The One Big Beautiful Bill Act (OBBBA), which was signed into law on July 4, has changed US taxation of multinational businesses. The most notable among these changes are various modifications that relate to the former global intangible low-taxed income (GILTI) regime enacted during the first Trump administration as part of the Tax Cuts and Jobs Act (TCJA). The changes to GILTI (covered in more depth below) include:
- a reduction in the percentage of tax deduction applied to this type of income; and
- changes in foreign tax credit rules intended to offset the impact of that reduced deduction, such as revised expense allocations and alterations to the creditable tax “haircut.”
Beyond the GILTI alterations, the OBBBA introduced new rules related to inventory sourcing and non-GILTI aspects of the foreign tax credit, and it could affect certain attributes of deductibility for interest and research and experimentation expenses. For tax years starting after December 31, 2025 (and certain tax provision components sooner), taxpayers can expect changes in how their foreign income is taxed, the mechanics of foreign tax credits, and the interplay with other changes in the OBBBA.
CFC Income No Longer “GILTI”
The OBBBA broadened the tax base and increased the net effective tax rate on income from controlled foreign corporations (CFCs) that had previously been labeled GILTI, and it assigned a new name to this category of income. The applicable provisions now refer to “net CFC tested income” (NCTI).
GILTI income—subject to some limitations—enjoyed the benefit of a fifty percent tax deduction under Internal Revenue Code Section 250. The OBBBA has reduced that tax deduction to forty percent, increasing the net effective rate on NCTI to 12.6 percent before credits, instead of the 10.5 percent effective rate that applied to GILTI. Additionally, the reduction for the deemed tangible income return has been eliminated, which will serve to broaden the tax base that will qualify as NCTI.
The OBBBA also made changes to the foreign tax credit that generally provide some relief for income in the Section 951A NCTI basket. There’s still no allowance for a credit carryforward, but the changes should provide extra options for taxpayers that rely on the foreign tax credit to reduce their US tax on NCTI.
Reduced Expense Allocations Should Increase Foreign Tax Credits
Although the general process of determining the net taxable income attributed to each of the foreign tax credit baskets remains the same, the OBBBA introduced Section 904(b)(5), which narrows the types of expenses that must be allocated against the NCTI (formerly GILTI) basket. Gone are the interest expense allocations that bedeviled taxpayers under the GILTI regime. Section 904(b)(5) specifically provides for the exclusion of allocation and apportionment of interest and research expenditures to this basket.
This change should increase the amount of foreign tax credit limit available to US taxpayers (and their foreign tax credit).
Only two types of deductions are now allocable against the Section 951A NCTI basket. They are:
- the Section 250 deduction for NCTI (and any related Section 78 gross-ups); and
- directly allocable expenses.
Directly allocable expenses include those incurred by the US taxpayer that are clearly and directly related to the Section 951A NCTI basket. Under Treasury regulations, as promulgated under Section 861, an expense qualifies as “directly related” to a basket if it meets any one of these three tests:
- the expense is incurred “as a result of” an activity or property from which the class of income is derived;
- the expense is incurred as “incident to” an activity or property from which the class of income is derived; and
- the expense is incurred “in connection with” an activity or property from which the class of income is derived.
It’s unclear which expenses should be considered directly allocable to the NCTI basket. State income taxes imposed on NCTI and “stewardship” expenses could be considered directly allocable, since the OBBBA doesn’t specifically address their treatment; otherwise, these presumably would be classified as having a US source, like interest and research expenditures. Future guidance in this area would be welcomed.
Stewardship expenses are US expenses that duplicate expenses incurred by a foreign subsidiary, primarily to protect a taxpayer’s investment in another entity or facilitate the taxpayer’s compliance with its own reporting, legal, or regulatory requirements (for example, the cost to prepare and file Form 5471).
It can be difficult to distinguish between related-party transaction expenses that are properly classified as stewardship expenses and other related-party transaction expenses that don’t meet the criteria, such as controlled expenses or supportive expenses. The main difference is that stewardship expenses generally don’t benefit the related party. Unfortunately, determining if and when a benefit is provided to a related party can be a fairly subjective exercise.
Even though this modification in expense allocation is generally expected to be a positive change, some taxpayers may not find much relief. Prior to the new law, the determination of the stewardship expense amount had been an afterthought—or simply a guess—for some. It’s hard to improve on an underallocation (or no allocation) of expense.
Should these expenses be considered allocable to NCTI, it seems likely that Internal Revenue Service scrutiny of a taxpayer’s stewardship expense allocation methodology will increase. A closer look at this category of expense will likely not favor taxpayers that haven’t historically put much effort into identifying the costs and allocating them appropriately.
Potential Overall Domestic Loss
Section 904(g) was previously enacted to prevent taxpayers from losing foreign tax credits when domestic losses reduce foreign-source income. When a US-source loss offsets foreign income, it creates an overall domestic loss (ODL), thereby reducing the foreign tax credit to a position that reflects overall taxable income. To preserve a foreign tax credit benefit, future US-source income is recharacterized as foreign-source income, allowing the taxpayer to recapture previously limited foreign tax credits.
The shift in the OBBBA providing interest and research expenditures under Section 904(b)(5) that are allocable only to US-source income increases the chances that an ODL will be created. Current drafting remains unclear whether this limitation also excludes its application from the recapture rules under Section 904(g). This ambiguity raises questions about whether taxpayers must still track and recapture ODLs when Section 904(b)(5) applies, especially in the context of NCTI, where foreign tax credit computations are already complex.
Reduced Haircut
The GILTI regime reduced the amount of foreign income taxes available for credit to eighty percent of the foreign income taxes related to GILTI income (the twenty percent GILTI foreign tax credit “haircut”). As a result of the Section 250 deduction and the creditable tax haircut, the foreign effective rate necessary to fully offset the US income tax on GILTI had to be 13.125 percent (assuming a taxpayer was able to take a credit).
Under the OBBBA’s lower forty percent Section 250 deduction and the lower ten percent haircut, the foreign effective rate now must be fourteen percent to fully offset the US tax on NCTI. Without the higher haircut, the required foreign effective rate would have risen to 15.75 percent.
Notably, the haircut now also applies to any credits available to distributions of previously taxed NCTI. If a CFC distributes previously taxed earnings, the US shareholder may be eligible for a foreign tax credit for any additional foreign taxes imposed on that distribution, such as foreign dividend withholding tax. Proposed regulations provide special rules for previously taxed earnings and profits (PTEP) tax pools and the distribution of foreign income taxes through tiered structures.
Net CFC Tested Income and the Foreign Tax Credit
With the elimination of the deemed tangible income return deduction in computing NCTI, the potential income inclusion base for many taxpayers will increase dramatically. Although the high-tax exception has provided relief for many taxpayers, it doesn’t work for all.
Many taxpayers that have relied on the high-tax exception to mitigate issues with foreign tax credit expense allocations could benefit from reviewing this strategy. With a potentially better foreign tax credit position, some of those taxpayers may want the flexibility of PTEP treatment rather than relying on other exceptions like the Section 245A deduction for the foreign-source portion of dividends. Section 245A provides a US corporate shareholder with a form of participation exemption on foreign-source dividends.
Taxpayers need to monitor how PTEP works for them compared to a dividends-received deduction. Rule changes may make PTEP and the foreign tax credit regime look like a much more favorable operation than it may have seemed in the past. PTEP provides another arrow in the quiver so that taxpayers don’t necessarily have to rely on a dividends-received deduction upon repatriation of foreign earnings.
Taxpayers in expanded corporate groups, particularly private equity–based groups and their portfolio companies, may be excluded from using the high-tax exception for various reasons. In those cases, the foreign tax credit will be their sole means of relief from US tax. The state tax implications of NCTI and monitoring changes to conformity also can’t be overlooked when making this assessment.
The foreign tax credit rules have always been difficult to manage in the GILTI (or NCTI) context. In particular, the inability to carry forward excess foreign taxes to credit in future years has made relief from double taxation on this type of income more difficult. Significant accounting differences for US and local foreign income purposes can result in a loss of credit. The lessening of expense allocations against the foreign tax credit limit and reduction of the creditable tax haircut should provide some relief, but taxpayers must still exercise caution.
Sourcing Rule Changes on Inventory Sales
The OBBBA provides a taxpayer-favorable change for US companies that sell US-produced inventory through a foreign branch. The OBBBA allows up to fifty percent of the income from the sale of US-produced inventory sold abroad to be treated as foreign-source income in computing the foreign tax credit limit.
Prior to the changes, income from the sale of inventory produced in the United States was generally treated as 100 percent US-source income, even if sold by a foreign branch. This rule limited the availability of foreign tax credits for the foreign branch basket and forced taxpayers to search for relief under double tax treaties.
This change signals an important development for US companies selling internationally as more countries adopt policies that establish a taxable presence based on local sales activity.
Other Foreign Tax Credit Changes
The OBBBA makes some non-NCTI-related foreign tax credit changes as well. Section 904(d)(2) corrects a drafting error from the TCJA concerning foreign income taxes imposed on items that aren’t considered income under US tax principles. Under TCJA-era regulations, foreign taxes on these “base differences” were allocated to the foreign branch basket, which could prevent a US company from taking a credit.
For tax years starting after 2025, these taxes will be assigned to the general foreign tax credit basket instead. Doing so prevents the loss of these credits when US law doesn’t recognize the corresponding income.
Indirect and Secondary Impact of OBBBA Changes and the FTC
Other provisions in the OBBBA ostensibly aimed at US-based income also require consideration and modeling for the foreign tax credit. The interplay and creation of an ODL due to increased interest deductions can’t be overlooked when modeling OBBBA changes.
Another change that may have a cascading effect on the international side is the return to current-year expensing for domestic research and experimentation (R&E) costs. Foreign R&E costs must still be capitalized and amortized. Taxpayers should review operations to see if R&E costs can be moved to more tax-advantageous locations and analyze options available for US-based costs that may have been capitalized previously. R&E expenses that remain offshore could provide larger foreign tax credit limits.
Last, a change in Section 250 deduction rates may serve to increase foreign-source income. The changes in this section replaced the 37.5 percent deduction for foreign-derived intangible income (FDII) with a 33.34 percent deduction for foreign-derived deduction eligible income (FDDEI). The lower rate for the deduction could result in higher foreign-source income and an increased foreign tax credit amount.
These three changes, just like all of the changes discussed throughout this article, point out the importance of fully analyzing the ins and outs, circularity, and interplay of the various OBBBA provisions that affect international income. A narrow look at one provision might suggest that a tax change could be beneficial, but negative impacts elsewhere can more than offset those benefits.
Closing Thoughts
As with any discussion of new tax law, it’s important to close with a reminder that many provisions are subject to future clarification through regulations and other guidance. An additional cautionary note applies to the international tax provisions in the OBBBA. The new law includes many provisions that likely conflict with the Organisation for Economic Co-operation and Development’s Pillar Two rules. The previous administration had taken more steps than any predecessor toward aligning US rules with OECD’s Pillar Two, and it remains to be seen how this administration will approach these potential conflicts.
Even as the dust settles and US taxpayers work to understand and comply with the new rules, it could take years for tax professionals to fully comprehend the international impact of these changes.
Robert Piwonski is a principal in Plante Moran’s Macomb, Michigan, office. Steve Schnepel is a partner in Plante Moran’s Denver office. Bill Henson is a partner in Plante Moran’s Schaumburg, Illinois, office.
