Foreign-Derived Intangible Income (FDII)

Foreign-derived intangible income (FDII) is a special category of earnings that come from the export of products related to intellectual property (IP). If a US company holds IP in the US, such as patents or trademarks, and has sales to foreign customers based on that IP, then the profits from those sales face a lower tax rate.

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How Does It Work?

FDII is income from the use of intellectual property—a company’s legally protected, non-physical assets—in the United States when creating an export. FDII is taxed at a lower rate of 13.125 percent. The US adopted FDII when it moved from a worldwide to a territorial system beginning in 2018, which changed incentives for tax avoidance and where companies held their IP. The motivation was to encourage businesses to bring and keep IP and the associated profits in the United States.

The definition of FDII is similar to that of global intangible low-taxed income (GILTI). GILTI is a minimum tax targeted at foreign earnings from intangible assets (copyrights, patents, trademarks, etc.) and was also adopted when the US moved from a worldwide tax system to a territorial tax system. It too changed incentives for tax avoidance and where companies hold their IP.

FDII is equal to foreign-derived profits in excess of the “normal” returns to qualified investments. More specifically, it is equal to foreign-derived income minus 10 percent of “qualified business asset investment” (QBAI). Foreign-derived income is the share of a corporation’s US income related to the export of goods or services. QBAI for purposes of FDII is equal to the value of tangible assets used in earning foreign-derived income. For example, a company may own a factory in the United States and export widgets to Germany. It’s foreign-derived income would be the income from selling widgets overseas, and the US factory would be counted as QBAI for the purposes of FDII.

Companies can deduct 37.5 percent of their FDII against their taxable income, bringing the effective tax rate on each dollar of FDII to 13.125 percent.

Suppose a company earned $10,000 in total income in the United States and 10 percent was from exporting goods overseas ($1,000). Suppose also that the company had $9,000 in QBAI related to its export activities. The company’s FDII would be $100: $1,000 in foreign-derived income minus 10 percent of QBAI ($900). The company would then be allowed to deduct 37.5 percent of its FDII ($37.50) against its taxable income, resulting in taxable FDII of $62.50. Multiplying taxable FDII by the federal corporate tax rate of 21 percent results in a tax liability of $13.125 for an effective tax rate on FDII of 13.125 percent.

The tax deduction for FDII is set to be reduced after 2025, so the effective tax rate would rise to 16.4 percent under current law.

Table 1. Example FDII Calculation
Total US Income	$10,000
Export Share of Income	10%
QBAI	$9,000
FDII
Foreign-Derived Income	$1,000
Minus
QBAI Exemption (10% of QBAI)	$900
Equals
FDII	$100
Taxable FDII (FDII minus 37.5% deduction)	$62.50
FDII Liability (Taxable FDII x Federal Corporate Tax Rate of 21%)	$13.13

For intangible earnings, the combination of the lower corporate tax rate and FDII, along with other international reforms toward territorial taxation without deferral of foreign income, benefits companies that hold their intangible assets in the US. The new system contrasts with the previous system of worldwide taxation, deferral, and a high corporate tax rate that incentivized companies to place their intangible assets in offshore, low-tax jurisdictions. Now, rather than facing large incentives to place intangibles in foreign jurisdictions to take advantage of lower foreign tax rates or patent boxes, companies can keep their assets in the US and pay tax on profits from exports at a lower 13.125 percent (scheduled to rise to 16.4 percent) using FDII.

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