Final Foreign Derived Intangible Income Deduction Regulations
By Ragini Subramanian, Manager, Tax & Business Services
On July 9, 2020, the Internal Revenue Service released final regulations under new Section 250, applicable to tax years beginning on or after January 1, 2021. Section 250 was enacted under the 2017 Tax Cuts and Jobs Act. This Section introduced two new deductions for U.S. domestic corporations:
(A) FDII deduction:
37.5% of a domestic corporation’s foreign derived intangible income (FDII income).
(B) GILTI deduction:
50% of the sum of a domestic corporation’s global intangible low-taxed income (GILTI income) plus gross-up attributable to the inclusion of GILTI income.
These percentages are applied to tax years beginning after December 31, 2017, and before January 1, 2026, and reduced in taxable years after 2025 (FDII deduction will be reduced to 21.875% and GILTI deduction will be reduced to 37.5%).
In simplified form, FDII is the income of a domestic corporation from exported goods and services. This Tax Flash highlights the changes made by the final regulations under Section 250 as they relate to FDII deductions only.
The final regulations retained the basic approach under the previous proposed regulations, while making significant, taxpayer-favorable changes to the proposed regulations. Below are the highlights of some of these changes:
- For tax years beginning before January 1, 2021, the final regulations allow taxpayers, at their choice, to rely on the final regulations or apply proposed regulations. Taxpayers that choose to rely on proposed regulations must do so for all taxable years before January 1, 2021.
- The final regulations continue to apply the taxable income limitation, but propose to undertake further study to determine certain ordering rules for various deductions. For taxable years beginning after January 1, 2021, taxpayers can apply any reasonable method, as long as that method is applied consistently to all taxable years. For taxable years prior to January 1, 2021, the taxable income is determined after applying certain ordering rules under the proposed regulations.
- The final regulations provided substantial relief from the specific documentation requirements of the proposed regulations, in order to be eligible for FDII deductions. The final regulations rely on presumption rules applicable to various types of export sales and services transactions. Essentially the final regulations allow the seller/renderer to rely on documents derived in the regular course of these transactions available with the seller or the renderer. The final regulations provide many examples for these presumption rules and export sale/service transactions that are eligible for FDII deductions. In certain specific situations, however, the final regulations impose specific substantiation requirements. For example, a specific substantiation requirement is imposed in the case of a sale of general property for resale, or sale of general property subject to manufacturing, assembly, or processing outside the U.S., or sale of intangible property, or provision of general service to a business recipient.
- The final regulations add two more categories of services that may be eligible for FDII deductions and provide extensive rules on qualifications requirements for seeking FDII deductions with respect to the same.
- The final regulations include an exception for small business similar to the exceptions in the proposed regulations. The final regulations, however, change the threshold requirement to meet this exception from $10 million in gross receipts to $25 million in gross receipts. As a result, a small business meeting $25 million gross receipts parameters will not have to meet the strict substantiation requirements laid out under final FDII regulations, but comply only with the ordinary course of business rules related to maintenance of documents.
- Under the final regulations, a partnership is treated as an entity to determine whether a sale or service provided by the partnership is eligible for FDII deduction. Where a partnership has a direct domestic corporate partner, the partnership is required to furnish a K-1 with specific information to calculate FDII deduction. The lower tier partnership must provide similar information to an upper tier partnership with a domestic corporate partner.
- In addition to the above, the final regulations provide additional guidance on aggregation rules for FDII deduction by consolidated groups, how certain components of FDII are calculated, related party transactions, and cost of goods allocations related to research and experimentation expenses.
Marcum’s international tax advisors will keep you posted on this regulation and its additional interpretations.