Key takeaways

The IRS Office of Chief Counsel advice has implications for businesses performing consulting and other services for US government agencies abroad, clarifying that such services can benefit from the foreign-derived intangible income (FDII) deduction.

In depth

The FDII regime, introduced as part of the Tax Cuts and Jobs Act (TCJA) of 2017, is designed to incentivize US businesses to engage in foreign activities by offering a deduction on income derived from the export of property and services. FDDEI is a key input in the FDII calculation, and section 250 provides rules for determining FDDEI for both property and services transactions. With respect to services, section 250(b)(4)(B) explains that FDDEI is income derived from providing services to any "person" or property located outside the United States. FDII is the deduction taxpayers can claim on a portion of the income that qualifies as FDDEI.

The recent IRS memorandum clarifies that the US government, including its agencies and instrumentalities, can be considered a "person" for purposes of FDII eligibility. The memorandum references existing case law and regulatory guidance, including Supreme Court decisions, to support the interpretation that the US government can qualify as a "person" when determining FDDEI. Therefore, the services provided to the US Department of Defense (DoD) or other federal agencies abroad may qualify for FDDEI, despite the recipient being a part of the US government.

A significant takeaway from this memorandum is that the nationality of the recipient of the services is irrelevant for determining FDDEI eligibility. The regulations emphasize that what matters is the recipient's location outside the United States, which means that services provided to US government employees, contractors, or agents on foreign military bases or other foreign locations fall within the scope of FDDEI.

In the scenario the memorandum addresses, a domestic corporation providing consulting services to US DoD personnel located on a military base in a foreign country ("Country X") is eligible to treat income from these services as FDDEI. This is because the services were provided to a recipient located outside the US, and the US DoD, as a US government agency, can be treated as a "person" under section 250(b)(4)(B).

This interpretation opens the door for companies engaged in various service industries—including consulting, engineering, logistics, and IT—to claim FDII benefits for services provided to US government entities operating abroad. US companies that regularly provide services to government entities stationed or operating outside the US, such as military contractors and consulting firms, may now be eligible for the FDII deduction on income derived from contracts with the US government. This can result in significant tax savings for qualifying companies, enhancing the competitiveness of US businesses in foreign markets.