The end of the “pay the higher of the US or Canadian tax liability” regime for certain US citizens living in Canada

At Catalyst, we have an entire team of accountants and trusted advisors that specialize in U.S. Tax and Cross Border Tax in Calgary and Alberta. Our recent blog series is […]

At Catalyst, we have an entire team of accountants and trusted advisors that specialize in U.S. Tax and Cross Border Tax in Calgary and Alberta. Our recent blog series is focusing on U.S. and Cross Border taxation matters that are pertinent to Canadians and Americans. This week we are looking at Global Intangible Low-Taxed Income.

By: Jeff Fortin CA, CPA (IL) -Tax Partner & James Luo CPA, CA, CPA (MA) – Senior Tax Manager

Global Intangible Low-Taxed Income (“GILTI”)

One of the most devastating provisions for US citizens living in Canada are the GILTI rules which were introduced as part of the Tax Cuts and Jobs Act in December 2017 (“US Tax Reform”). These provisions affect US shareholders that own 10% or more of the voting power or value of a “controlled foreign corporation” (“CFC”) for US tax purposes (hereinafter referred to as “10% Shareholders”). For example, an Alberta professional corporation owned by a US citizen/Canadian resident doctor would be a CFC and the doctor would be a 10% Shareholder.

The punitive effect of these rules is that 10% Shareholders of CFCs must include in their income the income of the CFC less a 10% return on certain of the CFC’s tangible assets (subject to a reduction for certain interest expense) (hereinafter referred to as “GILTI Income”). There is no credit available for foreign income taxes paid by the CFC, there’s no de minimis rules, there’s no high-tax exception.

10% Shareholders that are US corporations are eligible for a 50% deduction under Section 250 for the GILTI inclusion which effectively reduces the US tax rate on this income to 10.5%. This deduction is not available for individual taxpayers. A US corporate 10% Shareholder can also claim a foreign tax credit for up to 80% of the foreign taxes paid by the CFC attributable to the GILTI income. The GILTI income and related foreign (i.e., Canadian) taxes are reported in their own separate limitation “basket” meaning that the GILTI can’t be sheltered with Canadian taxes paid on other income such as salary or passive investment income. Moreover, foreign taxes in the GILTI basket are not eligible for carry back or carryover and so the computations each year stand on their own.

GILTI income excludes income that is already picked up under the existing anti-deferral regime of Subpart F income. GILTI is reported on Form 8992. There’s a $10,000 penalty for late filing.

There is potential relief from these draconian rules by filing a section 962 election. This election allows an individual to compute GILTI and the related tax liability using corporate tax rates. By making this election the tax rate is reduced from a maximum individual rate of 37% to the corporate rate of 21% and the deemed paid foreign tax credit may be claimed in respect of Canadian income taxes paid on the GILTI income. Fortunately, on March 4, 2019 the IRS clarified in proposed regulations that individual US shareholders making the Section 962 election are eligible for the 50% deduction under section 250.

By way of example, assume an Alberta professional corporation is wholly owned by a US citizen/Canadian resident shareholder, has $1,000,000 of income, pays $195,000 in Canadian income tax after claiming the full small business deduction and has immaterial tangible assets. The GILTI inclusion to the US shareholder would be $805,000 and the maximum US tax on that income would be at 37%, or $297,850.

If a Section 962 election is made, the US tax liability before foreign tax credit would be $10.5% of the pre-tax GILTI income, or $105,000. A foreign tax credit can be claimed on the US return equal to 80% of the Canadian taxes paid, or $156,000. In this example, the tax on the GILTI is totally eliminated by utilizing the Section 962 election and foreign tax credit mechanism. So long as the Canadian income bears a rate of corporate income tax of at least 13.125% the GILTI tax can generally be eliminated by electing under Section 962.

Please don’t hesitate to contact your trusted Catalyst Advisor if you have any questions. You can reach Jeff at (403) 767-1503 or James at (403) 767-1511 or send us an email