August 18, 2020
Foreign Derived Deduction Eligible Income – Summarized Documentation Roadmap
Posted by Surbhi Bordia
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:
- Sales of general property to recipients other than end users (i.e. to resellers and manufacturers (i.e. manufacturing outside the United States)
- Sales of intangible property
- 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 Type||Rules 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 commodity||Sales to an end user delivered by a carrier or freight forwarder||GSR||Yes|
|Sales to an end user where the property is already located outside the United States (includes foreign retail sales)||GSR||Yes|
|Sales for resale||SSR||Yes|
|Sales of digital content – end user||GSR||Yes|
|Sales for manufacturing, assembly, or other processing outside the United States||SSR||Yes|
|FDDEI Sales Transaction – Sale of intangible property||General rule for intangible property||SSR||Yes|
|Sale of intangible property embedded in general property or used in connection with the sale of general property||SSR||Yes|
|Sale of intangible property used in providing a service||SSR||Yes|
|Sale of intangible property consisting of a manufacturing method or process||SSR||Yes|
|Sale of intangible property used in research and development||SSR||Yes|
|FDDEI Services Transaction||General services provided to consumers||GSR||Yes|
|General services provided to business recipients||SSR||Yes|
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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Surbhi has over 10 years of extensive public accounting experience on addressing various complex international tax issues impacting companies’ ongoing international operations and future international operations. Surbhi has hands on experience in international tax restructuring, IP migration planning, legal entity rationalizations and integrations post mergers and acquisitions. Her areas of expertise include but is not limited to GILTI, BEAT, FDII, anti-hybrid rules, foreign tax credit, subpart F, withholding tax, investment in US property, FX gains and losses, treaty related issues, outbound transfers, permanent establishment and profit attribution rules etc. Before joining Armanino, Surbhi worked at PwC and Deloitte. Surbhi received her MBA at Haas School of Business at UC Berkeley, Master in Business and Bachelors of Commerce from Jai Narain Vyas University, India.
Co Authors :
Jon specializes in international tax structuring, cross-border transactions, transfer pricing, merger & acquisition integration and global earnings mobility strategies. He has extensive experience in the internet, software, computer hardware and services industries. Jon has a vast international network built on years of experience working with professionals around the world.
Jon is a Certified Public Accountant and earned his Bachelor of Science and Master’s in Taxation degrees at Brigham Young University. He is also a member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountants.