Changes to sections 250 and 960 have resulted in an increase in the tax burden to a CFC on active business income.
GIVEN, for Ontario CCPCs, the 2025 the annual tax rate on active business income on the first $500K is about 12.2% due to the federal & Ontario Canadian small business deduction. Income above this $500K threshold, the active business income is taxed at 26.5%.
HISTORY
Commencing in 2017, the December 2017 Tax Cuts and Jobs Act required U.S. persons to be taxed on accumulated profits, generally derived from active business income of controlled-foreign corporations (“CFC”s) under section 965 of the IRS Code. This was also known as the transition or repatriation tax.
Currently and prior to 2017, specific types of income earned by the CFC, primarily investment income, had to be accrued annually and taxable to the CFC shareholder if certain exclusions and exemptions were not available.
For subsequent taxation years, annual active business income as defined as global intangible low-tax income (“GILTI”) under section 951A of the IRS Code must be included in income. This is the continuation of the repatriation tax but in a different form.
U.S. corporate investors of CFC
Where the U.S. person is a U.S. C corporation, the GILTI provisions provided for a flat 50% deduction of the GILTI under Section 250 of the IRS Code bringing the tax rate to 10.5% from the 21% U.S. corporate rate.
An election is available under section 960 of the IRS Code for the C corporation to take an indirect foreign tax credit up to 80% of the foreign tax incurred by the CFC. Where the effective CFC tax rate was at least 13.12%, this election resulted in no tax to the C corporation on GILTI utilizing section 960.
U.S. individual investors of CFC
For individual U.S. investors, GILTI is included in their reported adjusted gross income reported on the U.S. 1040 tax return, taxed at their marginal tax rate that could be as high as 37%. However, a similar indirect foreign tax credit as outlined in section 960 available to the C corporation investor is available under section 962 of the IRS Code to the individual.
With an annual section 962 election, the IRS Code pretends that the individual is a corporation and in lieu of including GILTI in adjusted gross income taxed at the marginal tax rate of the individual, one could compute separately the tax on GILTI by applying the 21% corporate rate, claim the section 250 deduction in arriving at notional taxable tested income, with a foreign tax credit up to 80% of the foreign corporate tax. This section 962 tax payable is reported on a separate line of the U.S. 1040.
This means, prior to 2026, with an effective CFC tax rate of at least 13.12%, there would be no tax on GILTI, same as if the actual owner of the CFC was a C corporation.
As the Ontario corporate tax rate on the first $500K of active business income is 12.2% for 2025 taxation years, the pre-2026 U.S. tax law (ignoring any QBAI), will result is about an incremental U.S. tax burden of about .92%
CHANGES FOR 2026 & BEYOND AS WE KNOW IT
There is no longer the QBAI exemption under the new law. While the U.S. federal corporate rate remains at 21%, the section 250 deduction reduces to 40% from the prior 50% and the allowable FTC hair cut is increased to 90% limitation from 80%.
This means if the effective Canadian corporate tax rate on active business income is at least 14%, there will be no U.S. tax in utilizing Sections 960 or 962. At the SBL tax rate, this will result is about an incremental U.S. tax burden of about 1.8%
Therefore, the changes in tax law affecting tested income have increased.
Contact your professional advisor prior to implementing any of the outlined strategies.
