Treasury Issues Final Regulations for FDII and GILTI Deduction
Treasury Issues Final Regulations for FDII and GILTI Deduction
On July 15, 2020, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) published in the Federal Register final regulations under Section 250 that provide guidance regarding the deduction for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI). The final regulations also include guidance coordinating the deduction for FDII and GILTI with other provisions of the Internal Revenue Code. The final regulations generally affect domestic corporations and individuals who elect to be subject to tax at corporate rates for purposes of inclusions under Subpart F and GILTI.
On March 6, 2019, Treasury published proposed regulations (REG-104464-18) under Sections 250, 962, 1502, 6038, and 6038A in the Federal Register (84 FR 8188). For a summary discussion of the proposed regulations see BDO’s March 2019 tax alert.
The final regulations retain the basic approach and structure of the proposed regulations, with certain revisions. Some of the more noteworthy revisions in the final regulations are summarized below.
1. Substantiation Requirements
The final regulations eliminate the requirement in the proposed regulations to obtain specific types of documents to establish foreign person status, foreign use with respect to sales of certain general property made directly to end users, and the location of general services provided to consumers. The general requirement for taxpayers to substantiate their deductions will apply without any additional specific requirements as to the content of information or documents.
The final regulations adopt a more flexible approach regarding the types of substantiation required for foreign use with respect to sales of general property to non-end users, foreign use with respect to sales of intangible property, and with respect to determining whether services are performed for business recipients located outside the United States. With respect to these transactions, the final regulations describe the type of information necessary to meet the substantiation requirements.
In the preamble to the final regulations, Treasury notes that it is also considering issuing additional administrative guidance on acceptable documentation to substantiate the deduction.
The final regulations modify the small business exception in the proposed regulations to provide that the substantiation requirements do not apply if the taxpayer and all related parties of the taxpayer, in the aggregate, receive less than $25 million in gross receipts during the prior taxable year.
2. Reg. §1.250(a)-1 – Deduction for FDII and GILTI
In the preamble, Treasury notes that further study is required to determine the appropriate rule for coordinating Sections 250(a)(2), 163(j), 172, and other code provisions (including, for example, Sections 170(b)(2), 246(b), 613A(d), and 1503(d)), that limit the availability of deductions based, directly or indirectly, upon a taxpayer’s taxable income. Therefore, the final regulations remove Example 2 in proposed §1.250(a)-1(f)(2) and reserve a paragraph in §1.250(a)-1(c)(5)(ii) for coordinating Section 250(a)(2) with other provisions calculated based on taxable income. Before further guidance is issued regarding how allowed deductions are taken into account in determining the taxable income limitation in Section 250(a)(2), taxpayers may choose any reasonable method (which could include the ordering rule described in the proposed regulations or the use of simultaneous equations) if the method is applied consistently for all taxable years beginning on or after January 1, 2021.
3. Reg. §1.250(b)-1 – Computation of FDII
The final regulations define foreign branch income by cross reference to §1.904-4(f)(2) and remove the modification to that definition in the proposed regulations that would have included as foreign branch income any income from the sale, directly or indirectly, of any asset (other than stock) that produces gross income attributable to a foreign branch, including by reason of the sale of a disregarded entity or partnership interest.
In light of the issuance of proposed rules under §1.861-17 on December 17, 2019 (84 FR 69124), the final regulations remove the provision stating that the exclusive apportionment rules in §1.861-17(b) do not apply for purposes of apportioning research and experimentation (R&E) expenses to gross deduction eligible income (DEI) and gross foreign-derived deduction eligible income (FDDEI), and generally do not provide special rules for applying §1.861-17 for purposes of Section 250.
The final regulations provide that the following provisions (which limit certain deductions and provide for the carryover of the amounts not currently allowed) do not apply when allocating and apportioning deductions to gross DEI or gross FDDEI of a taxpayer for a taxable year: Sections 163(j), 170(b)(2), 172, 246(b), and 250. See §1.250(b)-1(d)(2)(ii) for additional details.
4. Reg. §1.250(b)-2 – QBAI
The final regulations include a transition period for the qualified business asset investment (QBAI) anti-avoidance rule in proposed §1.250(b)-2(h)(3) for transactions entered into before the date the proposed regulations were issued.
5. Reg. §1.250(b)-3 – FDDEI Transactions
The final regulations clarify the definition of “intangible property” for purposes of Section 250 to not include a copyrighted article as defined in §1.861-18(c)(3). The final regulations provide an additional rule for sales of general property that primarily contain digital content.
6. Reg. §1.250(b)-4 – FDDEI Sales
The final regulations define the “end user” as the person that ultimately uses the property, and that a person who acquires property for resale or otherwise as an intermediary is not an end user. The definition of end user is modified for intangible property used in connection with the sale of general property, provision of services, sale of a manufacturing method or process intangible property, and for research and development as provided in §1.250(b)-4(d)(2)(ii).
The final regulations also provide rules relating to sales in the following categories:
- Sales that are delivered to an end user by a carrier or freight forwarder.
- Sales to an end user without the use of a carrier or freight forwarder.
- Sales for resale.
- Sales of digital content.
- Sales of international transportation property used for compensation or hire.
- Sales of international transportation property not used for compensation or hire.
The final regulations make certain modifications to the rules in the proposed regulations relating to manufacturing, assembly or other processing.
7. Reg. §1.250(b)-5 – FDDEI Services
The final regulations provide additional guidance with respect to services that are “electronically supplied.” The final regulations create a new category of general services defined as “electronically supplied services,” which includes general services (other than advertising services, described in the following sentence) that are delivered over the internet or an electronic network. In addition, the final regulations create a new subcategory of general services for advertising services, including advertising services to display content via the internet.
The final regulations specify that manufacturing services are property services but allow property services performed in the United States to qualify as FDDEI services under some circumstances. The final regulations include an exception for property services performed with respect to property that is temporarily located in the United States and treats those services as being provided with respect to tangible property located outside the United States if several conditions are satisfied.
8. Reg. §1.250(b)-6 – Related Party Transactions
The final regulations modify the resale rule in proposed §1.250(b)-6(c)(1)(i) to allow a taxpayer to treat a sale to a related party as a FDDEI transaction in the tax year of the related party sale provided that an unrelated party transaction has occurred or will occur in the ordinary course of business with respect to the property sold to the related party, whether the property is a completed product or a component of a different product. The unrelated party sale can occur at any time in the future so that taxpayers with long production or sales cycles are not unduly prevented from claiming FDII benefits based on the period of limitations for filing an amended return under Section 6511.
The final regulations also remove the requirement that the FDII filing date is determinative with respect to related party sales and use of property in an unrelated party transaction.
9. Reg. §1.962-1
The final regulations update Reg. §1.962-1 to replace obsolete cross-references, make certain clarifications, provide a revised example and delete reference to the repealed Section 11(c) surtax exemption.
Treasury also notes in the preamble that it is considering issuing further guidance under Section 962 regarding the situations in which individuals may make a Section 962 election on an amended return. Until further guidance on this issue is published, individuals may make an otherwise valid Section 962 election on an amended return for the 2018 tax year and subsequent years, regardless of circumstance, provided the interests of the government are not prejudiced by the delay, as described in §301.9100-3(c).
10. Applicability Dates
Except for §1.250(b)-2(h), the rules in §§1.250(a)-1 through 1.250(b)-6 apply to taxable years beginning on or after January 1, 2021. Section 1.250(b)-2(h), which contains an anti-abuse rule for certain transfers of property, applies to taxable years ending on or after March 4, 2019, consistent with the applicability date in the proposed regulations.
However, for taxable years beginning before January 1, 2021, taxpayers may apply the final regulations or rely on the proposed regulations, except that taxpayers that choose to rely on the proposed regulations may rely on the transition rule 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).
For additional dates of applicability, see §§1.250-1(b), 1.962-1(d), 1.1502-50(g), 1.6038-2(m)(4), 1.6038-3(l), and 1.6038A-2(g).
For additional details along with other modifications made in the final regulations not discussed in this summary, see the final regulations.