Foreign Derived Intangible Income (FDII) regime continues to provide tax advantages for U.S. exporters of goods and services
Effective for tax years beginning after 2017, the Tax Cuts and Jobs Act introduced a new federal income tax deduction applicable to the foreign derived intangible income (FDII) of a domestic C corporation.
FDII is essentially income derived from the sale of property (including the license of intangible property) to a foreign person for “foreign use,” or from the provision of services to a person located outside of the U.S.
Under the new law, a domestic C corporation can now claim a 37.5% deduction (reduced to 21.875% for tax years beginning after 2025) against its FDII. This equates to a U.S. federal income tax rate of 13.125% on qualifying domestic C-corporation FDII (16.4% for tax years beginning after 2025).
The methodology for identifying qualifying income and calculating the FDII benefit is quite complex and, depending upon a company’s structure, proactive tax planning can be undertaken to maximize potential savings.
Specifically, eligible domestic C corporation taxpayers will need to perform a multi-step calculation to determine the FDII that qualifies for the 13.125% tax rate. The corporation will also be required to apportion expenses against such foreign sales and/or services income using the principles set forth under internal revenue code section 861 in order to derive the amount of their FDII.
However, the income derived by a foreign branch of a domestic C corporation cannot be included in the FDII computation even if it is derived from the sale of services to a person outside of the U.S., or from the sale of products to a foreign person for foreign use. For this purpose, a “foreign branch” is any separate and clearly identifiable unit of a trade or business which maintains separate books and records.
For example, if a U.S. C corporation maintains an office in the United Kingdom that has its own books and records, the U.K. office will be treated as a foreign branch, and the income it derives from the sale of products to U.K. customers for use in the U.K. cannot be included in the FDII computation. Therefore, C corporations with representative offices outside of the U.S. may wish to reconfigure certain aspects of their supply chains to support income from sales and services as FDII-eligible foreign derived income, rather than as foreign branch income.
In addition, domestic C corporation taxpayers with FDII and Global Intangible Low Taxed Income (GILTI) should perform modeling computations to understand the interaction of these two regimes on existing structures, and to identify planning scenarios to maximize the FDII benefit while minimizing the impact of GILTI.
The new FDII regime can provide significant tax savings to domestic C corporations by reducing the federal effective tax rate on FDII to 13.125% (16.4% for tax years beginning after 2025) rather than the standard 21% federal corporate income tax rate.
CohnReznick can assist domestic C corporations in the identification of FDII eligible sales and/or services, as well as approaches that may be used to maximize benefits to take full advantage of this exciting tax savings opportunity.
Christina Lee, Partner, International Tax Practice
James Robbins, Partner, International Tax Practice
Eytan Burstein, Partner, International Tax Practice
David Macall, Director, International Tax Practice
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.