The Treasury and IRS have issued final regulations covering the Code Sec. 250 deduction for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI). Proposed regulations were issued on March 6, 2019 (NPRM REG-104464-18). The final regulations maintain the basic approach and structure of the proposed regulations and provide guidance on computation of the deduction and the determination of FDII, including in the consolidated return context. Additionally, rules requiring the filing of Form 8993, Section 250 Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income, are finalized.
Section 250 Deduction
The Code Sec. 250 deduction is available to domestic corporations for:
- a portion of profits attributable U.S. activities that serve foreign markets, and
- a portion of profits of controlled foreign corporations (CFCs).
The deduction is available with respect to a domestic corporation’s “excess return” or return in excess of fixed return on tangible assets, derived from serving foreign markets. FDII is the portion of the excess return derived from serving foreign markets directly from the United States. GILTI is the portion of the excess return derived through foreign affiliates. The deduction results in a lower effective U.S. tax rate on a U.S. corporation’s FDII and GILTI.
The proposed regulations defined terms and provide specific documents that were required to establish that income was derived from serving foreign markets. Commentators found that the proposed regulations could present compliance burdens. Accordingly, the final regulations provide a more flexible approach than the specific documentation requirements.
For many types of sales and services, eligibility for the Code Sec. 250 deduction is subject to the general requirement under the Code that deductions must be supported by sufficient substantiation, including the use of available business records.
More specific substantiation requirements are required for:
- intangible property;
- sales of general property to resellers and manufacturers; and
- the provision of general services to recipients.
The requirements include either:
- a specific document;
- information from the recipient obtained or created in the ordinary course of a trade or business; or
- a taxpayer statement with corroborating evidence.
Taxpayers may choose a method of substantiation among the methods. The specific substantiation requirements do not apply to businesses with less than $25 million in gross receipts. The final regulations also eliminate references to the use of market research to establish foreign use.
The final regulations clarify how to establish foreign use for sales of digital content and how to establish a recipient’s location outside of the United States with respect to electronically supplied services and advertising services. The final regulations:
- evaluate the sale of a copyrighted article under the general property rules, rather than under the rules for foreign use of intangible property;
- provide new rules for establishing whether a sale of digital content is for foreign use;
- define “digital content” as a computer program or any other content in digital format; and
- provide that a sale of general property that primarily includes digital content is a foreign-derived deduction eligible income (FDDEI) sale if the end user downloads or accesses the content on a device located outside of the United States.
The final regulations add two subcategories of general services:
- a subcategory of general services for electronically supplied services; and
- a subcategory for advertising services.
In these cases, the location of the recipient is where the content is accessed or viewed.
Foreign Military Sales and Services
The proposed regulations provided special rules to cover U.S. Defense Contractors’ military sales of equipment and provision of services to the U.S. government that are subsequently sold or provided to a foreign government.
The final regulations adopt the proposed regulations, which treat sales and services provided to the U.S. government under the Arms Export Control Act as a sale or provision of services to the foreign government that is eligible for the deduction. The final regulations relax the substantiation requirements, so that the general substantiation requirements apply.
Ratio of FDDEI to DEI
A corporation’s FDII is defined as its deemed intangible income (DII) multiplied by the corporation’s foreign-derived ratio. This is the ratio of the corporation’s foreign-derived deduction eligible income (FDDEI) to its deduction eligible income (DEI).
The final regulations retain the rule that the domestic corporation must allocate expenses to its gross FDDEI to determine the numerator of the foreign-derived ratio.
Deduction for Individuals
The final regulations extend the Code Sec. 250 deduction with respect to GILTI, to individuals—including individual partners and individual S corporation shareholders—making the Code Sec. 962 election to be treated as a domestic corporation.
Additional changes in the final regulations generally expand situations in which a transaction will be an FDDEI transaction, including:
- a property service may be a FDDEI service if it is provided with respect to property temporarily located in the United States;
- the definition of transportation services is revised to include freight forwarding services;
- the sale of a manufacturing method or process intangible to a foreign unrelated party is for foreign use based on the location of the manufacture rather that the end user;
- elimination of the rule that allowed the deduction for sales of international property only if certain time and use thresholds were met and the replacement of foreign use based on place of registration;
- clarification that general property includes physical commodities sold pursuant to derivative contracts, and that hedging sales impact a taxpayer’s income; and
- removal of the rule that the sale of an interest in a foreign branch is treated as giving rise to foreign branch income preventing the deduction.
Taxpayers can also use any reasonable method to determine the ordering of rules that limit deductions based on taxable income until additional rules are issued.