Source: https://gtmtax.com/knowledge/tax-technology-blog/gilti-section-951a-section-78-basketing/
Timestamp: 2019-04-18 21:04:26+00:00

Document:
Let’s first quickly review IRC §951A to introduce the issues with tested loss CFCs and set the stage for the rest of the post. The GILTI inclusion of a U.S. shareholder under IRC §951A is the excess of that shareholder’s net CFC tested income over its net deemed tangible income return. Net CFC tested income is the excess of the aggregate of the shareholder’s pro rata share of each of its CFC’s tested income over the aggregate of each CFC’s tested loss. Tested income and tested loss are determined first at each CFC, and then the U.S. shareholder has net CFC tested income to the extent that the sum of the tested incomes exceeds the sum of the tested losses.
the deductions (including taxes) properly allocable to such gross income under rules similar to the rules of section 954(b)(5) (or to which such deductions would be allocable if there were such gross income).
Tested loss is the converse—any excess of 2 over 1. There is no carryforward of excess tested losses either at the CFC or U.S. shareholder level.
The specific reference to tested income and not tested loss in the definition of specified tangible property means that a CFC with a tested loss (allocable deductions exceed gross income) does not benefit to account for the QBAI in the loss year. This interpretation is confirmed in the Conference Committee Report as well as the legislative history of §951A. The result is a cliff effect, where $1 of tested loss results in the complete exclusion of a CFC’s tangible assets from being included in its U.S. shareholder’s aggregate QBAI. As a practical matter, this issue can be avoided by ensuring that CFCs with large amounts of tangible assets have some tested income each year, which may require reexamination of transfer pricing arrangements.
Under new IRC §960(d), a domestic corporation which is a U.S. shareholder of a CFC is permitted a foreign tax credit (FTC) equal to 80% of the inclusion percentage times the aggregate tested foreign income taxes paid or accrued by its CFCs. The §78 gross-up is 100% (rather than 80%) of the § 960 deemed paid taxes. “Tested foreign income taxes” is defined as “the foreign income taxes paid or accrued by such foreign corporation which are properly attributable to the tested income of such foreign corporation taken into account by such domestic corporation under §951A.” Excess GILTI credits cannot be carried forward and are separately basketed for purposes of the §904 FTC limitation.
The Conference Report also confirms that “properly attributable to tested income” does not include tested losses: “Tested foreign income taxes do not include any foreign income tax paid or accrued by a CFC that is properly attributable to the CFC’s tested loss (if any).” The same cliff effect discussed above in the QBAI context occurs, although the practical implications are usually limited as loss CFCs generally are not paying large amounts of foreign taxes. Taxpayers should ensure that they closely attend to any differences between U.S. and foreign tax law in the timing of recognition of income and expenses which may result in CFCs with positive income under foreign tax law but losses for U.S. tax purposes.
* FTCs apportioned by gross income, no apportionment of §250 deduction. Many alternative calculations are possible and not illustrated here.
If the §78 gross-up is general limitation income, not only would a CFC taxed well above 13.125% be subject to additional tax due to§ 951A, but the effective U.S. tax on GILTI would rise with increasing foreign tax rate above 13.125%. There would also be an opportunity for the U.S. shareholder to use any excess FTCs in the general basket (cross-credit), which is contrary to the purpose of §78 and the creation of a separate §904(d) GILTI basket in the first place.
Pursuant to its preexisting authority under §904(d)(7) and §960(f), we anticipate that the IRS will release regulatory guidance by the end of 2018 to include the §78 gross-up in the GILTI basket. In the meantime and absent such guidance, many firms have taken the position that they are unable to conclude that it is more likely than not that the gross-up on GILTI will be in the GILTI basket. For interim provision, communication with the auditors is important to ensure that all sides are working from the same understanding of the TCJA.
As discussed above, tested income is a CFC’s gross income (with specified exclusions) less allocable deductions. While the text of Sec. 951A does not specify, we believe that tested income is likely to be calculated using a taxable income approach rather than an E&P approach. Limitations on deductions that apply to calculating taxable income but not E&P, like the interest expense limitation of new §163(j) and the anti-hybrid rules of new §267A, appear to also apply to calculation of tested income at the CFC level. This could result in double taxation on interest paid between CFCs or from a CFC to its U.S. shareholder, as the payor CFC’s interest expense would be denied but the interest income would be included in the payee’s Subpart F income or GILTI.
Even though many aspects of the GILTI tax remain unresolved, companies should begin re-examining their international structure and operations to best take advantage of the international reforms in the TCJA. We have already mentioned, for example, possible adjustment to transfer pricing policies to ensure that CFCs with significant investment in tangible assets generate some tested income to maximize QBAI.
Another key consideration for companies going forward should be planning how to make full use of their FTCs by avoiding an excess GILTI credit position. One possibility is to make check-the-box elections to treat some or all CFCs in high-tax countries as foreign disregarded entities. For a CFC in a country with a tax rate above 21%, this will generate excess credits in the new §904(d)(1)(B) foreign branch income basket, which, unlike GILTI credits, are not haircut by 20% and can be carried forward to future periods. This opens some opportunities for the taxpayer to earn lower-taxed foreign branch income to soak up the excess credits.
Although taxation under the GILTI regime on CFCs is generally favorable compared with taxation as a foreign branch if the foreign tax rate is below 21%, there are a few circumstances where foreign branches may be preferred. If the taxpayer’s (domestic corporation) §250 deduction is limited by taxable income (because of significant Foreign-Derived Intangible Income), GILTI is taxed at a marginal rate of 21%. With the 20% haircut on GILTI FTCs, the foreign tax rate at which no additional tax on GILTI is imposed rises to 26.25%. In this case, checking the box on some CFCs may provide tax savings. The taxpayer may also not wish to convert low-taxed foreign branches into CFCs because of the recapture of foreign branch losses in the new §91 or repeal of the active trade or business exception of §367(a)(3). Of course, there may also be regulatory or foreign tax reasons for wishing to continue to operate through branches.
 In the description of the Chairman’s Mark of the TCJA prepared for the Senate Committee on Finance by the Joint Committee on Taxation (November 9, 2017), specified tangible property was defined to include “any property used in the production of tested income or tested loss.” The tax on Foreign High Return Amounts in the House’s version of IRC §951A also included tested loss in its definition of specified tangible property. The bill text released by the Senate Finance Committee on November 20, 2017 did not refer to tested loss.

References: §951
 §951
 §951
 §960
 §78
 § 960
 §951
 §904
 §250
 §78
 §78
 §904
 §904
 §960
 §78
 §163
 §267
 §904
 §250
 §91
 §367
 §951