GILTI and Subpart F: Implications for LatAm CFCs with US Shareholders

GILTI and Subpart F: Implications for LatAm CFCs with US Shareholders

A common misunderstanding we encounter with our LatAm family office and business group clients revolves around the belief that if their Controlled Foreign Corporations (CFCs) do not distribute dividends, there's no current U.S. tax liability for shareholders classified as U.S. Persons. This is a persistent myth that the Tax Cuts and Jobs Act of 2017 (TCJA) largely dismantled. The reality is that the introduction of the GILTI regime, alongside the existing Subpart F, created a comprehensive anti-deferral system that captures both operational and passive income, irrespective of whether cash crosses borders.

Deconstructing Subpart F and GILTI

The Subpart F regime, a long-standing provision in the U.S. Internal Revenue Code (IRC), aims to immediately tax U.S. shareholders on certain types of passive and "artificial" income of a CFC. This includes dividends, interest, rents, royalties, and gains from the sale of property, often resulting from intercompany transactions that lack clear economic substance. Its purpose is straightforward: to curb the practice of shifting passive income to low or no-tax jurisdictions.

In contrast, the GILTI (Global Intangible Low-Taxed Income) regime is mechanically broader. It captures a significant portion of a CFC's active income, not just passive income. The calculation method is quite specific: GILTI is determined based on the CFC's Net Tested Income (NTI). From this NTI, income already taxed under Subpart F is excluded, and a deemed normal return on the CFC's Qualified Business Asset Investment (QBAI) is deducted. Essentially, GILTI subjects a CFC's operating income to U.S. taxation if it is subject to a low foreign tax rate. What constitutes "low" is implicitly defined by the calculation mechanics and the foreign tax credits available.

Impact on Latin American Family Structures

The most common scenario we observe involves a family office in Colombia, Mexico, or Brazil with a member who has acquired U.S. citizenship or a Green Card, and holds more than 10% of the family business's shares. In such cases, the activation of Subpart F or GILTI, or both, is almost inevitable. For instance, a U.S. resident shareholder meeting that ownership threshold could face a GILTI inclusion on their proportional share of the company's operating profits. This applies even if the company decides to reinvest all its earnings and does not declare any dividends. The outcome: a U.S. tax liability for the shareholder without a corresponding cash flow distribution to cover it. This can lead to significant liquidity issues and create considerable strain within the family structure.

Planning and Mitigation Strategies

Proactive planning and managing the foreign effective tax rate (EFR) are crucial in this context. The IRC offers a high-tax exception for both Subpart F and GILTI. This exception allows the exclusion of income that has already been taxed abroad at a rate exceeding a certain threshold, generally 90% of the current U.S. corporate rate. Assessing whether the CFC's operations in its home jurisdiction meet this threshold is the first defensive step. Countries with high nominal corporate rates, such as Colombia, could, in theory, generate a sufficient EFR to avoid a GILTI inclusion, but a detailed analysis comparing the local tax base to the U.S. tax base, which is often broader, is always required.

Furthermore, elective options are available for individual shareholders, most notably the Section 962 election under the IRC. This allows the individual to be taxed on their Subpart F and GILTI inclusions at U.S. corporate tax rates · which can be lower for certain incomes · and to claim a credit for a portion of the taxes paid by the CFC. While this can mitigate the immediate tax rate, subsequent distributions of those Previously Taxed Earnings (PTI) may be subject to a second layer of taxation, depending on how they are managed. Careful financial modeling is essential to understand all implications.

The presence of a U.S. shareholder in a Latin American business structure undoubtedly adds a layer of complexity. Inaction or inadequate planning can lead to significant tax contingencies and, in the worst-case scenario, erode cross-border family wealth. Therefore, we always recommend a thorough review of the EFR, strategic segregation of income to avoid Subpart F characteristics, and a diligent evaluation of elections like Section 962, among other available tools.