New proposed regulations for the foreign-derived intangible income (FDII) deduction include strict documentation requirements. A recent KPMG audio conference stressed the importance of obtaining the necessary records.
Only Prescribed Records Can Document FDII
To realize FDII, a taxpayer must:
- provide services to a foreign person, or
- sell property for a foreign use.
The proposed regulations list the only documents that can establish the “foreignness” of FDII transactions.
The participants in the KPMG conference agreed that some taxpayers might have trouble obtaining these documents. However, the proposed regs make it clear that FDII benefits depend on proper documentation.
FDII Documentation Must Be Reliable
FDII documents must be reliable. Documentation is reliable only if the taxpayer does not know or have reason to know that the documentation is unreliable or incorrect, as of the FDII filing date. The FDII filing date is the date the taxpayer’s return for the sale or service is due.
The taxpayer must also obtain the reliable documentation:
- by the FDII filing date,
- but no more than one year before the sale or service that produced the FDII.
Documentation Requirements Don’t Apply to FDDEI Losses
Some taxpayers might be tempted to intentionally fail the FDII documentation requirements for a foreign-derived deduction eligible income (FDDEI) loss. These taxpayers might hope that if the loss is not properly documented, they can avoid taking into account. Ignoring the loss would effectively increase their FDDEI and, therefore, their FDII deduction.
However, the proposed regulations do not allow a taxpayer to intentionally fail the documentation requirements for FDDEI loss transactions. Instead, an improperly documented transaction must be taken into account if:
- it would reduce FDDEI, and
- the taxpayer knows or has reason to know that it is a foreign transaction.
FDII Documentation Exceptions
The FDII documentation requirements in the proposed regulations do not apply to:
- a small business with less than $10 million in annual gross receipts, or
- a small transaction that produces less than $5,000 in gross receipts from a single recipient.
Effective Date for FDII Documentation Requirements
These FDII documentation requirements are proposed to apply to tax years ending on or after March 4, 2019. They will not apply retroactively.
Instead, for tax years beginning on or before that date, taxpayers may use any reasonable documentation that establishes that a transaction involved:
- services provided to a foreign person, or
- property for a foreign use.
Other TCJA Regulations Soon?
Finally, the conference also reviewed the status of some final Tax Cuts and Jobs Act regulations. Participants reported that the government intends to finalize regulations for global intangible low-taxed income (GILTI) by June 22, 2019. If the IRS finalizes the regulations by this date, they can be retroactive.
The government may also re-propose the controversial GILTI rules in Proposed Reg. §1.951A-6 related to adjustments to earnings and profits and basis.
It is not clear, however, when the IRS might finalize proposed regulations for the base erosion and anti-abuse tax (BEAT) and the Code Sec. 163(j) limits on deductible business interest.
Anne E. Bowker, J.D., LL.M.
Sr. Writer Analyst, Wolters Kluwer