This information is based on the statutes and guidance available as of the date of publication and is subject to change. 

Effective for tax years beginning after December 31, 2017, domestic (U.S.) corporations are allowed a new tax deduction in the amount of 37.5% of “foreign derived intangible income” (“FDII”). It is important to understand that the deduction has little to do with intangible income or property, but is in fact an export incentive that effectively reduces the tax on foreign derived sales and service income in excess of a base amount to 13.125% (as compared to the regular corporate income tax rate of 21%). Accordingly, the deduction is potentially available to every U.S. corporation that exports property or provides services to a person located outside the U.S., including sales or services provided to related parties.

Summary

The computation of “foreign-derived intangible income” is relatively complex, and dependent on a number of defined terms (see the more detailed analysis and example below). In broad concept, a U.S. corporation with foreign sales and/or providing services to persons outside the U.S. computes a deemed tangible income return by multiplying the adjusted basis of its depreciable business property (computed under the ADS depreciation system) by 10%. This is the same net deemed tangible return as computed under GILTI and explained in a prior volume. This amount is deducted from the corporation’s total income as defined to arrive at deemed intangible income. The deemed intangible income (if any) is then allocated to arrive at foreign derived intangible income, based on the ratio of net income from foreign sales and services to total net income (in both cases excluding Subpart F income, dividends and certain other listed amounts). The allowable deduction is 37.5% of foreign-derived intangible income.

Computation of the Foreign-Derived Intangible Income Deduction

1)         Determine deduction eligible income

2)         Determine foreign-derived deduction eligible income

3)         Determine deemed intangible income, if 1) and 2) are positive

4)         Determine foreign derived intangible income

5)         Determine deduction allowable

 

A more detailed description of the steps necessary to compute the deduction follows:

1.         Does the corporation have “deduction eligible income” under IRC § 250(b)(3)?  

Generally, this answer will be yes for any corporation that has taxable income. Deduction eligible income is gross income net of allocable deductions (including taxes), excluding only Sub F income, GILTI income, dividends from CFC’s, foreign branch income, financial services income, and domestic oil and gas extraction income.

2.         If the corporation has deduction eligible income, does the corporation have “foreign-derived deduction eligible income” under IRC § 250(b)(4)? 

This is deduction eligible income from 1) the sale of property to a non-US person for use outside the U.S., or 2) the provision of services to a person, or with respect to property not located in the U.S. 

Note that the sale or services can be to a related foreign person as long as the property or services are ultimately sold to or used by an unrelated person who is not a U.S. person. Sales to a U.S. person for use outside the U.S. will NOT qualify. 

Deduction eligible income is net of allocable expenses, so it will be necessary to allocate and apportion expenses (presumably per Treas. Reg. 1.861-8 principles) between foreign derived and other sales and service income to arrive at foreign-derived eligible income. 

3.         If 1 and 2 are positive, is there “deemed intangible income” under IRC § 250(b)(2))?  

Deemed intangible income is deduction eligible income (see 1 above), less the “deemed tangible income return”

The deemed tangible income return is 10% of the corporation’s “qualified business asset investment” as defined in IRC § 951A(d).

Qualified business asset investment is the quarterly average of the adjusted basis of specified property used in a trade or business, and of the type that would be subject to depreciation. “Adjusted basis” for this purpose is based on the Sec 168(g) alternative depreciation system. “Specified property” is tangible property used in the production of deduction eligible income (see 1, above). 

4.         If there is deemed intangible income, determine the foreign-derived intangible income.  

Foreign derived intangible income is computed by multiplying deemed intangible income by the ratio of foreign derived eligible income to total deduction eligible income.

The allowable deduction is 37.5% of the foreign derived intangible income.