17 July 2025 United States | Changes to GILTI, FDII and BEAT, among others, included in final reconciliation legislation, but not previously proposed remedy for "unfair foreign taxes"
The Act, which was signed into law on July 4, 2025, changes international tax provisions enacted under the Tax Cuts and Jobs Act (TCJA), as well as provisions preceding the TCJA's enactment. These changes are largely consistent with international tax proposals included in a bill released by the Senate Finance Committee on June 16, 2025, amended on June 28, 2025, and passed by the Senate on July 1, 2025. For detailed discussions on the Senate Bill, please refer to Tax Alert 2025-1330, dated June 23, 2025.
The Act also modifies the headings of the FDII and GILTI provisions and, correspondingly, the acronyms by which these regimes are known. FDII becomes "foreign-derived deduction eligible income" (FDDEI); GILTI becomes "net CFC tested income" (NCTI); For ease of discussion, this Alert uses the original acronyms. IRC Section 163(j). The Act permanently adds back depreciation, amortization and depletion when determining adjusted taxable income (ATI) (i.e., uses EBITDA, rather than EBIT, to determine the interest limitation under IRC Section 163(j)). However, all inclusions under subpart F, GILTI or IRC Section 78 are fully excluded from ATI. In addition, certain capitalized interest expense will be treated as interest expense subject to the IRC Section 163(j) limitation. BEAT. The Act repeals the scheduled increase in the BEAT rate, which was set to rise from 10% to 12.5% for tax years beginning after December 31, 2025. Instead, the Act permanently sets the BEAT rate at 10.5% for tax years beginning after December 31, 2025. The Act also modifies the BEAT rules to preserve the current (i.e., pre-2026) treatment of "BEAT favored" credits, which was set to change after 2025 under the TCJA.
Proposed Section 899. The Act does not include the formerly proposed Section 899. It also does not eliminate or otherwise modify IRC Section 891, which is a longstanding provision that (if activated) could have a similar effect. For tax years beginning before January 1, 2026, IRC Section 250 generally allows a domestic corporation to deduct 37.5% of its FDII, which results in an effective federal corporate tax rate of 13.125% on FDII. This deduction was scheduled to decrease for tax years beginning after December 31, 2025, to 21.875%, which would cause the effective corporate tax rate on FDII to increase to 16.406%. A domestic corporation currently determines its FDII in a tax year under a formula. The corporation first determines its gross DEI for the year by excluding from its total gross income certain enumerated categories of income, such as subpart F and GILTI inclusions, financial services income, certain dividends and foreign branch income. Gross DEI is then reduced by the deductions that are "properly allocable" to that income, including interest expense and research and experimentation expenditures, to arrive at the corporation's DEI. The corporation then determines its deemed intangible income by reducing its DEI by its deemed tangible income return (DTIR), which is 10% of the domestic corporation's QBAI. Finally, the corporation's FDII is the amount that bears the same ratio to deemed intangible income as the ratio of (i) the foreign-derived portion of the corporation's DEI (FDDEI) to (ii) its DEI. The Act permanently reduces the 37.5% IRC Section 250 FDII deduction rate to 33.34%, resulting in an effective tax rate of approximately 14%. The Act revises the expense allocation provision by (i) excluding interest expense and research and experimentation expenditures; and (ii) adding the word "expenses," so both deductions and expenses must be allocated. As a result, DEI is defined as gross income minus six exclusions less deductions and expenses. The Act further modifies the definition of DEI so that it does not include any income from the sale or other disposition (including from a transaction subject to IRC Section 367(d)) of (i) intangible property (as defined in IRC Section 367(d)(4)) or (ii) property "of a type" that is subject to depreciation, amortization or depletion. Consequently, these items of income are no longer eligible for the FDII deduction. The reduction to the IRC Section 250 FDII deduction rate, the elimination of the DTIR and the limitation on deductions allocable to DEI are effective for tax years beginning after December 31, 2025. The exclusion from DEI of income from the sale or other disposition of IRC Section 367(d) intangibles and property of a type that is subject to depreciation, amortization, or depletion applies to sales or other dispositions occurring after June 16, 2025. The Act increases the headline FDII federal effective tax rate to 14% from the currently effective rate of 13.125%. This rate, however, is less than the rate that was scheduled under the TCJA for tax years beginning after December 31, 2025 (16.406%). On the other hand, DEI will no longer be reduced by interest expenses and research and experimental expenditures. All other "properly allocable" deductions continue to be allocated to DEI. These changes to expenses allocation, especially for R&D previously allocated to FDII, are expected to result in significant benefits for many taxpayers. The reduction in the expenses apportioned to DEI should generally increase the FDII deduction. Accordingly, the federal effective tax rate on net income from activities that give rise to FDII is likely, in many circumstances, to be lower than 14% (perhaps significantly). The exclusion of new types of income from DEI and its immediate effective date could catch taxpayers by surprise and impact the anticipated US tax consequences of pending transactions (e.g., dispositions of certain businesses with intellectual property). The removal of the DTIR for QBAI could provide a significant FDII benefit for companies with significant tangible property in the US. Under IRC Section 951A, a US shareholder of a CFC must include GILTI in gross income. GILTI is the excess of a US shareholder's net CFC tested income over its net deemed tangible income return (NDTIR). In determining a CFC's tested income (which is taken into account when computing a US shareholder's net CFC tested income), certain types of income (for instance, income effectively connected with a US trade or business and subpart F income) are excluded. The NDTIR is the excess of 10% of the US shareholder's pro-rata share of the QBAI of each CFC, reduced by certain interest expense. For tax years beginning before January 1, 2026, IRC Section 250 permits a domestic corporation to deduct 50% of its GILTI, including the corresponding deemed-paid foreign taxes treated as a dividend under IRC Section 78. Unlike the full 21% corporate tax rate applied to subpart F income, the IRC Section 250 deduction results in a 10.5% effective federal corporate tax rate on GILTI. For tax years beginning after December 31, 2025, the GILTI deduction rate was scheduled to decrease to 37.5%. Against this 10.5% effective corporate tax rate, IRC Section 960(d) deems certain US shareholders to have paid (and may therefore credit, subject to limitations) 80% of the foreign income taxes that are paid by the CFC and properly attributable to its tested income. Taken together, the 50% IRC Section 250 deduction and 80% deemed paid credit allowance mean that a taxpayer with a foreign effective tax rate of at least 13.125% would not generally expect to pay residual US tax on its GILTI inclusion (setting aside taxpayer-level expense apportionment that reduces a taxpayer's FTC limitation). We refer to this rate at which no residual US tax on GILTI would apply as the "Crossover Rate." To determine its GILTI FTC limitation, a US shareholder of a CFC must allocate and apportion certain deductions to its GILTI inclusion. Interest expense is generally apportionable based on the relative values of the taxpayer's assets in each FTC limitation category. Because CFC stock is often treated as an asset in the GILTI category, interest expense (among other expenses) is often apportioned to the GILTI category, thus reducing a taxpayer's ability to claim GILTI FTCs. The Act permanently reduces the IRC Section 250 deduction from 50% to 40%, resulting in a 12.6% effective federal corporate tax rate on GILTI before any FTCs. Additionally, it increases the current 80% deemed-paid allowance under IRC Section 960(d) for foreign income taxes deemed paid on GILTI inclusions to 90%, bringing the Crossover Rate to 14%. The NDTIR for QBAI is also eliminated. For purposes of the IRC Section 904(a) FTC limitation, the Act limits the deductions allocable to GILTI inclusions to (i) the IRC Section 250 deduction for both GILTI and its associated IRC Section 78 gross-up; (ii) certain deductible taxes allocable to GILTI inclusions; and (3) any other deductions that are "directly allocable" to GILTI inclusions. Expenses that otherwise would have been allocated or apportioned to the GILTI FTC category are instead allocated to US-source income. Interest and R&D expenses, however, are not allocated or apportioned to GILTI. The provisions modifying the IRC Section 250 GILTI deduction and the apportionment of deductions to the GILTI category for IRC Section 904(a) purposes are effective for tax years beginning after December 31, 2025. The provisions eliminating the NDTIR and increasing the deemed-paid allowance to 90% for FTCs in the GILTI category are effective for (i) foreign corporations' tax years beginning after December 31, 2025, and (ii) US shareholders' tax years in which or with which the foreign corporations' tax years end. The Act's GILTI Crossover Rate of 14% is higher than the existing rate (13.125%) but would still be less than the 16.406% Crossover Rate that was scheduled under the TCJA for tax years beginning after December 31, 2025. The changes to expense apportionment appear intended to prevent, at a minimum, the allocation and apportionment of most interest expense to the GILTI category. Interest expense is often the largest expense apportioned to the GILTI category under current law (other than the IRC Section 250 deduction), so the reallocation of interest expense from GILTI to US-source income could significantly increase taxpayers' GILTI FTC limitation. Under the TCJA, foreign taxes imposed on an amount that does not constitute income under US tax principles (i.e., base differences) are allocated to the foreign branch basket for the purposes of the FTC limitation. Dividends from noncontrolled 10%-owned foreign corporations are allocated to the GILTI basket for the purposes of the FTC limitation if a taxpayer cannot substantiate the character of the underlying earnings and profits. The taxes deemed-paid by a domestic corporation on distributions of previously taxed earnings and profits (PTEP) under IRC Section 960(b), are treated as dividends received by the domestic corporation under IRC Section 78 from the foreign corporation. The 80% FTC limitation on GILTI inclusions does not apply to foreign taxes paid or accrued on PTEP distributions of GILTI inclusions, including IRC Section 960(b) deemed-paid taxes. The Act makes technical corrections to align the separate limitation categories with the categories applicable pre-TCJA. First, amounts categorized as base differences are allocated to the general basket (although in practice, only a very limited class of gross income would have been treated as related to base differences). Second, the dividends are allocated to the passive basket if the taxpayer cannot substantiate the character of the underlying earnings and profits for dividends from noncontrolled 10% owned foreign corporations. The Act eliminates the reference to IRC Section 960(b) from IRC Section 78 so that the taxes deemed-paid by a domestic corporation on distributions of PTEP are not treated as IRC Section 78 deemed dividends. In addition, the Act imposes the new 90% limitation on foreign taxes paid or accrued on PTEP distributions of GILTI inclusions, including IRC Section 960(b) deemed-paid taxes. The changes to the separate limitation categories and the elimination of IRC Section 960(b) deemed-paid taxes from IRC Section 78 are effective for tax years beginning after December 31, 2025. The 90% limitation applies to foreign income taxes paid or accrued (or deemed paid under IRC Section 960(b)) on PTEP distributions of GILTI inclusions after June 28, 2025. The restoration of the pre-TCJA separate limitation categories for base differences and unsubstantiated dividends from noncontrolled 10% owned foreign corporations provides taxpayer with clarity and addresses unintended outcomes. Similarly, the elimination of the deemed dividend treatment of IRC Section 960(b) deemed-paid taxes is a welcome change that resolves potential overstatement of income by taxpayers. IRC Section 163(j) limits the business interest expense that may be deducted in a tax year to the sum of (i) the taxpayer's business interest income, (ii) 30% of the taxpayer's adjusted taxable income (ATI), and (iii) the taxpayer's floor plan financing interest. For tax years beginning before January 1, 2022, a taxpayer's ATI was based on earnings before interest, taxes, depreciation, amortization, or depletion (EBITDA). Thereafter, a taxpayer's ATI has been computed before interest and taxes, but after depreciation, amortization, or depletion (EBIT). Under proposed IRC Section 163(j) regulations, a U.S. shareholder of a CFC may, in certain circumstances, include a portion of its GILTI, subpart F income, and IRC Section 78 inclusions in its ATI. Under the final IRC Section 163(j) regulations, IRC Section 163(j) generally applies after provisions that subject business interest expense to disallowance, deferral, capitalization, or other limitations. As a result, capitalized interest expense is not treated as business interest expense for purposes of IRC Section 163(j). The Act amended IRC Section 163(j) so that ATI is permanently computed before any deduction allowable for interest, taxes, depreciation, amortization or depletion (i.e., based on EBITDA). The Act also amended the definition of ATI by specifically excluding CFC income inclusions under IRC Sections 78, 951(a), and 951A, and the corresponding deductions allowed under IRC Sections 245A(a) (by reason of IRC Section 964(e)(4)) and 250(a)(1)(B) by reason of those inclusions. Additionally, the Act modified interest deductibility under IRC Section 163(j) by generally applying the IRC Section 163(j) limitation before interest capitalization provisions, thus subjecting business interest expense that might otherwise be capitalized to the IRC Section 163(j) limitation (with certain exceptions). The Act's change to the determination of ATI based on EBITDA is retroactively effective for tax years beginning after December 31, 2024. The provisions on CFC income inclusions and interest capitalization coordination are effective for tax years beginning after December 31, 2025. The specific exclusion of GILTI, subpart F, and IRC Section 78 gross-up inclusions (net of certain corresponding deductions) from the statutory determination of ATI is a significant change for many taxpayers that have been applying the proposed IRC Section 163(j) regulations. As a result, US shareholders of CFCs will no longer benefit from CFC income inclusions (net of certain corresponding deductions) in determining ATI, for tax years beginning after December 31, 2025. On the other hand, taxpayers whose interest expense is currently limited under IRC Section 163(j) could benefit significantly from the permanent reinstatement of the EBITDA-based limitation for ATI. For tax years beginning before January 1, 2026, an applicable taxpayer must pay a "base erosion minimum tax amount" (BEMTA) equal to the excess (if any) of 10% of an applicable taxpayer's modified taxable income over its regular tax liability. A taxpayer's regular tax liability for this purpose is reduced by some tax credits, but not all. Specifically, for tax years beginning before January 1, 2026, regular tax liability is reduced by the excess of all tax credits allowed against regular tax liability under chapter 1 of the Code over the sum of certain BEAT-favored tax credits: (1) the credit allowed under IRC Section 38 for the tax year that is properly allocable to the research credit determined under IRC Section 41(a); (2) the lesser of 80% of the taxpayer's applicable IRC Section 38 credits or 80% of the BEMTA determined as if the taxpayer's total credits were not reduced by any amount of applicable IRC Section 38 credits; and (3) credits allowed under IRC Section 33 (for US withholding taxes), IRC 37 (for overpayments of tax), and IRC Section 53 (for refundable AMT credits). An applicable taxpayer that is a member of an affiliated group that includes a bank (as defined in IRC Section 581), or securities dealer registered under IRC 15(a) of the Securities Exchange Act of 1934 is subject to a tax rate on its modified taxable income that is one percentage point higher than the generally applicable tax rate. For tax years beginning after December 31, 2025, the BEAT rate was scheduled under the TCJA to increase from 10% to 12.5% (or 13.5% for members of affiliated groups that include a bank or registered securities dealer). The regular tax liability was scheduled to decrease (and the BEMTA therefore increase) by the sum of all the taxpayer's income tax credits for the tax year. The Act permanently increases the BEAT rate to 10.5% (or 11.5% for members of affiliated groups that include a bank or registered securities dealer). It also permanently retains the favorable treatment of research and certain other BEAT-favored credits in calculating the BEMTA by eliminating the post-2025 scheduled change that would have reduced regular tax liability by the sum of all the taxpayer's income tax credits for the tax year. Taxpayers that are subject to BEAT will incur higher tax costs as a result of the rate increase from 10% to 10.5%. However, that rate is still lower than the scheduled rate increase to 12.5% under TCJA. The permanent retention of the favorable treatment of research and certain other credits in calculating BEAT liability also represents a welcome development for taxpayers. Under IRC Section 954(c)(6), dividends, interest, rents and royalties received or accrued by a CFC from a related CFC are generally not treated as foreign personal holding company income, provided certain requirements are met. The provision currently applies to tax years of foreign corporations beginning before January 1, 2026. The Act makes permanent the look-through exception for foreign personal holding company income under IRC Section 954(c)(6). This provision is effective for foreign corporations' tax years beginning after December 31, 2025, and to US shareholders' tax years in which or with which the foreign corporations' tax years end. In general, gains, profits and income from the sale or exchange of inventory that is produced by a taxpayer are treated as US- or foreign-source income based solely on whether the production activities with respect to the inventory occur within or outside the United States. Thus, income from the sale or exchange of inventory produced by the taxpayer in the United States is treated as US-source income regardless of whether it was sold through a foreign branch. For the purposes of the FTC limitation, the Act treats as foreign-source taxable income up to 50% of the income from inventory property that is:
The new provision helps address concerns of taxpayers that incur foreign tax on sales or distribution activities through foreign branches (including disregarded entities) but cannot credit those foreign taxes because all income from the sale is treated as US-source income under current law (because the property is produced in the US). IRC Section 898 generally requires a CFC to use the tax year of its majority US shareholder. IRC Section 898(c)(2), however, permits a CFC to elect a tax year beginning one month earlier than the majority US shareholder's year. The Act repeals the one-month deferral election. A transition rule will require a CFC's first tax year beginning after November 30, 2025, to end at the same time as the first "required" year (generally that of its majority US shareholder) ending after that date. Therefore, CFCs with a tax year ending November 30, 2025, and a one-month deferral election automatically have a short tax year ending December 31, 2025. The Act explicitly authorizes the Secretary to issue guidance on allocating foreign taxes between the short year and the succeeding tax year. This provision is effective for specified foreign corporations' tax years beginning after November 30, 2025. With the effective date, many calendar-year taxpayers will have a one-month CFC short period from December 1, 2025, to December 31, 2025. Absent a special allocation of foreign taxes (which the Act authorizes Treasury to provide), taxpayers with a foreign tax year ending December 31, 2025, can accrue 12 months of foreign taxes in the CFC's one-month transition year, which can result in taxes not being eligible for an FTC due to the creation of a deficit or loss. If one or more US shareholders own directly or indirectly under IRC Section 958(a), or constructively under IRC Section 958(b), more than 50% of the stock (by vote or value) of a foreign corporation, that foreign corporation is a CFC. A US shareholder of a foreign corporation is a US person that owns, under IRC Section 958(a) and IRC Section 958(b), 10% or more of the shares (by vote or value) of the foreign corporation. IRC Section 958(b) applies the constructive ownership rules of IRC Section 318(a), including the downward ownership attribution rules of IRC Section 318(a)(3). If a shareholder owns 50% or more of the shares of a corporation by value, the downward attribution rules of IRC Section 318(a)(3) treat any other stock owned by the shareholder as owned by that corporation. The rules also treat stock owned by a partner as owned by the partnership. IRC Section 958(b)(4) previously prevented downward attribution of stock owned by a foreign person to a US person before its repeal by the TCJA. The TCJA repealed IRC Section 958(b)(4), effective for a foreign corporation's last tax year beginning before January 1, 2018. IRC Section 958(b)(4)'s repeal caused many foreign corporations that previously were not CFCs to become CFCs without any change in ownership. The Act reinstates IRC Section 958(b)(4), thus limiting downward attribution of stock ownership when applying the constructive ownership rules. This causes many foreign corporations that became CFCs with the repeal of IRC Section 958(b)(4) to no longer be treated as CFCs. However, the Act introduces a new IRC Section 951B, which applies downward attribution from foreign persons in certain cases and applies the subpart F and GILTI inclusion rules to a "foreign controlled US shareholder" (FCUSS) of a "foreign controlled foreign corporation" (FCFC) as if the former were a US shareholder and the latter were a CFC. An FCUSS is a US person that is a US shareholder of a foreign corporation if (i) downward attribution from foreign persons applied, and (ii) the definition of US shareholder applied with a threshold of more than 50% rather than a threshold of 10% or more. An FCFC is a foreign corporation that is not a CFC but would be a CFC if (i) the definition of CFC applied to FCUSS instead of US shareholders, and (ii) downward attribution from foreign persons applied. The Act authorizes Treasury to treat an FCUSS as a US shareholder and an FCFC as a CFC for purposes other than subpart F and GILTI, such as reporting requirements or coordinating the treatment of FCFCs with the PFIC rules. This provision is effective for foreign corporations' tax years beginning after December 31, 2025, and for US shareholders' tax years in which or with which the foreign corporations' tax years end. The reinstatement of IRC Section 958(b)(4) is a welcome change for many taxpayers — especially members of foreign-parented multinational groups — as it eliminates CFC status for many foreign corporations that are not controlled, directly or indirectly, by US shareholders. However, the introduction of the new IRC Section 951B inclusion rule increases complexity and prevents a complete return to a pre-TCJA state. For example, a wholly owned US subsidiary (USSUB) of a foreign corporation may own 20% of a foreign corporation (FSUB) that is otherwise wholly owned by a foreign parent that does not have any direct or indirect US shareholders (i.e., USSUB and FSUB are brother-sister but for the USSUB's 20% ownership in FSUB). Before the TCJA, FSUB would not have been a CFC, and USSUB would not have had subpart F inclusions with respect to its 20% interest. Under new IRC Section 951B, FSUB is not a CFC but is a FCFC, requiring USSUB to include subpart F and NCTI from FSUB based on its 20% ownership interest (consistent with the inclusions required under current law). If a foreign corporation is a CFC at any time during the foreign corporation's tax year, a US shareholder in the foreign corporation on the last day of the year on which the foreign corporation is a CFC (the Last Relevant Day) must include in gross income the US shareholder's pro-rata share of the CFC's subpart F income for the year. A US shareholder's pro-rata share is determined by first proportionally allocating subpart F income to the US shareholder based on its share of a hypothetical distribution treated as made by the CFC on the Last Relevant Day. Next, if the US shareholder does not own its CFC stock all year, the allocation is reduced by certain dividends received by another person on that stock. First, it removes the Last-Relevant-Day rule. Instead, each US shareholder owning stock in a foreign corporation at any time during a year in which the foreign corporation is a CFC will include in gross income its pro rata share of the CFC's subpart F income. Thus, Subpart F income inclusions will no longer be limited to the US shareholders on the Last Relevant Day. Second, a US shareholder's pro-rata share will be determined under a new, more flexible standard based on the portion of the CFC's subpart F income that is "attributable to" the CFC stock owned by the US shareholder and the period of the CFC year during which all of the following are true - (i) the shareholder was a US shareholder; (ii) the US shareholder owned the stock (within the meaning of IRC Section 958(a)); and (iii) the corporation was a CFC. Third, the Act authorizes Treasury to carry out the purposes of IRC Section 951(a). Examples of this authority include allowing or requiring taxpayers to elect to close a CFC's tax year upon a direct or indirect transfer of the CFC's stock. The modifications to this provision are effective for foreign corporations' tax years beginning after December 31, 2025. The Act provides a special transition rule for certain dividends that (i) are paid (or deemed paid) by a CFC before the effective date of the Act's revisions; and (ii) do not increase the taxable income of a US person (including by reason of a dividends received deduction, an exclusion from gross income or a subpart F income exclusion). These amounts are not treated as a dividend for purposes of IRC Section 951(a)(2)(B) (as in effect before December 31, 2025). The Act addresses concerns that a transfer of CFC stock could result in subpart F income or tested income attributable to a US shareholder's ownership of stock of the CFC escaping taxation. It will likely promote consistent treatment of that income while supplanting regulations like Treas. Reg. Section 1.245A-5(e), which address similar concerns by denying an IRC Section 245A(a) deduction for certain dividends viewed as attributable to subpart F income or tested income. In recognition of the understanding reached by the US Treasury and G7, the Act does not include proposed Section 899, which, under the Senate Bill, would have imposed higher tax rates on certain persons and entities with a connection to countries with an extraterritorial or discriminatory tax (e.g., a UTPR). Unlike the Senate Bill, the Act also does not include "super BEAT" provisions that were included in proposed Section 899 and would have made BEAT applicable to more taxpayers. The removal of proposed Section 899 from the final legislation is a favorable policy outcome for inbound taxpayers. Taxpayers should be mindful, however, that IRC Section 891 remains relevant. IRC Section 891 authorizes the President, by proclamation, to double the applicable tax rates on citizens and corporations of a foreign country that imposes discriminatory or extraterritorial taxes on US persons. This provision could be invoked if negotiations with the OECD and/or G7 do not yield a favorable outcome for the US. Any such proclamation could result in increased rates applying retroactively to the first day of the tax year in which it is made. No proclamation has ever been made under IRC Section 891, and no guidance exists on how it would be implemented. It is not self-executing because certain actions must be taken by the President before the increased tax rates apply.
Document ID: 2025-1510 | ||||||
