What Is Foreign Derived Intangible Income?

Foreign Derived Intangible Income (FDII) represents a tax incentive for U.S. corporations, introduced by the Tax Cuts and Jobs Act of 2017 (TCJA). This provision aims to encourage domestic companies to export goods and services from the United States. Its primary objective is to make the U.S. a more appealing location for businesses that generate income from foreign sales. The incentive provides a lower tax rate on certain income derived from intangible assets, fostering economic activity within the country.

Understanding Foreign Derived Intangible Income

FDII focuses on a portion of a U.S. corporation’s income that originates from intangible assets, such as patents, copyrights, trademarks, and specialized know-how, used to generate foreign sales or services. The deduction, outlined in Internal Revenue Code Section 250, provides a reduced effective tax rate on specific export-related income. This mechanism aims to create a more equitable competitive environment for U.S. companies operating internationally. By offering this deduction, the government seeks to incentivize U.S. businesses to retain their intellectual property and associated operations within the United States.

Key Elements of the FDII Calculation

Deduction Eligible Income (DEI) is a U.S. corporation’s gross income. Certain income types are specifically excluded from DEI, such as income from Subpart F, Global Intangible Low-Taxed Income (GILTI), financial services income, and domestic oil and gas income.

Qualified Business Asset Investment (QBAI) is the adjusted basis of depreciable tangible property used in the trade or business that generates DEI. QBAI serves as a proxy for a “routine return” on a company’s tangible assets. This routine return is currently set at 10% of the QBAI.

Deemed Intangible Income (DII) is calculated by subtracting this 10% routine return on QBAI from DEI. The resulting DII amount is the portion of income presumed to be generated from a company’s intangible assets.

Identifying Qualifying Foreign-Derived Income

Foreign-Derived Deduction Eligible Income (FDDEI) is DEI from transactions with foreign persons for use outside the United States. This includes income from the sale of property to any foreign person, provided the property is intended for use outside the U.S., such as goods shipped directly to a foreign country for consumption there.

Income from services can also qualify as FDDEI. Services performed outside the U.S. for any person, whether foreign or domestic, can qualify. Services performed within the U.S. for a foreign person may also qualify if they relate to property located outside the U.S., such as architectural services for a building being constructed in a foreign country. Income that does not qualify as foreign-derived includes sales to U.S. persons or income from property or services intended for use within the U.S. Income attributable to a foreign branch of a U.S. corporation is also excluded from FDDEI.

Calculating the FDII Deduction

The actual Foreign Derived Intangible Income deduction is computed by bringing together the previously defined income components. FDII is calculated by taking the ratio of a corporation’s Foreign-Derived Deduction Eligible Income (FDDEI) to its total Deduction Eligible Income (DEI), and then multiplying this ratio by its Deemed Intangible Income (DII).

The deduction is applied as a specific percentage of this calculated figure. For tax years beginning before 2026, the deduction rate is 37.5% of the calculated FDII, effectively reducing the corporate tax rate on this income. After 2025, for tax years beginning in 2026 and thereafter, the deduction percentage decreases to 21.875%. This deduction is subject to a taxable income limitation, meaning it cannot reduce a corporation’s taxable income below zero for the tax year.