FDII is foreign derived intangible income that a U.S. domestic corporation derives from selling products or providing services to unrelated foreign persons when that product or service is for foreign use by the customer. Income successfully characterized as FDII is subject to a lower effective tax rate of tax (currently, 13.5% instead of the 21% normal corporate tax rate). Specifically, the Tax Cuts and Jobs Act (TCJA) introduced a statutory deduction under new IRC Section 250, which provides domestic corporations with a 37.5% deduction for any FDII. This deduction is calculated as a specified percentage of the excess income derived from export sales and services over a fixed return on tangible depreciable assets for the year.
In March 2019, Treasury published proposed regulations (REG-104464-18), providing guidance for determining FDII deduction.
Among other things, the proposed regulations described specific documentation that must be obtained in order to establish that: (1) a recipient of property is a foreign person; (2) a sale of property is for a foreign use; or (3) a recipient of general property is located outside the United States. Most of the comments objected that the documentation requirements presented an administrative burden that would lead to practical implementation issues for many otherwise qualifying taxpayers.
In July 2020, the IRS finalized, with modifications, the proposed regulations.
The final regulations remove the specific documentation requirements for establishing: (1) foreign person status; (2) foreign use with respect to certain sales of general property; and (3) the location of a consumer of a general service. Instead, the general rule will apply: general tax law requires taxpayers claiming a deduction to be able to prove that they are entitled to the deduction. Additionally, in certain circumstances, foreign person status is presumed. Also, under final regulations, no carryforwards of excess FDII deduction is allowed.
Essentially, the final regulations relax the specific documentation requirements for establishing: foreign use for sales of general property for resale and foreign use for sales of general property subject to manufacture. The regulations also provide some simplification in the calculation, by permitting taxpayers to exclude from the calculation of qualifying income certain tax circular tax adjustments.
The final regulations are applicable for taxable years beginning on or after January 1, 2021. However, in some cases, taxpayers may choose to apply the final regulations for taxable years beginning on or after January 1, 2018.
The final regulations adopted a more flexible approach, which is good news for taxpayers with FDII. The final regulations should result in less administrative burden for these taxpayers and should reduce compliance costs.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.