Question

Suppose the Irish sub of a U.S. multinational earned $100 pretax, the Irish tax rate is 12.5% and the U.S. tax rate is 21%. Further assume the Irish sub immediately repatriates the remaining after-tax income back to the U.S. parent. Under a territorial tax system how is the income of an Irish subsidiary owned by a U.S. multinational company taxed? What is the total tax on the $100 of income assuming the U.S. firm faces a territorial tax system?

Suppose instead the U.S. firm above faced a worldwide tax system where its income whether earned in the U.S. or overseas was taxed at the US tax rate with a tax credit for foreign taxes paid. What is the total tax on the $100 of income under this system?

What is the purpose of the GILTI introduced in the TCJA of 2017?

Answer 1

Territorial tax system

• The company pays the Irish government $12.5 of tax on the $100 of profits earned in Irish.
• The company owes a tax before credits of $10.5 on the $100 of GILTI (intangible profits). Its US tax before credits is $10.5.
• The company can claim a foreign tax credit of $10 from its Irish investments. This consists of $10 from the Irish tax on GILTI income (80 percent of .125 × $100) .
• So, overall, the US company pays $12.5 of tax to Ireland and an additional $0.5 to the United States ($10.5 less the $10 foreign tax credit) for a total tax liability of $13.

Worldwide tax system

The United States’ worldwide system of corporate taxation requires multinational corporations to pay taxes twice, first to the foreign country in which they do business and then to the IRS after they repatriate their profits.

• The company pays the Irish government $12.5 of tax on the $100 of profits earned in Irish.
• The company owes $21 (21 percent of $100) on the income from Irish. So, its US tax before credits is $21.
• The company can claim a foreign tax credit of $12.5 from its Irish investments. This consists of the full $12.5 of Irish tax on income.
• So, overall, the US company pays $12.5 of tax to Ireland and an additional $8.5 to the United States ($21 less the $12.5 foreign tax credit) for a total tax liability of $21.

Purpose of the GILTI introduced in the TCJA of 2017

GILTI is the income earned by foreign affiliates of US companies from intangible assets such as patents, trademarks, and copyrights. The Tax Cuts and Jobs Act imposes a new minimum tax on GILTI. Before the 2017 Tax Cuts and Jobs Act (TCJA), the United States generally taxed its firms and residents on their worldwide income. After the TCJA, the United States generally exempts earnings from active businesses of US firms’ foreign subsidiaries, even if the earnings are repatriated. But Congress worried that completely exempting US multinationals’ foreign earnings might exacerbate the incentive to shift profits to low-tax jurisdictions abroad. So, Congress added a new 10.5 percent minimum tax on global intangible low-taxed income (GILTI) to discourage such profit shifting. More specifically, a US business must include GILTI in its gross income annually. If the foreign tax rate is 13.125 percent or higher, there will be no US tax after the 80 percent credit for foreign taxes.