticipatory FTCs (discussed later in this section) may only be recorded for the local jurisdiction deferred tax assets or liabilities of the CFC.
Example TX 11-10 illustrates GILTI deferred tax considerations for CFCs with tested losses.
EXAMPLE TX 11-10
Temporary differences for CFCs with tested losses
Temporary differences for CFCs with tested losses
Company A (US shareholder) has two CFCs: CFC1 and CFC2. CFC1 is expected to consistently generate tested income that exceeds CFC2’s tested losses. CFC1 has a $100 taxable temporary difference that will increase the GILTI inclusion upon reversal. CFC2 also has a $100 taxable temporary difference that would contribute to a GILTI inclusion upon reversal.
If Company A has elected to record GILTI deferred taxes, should the measurement of the GILTI deferred taxes include the taxable temporary differences for both CFC1 and CFC2?
Analysis
Yes. The taxable temporary difference of CFC2 would not be ignored just because CFC2 is expected to have a tested loss that would not result in a GILTI inclusion if calculated on a stand-alone basis. Company A’s net share of the tested income or loss for CFC1 and CFC2 would be aggregated to calculate the GILTI inclusion.
Step 2: Consider residual outside basis differences
After “looking-through” the CFC to determine the inside basis differences, a residual outside basis difference between the inside and outside tax basis may remain. The residual outside basis difference may reverse in a sale, distribution, or liquidation, as it would have prior to the enactment of the GILTI provisions and should be evaluated in accordance with ASC 740-30-25-17 (see TX 11.4 and 11.5).
Special considerations in GILTI deferred accounting
Net deemed tangible income return
Because the net deemed tangible income return is dependent on future events, such as investments in specified tangible property and interest expense of CFCs, we believe it is acceptable to account for the related tax benefit in the period it arises, similar to a “special deduction” as described in TX 4.3.3.2. Using this approach, the net deemed tangible income return would not be considered in the measurement of GILTI deferred taxes.
An alternative approach is to estimate the net deemed tangible income return to determine an average tax rate expected to apply in the period the temporary difference reverses. This average tax rate would be used to measure the GILTI deferred taxes. This approach is similar to accounting for graduated tax rate structures, discussed in TX 4.3.1. A reporting entity following this approach would need to develop an expectation of tested income and QBAI to calculate the average rate and would need to update its estimate each reporting period as facts and circumstances change.
A reporting entity’s selected approach as it relates to the net deemed tangible income return should be applied on a consistent basis.
Section 250 deduction
Because of the mechanics of the Section 250 deduction and taxable income limitations, a reporting entity’s eligible Section 250 deduction could be less than 50% (or 37.5% for tax years beginning after December 31, 2025) of the GILTI inclusion. We believe it is generally appropriate to presume that the Section 250 deduction will not be limited in determining the tax rate applied to measure GILTI deferred taxes.
Example TX 11-11 illustrates considerations related to accounting for the Section 250 deduction.
EXAMPLE TX 11-11
Section 250 deduction
Section 250 deduction
Company A (US shareholder) has one CFC (CFC1). CFC1 has identified a $1,000 GILTI taxable temporary difference related to its intellectual property (IP). The difference is expected to reverse and increase tested income by a total of $600 in taxable years when the Section 250 deduction is 50% and a total of $400 in taxable years when the Section 250 deduction is 37.5%. Company A expects to be able to apply the full GILTI deduction in all years and has elected to account for the net deemed tangible income return in the period that it arises.
How should Company A account for the Section 250 deduction when measuring GILTI deferred taxes?
Analysis
Company A could presume the full Section 250 deduction in determining the tax rate that applies in the measurement of its GILTI deferred taxes as illustrated below.
50% |
37.5% |
Total |
|
|---|---|---|---|
Expected reversal |
$600 |
$400 |
$1,000 |
Section 250 deduction |
(300) |
(150) |
(450) |
Impact on taxable income |
$300 |
$250 |
$550 |
Because of the Section 250 deduction, only $550 of the $1,000 taxable temporary difference is expected to have a GILTI impact in the future. Company A’s GILTI deferred tax liability before consideration of anticipatory FTCs would be $115.50 ($550 multiplied by 21%).
As an alternative approach, a reporting entity could consider whether it expects to be able to apply the Section 250 deduction to reduce GILTI in the year in which a GILTI temporary difference reverses. A reporting entity’s Section 250 deduction may be limited, for example, if a reporting entity expects US-sourced losses to offset any GILTI inclusions, or it expects to utilize NOLs or other tax attributes to offset taxable income in future periods. To the extent a reporting entity does not expect to be able to benefit from some or all of the applicable Section 250 deduction in the relevant year, it would measure the temporary difference at a tax rate that excludes the portion of the Section 250 deduction that is expected to be lost.
In cases when limitations on the Section 250 deduction are considered in assessing the realization of NOLs (see TX 5.7.3.5), reporting entities should be consistent when considering the limitation. Reporting entities that follow the incremental cash tax savings approach for purposes of assessing realization of their NOLs should include the Section 250 deduction in measuring GILTI deferred taxes in all cases. Reporting entities that follow the tax-law ordering approach for purposes of assessing realization of their NOLs should exclude the Section 250 deduction in measuring GILTI deferred taxes for temporary differences that reverse during the relevant periods in which NOLs are utilized.
Whichever approach is selected would need to be applied consistently.
Foreign tax credits
FTCs may be used to reduce the US tax cost of GILTI. The measurement of GILTI deferred taxes should reflect the expected impact of “anticipatory” FTCs similar to the manner in which deferred taxes are recorded for the home country tax effect of foreign taxes incurred by a branch operation (see TX 11.10.1). When a foreign deferred tax liability is settled, it increases foreign taxes paid, which may increase GILTI FTCs available to reduce the GILTI tax cost in that year (i.e., additional “anticipatory” FTCs). Conversely, when a foreign deferred tax asset is recovered, it reduces foreign taxes paid, which may decrease GILTI FTCs available to reduce the GILTI tax cost in that year (i.e., less “anticipatory” FTCs). US deferred taxes for “anticipatory” FTCs may only be recorded for the local jurisdiction deferred tax assets or liabilities of the CFC. In other words, the “anticipatory” FTCs considered in the measurement of GILTI deferred taxes should not consider FTCs that are attributable to future earnings. Under the tax law, GILTI FTCs are subject to a number of limitations. At a minimum, for a reporting entity that did not expect to be subject to other FTC limitations, such as expense allocation, the “anticipatory” GILTI FTCs would be limited to 80% of the in-country foreign deferred tax asset or liability since, in all cases, GILTI FTCs are subject to the 80% limitation. However, a reporting entity would need to consider all limitations that may reduce the amount of the “anticipatory” FTCs.
Example TX 11-12 addresses whether to consider GILTI FTCs in the measurement of an outside basis deferred tax liability when the reporting entity accounts for GILTI as period cost.
EXAMPLE TX 11-12
Consideration of GILTI- basket FTCs when measuring an outside basis deferred tax liability
Consideration of GILTI- basket FTCs when measuring an outside basis deferred tax liability
Assume that a reporting entity has elected to account for GILTI as a period cost and does not assert indefinite reinvestment for a CFC for which a book over tax outside basis difference exists. Presume that the CFC generates GILTI and any future remittance is expected to generate withholding tax. As a result, the reporting entity must accrue a deferred tax liability for withholding taxes that would be triggered when those underlying foreign earnings are distributed from the foreign subsidiary to the US. The reporting entity expects to be able to claim on its US tax return a GILTI-basket FTC for the withholding taxes paid on those earnings and foresees no limitation on its ability to realize the benefit of that FTC. When measuring the deferred tax liability for withholding taxes, should the reporting entity reduce the deferred tax liability to reflect the tax benefit for the GILTI FTC that will be generated upon payment of the withholding tax?
Analysis
Yes, the US reporting entity should recognize the tax benefit of the GILTI FTC as part of the measurement of its deferred tax liability on the outside basis difference. The deferred tax liability for undistributed earnings of a foreign subsidiary should incorporate the effects of FTCs. We do not believe that consideration of the expected GILTI FTC is inconsistent with the reporting entity’s policy to account for GILTI as a period cost.
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