A&M Tax Advisor Weekly

Final Guidance on FDII and GILTI Deduction Relaxes Documentation Rules

Alan Cathcart, Senior Advisor

acathcart@alvarezandmarsal.com

Kevin M. Jacobs, Managing Director

kjacobs@alvarezandmarsal.com

July 10, 2020 / North America

Yesterday, Treasury and the IRS released final regulations under section 250. Section 250 allows a deduction for domestic corporations (and in limited circumstances individuals) with respect to global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII). Proposed regulations under section 250 were published on March 6, 2019 and were previously discussed in greater detail here. The final regulations generally follow the proposed regulations, with a few notable exceptions. The bulk of the regulations relate to FDII and the determination of various items required in order to compute FDII. The regulation package is 295 pages long, of which 140 pages are occupied by the regulations themselves. The following is a summary of some of the more notable changes (or lack thereof) made by the final regulations.

Background
FDII is defined by reference to the U.S. taxpayer’s income derived, in general, from the sale of property to a foreign person for a foreign use, or from the provision of services to any person, or with respect to property, not located within the United States. The proposed regulations included detailed requirements for taxpayers to provide specific documentation establishing that a sale was to a foreign person and for a foreign use, or that services were provided to a person, or with respect to property, located outside the United States. The most significant feature of the final regulations is the relaxation of these documentation requirements.

Documentation Rules
Under the final regulations, no specific type of documentation is required in order to establish that “general property” (which includes most tangible property) that is sold to an end user is sold to a foreign person for a foreign use, or that services to a consumer are provided outside the United States. The taxpayer can rely on any reasonable method to establish these facts. However, the taxpayer retains its general obligation to show that its transactions satisfy the requirements of the Code. The final regulations provide examples of documentation that may be used to establish the support for the sourcing of items.

The final regulations also provide relaxed documentation requirements for other foreign transactions, such as sales to retailers and distributors, sales of property for further manufacturing, sales (including licenses) of intangible property, and services provided to business recipients outside the United States.

The documentation on which a taxpayer relies must be in existence by the time the U.S. federal income tax return is filed, with greater credibility given to documentation created at or near the time of the transaction.

Delayed Applicability Date
The final regulations apply to taxable years beginning on or after January 1, 2021. For taxable years beginning before that date, taxpayers may rely on the final regulations or on the proposed regulations. A transition rule in the proposed regulations would have allowed a taxpayer to rely on any reasonable documentation maintained in the ordinary course of its business to establish that a recipient is a foreign person, property is for a foreign use, or a recipient of a general service is located outside the United States, for taxable years beginning before March 4, 2019. The final regulations extend that transition rule to taxable years beginning before January 1, 2021.

Taxable Income Limitation
The amount of GILTI and FDII that can be taken into account for purposes of calculating the section 250 deduction is limited to the taxpayer’s taxable income. The proposed regulations provided an ordering rule under which all other deductions (including the section 163(j) interest deduction) would be taken into account in determining the taxpayer’s taxable income for purposes of the section 250 deduction.

The final regulations do not include this provision. Rather, they provide that Treasury and the IRS intend to study the issue. In the meantime, taxpayers may apply the proposed regulations or any other reasonable method, including the use of simultaneous equations. Thus, taxpayers may want to rethink the methodology that they plan on using for filing their 2019 and subsequent U.S. income tax return.

The final regulations, unfortunately, do not adopt the comment that pre-TCJA NOL carryforwards should not be factored into the calculation of taxable income for purposes of the section 250 deduction. Additionally, the final regulations do not adopt the comment to allow for the carryforward or carryback of any excess FDII that is limited due to the taxable income limitation.

Other Notable Items

  • Hedges – The regulations confirm the general rule in the proposed regulations that financial instruments are not property the sale of which can give rise to FDII. However, an exception is made for certain hedging transactions.
  • Branch Income – The regulations conform the definition of foreign branch income (which is not taken into account as eligible for the FDII deduction) to the definition applied for purposes of the separate foreign tax credit limitation on foreign branch income. The proposed regulations had included a modification to that definition.
  • Expense Carryovers – The final regulations provide that deductions carried over under sections 163(j), 170(b)(2), 172, 246(b), and 250 are not taken into account for purposes of the FDII deduction.
  • Partnership Reporting – The final regulations retain the partnership information reporting requirements of the proposed regulations. The regulations clarify the reporting rules for tiered partnerships.
  • Entity Treatment of Partnerships – The regulations provide that an interest in a partnership, trust, or estate is not general property.
  • Copyrighted Articles – The regulations provide that a copyrighted article (such as downloaded software) is not intangible property. Special rules are provided for general property that includes digital content…

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