U.S. manufacturing C-corporations that generate revenue through sales and services provided to foreign markets may be missing opportunities for tax benefits offered by the Foreign-Derived Intangible Income (FDII) deduction. Created by the Tax Cuts and Jobs Act of 2017 (TCJA), this income category does not have to be derived from intangible assets and may represent a significant deduction for eligible corporations.
This deduction has now been in place for several years, but guidance and regulations have been changing as recently as 2020. Even if a corporation is already taking advantage of some of the benefits of this deduction, they may be missing additional opportunities.
The formula to determine FDII results in a permanent benefit through a 37.5% deduction against taxable income under Section 250. It is computed based on the excess of export sales and services income above a fixed rate of return on the corporation’s tangible depreciable assets (known as Qualified Business Asset Investment (QBAI).
Manufacturers typically have large amounts of QBAI given their general need for significant capital investment in machinery and equipment for their business. Since companies are required to calculate QBAI using Alternative Depreciation System (ADS) rather than an accelerated methodology, companies may have basis in these fixed assets when determining their QBAI. This reduces the available FDII deduction, though this may not be the case for those same assets when computing tax depreciation using MACRS.
For manufacturers, comparatively large capital investments translates into more QBAI and a lower FDII benefit. This is why manufacturer should evaluate planning opportunities to enhance their available FDII deduction.
The deduction is available to corporate taxpayers that have positive taxable income after applying available net operating losses under Section 172.
A taxpayer’s foreign derived income may translate into a significant deduction for a C-Corporation taxpayer that generates income from Foreign Derived Deduction Eligible Income (FDDEI):
- Sale of property to a non-U.S. unrelated or related person for foreign use. A sale includes any lease, license, exchange, or other disposition.
- Services provided to any unrelated or related person or with respect to any property outside of the United States.
These elements of FDII are frequently overlooked:
- Items that qualify for the exemption. For example, services provided to certain foreign customers in connection or supplementary to the manufacturing function may also qualify for the FDII deduction.
- Intercompany activities may qualify for the exemption (special rules apply).
- For a U.S. company in a loss position, there may be planning opportunities, including method planning to defer deductions in order to obtain this permanent benefit.
Weaver can assist manufacturers seeking to maximize the benefits of this deduction by:
- Identifying potential third-party and related party FDDEI transactions and preparing a preliminary high level estimate of the likely Section 250 deduction;
- Evaluating transfer pricing policies (e.g., head office services, royalty payments to the US as well as supply chain and product flows to maximize FDDEI and increase the available Section 250 deduction;
- Reviewing expense allocation and apportionment methodologies to minimize deductions against gross FDDEI, which reduces the Section 250 deduction;
- Computing QBAI using the requisite ADS methodology as opposed to an accelerated depreciation systems (e.g., MACRS and including bonus depreciation); and
- Providing an IRS “audit-ready” file to meet requisite substantiation and documentation requirements to support any Section 250 deduction.
For more information about qualifying for this deduction, contact us. We are here to help.
Many U.S. C-corporations that generate revenue from serving foreign markets may be missing opportunities for tax benefits…