As part of the US tax reform in late 2017, US citizens who owned Canadian corporations which are CFCs were subject to a repatriation tax on an amount approximating the retained earnings of the corporation (i.e. commonly referred to as the Section 965 or transition tax) as well as a prospective tax on the earnings of the corporation called the “GILTI tax.” The GILTI tax impacts all tax years beginning in 2018.
The GILTI tax subjected US corporate shareholders of CFCs to an additional level of tax to the extent that the CFC it owns was subject to a tax on less than 13.125% in its country of organization. For US citizens who owned CFCs, the threshold was 26.25%.
Under a law passed in 1962, US individuals who owned CFCs could elect under Section 962 of the US tax code to use corporate tax rates on income earned by said company. The stated intent of the 1962 law was to ascertain that individuals who owned said corporations were not at a tax disadvantage relative to US corporations which owned CFCs.
The 2017 law was ambiguous as to whether, when making a Section 962 election, individual owners could also access the 13.125% rate applicable to corporate owners as a mechanism to avoid or mitigate the impact of the GILTI.
On March 4, 2019, the IRS released regulations which finally confirmed that the lower rate could be accessed by US expatriates who own CFCs.
What This Means for Ontario Taxpayers
In 2018, the combined Federal and Ontario small business tax rate was 13.5%, slightly above the 13.125% threshold applicable to corporations. Therefore, in 2018, the GILTI should not apply where a Section 962 election is made.
For 2019 and later years, the combined Federal and Ontario small business has been reduced to 12.5%. To the extent a CFCs has net income subject to GILTI and makes a Section 962 election, the US owner may be subject to a US effective rate of approximately 1% on said amount.
Investment Income Increasing Canadian Tax Rate
The law is crafted to that only the tax attributable to earned income of the foreign corporation may be used in calculating the GILTI tax. Therefore, using the higher tax rate on investment income earned by the corporation to calculate an average rate in excess of the 13.125% threshold may not assist in mitigating the GILTI tax.
For more information on this topic read, GILTI or Not GILTI: A guide for US expatriates living in Canada.