New Rules to Take Deduction on Foreign Income
Proposed regulations on Foreign Derived Intangible Income (FDII) were released earlier in 2019. One of the main highlights to these proposed regulations was the new strict documentation rules. For a brief recap on the release, and to learn when a C-corporation can benefit from the FDII deduction due to revenue generated outside of the U.S please visit our recent blog on Tax Deductions on Foreign Income.
Documentation must be in order by the tax filing date and must be obtained no sooner than one year prior to the sale or service to be able to treat the sale as foreign for FDII. Special exemptions do apply for “small businesses” (less than $10 million in gross receipts in the prior tax year), and “small transactions” (less than $5,000 in gross receipts from a single recipient in a tax year). For the sale to qualify, the taxpayer must first show that the sale is to a foreign recipient. This is documented by either a written statement from the recipient, or identification the recipient is filing with a foreign government. After this is satisfied, the taxpayer must document that the sale is for foreign use. Documentation requirements vary depending on the type of foreign transaction, which is shown in greater detail below.
Services Provided to Consumers
- Service providers need only to demonstrate, through appropriate documentation, that the consumer is located outside of the US when the service is received
- The customer’s location can be documented through a written statement of non-US residency, appropriate government-issued ID, or other valid forms of documentation prescribed by the IRS in instructions or forms
Services Provided to Business Recipients
- Insufficient documentation to demonstrate that the business recipient is a foreign entity by showing the entity has a foreign invoice address
- Service provider must demonstrate through appropriate documentation the location of operations of the business recipient that benefit from the general service
- Documentation may include:
- A written statement from the service recipient as to where the benefit of the service is provided
- Binding contractual provision as to where the benefit of the service is provided
- Documentation received in the ordinary course of business
- Publicly available information
General Property (Foreign Use Requirement)
- Written statement from recipient stating that the recipient’s use or intended use is foreign use
- Binding contract between seller and recipient stating the property’s intended use is a foreign use
- Documentation of the shipment from a location within the U.S. to a location outside the U.S. (copy of export bill of lading)
Intangible Property (IP) (Foreign Use Requirement)
- Written statement from recipient providing annual revenue from sales of IP from exploitation outside the U.S.
- Binding contract for sale of IP stating property can be exploited solely outside of the U.S.
- Audited financial statements/ annual reports stating revenue earned inside and outside of the U.S. from products using IP
- Statements/ documents used by parties to determine the payment for exploitation of IP, providing reliable date of revenue within and without the U.S.
There are also special documentation rules for foreign loss transactions to ensure taxpayers do not abuse the deduction. FDII provides a permanent deduction for taxpayers, but the new documentation rules have proven to be time consuming and confusing for some.
If you would like more information or have questions about how to move forward, please have a member of the Barnes Dennig international team contact you. Contact us here to talk, or call 513-241-8313 to learn more.