On March 4, 2019, the Internal Revenue Service issued much anticipated proposed regulations under Internal Revenue Code Section 250 to provide guidance on the deduction for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI).
The proposed guidance expands the scope and computation of FDII and provides new reporting rules requiring the filing of Form 8993 Section 250 Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income. The proposed regulations provide significant details on computation of the Section 250 deduction, limitations, and other rules. In addition, the guidance provides clarity regarding the ordering rules for sections 250, 163(j) and 172(a). To summarize, the proposed Section 250 regulations cover the following topics:
- Regs. Sec. 1.250(a)-1 provides guidelines for determining the amount of section 250 deduction allowed to a domestic corporation
- Regs. Sec. 1.250(b)-1 provides general rules for computing a domestic corporation’s FDII
- Regs. Sec. 1.250(b)-2 provides rules for determining a domestic corporation’s qualified business asset investment (“QBAI”), a component of FDII
- Regs. Sec. 1.250(b)-3 provides general rules for determining gross income included in gross foreign-derived deduction eligible income (“gross FDDEI”), a component of FDII
- Regs. Sec. 1.250(b)-4 provides rules for determining gross FDDEI from sales of property
- Regs. Sec. 1.250(b)-5 provides rules for determining gross FDDEI from the provision of services
- Regs. Sec. 1.250(b)-6 provides rules relating to the sale of property or the provision of services to a related party
Section 250 and FDII
Enacted by the Tax Cuts and Jobs Act, the Foreign-Derived Intangible Income (FDII) deduction establishes preferential tax treatment for domestic C corporations serving foreign markets. The deduction is equal to 37.5% of the C corporation’s foreign-derived intangible income. Companies with eligible income can take advantage of this incentive by claiming a permanent deduction against taxable income, thus lowering the cost to enter foreign markets. To learn more about the deduction, please see our previous article.
Key observations on the section 250 proposed regulations
Section 250 and Qualifying Sales: The sale of general property is for foreign use if the property is either subject to domestic use within three years of the sale or the property is subject to manufacture, assembly, or other processing outside of the United States. This significantly expands the possible qualifying sales. A sale of intangible property is for foreign use if the property generates revenue from exploitation outside of the United States. The term “sale” includes any lease, license, exchange, or other disposition.
Section 250 and Qualifying Services: The determination of foreign use of qualifying service income depends on the type of recipient and the type of service provided. The recipient will either be classified as a consumer or business recipient. The services will either be classified as general, proximate, property, or transportation services.
Section 250 and Expense Allocation and Apportionment: For purposes of allocating and apportionment of expenses, the rules in Reg. 1.161-8 through 1.861-14T and 1.861-17 will apply. When allocating cost of goods sold, any reasonable method may be applied. However, cost of goods sold cannot be segregated into component costs and attributed disproportionately to amounts excluded from gross foreign derived deduction eligible income or to amounts excluded from gross deduction eligible income. In order to fully maximize the deduction, the allocation of expenses will become key.
Section 250 and Documentation: The proposed regulations describe specific documentation that must be obtained in order to claim the FDII deduction. This documentation generally must be obtained by the filing date of the tax return that claims the FDII deduction. The taxpayer is allowed to rely upon the information as long as the taxpayer knows or has reason to know that the sale is qualifying.
Section 250 and Small Business Exceptions: To minimize the burden of documentation, the proposed regulations provide that a seller with gross receipts of less than $10,000,000 from the prior tax year can treat the recipient as a foreign person if the recipient has a foreign shipping address. For services, the recipient is treated as not located within the United States if the recipient has a foreign billing address.
Section 250 and Small Transaction Exceptions: The proposed regulations provide a small transaction exception for transactions for less than $5,000 from a single recipient in the current tax year. The seller can treat the recipient as a foreign person if the recipient has a foreign shipping address. For services, the recipient is treated as not located within the United States if the recipient has a foreign billing address.
Section 250 and US Territories: Sales of property and services provided to recipients in US territories, such as American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, or the U.S. Virgin Islands, will be considered qualifying for FDII purposes.
Section 250 and Partnerships: The proposed regulations clarify that partnerships that have one or more direct or indirect corporate partners must disclose Section 250 pass-through items to their partners on the Schedule K-1.
Section 250 and Individuals Making the 962 Election: Included in the proposed regulations is an amendment to the regulations under Section 962, which would allow certain individuals to elect to claim a 50 percent deduction under Section 250(a)(1)(B) for GILTI income. This effectively neutralizes the tax disparity between corporate and individual taxpayers.
The IRS is seeking comments on the proposed Section 250 regulations within 60 days after being published in the Federal Register (publishing date of March 6, 2019).
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Please reach out to an Elliott Davis advisor with any questions or concerns with how these proposed regulations may impact your business.