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BEPS

EU Intensifies Criticism of U.S. Section 250 Deduction for FDII

Jessica Silbering-Meyer  

Jessica Silbering-Meyer  

On May 6, 2019, the EU Delegation to the U.S. published comments regarding the deduction for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI) under the Proposed Regulations (REG-104464-18) under Internal Revenue Code (IRC) section 250. The Proposed Regulations were published in the Federal Register on March 6, 2019.

After the U.S. Tax Cuts and Jobs Act (TCJA), income earned directly by a U.S. corporation is subject to tax at 21%. Absent a deduction with respect to intangible income attributable to foreign market activity earned directly by a domestic corporation, the lower effective tax rate applicable to GILTI under section 250 would provide an incentive for domestic corporations to allocate intangible income to CFCs formed in low- or zero-tax jurisdictions. Therefore, to neutralize the effect of providing a lower U.S. effective tax rate with respect to the active earnings of a CFC of a domestic corporation through a deduction for GILTI, section 250 provides a lower effective U.S. tax rate with respect to FDII earned directly by the U.S. corporation through a deduction of 37.5 percent for taxable years beginning after December 31, 2017 and before January 1, 2026.

According to the EU Delegation, section 250 and the Proposed Regulations on FDII are “(1) most likely breaching US obligations under the World Trade Organization (WTO) and other international obligations, and (2) not fit to reduce tax avoidance and aggressive tax planning.” The Delegation noted that since the tax treatment of FDII provides a tax deduction to U.S. corporations that is directly linked to exports of goods and services, and U.S. corporations that earn income from domestic sales of the same goods and services are not afforded the same benefit, the FDII tax deduction is “most likely” a prohibited export subsidy and in conflict with U.S. treaty obligations.

In addition, the Delegation noted that the FDII provisions are broader than targeted R&D tax credits, which apply only to specific types of R&D expenditure. “The FDII applies to exports and rewards outputs irrespective of innovation, rather than subsidising R&D inputs.”

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