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Foreign-Derived Intangible Income Tax Benefits

by Kevin Ryan, CPA/Partner, Citrin Cooperman

Mar 9, 2020

PHOTO: © CYBRAIN – DREAMSTIME.COM

March 2020

IF YOUR U.S.-BASED BUSINESS SELLS PRODUCTS to the foreign marketplace or provides services to foreign customers, you may be entitled to significant tax benefits.

One new tax opportunity ushered in by the Tax Cuts and Jobs Act is the foreign-derived intangible income deduction, referred to as FDII. This new tax deduction (37.5 percent), effective for tax years beginning after Dec. 31, 2017, can reduce the U.S. corporate tax rate to a rate of 13.125 percent for certain qualified businesses. FDII aims to provide an incentive to domestic corporations to provide goods and services to foreign markets. However, consistent with many other elements of preferential tax relief under the new law, it only applies to domestic C corporations.

Don’t let the word “intangible” cause confusion. The deduction applies to all non-excluded foreign-derived gross income in excess of a routine return. Excluded foreign income includes Subpart F income, global intangible low-taxed income, financial services income and foreign branch income. The routine return equals 10 percent of the adjusted tax basis of a C corporation’s depreciable tangible assets used in its trade or business.

FDII is equal to the foreign source portion of its intangible income. It includes sales or other dispositions of property to a foreign person for foreign use, a license of intellectual property to a foreign person for foreign use, and services provided to a person located outside of the United States.

Corporations must maintain documentation to support the sale or service destination for foreign use. Property sold or services provided to a related party are not considered unless the related party then sells the product or provides the service to an unrelated foreign third party.

Calculating the FDII deduction involves a complex analysis, first determining qualified business asset investment, deduction-eligible income and foreign-derived deduction-eligible income before calculating deemed intangible income and FDII, then multiplied by 37.5 percent to arrive at the deductible amount.

Foreign tax credits are also allowed against FDII, but only the taxable portion of FDII (62.5 percent) is taken into account to determine the foreign tax credit limitation. The FDII deduction is limited to taxable income of the C corporation.

The FDII tax deduction can provide significant tax savings for U.S. companies. When first introduced, there was some concern the World Trade Organization might view it as an illegal export subsidy. However, it is current tax law and companies should take advantage of it. U.S. corporations must also consider the state tax implications associated with FDII. In addition, many are now considering housing intellectual property in the United States, as the low rate of tax competes with patent box regimes offered by other countries. Further, companies should analyze whether it is worthwhile to transfer existing foreign business into newly formed C corporations to reap the FDII tax benefits.

The content of this article is for informational purposes only. It is not intended to be a substitute for professional financial advice. Always seek the expertise of a certified financial advisor or other qualified provider with any questions you may have regarding personal finance, investment and money-related issues.

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