With U.S. multinational corporations facing uncertain economic times due to the worldwide spread of the Coronavirus (COVID-19), there will be increased focus on the ability of these companies to use net operating losses (NOLs), both domestically and offshore.
The interaction of the NOL rules and certain recently enacted international tax rules in the Tax Cuts and Jobs Act of 2017 (TCJA) is complex and may deny taxpayers otherwise available benefits. One such provision generally imposes a lower federal income tax rate on certain income earned by certain foreign entities owned by U.S. multinational corporations – so-called “global intangible law taxed income” (GILTI). Although the GILTI rules generally impose a 10.5% tax rate on such income (as opposed to a 21% rate), the use of NOLs by a taxpayer may eliminate the benefit of the reduced tax rate on such income (effectively denying a U.S. multinational corporation a tax benefit from its NOLs). Some examples may include:
- GILTI taxed at a 21% ordinary rate rather than the reduced 10.5% rate: A U.S. taxpayer that has GILTI is generally entitled to a deduction (GILTI Deduction) equal to 50% of its GILTI (resulting in a 10.5% tax rate on GILTI (21%x50%)). This GILTI Deduction can only be used to offset GILTI (i.e., it cannot be used to offset other non-GILTI taxable income). When a taxpayer has both an NOL and a GILTI Deduction, specific ordering rules require it essentially to use the NOL to offset the GILTI income before it uses the GILTI Deduction (which results in excess GILTI Deductions). In other words, the NOL reduces the amount of income potentially subject to the reduced tax rate (by virtue of the GILTI Deduction) as opposed to other Non-GILTI taxable income. Because the taxpayer cannot use this excess GILTI Deduction to reduce its non-GILTI taxable income (and because, absent this ordering rule, the taxpayer could have used the NOL to reduce non-GILTI taxable income), the effect is GILTI will be taxed at a 21% tax rate (rather than the legislatively intended 10.5% tax rate) to the extent of any NOL.
- No Foreign Tax Credits: In very general terms, when a U.S. corporation pays non-U.S. taxes, a foreign tax credit often will reduce its U.S. income tax liability. Where a CFC has an NOL that it uses to eliminate local country taxable income, a U.S. corporate taxpayer may have GILTI for the current year with no foreign tax credit available (which effectively eliminates the benefit of the foreign NOL).
- Reduced QBAI: The computation of a U.S. corporation’s GILTI is complex and dependent, in part, on a foreign entity’s qualified business assets investment (QBAI). QBAI is a helpful tax attribute that generally reduces the amount of a U.S. shareholder’s GILTI. An NOL may result in a foreign entity having a “tested loss”. In very general terms, a foreign entity with a tested loss is treated as having no QBAI, thus, potentially increasing the U.S. shareholder’s GILTI.
There may be other ways in which NOLs otherwise negatively affect the GILTI calculation. As we head into the first serious economic downturn after the enactment of the TCJA, taxpayers need to be diligent about the interaction of the GILTI rules with the NOL provisions to avoid these traps for the unwary.
If you have any questions about how this may affect your tax liability, please contact tax partners Devon Bodoh, Greg Featherman, Graham Magill, Joseph Pari or speak to your regular contact at Weil, Gotshal & Manges LLP or to any member of Weil’s Tax Department.
|Joseph M. Pari, Co-Chair Tax Departmentfirstname.lastname@example.org||+1 202 682 7001|
|Paul Wessel, Co-Chair Tax Department and|
Head of Executive Compensation & Benefits
|email@example.com||+1 212 310 8720|
|Noah Beck, Tax Partnerfirstname.lastname@example.org||+1 212 310 8890|
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|Devon Bodoh, Tax Partnerfirstname.lastname@example.org||+1 202 682 7060|
|Jennifer Britz, Executive Compensation & Benefits Partneremail@example.com||+1 212 310 8774|
|Sarah Downie, Executive Compensation & Benefits Partnerfirstname.lastname@example.org||+1 212 310 8030|
|Greg Featherman, Tax Partneremail@example.com||+1 212 310 8250|
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