Should states embrace GILTI?

Proceed with caution, hazards ahead

While the tax department trend continues of “doing more with less,” the sheer increased administrative burden of post-tax reform state filing compliance leaves many “doing less with more”—less time on analysis and planning, and more time on compliance with increased complexity, if not increased volume. While a number of states (and localities notably, the city of Philadelphia) have prioritized issuing timely guidance, even more is needed. For example, the global intangible low-taxed income (GILTI) computations involve, among other things, expense apportionment, foreign tax credit utilization, and consolidated return principles for purposes of undertaking the complex computations necessary for GILTI. Should states leave taxpayers to choose between allocating federal consolidated computations back to the various state filers versus undertaking state-specific computations? Depending on the facts, the difference in computational methods could have a significant impact on the reported GILTI inclusion.

Conformity isn’t just a matter of opting in or opting out. Important state tax policy decisions are at stake. State tax policymakers have the opportunity to reflect on the federal and state taxing regimes and the carefully considered means by which their state has previously dealt with arguably the same issues. For example, both GILTI inclusion and the states’ related-party intangible expense addbacks and unitary combined filing provisions arguably deal with the same concept of perceived profit shifting through intangibles. That realization alone should urge caution against potential overlapping policies that possibly over-complicate the matter. What do we accommodations for the pre-existing state taxing regime.

In any event, whether a state conforms to the GILTI regime, taxpayers need guidance. For example, worldwide combined reporting taxpayers need guidance on the treatment of GILTI inclusion. Logically, if a controlled foreign corporation (CFC) is already included in a worldwide return, its income should not again be included as GILTI to its shareholder. Since most GILTI inclusions may not be able to be eliminated as an intercompany transaction, states may lack a clear mechanism to exclude it in a combined report. Guidance on similar questions of mechanics will be important in water’s-edge combined reporting states as well.

Companies facing inadequate factor representation as compared to the amount of GILTI inclusion may consider computing taxable income and filing on a worldwide basis even in waterʹs-edge combined reporting states to alleviate the increased tax burden. However, states could potentially stem that tide by confirming a dividend-received-deduction (DRD) approach or by adopting additional apportionment factor provisions that deal with GILTI inclusion more specifically^.1 Lack of specific guidance that considers the unique qualities of GILTI inclusion leaves taxpayers to develop their own reasonable approaches. A variety of non-statutory approaches may be reasonable depending on the circumstances, among them (1) including CFC gross receipts in the sales factor denominator, or (2) for three-factor states, likewise including CFC payroll and property factors in the denominator in addition to sales. States seeking to avoid future tax controversy arising from confusion about the rules might ease current burdens and future disputes by providing preemptory affirmative notice on the matter of apportionment.

States adopting or considering adopting the GILTI provisions face the responsibility to ensure that treatment of taxpayers with non-domestic subsidiaries is consistent with that of taxpayers with domestic subsidiaries. For a separate-filing state that normally would exclude the income of a foreign subsidiary or afford a DRD for a dividend of foreign income, that state might consider extending that foreign income exclusion or DRD to GILTI income. While not strictly a dividend, there is an obvious comparison to a dividend at the highest level since GILTI is a form of, or portion of, net income included in the income of its shareholder. In addition to providing consistency, extending the foreign income exclusion or DRD to GILTI would provide valuable reliance authority and help ease the compliance burden for taxpayers. 

Regardless of whether a state conforms to the GILTI regime, the battle for certainty will continue. Absent pertinent state tax guidance, a mix of both practicality and experimentation seem likely to prevail with years of resolution to come.

¹ States are constitutionally required in any apportionment formula to use factors that “actually reflect a reasonable sense of how income is generated.” See Container Corp. of America v. Franchise Tax Board, 463 U.S.159, 169 (1983).