Revamp and rebrand of the FDII regime

On July 4, 2025, President Trump signed into law the One Big Beautiful Bill Act (the Act) (P.L. 119-21). The Act made some key changes to the existing foreign-derived intangible income (FDII) deduction regime as tax practitioners have come to know it.

Background

For reference, the FDII deduction, as initially established under the Tax Cuts and Jobs Act of 2017 (TCJA), was intended to encourage export activities by C corporations that are attributable to U.S. intangible assets. FDII is equal to deemed intangible income (DII) multiplied by its foreign-derived ratio, which is foreign-derived deduction eligible income (FDDEI) divided by deduction eligible income (DEI). DEI is generally all gross income of the taxpayer, less certain prescribed exclusions (e.g., global intangible low-taxed income (GILTI), subpart F income and foreign branch income, less deductions properly allocable to such income (including interest and research and development (R&D) expenses). DII is the excess of DEI over the deemed tangible income return (DTIR) or 10% of the taxpayer’s qualified business asset investment (QBAI). DTIR is effectively a substance-based hurdle that was designed to promote an FDII benefit that is attributable to the residual income being generated from a company's intangible assets used in serving foreign markets through U.S. operations as derived through the proxy of a deemed intangible income return (that being eligible income in excess of this hurdle amount). This in turn provides a similar tax incentive to U.S. corporate exporters as provided to U.S. corporations earning income via controlled foreign corporations (CFCs) at a reduced GILTI tax rate, while encouraging investment, creation of jobs and development/retention of IP within the U.S. from an overall domestic tax policy perspective. FDDEI generally includes the gross income of a taxpayer that is from qualified foreign-derived sales and services less allocated and apportioned deductions which, again, inclusive of U.S. interest and R&D expenses. The resulting FDII amount is then multiplied by the FDII deduction percentage, which under TCJA is 37.5% resulting in an effective tax rate of 13.125% on qualifying foreign-derived income.

The Act

Applicable taxpayers should be made aware of the following key changes brought about by the Act that impact upon the application of the FDII regime: (1) the removal of the substance-based hurdle, (2) the exclusion from DEI of any income and gain from the sale or other disposition of intangible property or any other property of a type that is depreciable, amortizable or depletable, (3) a decreased available deduction percentage and (4) a simplification for expense allocation and apportionment. Changes to the regime will mostly apply to taxable years beginning after Dec. 31, 2025, unless otherwise noted.