On July 9, 2020, the Treasury Department and IRS issued final regulations (T.D. 9901, the “Final Regulations”) under IRC § 250 and related provisions of §§ 861, 962, 1502, 6038 and 6038A. The regulations finalize proposed regulations issued on March 6, 2019. This blog will address the most important provisions of the Final Regulations. These provisions relate to:
- GILTI: the availability and conditions for a § 250 deduction for GILTI allowed by an individual U.S. shareholder making a § 962 election; and
- FDII: the detailed rules relating to elements of the § 250 deduction for FDII, including documentation requirements.
Global intangible low-taxed income (GILTI) is a TCJA provision under which the “tested income” of a controlled foreign corporation (CFC) is included in the gross income of its 10-percent-or-greater U.S. shareholders, and is subject to tax at the U.S. shareholder’s tax rate. If the U.S. shareholder is a domestic corporation, it is also entitled to a deduction under § 250 for 50% of the GILTI inclusion, as well as an indirect tax credit of 80% of the foreign taxes of the CFC attributable to the CFC’s tested income. If the owner is an individual and makes an election under § 962, he or she pays a tax on GILTI equal to the tax that would be imposed on a domestic corporation, and is entitled to an indirect foreign tax credit as if he or she were a domestic corporation. The statute is not clear, however, regarding an electing individual’s eligibility for the § 250 deduction from GILTI.
The Final Regulations follow the proposed regulations in allowing the electing individual the § 250 election. The Final Regulations, however, permit an earlier effective date (than the proposed regulations) for this provision, allowing the election for taxable years of foreign corporations beginning on or after January 1, 2018, and for taxable years of the U.S. shareholder in which or with which such year of foreign corporations end. This new effective date relates back to the first year that GILTI was in force.
In addition, T.D. 9901 also permits individuals to make a § 962 election on an amended return. The eligibility and procedural conditions for such an election were previously unclear. Specifically, T.D. 9901 states that the Treasury Department and IRS are considering issuing further § 962 guidance, but until then, individuals may make an otherwise valid § 962 election on an amended return for the 2018 and subsequent tax years, “regardless of circumstance,” provided the interests of the government are not prejudiced by the delay. This clarity is significant and welcome. If the foreign tax rate applicable to the CFC is greater than 13.125% (equal to 21% x .50)/.80, an individual U.S. shareholder making the § 962 election would generally bear no residual U.S. federal tax after taking into account the § 250 deduction and foreign tax credit.
Individuals who have not made § 962 elections back to 2018 should consider doing so, but should also consider that the related previously taxed income will be subject to additional U.S. tax when distributed by the CFC to the U.S. shareholder.
IRC § 250 also allows a domestic corporation a deduction equal to 37.5% of its foreign-derived intangible income (FDII). Essentially, the FDII deduction is a tax benefit provided with respect to exported goods and services. FDII is equal to the amount that bears the same ratio to deemed intangible income (“DII”) that foreign-derived deduction eligible income (“FDDEI”) bears to deduction eligible income (“DEI”). DII is the excess of DEI over a presumed 10% return on the domestic corporation’s qualified business asset return (“QBAI”). QBAI is calculated based on the adjusted basis of the corporation’s productive tangible assets.
DEI is gross income of the domestic corporation, less allocable deductions, excluding certain foreign income, financial services income and oil and gas extraction income. FDDEI is that portion of DEI that generally results from: (a) sales of property to a non-U.S. person for a foreign use, or (b) services provided to any person or with respect to property, not located within the United States. There are special rules for sales or services provided to domestic intermediaries and related parties.
For purposes of the FDII rules, the term “sale” includes a lease, license, exchange or other disposition of property.
Documentation and other FDII requirements
As in the proposed regulations, the FDII portion of the Final Regulations are very detailed and complex, and only a small portion of the updated FDII rules are described in this blog.
The proposed regulations required specific types of documentation to establish foreign person and foreign use status with regard to different types of FDDEI sales and the location of certain services provided to consumers. The Final Regulations simplify these rules by providing that the sale of property is presumed made to a recipient that is a foreign person if the sale falls into one of four categories: (1) foreign retail sales; (2) sales of general property that are delivered to an address outside the United States; (3) in the case of general property that is not sold in a foreign retail sale or delivered overseas, the billing address of the recipient is outside the United States; or (4) in the case of sales of intangible property, the billing address of the recipient is outside the United States.
The Final Regulations also take a flexible approach with respect to the requirement of “foreign use.” Under the Final Regulations, “foreign use” generally means the sale (or eventual sale) of the property to end users outside the United States or the sale of the property to a person that subjects the property to manufacture, assembly, or other processing outside the United States. The Final Regulations also adopt a more flexible approach to documentation with respect to foreign use for sales of intangible property, but require a taxpayer to specifically substantiate such use. Accordingly, the Final Regulations provide that foreign use of intangible property is determined based on revenue earned from end users located outside the United States.
The Final Regulations relating to FDII apply to tax years beginning on or after January 1, 2021, so there is ample time for taxpayers to put in place a documentation system that will fully satisfy the updated FDII rules. For earlier years, taxpayers may either apply the Final Regulations or rely on the proposed regulations, which contain a transition rule under which any reasonable documentation maintained in the ordinary course of business may serve to substantiate FDII transactions.