The US Treasury has issued proposed regulations relating to foreign-derived intangible income (FDII).
The FDII regime was introduced as part of a tax reform legislation which would act as an incentive for corporations that are taxed separately from their owners, known as C corporations in the US.
The proposed reform enables a 37.5% tax deduction for a portion of income earned from certain export or foreign source incomes. This will be reduced to 21.875% in 2026.
Here’s how the proposed regulations may impact on international companies.
To qualify for the Foreign-Derived Deduction-Eligible Income (FDDEI), any sales or service income must meet certain requirements based on the nature of the products sold or the services provided.
Sales income only qualifies as FDDEI if the sale is made to a foreign person for a foreign use. There is no requirement for a property, either tangible or intangible, that is sold to a foreign person to be manufactured or created in the US, to qualify. If it is manufactured in the US the property must have a certain level of US content, for example, US components or labour.
Sales of intangible property (such as a patent, design, copyright, trademark or goodwill), as well as royalties from licensing and gains from the sale or transfer of intangible property are all considered ‘foreign use’ when income is earned from them outside the US.
Determining how much income is attributable to non-US sources is based on a ‘reasonable method’ defined by the IRS for attributing use between US and non-US sources.
Income from services
The regulations also define four types of services where service income is considered to be derived from a foreign use:
• Proximate services – provided to a recipient outside the US, where the provider spends more than 80% of its time in the physical presence of the recipient.
• Property and transportation services – based on the location of the property rather than the recipient.
• General services, a catch-all term. For business recipients, these are FDDEI based on where the operation is located and the location of any related party receiving a benefit.
Related party transactions
Where sales are made to a ‘foreign related party’1 (for example, a non-US person connected to the C corporation through a chain of common ownership), that party must sell-on to an unrelated foreign person by the taxpayer’s return filing date.
If the related party sale occurs within three years of the return filing date, an amended return can be filed to recharacterise the income as FDDEI.
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Date: July 2019