INSIGHT: It’s All in the Details: Proposed Regulations Clarify Section 250 Deduction, Introduce Detailed Documentation Requirements

A hallmark of U.S. tax reform is its provisions focused on deemed ‘intangible’ income, including: a new foreign income inclusion rule for global intangible low-taxed income (GILTI) under new IRC Section 951A (See also REG-104390-18, 83 Fed. Reg. 51,072 (Oct. 10, 2018).), and a new deduction for domestic corporations with respect to their GILTI and foreign-derived intangible income (FDII) under new IRC Section 250. In proposed regulations under IRC Section 250, issued on March 4, 2019, the Department of the Treasury and the Internal Revenue Service detail the intended interaction of these provisions to “neutralize the role that tax considerations play when a domestic corporation chooses the location of intangible income attributable to foreign market activity.” (Preamble to REG-104464-18, 84 Fed. Reg. 8188, 8189 (Mar. 6, 2019).)

As described in the preamble to the proposed regulations, the deductions for GILTI and FDII under IRC Section 250 are intended to neutralize the effective rate of U.S. tax on ‘intangible’ income, whether such income is earned through U.S. based operations or through controlled foreign corporations (CFCs). The proposed regulations provide details regarding the determination of the IRC Section 250 deduction. And, they are particularly significant in providing guidance on the determination of a domestic corporation’s FDII. To this latter point, the proposed regulations establish detailed documentation requirements that taxpayers must satisfy to establish that a transaction qualifies as generating foreign-derived deduction eligible income (FDDEI). Absent such documentation, taxpayers will not be able to claim the deduction on FDII under IRC Section 250.

THE SECTION 250 DEDUCTION

For tax years beginning after Dec. 31, 2017, IRC Section 250 permits a domestic corporation to take a deduction in an amount equal to the sum of: (1) 37.5 percent of the FDII of such domestic corporation for the tax year, plus (2) 50 percent of the GILTI included by such corporation under IRC Section 951A for the year and the associated IRC Section 78 gross-up. (IRC Section 250(a)(1).) For tax years beginning after Dec. 31, 2025, the amount of the deduction is calculated by substituting 21.875 percent for 37.5 percent and 37.5 percent for 50 percent, respectively. (IRC Section 250(a)(3).)

The effect of the IRC Section 250 deduction is to reduce the effective rate of U.S. tax on FDII and GILTI. As a result of the IRC Section 250 deduction, the effective rate of U.S. tax on FDII is 13.125 percent (16.40625 percent for taxable years beginning after 2025). As discussed below, before taking into account the potential limitation resulting from expense allocation to the GILTI foreign tax credit basket, a taxpayer’s GILTI inclusion will not be subject to U.S. residual tax if the income has been subject to an average foreign effective rate of tax of at least 13.125 percent (16.40625 percent for taxable years beginning after 2025).

GILTI RECAP

Under IRC Section 951A, a U.S. shareholder must include in gross income its GILTI with respect to CFCs whose taxable years begin after Dec. 31, 2017. (IRC Section 951A(a).) A U.S. shareholder does not compute a separate GILTI inclusion with respect to each CFC, but rather, it computes a single GILTI inclusion amount by reference to all of its CFCs. (IRC Section 951A(b)(1), (c)(1) - (2).) GILTI is the U.S. shareholder’s “net CFC tested income” less its “net deemed tangible income return.” (IRC Section 951A(b)(1).) Net CFC tested income is the excess, if any, of the U.S. shareholder’s aggregate pro rata share of its CFC tested income over its aggregate pro rata share of CFC tested loss. (IRC Section 951A(c)(1).) Net deemed tangible income return is 10 percent of a U.S. shareholder’s aggregate pro rata share of a qualified business asset investment (i.e., depreciable tangible property used in a business that produces CFC tested income) of each CFC, reduced for its “specified interest expense.” (IRC Section 951A(b)(2); Proposed Treasury Regulation Section 1.951A-1(c)(3).)

As noted above, under IRC Section 250 a domestic corporation is permitted a deduction in an amount equal to 50 percent (37.5 percent for taxable years beginning after 2025) of the amount of the GILTI inclusion (and associated IRC Section 78 gross-up) in calculating the U.S. shareholder’s taxable income, resulting in an effective rate of U.S. tax of 10.5 percent (13.125 percent for taxable years beginning after 2025). (IRC Section 250(a)(1)(B).) In addition, 80 percent of the foreign income taxes attributable to the GILTI inclusion can be claimed as a foreign tax credit, subject to applicable foreign tax credit limitations. (IRC Section 960(d)(1).) Before taking into account the potential limitation resulting from expense allocation to the GILTI basket, a taxpayer’s GILTI inclusion will not be subject to U.S. residual income tax if the income has been subject to an average foreign effective rate of tax of at least 13.125 percent (16.40625 percent for taxable years beginning after 2025), which, as noted above, is equal to the effective rate of U.S. tax on FDII.

Under IRC Section 962, an individual that is a U.S. shareholder of a CFC may elect to be taxed on amounts included in the individual’s gross income under IRC Section 951(a) in “an amount equal to the tax that would be imposed under IRC Section 11 if such amounts were received by a domestic corporation.” (IRC Section 962(a)(1).) GILTI is treated as an amount included under IRC Section 951(a) for purposes of IRC Section 962. (Prop. Treas. Reg. Section 1.962-1(b)(1)(i)(A)(2).) Prior to the proposed regulations, it was not clear whether an individual U.S. shareholder making an election under IRC Section 962 would be able to claim a deduction under IRC Section 250, resulting in U.S. tax on such individual’s GILTI inclusion (and associated IRC Section 78 gross-up) at rates up to 37 percent. The proposed regulations address this point, providing that an individual U.S. shareholder electing under IRC Section 962 is permitted to claim the IRC Section 250 deduction. (Prop. Treas. Reg. Section 1.962-1(b)(3).)

WHAT IS FDII?

FDII is certain income of a domestic corporation in excess of a permitted return on tangible assets attributable to certain sales, and the provision of certain services, to foreign persons. As reflected below, calculating FDII involves working through numerous defined terms.

• FDII is equal to a domestic corporation’s deemed intangible income (DII) for the year multiplied by the corporation’s foreign-derived ratio for the year. (IRC Section 250(b)(1); Prop. Treas. Reg. Section 1.250(b)-1(b).)
• DII is equal to a domestic corporation’s deduction eligible income (DEI) for the year over the corporation’s deemed tangible income return (DTIR) for the year. (IRC Section 250(b)(2); Prop. Treas. Reg. Section 1.250(b)-1(c)(3).)
  • DEI is equal to the gross income of the corporation (or partnership) for the year (1) determined without regard to certain items, including: subpart F income and amounts included under IRC Section 956, GILTI, dividends from CFCs, and foreign branch income; and (2) reduced by deductions properly allocated to such income. (IRC Section 250(b)(3); Prop. Treas. Reg. Sections 1.250(b)-1(c)(2), (14), 1.250(b)-1(d)(2).)
  • DTIR is equal to 10 percent of the corporation’s qualified business asset investment (QBAI) for the year. (IRC Section 250(b)(2)(B); Prop. Treas. Reg. Section 1.250(b)-1(c)(4).) QBAI is described in greater detail below.
• A corporation’s foreign-derived ratio is the ratio (not to exceed one) of (1) the corporation’s FDDEI for the year to (2) the corporation’s DEI. (Prop. Treas. Reg. Section 1.250(b)-1(c)(13).)
  • FDDEI is equal to the gross income of the corporation (or partnership) from FDDEI transactions reduced by deductions properly allocable to such income. (IRC Section 250(b)(4); Prop. Treas. Reg. Section 1.250(b)-1(c)(12).)
  • FDDEI transactions include FDDEI sales and FDDEI services, which are described in greater detail below. (Prop. Treas. Reg. Section 1.250(b)-1(c)(10).)

Both GILTI and FDII are keyed to an excess return over a 10 percent return on the taxpayer’s QBAI. For the purposes of FDII, QBAI is the average of a domestic corporation’s aggregate adjusted basis as of the close of each quarter of the year in specified tangible property generally, depreciable tangible property used in the production of DEI. (IRC Section 951A(d); Prop. Treas. Reg. Section 1.250(b)-2(b), (c)(1).) In the case of tangible property that is used in both the production of DEI and the production of income that is not DEI (dual use property), the proposed regulations provide rules that allocate and treat a portion of the adjusted basis in such property as adjusted basis in specified tangible property. (Prop. Treas. Reg. Section 1.250(b)-2(d)(1).)

The proposed regulations include anti-avoidance rules that, where a domestic corporation transfers specified tangible property to a related, or in some cases unrelated, party and leases back the same or substantially similar property to decrease the domestic corporation’s DTIR, treat the domestic corporation, solely for purposes of determining its QBAI, as continuing to own the transferred property. (Prop. Treas. Reg. Section 1.250(b)-2(h)(1), (3).)

THE DETAILS: WHAT TRANSACTIONS GENERATE ELIGIBLE INCOME?

One of the central issues addressed in the proposed regulations is which transactions qualify as FDDEI sales or FDDEI services and as such, generate income eligible for a reduced effective rate of U.S. tax as a result of the IRC Section 250 deduction. If a transaction includes both a sale component and a service component, it is classified according to its overall predominant character for purposes of determining whether it is subject to the FDDEI sales or FDDEI services rules. (Prop. Treas. Reg. Section 1.250(b)-3(e).) The FDDEI transaction rules incorporate some familiar rules from the “manufacturing” rules under the foreign base sales company income regulations and the defunct foreign sales company regulations.

FDDEI Sales

An FDDEI sale is a sale by a domestic corporation (or a partnership in which a domestic corporation is a partner) of general property or intangible property to a foreign person for foreign use. (Prop. Treas. Reg. Section 1.250(b)-4(b).) For these purposes, a “sale” includes any lease, license, exchange or other disposition of property, including a transfer of property resulting in gain or an income inclusion under IRC Section 367. (Prop. Treas. Reg. Section 1.250(b)-3(b)(7).) A recipient is a foreign person for these purposes only if the seller obtains the documentation prescribed in the proposed regulations (satisfying the reliability rules) establishing the recipient’s status as a foreign person. (Prop. Treas. Reg. Section 1.250(b)-4(c)(1).) A sale of general property is for foreign use for these purposes only if the seller obtains the documentation prescribed in the proposed regulations (satisfying the reliability rules) establishing that the property is for a foreign use. (Prop. Treas. Reg. Section 1.250(b)-4(d)(1).)

A sale of general property is for a foreign use if the property (1) is not subject to domestic use within three years, or (2) is subject to manufacture, assembly or other processing outside the U.S. before the property is subject to a domestic use. (Prop. Treas. Reg. Section 1.250(b)-4(d)(2)(i).) General property is subject to manufacturing, assembly or other processing only if (1) there is a physical or material change to the property (a facts and circumstances standard); or (2) the property is incorporated as a component into a second product (and the fair market value (FMV) of the component does not exceed 20 percent of the FMV of the second product). (Prop. Treas. Reg. Section 1.250(b)-4(d)(2)(iii).)

A sale (or license) of intangible property by a domestic corporation (or a partnership in which a domestic corporation is a partner) is for a foreign use only to the extent that the intangible property generates revenue from exploitation outside the U.S. and the seller obtains the documentation prescribed in the proposed regulations (satisfying the reliability rules) of such foreign use. (Prop. Treas. Reg. Section 1.250(b)-4(e)(1)–(2).) Intangible property providing for rights both within and outside the U.S. is for foreign use in proportion to the revenue generated outside the U.S. (Prop. Treas. Reg. Section 1.250(b)-4(e)(2)(i).) Intangible property used in the development, manufacture, sale or distribution of a product is treated as exploited at the location of the end user of the product. Unless the exploitation of intangible property is contractually limited to outside the U.S., the seller will need to be able to document an allocation of the recipient’s revenues from exploiting the intangible property within and outside of the U.S. (Prop. Treas. Reg. Section 1.250(b)-4(e)(1)–(3).)

In addition, special rules apply to certain classes of property:

• Transportation property: A sale of transportation property is for foreign use only if, during the three years after sale, the property is located outside of the U.S. for more than 50 percent of the year and more than 50 percent of the miles traversed in the use of the property are traversed outside of the U.S. (Prop. Treas. Reg. Section 1.250(b)-4(d)(2)(iv).)
• Foreign military sales: If a sale of property or a provision of a service is made to the U.S. government under 22 U.S.C. Section 2715 et seq., and the U.S. government then resells the property to, or performs the services for, a foreign government, the sale of property or provision of a service is treated as a sale of property or a provision of a service directly to the foreign government. (Prop. Treas. Reg. Section 1.250(b)-3(c).)
• Sales of securities (as defined in IRC Section 475(c)(2)) and commodities (as defined in IRC Section 475(e)(2)(B)) are not FDDEI sales. Thus, sales of stock and partnership interests do not qualify as FDII. (Prop. Treas. Reg. Section 1.250(b)-4(f).)

FDDEI Services

FDDEI services include the provision by a domestic corporation (or a partnership in which a domestic corporation is a partner) of a general service to a consumer or a business recipient located outside the U.S. (Prop. Treas. Reg. Section 1.250(b)-5(b)(1) - (2).) A general service is provided to a consumer outside of the U.S. only if the provider obtains the documentation prescribed in the proposed regulations (satisfying the reliability rules) that the consumer is located outside the U.S. (Prop. Treas. Reg. Section 1.250(b)-5(d)(1).) A consumer is located where the consumer resides when the service is provided. (Prop. Treas. Reg. Section 1.250(b)-5(d)(2).)

A general service is provided to a business recipient outside the U.S. only if the provider obtains the documentation prescribed in the proposed regulations (satisfying the reliability rules) that the service is provided to a business recipient outside the U.S. (Prop. Treas. Reg. Section 1.250(b)-5(e)(1).) A service is provided to a business recipient outside the U.S. to the extent the gross income of the service provider is allocated to the recipient’s business operations outside the U.S.—generally based on the location of the operations of the recipient benefitting from the service. (Prop. Treas. Reg. Section 1.250(b)-5(e)(2).) If the provider is unable to document the recipient’s locations or the services confer a benefit on all locations, the income is allocated ratably among the recipient’s locations at the time the service is provided. (Prop. Treas. Reg. Section 1.250(b)-5(e)(2)(A).)

FDDEI services also include the provision of certain proximate services (generally where substantially all of the service is performed in the physical presence of the recipient or its employees) to recipients located outside the U.S. (Prop. Treas. Reg. Section 1.250(b)-5(b)(3), (c)(6).), the provision of certain property services (generally where substantially all of the service is performed at the location of the tangible property and results in physical manipulation of the property) with respect to tangible property located outside the U.S. (Prop. Treas. Reg. Section 1.250(b)-5(b)(4), (c)(5).), and the provision of certain transportation services (generally transporting persons or property using aircraft, railroad rolling stock, vessels, motor vehicles, or other similar modes of transport) to recipients, or with respect to property, located outside the U.S. (Prop. Treas. Reg. Section 1.250(b)-5(b)(5), (c)(7).)

THE DETAILS: WHEN CAN A RELATED PARTY TRANSACTION GENERATE ELIGIBLE INCOME?

Under IRC Section 250, sales and services provided to foreign related parties qualify as FDDEI transactions only if certain additional requirements are satisfied. The proposed regulations detail the requirements for a sale of general property or the provision of a general service by a domestic corporation (or partnership in which a domestic corporation is a partner) to a foreign related party to qualify as an FDDEI transaction. (Prop. Treas. Reg. Section 1.250(b)-6.) In the first instance, a sale of general property to a foreign related party must satisfy the FDDEI sales requirements, including the documentation requirements, described above. (Prop. Treas. Reg. Section 1.250(b)-6(b)(3).) Similarly, the provision of a general service to a related business recipient must satisfy the FDDEI services requirements, including the documentation requirements, described above. (Prop. Treas. Reg. Section 1.250(b)-6(b)(4).)

In addition to satisfying the FDDEI sales requirements with respect to the related party sale, an unrelated party transaction (which must also satisfy the FDDEI sales or FDDEI services requirements, as applicable) must subsequently occur with respect to the property for the related party sale to qualify as an FDDEI sale. (Prop. Treas. Reg. Section 1.250(b)-6(c)(1)(i) - (ii).) An “unrelated party transaction” includes: a sale of the property to a foreign party unrelated to the seller (Prop. Treas. Reg. Section 1.250(b)-6(b)(5)(i), (c)(1)(i).); a sale of a second property to a foreign party unrelated to the seller if the first property is a component of the second property (Prop. Treas. Reg. Section 1.250(b)-6(b)(5)(ii), (c)(1)(i).); a sale of a second property to a foreign party unrelated to the seller if the first property is used in connection with the second property (and more than 80 percent of the revenue earned by the foreign related party will be earned from such unrelated party transactions) (Prop. Treas. Reg. Section 1.250(b)-6(b)(5)(iii), (c)(1)(ii).); and a provision of a service to a foreign party unrelated to the seller if the property was used in connection with the provision of the service (and more than 80 percent of the revenue earned by the foreign related party will be earned from such unrelated party transactions) (Prop. Treas. Reg. Section 1.250(b)-6(b)(5)(iv), (c)(1)(ii).).

In addition to satisfying the FDDEI services requirements with respect to the related party service, a related party service will only qualify as an FDDEI service if the related party service is not substantially similar to a service provided by the related party to a person in the U.S. (Prop. Treas. Reg. Section 1.250(b)-6(d)(1).). A related party service is substantially similar to a service provided by the related party to a person in the U.S. if the related party service is used by the related party to provide a service to a person in the U.S. and either (1) 60 percent or more of the benefits conferred by the service are to persons in the U.S., or (2) 60 percent or more of the price paid by persons in the U.S. for the service is attributable to the related party service. (Prop. Treas. Reg. Section 1.250(b)-6(d)(2).). If the service is substantially similar to a service provided by the related party to a person in the U.S., the gross income attributable to an FDDEI service is reduced proportionately by the amount of benefits conferred by the related party service to persons in the U.S. (Prop. Treas. Reg. Section 1.250(b)-6(d)(1).)

THE DETAILS: HOW DO TAXPAYERS SATISFY THE DOCUMENTATION REQUIREMENTS?

As described above, in numerous instances the proposed regulations require prescribed documentation to establish the qualification of transactions as FDDEI sales and FDDEI services. These documentation requirements present a menu of items in order to be flexible but which may, in the end, be more difficult and burdensome to apply than if a withholding certification similar to the IRS Form W-8BEN-E were required where the recipient of the services or goods could check a box on the form to confirm the foreign service or sale.

In each instance, documentation may only be relied upon if it satisfies the following requirements:

• As of the date the seller/service provider is required to file (including extensions) an income tax return for the year the income from the sale/provision of service is included in income (the FDII filing date), the seller/service provider does not know or have reason to know that the documentation is unreliable or incorrect;
• The documentation is obtained by the seller/service provider by the FDII filing date with respect to the sale/service; and
• The documentation is obtained no earlier than one year before the date of the sale or service. (Prop. Treas. Reg. Section 1.250(b)-3(d)(1)–(3).)

The proposed regulations include exceptions to the documentation requirements for certain small businesses and certain small transactions, and a special rule for certain loss transactions:

• A seller with less than $10 million in gross receipts during a prior tax year may rely on the recipient’s address to (1) in the case of sales of general property, establish the recipient’s status as a foreign person (Prop. Treas. Reg. Section 1.250(b)-4(c)(2)(ii)(A).) and that the sale is for foreign use (Prop. Treas. Reg. Section 1.250(b)-4(c)(3)(ii)(A).), and (2) in the case of provision of general services to consumers and business recipients, establish that the recipient is located outside the U.S. (Prop. Treas. Reg. Section 1.250(b)-5(d)(3)(ii)(A).)
• A seller that receives less than $5,000 in gross receipts during a tax year from a recipient may rely on the recipient’s address to (1) in the case of sales of general property, establish the recipient’s status as a foreign person (Prop. Treas. Reg. Section 1.250(b)-4(c)(2)(ii)(B).) and that the sale is for foreign use (Prop. Treas. Reg. Section 1.250(b)-4(c)(3)(ii)(B).), and (2) in the case of provision of general services to consumers and business recipients, establish that the recipient is located outside the U.S. (Prop. Treas. Reg. Sections 1.250(b)-4(c)(2)(ii)(B), 1.250(b)-5(d)(3)(ii)(B).)
• If a seller/service provider knows or has reason to know that property is sold to a foreign person for foreign use or a general service is provided to a person outside the U.S., but does not satisfy the documentation rules, the sale/provision of service is nonetheless treated as an FDDEI transaction if doing so would reduce a domestic corporation’s FDDEI (and correspondingly, its FDII). (Prop. Treas. Reg. Section 1.250(b)-3(f). Prop. Treas. Reg. Section 1.250(b)-3(f) Ex. 2 illustrates the application of this rule.)

THE DETAILS: TAXABLE INCOME LIMITATION AND COORDINATION WITH OTHER PROVISIONS

The IRC Section 250 deduction is subject to a taxable income limitation. If the sum of a domestic corporation’s FDII and GILTI exceeds its taxable income for a given year, the excess is allocated pro rata to reduce the corporation’s FDII and GILTI solely for purposes of computing the amount of the IRC Section 250 deduction. (IRC Section 250(a)(2).)

The proposed regulations provide a complicated, five-step ordering rule for applying IRC Section 163(j) (limitation on business interest expense) and IRC Section 172 (net operating losses) in conjunction with IRC Section 250. (Prop. Treas. Reg. Section 1.250(a)-1(b)(2), (c)(4). Prop. Treas. Reg. Section 1.250(a)-1(f)(2) Ex. 2 illustrates the application of this five-step ordering rule.) Specifically, the proposed regulations provide that a domestic corporation’s taxable income for purposes of the taxable income limitation described above is determined after all of the corporation’s other (i.e., non-IRC Section 250) deductions are taken into account. (Prop. Treas. Reg. Section 1.250(a)-1(b)(2).)

THE DETAILS: SPECIAL RULES FOR PARTNERSHIPS AND CONSOLIDATED GROUPS

A domestic corporation’s DEI and FDDEI for a taxable year are determined taking into account the corporation’s share of DEI, FDDEI, and related deductions of any partnership in which the corporation is a direct or indirect partner. (Prop. Treas. Reg. Section 1.250(b)-1(e)(1).) The proposed regulations provide rules for determining a domestic corporation’s partnership QBAI. (Prop. Treas. Reg. Section 1.250(b)-2(g).)

While the proposed regulations adopt an aggregate approach for the purposes noted above, for purposes of determining whether a sale of property to or by a partnership qualifies as an FDDEI sale, or the provision of services to or by a partnership qualifies as an FDDEI service, the proposed regulations treat a partnership as an entity. (See Prop. Treas. Reg. Section 1.250(b)-3(g)(1).)

A partnership that has one or more direct or indirect partners that are domestic corporations and that is required under IRC Section 6031 to file returns must furnish each such partner, on the partner’s Schedule K-1: the partner’s share of the partnership’s DEI, FDDEI, related deductions and partnership QBAI for each year the partnership has such items. (Prop. Treas. Reg. Section 1.250(b)-1(e)(2).)

For consolidated groups, the IRC Section 250 deduction is determined at the group level. The proposed regulations include rules for allocating the consolidated IRC Section 250 deduction among members of the group on the basis of their respective contributions to the group’s aggregate amount of FDDEI and GILTI. (Prop. Treas. Reg. Section 1.250(a)-1(e).)

THE DETAILS: TO BE, OR NOT TO BE A FOREIGN BRANCH?

There is a tension between DEI and foreign branch income because the two are mutually exclusive, and foreign branch income generally is subject to U.S. tax at regular rates, albeit with the possibility of a U.S. foreign tax credit. The proposed foreign tax credit regulations provide a general anti-abuse provision that would prevent a taxpayer from artificially increasing either foreign branch income or DEI and decreasing the other. (Prop. Treas. Treas. Reg. Section 1.904-4(f)(2).) Although the proposed foreign tax credit regulations provide no indicators or examples of when the anti-abuse rule would apply, Treas. Reg. Section 1.987-2(b)(3) provides factors that indicate tax avoidance and factors that do not indicate tax avoidance. Presumably, the principles of those rules may be applied to determine when the anti-abuse rule would apply.

PUTTING THE RULES INTO PRACTICE: EFFECTIVE DATE

IRC Section 250, which requires domestic corporations to show that a sale or service qualifies as an FDDEI transaction “to the satisfaction of the Secretary” (IRC Section 250(b)(4)(A)–(B), (c)(5)(C)(i)–(ii).), is effective for tax years beginning after Dec. 31, 2017. The proposed regulations, however, generally apply to taxable years ending on or after March 4, 2019. (Prop. Treas. Reg. Section 1.250-1(b).) Acknowledging that taxpayers likely have entered into transactions implicated by IRC Section 250 prior to the effective date of the proposed regulations, the proposed regulations provide that taxpayers may use any reasonable documentation maintained in the ordinary course of a taxpayer’s business to establish that a recipient is a foreign person, property is for a foreign use, or a recipient of a general service is located outside the U.S. (provided such documentation meets certain reliability requirements), for taxable years beginning on or before March 4, 2019.

As noted above, the proposed regulations permit taxpayers to use any reasonable documentation maintained in the ordinary course of a taxpayer’s business to establish that a sale or the provision of a service qualifies as an FDDEI transaction, for taxable years beginning on or before March 4, 2019. In effect, this transition rule pushes back the effective date of the more formal documentation requirements in the proposed regulations to taxable years beginning after March 4, 2019. Thus, for a calendar year taxpayer, the specific documentation required by the proposed regulations does not need to be obtained until the FDII filing date for the 2020 taxable year.

CONCLUSION

The proposed regulations provide welcome guidance under IRC Section 250. However, taxpayers may find it challenging to comply with the numerous, detailed documentation requirements in the proposed regulations. As noted above, the deductions for GILTI and FDII under IRC Section 250 are intended to make domestic corporations indifferent between conducting FDDEI transactions directly (in which case the resulting income may be FDII) or through CFCs (in which case the resulting income may be GILTI). If domestic corporations are not able to satisfy the documentation requirements necessary to establish the qualification of transactions as FDDEI transactions, they would not be indifferent and, in fact, may in some cases prefer GILTI treatment for the resulting income.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Taylor Kiessig is a partner in the Washington, D.C. office of Eversheds Sutherland LLP. He advises clients on federal and international tax planning and transactions and the taxation of financial products.

Carol P. Tello is a partner in Washington, D.C. Her practice includes a broad range of cross-border tax planning and IRS controversy matters, including compliance with the Foreign Account Tax Compliance Act (FATCA).

Brian Tschosik is an associate in the Washington, D.C. He represents multinational clients in international tax planning, joint ventures, corporate restructurings and related financing.