FOREIGN-DERIVED INTANGIBLE INCOME (FDII) DEDUCTION

What is the FDII?

  • The U.S. has a hybrid territorial tax system, meaning that income is generally taxed in the location it is earned and payments made from a foreign subsidiary of a U.S. company are generally exempt from U.S. taxation. To minimize potential profit shifting to no- or low-tax jurisdictions, two base erosion measures exist – a deduction, the Foreign-Derived Intangible Income (FDII), and a minimum tax, the Global Intangible Low-Taxed Income (GILTI).

  • Businesses can service foreign markets from the U.S. or a foreign subsidiary. In combination, GILTI and FDII act as a worldwide tax on highly mobile income and encourage that activity to take place in the U.S. This approach was intended to reach a neutral balance and allow American companies to operate competitively and efficiently in the global marketplace.

  • The FDII deduction provides a net U.S. corporate income tax rate of 13.125% (16.406% for tax years after 2025) for property and services that serve foreign markets from the U.S. This rate approximates the tax burden under the GILTI and effectively takes tax out of the equation as to where businesses decide to locate valuable assets and their next investment.

The FDII is critical to promoting U.S. innovation and job growth, preserving U.S. competitiveness, and protecting the U.S. tax base and must be preserved.

  • encourages U.S. Job Growth: The competitive tax rate resulting from the FDII deduction creates a powerful incentive to invest and hire in the U.S. Specifically, the FDII:

    • encourages companies to develop and mature their IP in the US which leads to the creation of more jobs and manufacturing – new manufacturing lines for new products, incorporating new technologies into existing processes and products, etc;

    • provides the resources to reinvest in innovation-spurring jobs and capital investment; and

    • the encourages the onshoring of IP which result in key decision-makers and associated job growth being based in the U.S.

  • Connection to Manufacturing and Services: The creation of IP represents the first step in the manufacturing and services life cycle, and the maturation of IP requires significant investment in factories, equipment, and jobs to produce the product or service covered by the IP.

  • Bipartisan Support: Over the years, there has been bipartisan recognition of the importance of encouraging the development and ownership of innovation in the U.S., along with the associated R&D and domestic manufacturing (e.g. The International Tax Bipartisan Working Group Report, July 2015)

  • FDII Does Not Encourage Offshoring of Jobs and Operations: The FDII was designed to encourage activities to take place in the U.S. and the GILTI to discourage the offshoring of activities. One part of determining income under both FDII and GILTI is a business’ tangible or physical assets known as Qualified Business Asset Investment (“QBAI”). Under both calculations, 10% of a company’s profits are excluded as they are taxed in the U.S. or in a local jurisdiction and generally tied to physical assets that are permanently reinvested (i.e. a factory that has existed for 30 years). There is a misconception that the 10% exclusion under QBAI provides an incentive to build factories overseas, but there is limited evidence to support that claim. Additionally, there are safeguards that protect against offshoring as well as the fact that many IP-intensive companies have limited investments in physical assets, and thus have no such incentive to offshore.

  • Return of Capital: Several major U.S. companies responded to the enactment of FDII and brought IP into the United States that had been developed abroad. Since the enactment of FDII, those companies have invested billions of dollars in U.S. including R&D and capital improvements and hired thousands of workers in U.S. high-technology positions. This innovation income broadens the tax base and increases federal tax payments. In fact, a recent study found a significant increase in royalty payments to the U.S. from Ireland, shifting from an average of 8 billion euros a year in the five previous years to 52 billion euros in 2020.

  • Innovation is Valued Globally: Generous tax incentives offered by other countries tilt the balance strongly in favor of offshore research, design, and manufacturing. For example, other countries offer a “super-deduction” of up to 200 percent of their research costs, and in some cases a full corporate tax exemption. Additionally, the United Kingdom and Australia understand the strong value derived from keeping IP within their respective borders and are focused on complementing R&D incentives with innovation incentives that encourage IP development. While the tax incentive offered by FDII is much smaller, it provides critical support for U.S. companies that are driving economic growth, innovation, and job creation in the United States.

  • OECD Members Preserving and Promoting Similar Policies while Discussing Global Minimum Tax: As with the GILTI/FDII structure the OECD discussions are focused on creating a global minimum tax while preserving sovereignty and the ability to implement similar policies to encourage beneficial behavior. For example, the IP Boxes throughout Europe (e.g. France, UK, etc) will still continue irrespective of a country minimum tax being established, and other countries are actively proposing similar incentives (e.g. Australia). The U.S. continuing to incentivize certain activities is aligned globally and, with application of a minimum tax, discourages a “race to the bottom”.

  • Location of Innovation is Important: The IP associated with innovation generates taxable income which chiefly benefits the tax environment where it is located. This location drives associated job growth in R&D, services, and importantly, manufacturing. Commonly, highly compensated decision-makers are key to the location of the innovation activity. Consequently, numerous countries would like to have this mobile activity located in their country and develop incentives to attract this activity.

    • USPTO found that IP-intensive industries continue to be an important and integral part of the U.S. economy and historically have accounted for more jobs and a larger share of U.S. GDP. IP-intensive industries directly and indirectly supported 45.5 million jobs, about 30 percent of all employment. More R&D-intensive industries, i.e., those with above average share of firms investing in R&D, tend to patent new products at higher than average rates. Roughly 63 percent of large manufacturing firms reported patenting their most significant new product innovation, compared to only 47 percent of medium firms and 36 percent of small firms.

  • Stability Leads to Long-Term Growth: The regulatory process is lengthy and complex, with the FDII and GILTI regulations only recently finalized. Stable and predictable tax rules allow for longer-term investment strategies in high-return locations (e.g., R&D and manufacturing in the United States). For instance, Ireland has continued to attract and expand business operations due to their commitment to consistent tax policy, irrespective of political leadership.