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FDII: Significant New Tax Law Incentives for Global Manufacturers and Distributors to Know

March 13, 2019

Paul Dailey, CPA, MBA

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Does your U.S.-based business sell products to the foreign marketplace, or provide services to foreign customers? If the answer to either question is YES, there are significant tax benefits you may be entitled to.

WHAT IS FOREIGN-DERIVED INTANGIBLE INCOME (FDII)?

One new tax opportunity ushered in by the Tax Cuts and Jobs Act is the foreign-derived intangible income (FDII) deduction. This new tax deduction (37.5%), effective for tax years beginning after December 31, 2017, can reduce the U.S. corporate tax rate to 13.125% for certain qualified businesses. The deduction is aimed at incentivizing U.S. taxpayers 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” in FDII 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 (GILTI), financial services income, and foreign branch income. The routine return is 10% 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 (IP) to a foreign person for foreign use
  • Services provided to a person located outside of the U.S.

Documentation must be maintained to support that the sale or service destination is 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.

HOW IT WORKS

Assume the following:

C Corporation
Total gross revenue $400
Allocable deductions $100
Deduction eligible income $300
Qualified business assets $100
Routine return (10%) $10
Deemed intangible income $290
Foreign gross revenue $300
Cost of goods sold and allocable deductions $120
Foreign derived deduction eligible income $180
% to deduction eligible income (180/300) 60%
Foreign derived intangible income (60% x 290) $174
FDII Deduction (37.5% x 174) $65.25
Taxable FDII $108.75
Corporate tax (21%) $22.84
FDII effective tax rate (22.84/174) 13.125%

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

CONCLUSION

The FDII tax deduction can provide significant tax savings for U.S. companies. When first introduced, there was some concern that it might be viewed as an illegal export subsidy by the World Trade Organization. However, it is current tax law and should be taken advantage of. U.S. corporations must also consider the state tax implications associated with FDII. In addition, many are now considering housing IP in the U.S., as the low rate of tax competes with patent box regimes as offered by other countries. Further, analysis should be afforded to the possibility of transferring existing foreign business into newly formed C Corporations, so as to reap the FDII tax benefits.