U.S. Professionals: Avoid Paying Taxes Twice Under New GILTI Rules

If you are a U.S. citizen living in Canada who controls a Canadian corporation (Canco), you are subject to the new U.S. Global Intangible Low-taxed Income (GILTI) regime — and could face double taxation if you don’t implement the right tax strategy.

Originally intended to discourage U.S. firms from shifting income from intangible assets such as patents and copyrights to low-tax jurisdictions abroad, GILTI is a 10.5 percent minimum tax on income earned from those assets.

The tax regime was part of the sweeping 2017 tax reform which included the U.S. converting to a territorial tax system for multi-nationals, like Canada and most of the OECD countries. These rules particularly impact owners of services’ businesses such as professionals, consultants or technology enterprises with limited tangible business assets.

GILTI attributes an annual deemed dividend to the U.S. shareholder roughly equal to the net income of the corporation and makes certain upward adjustments. Importantly, GILTI basket foreign tax credits are restricted and matched to tax paid for that particular year.

Tax Planning Tools

For U.S. citizens subject to GILTI, cross-border tax planning will be required to ensure there is enough Canadian tax paid — and in the correct tax baskets — to offset the U.S. tax owing. The following are planning options:

• Bonusing Out Income: Where the corporate taxable income is relatively small (under $50,000), it may be prudent to pay the income to the principal (or spouse) as the compliance cost of alternate approaches would exceed any benefit.
• Personal Tax Rate Arbitrage: Payment of Canco dividends can eliminate the GILTI tax. The top marginal U.S. tax rate for individuals begins at taxable income over US$500,000. Properly planned, the foreign tax credit will usually eliminate the tax.
• Use of an Unlimited Company (ULC): ULC statutes exist in Nova Scotia, Alberta and B.C. — each with their own limitations. A ULC results in the U.S. person reporting the income, expenses and corporate taxes as if the income was earned by them. The income is taxed at the graduated U.S. personal rates.
  Where permitted, the ULC option may be viable for U.S. persons who are close to retirement and where there are limited accrued gains in their corporate held portfolio investments or for professionals considering incorporation.
• IRC 962 Election with GILTI Income: This election allows a taxpayer to treat the GILTI as if it were earned by a U.S. corporation. This election allows several benefits:
  • A reduction of 50 percent in the income inclusion;
  • A tax rate of only 21 percent (compared to 37 percent personally); and
  • A foreign tax credit for the 80 percent of the corporate tax.
  To avoid GILTI, the Canadian corporation’s tax liability must be at least 13.125 percent of the GILTI income. In general, for our clients using the small business rate for 2018 there will be a small amount of GILTI tax except in the provinces / territories of Quebec, Prince Edward Island, Northwest Territories and Nunavut.
  Notably, this is a year-by-year election which allows us to plan for fluctuations to the client’s cashflow demands, financial situation and any future changes to personal and corporate taxation in Canada and the U.S. With proper planning, the use of 962 election will also permit a U.S. person to effectively tax plan for RRSP contributions.

Conclusion

These proposed regulations provide a degree of relief from 2017 Tax Reform. The proposed rules will principally benefit professionals, who are U.S. persons considering incorporating in Canada.

For more details, contact your local U.S. personal tax advisor or visit MNP.ca.