On July 9, 2020, the Internal Revenue Service (IRS) issued the final regulations for the deductions for two international tax regimes: foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI) for U.S.-based multinational corporations. The final regulations also include guidance as to how FDII and GILTI provisions coordinate with other measures of the Internal Revenue Code (IRC). Overall, 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.
The FDII and GILTI deductions are relatively new tax regimes, introduced in Section 250 of the Code through the Tax Cuts and Jobs Act (TCJA), and are effective for tax years beginning after December 31, 2017. Section 250 sets forth a deduction for domestic corporations equal to the sum of 37.5% of their FDII and 50% of their GILTI and Section 78 amount, up to a limit based on taxable income. The Section 250 deduction for both GILTI and FDII helps to neutralize the role that tax considerations play when a domestic corporation chooses the location of intangible income attributable to foreign-market activity; that is, whether to earn that income through its U.S.-based operations or through controlled foreign corporations (CFCs).
The final rules contain amendments to regulations issued under Section 962 (election by individuals to be taxed at corporate tax rates), 1502 (how the deduction applies to consolidated groups), 6038 (information reporting for certain CFCs and partnerships), and 6038A (information reporting for certain foreign-owned corporations).
The final regulations retain the basic approach and structure of the proposed regulations issued in March 2019, but contain several significant, and mostly taxpayer-favorable, changes. For example, the final regulations:
- Modify the documentation requirements for establishing foreign use to no longer require taxpayers to obtain specific documentation to establish (i) foreign person status; (ii) foreign use with respect to sales of certain property sold directly to end users; or (iii) the location of certain services provided to consumers.
- Provide that the following are presumed made to a foreign person: (1) foreign retail sales; (2) sales of general property delivered to an address outside the U.S.; (3) other sales of general property to recipients whose billing address is outside the U.S.; and (4) sales of intangible property to recipients whose billing address is outside the U.S.
- Consider the sale of general property to be for a foreign use if (i) the property is subject to manufacturing, assembly or other processing outside the United States; or (ii) the property is, in specified cases, delivered to an end user (e.g., a foreign retail sale, property delivered to a location outside the United States, or an electronic transfer of digital content outside the United States).
- Consider a sale of intangible property to be for a foreign use if the end user of the intangible is located outside the United States, including when the intangible is used to provide a service outside the United States.
- Relax certain provisions that apply to limit a deduction for related-party sales that are followed by unrelated-party sales
- Remove the ordering rules with Section 163(j) and 172 from the proposed regulations. Taxpayers may choose any reasonable method until further guidance is released.
In response to objections on the previously proposed regulations, the final regulations remove the specific documentation requirements to establish foreign person status and foreign use with respect to certain sales of general property and the location of a consumer of a general service. Instead, 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 also adopt a more flexible approach on the types of substantiation required for foreign use for sales of general property to non-end users, for foreign use with respect to sales of intangible property, and for determining whether services are performed for business recipients located outside of the United States. With regards to these transactions, the final rules describe the type of information necessary to fulfill the substantiation requirements.
Note that the Treasury indicated they may issue additional administrative guidance on acceptable documentation to substantiate the deduction.
Finally, 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.
When do I need to apply the final regulations?
The final regulations generally apply only to tax years beginning on or after January 1, 2021. For tax years beginning before January 1, 2021, taxpayers may apply the final regulations or rely on the proposed regulations (including the documentation transition rule whereby a transaction may be substantiated by any reasonable documentation maintained in the ordinary course).
How can Squar Milner help?
Our International Tax practice has the expertise and knowledge to answer all of your GILTI and FDII questions, including those that may arise in response to the final regulations.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.
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