The 2017 Tax Act, signed into law on December 22, 2017, encompasses the most significant and wide-ranging changes to the U.S. Internal Revenue Code (“IRC”) since 1986. This article addresses both the new taxation of global intangible low-taxed income (“GILTI”) and a new deduction for foreign-derived intangible income (“FDII”), as they relate to patent rights. GILTI and FDII will significantly affect the tax strategies of multinational corporations, particularly those with valuable intellectual property rights held abroad.
The new tax laws do not define intangible property through a list of specific types of assets, including intellectual property like patents. Rather, intangible property under the new laws encompasses anything not strictly considered a tangible asset. This expanded definition applies when determining the GILTI and FDII amounts.
New IRC Section 951A effectively imposes a minimum tax on U.S. shareholders who own at least 10% of controlled foreign corporations (“CFCs”) to the extent the CFCs have “global intangible low-taxed income.” The Tax Act provides a formula for calculating GILTI, which exempts the deemed returns on tangible assets. The GILTI amount is calculated by subtracting the “net deemed tangible income return” from the “net CFC tested income.” The remainder is deemed intangible income subject to income tax. Practically, the GILTI base is determined by subtracting a normal return for the CFC’s foreign depreciable tangible property and taxing a portion of the remainder to the U.S. shareholder.
New IRC Section 250 allows domestic C corporations subject to the GILTI tax to deduct 50 percent of the amount calculated under IRC Section 951A as well as any deemed dividend under IRC Section 78 to the extent attributable to foreign taxes paid on income includible in GILTI. At the new 21% corporate tax rate, this results in an effective tax rate of 10.5% on GILTI (without taking into account the new foreign tax credit). After 2025, the deduction will be reduced to 37.5% of GILTI resulting in an effective tax rate of 13.125% on income includible in GILTI. Amended IRC Section 960 entitles eligible C corporations to a foreign tax credit for 80% of the foreign taxes paid by their CFCs that are paid on income includible in GILTI. Individual U.S. shareholders of CFCs that generate GILTI will not benefit from the forgoing deductions or indirect tax credits.
While the GILTI provisions levy income tax on income derived from intangible assets held abroad, the FDII provision allows U.S. corporations to take a deduction against foreign-derived income treated as attributable to IP and other intangible assets. New IRC Section 250 allows a deduction for eligible C corporations of “37.5 percent of the foreign-derived intangible income.” The FDII benefit is determined based on a multi-step calculation. First, a domestic corporation’s gross income is determined and then reduced by certain items of income. Second, the corporation’s deemed intangible income is determined. And, third, the foreign portion of such income is determined.
FDII generally consists of that portion of a domestic corporation’s net income, excluding GILTI and certain other income, (1) that exceeds a deemed rate of return on the domestic corporation’s tangible depreciable business assets, and (2) that is attributable (i) to certain sales of property to foreign persons, (ii) to the provision of certain services to foreign persons, or (iii) to the provision of services with respect to property not located in the U.S. Again, for the taxable years 2018-25, the FDII deduction is 37.5%. At the new 21% corporate tax rate, this results in an effective tax rate of 13.125% on FDII. After 2025, the FDII deduction will reduce to 21.875%, resulting in an effective tax rate of 16.406%.
U.S. multinational corporations with patents or other IP offshore should assess whether retaining the IP offshore or migrating it to the U.S. produces a better tax result from a global perspective. While the GILTI provisions tax U.S. shareholders on income derived from IP held by controlled foreign corporations, the FDII provision incentivizes U.S. multinationals to retain their IP in the U.S., while encouraging export activity. FDII offers a reduction of the tax rate on income a U.S. corporation earns when it exports goods or services that are performed overseas involving IP owned by the U.S. corporation. FDII is thus comparable to the patent box regimes employed by some other countries. If a U.S. company derives an income from patents held offshore, it has to pay a GILTI tax on the income at a current rate of 10.5%. If the patents are held in the United States, the foreign income would qualify as FDII, and be subject to the effective tax rate of 13.125%.
This analysis, although high-level, gives a general sense of these two new provisions addressing GILTI and FDII. U.S. corporations that perform IP-intensive services overseas should evaluate where their critical IP should reside. In making the decision, the companies should carefully consider the implications of the GILTI and FDII provisions, and the tax laws of the applicable foreign jurisdiction.