Advisories April 2, 2018

Federal Tax Advisory: Foreign-Derived Intangible Income

Executive Summary
Minute Read

It’s probably the next-best part of the Tax Cuts and Jobs Act for multinationals. Our Federal Tax Group investigates the foreign-derived intangible income regime and how you can use it.

  • What is an export?
  • Getting the CFC involved
  • Selling a service

Domestic corporations that export their products or services may be able to claim a new deduction designed to lower the effective tax rate on deemed intangible income from such sales. Most potential users of the deduction have addressed it by now. We focus here on the foreign-derived part.

Nothing happens for purposes of this deduction unless a domestic C corporation exports goods or services. The key is what is an export? The definitions are quite odd and have nothing to do with whether the income from the sale is foreign sourced under the income sourcing rules of the Code.

For property exports, the buyer must be a non-U.S. person and it must buy for foreign use. In theory it is easy enough to identify non-U.S. persons—if you can get your buyer to tell you where it is organized. But what if the buyer plans to take delivery in New Jersey and modify the goods in its plant there in a branch? Well, if you know that, it is not a sale for foreign use.

Should you be on notice because you deliver in New Jersey? Not necessarily. The deduction does not require foreign delivery and does not require that you send the buyer a questionnaire, at least not until regulations are issued.

In many cases, the domestic corporation will sell to its controlled foreign corporation (CFC). It used to be that sellers wanted to hold down the profit on those sales and shift profit to the CFC. Now there may be cases where the seller wants to increase the domestic profit share and hold down the CFC profit. The CFC profit might incur the new global intangible low tax income (GILTI) tax, and more profit in the U.S. nominally taxed at a mere 21% may enjoy an even lower rate with the deduction.

The export sale to the CFC will qualify if the CFC “ultimately” will sell the property to an unrelated foreign buyer. That should be easy enough to arrange, but in this case the seller will know what its CFC plans to do. Actually, there may be several CFC-to-CFC sales before the goods reach the final foreign buyer for foreign use.

Sales of service have a different requirement. The service recipient must be located outside the U.S. The recipient need not be the buyer, just the recipient. Suppose U.S. corporation A hires U.S. corporation B to provide IT services to A’s customers in Europe? Corp B may be able to perform the services from the U.S. for the European persons, who are not even its buyers, and claim the deduction, although that is not entirely clear from the statute.

The foreign-derived intangible income regime is probably the next-best part of the tax act for multinational corporations, after the foreign dividends received deduction. All such corporations should be preparing to use it.

For more information, please contact Jack Cummings at 919.862.2302.

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