Foreign Derived Intangible Income (FDII) is a special category of earnings that come from the sale of products related to intellectual property (IP). If a U.S. company holds IP in the U.S., such as patents or trademarks, and has sales to foreign customers based on that IP, the profits from those sales face a lower tax rate.
How does FDII work?
FDII is income from the use of intellectual property, a company’s legally protected, non-physical assets, in the United States in creating an export. FDII is provided a special lower tax rate of 13.125 percent. FDII was adopted when the U.S. moved from a worldwide to a territorial system, which changed incentives for tax avoidance and where companies held their IP. FDII is supposed to increase businesses’ incentive to bring and keep IP and the associated profits in the United States.
The definition of FDII is very similar to that of GILTI. FDII is equal to foreign-derived profits in excess of the “normal” returns to qualified investments. More specifically, FDII 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 U.S. income related to the export of goods or services. QBAI for purposes of the 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. This company’s foreign-derived income would be the income from the sale of those widgets overseas, and the U.S. factory would be counted as QBAI for the purposes of FDII.
Companies can deduct 37.5 percent of their FDII against their taxable income. This brings the effective 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 earned by exporting goods overseas ($1,000). This company has $9,000 in QBAI related to its export activities. This implies that the company’s FDII is $100: $1,000 in foreign-derived income minus 10 percent of QBAI ($900). This company would then be allowed to deduct 37.5 percent of its FDII ($37.50) against its taxable income. The result is taxable FDII of $62.50. Multiplying this by the federal corporate tax rate of 21 percent results in a tax liability of $13.125, 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.
|Total U.S. Income||$10,000|
|Export Share of Income||10%|
|QBAI Exemption (10% of QBAI)||$900|
|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, territorial treatment, and FDII serves to provide a tax benefit to companies that hold their intangible assets in the U.S. 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.
A business paying low rates of tax on intangible assets abroad before tax reform now has fewer incentives to place new intangibles in foreign jurisdictions. Low tax rates on earnings from intangibles abroad could arise because of low statutory corporate rates or because a company was availing itself of benefits of patent boxes, which tax earnings from certain intangible assets at very low rates. Now, instead, the business could choose to keep its assets in the U.S. and pay taxes on its profits from exports at a lower rate of 13.125 percent due to FDII.Share