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August 18, 2020

Foreign Derived Deduction Eligible Income – Summarized Documentation Roadmap

Posted by Surbhi Bordia

tax, taxes, tax payments, tax rules

On July 9, 2020, the Treasury and IRS released 295 pages of the final foreign-derived intangible income (“FDII”) and Global Intangible Low-Taxed Income (“GILTI”) regulations under Section 250 (“the Final regulations”).

Section 250 was enacted under TCJA to provide domestic corporation with a deduction (“Section 250 deduction”) for its FDII earned directly by the domestic corporation and GILTI and Section 78 amount attributable to its GILTI. Section 250 deduction, subject to limitation, is equal to 37.5% (21.875% for tax years beginning after December 31st, 2025) of its FDII and 50% (37.5% for tax years beginning after December 31st, 2025) of its GILTI and Section 78 amount.

In March 2019, the Treasury released the proposed regulations (REG-104464-18) providing detailed guidance for determining the amount of the Section 250 deduction allowed to a domestic corporation for its FDII and GILTI. The proposed regulations required taxpayers to obtain and provide specific documentation requirements in order to claim Section 250 deduction with respect to FDII for foreign derived deduction eligible income transactions (“FDDEI transactions”) (i.e. FDDEI sales or FDDEI services). Specific type of FDDEI transactions had specific documentation requirements to establish that a recipient is a foreign person, the property sold is for a foreign use and the recipient of a general service is located outside the United States. In general, tax practitioners found the documentation requirements under the proposed regulations to be unduly burdensome on taxpayers.

The final regulations differ from the proposed regulations in various aspects; however, this article limits the discussion to highlights of changes in the documentation requirements in the final regulations as discussed below:

Removal of Specific Documentation Requirements

The final regulations eliminate the documentation requirement to establish foreign person status, foreign use with respect to sales of certain general property that are made directly to end users, and the location of general services provided to consumers.

A taxpayer claiming a Section 250 deduction will still bear the burden of demonstrating that it is entitled to the deduction regardless of the fact whether or not it is subject to specific substantiation requirements contained in the final regulations.

Substantial Requirement for Specific Transactions

In lieu of the documentation requirements in the proposed regulations, the final regulations provide substantiation requirements with respect to the following FDDEI transactions:

  1. Sales of general property to recipients other than end users (i.e. to resellers and manufacturers (i.e. manufacturing outside the United States)
  2. Sales of intangible property
  3. General services provided to business recipients

Timing to Obtain and Provide Specific Substantiation

The final regulations require that the substantiating document be in existence by the time the taxpayer files its return (including extensions) with respect to the FDDEI transaction (the “FDII filing date”).  Further, the substantiating documents must be provided to the IRS upon request, generally within 30 days or some other period agreed upon by the IRS and the taxpayer.

Applicability Dates of the Final Regulations

In general, the final regulations are applicable for taxable years beginning on or after January 1, 2021. However, for taxable years beginning before January 1, 2021, taxpayers may apply the final regulations or rely on the transition rule provided in the proposed regulations for documentation for all taxable years beginning before January 1, 2021 (rather than only for taxable years beginning on or before March 4, 2019, which was the limitation contained in the proposed regulations).

Under the transition rule, taxpayers could satisfy the documentation requirements with any reasonable documentation maintained in the ordinary course of the taxpayer’s business, provided that such documentation met certain reliability requirements. 

Summarized Matrix for the Substantiation Requirements

Below is the matrix summarizing which FDDEI transactions require specific substantiation requirements as provided under the final regulation and which would still require general substantiation requirements.

FDDEI Substantiation Requirements Roadmap for Select Transactions
Transaction TypeRules for Determining Foreign Use with respect to:General Substantiation Requirements (“GSR”) / Specific Substantiation Requirements (“SSR”)GSR/SSR at FDII Filing date
FDDEI Sales Transaction – Sale of general property (includes copyright article and digital content) but not an intangible property, a security or a commoditySales to an end user delivered by a carrier or freight forwarderGSRYes
Sales to an end user where the property is already located outside the United States (includes foreign retail sales)GSRYes
Sales for resaleSSRYes
Sales of digital content – end userGSRYes
Sales for manufacturing, assembly, or other processing outside the United StatesSSRYes
FDDEI Sales Transaction – Sale of intangible propertyGeneral rule for intangible propertySSRYes
Sale of intangible property embedded in general property or used in connection with the sale of general propertySSRYes
Sale of intangible property used in providing a serviceSSRYes
Sale of intangible property consisting of a manufacturing method or processSSRYes
Sale of intangible property used in research and developmentSSRYes
FDDEI Services TransactionGeneral services provided to consumersGSRYes
General services provided to business recipientsSSRYes

The final regulations have simplified the documentation requirements substantially compared to the documentation requirements that were set forth in the proposed regulations, however taxpayers still need to evaluate if they have adequate processes and information to satisfy these requirements.

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For detail discussion on how these provisions may apply to your organization’s specific facts, reach out to our experts.

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