Final regulations ease FDII documentation requirements

| 7/30/2020
Final regulations ease FDII documentation requirements

On July 15, the U.S. Department of the Treasury and the IRS published final regulations addressing the computation of the deduction for foreign-derived intangible income (FDII) under IRC Section 250. Enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA) and effective for taxable years beginning on or after Jan. 1, 2018, Section 250 allows corporate taxpayers a deduction equal to 37.5% of their FDII and 50% of their global intangible low-taxed income inclusion under Section 951A. While the regulations do not provide the relief many taxpayers wanted, they mostly improve on the proposed regulations issued in March 2019. What follows focuses on the easing of the documentation rules. A subsequent article will focus on aspects of the final regulations relating to computation of the deduction.

Documentation requirements

In order to claim an FDII deduction under Section 250, a corporate taxpayer must substantiate with specific documentation that qualifying sales or services are 1) provided to foreign persons (if a sale of property) and 2) for foreign use or benefit. Under the proposed regulations, in many cases taxpayers were required to obtain information not ordinarily collected as part of a normal business transaction. The proposed regulations also provided a transition rule that allowed taxpayers to use any reasonable method for documentation for tax years beginning before March 4, 2019. 

Substantiation that recipient is a foreign person

The final regulations ease the substantiation documentation rules by allowing taxpayers in certain circumstances to rely on information already required to be maintained by the corporation as substantiation rather than requiring specific documentation. For instance, the final regulations allow taxpayers to presume the recipient is a foreign person if the sale is a retail sale and the product is delivered to a foreign address or, for intangible property, if the purchaser’s billing address is outside of the U.S.

The final regulations also expand the documentation exception for small businesses. Under the proposed regulations, a small business included taxpayers with gross receipts up to $10 million. The final regulations increased the threshold to $25 million.

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Substantiation of foreign use

Under both the proposed and final regulations, general property is defined as property other than intangible property, a security, or a commodity. The proposed regulations required taxpayers to establish foreign use under one of two standards for a sale of general property: the no domestic use rule or the further manufacture rule. The no domestic use rule regarded a sale of general property as a sale for foreign use if the property sold was not used in the U.S. within three years of delivery. The further manufacture rule under the proposed regulations regarded a sale of general property as a sale for foreign use if the property was subject to manufacture, assembly, or other processing outside the U.S. 

The final regulations adopt the proposed regulations’ definition of the further manufacture rule but remove the no domestic use rule, replacing it with more specific and administrable rules based on how the end user obtains the property. The final regulations also define an end user as the person who ultimately uses or consumes the property or any person who acquires property in a foreign retail sale. For example, the foreign use requirement is met under the final regulations when the property sold is delivered via a common carrier or, if not delivered by a common carrier, when the goods are already outside the U.S. at the time of sale.

Additionally, the final regulations add guidance regarding digital content. Digital content will be considered sold for foreign use if the device receiving the content is located outside the U.S. 

The final regulations adopt the rules in the proposed regulations requiring taxpayers to obtain specific information to establish that:

  • Sales of general property for resale are for a foreign use.
  • Sales of property are for a foreign use by reason of manufacture, assembly, or processing outside the U.S.
  • Sales of intangible property are for a foreign use.
  • General services are provided to business recipients located outside the United States.

Delayed effective date

The final regulations are effective for tax years beginning on or after Jan. 1, 2021, which is possibly the best news of all in these final regulations. The delayed effective date allows taxpayers more time to prepare before the rules take effect. Taxpayers may rely on the final regulations prior to the effective date provided they comply with the regulations in their entirety. Meanwhile, taxpayers may continue to rely on the proposed regulations for tax years beginning on or after Jan. 1, 2018, and before Jan. 1, 2021.

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Brent Felten
Brent Felten
Partner, Washington National Tax
John Kelleher - Large
John Kelleher
Partner, Tax