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Eligibility Requirements for Reduced Tax Rate on FDII for Royalties

A domestic corporation's royalty income derived in connection with business conducted outside the United States generally is eligible for the reduced 13.125 percent effective tax rate on foreign derived intangible income (FDII). To qualify, the licensee must be a foreign person, and the intangible property must be used outside the US for the ultimate benefit of an unrelated foreign person.

For example, the lower rate generally should be available for royalties from licensing intangible property to an unrelated foreign person for use: (1) in the production and sale of products to foreign customers; (2) to provide services to foreign customers; or (3) to sublicense the intangible property to foreign persons.

Royalties from licensing intangible property to an unrelated US corporation that is for use outside the US may not qualify for FDII benefits. Such royalties should qualify, however, if instead the license is with a foreign subsidiary of the US corporation, or if a foreign subsidiary otherwise economically is considered the licensee.

The 13.125 percent tax rate is also available for certain royalties derived from licensing intangible property to related foreign persons. For example, royalties generally should qualify if the related foreign person uses the intangibles outside the United States to (1) produce and sell products to unrelated foreign customers; (2) provide services to unrelated foreign customers, or (3) sublicense the intangibles to unrelated foreign persons.

If one member of a US consolidated group first licenses the intangible property to another member of the group, which then sublicenses the intangible property to a foreign person, the group’s royalty income may nevertheless qualify for the 13.125 percent rate as a result of the consolidated return regulations. In the absence of guidance confirming this point, steps may be taken to combine the two domestic entities to avoid any issue (e.g., as disregarded LLCs under a single domestic corporation).

A company will need to develop reasonable methods for documenting the foreign use of the licensed intangibles. Additional analysis and support may be necessary where products or services ultimately have some connection to US customers.

Royalties that qualify as FDII generally should be foreign source income. US tax on foreign source royalties can be reduced by foreign tax credits for any withholding taxes paid on the royalties, and also potentially reduced by foreign taxes paid on other income (although the basketing of FDII royalties is not entirely clear and will need to be addressed in guidance).

A domestic corporation should carefully analyze the royalties it derives from licensing intangible property for use outside the United States and ensure that the FDII requirements are satisfied, and develop documentation supporting the applicability of the 13.125 percent tax rate.

© 2020 McDermott Will & EmeryNational Law Review, Volume VIII, Number 198
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About this Author

David G. Noren, International Tax Planning Attorney, McDermott Will Emery Law firm Washington DC
Partner

David G. Noren is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm's Washington, D.C. office.  He focuses his practice on international tax planning for multinational companies.  David’s work in this area covers a wide range of both “outbound” and “inbound” issues, with a particular focus on the “subpart F” anti-deferral rules, the application of bilateral income tax treaties, and the treatment of cross-border flows of services and intellectual property rights under transfer pricing and other rules.  He has been ranked as...

202-756-8256
Lowell D. Yoder, International Tax Planning, Attorney, McDermott Will, Law Firm
Partner

Lowell D. Yoder is a partner in the law firm of McDermott Will & Emery LLP and is based in the Chicago office.  He is head of the U.S. & International Tax Practice Group. Lowell’s practice focuses on international tax planning for multinational companies.   He handles cross-border acquisitions, dispositions, mergers, reorganizations, joint ventures and financings.  He advises concerning multi-jurisdictional business structures and the use of special purpose foreign entities.  He also works with an extensive network of foreign lawyers on developing structures that minimize foreign taxes of U.S. multinationals without adversely affecting their U.S. tax position.  Lowell was listed in the latest, as well as previous editions of Chambers Global:  The World’s Leading Lawyers for Business, Chambers USA:  America’s Leading Lawyers for Business,International Tax Review’s World Tax Directory, The Best Lawyers in America, PLC Which Lawyer?The International Who's Who Of Corporate Tax Lawyers, The Legal 500 United States,The International Who's Who of Business Lawyers, Who’s Who Legal:  IllinoisandEuromoney’s Guide to the World’s Leading Tax Advisors and Best of the Best USA. Lowell has also been named an Illinois Super Lawyer byLaw & Politics.

31-984-7523
Elizabeth Chao, International Tax Matters Attorney, McDermott Will, Law firm
Associate

Elizabeth Chao focuses her practice on US and international tax matters.

Previously, Elizabeth worked at the University of Chicago Law School as the chief research assistant to Judge Richard A. Posner and Professor William M. Landes. She also served a project associate with Innovations for Poverty Action in Nairobi, Kenya.

While in law school, Elizabeth served as a features editor for the Yale Law Journal.

312-984-6949
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