New IRS regulations issued Monday make it easier for companies to claim a tax break for exporting their made-in-America goods and services.
The release of the regulations gives corporations a first look at what they need to do to claim a new deduction in the 2017 tax overhaul, which could lower their export income tax to about 13% from 21%.
From airlines to defense companies, the Internal Revenue Service clarified that those industries can claim a sizable deduction for the income they earn from selling goods and services made in the United States overseas.
The deduction for foreign derived intangible income, or FDII, was designed to encourage American companies to produce more in the U.S. The law cut the corporate tax rate to 21% from 35% and moved the U.S. toward a territorial tax system, so companies don’t owe the full U.S. tax rate on foreign income.
The FDII provision works in tandem with the levy on global intangible low-taxed income, or GILTI, which taxes profits made in countries that didn’t tax them in the first place.
Designers of the Republican tax law hoped the two measures would level the playing field. Since it was enacted, companies pay roughly the same amount of tax on exports made in the U.S. as they do on profits earned offshore.
So far, the FDII deduction hasn’t stopped U.S. manufacturers from moving overseas. Motorcycle manufacturer Harley Davidson announced in May that it will build a plant in Thailand to sell in Asian markets. General Motors Co. said in November that it would close four factories in the U.S. by the end of 2019. The carmaker plans to shift some production to Mexico.
“Companies are not necessarily changing their whole mode of operation to take advantage of it,” said Derek Schraw, a partner at accounting firm Deloitte Tax. “If companies are going to move their intellectual property, people or business, it’s going to be for business considerations as opposed to tax purposes.”
FDII could also face a challenge. Tax professionals disagree about whether the measure is compliant with World Trade Organization rules, so another country could try to get the U.S. to repeal or modify the measure.
“There is still a concern that WTO foreign trading partners will continue to challenge FDII as an illegal export subsidy,” said Larry LeBlanc, a partner at accounting firm RSM.
Such a challenge would likely take years to resolve, and any repeal is not likely to be retroactive, so companies can expect to benefit in the interim.
Corporations are double-checking their supply chains to make sure they can qualify for the $63.8 billion tax break in President Donald Trump’s tax law.
The rules clarify that defense contractors can get the deduction when they sell to foreign governments, a point that had confused the industry. Federal law requires them to sell weapons and missile defense systems through the Department of Defense instead of directly to the buyer.
The substantial tax break has encouraged companies, such as retailers that manufacture domestically and sell overseas, to make sure that their exports qualify for the deduction, LeBlanc said.
The IRS rules also matter to companies that provide transport services, such as United Continental Holdings Inc. The airline asked the Treasury Department in September to clarify that the deduction applies to services offered while in transit between two countries. The rules say U.S. airlines can get the full deduction on flights that begin and end in foreign countries. Half of the income from flights that either originate or terminate in the U.S. qualify for the tax break.
The IRS also made the tax burden a little lighter for individuals who choose to be treated like a corporation for tax purposes. Individuals can gain access to the benefits of the new international tax system, but it comes with a cost. Those tax breaks come with significantly more paperwork, a function of how the tax code treats individuals who want to pay the lower corporate rates, John Harrington a partner at Dentons in Washington and chair of the Bloomberg Tax International Advisory Board.
FDII has received much less attention than GILTI from corporate tax accountants in the months following the tax law’s passage, said Jonathan Brenner, a member at law firm Caplin and Drysdale. Companies have been more focused on GILTI because it takes away something they used to have -- the ability to defer taxes on offshore cash indefinitely and now requires them to pay at least some tax on those profits.
By Laura Davison and Siri Bulusu