Most headlines since the TCJA was passed have focused on the overall corporate income tax cut from 35 percent to 21 percent,2 which can already help make exporters more competitive abroad. Another focus has been on the repatriation of overseas earnings by large multinationals. However, the law includes multiple international tax rules.3 The Internal Revenue Service (IRS) proposed its rule for what is called “foreign-derived intangible income” (FDII) in March 2019, in what is considered to be the last major international tax provision left to be fleshed out.4
Who Benefits from the U.S. Export Tax Break?
Companies large and small can benefit from the FDII provision. The term reflects the tax writers’ intent to encourage American companies to keep more of their business activities in the U.S., particularly those involving intangibles such as intellectual property (IP). However, “regardless of whether companies have intangible assets, FDII can be a boon for companies that produce goods and services in the U.S. and sell abroad,” the Wall Street Journal reported.5
According to Deloitte, “FDII is a new category of income and it does not have to come from intangible assets.” Instead, the new tax law assumes a fixed rate of return on a company’s tangible assets, such as factories and equipment, and any remaining income is deemed to be generated by intangible assets. This is the income that is subject to the new U.S. export tax break.6
A company’s organizational structure will be key to determining whether it can benefit. For example, companies earning income from foreign subsidiaries may be less advantaged, under a related tax provision for “global intangible low-taxed income.” In addition, the FDII only applies to “C corporations,” for which earnings are taxed at the corporate level, and not to “S corporations” or other partnerships and sole-proprietor setups in which income is passed through to owners to be taxed at an individual level. Many small businesses fall in the second category, which has also received its own tax break on overall income.7 Tax analysts noted that the relative benefits of each category are shifting under the TCJA.8
The U.S. export tax provision also proposes reducing paperwork for small businesses (under $10 million in gross annual receipts) and small transactions (under $5,000). For these companies or sales, a shipping address may serve as sufficient documentation of the foreign status of a purchaser.9
Until the U.S. export tax rule is finalized, many companies still have questions about the rule. Many are also trying to figure out whether they qualify for the FDII benefit under their current structure or whether they would benefit by making a change.10
What Happens Next?
The IRS has requested public comments and may revise the FDII rule before finalizing it, which is expected in the summer. Meantime, several observers have warned of a possible challenge to the rule in the World Trade Organization, which could delay or even undermine the provision.11
Ultimately, “companies that have U.S. operations no doubt will be further incentivized to increase exports, which is one of the stated goals of the legislation,” said Alan Cathcart, Senior Director with the Alvarez & Marsal consultancy. However, he cautioned, “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.”12
