GILTI High-Tax Exception: How It Works and Key Tax Implications

The Global Intangible Low-Taxed Income (GILTI) high-tax exception allows U.S. multinational companies to exclude certain foreign earnings from GILTI taxation if they are already subject to a sufficiently high foreign tax rate. This can significantly impact a company’s tax liability and planning strategies.

Understanding its criteria and interaction with other tax provisions is essential for businesses operating internationally.

Eligible Income

To qualify for the GILTI high-tax exception, foreign earnings must meet specific criteria regarding the type of income and the entity generating it. The exception applies to income earned by a controlled foreign corporation (CFC), where U.S. shareholders own more than 50% of the voting power or value. However, not all CFC income is eligible. The focus is on tested income, which includes a CFC’s gross income after excluding items such as Subpart F income, effectively connected income (ECI) with a U.S. trade or business, and certain high-taxed foreign base company income.

Eligibility depends on whether the income is subject to a sufficiently high foreign tax rate. The high-tax exception is applied on a qualified business unit (QBU) basis, meaning each distinct business operation within the CFC is analyzed separately. This prevents companies from averaging tax rates across jurisdictions to qualify artificially. The income must also be attributable to a foreign jurisdiction where it is taxed at or above the required threshold.

Rate Threshold

The GILTI high-tax exception applies if the foreign income is taxed at a rate of at least 90% of the U.S. corporate tax rate. Since the U.S. corporate tax rate is 21%, the effective foreign tax rate must be at least 18.9%.

The effective foreign tax rate is calculated on a tested unit basis, meaning tax imposed on specific income categories within a foreign jurisdiction is assessed separately. If a CFC operates in multiple countries, each jurisdiction’s tax rate is evaluated individually.

Exchange rates can affect whether the threshold is met. Since foreign taxes are typically paid in local currency, fluctuations in exchange rates impact the U.S. dollar equivalent of taxes paid. A depreciation in foreign currency relative to the dollar may reduce the effective tax rate when converted, potentially disqualifying income that would otherwise meet the requirement. Companies operating in countries with currency volatility must monitor these changes closely.

Calculation Steps

Determining whether income qualifies for the GILTI high-tax exception involves calculating tested income, determining the effective foreign tax rate, and comparing it to the required threshold. Each step must be performed accurately to comply with IRS regulations and avoid misstatements that could lead to additional tax liabilities.

Determining the Tested Income

Tested income is the portion of a CFC’s earnings subject to GILTI after removing excluded items. To determine tested income, a CFC’s gross income is reduced by deductions such as cost of goods sold (COGS), interest expenses, and other operating costs. Additionally, specific types of income, including Subpart F income and ECI, are excluded.

For example, if a CFC has $10 million in gross income, but $2 million is Subpart F income and $3 million is attributable to deductible expenses, the tested income would be $5 million ($10M – $2M – $3M). This figure serves as the basis for determining the effective foreign tax rate. Companies must ensure their financial records accurately reflect these calculations.

Calculating the Effective Foreign Tax Rate

Once tested income is determined, the effective foreign tax rate is calculated by dividing the foreign income taxes paid or accrued by the tested income. Only taxes directly attributable to tested income are considered.

For example, if a CFC has $5 million in tested income and pays $1 million in foreign taxes on that income, the effective foreign tax rate is 20% ($1M ÷ $5M). This rate is then compared to the 18.9% threshold. Only taxes imposed by the foreign jurisdiction count toward this calculation—U.S. tax credits or deductions do not affect the effective foreign tax rate.

Timing differences between when foreign taxes are accrued and when they are paid can also impact eligibility. Under U.S. tax rules, foreign tax credits are generally determined on an accrual basis, meaning taxes must be accounted for in the year they are incurred, even if payment occurs later. If tax rates change between accrual and payment, it could affect whether the high-tax exception applies.

Comparing to the Threshold

The final step is comparing the effective foreign tax rate to the 18.9% threshold. If the calculated rate meets or exceeds this level, the income qualifies for the high-tax exception and can be excluded from GILTI. If the rate falls below the threshold, the income remains subject to GILTI taxation at the standard U.S. corporate tax rate of 21%.

For example, if a CFC’s effective foreign tax rate is 19%, the income qualifies for the exception, and the company can elect to exclude it from GILTI. If the rate is 18.5%, the income does not meet the threshold and is included in the GILTI calculation.

Since the high-tax exception is applied on a tested unit basis, income from different jurisdictions is evaluated separately. Proper documentation and record-keeping are necessary to support calculations and ensure compliance with IRS requirements.

Election Process

Making the GILTI high-tax exception election requires careful timing and compliance with IRS procedural rules. The election must be made annually on a CFC-by-CFC basis, meaning companies cannot selectively apply it to certain income streams while excluding others within the same entity. This prevents taxpayers from shifting the election to optimize tax outcomes. The election is made by attaching a statement to the taxpayer’s U.S. federal income tax return, following the requirements outlined in Treasury Regulation 1.951A-2(c)(7).

Once made, the election remains in effect for subsequent years unless revoked. Revocation requires IRS consent and typically necessitates demonstrating a material change in circumstances. The election applies uniformly to all tested units within a CFC that meet the high-tax threshold, preventing businesses from selectively applying the exception for tax efficiency.

Coordination with Foreign Tax Credits

The GILTI high-tax exception interacts with the foreign tax credit (FTC) system, which allows U.S. taxpayers to offset foreign taxes paid against their U.S. tax liability. When income qualifies for the high-tax exception and is excluded from GILTI, the foreign taxes associated with that income cannot be claimed as FTCs.

The FTC system includes separate limitation categories, with GILTI-related foreign taxes placed in a distinct basket. Since unused FTCs in the GILTI category cannot be carried forward or back, companies with high foreign tax liabilities may find that electing the high-tax exception prevents them from losing valuable credits. However, if a company has low U.S. taxable income and excess FTCs in other categories, forgoing the high-tax exception may allow for better utilization of credits.

This decision requires a detailed analysis of a company’s overall tax position, including projected foreign earnings, tax rates, and available FTC carryovers in other categories.