# Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2019-03848 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** March 6, 2019 - **Citation:** 84 FR 8188 ## Text DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [REG-104464-18] RIN 1545-BO55 Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Notice of proposed rulemaking. SUMMARY: This document contains proposed regulations that provide guidance to determine the amount of the deduction for foreign-derived intangible income and global intangible low-taxed income. This document also contains proposed regulations coordinating the deduction for foreign-derived intangible income and global intangible low-taxed income with other provisions in the Internal Revenue Code. DATES: Written or electronic comments and requests for a public hearing must be received by May 6, 2019. ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-104464-18), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-104464-18), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC 20224. Alternatively, taxpayers may submit comments electronically via the Federal eRulemaking Portal at http://www.regulations.gov (REG-104464-18). FOR FURTHER INFORMATION CONTACT: Concerning proposed §§ 1.250(a)-1 through 1.250(b)-6, 1.962-1, 1.6038-2, 1.6038-3, and 1.6038A-2, Kenneth Jeruchim at (202) 317-6939; concerning proposed §§ 1.1502-12, 1.1502-13 and 1.1502-50, Michelle A. Monroy at (202) 317-5363 or Austin Diamond-Jones at (202) 317-6847; concerning submissions of comments and requests for a public hearing, Regina L. Johnson, (202) 317-6901 (not toll free numbers). SUPPLEMENTARY INFORMATION: Background This document contains proposed amendments to 26 CFR part 1 under sections 250, 962, 1502, 6038, and 6038A (“proposed regulations”). Section 14202(a) of the Tax Cuts and Jobs Act, Public Law 115-97 (2017) (the “Act”), added section 250 to the Internal Revenue Code (the “Code”). 1 The new section provides a domestic corporation with a deduction (“section 250 deduction”) for its foreign-derived intangible income (“FDII”) and its global intangible low-taxed income (“GILTI”) and the amount treated as a dividend under section 78 which is attributable to its GILTI. Section 14202(c) of the Act provides that section 250 and the conforming amendments in section 14202(b) apply to taxable years beginning after December 31, 2017. 1 Except as otherwise stated, all section references in this preamble are to the Internal Revenue Code. Section 14201(a) of the Act (codified in section 951A) requires a United States shareholder (“U.S. shareholder”) of any controlled foreign corporation (“CFC”) for any taxable year to include in gross income the shareholder's GILTI for the year. The Department of the Treasury (“Treasury Department”) and the IRS published a separate notice of proposed rulemaking that provides guidance to U.S. shareholders on how to determine the amount of GILTI to include in gross income. See 83 FR 51072 (Oct. 10, 2018). Section 14302(a) of the Act also added a new foreign tax credit category for foreign branch income (defined in section 904(d)(2)(J)), which is cross-referenced in section 250(b)(3)(A)(i)(VI). The Treasury Department and the IRS published a separate notice of proposed rulemaking that provides rules for determining a corporation's foreign branch income for purposes of section 904. See 83 FR 63200 (Dec. 7, 2018). Explanation of Provisions I. Overview of Proposed Regulations In general, income earned directly by a U.S. person on foreign business income is subject to U.S. tax on a current basis. Before the Act, foreign business income earned indirectly by a U.S. person through a foreign corporation was not generally subject to U.S. tax until such income was distributed as a dividend to the U.S. person. Certain anti-deferral regimes could cause the U.S. owner to be taxed on a current basis in the United States regardless of whether the income had been distributed as a dividend to the U.S. owner. Sections 951 through 965 of the Code (generally referred to as the “subpart F” provisions), applicable to certain passive and mobile categories of income earned by CFCs, is the main anti-deferral regime of relevance to U.S.-based corporate groups. However, because subpart F does not generally apply to active foreign business income of a CFC (as defined in section 957(a)), U.S. shareholders before the Act could indefinitely defer U.S. taxation with respect to their foreign business income—in particular, mobile income arising from the exploitation of intangible property—by allocating such income to its CFCs operating in low- or zero-tax jurisdictions. This system of deferral, in turn, resulted in a “lock-out effect,” whereby U.S. shareholders that had allocated income to CFCs formed in low- or zero-tax jurisdictions could not repatriate such income to the United States without incurring significant U.S. tax. In order to facilitate the efficient redeployment of foreign earnings in the United States, the Act established a participation exemption system under which certain earnings of a foreign corporation can be repatriated to a corporate U.S. shareholder without U.S. tax. See section 14101(a) of the Act and section 245A. However, Congress recognized that, without any base protection measures, the participation exemption system could further incentivize taxpayers to allocate intangible income to CFCs formed in low- or zero-tax jurisdictions because the earnings related to such intangible income could now be repatriated to the United States without incurring any U.S. tax. See Senate Committee on the Budget, 115th Cong., “Reconciliation Recommendations Pursuant to H. Con. Res. 71,” at 370 (Comm. Print 2017) (“Senate Explanation”). Therefore, Congress enacted section 951A, which subjects a U.S. shareholder's “global intangible low-taxed income” or “GILTI” (a new term created by the Act) derived through its CFCs to U.S. tax on a current basis, similar to the taxation of such CFCs' subpart F income under section 951(a)(1)(A). Most member countries of the Organisation for Economic Co-operation and Development (“OECD”) provide a full or partial ( e.g., 95 percent) participation exemption with respect to income of foreign subsidiaries distributed to domestic shareholders. See OECD (2018), Tax Policy Reforms 2018: OECD and Selected Partner Economies, at 73, OECD Publishing, Paris (Sept. 2018). While some countries also have CFC inclusion regimes similar to subpart F that subject certain narrow classes of income of foreign subsidiaries to current tax in the home country, many countries do not subject active foreign business income of foreign subsidiaries to current tax. Congress recognized that taxing such income at the full U.S. corporate tax rate could hurt the competitive position of U.S. corporations relative to their foreign peers, and therefore determined that GILTI earned by such corporations should be subject to a reduced effective U.S. tax rate. See Senate Explanation, at 370. Accordingly, Congress enacted section 250, which provides corporate U.S. shareholders a deduction of 50 percent for taxable years beginning after December 31, 2017, and before January 1, 2026, with respect to their GILTI, and the amount treated as a dividend under section 78 which is attributable to their GILTI (“section 78 gross-up”). In contrast, a domestic corporation's inclusion of its CFCs' subpart F income is not eligible for the section 250 deduction, and is therefore generally subject to U.S. tax at the full corporate rate. After the Act, income earned directly by a domestic corporation is subject to a 21 percent rate. 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 by reason of the section 250 deduction would perpetuate the pre-Act 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 “foreign-derived intangible income” or “FDII” (a new term created by the Act) earned directly by the domestic corporation through a deduction of 37.5 percent for taxable years beginning after December 31, 2017, and before January 1, 2026. The result of the section 250 deduction for both GILTI and FDII is to help neutralize the role that tax considerations play when a domestic corporation chooses the location of intangible income attributable to foreign-market activity, that is, whether to earn such income through its U.S.-based operations or through its CFCs. The proposed regulations provide guidance for determining the amount of the section 250 deduction allowed to a domestic corporation for its FDII and GILTI. Proposed § 1.250(a)-1 provides rules for determining the amount of the deduction, including rules for applying the taxable income limitation of section 250(a)(2). Proposed § 1.250(b)-1 provides general rules for computing a domestic corporation's FDII. Proposed § 1.250(b)-2 provides rules for determining a domestic corporation's qualified business asset investment (“QBAI”), which is a component of the computation of FDII. Proposed § 1.250(b)-3 provides general rules for determining gross income included in gross foreign-derived deduction eligible income (“gross FDDEI”), which is a component of the computation of FDII. Proposed § 1.250(b)-4 provides rules for determining gross FDDEI from sales of property. Proposed § 1.250(b)-5 provides rules for determining gross FDDEI from the provision of a service. Proposed § 1.250(b)-6 provides rules relating to the sale of property or the provision of a service to a related party. II. Amount of Deduction Allowed Under Section 250(a) Proposed § 1.250(a)-1 provides general rules to determine the amount of a domestic corporation's section 250 deduction and associated definitions that apply for purposes of the proposed regulations. The section 250 deduction is available only to domestic corporations. See section 250(a)(1) and proposed § 1.250(a)-1(b)(1). For this purpose, the term “domestic corporation” has the meaning set forth in section 7701(a)—an association, joint-stock company, or insurance company created or organized in the United States or under the law of the United States or of any State—but does not include a regulated investment company (as defined in section 851), a real estate investment trust (as defined in section 856), or an S corporation (as defined in section 1361). See proposed § 1.250(a)-1(c)(1). The section 250 deduction is not available to individuals except in certain cases where an individual makes an election under section 962. See part IV of this Explanation of Provisions section for more information about that provision. As discussed in part I of this Explanation of Provisions section, the deduction under section 250 is generally intended to reduce the effective rate of U.S. income tax on FDII and GILTI in order to help neutralize the role that tax considerations play when a domestic corporation chooses the location of intangible income attributable to foreign-market activity. There is no indication that Congress intended the section 250 deduction to reduce the effective rate of tax imposed by non-income tax provisions outside of chapter 1 of the Internal Revenue Code. Accordingly, for purposes of the excise tax imposed by section 4940(a), the proposed regulations provide that a section 250 deduction is not treated as an ordinary and necessary expense paid or incurred for the production or collection of gross investment income within the meaning of section 4940(c)(3)(A). See proposed § 1.250(a)-1(b)(4). The section 250 deduction is subject to a taxable income limitation. If, for any taxable year, the sum of a domestic corporation's FDII and GILTI exceeds its taxable income, the excess is allocated pro rata to reduce the corporation's FDII and GILTI solely for purposes of computing the amount of the section 250 deduction. See section 250(a)(2) and proposed § 1.250(a)-1(b)(2). For this purpose, a domestic corporation's taxable income is determined without regard to the section 250 deduction. See section 250(a)(2)(A)(ii) and proposed § 1.250(a)-1(c)(4). The Code does not otherwise define “taxable income” for purposes of applying the taxable income limitation of section 250(a)(2). In general, a taxpayer's taxable income is based, in part, upon the availability, and proper calculation, of deductions. However, multiple Code provisions simultaneously limit the availability of a deduction based, directly or indirectly, upon a taxpayer's taxable income, including sections 163(j)(1) (limiting a deduction for business interest) and 172(a)(2) (limiting a net operating loss deduction). Sections 163(j)(2) and 172(b) also provide that any deduction not allowed to a taxpayer for a taxable year by reason of the limitation in section 163(j)(1) or 172(a)(2), respectively, may be allowed to the taxpayer, subject to the same limitation, in its succeeding taxable year. A taxpayer's net operating loss for a taxable year is determined without regard to the section 250 deduction (see section 172(d)(9)), and a taxpayer's adjusted taxable income is determined without regard to section 172. See section 163(j)(8)(A)(iii). However, neither section 163(j) nor section 250 prescribes an ordering rule with respect to the other provision. The Treasury Department and the IRS considered proposing computations requiring the use of simultaneous equations in lieu of an ordering rule but determined that an approach that requires such computations would result in undue administrative and compliance burdens. Therefore, the proposed regulations provide an ordering rule for applying sections 163(j) and 172 in conjunction with section 250 that the Treasury Department and the IRS have determined is consistent with the statutory language for each provision. Specifically, the proposed regulations provide that a domestic corporation's taxable income for purposes of applying the taxable income limitation of section 250(a)(2) is determined after all of the corporation's other deductions are taken into account. See proposed § 1.250(a)-1(c)(4). Accordingly, a domestic corporation's taxable income for purposes of section 250(a)(2) is its taxable income determined without regard to section 250, but taking into account the application of sections 163(j) and 172(a), including amounts permitted to be carried forward to such taxable year by reason of sections 163(j)(2) and 172(b). Proposed regulations issued under section 163(j) provide guidance on the interaction of sections 163(j) and 250 that the Treasury Department and the IRS consider to be consistent with these proposed regulations under section 250. See 83 FR 67490 (Dec. 28, 2018). Specifically, the proposed regulations under section 163(j) provide that, for purposes of determining the limitation under section 163(j), a deduction under section 250(a)(1) that is properly allocable to a non-excepted trade or business is taken into account in determining a taxpayer's taxable income and thus its adjusted taxable income. See proposed § 1.163(j)-1(b)(37)(ii). However, for this purpose, the taxpayer's deduction under section 250(a)(1) is determined without regard to the limitations under sections 250(a)(2) and 163(j). See id. As a result of these proposed regulations under section 250 and the proposed regulations under section 163(j), a domestic corporation's allowable business interest under section 163(j), its net operating loss deduction under section 172(a), and its section 250 deduction are determined in the following manner: First, a domestic corporation computes the tentative amount of its FDII and the tentative amount of its section 250 deduction (“tentative section 250 deduction”) taking into account all deductions, but without regard to any carryforwards or disallowances under section 163(j), the amount of any net operating loss deduction under section 172(a), or the taxable income limitation of section 250(a)(2) and proposed § 1.250(a)-1(b)(2). Second, the corporation computes the amount of its business interest allowed after the application of section 163(j), for this purpose taking into account the amount of its tentative section 250 deduction but without regard to the amount of any net operating loss deduction under section 172(a). See section 163(j)(8)(A)(iii) and proposed § 1.163(j)-1(b)(1)(i)(B) and (b)(37)(ii). Third, the corporation computes the amount of its net operating loss deduction under section 172(a), for this purpose taking into account the amount of its business interest allowed after application of section 163(j) and the taxable income limitation of section 172(a)(2), but without regard to the amount of its section 250 deduction (including its tentative section 250 deduction). See section 172(d)(9). Fourth, the corporation computes the amount of its FDII, for this purpose taking into account the amount of its business interest allowed after application of section 163(j) and the amount of its net operating loss deduction under section 172(a) (determined in steps two and three, respectively). See part III(A)(2) of this Explanation of Provisions section for a discussion on the allocation of deductions to gross DEI and gross FDDEI. Fifth, the corporation computes the amount of its section 250 deduction after the application of the taxable income limitation of section 250(a)(2) and proposed § 1.250(a)-1(b)(2), for this purpose taking into account the amount of its business interest allowed after application of section 163(j) and the amount of its net operating loss deduction under section 172(a). See proposed § 1.250(a)-1(f)(2) ( Example 2 ), which illustrates the interaction of sections 163(j), 172, and 250. The Treasury Department and the IRS request comments on the proposed ordering rule, as well as how the section 250 deduction should be accounted for in determining adjusted taxable income at the partnership level under section 163(j)(4)(A). III. Determination of FDII A. General Computational Rules 1. In General A domestic corporation's FDII is the corporation's deemed intangible income (“DII”) multiplied by the corporation's foreign-derived ratio. Proposed § 1.250(b)-1(b). A domestic corporation's DII is the excess (if any) of the corporation's deduction eligible income (“DEI”) over its deemed tangible income return (“DTIR”). Proposed § 1.250(b)-1(c)(3). A domestic corporation's DTIR is 10 percent of the corporation's QBAI. Proposed § 1.250(b)-1(c)(4). The foreign-derived ratio is the domestic corporation's ratio of foreign-derived deduction eligible income (“FDDEI”) to DEI. Proposed § 1.250(b)-1(c)(13). 2. Determination of DEI and FDDEI A domestic corporation's DEI is the excess of its gross income without regard to certain excluded items (“gross DEI”) over the deductions properly allocable to gross DEI. See proposed § 1.250(b)-1(c)(2). Gross DEI excludes six categories of gross income: any amount included in gross income under section 951(a), GILTI, financial services income, dividends from CFCs, domestic oil and gas extraction income, and foreign branch income. See proposed § 1.250(b)-1(c)(14). The proposed regulations clarify that, for this purpose, a dividend includes any amount treated as a dividend under any other provision of subtitle A of the Internal Revenue Code, including the section 78 gross-up attributable to inclusions under sections 951(a) and 951A(a). See proposed § 1.250(b)-1(c)(5). In addition, the proposed regulations define foreign branch income by reference to proposed § 1.904-4(f), except that it also includes the sale, directly or indirectly, of any asset (other than stock) that produces gross income attributable to a foreign branch, including by reason of the sale of a disregarded entity or partnership interest. See proposed § 1.250(b)-1(c)(11). The result is that income from the sale of any such asset is not included in gross DEI. For purposes of calculating the foreign-derived ratio, FDDEI is the excess of gross FDDEI over deductions properly allocable to gross FDDEI. See proposed § 1.250(b)-1(c)(12). The proposed regulations define gross FDDEI as the portion of a corporation's gross DEI that is derived from all of its “FDDEI sales” and “FDDEI services” (collectively, “FDDEI transactions”). See proposed § 1.250(b)-1(c)(8), (9), (10), and (15). The determination of whether a sale of property or a provision of a service is a FDDEI sale or a FDDEI service, respectively, is made under the provisions of proposed §§ 1.250(b)-3 through 1.250(b)-6. See part III(B) through (F) of this Explanation of Provisions section. The portion of a corporation's gross DEI that is not gross FDDEI is referred to as gross non-FDDEI. See proposed § 1.250(b)-1(c)(16). Therefore, all income included in gross DEI is included in either gross FDDEI or gross non-FDDEI, and all income included in either gross FDDEI or gross non-FDDEI is included in gross DEI. In the case of property produced or acquired for resale, gross income is generally determined by subtracting cost of goods sold from gross sales receipts. In determining the amount of gross income included in gross DEI or gross FDDEI, cost of goods sold is attributed to gross receipts with respect to gross DEI and gross FDDEI using any reasonable method. See proposed § 1.250(b)-1(d)(1). The proposed regulations clarify that cost of goods sold that is associated with activities undertaken in an earlier taxable year cannot be segregated into component costs and attributed disproportionately to amounts excluded from gross FDDEI or to amounts excluded from gross DEI. See id. This is similar to the clarification in proposed § 1.199-4(b)(2)(iii)(A) and is intended to preclude a method that attributes cost of goods sold of an inventory item to gross receipts other than gross receipts included in the computation of gross DEI or gross FDDEI if the gross receipts from the sale of that item are included in the computation of amounts included in the computation of gross DEI or gross FDDEI, respectively. See 80 FR 51978, 51990 (Aug. 27, 2015). The Treasury Department and the IRS request comments on whether there are alternative approaches for dealing with timing issues, and whether additional rules should be provided for attributing cost of goods sold in determining gross DEI and gross FDDEI. Cf. § 1.199-4(b)(2) through (6). Section 250(b)(3)(A) defines DEI as the excess of a domestic corporation's gross income (excluding certain items) over “the deductions (including taxes) properly allocable to such gross income.” FDDEI is defined as “any deduction eligible income” of the taxpayer generated through foreign-market sales and services. See section 250(b)(4). Therefore, a taxpayer's deductions that are “properly allocable” to gross DEI and gross FDDEI must be determined for purposes of calculating its DEI and FDDEI. The statute does not specify how deductions should be allocated for purposes of determining DEI and FDDEI. However, the rules set forth in §§ 1.861-8 through 1.861-14T and 1.861-17 apply for purposes of several other provisions in the Code which require the determination of taxable income from specific sources or activities, for example, for purposes of determining the foreign tax credit limitation under section 904 or qualified production activities income under former section 199. See generally §§ 1.199-4 and 1.861-8(f)(1). Accordingly, the proposed regulations provide that the rules set forth in §§ 1.861-8 through 1.861-14T and 1.861-17 apply for purposes of determining DEI and FDDEI. See proposed § 1.250(b)-1(d)(2)(i). In order to avoid circularity, in applying those rules for purposes of determining DEI and FDDEI, the section 250 deduction is not treated as giving rise to exempt income or assets. See proposed § 1.861-8(d)(2)(ii)(C)( 4 ). Comments are requested on whether alternative approaches should be considered or additional rules are needed for purposes of allocating and apportioning a net operating loss deduction to gross DEI and gross FDDEI. In certain circumstances, as a result of expense apportionment or attribution of cost of goods sold, a domestic corporation's FDDEI could exceed its DEI. For example, a domestic corporation could have $80x of DEI and $100x of FDDEI, with losses attributable to domestic market sales accounting for the $20x difference between DEI and FDDEI. However, it would be inconsistent with the statutory language to treat a domestic corporation as having a foreign-derived ratio in excess of one, and therefore FDII in excess of DII. In particular, section 250(b)(4) defines FDDEI as a subset of DEI, that is, “any deduction eligible income of such taxpayer which is derived in connection with” certain transactions. Therefore, the proposed regulations clarify that the foreign-derived ratio cannot exceed one. See proposed § 1.250(b)-1(c)(13). 3. Treatment of Partnerships Section 250(a)(1) allows a deduction to a domestic corporation, but does not provide any rules for domestic corporations that are partners in a partnership. However, the conference report accompanying the Act (“Conference Report”) suggests that Congress intended that a domestic corporate partner of a partnership receive the benefit of a section 250 deduction for its FDII and GILTI. See H. Rept. 115-466, at 623, fn. 1517 (2017) (Conf. Rep.) (“The Committee intends that the deduction allowed by new Code section 250 be treated as exempting the deducted income from tax. Thus, for example, the deduction for global intangible low-taxed income could give rise to an increase in a domestic corporate partner's basis in a domestic partnership under section 705(a)(1)(B).”). The proposed regulations give effect to this legislative intent by adopting an aggregate approach to partnerships for determining a domestic corporate partner's FDII attributable to the income and assets of a partnership. Specifically, the proposed regulations provide that a domestic corporate partner of a partnership takes into account its distributive share of a partnership's gross DEI, gross FDDEI, and deductions in order to calculate the partner's FDII. See proposed § 1.250(b)-1(e)(1). In addition, for purposes of determining a domestic corporate partner's DTIR, a domestic corporation's QBAI is increased by its share of the partnership's adjusted basis in partnership specified tangible property. See proposed § 1.250(b)-2(g). Under the proposed regulations, the section 250 deduction is computed and allowed solely at the level of a domestic corporate partner. The Conference Report in footnote 1517 suggests that the section 250 deduction could give rise to an increase in a domestic corporate partner's basis in a domestic partnership under section 705(a)(1)(B) because some of the partnership's income may be treated as exempt income by reason of section 250. However, regardless of whether the deduction gives rise to exempt income in other contexts, because the section 250 deduction is computed and allowed solely at the level of a domestic corporate partner, the section 250 deduction does not exempt the deducted income from tax for purposes of applying section 705(a)(1)(B). As a result, a basis adjustment to a domestic corporate partner's interest in a domestic partnership is not appropriate to account for a section 250 deduction. 4. Treatment of Tax-Exempt Corporations A domestic corporation that is subject to the unrelated business income tax under section 511 may claim a section 250 deduction. However, the proposed regulations clarify that such corporation's FDII for this purpose is determined only with respect to the corporation's items of income, gain, deduction, or loss, and adjusted bases in property, that are taken into account in computing its unrelated business taxable income. See proposed § 1.250(b)-1(g). The proposed regulations also clarify how a tax-exempt corporation subject to the unrelated business income tax under section 511 computes the dual use ratio with respect to property used in the production of gross DEI and income that is not gross DEI for purposes of determining its QBAI. See id. 5. Determination of QBAI Section 250(b)(2)(B) provides that QBAI for purposes of section 250 is defined under section 951A(d), and is determined by substituting “deduction eligible income” for “tested income” and without regard to whether the corporation is a CFC. Accordingly, the determination of QBAI for purposes of FDII is similar to the determination of QBAI for purposes of GILTI. Compare proposed § 1.951A-3 with proposed § 1.250(b)-2. A domestic corporation's QBAI for FDII is equal to its aggregate average adjusted bases in specified tangible property, which is defined as tangible property used in the production of gross DEI. See proposed § 1.250(b)-2(b) and (c). The proposed regulations also provide rules for dual use property, calculating QBAI in a short taxable year, and calculating a domestic corporate partner's share of partnership QBAI. See proposed § 1.250(b)-2(d), (f), and (g). In order to prevent the avoidance of the purposes of QBAI, the proposed regulations disregard certain transfers of specified tangible property by a domestic corporation to a related party where the corporation continues to use the property in production of gross DEI. See sections 250(c) and 951A(d)(4). Specifically, for purposes of calculating a domestic corporation's QBAI, the proposed regulations disregard a transfer of specified tangible property by the domestic corporation to a related party (whose QBAI would not be taken into account in calculating the corporation's DTIR) if, within a two-year period beginning one year before the transfer, the domestic corporation (or a related party whose QBAI would be taken into account in calculating the corporation's DTIR) leases the same or substantially similar property from a related party and such transfer and lease occur pursuant to a principal purpose of reducing the domestic corporation's DTIR. See proposed § 1.250(b)-2(h)(1) and (h)(4)(i) through (iv). A transfer and lease described in the preceding sentence is treated per se as occurring pursuant to a principal purpose of reducing a domestic corporation's DTIR if both the transfer and the lease occur within the same six-month period. See proposed § 1.250(b)-2(h)(3). If the anti-avoidance rule applies, the domestic corporation that transferred the property is treated as owning such property from the later of the beginning of the term of the lease or date of the transfer until the earlier of the end of the term of the lease or the end of the recovery period of the transferred property. See proposed § 1.250(b)-2(h)(1). The anti-avoidance rule does not apply to a transfer to and lease from an unrelated party, unless the transfer to and lease from the unrelated party is pursuant to a structured arrangement. See proposed § 1.250(b)-2(h)(2). A structured arrangement exists only if either a reduction in the domestic corporation's DTIR is a material factor in the pricing of the arrangement with the transferee or, based on all the facts and circumstances, the reduction in the domestic corporation's DTIR is a principal purpose of the arrangement. See id. The proposed regulations provide a non-inclusive list of facts and circumstances indicating that a principal purpose of an arrangement is the reduction of DTIR. See proposed § 1.250(b)-2(h)(2)(ii)(A) through (D). The Treasury Department and the IRS welcome comments on alternative approaches to identifying a structured arrangement involving unrelated parties. No inference is intended regarding the application of any other Code section or judicial doctrine that may apply to affect the determination of FDII and its components. B. General Rules for FDDEI Transactions 1. Definitions of Sale, Foreign Person, and United States Proposed § 1.250(b)-3 provides rules relevant to determining whether a sale of property is a FDDEI sale and whether a provision of a service is a FDDEI service. Section 250(b)(5)(E) provides that for purposes of section 250(b), the term “sale” includes any lease, license, exchange, or other disposition. Accordingly, for purposes of determining whether a sale of property is a FDDEI sale, the proposed regulations define “sale” to include a lease, license, exchange, or other disposition of property, including a transfer of property resulting in gain or an income inclusion under section 367. See proposed § 1.250(b)-3(b)(7). The proposed regulations define a foreign person as a person that is not a United States person, which includes a foreign government or international organization for purposes of the proposed regulations. See proposed § 1.250(b)-3(b)(2). A United States person (“U.S. person”) has the same meaning as under section 7701(a)(30), except that an individual that is a bona fide resident of a U.S. territory within the meaning of section 937(a) is excluded. See proposed § 1.250(b)-3(b)(10). While corporations formed in U.S. territories are generally treated as foreign corporations, under section 7701(a)(30), U.S. persons include all U.S. citizens or residents, regardless of whether they reside in a U.S. territory. However, a bona fide resident of a U.S. territory is generally exempt from U.S. tax on income sourced in that territory. See sections 931(a), 932(c)(4), 933(1), and 935. Therefore, to prevent the disparate treatment of sales to entities in a U.S. territory (potentially qualifying as a FDDEI sale) and sales to individuals in a U.S. territory (not qualifying as a FDDEI sale), the proposed regulations exclude bona fide residents of a U.S. territory from the definition of U.S. person. A partnership is generally a “person” for purposes of the Code. See section 7701(a)(1). Accordingly, in determining whether a sale of property to or by a partnership qualifies as a FDDEI sale, or the provision of a service to or by a partnership qualifies as a FDDEI service, the proposed regulations treat a partnership as a person. See proposed § 1.250(b)-3(g). Therefore, for example, a sale of property to a foreign partnership for a foreign use may constitute a FDDEI sale because such sale is to a foreign person, whereas a sale of property to a domestic partnership, even if for a foreign use, will not constitute a FDDEI sale because such sale is to a domestic person. The Treasury Department and the IRS request comments on whether there are circumstances where it would be appropriate to treat a partnership as an aggregate of its partners for purposes of determining whether a sale of property or a provision of a service to a partnership is a sale or service to a foreign person. The proposed regulations provide that the term “United States” generally has the meaning described in section 7701(a)(9). See proposed § 1.250(b)-3(b)(9). However, with respect to mines, oil and gas wells, and other natural deposits, the term United States includes certain seabed and subsoil of submarine areas adjacent to the territorial waters of the United States, as described in section 638(1). See id. 2. Foreign Military Sales The Treasury Department and the IRS recognize that the statute is unclear as to whether a sale of property or the provision of a service to the U.S. government for resale or on-service to a foreign government under the Arms Export Control Act of 1976, as amended (22 U.S.C. 2751 et seq. ), may qualify for the section 250 deduction. In general, the Arms Export Control Act governs the export of certain sales and services to foreign governments. Under the Arms Export Control Act, a seller or service provider provides sales or services to the U.S. government that are for the ultimate benefit of a foreign government. The concern is that such sale or service to the U.S. government governed by the Arms Export Control Act is not a sale to a “person who is not a United States person” within the meaning of section 250(b)(4)(A) or a service to a “person not located within the United States” within the meaning of section 250(b)(4)(B), notwithstanding that such a sale or service is ultimately provided to the foreign government. The proposed regulations provide that, for purposes of section 250, a sale of property or the provision of a service to the U.S. government under the Arms Export Control Act of 1976 is treated as a sale of property or provision of a service to a foreign government. See proposed § 1.250(b)-3(c). See part I(D)(3) of the Special Analyses section for additional discussion regarding the analysis for the adoption of this rule. As discussed in part III(B)(1) of this Explanation of Provisions section, a foreign government or international organization is a foreign person for purposes of section 250 and the proposed regulations. See proposed § 1.250(b)-3(b)(2). Therefore, a sale of property or provision of a service to the U.S. government under the Arms Export Control Act may qualify as a FDDEI transaction if the other requirements under proposed §§ 1.250(b)-3 through 1.250(b)-6 are satisfied. To the extent other requirements under proposed §§ 1.250(b)-3 through 1.250(b)-6 are not satisfied, a sale or service will not qualify as a FDDEI transaction regardless of whether such sale or service is pursuant to the Arms Export Control Act. The Treasury Department and the IRS have not currently identified readily available documentation sufficient to demonstrate that a particular sale or service was made pursuant to the Arms Export Control Act. Comments are requested on whether final regulations should provide guidance on how taxpayers can demonstrate that a sale or service has been made pursuant to the Arms Export Control Act. 3. Knowledge and Reason To Know As discussed in part III(C) of this Explanation of Provisions section, the proposed regulations provide that a sale of property qualifies as a FDDEI sale only if the seller or renderer does not know or have reason to know that the recipient is not a foreign person or that the property will not be for a foreign use. See proposed § 1.250(b)-4(c), (d), and (e). In addition, as discussed in part III(D) of this Explanation of Provisions section, the proposed regulations provide that the provision of a general service (as defined in proposed § 1.250(b)-5(c)(4)) qualifies as a FDDEI service only if the renderer of the service does not know or have reason to know that the recipient is located within the United States. See proposed § 1.250(b)-5(d)(1) and (e)(1). The terms “know” and “reason to know” are used throughout the Code and Treasury regulations. The Treasury Department and the IRS request comments regarding whether definitions of “know” and “reason to know” are necessary for purposes of the section 250 regulations. 4. Reliability of Documentation In order for a transaction to constitute a FDDEI transaction, the proposed regulations prescribe different types of documentation that are required to be obtained for each type of transaction. For example, in the case of a sale of property, the seller must obtain documentation that establishes the recipient's status as a foreign person. See proposed § 1.250(b)-4(c)(2). See parts III(C) and III(D) of this Explanation of Provisions section for an explanation of the documentation requirements in these proposed regulations; see also part II of the Special Analyses section for a discussion of the Paperwork Reduction Act. The proposed regulations provide that, for any documentation described in the proposed regulations to be relied upon, the seller or renderer must obtain the documentation by the FDII filing date, the documentation must be obtained no earlier than one year before the sale or service, and the seller or renderer must not know or have reason to know that the documentation is incorrect or unreliable. See proposed § 1.250(b)-3(d); see also proposed § 1.250(b)-3(b)(1) (defining the term “FDII filing date”). For this purpose, a seller or renderer has reason to know that documentation is unreliable or incorrect if its knowledge of all the relevant facts or statements contained in the documentation is such that a reasonably prudent person in the position of the seller or renderer would question the accuracy of the documentation. See proposed § 1.250(b)-3(d)(1). The Treasury Department and the IRS welcome comments on the documentation requirements in the proposed regulations. 5. Transactions Consisting of Both Sales and Services Under section 250(b)(4) and (5) and these proposed regulations, the criteria for establishing that a transaction is foreign-derived is different for sales and services. For example, a transaction with a U.S. person that is located outside of the United States may qualify as a FDDEI service, but cannot qualify as a FDDEI sale. Because a transaction might include elements of both a sale and a service, the proposed regulations clarify that a transaction is classified according to the overall predominant character of the transaction. See proposed § 1.250(b)-3(e). For example, a sale of equipment that includes incidental support services from the seller at no additional cost would be classified as a sale, and therefore the provisions of proposed § 1.250(b)-4 would apply to determine whether gross income from the transaction is included in gross FDDEI. 6. Special Rule for Certain Loss Transactions A domestic corporation's FDDEI includes all gross income included in gross DEI that is derived from FDDEI sales and FDDEI services in a taxable year, reduced by the amount of deductions properly allocable to such income. See proposed § 1.250(b)-1(c)(12) and part III(A)(2) of this Explanation of Provisions section. In most cases, a FDDEI sale or FDDEI service will increase a domestic corporation's section 250 deduction, because the income from such sale or service will increase the corporation's FDDEI and thus its foreign-derived ratio. However, in some cases, a FDDEI sale or a FDDEI service could have the effect of reducing FDDEI and thus a domestic corporation's section 250 deduction for the year. This could happen where, for instance, the domestic corporation's cost of goods sold attributed to property sold in a FDDEI sale exceeds its gross receipts from the sale, or the expenses allocated to the gross income from a FDDEI sale or FDDEI service exceed the gross income arising from the sale or service. In such a case, absent a rule to the contrary, a domestic corporation could intentionally fail to satisfy the documentation requirements with respect to a transaction that would otherwise qualify as a FDDEI sale or FDDEI service in order to prevent the transaction from reducing its FDDEI and thereby its section 250 deduction. Section 250(b) does not contemplate a transaction-by-transaction determination of FDII, but rather an aggregate calculation based on all gross income “which is derived in connection with” sales and services described in section 250(b)(4). Therefore, it would be inappropriate to permit taxpayers to elect to exclude losses related to sales to foreign persons for a foreign use and services to persons located outside the United States by merely failing the documentation requirements. Accordingly, the proposed regulations provide that if a seller or renderer knows or has reason to know that property is sold to a foreign person for a foreign use or a general service is provided to a person located outside the United States, but the seller or renderer does not satisfy the documentation requirements applicable to such sale or service, the sale of property or provision of a service is nonetheless deemed a FDDEI transaction if treating the sale or service as a FDDEI transaction would reduce a domestic corporation's FDDEI. See proposed § 1.250(b)-3(f). The special loss transaction rule in proposed § 1.250(b)-3(f) does not apply to proximate services, property services, and transportation services, each of which is defined and discussed in part III(D)(3) through (5) of this Explanation of Provisions section, because the proposed regulations do not require documentation with respect to such services. Therefore, a proximate service, property service, or transportation service is a FDDEI service if it meets the applicable substantive requirements for a FDDEI service described in § 1.250(b)-5(f), (g), and (h), respectively. C. FDDEI Sales 1. In General Section 250(b)(4)(A) provides that FDDEI includes income from property the taxpayer sells to any person who is not a U.S. person, and which the taxpayer establishes to the satisfaction of the Secretary is for a foreign use. Accordingly, the proposed regulations define a FDDEI sale as a sale of property to a foreign person for a foreign use. See proposed § 1.250(b)-4(b). 2. Foreign Person The proposed regulations provide that a recipient is treated as a foreign person only if the seller obtains documentation of the recipient's foreign status and does not know or have reason to know that the recipient is not a foreign person. See proposed § 1.250(b)-4(c)(1). The proposed regulations provide several types of permissible documentation for this purpose, such as a written statement by the recipient indicating that the recipient is a foreign person. See proposed § 1.250(b)-4(c)(2)(i). To alleviate the burden of documentation on small businesses and small transactions, the proposed regulations allow a seller that has less than $10,000,000 of gross receipts in the prior taxable year, or less than $5,000 in gross receipts from a single recipient during the current taxable year, to treat a recipient as a foreign person if the seller has a shipping address for the recipient that is outside the United States. See proposed § 1.250(b)-4(c)(2)(ii). The $10,000,000 and $5,000 thresholds were chosen based on the experience of the Treasury Department and the IRS and not based on any specific quantitative analysis. The Treasury Department and the IRS request comments regarding whether the $10,000,000 and $5,000 thresholds are appropriate and especially solicit comments that provide data, other evidence, and models that can enhance the rigor of the process by which such thresholds are determined. 3. Foreign Use Under the proposed regulations, the rules applicable to the determination of whether a sale of property is for a foreign use depends on whether the property sold is “general property” or “intangible property.” See proposed § 1.250(b)-4(d) and (e). The proposed regulations define general property as property other than intangible property, a security (as defined in section 475(c)(2)), or a commodity (as defined in section 475(e)(2)(B) through (D)). See proposed § 1.250(b)-3(b)(3). The proposed regulations define intangible property by cross-reference to section 367(d)(4). See proposed § 1.250(b)-3(b)(4). The proposed regulations provide that a sale of a security (as defined in section 475(c)(2)) or a commodity (as defined in section 475(e)(2)(B) through (D)) is not a FDDEI sale because such financial instruments are not subject to “any use, consumption, or disposition” outside the United States within the meaning of section 250(b)(5)(A). See proposed § 1.250(b)-4(f). The proposed regulations provide that a sale of property (whether general property or intangible property) is treated as for a foreign use only if the seller obtains documentation that the property is for a foreign use and does not know or have reason to know, as of the FDII filing date, that the property is not for a foreign use (or, in the case of intangible property, that the portion of the sale of the intangible property for which the seller establishes foreign use is not for a foreign use). See proposed § 1.250(b)-4(d)(1) and (e)(1). Accordingly, if, as of the FDII filing date, the seller does not know or have reason to know that either the documentation obtained with respect to the sale is not reliable or that the property is not for a foreign use within the meaning of § 1.250(b)-4(d)(2) or (e)(2), then the sale of the property is treated as for a foreign use under § 1.250(b)-4(d)(1) or (e)(1) even if, in fact, the sale of such property is not for a foreign use within the meaning of § 1.250(b)-4(d)(2) or (e)(2). a. Foreign Use for General Property The sale of general property is for a foreign use if either the property is not subject to domestic use within three years of delivery of the property or the property is subject to manufacture, assembly, or other processing outside the United States before any domestic use of the property. See proposed § 1.250(b)-4(d)(2)(i) and Conf. Rep. at 625, fn. 1522 (“If property is sold by a taxpayer to a person who is not a U.S. person, and after such sale the property is subject to manufacture, assembly, or other processing (including the incorporation of such property, as a component, into a second product by means of production, manufacture, or assembly) outside the United States by such person, then the property is for a foreign use.”). Domestic use is defined as the use, consumption, or disposition of property within the United States, including manufacture, assembly, or other processing within the United States. See proposed § 1.250(b)-4(d)(2)(ii). Comments are requested on the supply chain implications of these rules. General property is subject to manufacturing, assembly, or other processing only if it meets either of the following two tests: (1) There is a physical and material change to the property, or (2) the property is incorporated as a component into a second product. See proposed § 1.250(b)-4(d)(2)(iii)(A). The proposed regulations clarify that a physical and material change does not include “minor assembly, packaging, or labeling.” See proposed § 1.250(b)-4(d)(2)(iii)(B). However, whether property has undergone a physical and material change (as opposed to minor assembly, packaging, or labeling) is determined based on all the relevant facts and circumstances. The Treasury Department and the IRS request comments regarding whether additional guidance should be provided for determining whether property has undergone a physical and material change. General property is incorporated as a component into a second product only if the fair market value of the property when it is delivered to the recipient constitutes no more than 20 percent of the fair market value of the second product, determined when the second product is completed. See proposed § 1.250(b)-4(d)(2)(iii)(C). If the seller sells multiple items of property that are incorporated into the second product, an aggregation rule treats all of the property sold by the seller that is incorporated into the second product as a single item of property for purposes of determining whether the property constitutes more than 20 percent of the fair market value of the second product. See id. In order to establish that general property is for a foreign use, the seller must generally obtain documentation with respect to the sale. See proposed § 1.250(b)-4(d)(3). Such documentation could include, for example, proof of shipment of the property to a foreign address. See proposed § 1.250(b)-4(d)(3)(i). However, in the case of certain small businesses and small transactions, the seller may rely on a foreign shipping address for the recipient instead of obtaining documentation. See proposed § 1.250(b)-4(d)(3)(ii). In lieu of the general documentation requirements for determining foreign use for sales of general property, in the case of a sale of multiple items of general property, which because of their fungible nature cannot reasonably be specifically traced to the location of use (“fungible mass”), a seller may establish that some, but not all, of the property is for a foreign use through market research, including statistical sampling, economic modeling, and other similar methods. See proposed § 1.250(b)-4(d)(3)(iii). A de minimis rule applies to treat the entire fungible mass as for a foreign use if a seller obtains documentation establishing that 90 percent or more of the fungible mass is for a foreign use. See id. Conversely, no portion of the fungible mass is treated as for a foreign use if the seller does not obtain documentation establishing that 10 percent or more of the fungible mass is for a foreign use. Id. A special rule applies for purposes of determining whether the sale of certain transportation property is for a foreign use, which takes into account the special nature of property used for international transportation. Specifically, the sale of aircraft, railroad rolling stock, vessel, motor vehicle, or similar property that provides a mode of transportation and is capable of traveling internationally is for a foreign use only if, during the three-year period from the date of delivery of the property, the property is located outside the United States more than 50 percent of the time and more than 50 percent of the miles traversed in the use of such property will be traversed outside the United States. See proposed § 1.250(b)-4(d)(2)(iv). The seller can establish that a sale of general property used for international transportation is for a foreign use through, for example, a written statement from the recipient that the property is anticipated to satisfy the test described in the preceding sentence. See proposed § 1.250(b)-4(d)(3)(i)(A). b. Foreign Use for Intangible Property As discussed in part III(B) of this Explanation of Provisions section, a sale includes a license and any transfer of property in which gain or income is recognized under section 367, including a transfer of intangible property subject to section 367(d). See proposed § 1.250(b)-3(b)(7). The proposed regulations provide that a sale of intangible property is for a foreign use to the extent revenue is earned from exploiting the intangible property outside the United States, the documentation requirements are satisfied, and the seller does not know or have reason to know that the portion of the sale of the intangible property for which the seller establishes foreign use is not for a foreign use. See proposed § 1.250(b)-4(e)(1). Unlike a sale of general property (other than a sale of a fungible mass), a seller may establish foreign use for a portion of the income from the sale of intangible property. For purposes of determining whether a sale of intangible property is for a foreign use, the location where revenue is earned is generally determined based on the location of end-user customers licensing the intangible property or purchasing products for which the intangible property was used in development, manufacture, sale, or distribution. See proposed § 1.250(b)-4(e)(2). This determination is generally made on an annual basis based on the actual revenue earned by the recipient. Id. Special rules apply to lump sum sales because, in these cases, it may be difficult or impossible to know the location where revenue will be generated when the sale occurs. The determination of foreign use in these cases is made based on the net present value of revenue the seller would have reasonably expected to earn from the exploitation of the intangible property. See proposed § 1.250(b)-4(e)(2)(iii). For sales of rights to intangible property for use both within and outside the United States, the seller must establish the proportionate amount of revenue earned within and outside the United States from use of the intangible property to establish foreign use. The proposed regulations describe documentation that can be used to establish where revenue is earned from use of the intangible property. See proposed § 1.250(b)-4(e)(3)(i). For example, if a domestic corporation licenses to a foreign person the worldwide rights to market and sell an item protected by a copyright, the domestic corporation would need to obtain documentation, as provided in the proposed regulations, establishing where revenue is earned from sales of the copyright-protected item. A seller may establish the extent to which a sale of intangible property for a lump sum is for a foreign use through documentation containing reasonable projections of the amount and location of revenue that the seller would have reasonably expected to earn from the use of intangible property. See proposed § 1.250(b)-4(e)(3)(iii). To be considered reasonable, the net present value must be consistent with the financial data and projections used by the seller to determine the sales price to the foreign person. See id. The same rule for documentation applies to a sale to a foreign person (other than a related party of the seller) for annual payments that are not contingent on revenue or profit unless the seller has access to reliable information to determine the actual revenue earned by the foreign unrelated party from the exploitation of the intangible property. See proposed § 1.250(b)-4(e)(3)(ii). As discussed in part III(C)(3)(a) of this Explanation of Provisions section, a sale of general property is treated as for a foreign use if the property is subject to manufacturing, assembly, or other processing outside the United States. See proposed § 1.250(b)-4(d)(2)(i)(B). This rule is based on footnote 1522 of the Conference Report, which provides that “[i]f property is sold by a taxpayer to a person who is not a U.S. person, and after such sale the property is subject to manufacture, assembly, or other processing (including the incorporation of such property, as a component, into a second product by means of production, manufacture, or assembly) outside the United States by such person, then the property is for a foreign use.” Intangible property is not “subject to” manufacture, assembly, or processing, and there is no other discussion in the Conference Report that indicates an intent to provide an analogous rule for intangible property otherwise used in the manufacturing process. However, comments are requested on whether a rule for intangible property similar to proposed § 1.250(b)-4(d)(2)(i)(B) is appropriate. Comments are also requested on what additional rules may be needed for determining the location of revenue generation from end-users and what types of documentation should be accepted to document the location of revenue generation with respect to intangible property. D. FDDEI Services 1. In General Section 250(b)(4)(B) provides that FDDEI includes income from services provided by a domestic corporation to any person, or with respect to property, not located within the United States. Section 250 does not prescribe rules for determining whether a person or property is “not located within the United States.” Proposed § 1.250(b)-5 provides rules for determining whether a service is provided to a person, or with respect to property, located outside the United States. Under the proposed regulations, whether a service is provided to a person, or with respect to property, located outside the United States, depends on the type of service provided and, in the case of a general service (defined below), the type of recipient of the service. The proposed regulations distinguish between services where the service provider (the “renderer”) and the recipient are in physical proximity when the service is performed (“proximate services”), services with respect to tangible property (“property services”), services to transport people or property (“transportation services”), and all other services (“general services”). See proposed § 1.250(b)-5(b) and (c)(4) through (7). For purposes of determining whether a service constitutes a FDDEI service, the proposed regulations look to the location of the performance of the service for proximate services, the location of the property for property services, the origin and destination of transportation services, and the location of the recipient for general services. See proposed § 1.250(b)-5(d) through (h). Each category of service described in § 1.250(b)-5 is mutually exclusive of each other category, and every possible service is described in a single category. Therefore, whether a service is a FDDEI service is determined under the rules relevant to one, and only one, category of service described in § 1.250(b)-5. For example, a general service that is provided to a recipient located within the United States is not a FDDEI service, even if the service is performed outside the United States, whereas a property service that is performed outside the United States is a FDDEI service, even if the recipient of the service is located within the United States. See parts III(D)(2) and (4) of this Explanation of Provisions section. 2. General Services to Persons Located Outside the United States A general service is a service other than a proximate service, a property service, or a transportation service. See proposed § 1.250(b)-5(c)(4). General services is the residual category of services. Accordingly, a service that is not a property service, a transportation service, or a proximate service is analyzed as a general service. For general services, the proposed regulations distinguish between services provided to “consumers” and services provided to “business recipients.” A consumer is defined as an individual that purchases a service for personal consumption. See proposed § 1.250(b)-5(c)(3). A business recipient is defined as any recipient other than a consumer. See proposed § 1.250(b)-5(c)(2). In both cases, general services are treated as provided to a person located outside the United States if the renderer does not know or have reason to know that the consumer or business recipient is located within the United States and obtains appropriate documentation. See proposed § 1.250(b)-5(d)(1) and (e)(1). a. General Services to Consumers The provision of a general service to a consumer located outside the United States is a FDDEI service. See proposed § 1.250(b)-5(b)(1). The proposed regulations provide that the consumer is located where a consumer resides when the service is provided. See proposed § 1.250(b)-5(d)(2). The proposed regulations require a domestic corporation to document the location of the consumer. See proposed § 1.250(b)-5(d)(1) and (3). The proposed regulations provide several types of permissible documentation for this purpose, including a written statement by the consumer indicating the residence of the consumer when the service is provided. See proposed § 1.250(b)-5(d)(3)(i). However, in the case of certain small businesses and small transactions, the renderer may rely on a foreign billing address for the consumer instead of obtaining documentation. See proposed § 1.250(b)-5(d)(3)(ii). b. General Services to Business Recipients The provision of a general service to a business recipient located outside the United States is a FDDEI service. See proposed § 1.250(b)-5(b)(2). Under the proposed regulations, all general services that are not provided to consumers are treated as services provided to business recipients, regardless of whether the recipient is engaged in a trade or business. See proposed § 1.250(b)-5(c)(2). The proposed regulations determine the location of a business recipient based on the location of the business recipient's operations, and the operations of any related party of the recipient, that receive a benefit (as defined in § 1.482-9(l)(3)) from such service. See proposed § 1.250(b)-5(e)(2) and (4). For purposes of this determination, the location of residence, incorporation, or formation of a business recipient is not relevant. For example, a general service that confers a benefit only on the U.S. operations of a foreign person will generally not qualify as a FDDEI service, whereas a service that confers a benefit only on the foreign operations of a U.S. person will generally qualify as a FDDEI service. For purposes of this rule, a business recipient is treated as having operations in any location where it maintains an office or other fixed place of business. See proposed § 1.250(b)-5(e)(2)(ii). The proposed regulations provide that a service is generally provided to a business recipient located outside the United States to the extent that the renderer's gross income from providing the service is allocated to the business recipient's operations outside the United States. See proposed § 1.250(b)-5(e)(2)(i). To make this allocation, the renderer must first determine which of the business recipient's operations receive a benefit from the service. See proposed § 1.250(b)-5(e)(2)(i)(A). Where the service confers a benefit on the operations of the business recipient in specific locations, gross income of the renderer is allocated based on the location of the operations in specific locations that receive the benefit. See id. Where a service confers a benefit on the recipient's business as a whole, or where reliable information about the particular portion of the operations that specifically receive a benefit from the service is unavailable, the proposed regulations provide that the service is deemed to confer a benefit on all of the business recipient's operations. See id. The renderer then must allocate its gross income from providing the service between the operations that receive a benefit from the service that are located within and outside the United States. See proposed § 1.250(b)-5(e)(2)(i)(B). For this purpose, any reasonable method may be used, and the principles of § 1.482-9(k) apply to determine whether a method is reasonable. See id. A reasonable method may include, for example, an allocation based on the renderer's time spent working with different offices of the business recipient or publicly available information about the business recipient's revenue from different markets. See id. The Treasury Department and the IRS request comments on this approach for determining the location of a business recipient that operates both within and outside of the United States. The proposed regulations also require a domestic corporation to obtain documentation sufficient to establish the location of a business recipient's operations that benefit from the service. See proposed § 1.250(b)-5(e)(1) and (3). A domestic corporation may obtain a statement from the recipient specifying the location of the operations that will benefit from the service or include a similar statement in a binding contract. See proposed § 1.250(b)-5(e)(3)(i)(A) and (B). A domestic corporation may also establish the location of the business recipient using information provided in the ordinary course of the provision of a service or publicly available information. See proposed § 1.250(b)-5(e)(3)(i)(C) and (D). However, in the case of certain small businesses and small transactions, the renderer may rely on a foreign billing address for the business recipient instead of obtaining documentation. See proposed § 1.250(b)-5(e)(3)(ii). 3. Proximate Services The provision of a proximate service to a recipient located outside the United States is a FDDEI service. See proposed § 1.250(b)-5(b)(3). A proximate service is defined as a service, other than a property service or a transportation service, substantially all of which is performed in the physical presence of the recipient or, in the case of a business recipient, its employees. See proposed § 1.250(b)-5(c)(6). For example, a training, consulting, or auditing service that is performed on-site would generally constitute a proximate service. Substantially all of a service is performed in the physical presence of the recipient or its employees if the renderer spends more than 80 percent of the time providing the service in the physical presence of the recipient or its employees. See proposed § 1.250(b)-5(c)(6). The recipient of a proximate service is treated as located where the service is performed. See proposed § 1.250(b)-5(f). If a proximate service is performed partly within and partly outside the United States, a proportionate amount of the service is treated as rendered to a person located outside the United States corresponding to the portion of time spent providing the proximate service outside the United States. See id. 4. Property Services The provision of a property service with respect to tangible property located outside the United States is a FDDEI service. See proposed § 1.250(b)-5(b)(4). A property service is defined as a service, other than a transportation service, provided with respect to tangible property, but only if substantially all of the service is performed at the location of the property and results in physical manipulation of the property such as through assembly, maintenance, or repair. See proposed § 1.250(b)-5(c)(5). The proposed regulations provide that substantially all of a service is performed at the location of property if the renderer spends more than 80 percent of the time providing the service at or near the location of the property. See id. A property service is a FDDEI service only if the tangible property with respect to which the service is performed is located outside the United States for the duration of the period of performance. See proposed § 1.250(b)-5(g). The Treasury Department and the IRS request comments on whether to consider an exception for property that is located in the United States temporarily solely for purposes of the performance of certain services, such as maintenance or repairs. As discussed in part III(E) of this Explanation of Provisions section, a property service may qualify as a FDDEI service even if it is performed for a person located within the United States. Other services that relate to property but may not necessarily be provided in close proximity to tangible property or do not result in the physical manipulation of such property such as through assembly, maintenance, or repair may be subject to the rules for proximate services, transportation services, or general services. For example, an architectural or engineering service that is not performed in physical proximity to the property or the recipient will be evaluated as a general service even if the service relates to property located outside the United States, and thus whether such a service is a FDDEI service will be determined based on the location of the recipient rather than the location of the property. 5. Transportation Services The provision of a transportation service to a recipient, or with respect to property, located outside the United States is a FDDEI service. See proposed § 1.250(b)-5(b)(5). A transportation service is defined as a service to transport a person or property using any mode of transportation (such as an airplane). See proposed § 1.250(b)-5(c)(7). Basing the location of a transportation service on the residence of the recipient of the transportation service could provide inconsistent results with respect to similar services. Similarly, providing different rules for the transportation of a person or property could provide inconsistent results with respect to similar services. Therefore, the proposed regulations provide that whether a “transportation service” is provided to a recipient, or with respect to property, located outside the United States is determined based on the origin and destination of the service. See proposed § 1.250(b)-5(h). If both the origin and destination of a transportation service are outside of the United States, then the service is a FDDEI service. See id. If either the origin or the destination of the transportation service is outside of the United States, but not both, then 50 percent of the service is a FDDEI service and thus 50 percent of the gross income from the provision of the service is included in the renderer's gross FDDEI. See id. E. Domestic Intermediary Rules Section 250(b)(5)(B) describes special rules for “domestic intermediaries” (the “domestic intermediary rules”). Section 250(b)(5)(B)(i) provides that if a seller sells property to another person (other than a related party) for further manufacture or other modification within the United States, the property is not treated as sold for a foreign use even if such other person subsequently uses such property for a foreign use. Section 250(b)(5)(B)(ii) provides that services provided to a person (other than a related party) located within the United States are not treated as services described in section 250(b)(4)(B) even if such other person uses such services in providing services that are described in section 250(b)(4)(B). The proposed regulations do not contain specific rules corresponding to the domestic intermediary rules because those rules are encompassed within the general rules relating to FDDEI sales and FDDEI services in the proposed regulations. With respect to sales of property, the proposed regulations provide that general property is not for a foreign use if, before being subject to manufacture, assembly, or other processing outside the United States, the property is subject to a domestic use. See proposed § 1.250(b)-4(d)(2)(i). For this purpose, domestic use includes manufacture, assembly, or other processing within the United States. See proposed § 1.250(b)-4(d)(2)(ii)(B). In addition, a sale of property to a U.S. person cannot qualify as a FDDEI sale under any circumstance. See section 250(b)(4)(A) and proposed § 1.250(b)-4(b). Therefore, a sale of property to a foreign person for further manufacture in the United States or to a U.S. person does not qualify for a FDDEI sale, regardless of the ultimate use of the property by the recipient. With respect to the provision of services, the proposed regulations provide that a service is a FDDEI service only if the recipient of the service, or the property to which the service relates, is located outside the United States. See proposed § 1.250(b)-5(b)(1) through (5). Therefore, a service provided to a person, or with respect to property, located within the United States is not a FDDEI service, regardless of the ultimate use of the service by the recipient. Section 250(b)(5)(B)(ii) could be read literally to provide that a FDDEI service includes only services provided to a person not located within the United States, in which case a service provided “with respect to property located outside the United States” would not qualify as a FDDEI service if the recipient of such service was located within the United States. As discussed in part III(D) of this Explanation of Provisions section, consistent with the general rule of section 250(b)(4)(B), the proposed regulations clarify that a service qualifies as a FDDEI service if it is provided either to a person located outside the United States or with respect to property located outside the United States. The Treasury Department and the IRS have determined that an interpretation of section 250(b)(5)(B)(ii) that effectively eliminates the disjunctive test of section 250(b)(4)(B) would not be reasonable. Therefore, under the proposed regulations, whether a service that is treated as with respect to property—a property service or a transportation service—is a FDDEI service is determined solely by reference to the location of the property, and not the location of the recipient. See proposed § 1.250(b)-5(g) and (h). Finally, the parenthetical references to related parties in the domestic intermediary rules could be read to imply the existence of an exception for further manufacture or modification in the United States by a related party or a service provided to a related party located within the United States. However, the general rules of section 250(b)(4)(A) and (B) do not authorize such exceptions, and the domestic intermediary rules do not purport to expand these general rules, but rather to limit the transactions that qualify under them. Therefore, with respect to related party domestic intermediaries, the proposed regulations do not provide an exception to the general rule that property must be sold to a foreign person to qualify as a FDDEI sale or that a service must be provided to a person located outside the United States to qualify as a FDDEI service. Cf. part V of this Explanation of Provisions section regarding the applicability of the attribute redetermination rule of § 1.1502-13(c)(1)(i) to the determination of FDDEI of a member of a consolidated group. F. Related Party Transactions A sale of property or a provision of a service may qualify as a FDDEI transaction, regardless of whether the recipient of such service is a related party of the seller or renderer. However, in the case of a sale of general property or a provision of a general service to a related party, section 250(b)(5)(C) and proposed § 1.250(b)-6 provide additional requirements that must be satisfied for the transaction to qualify as a FDDEI sale or FDDEI service. These requirements must be satisfied in addition to the general requirements that apply to such sales and services as provided in proposed §§ 1.250(b)-3 through 1.250(b)-5. The proposed regulations define a related party with respect to any person as any member of a modified affiliated group that includes such person. Proposed § 1.250(b)-1(c)(19). A modified affiliated group is defined as an affiliated group as provided in section 1504(a) by substituting “more than 50 percent” for “at least 80 percent” each place it appears, and without regard to section 1504(b)(2) and (3). Proposed § 1.250(b)-1(c)(17)(i). A modified affiliated group also includes any person other than a corporation that is controlled by one or more members of a modified affiliated group or that controls such a member. Proposed § 1.250(b)-1(c)(17)(ii). For this purpose, “control” is defined as provided in section 954(d)(3), meaning direct, indirect, or constructive ownership under section 958 of more than 50 percent of the value of the beneficial interests in such person. Proposed § 1.250(b)-1(c)(17)(iii). 1. Related Party Sales Section 250(b)(5)(C)(i) provides that property sold to a related party that is not a U.S. person “shall not be treated as for a foreign use unless (I) such property is ultimately sold by a related party, or used by a related party in connection with property which is sold or the provision of services, to another person who is an unrelated party who is not a United States person, and (II) the taxpayer establishes to the satisfaction of the Secretary that such property is for a foreign use.” Accordingly, the proposed regulations provide that a sale of general property to a foreign related party (a “related party sale”) qualifies as a FDDEI sale only if certain additional requirements described in § 1.250(b)-6(c)(1)(i) or (ii) are satisfied. See proposed § 1.250(b)-6(c)(1). If a foreign related party resells the purchased property (such as where the foreign related party is a distributor or a manufacturer of a product that incorporates the purchased property as a component), the sale to the foreign related party qualifies as a FDDEI sale only if an unrelated party transaction with respect to such sale occurs and the unrelated party transaction is a FDDEI sale. An unrelated party transaction is generally a transaction between the foreign related party and an unrelated foreign person in which the property purchased by the foreign related party is sold or used. See proposed § 1.250(b)-6(b)(5). For purposes of this rule, whether property is a component of another property that is subsequently sold in an unrelated party transaction is determined without regard to the rule defining a “component” for purposes of determining whether general property is subject to manufacturing, assembly, or other processing, as described in part III(C)(3)(a) of this Explanation of Provisions section. The unrelated party sale generally must occur on or before the FDII filing date; otherwise the gross income from the related party sale is included in the domestic corporation's gross DEI for the taxable year of the related party sale, but is not included in its gross FDDEI. See proposed § 1.250(b)-6(c)(1)(i). However, if an unrelated party transaction occurs after the FDII filing date but within the period of limitations provided by section 6511, the proposed regulations provide that the domestic corporation may file an amended return for the taxable year in which the related party sale occurred claiming the related party sale as a FDDEI sale for purposes of determining the taxpayer's foreign-derived intangible income for that taxable year, provided that the sale otherwise meets the requirements in proposed § 1.250(b)-6(c)(1)(i). See id. The Treasury Department and the IRS welcome comments on whether alternatives should be considered in lieu of requiring the filing of an amended return. For transactions other than the resale of purchased property, such as where the foreign related party uses the purchased property to produce other property that is sold in unrelated party transactions, or where the foreign related party uses the property in the provision of a service in an unrelated party transaction, the sale of property does not qualify as a FDDEI sale unless, as of the FDII filing date, the seller reasonably expects that more than 80 percent of the revenue earned by the foreign related party from the use of the property in all transactions will be earned from unrelated party transactions that are FDDEI transactions (determined without regard to the documentation requirements in § 1.250(b)-4 or § 1.250(b)-5). See proposed § 1.250(b)-6(c)(1)(ii). The rules applicable to related party sales apply only to determine whether sales of general property qualify as a FDDEI sale. See proposed § 1.250(b)-6(c)(1). Sales of intangible property, whether to a related or an unrelated party, are for a foreign use only to the extent that the intangible property generated revenue from exploitation outside the United States. See proposed § 1.250(b)-4(e)(2) and part III(C)(3)(b) of this Explanation of Provisions section. Thus, additional rules with respect to related party sales of intangible property are unnecessary to ensure that such sales are ultimately for a foreign use. 2. Related Party Services Section 250(b)(5)(C)(ii) provides that a service provided to a related party not located in the United States “shall not be treated [as a FDDEI service] unless the taxpayer establishe[s] to the satisfaction of the Secretary that such service is not substantially similar to services provided by such related party to persons located within the United States.” Accordingly, the proposed regulations generally provide that a provision of a general service to a business recipient that is a related party qualifies as a FDDEI service only if the service is not substantially similar to a service provided by the related party to persons located within the United States. See proposed § 1.250(b)-6(d)(1). Absent section 250(b)(5)(C)(ii) and proposed § 1.250(b)-6(d)(1) (the “related party services rule”), a domestic corporation could generate gross FDDEI from the provision of services that primarily benefit persons within the United States by using a related party located outside the United States as a conduit. The related party services rule prevents taxpayers from claiming gross FDDEI derived from such “round tripping” arrangements. In contrast, proximate services, property services, and transportation services by their nature present minimal risk for “round tripping,” because the location of the recipient or property, as applicable, for purposes of such services is generally determined based on the place of performance. See proposed § 1.250(b)-5(f), (g), and (h), and parts III(D)(3), (4), and (5) of this Explanation of Provisions section. Further, a general service provided to a consumer that is a related party cannot be substantially similar to a service provided by a consumer to a person located within the United States, because a consumer, by definition, is an individual that purchases the service for personal use. See proposed § 1.250(b)-5(c)(3). Accordingly, the proposed regulations provide that the related party services rule applies only to determine whether a general service provided to a business recipient that is a related party is a FDDEI service. See proposed § 1.250(b)-6(d)(1). A service provided by a renderer to a related party is “substantially similar” to a service provided by the related party to a person located within the United States if the renderer's service (or “related party service”) is used by the related party to provide a service to a person located within the United States and either the “benefit test” of proposed § 1.250(b)-6(d)(2)(i) or the “price test” of proposed § 1.250(b)-6(d)(2)(ii) is satisfied. The rules to determine the location of a recipient of a service provided by a related party are generally the same as the rules for determining the location of a recipient of a service provided by the renderer. The benefit test is satisfied if 60 percent or more of the benefits conferred by the related party service are to persons located within the United States. See proposed § 1.250(b)-6(d)(2)(i). For this purpose, the term “benefit” has the meaning provided in § 1.482-9(l)(3). See proposed § 1.250(b)-5(c)(1). Therefore, a related party service provides a benefit to a customer of the related party if it provides “a reasonably identifiable increment of economic or commercial value” to the customer, rather than an indirect or remote benefit. See § 1.482-9(l)(3)(i) and (ii). Because the benefit test compares the benefits from the service provided to persons located in the United States to the total benefits from the service provided by the renderer (rather than to the total benefits of the service provided by the related party), a service provided to a related party is “substantially similar” to a service provided by the related party to persons located within the United States if 60 percent or more of the benefits of the service are conferred on persons located within the United States, even if the related party adds significant value to the service through, for instance, bundling the related party service with other high value services. Under the price test, a service provided by a renderer to a related party is “substantially similar” to a service provided by the related party to a person located within the United States if the renderer's service is used by the related party to provide a service to a person located within the United States and 60 percent or more of the price that persons located within the United States pay for the service provided by the related party is attributable to the renderer's service. See proposed § 1.250(b)-6(d)(2)(ii). Therefore, the price test compares the value of the service that is provided by the renderer to the related party to the value of the service that is provided by the related party to its customers. Consequently, a related party service that is not treated as substantially similar to a service provided by the related party to persons located in the United States under the benefit test, because more than 40 percent of the benefits from the service are conferred to persons located outside the United States, is nonetheless treated as “substantially similar” under the price test if the related party service accounts for 60 percent or more of the total price that is charged to customers located within the United States. If a related party service is treated as substantially similar to a service provided by the related party to a person located within the United States solely by reason of the price test, the general rule that wholly disqualifies the related party service as a FDDEI service does not apply. Rather, in such case, a portion of the gross income from the related party service will be treated as a FDDEI service corresponding to the ratio of benefits conferred by the related party service to persons not located within the United States to the sum of all benefits conferred by the related party service. See proposed § 1.250(b)-6(d)(1). IV. Section 250 Deduction for Individuals Making a Section 962 Election As discussed in part II of this Explanation of Provisions section, the section 250 deduction for FDII and GILTI is available only to domestic corporations. However, section 962(a)(1) provides that an individual that is a U.S. shareholder may generally elect to be taxed on amounts included in the individual's gross income under section 951(a) in “an amount equal to the tax that would be imposed under section 11 if such amounts were received by a domestic corporation.” GILTI is treated as an amount included under section 951(a) for purposes of section 962. See section 951A(f)(1)(A) and proposed § 1.951A-6(b)(1). A section 962 election can be made by an individual U.S. shareholder who is considered, by reason of section 958(b), to own stock of a foreign corporation owned (within the meaning of section 958(a)) by a domestic pass-through entity, including a partnership or an S corporation. See § 1.962-2(a). Congress enacted section 962 to ensure that individuals' tax burdens with respect to undistributed foreign earnings of their CFCs “will be no heavier than they would have been had they invested in an American corporation doing business abroad.” S. Rept. 1881, 1962-3 C.B. 784, at 798. Existing § 1.962-1(b)(1)(i) provides that a deduction of a U.S. shareholder does not reduce the amount included in gross income under section 951(a) for purposes of computing the amount of tax that would be imposed under section 11. However, allowing a section 250 deduction with respect to GILTI of an individual (including an individual that is a shareholder of an S corporation or a partner in a partnership) that makes an election under section 962 is consistent with the purpose of that provision of ensuring that such individual's tax burden with respect to its CFC's undistributed foreign earnings is no greater than if the individual owned such CFC through a domestic corporation. Accordingly, the proposed regulations provide that, for purposes of section 962, “taxable income” as used in section 11 of an electing individual is reduced by the portion of the section 250 deduction that would be allowed to a domestic corporation with respect to the individual's GILTI and the section 78 gross-up attributable to the shareholder's GILTI. See proposed § 1.962-1(b)(1)(i)(B)( 3 ). V. Application of Section 250 to Consolidated Groups As discussed in the Background section of this preamble, section 250 provides a domestic corporation a deduction for its FDII, GILTI, and the section 78 gross-up attributable to its GILTI. The section 250 deduction is available to a member of a consolidated group (“member”) in the same manner as the deduction is available to any domestic corporation. However, a computation of a member's section 250 deduction based solely on its items of income and QBAI may not result in a clear reflection of the consolidated group's income tax liability. For example, a consolidated group could segregate all of its QBAI in one member, thereby decreasing the DTIR of other members relative to the consolidated group's DTIR if determined at a group level. Alternatively, a strict, separate-entity application of section 250 could inappropriately decrease a consolidated group's aggregate amount of deduction for its FDII, for instance, because one member's DII (which is the excess of DEI over DTIR) would not be taken into account in calculating the FDII of another member that has FDDEI in excess of its DEI. Based on the foregoing, the proposed regulations provide that a member's section 250 deduction is determined by reference to the relevant items of all members of the same consolidated group. Consistent with the authority provided by section 1502, the proposed regulations ensure that the aggregate amount of section 250 deductions allowed to members appropriately reflects the income, expenses, gains, losses, and property of all members. Definitions in proposed § 1.1502-50(f) result in the aggregation of the DEI, FDDEI, DTIR, and GILTI of all members. These aggregate numbers and the consolidated group's consolidated taxable income are then used to calculate an overall deduction amount for the group. Proposed § 1.1502-50(b) then allocates this overall deduction amount among the members on the basis of their respective contributions to the consolidated group's aggregate amount of FDDEI and the consolidated group's aggregate amount of GILTI. The proposed regulations also address two issues relating to intercompany transactions. First, the proposed regulations add an example to § 1.1502-13 demonstrating the applicability of the attribute redetermination rule of § 1.1502-13(c)(1)(i) to the determination of FDDEI. This example applies the intercompany transaction rules to clearly reflect consolidated taxable income. It does not indicate a change in the law. In this example, the attribute redetermination rule applies to gross DEI and gross FDDEI, which are attributes of an intercompany or corresponding item. The Treasury Department and the IRS were concerned that applying § 1.1502-13(c) to DEI and FDDEI directly could result in circular computations due to the apportionment of certain expenses on a gross income basis. In addition, the example illustrates the applicability of the attribute redetermination rule in the context of an intercompany loss. In such circumstances, the application of the allocation and apportionment rules of §§ 1.861-8 through 1.861-14T and 1.861-17 may be modified in order to achieve the same overall result within the consolidated group that would occur if the members were divisions of a single corporation. Second, the proposed regulations provide that, for purposes of determining a member's QBAI, the basis of specified tangible property will not be affected by an intercompany transaction. See proposed § 1.1502-50(c)(1). Accordingly, an intercompany transaction cannot result in the increase or decrease of a consolidated group's aggregate amount of DTIR or, in turn, aggregate amount of deduction. VI. Reporting Requirements To claim a deduction under section 250 by reason of having FDII, a taxpayer must calculate its deemed intangible income, deduction eligible income, and foreign-derived deduction eligible income. None of these terms are used in other provisions of the Code, and thus pre-existing forms do not collect data relevant to determining these amounts. In addition, when calculating its deduction under section 250, a taxpayer must determine the application of the taxable income limitation of section 250(a)(2). In order to effectively administer and enforce section 250, the proposed regulations require the collection of relevant information on new or existing forms. A domestic corporation or an individual making an election under section 962 that claims a deduction under section 250 for a taxable year must make an annual return on Form 8993, “Section 250 Deduction for Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI)” (or any successor form) for such year, providing the information required by the form. See proposed § 1.250(a)-1(d). Certain related party transactions are reported on various information returns under sections 6038 and 6038A. Under section 6038(a)(1), U.S. persons that control foreign business entities (“controlling U.S. persons”) must report certain information with respect to those entities, which includes information listed in section 6038(a)(1)(A) through (E), as well as information that “the Secretary determines to be appropriate to carry out the provisions of this title.” This information is reported on Form 5471, “Information Return of U.S. Persons With Respect To Certain Foreign Corporations,” or Form 8865, “Return of U.S. Persons With Respect to Certain Foreign Partnerships,” as applicable. Section 6038A requires 25-percent foreign-owned domestic corporations (“reporting corporations”) to file certain information returns with respect to those corporations, including information related to transactions between the reporting corporation and each foreign person which is a related party to the reporting corporation. This information is reported on Form 5472, “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.” In order to effectively administer and enforce section 250, the proposed regulations provide that controlling U.S. persons or reporting corporations, as described above, that claim a deduction under section 250 determined by reference to FDII with respect to amounts reported on Form 5471, 5472, or 8865 must report certain information relating to transactions with foreign business entities or related parties in accordance with sections 6038 and 6038A. See proposed §§ 1.6038-2(f)(15), 1.6038-3(g)(4), and 1.6038A-2(b)(5)(iv). Certain partnerships and their partners also have reporting requirements under sections 6031 and 6038 with respect to partnership income. A domestic partnership is generally required to file an annual information return (Form 1065, “U.S. Return of Partnership Income”) and provide information to its partners on Schedule K-1 (Form 1065), “Partner's Share of Income, Deductions, Credits, etc.,” with respect to each partner's distributive share of partnership items and other information. See section 6031 and § 1.6031(b)-1T. The proposed regulations provide that a partnership that has one or more direct or indirect partners that are domestic corporations and that is required to file a return under section 6031 must furnish on Schedule K-1 (Form 1065) the partner's share of the partnership's gross DEI, gross FDDEI, deductions that are definitely related to the partnership's gross DEI and gross FDDEI, and partnership QBAI for each taxable year in which the partnership has gross DEI, gross FDDEI, or partnership specified tangible property. See proposed § 1.250(b)-1(e)(2). Although a foreign partnership that does not have income effectively connected with a trade or business within the United States or U.S. source income is not required to file Form 1065, a U.S. person who owns a ten-percent interest or a fifty-percent interest of a foreign partnership controlled by U.S. persons is required to report certain information under section 6038. Similar to the requirements for partnership reporting on Form 1065, the proposed regulations require controlling ten-percent partners and controlling fifty-percent partners (as defined in § 1.6038-3(a)(1) and (2)) of certain foreign partnerships controlled by U.S. persons to report on Schedule K-1 (Form 8865), “Partner's Share of Income, Deductions, Credits, etc.,” the partner's share of the partnership's gross DEI, gross FDDEI, deductions that are definitely related to the partnership's gross DEI and gross FDDEI, and partnership QBAI. See proposed § 1.6038-3(g)(4). VII. Applicability Dates Proposed §§ 1.250(a)-1 through 1.250(b)-6 are proposed to apply to taxable years ending on or after March 4, 2019. See section 7805(b)(1)(B). However, the Treasury Department and the IRS recognize that these rules may apply to transactions that have occurred before the filing of these proposed regulations and that taxpayers may not be able to obtain the documentation required for transactions that have already been completed. Accordingly, for taxable years beginning on or before March 4, 2019, taxpayers may use any reasonable documentation maintained in the ordinary course of the taxpayer's business that establishes that a recipient is a foreign person, property is for a foreign use (within the meaning of proposed § 1.250(b)-4(d) and (e)), or a recipient of a general service is located outside the United States (within the meaning of proposed § 1.250(b)-5(d)(2) and (e)(2)), as applicable, in lieu of the documentation required in proposed §§ 1.250(b)-4(c)(2), (d)(3), and (e)(3) and 1.250(b)-5(d)(3) and (e)(3), provided that such documentation meets the reliability requirements described in proposed § 1.250(b)-3(d). Reasonable documentation includes, but is not limited to, documents described in or similar to the documents described in proposed §§ 1.250(b)-4(c)(2), (d)(3), and (e)(3) and 1.250(b)-5(d)(3) and (e)(3). For this purpose, reasonable documentation also includes the documentation described in the special rules for small businesses and small transactions in proposed §§ 1.250(b)-4(c)(2)(ii) and (d)(3)(ii) and 1.250(b)-5(d)(3)(ii) and (e)(3)(ii), even if the taxpayer would not otherwise qualify for the special rules. The Treasury Department and the IRS welcome comments on this special applicability date rule. Proposed § 1.962-1(b)(1)(i)(B)( 3 ), which allows individuals making an election under section 962 to take into account the section 250 deduction, is proposed to apply to taxable years of a foreign corporation ending on or after March 4, 2019, and with respect to a U.S. person, for the taxable year in which or with which such taxable year of the foreign corporations ends. See id. Taxpayers may rely on proposed §§ 1.250(a)-1 through 1.250(b)-6 and § 1.962-1(b)(1)(i)(B)( 3 ) for taxable years ending before May 4, 2019. Proposed § 1.1502-50 is proposed to apply to consolidated return years ending on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register . See sections 1503(a) and 7805(b)(1)(A). Taxpayers may rely on proposed § 1.1502-50 for taxable years ending before the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register . Proposed §§ 1.6038-2(f)(15) and 1.6038A-2(b)(5)(iv) are proposed to apply with respect to information for annual accounting periods beginning on or after May 4, 2019. See sections 6038(a)(3) and 7805(b)(1)(B). Proposed § 1.6038-3(g)(4) is proposed to apply to taxable years of a foreign partnership beginning on or after May 4, 2019. See section 7805(b)(1)(B). Special Analyses I. Regulatory Planning and Review—Economic Analysis Executive Orders 13563 and 12866 direct agencies to assess costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing rules, and of promoting flexibility. These proposed regulations have been designated as economically significant by the Office of Management and Budget's Office of Information and Regulatory Affairs (OIRA) and subject to review under Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Treasury Department and the Office of Management and Budget regarding review of tax regulations. A. Background As described in part I of the Explanation of Provisions section, the section 250 deduction is an important component of the changes to the U.S. international tax system included in the Act. The purpose of the section 250 deduction is to minimize the role that U.S. tax considerations play in a domestic corporation's decision whether to service foreign markets directly or through a controlled foreign corporation (“CFC”). See Senate Explanation, at 370 (“[O]ffering similar, preferential rates for intangible income derived from serving foreign markets, whether through U.S.-based operations or through CFCs, reduces or eliminates the tax incentive to locate or move intangible income abroad, thereby limiting one margin where the Code distorts business investment decisions.”). Further, the section 250 deduction protects the U.S. tax base against base erosion incentives created by the new participation exemption system established under section 245A, discussed in part I of the Explanation of Provisions section. At the most basic level, the section 250 deduction is allowed to a domestic corporation with respect to its intangible income derived from foreign markets, resulting in a lower effective rate of U.S. tax on its global intangible low-taxed income (“GILTI”) and foreign-derived intangible income (“FDII”). The Act defines a corporation's FDII as the portion of its return in excess of a return on tangible assets that is derived from serving foreign markets, while it defines a corporation's GILTI as the portion of its return in excess of a return on tangible assets that is derived through its foreign affiliates. FDII and GILTI are calculated through formulas set out in sections 250 and 951A, respectively. For taxable years between 2018 and 2026, section 250 generally allows a deduction equal to the sum of 37.5 percent of the corporation's FDII plus 50 percent of its GILTI (thereafter, these deductions are reduced to 21.875 percent and 37.5 percent, respectively). These deduction rates produce comparable tax rates on income earned from serving foreign markets, regardless of where such income is earned. Different percentages are required by the Act to achieve approximate parity, given that the 80 percent limitation on foreign tax credits in section 960(d) results in additional U.S. tax. 2 More specifically, the Act defines a domestic corporation's FDII as its deemed intangible income (“DII”) multiplied by the percentage of its deduction eligible income (“DEI”) that is foreign-derived deduction eligible income (“FDDEI”). The Act defines DEI as the excess of the corporation's gross income (with certain exclusions 3 ) over deductions (including taxes) properly allocable to the income. The Act defines DII as the excess (if any) of its DEI over 10 percent of its qualified business asset investment (“QBAI”), or tangible asset base. The Act defines FDDEI as DEI derived from sales of property to foreign persons for foreign use and from the provision of services to persons, or with respect to property, located outside the United States. Finally, if the sum of a corporation's FDII and GILTI exceeds its taxable income (determined without regard to section 250), then the Act requires that the amount of FDII and GILTI for which a deduction is allowed is reduced pro rata by the excess. While the Act provides the framework for determining a domestic corporation's FDII, it grants discretion to the Secretary to establish how certain requirements, such as whether sales are for a foreign use, are satisfied. See sections 250(b)(4)(A) and (B), (b)(5)(C)(i)(II), and (b)(5)(C)(ii). In addition, the Act does not address all of the details necessary to calculate FDII, such as the allocation of expenses. Further, the Act is unclear regarding whether the section 250 deduction for FDII is available for certain foreign military sales or services and whether a section 250 deduction for GILTI is available for an individual taxpayer making a section 962 election. The following analysis describes the need for the proposed regulations and discusses the costs and benefits relative to the baseline, as well as the important alternative regulatory choices that were considered. 2 At the most basic level, abstracting from various complexities of the GILTI regime, the 21 percent U.S. statutory rate with a 50 percent deduction for GILTI implies that at foreign effective rates in excess of 10.5 percent (assuming no U.S. expenses), foreign tax credits are sufficient to fully offset U.S. tax on GILTI income. However, the GILTI regime limits foreign tax credits to 80 percent of their total value, so a “baseline” GILTI scenario, with zero expense allocations, implies that foreign tax credits can fully offset U.S. tax on GILTI at foreign effective tax rates in excess of 13.125 percent ( i.e., 10.5/0.8). The section 250 deduction for FDII is also intended to have a “baseline rate” of 13.125 percent ( i.e., 0.21 × (1−0.375)); typically foreign tax credits are not relevant for FDII, and there is no 80 percent limitation applied to foreign tax credits with respect to FDII. 3 The exclusions are: (1) Subpart F inclusions (section 951); (2) GILTI; (3) financial services income (as defined in section 904(d)(2)(D)); (4) dividends received from the corporation's CFCs; (5) domestic oil and gas extraction income; and (6) foreign branch income (as defined in section 904(d)(2)(J)). B. The Need for Proposed Regulations The purpose of the proposed regulations is to provide guidance to taxpayers in determining the amount of their deduction under section 250. Section 250(c) states that “[t]he Secretary shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 250].” Therefore, the proposed regulations seek to provide the detail, structure, and language required to implement section 250. The proposed regulations seek to assist taxpayers in calculating the allowable section 250 deduction, for example, by providing details on how to compute FDII, and the components of FDII such as QBAI, DEI, and FDDEI. In particular, with respect to FDDEI, the proposed regulations provide guidance on which sales of property and which provisions of services generate gross income included in FDDEI, and on how to allocate expenses to such gross income to determine FDDEI. In addition, the proposed regulations provide an ordering rule to coordinate the computation of the section 250 taxable income limitation with the taxable income limitations across other provisions of the Code. The proposed regulations also seek to clarify that the section 250 deduction for FDII is available for certain foreign military sales and services. In addition, the proposed regulations allow a section 250 deduction to individual taxpayers with respect to GILTI if they make an election under section 962. Finally and importantly, the proposed regulations also seek to provide clarity and guidance regarding the types of documentation required to substantiate that, in fact, sales of property are to foreign persons for a foreign use and provisions of services are to persons, or with respect to property, located outside the United States. In developing the proposed regulations, the Treasury Department and the IRS sought to balance the need for rigorous documentation to ensure compliance with the desire to minimize administrative burden and costs to taxpayers. C. Baseline The economic analysis that follows compares the proposed regulations to a no-action baseline reflecting anticipated Federal income tax-related behavior in the absence of the proposed regulations. A no-action baseline reflects the current environment including the existing international tax regulations, prior to any amendment by the proposed regulations. D. Cost and Benefits of the Proposed Regulations and Potential Alternatives The proposed regulations provide certainty, clarity, and consistency in the application of the section 250 deduction by unambiguously defining terms, calculations, and acceptable forms of documentation, and also by making clear the conditions under which military sales are eligible to claim the deduction. In the absence of such guidance, the chance that different taxpayers would interpret the statute differently would be exacerbated. Similarly situated taxpayers might interpret the statutory rules pertaining to particular sales or services differently, with one taxpayer pursuing a sale that another taxpayer might decline to make, because of different interpretations of how the income would be treated under section 250. If this second taxpayer's activity were more profitable, an economic loss arises. Such situations are more likely to arise in the absence of guidance. While no guidance can curtail all differential or inaccurate interpretations of the statute, the proposed regulations will significantly mitigate the chance for such interpretations and thereby increase economic efficiency. In general, the Treasury Department and the IRS expect that in the absence of this guidance, taxpayers would undertake fewer eligible sales and services. Thus, the proposed regulation will generally enhance U.S. sales and services across all eligible activities. The Treasury Department and the IRS have not made quantitative estimates of these effects. The benefits and costs of major, specific provisions of these proposed regulations relative to the no-action baseline and alternatives to these proposed rules considered by the Treasury Department and the IRS are discussed in further detail below. 1. Documentation Requirements The proposed regulations set forth what forms of documentation can be used to substantiate that receipts qualify as “foreign-derived” for purposes of FDII and the section 250 deduction. In general, the Treasury Department and the IRS weighed the compliance burden imposed on taxpayers from documentation requirements against the need for documentation to be sufficiently rigorous in establishing foreign use or the location of a person that receives a service. Because the statute provides different requirements for sales or services to qualify for a section 250 deduction and the proposed regulations provide different requirements depending on the type of sale or the type of service, and because documentation needs to be tailored to the applicable requirement, the proposed regulations specify different types of acceptable documentation for different types of transactions. In particular, documentation requirements vary with respect to the determination of whether a sale of property is to a foreign person, whether a sale of general property is for a foreign use, whether a sale of intangible property is for a foreign use, whether an individual consumer of a general service is located outside the United States, and whether a business recipient of a general service is located outside the United States. In each case, the proposed regulations provide that the list of acceptable documentation constitutes reasonable proof that a transaction is a FDDEI transaction. In general, the types of documentation listed are readily accessible to most taxpayers. For example, with respect to demonstrating foreign use for general property, taxpayers can show evidence of shipment to a location outside the United States (presuming that the seller has no knowledge or reason to know that that information is unreliable or incorrect). To further reduce compliance burdens, the proposed regulations allow additional flexibility for particular types of taxpayers or transactions. For example, throughout the proposed regulations, small businesses (defined in the proposed regulations as taxpayers with less than $10 million of gross receipts annually) are subject to less stringent documentation requirements because their smaller scale makes compliance more burdensome for them and makes the sophisticated tax minimization planning that can sometimes characterize abuse unlikely. Small transactions (defined in the proposed regulations as less than $5,000 of gross receipts from a single recipient) are also subject to less stringent documentation requirements, because the fixed costs of compliance likely account for a larger fraction of the profit on small transactions, and large scale abuse is less likely. The Treasury Department and the IRS request comments on whether the thresholds in the proposed regulations for small businesses and small transactions are appropriate and especially solicit comments that provide data, other evidence, and models that can enhance the rigor of the process by which such thresholds are determined. Further, the proposed regulations allow a more flexible approach for the documentation of sales of fungible general property because it is burdensome and unnecessary to track each sale of a fungible item as long as the taxpayer can establish by documentation that a certain percentage of the fungible property is for a foreign use. In determining appropriate documentation requirements, the Treasury Department and the IRS balanced the rigor and reliability of the proof that transactions are foreign-derived with the cost to taxpayers of obtaining such documentation. The Treasury Department and the IRS considered a spectrum of trade-offs between the rigor of proof of foreign use and the burden such proof would impose on taxpayers. One option considered was allowing only the most stringent form of documentation in each case (for example, a written statement of foreign use made under penalties of perjury, plus evidence of such use) without any flexibility, but this was deemed overly burdensome for taxpayers and foreign buyers. Overly burdensome documentation requirements might shift transactions to sellers that do not need or cannot use the FDII deduction, or it may discourage foreign persons from transacting with a U.S. seller or renderer. The Treasury Department and the IRS aimed to propose rules that would not alter economic decisions because of these concerns. In addition, highly burdensome rules may lead to abuse. For example, a foreign buyer that falsifies documentation provided to a domestic corporation to allow the corporation to obtain a deduction would not be subject to penalties by the IRS. Because the incentives for compliance by foreign buyers are limited (for example, contractual liability between the parties), the burden should also be limited. In comparison, chapters 3 and 4 of subtitle A of the Code require U.S. financial institutions to withhold on certain payments to foreign persons if they do not provide documentation. Because of the enforcement mechanism built into the statutes in chapters 3 and 4 ( i.e., withholding), the IRS can require stricter documentation (for example, most foreign persons have to provide to the financial institution a specific IRS form, completed and signed under penalties of perjury, and in some cases must attach additional documentation on underlying payees). The Treasury Department and the IRS also considered a system in which taxpayers submitted documentation in advance of a potential FDDEI transaction for the IRS to review and determine whether the documentation is sufficient. This option was rejected because the time involved would delay normal business transactions. A third option that the Treasury Department and the IRS considered was to allow a taxpayer to use its discretion to determine what type of documentation is appropriate, but this would not provide sufficient clarity and assurance to taxpayers and is potentially open to abuse. For each type of transaction, the Treasury Department and the IRS chose to allow a menu of acceptable documentation options that vary according to the type of transaction, and selected documentation options that would be readily available to the taxpayer whenever possible. By allowing taxpayers to, in some cases, rely on documents already obtained in the normal course of business, the proposed regulations impose essentially zero documentation cost in such cases. The Treasury Department and the IRS request comments on the approaches and decisions relating to documentation requirements discussed in this part I(D)(1) of this Special Analyses section. See part II of this Special Analyses section regarding the Paperwork Reduction Act for additional discussion on the expected paperwork burden of these documentation requirements. 2. Computation of the Ratio of FDDEI to DEI The propos [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2019-03848. Public record. Not legal advice.