In an effort to boost the production of U.S. goods, the 2017 Tax Act introduced a Foreign Derived Intangible Income (FDII) deduction for tax years 2018 and beyond. But despite the deduction representing a significant reduction in tax rates, the benefit remains under-utilized. If your corporation exports goods or sells services outside of the U.S., it’s important to understand how FDII impacts your taxable income. Here’s what you need to know about this important export incentive.
What is Considered Foreign Derived Intangible Income?
Foreign Derived Intangible Income is any income that can be attributed to:
- The sale, exchange, leasing, or licensing of property to a foreign party for use outside of the U.S.
- The sale of services to any individual not located in the U.S.
U.S. exporters who supply receipts from the above activities can qualify for the FDII deduction. The following types of income typically do not qualify for the deduction:
- Gross income derived from controlled foreign corporations (CFCs) or foreign branches of corporations (including GILTI and Subpart F income)
- Income derived from domestic oil and gas extraction
- Financial services income
How is the FDII Deduction Calculated?
The FDII deduction is calculated by first determining a corporation’s gross income and reducing it by certain items of income, such as Subpart F and dividends received from CFCs. The amount is then further reduced by deductions that are attributable to such income, including taxes. This, in turn, yields a deduction eligible income.
Next, the foreign portion of the deduction eligible income is calculated. This foreign portion includes any income that was derived from the sale, exchange, leasing, or licensing of property to any foreign person for foreign use. Finally, the corporation’s deemed intangible income is determined. This income represents the remainder of the corporation’s deduction eligible income over 10 percent of the corporation’s qualified business asset investment (QBAI).
A domestic C corporation can deduct 37.5 percent of its foreign-derived intangible income through 2025, effectively reducing the tax rate on such income to 13.125 percent. For the tax years after 2025, the maximum allowable deduction will be 21.85 percent, resulting in a tax rate of 16.406 percent. Corporate taxpayers who wish to take advantage of the FDII benefit should be aware that the deduction is subject to a taxable income limitation. If deemed intangible income is calculated as zero or less, there is no benefit.
Who Benefits from the FDII Deduction?
The FDII deduction is available to U.S. corporations that are classified as C corporations, including domestic corporate subsidiaries of foreign-based entities. The corporations who will benefit the most from the FDII deduction are those that generate income from licensing and royalties, such as software development companies, technology companies, and pharmaceutical manufacturers. These corporations have a long history of being subject to a higher tax rate than their CFC competitors, who are able to circumvent tax jurisdictions by moving their intellectual property outside of the U.S.
Put simply, if your domestic C corporation generates any income from the sale of products or services outside of the U.S., you should consider taking advantage of this generous export incentive. Contact us for more information about the Foreign Derived Intangible Income deduction and for assistance in determining whether your corporation qualifies for the benefit.
About this Author
Adam specializes in international tax planning and analysis. Since 2012 he has coordinated offshore compliance submissions, international tax training relating to foreign pension plans, foreign investment in US property, and general foreign compliance. In addition, in conjunction with legal counsel, he assists international families regarding planning, entity structure, and transaction analysis.