Could Alibaba Be GILTI of Owning a U.S. Subsidiary? If So, There Is a Potential Unexpected Tax Benefit for Altaba

By Stuart E. Leblang, Michael J. Kliegman, and Amy S. Elliott

On January 24, The Deal reported that Alibaba Group Holding Limited (NYSE:  BABA) (Alibaba) had increased its lobbying activity targeted at the Committee on Foreign Investment in the U.S. (CFIUS) after the interagency committee declined to approve the $1.2 billion acquisition of a

U.S. company by one of Alibaba’s affiliates. ¹  The article suggests that Alibaba’s Executive Chairman Jack Ma may wish to pursue one or more acquisitions in the United States. ²  We think that Alibaba owning even a relatively small controlled corporate subsidiary in the United States may have a U.S. tax impact on Altaba Inc. (NASDAQ:  AABA) (Altaba).

Under U.S. tax law, a U.S. corporation owning at least 10 percent of a “controlled foreign corporation” (CFC) must pick up its share of certain types of income of the CFC.  Prior to the Tax Cut and Jobs Act (TCJA) enacted at the end of 2017, certain prescribed types of Subpart F income were passed through to the 10‐percent U.S. shareholder; these rules are largely left in place by the TCJA. ³  It is an overgeneralization to say that an active foreign company like Alibaba is unlikely to generate Subpart F income, but for our purposes we are going to go with that assumption.  Of greater interest to us, the TCJA added a new set of rules involving global intangible low‐taxed income (GILTI) that have much broader application to the 10‐percent U.S. shareholders of a CFC. ⁴ 

The GILTI rules generally provide that a 10‐percent U.S. Shareholder of a CFC must pick up its share of the CFC’s net income, less a prescribed return on the company’s tangible assets.  This is the mechanism for purportedly imposing a minimum tax on deemed income associated with overseas intangible assets.  Operating in conjunction with a partially offsetting tax deduction, ⁵ this has the effect of subjecting a 10‐percent U.S. corporate shareholder of a CFC to a 10.5 percent tax on what may be a substantial portion of the foreign corporation’s income.

In addition to foreign tax credit (FTC) relief, any income picked up by the 10‐percent U.S. shareholder on Subpart F income or GILTI gives rise to an increase in the U.S. shareholder’s tax basis in the stock of the foreign corporation. ⁶ 

Does any of this apply to Altaba?  Well, we don’t know.  It is clear that Alibaba was not a CFC prior to enactment of the TCJA.  However, another provision buried in the TCJA amended certain attribution rules tied to the definition of a CFC, with the effect that if Alibaba owns a majority interest in a U.S. corporation, then that could cause not Alibaba itself but many if not all of its non‐U.S. subsidiaries to be treated as CFCs, ⁷ in which case Altaba, as a 10‐percent U.S. shareholder of Alibaba, would be subject to the Subpart F and GILTI rules. ⁸ 

As we look through Alibaba’s Form 20‐F, ⁹ we see at least one minority investment in a U.S. start‐ up, ¹⁰ but we have not come across evidence of a controlling position that would trigger the CFC rule.  On the other hand, it is possible that there could be one or more controlled U.S. entities in the group, perhaps of an otherwise immaterial nature.  It is also possible that the group may have established a wholly owned U.S. holding company for the purpose of holding its minority investment in one or more minority investments.  Further, it could happen at any time that Alibaba seeks a controlling interest in a U.S. company, as its apparently stepped‐up CFIUS lobbying implies.

Assuming Alibaba’s subsidiaries were CFCs, then Altaba, as a 10‐percent U.S. shareholder, would pick up its estimated share of their net income, subject to the prescribed offsets and with some FTC relief.  Assuming Altaba paid a 10.5 percent federal income tax on that amount, it would obtain a corresponding tax basis increase in its Alibaba shares.  For a U.S. corporation with an expected indefinite holding period in the stock of the CFC, the basis increase may be relatively small consolation.  But insofar as Altaba is a company that is valued with an expectation that it will incur a tax on its gain in its Alibaba holdings, every dollar of GILTI brings about a net benefit, due to the trade‐off of an effective 10.5 percent GILTI tax rate against a 21 percent corporate income tax rate on capital gains.

While it is hard to predict the exact impact to Altaba of such a GILTI inclusion, based on Alibaba’s income before taxes for its year ended March 31, 2018 ¹¹ (as a proxy for the 2019 net tested income of its CFCs ¹² ) and assuming the CFCs have no qualified business asset investment to reduce the GILTI amount, then Altaba could be facing a GILTI inclusion (and basis increase in its Alibaba shares) of about $1.76 billion (ignoring any possible FTCs, which could decrease the inclusion amount), with a corresponding GILTI tax hit of about $185 million (again, ignoring FTC relief).  Note that the benefit of the $1.76 billion basis step‐up, assuming a 21 percent federal tax rate, is twice that of the tax hit, at nearly $370 million—for a net benefit of $185 million. ¹³ 

Throwing a wrench into this discussion, before the 116th Congress convened on January 3, 2019, marking a shift in the balance of power, the House Ways and Means Committee Chair issued a discussion draft of technical corrections legislation to clean up various provisions of the TCJA, including the provision that could cause Alibaba’s subsidiaries to be CFCs. ¹⁴  It is anyone’s guess what may become of the technical corrections bill as this year’s politics play out, including in the tax arena.

^{[1] “For the past three quarters, [Alibaba] listed Cfius and foreign direct investment among its lobbying priorities in Congress, according to Senate lobbying disclosures.  In the past, Alibaba listed foreign direct investment as a lobbying concern without specifying the committee,” as reported by David Hatch in The Deal Jan. 24, 2019 (https://pipeline.thedeal.com/article/14844821/index.dl).}

^{[2] And, indeed, Alibaba has a history of investing in U.S. companies (see “Alibaba Is Investing Huge Sums in an Array of U.S. Tech Companies,” a June 31, 2014, New York Times article by Mike Isaac and Michael J. de la Merced, https://www.nytimes.com/2014/08/01/technology/alibaba‐is‐investing‐huge‐sums‐in‐an‐array‐of‐us‐tech‐companies.html); although only certain covered transactions (generally, those transactions that could result in a foreign person gaining control of a U.S. business) are subject to review by CFIUS, the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) expanded CFIUS’s jurisdiction by broadening the scope of covered transactions to include non‐controlling investments in certain U.S. business “that afford a foreign person access to material nonpublic technical information” or membership on the board of directors, among other things (https://www.treasury.gov/resource‐center/international/Documents/Summary‐of‐ FIRRMA.pdf).}

^{[3] Subpart F income is defined in § 952 and succeeding provisions of the Internal Revenue Code (I.R.C.).}

^{[4] I.R.C. § 951A.}

^{[5] I.R.C. § 250.}

^{[6] I.R.C. §§ 951A(f)(1), 961.}

^{[7] Alibaba is a holding company.  For this discussion, we are effectively assuming that all of its subsidiaries are CFCs.  That said, most of Alibaba’s so‐called subsidiaries are actually not legally owned but consolidated for book purposes as so‐called variable interest entities.}

^{[8] Section 14213(a) of the TCJA deleted former § 958(b)(4), which had removed “downward attribution” from a foreign “person” to a U.S. “person.” One effect of the change is to cause a U.S. subsidiary of a foreign group to own the parent’s share (e.g., 100%) of the stock of other foreign entities in the group.  Congress included language in the TCJA’s accompanying legislative history directing Treasury to limit the scope of the removal in such cases, resulting in the TCJA provision being subject to differing legal interpretations.  It is not clear at this time whether Treasury will issue further guidance interpreting the removal consistent with the legislative history or whether further legislative change is forthcoming.}

^{[9] Alibaba’s Form 20‐F, filed July 27, 2018 (https://www.sec.gov/Archives/edgar/data/1577552/000104746918005257/a2235254z20‐f.html).}

^{[10] In Dec. 2015, Alibaba invested $430 million in Magic Leap, Inc.  In Oct. 2017, Alibaba invested an additional $68 million in the augmented reality start‐up.  As of March 31, 2018, Alibaba’s had about a 9% equity interest in Magic Leap.}

^{[11] According to Alibaba’s Form 20‐F filed July 27, 2018, it had just over $16 billion of “income before income tax and share of results of equity investees” for the year ended March 31, 3018.  Because Altaba is an 11 percent shareholder (as of Sept. 30, 2018, Altaba owned 283,315,416 of the (as of March 31, 2018) 2,571,929,843 outstanding shares of Alibaba), and assuming Alibaba is simply a holding company of CFC subsidiaries, then $16 billion x 11% x 10.5% = about $185 million.  (https://www.sec.gov/Archives/edgar/data/1577552/000104746918005257/a2235254z20‐f.html).} 

^{[12] Because Alibaba is a fiscal‐year taxpayer (its fiscal year ends March 31) and because Altaba is a calendar‐year taxpayer—and because of how the effective dates are drafted for both the GILTI change and the downward attribution change—Altaba will not have a GILTI inclusion until its 2019 tax year ending Dec. 31, 2019 (though it may decide to accrue a GILTI impact for book purposes for periods before then).}

^{[13] Apart from the GILTI tax basis increase, we note that to the extent Altaba earnings are not otherwise taken into account, Altaba can obtain a significant tax benefit under § 1248 upon a disposition of Alibaba shares.  Provided Alibaba is treated as a CFC under the above analysis, § 1248 will treat the gain on sale as a dividend, subject to the dividends‐received deduction under § 245A.}

^{[14] For the House Ways and Means Committee Chairman’s discussion draft of the “Tax Technical and Clerical Corrections Act,” released Jan. 2, 2019, see https://republicanswaysandmeansforms.  house.gov/uploadedfiles/tax_technical_and_clerical_corrections_act_discussion_draft.pdf.  For the Joint Committee on Taxation’s Jan. 2, 2019, technical explanation of the draft (JCX‐1‐19), see https://www.jct.gov/publications.html?func=startdown&id=5154.  In addition, on Dec. 20, 2018, the House passed H.R. 88, which contained a technical correction to downward attribution in Section 501(f) of Division A of that bill (the Retirement, Savings, and Other Tax Relief Act of 2018) (page 137 of https://www.congress.gov/115/bills/hr88/BILLS‐115hr88eah.pdf).  However, the Senate did not take up the bill.}