2024-08-30
Today I was reading a Tax Court case that came out earlier this week, Varian Medical Systems, Inc. v. Commr., 163 T.C. No. 4 (August 26, 2024).
In the case, the Tax Court allowed a Code §245A dividends received deduction for a Code §78 gross up for a fiscal year taxpayer. Code §245A was a new section created by the Tax Cuts and Jobs Act (“TCJA”), and Code §78 was amended by TCJA. However, the effective date for Code §245A differed from the effective date for the amendment to Code §78. Due to these differing effective dates, Varian Medical was allowed to claim the Code §245A dividends received deduction for the Code §78 gross up with respect to its 2018 fiscal year.
The Tax Court focused heavily on the statute and how the effective dates of the different provisions were clear. Since the statute was clear, it didn’t really matter what the Treasury regulations provided, citing the recent Supreme Court decision of Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244 (2024).
With the recent Loper Bright decision, I was reminded of the Treasury Department’s liberal interpretation of the GILTI statute to benefit large U.S. multinational corporations by creating the GILTI high-tax exception.
The GILTI high-tax exception is found in Treas. Reg. §1.951A-7(c). When I originally read Code §951A upon the enactment of TCJA, I did not see a GILTI high-tax exception. I still don’t see where in the statute the Treasury Department found this exception. I know where they “said” the exception is derived from, but I just don’t see any ambiguity in the statute.
Before we get to the GILTI high-tax exception, lets start with the definition of Subpart F Income.
Code §952(a) defines Subpart F Income as:
* * * [T]he sum of—(1) insurance income * * *,
(2) the foreign base company income * * *,
(3) [boycott related income],
(4) [illegal bribes, kickbacks, etc.], and
(5) [income derived from certain foreign countries, such as Iran and North Korea].
The first two items, insurance income and foreign base company income, are the most common types of Subpart F Income. In addition, Code §952(b) provides that if the income would otherwise be Subpart F Income, but it is effectively connected to a U.S. trade or business (“ECI”), then it is not treated as Subpart F Income.
The Subpart F Income high-tax exception is found in Code §954(b)(4), which provides in part:
* * * [F]oreign base company income and insurance income shall not include any item of income * * * [that] was subject to [a high] effective rate of income tax * * * imposed by a foreign country * * *.
This high-tax exception only applies to foreign base company income and insurance income, two types of Subpart F Income. The exception is elective. Treas. Reg. §1.954-1(d)(1)(i).
The GILTI rules are keyed off of a new term called “tested income”. Code §951A(c)(2)(A) defines tested income as:
(i) the gross income of such corporation determined without regard to—(I) any item of income described in section 952(b) [ECI],(ii) the deductions (including taxes) properly allocable to such gross income * * *.
(II) any gross income taken into account in determining the subpart F income of such corporation,
(III) any gross income excluded from the foreign base company income * * * and the insurance income * * * of such corporation by reason of section 954(b)(4) [the Subpart F Income high-tax exception],
(IV) any dividend received from a related person * * *, and
(V) any foreign oil and gas extraction income * * * of such corporation,
over
Focusing on gross income, the statute starts with all the gross income earned by the corporation. It then subtracts out five items. Subclause I provides that ECI is subtracted from gross tested income. Subclause II provides that gross Subpart F Income is subtracted from gross tested income.
As noted above, there is a high-tax exception to Subpart F Income. If a foreign corporation earns income that would be Subpart F Income under the foreign base company income or insurance income rules, but it is exempt from those rules under the high-tax exception, then Subclause III provides that this gross income is also subtracted from gross tested income.
If a foreign corporation earns high-taxed Subpart F Income and no high-tax exception election is made, then the gross income would fall in Subclause II. On the other hand, if the foreign corporation earns high-taxed Subpart F Income and a high-tax exception election is made, then the gross income would fall in Subclause III.
Subclause IV subtracts related person dividends from gross tested income. Lastly, Subclause V subtracts foreign oil and gas extraction income from gross tested income.
The language of Subclause III is perfectly clear to me, especially in the context of the two preceding subclauses: Subclause I applies to one exception from Subpart F Income (ECI); Subclause II applies to Subpart F Income itself; and Subclause III applies to another exception from Subpart F Income (the high-tax exception).
Apparently, after the GILTI high-tax exception proposed regulations were published, commenters suggested that the Treasury Department did not have the authority to grant taxpayers the GILTI high-tax exception. The Treasury Department addressed this criticism when in finalized the regulations in Treasury Decision 9902, stating:
[T]he Treasury Department and the IRS have determined that the GILTI high-tax exclusion is a valid interpretation of ambiguous statutory text in section 951A(c)(2)(A)(i)(III) * * *.
To me, there is no ambiguity in the statute --- Subclause III applies if the gross income would have been Subpart F Income but it was not Subpart F Income due to the high-tax exception in Code §954(b). I agree with the commenters that Congress did not include language in the statute which would support a GILTI high-tax exception.
As discussed in Varian Medical Systems, large U.S. multinational corporations are able to claim a dividends received deduction under Code §245A for dividends from foreign subsidiaries. When the GILTI high-tax exception applies, the U.S. parent company is able to entirely exclude the income earned by the foreign subsidiary from U.S. tax. No U.S. tax is imposed when the income is earned, and no U.S. tax is imposed when the earnings are repatriated to the U.S. While that may make logical sense, it is not what Congress provided. If the Treasury Department had not created the GILTI high-tax exception, large portions of earnings of the foreign subsidiaries would be subject to the GILTI inclusion rules, resulting in additional U.S. corporate income tax revenue.