Have you heard of the Foreign Derived Intangible Income deduction also known as FDII, but never thought it may apply to your business because it applies to manufacturers and distributors of tangible property? This article will review how FDII also applies to domestic corporations that provide various types of services. FDII is actually meant to incentivize U.S. corporations to retain their intangible assets and associated profits in the United States and to reduce the tax burden on foreign income.
In general, a domestic corporation may claim a deduction, equal to 37.5 percent of its foreign-derived eligible income. It is only available for income from sales of goods or services, and notably, after December 31, 2025, the 37.5 percent rate of the deduction is set to be reduced to 21.875 percent. To calculate FDII, a corporation must first determine the amount of income from the sale of goods or services for use abroad that exceeds an assumed normal return on assets. The corporation can then deduct for tax purposes 37.5 percent of that amount.
Different types of services qualify for FDII deduction, and these include “general” service, electronically supplied service, property service, and transportation service. A “general” service is defined as a service to a consumer or business recipient located outside the United States.1 The services that qualify for FDII can be provided physical or electronic form.
An “electronically supplied service” that qualifies for FDII is one delivered primarily over the internet or an electronic network.2 For example, it may include streaming content, on-demand network access to networks, servers, storage, and software, the provision or support of a business or personal website, online intermediation platform services, and so on. It is important to note that electronically supplied services do not include services that primarily involve the application of human effort by the renderer, such as legal, accounting, medical, or teaching services that are provided electronically.3 These would be considered general services.
Before the FDII deduction can be taken, however, the taxpayer should gather appropriate substantiation that general or electronic services provided were to the consumers or business recipients outside the United States. For example, a support of consumer’s residence outside the United States when the service is provided. If the service provider cannot identify the residency of the consumer, then the consumer’s billing address can be used to substantiate the location of the recipient. However, if there is a belief that the consumer does not reside outside the United States, the rule allowing the use of a consumer’s billing address does not apply.4 On the other hand, when a general service is provided to a business recipient it is eligible for the deduction only if the provider substantiates its determination of the extent to which the service benefits a business recipient’s operations outside the United States.
Services that qualify for FDII deduction also include “property” service with respect to tangible property located outside the United States, and “transportation” service to a recipient, or with respect to property, located outside the United States. Note that the requirement for a recipient of these services to reside outside the United States does not necessarily apply to property or transportation services, which are different from general services.
Generally, “property” service includes service substantially (i.e., 80 percent) performed at the location of the property and results in physical manipulation of that property. The examples of physical manipulation are manufacturing, assembly, maintenance, or repair.5 Even if the property was temporarily brought to the U.S., it may still be considered to be located outside the United States depending on circumstances and certain other facts.
Transportation service, on the other hand, is defined as a service to transport a person or property using aircraft, train, vessel, motor vehicle, or any other mode of transportation. It also includes freight forwarding and similar services.6 The transportation service provided to a recipient, or with respect to the property, would be considered located outside the United States only if both the origin and the destination of the service are outside of the United States. However, in the case of a transportation service provided where either the origin or the destination of the service is outside of the United States, then only half of the gross income derived from the transportation service would be considered derived from services provided to a recipient, or with respect to the property, located outside the United States.7
The FDII deduction can result in tax savings to qualifying service providers. Should you have any questions about whether the services your company provides qualify for the FDII deduction, reach out to the HBK Tax Advisory Group at (239) 263-2111.
1 IRC Reg. §1.250(b)-5(b)
2 IRC Reg. §1.250(b)-3
3 IRC Reg §1.250(b)-5(c)(5)
4 IRC Reg. §1.250(b)-5(d)(1)
5 IRC Reg §1.250(b)-5(c)(7)
6 IRC Reg §1.250(b)-5(c)(9)
7 IRC Reg §1.250(b)-5(h)
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