On January 25, 2018, Jason Yen, Attorney-Advisor, Office of Tax Policy, U.S. Treasury, said during a panel event at a conference sponsored by the Washington, D.C. Bar that Treasury feels the “foreign-derived intangible income” (FDII) rules introduced by the 2017 U.S. tax reform legislation (the “Tax Cuts and Jobs Act” or TCJA) comply with the OECD BEPS Action 5 recommendations on substantial activity requirements for intellectual property (IP) incentive regimes.
Mr. Yen made the comments during a panel event that focused on IP planning as a result of the new “global intangible low-taxed income” (GILTI) and FDII rules. The foregoing rules are discussed – at a high level – below.
Zachary M. Rudisill, Tax Counsel, Sen. Robert Portman (R-OH) said during the same panel that the GILTI and FDII “carrot” and “stick” approach on IP income originated in the Dave Camp (R-MI) proposals in the U.S. House in 2011. The GILTI rules are meant to reduce any benefit to U.S. taxpayers from operating in offshore havens, whereas, the FDII rules are intended to increase the benefit of basing international operations in the U.S.
Joseph Goldman, Partner, Jones Day, said that the FDII rules are intended to level the playing field for taxpayers as to whether to hold IP in the U.S. or abroad. Where foreign taxes are greater than 21%, GILTI treatment may be more costly for taxpayers than Subpart F treatment.
Rocco Femia, Member, Miller & Chevalier Chartered, said that while some of the patent box incentive objectives of the BEPS Action 5 recommendations are reflected in the FDII rules, the rules do not contain any nexus requirement. Whereas the FDII rules are mechanical in application, the Action 5 recommendations use a subjective IP standard (i.e., treatment of IP income is determined under transfer pricing rules).
Mr. Femia also discussed the EU financial ministers’ letter, sent to Treasury Secretary Steven Mnuchin on December 12, 2017, regarding EU concerns with the IP incentives, which “would subsidize exports compared with the domestic consumption [and] …. therefore face challenges as an illegal export subsidy under WTO … rules.” The EU reaction creates uncertainty for U.S. taxpayers in considering medium or long-term IP planning under the FDII rules, said Mr. Femia.
Under Section 951A(a) of the Internal Revenue Code (Code), each person who is a U.S. Shareholder of any CFC for any tax year must include in gross income its GILTI for the tax year. See Section 14201(a) of the TCJA.
The GILTI rules apply for tax years of foreign corporations beginning after December 31, 2017, and for tax years of U.S. Shareholders in which or within which the tax years of foreign corporation’s end.
Editor’s Note: Under the TCJA, foreign income earned by a U.S. corporation through a foreign subsidiary is generally exempt from U.S. tax under the new participation exemption system. The imposition of a tax on foreign-source intangible income aims to counteract the incentive created by the participation exemption to shift profits abroad.
Under new Section 250(a)(1) of the Code, in the case of a domestic corporation for any tax year, a deduction is allowed in an amount equal to the sum of:
- 37.5% of the FDII of the domestic corporation for the tax year, plus.
- 50% of (1) the GILTI amount (if any) which is included in the gross income of the domestic corporation under Section 951A for the tax year, and (2) the amount treated as a dividend received by the corporation under Section 78, which is attributable to the amount described in the first bullet above. See Section 14202(a) of the TCJA.
Coupled with the 21% U.S. tax rate for domestic corporations, these deductions result in effective tax rates of 13.125% on FDII and 10.5% on GILTI (with respect to domestic corporations) for tax years beginning after December 31, 2017 and before January 1, 2026.
The FDII rules apply for tax years beginning after December 31, 2017.
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