Matter & Substance
  October 5, 2023

Unlocking the Potential of Foreign Derived Intangible Income

Content Provided by Damian Stanislaw Ponicki, Senior International Tax Associate

In an increasingly globalized world, international business transactions have become the norm rather than the exception. For businesses in the United States engaged in cross-border commerce, understanding the nuances of international taxation is crucial. 

One significant development in the realm of international taxation is Foreign Derived Intangible Income (FDII), a provision introduced as part of the Tax Cuts and Jobs Act (TCJA) in 2017. This article explores what FDII is, its implications for businesses, and the key considerations associated with it.

What is Foreign Derived Intangible Income (FDII)?

FDII is a tax incentive implemented in the United States to encourage businesses to engage in international trade via export of products and services. While it initially may seem like a benefit solely for American companies, it has the potential to benefit a broad range of U.S. businesses, including corporations, partnerships, S corporations, and more. FDII represents income earned by U.S. companies from foreign sales, services, or licenses.

However, it's important to note that FDII is exclusively available to U.S. corporations, so businesses not in corporate form may need to consider conversion. The FDII tax incentive is also available to non-U.S. businesses as long as they set up a U.S. corporation to export products or services.

How Does FDII Work?

FDII operates by providing a favorable tax rate on qualifying income derived from export activities. This tax incentive can significantly reduce a business's tax liability, potentially leading to substantial tax savings. In essence, FDII operates to provide a 37% deduction for qualifying export income, resulting in an effective tax rate as low as 13.125%. Unlike the U.S.’ IC-DISC export incentive, the FDII rules do not require that the exported property have a certain percentage of domestic content. Therefore, it should be possible for a U.S. corporation to qualify for the FDII deduction even the products exported are purchased from a foreign seller.

What are the Implications for Businesses?

The implications of FDII for businesses are substantial:

Tax Savings: FDII offers a reduced corporate tax rate on qualifying export income (from 21% down to 13.125%), making it an attractive incentive for businesses looking to expand their international operations.

Encouragement of Domestic Investment: FDII encourages U.S. and foreign businesses to invest in the U.S. and to use it as a platform for global sales for products and services.

Promotion of International Trade: By providing tax incentives for companies engaged in international trade, FDII promotes American exports and enhances the competitiveness of U.S. businesses in the global market.

Additionally, FDII is also available to foreign-owned U.S. businesses that may wish to export to other countries from within the United States. As long as they set up a U.S. corporate subsidiary, they can take advantage of the favorable tax rate.

Considerations for Businesses

While FDII offers numerous benefits, there are important considerations to keep in mind:

Complexity: Calculating FDII can be complex, and the rules governing qualification require careful attention. It involves a significant amount of information that businesses may not have readily available, depending on their level of sophistication and accounting methods.

Limitations: FDII primarily applies to income from certain types of property sales, services, and licenses. Some income may not qualify, limiting its applicability for certain businesses.

Global Tax Impact: Utilizing FDII may have implications for a company's tax position in foreign countries. It's essential to consider the broader international tax ramifications when incorporating FDII into a tax strategy.

Foreign Businesses: For non-U.S. businesses, the FDII export incentive makes the U.S. a very attractive location for setting up a subsidiary that markets products or services globally.

Foreign Derived Intangible Income (FDII) is a valuable tax incentive that promotes economic growth and encourages U.S. businesses to engage in international trade and export. It underscores the importance of retaining and developing intangible assets domestically.

While FDII offers significant benefits, its complexity and potential global tax implications necessitate careful planning and consultation with tax professionals. As businesses continue to expand their international operations, understanding and harnessing the benefits of FDII can be a valuable tool in optimizing their overall tax strategy and maintaining a competitive edge in the global marketplace.