This article was originally published in the Central New York Business Journal.
The Tax Cuts and Jobs Act of 2017 added many new acronyms to tax advisers’ vocabularies. A few of the new acronyms in the international arena are GILTI, FDII, BEAT, DEI, and QBAI. Some of these acronyms have positive connotations; others, not so much.
Foreign derived intangible income (FDII) is one acronym with a positive connotation and one that should be on the radar of CFOs and tax advisers of C corporations, as calculating FDII can result in a smaller federal-tax liability for a corporation. But before we get into FDII and its related acronyms, we first should mention BEAT and GILTI.
BEAT stands for base erosion anti-abuse tax. The BEAT provisions in the new tax law impose a minimum tax on a corporation’s taxable income as modified to eliminate deductions for certain cross-border payments to related parties. The rules are complex and apply only to companies with at least $500 million of gross receipts. The gross receipts of certain related parties are included when determining whether the threshold is met. Nevertheless, BEAT applies mainly to large multinational corporations.
GILTI means global intangible low-taxed income. This is income (with certain exceptions) of a controlled foreign corporation (CFC) in excess of a standard rate of return on the tangible assets of the CFC. The GILTI rules require a U.S. person (individual, domestic corporation, partnership, trust, or estate) owning at least 10 percent of the value or voting rights of the CFC to include the global intangible low-taxed income of the CFC in its taxable income, regardless of whether any amount was received from the CFC.
In the carrot-and-stick analogy, FDII is the carrot and GILTI is the stick. GILTI aims to discourage shifting profits to overseas subsidiaries, whereas FDII seeks to encourage U.S. corporations to generate profits from overseas customers. The FDII rules allow a deduction against taxable income equal to 37.5 percent of the corporation’s foreign derived intangible income, effectively reducing the federal corporate tax rate on that income from 21 percent to 13.125 percent. So how is a corporation’s FDII calculated?
The corporation must first determine its deduction eligible income (DEI). This is the excess (if any) of gross income over deductions allocable to such gross income, but it does not include income from foreign branches, GILTI, subpart F income, and certain other specific types of income. The next step is the determination of qualified business asset investment (QBAI), which is the average of the corporation’s aggregate adjusted bases of its tangible assets used in the production of the DEI.
Now come even more acronyms: the corporation’s deemed tangible income return (DTIR) is 10 percent of the corporation’s QBAI. The deemed intangible income (DII), is the excess of the deduction eligible income (DEI) over the DTIR. Note that the DII calculation attempts to quantify the income being generated from the company’s intangibles. FDII is the portion of the DII that is allocable to foreign revenues.
Here is a hypothetical example to demonstrate how this works.
High Performance Inc. has $4 million of revenues from the sale of running shoes, of which $1.5 million of sales are to foreign customers. The corporation incurs expenses of $2.75 million, all of which are deductible for determining the corporation’s deduction eligible income. Of the $2.75 million of expenses, $1.125 million are related to foreign sales. The average aggregate bases of the machinery and equipment used in the production of the running shoes (QBAI) is $2.1 million. Its FDII can be calculated as follows:
- DEI = $4,000,000 – $2,750,000 = $1,250,000
- Foreign-derived DEI = $1,500,000 – $1,125,000 = $375,000
- DTIR = 10 percent * QBAI = 10 percent * $2,100,000 = $210,000
- DII = DEI – DTIR = $1,250,000 – $210,000 = $1,040,000
- FDII = DII * (Foreign-derived DEI/DEI) = $1,040,000 * ($375,000/$1,250,000) = $312,000
Conclusion: High Performance Inc. would get a tax deduction against its taxable income of $117,000 (37.5 percent * $312,000). Since the federal corporate tax rate is now 21 percent, the federal tax savings for the corporation would be $24,570.
This is a general overview of the FDII calculation. All along the way, there are more specific definitions and computational rules. Note that the same code section (IRC §250) that allows the deduction for FDII also provides a deduction of 50 percent of the domestic C corporation’s GILTI income that was required to be included in current income, but the combined deductions for FDII and GILTI cannot exceed the corporation’s current taxable income. For taxable years beginning after Dec. 31, 2025, the deductions for FDII and GILTI are reduced to 21.875 percent (from 37.5 percent) and 37.5 percent (from 50 percent), respectively.
It’s important to emphasize that the FDII and GILTI deductions under code section 250 apply only to domestic C corporations. However, for those C corporations with taxable income, despite the complexity of the calculations needed to determine the company’s FDII, the calculations are likely worth the effort.