U.S. manufacturing C-corporations that generate revenue through sales and services provided to foreign markets may be missing opportunities for tax benefits offered by the Foreign-Derived Intangible Income (FDII) deduction. Created by the Tax Cuts and Jobs Act of 2017 (TCJA), this income category does not have to be derived from intangible assets and may represent a significant deduction for eligible corporations.
This deduction has now been in place for several years, but guidance and regulations have been changing as recently as 2020. Even if a corporation is already taking advantage of some of the benefits of this deduction, they may be missing additional opportunities.
The formula to determine FDII results in a permanent benefit through a 37.5% deduction against taxable income under Section 250. It is computed based on the excess of export sales and services income above a fixed rate of return on the corporation’s tangible depreciable assets (known as Qualified Business Asset Investment (QBAI).
Manufacturers typically have large amounts of QBAI given their general need for significant capital investment in machinery and equipment for their business. Since companies are required to calculate QBAI using Alternative Depreciation System (ADS) rather than an accelerated methodology, companies may have basis in these fixed assets when determining their QBAI. This reduces the available FDII deduction, though this may not be the case for those same assets when computing tax depreciation using MACRS.
For manufacturers, comparatively large capital investments translates into more QBAI and a lower FDII benefit. This is why manufacturer should evaluate planning opportunities to enhance their available FDII deduction.
