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FDII Deduction: Winners and Losers

FEI Daily spoke with Alan Cathcart, Senior Director with Alvarez & Marsal Taxand, about what tax directors at companies affected by foreign-derived intangible income (FDII) need to know about the regulations.

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The Treasury Department recently proposed new international-tax regulations under the 2017 Tax Cuts and Jobs Act (TCJA), outlining how individual taxpayers with businesses abroad can claim a break for exporting goods and services made in the United States. The new rules on how corporations can claim deductions for foreign-derived intangible income (FDII), a method to encourage American companies to produce more in the U.S., lower their export income tax rate from 21 percent to roughly 13 percent.

FEI Daily spoke with Alan Cathcart, Senior Director with Alvarez & Marsal Taxand, about what tax directors at companies affected by FDII need to know about the regulations.

FEI Daily: Were any significant changes made to final rules based on the feedback received during the comment period for the proposed regulations? Were there any significant areas of concern with the proposed version that received a lot of comments that were not addressed in the final rules?

Alan Cathcart: In this case, we are dealing with proposed regulations and not final ones. The proposed regulations are our first official look at the IRS’ thinking on the subject area, and our first opportunity to comment formally. I will be participating in the preparation of comments on behalf of the American Bar Association Tax Section, and the deadline for comment is May 5.

FEI Daily: Will certain industries/companies be winners and will certain ones be losers?

Cathcart: This may be stating the obvious, but profitable companies that qualify for FDII treatment will benefit the most, because loss companies do not get the benefit, and those that are marginally profitable are likely to obtain a reduced benefit. Companies that derive their income from intangibles such as patents and software should benefit significantly from provisions that allow the FDII deduction with respect to the sale or licensing of intangibles abroad, including the transfer of intangibles to foreign subsidiaries. Transportation companies may benefit from a provision that allows the FDII deduction with respect to half the income from providing transportation services between the US and a foreign country, though they might have preferred a rule that measures the foreign component of the service on a mileage basis.

FEI Daily: If you could tell tax directors at companies affected by FDII one thing they need to know about the regulations, what would it be? 

Cathcart: In this and all areas affected by the TCJA, you can’t plan or predict outcomes by the seat of your pants. Careful modeling and study of the interaction of the various new provisions is essential.

FEI Daily: According to the tax writers in Congress, the FDII provisions in the Tax Cuts and Jobs Act are designed to make exporting good more attractive to companies and to entice them to shift production back to the U.S. Do you think that is what will happen now that the regulations have been finalized?

Cathcart: Recognizing that these are only proposed regulations, but assuming they are finalized without change, I do not expect them to cause major changes in the behavior of American companies. As a policy matter, the decision to allow benefits with respect to the export of intangibles was a surprise, though I understand how it fits within the structure of the statute as written. This goes to the question whether the trend of locating productive activities will be toward the US. The FDII regime may lessen the incentive to locate operations offshore, but I do not believe the incentive will be eliminated. Companies that do have US operations no doubt will be further incentivized to increase exports, which is one of the stated goals of the legislation. This in turn leads to the question whether the FDII regime will survive challenges in the WTO and elsewhere as an improper export incentive.