On March 4, 2019, the Treasury Department (Treasury) and the Internal Revenue Service (IRS) issued proposed regulations (the Proposed Regulations) that provide guidance and clarification on certain aspects of the section 250 deduction related to global intangible low-taxed income (GILTI), and foreign-derived intangible income (FDII). Once published in the Federal Register, the Proposed Regulations will be open for public comment for 60 days, after which the regulations may be issued as final.
This alert provides an overview of some of the key takeaways addressed in the Proposed Regulations. We expect to publish an in-depth alert in the coming days.
GILTI is a new category of income for U.S. taxpayers owning a controlled foreign corporation (CFC). Very generally, all income of a CFC in excess of a 10 percent return on the CFC’s basis in tangible depreciable property, with certain exceptions, is GILTI. The GILTI provisions are effective for tax years of CFCs beginning after Dec. 31, 2017. Proposed regulations on the computation of GILTI income were published in the Federal Register on Oct. 10, 2018.
Domestic corporations are allowed a deduction under section 250(a)(1)(B) equal to 50 percent of their GILTI inclusion (as well as any related section 78 gross-up), subject to a taxable income limitation. Domestic corporations are also entitled to claim a credit for up to 80 percent of the foreign taxes paid or accrued by the CFC on GILTI.
- Application of section 250 to taxpayers making a section 962 election. Noncorporate taxpayers (individuals and certain trusts and estates) that own at least 10 percent of a CFC directly (or indirectly through a partnership or S corporation) generally may make a section 962 election with respect to their pro rata share of CFC GILTI income. A section 962 election causes the GILTI income to be taxed at the U.S. corporate tax rate and allows for the 80 percent foreign tax credit as though the CFC stock was held through a hypothetical domestic corporation. The Proposed Regulations clarify that noncorporate taxpayers will be permitted to claim the 50 percent section 250(a)(1)(B) deduction in connection with a section 962 election. This is a significant change and could make the section 962 election more attractive for individuals as a way to manage their GILTI exposure.
Section 250(a)(1)(A) allows a domestic corporation to take a deduction equal to 37.5 percent of its FDII. Broadly, a domestic corporation's FDII is the amount of its deemed intangible income from the sale, lease or license of property to persons located outside the U.S. or from services provided to persons located outside the U.S., i.e., export sales.
A domestic corporation's deemed intangible income generally is its gross income that is not attributable to a CFC, foreign branch, or to domestic oil and gas income, reduced by related deductions (including taxes) and an amount equal to 10 percent of the aggregate adjusted basis of its U.S. depreciable property.
FDII is effective for tax years beginning after Dec. 31, 2017.
- Applicability to partnerships. The Proposed Regulations clarify that partnerships with one or more direct or indirect partners that are domestic corporations are required to furnish certain information to their partners related to FDII. The Schedule K-1 provided to such partners must include the partners’ share of:
- Gross Deduction Eligible Income (DEI),
- Gross Foreign-Derived Deduction Eligible Income (FDDEI),
- Deductions definitely related to the partnership’s gross DEI,
- Deductions definitely related to the partnership’s gross FDDEI, and
- Partnership qualified business asset investment (QBAI).
- Consolidated returns. The Proposed Regulations provide that the section 250 deduction for a member of a consolidated group is determined by reference to the relevant items of all members of the same consolidated group. The Proposed Regulations provide for the aggregation of the consolidated group’s DEI, FDDEI, deemed tangible income return (DTIR), and GILTI for all members. These aggregated numbers and the group’s consolidated taxable income are used to calculate an overall deduction for the group, and then the overall deduction is allocated to the members of the group.
- Documentation requirements. The Proposed Regulations outline specific documentation required to support a recipient’s foreign status. However, the Proposed Regulations also recognize that these rules may apply to certain transactions that have already occurred, which may make it difficult to obtain the necessary documentation. Therefore, for taxable years beginning on or before the date of filing in the Federal Register, the Proposed Regulations allow taxpayers to use any reasonable documentation maintained in the ordinary course of business that establishes the recipient’s foreign status, provided it meets certain reliability requirements. This reasonable documentation includes documentation that is otherwise only available to certain small businesses and small transactions, such as the foreign shipping address.
- Sales to domestic intermediaries. The Proposed Regulations clarify that a sale of property to a U.S. person (related or unrelated) cannot qualify as FDDEI under any circumstance. In addition, the Proposed Regulations provide that the sale of property to a foreign person for further manufacture in the U.S. will not qualify regardless of the ultimate use of the property by the recipient.
- Expense allocation and apportionment. The Proposed regulations indicate that deductions are allocated and apportioned to gross DEI and gross FDDEI under the rules of sections 1.861-8 through 1.861-14T and 1.861-17. For these allocations and apportionments, gross FDDEI and gross non-FDDEI are treated as separate statutory groupings. The Proposed Regulations also provide that section 250(b) does not contemplate a transaction-by-transaction approach, but rather an aggregate calculation based on all gross income derived in connection with sales and services described in section 250(b)(4). Finally, for purposes of calculating gross DEI and gross FDDEI, the Proposed Regulations specify that cost of goods sold is attributed to gross receipts under any reasonable method, but may not be segregated with respect to a particular product into component costs and attributed disproportionately to gross receipts with respect to amounts excluded from gross DEI or gross FDDEI.
The Proposed Regulations will have a significant impact on taxpayers eligible for the section 250 deduction as well as partnerships with direct or indirect corporate partners. These regulations may affect their tax liability and reporting obligations for the 2018 year. Taxpayers should examine them closely with their advisors immediately to develop their response.