U.S. GILTI is not CFC rule for purposes of Australia’s hybrid mismatch rules

On 29 June 2022, the Australian Taxation Office (ATO) issued Tax Determination TD 2022/9, which finalises the ATO’s view on whether the U.S. global intangible low-taxed income (GILTI) rules correspond with the Australian controlled foreign company (CFC) rules for purposes of the Australian hybrid mismatch rules found in Division 832 of the Income Tax Assessment Act 1997 (ITAA 1997). (Australia’s hybrid mismatch rules implement part of the OECD hybrid mismatch rules by preventing entities that are liable to income tax in Australia from avoiding tax or obtaining a double nontaxation benefit by exploiting differences in the treatment of entities and instruments across different jurisdictions.)

The GILTI rules, found in section 951A of the U.S. Internal Revenue Code (IRC), were introduced as part of the 2017 tax reform. In broad terms, GILTI is a deemed amount of income derived from CFCs in which a U.S. person is a 10% direct or indirect shareholder and its purpose is to impose a minimum rate of tax on deemed high or above-normal returns of CFCs. Under existing rules, U.S. shareholders of CFCs are taxed on their pro rata share of certain CFC income, regardless of whether the income is repatriated. U.S. companies are allowed to reduce their share of CFC income by a 10% deemed return on their “qualified business asset investments.” The net result is included in U.S. taxable income and taxed at an effective rate of 10.5%.

The final TD confirms the ATO’s original view contained in the draft TD released on 21 November 2019 that the U.S. GILTI rules do not correspond to the Australian CFC rules (specifically, section 456 or 457 of the ITAA 1997) for purposes of determining whether an amount is “subject to foreign income tax” under the hybrid mismatch rules. Sections 456 and 457 are assessing provisions that include the attributable income of a CFC in the assessable income of certain Australian residents that have a defined controlling interest in the CFC (attributable taxpayers).

The impact of this position is significant as the term “subject to foreign income tax” appears over 40 times in the hybrid mismatch rules. It primarily impacts whether a deduction/noninclusion mismatch arises, e.g., a payment is tax deductible to the Australian payer, but the foreign recipient of the payment is not subject to foreign income tax. If the U.S. GILTI rules applied to the payment, it may be taxed to the parent company in the U.S., i.e., it would be subject to foreign income tax. However, due to the ATO’s view, the deduction could be denied in the Australian taxpayer’s tax return, or income that is otherwise taxed both in Australia and in the U.S. is not considered dual inclusion income, which is important in limiting the amount of deductions that are denied.

The ATO’s arguments in arriving at its conclusion are that:

The law requires the U.S. GILTI rules to “correspond” to the Australian CFC rules. According to Australian case law, correspond means that two things should agree, be similar or analogous or be equivalent in function.
The Australian CFC regime is an anti-deferral regime for taxing certain foreign-source income of an Australian controlled foreign entity. When the CFC rules apply, the calculation of the income that is taxable in an Australian return is largely similar to that where the foreign entity is an Australian tax resident.
A feature of the GILTI rules results in the applicable tax rate under the GILTI regime to be significantly reduced to between 10% and 12.5%, a feature that makes the GILTI rules more akin to a minimum tax regime.
Generally, GILTI is the excess of the CFCs’ net income over a deemed “normal” return on the CFCs’ tangible property, which is generally taxed at a rate of 10.5% in the U.S.

The ATO did not consider it important that the GILTI rules sit within the broader U.S. CFC rules or that the ATO’s position can result in an inequitable outcome for an Australian taxpayer.

A positive note

Interestingly, in the compendium to TD 2022/9, the ATO acknowledges there are some similarities between the U.S. traditional subpart F rules (IRC section 951(a)) and Australia's CFC rules. The ATO states that the U.S.’s standard CFC rules do correspond to the Australian CFC rules. Although these comments are not binding on the ATO, the ATO considers that the purpose of section 951(a) is more aligned with the purpose of Australia’s CFC rules (sections 456 and 457 of the ITAA 1936) and, therefore, section 951(a) is likely to be a provision that corresponds to sections 456 or 457. Accordingly, those amounts subject to tax under the standard CFC rules in the U.S. may be considered subject to foreign income tax for purposes of Australia's hybrid mismatch rules.

Comments

Australian subsidiaries of U.S. multinationals that have transactions falling within the scope of the Australian hybrid mismatch rules should reassess their existing hybrid mismatch positions and determine whether a previous analysis had relied on income being taxed under the GILTI regime as a basis for not having a deduction denied. Also, if a conservative position has previously been taken that the U.S. CFC rules do not correspond to the Australian CFC rules, this position may need to be reconsidered.

Gary Poon
gary.poon@bdo.com.au