Tax Group Suggests Changes to Proposed FDII, GILTI Regs

May 6, 2019

Internal Revenue Service
CC:PA:LPD:PR (REG-104464-18)
Room 5203
Post Office Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Comments on proposed regulations implementing IRC section 250 (NPRM REG-104464-18)

Dear Sir or Madam:

The Alliance for Competitive Taxation (“ACT”) is a coalition of leading American companies from a wide range of industries that supports a globally competitive corporate tax system that aligns the United States with other advanced economies.

Attached are ACT's comments on the proposed regulations implementing section 250 of the Internal Revenue Code (“Code”) as amended by the Tax Cuts and Jobs Act (“TCJA”). We recognize and commend the extraordinary efforts of Treasury and IRS staff in issuing TCJA guidance in a timely and comprehensive manner.

We appreciate your consideration of these comments. ACT representatives welcome future discussion of these comments with your staff.

Yours sincerely,

Alliance for Competitive Taxation
Washington, DC

cc:
Charles P. Rettig, Commissioner, Internal Revenue Service
L.G. “Chip” Harter, Deputy Assistant Secretary (International Tax Affairs), U.S. Treasury Department
Harvey Mogenson, U.S. Treasury Department
Brenda Zent, U.S. Treasury Department
Peter Blessing, Associate Chief Counsel (International), Internal Revenue Service
Leni Perkins, Attorney-Advisor, Branch 8, ACC(I), Internal Revenue Service
Kenneth Jeruchim, Office of Associate Chief Counsel (International), Internal Revenue Service
Michelle Monroy Office of Associate Chief Counsel (Corporate), Internal Revenue Service
Austin Diamond-Jones Office of Associate Chief Counsel (Corporate), Internal Revenue Service
Marissa Rensen, Office of Associate Chief Counsel (International), Internal Revenue Service

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COMMENTS BY ALLIANCE FOR COMPETITIVE TAXATION ON
PROPOSED REGULATIONS IMPLEMENTING SECTION 250

I. INTRODUCTION

This document sets forth the comments of ACT on the proposed regulations regarding the deduction for foreign-derived intangible income and global intangible low-taxed income, as enacted by the Tax Cuts and Jobs Act (NPRM REG-104464-18).

II. COMMENTS RELATING TO CERTAIN ASPECTS OF PROPOSED SECTION 250 REGULATIONS

A. General Documentation Requirements (Prop Reg. §§ 1.250(b)-3(d), 1.250(b)-4(c)(2), (d)(3), and (e)(3) and 1.250(b)-5(d)(3) and (e)(3))

Proposed Regulations

The proposed regulations provide detailed documentation requirements for establishing: (i) a purchaser is a foreign person, (ii) foreign use of general and intangible property, (iii) a general service recipient's location, and (iv) the reliability of such obtained documentation.

1. FDDEI Sales

The proposed regulations divide FDDEI sales into sales of “general property” and sales of “intangible property” and set forth requirements to document that the purchaser is a foreign person and the property is used abroad.

a. Documentation of “Foreign Person”

Under Prop. Reg. § 1.250(b)-4(c)(2)(i), a seller of property (both general and intangible) establishes the status of a recipient as a foreign person by obtaining one or more of the following types of documentation with respect to the person: (a) a written statement by the recipient that the recipient is a foreign person; (b) with respect to a recipient that is an entity, documentation that establishes that the entity is organized or created under the laws of a foreign jurisdiction; (c) with respect to an individual, any valid identification issued by a foreign government or an agency thereof that is typically used for identification purposes; (d) documents filed with a government or an agency or instrumentality thereof that provide the foreign jurisdiction of organization or residence of an entity (for example, a publicly traded corporation's annual report filed with the U.S. Securities and Exchange Commission that includes the jurisdiction of organization or residence of foreign subsidiaries of the corporation); or (e) any other forms of documentation as prescribed by the Secretary.

b. Documentation of “Foreign Use”

The proposed regulations provide different documentation requirements (dependent upon the type of property sold) for sellers to establish that property sold is for foreign use.

General Property

The proposed regulations generally provide that the sale of general property (defined as any property other than (i) intangible property, (ii) a security (as defined in section 475(c)(2)), or (iii) a commodity (as defined in section 475(e)(2)(B) through (D)) is for a foreign use if either (i) the property is not subject to domestic use within three years of delivery or (ii) the property is subject to manufacture, assembly, or other processing outside of the United States before any domestic use of the property.

Prop. Reg. § 1.250(b)-4(d)(3)(i) provides specific documentation rules for establishing foreign use of general property. Specifically, a seller establishes that general property, or a portion of a particular class of fungible general property, is for a foreign use only if the seller obtains one or more of the following types of documentation with respect to the sale: (a) a written statement from the recipient or a related party of the recipient that the recipient's use or intended use of the property is for a foreign use; (b) a binding contract between the seller and the recipient which provides that the recipient's use or intended use of the property is for a foreign use; or (c) documentation of shipment of the general property (including both property located within the United States or outside the United States, such as in a warehouse, storage facility, or assembly site located outside the United States) to a location outside the United States (for example, a copy of the export bill of lading issued by the carrier which delivered the property, or a copy of the certificate of lading for the property executed by a customs officer of the country to which the property is delivered).

If the sale of property involves the sale of a “fungible mass” (i.e., multiple items of general property, which because of their fungible nature cannot reasonably be specifically traced to the location of use), Prop. Reg. § 1.250(b)-4(d)(3)(iii) states that a seller may establish that a portion of the fungible mass is for a foreign use through market research, including statistical sampling, economic modeling and other similar methods indicating that the property will be subject to a foreign use. Under Prop. Reg. § 1.250(b)-4(d)(3)(iii) if the seller establishes that 90 percent or more of a fungible mass is for a foreign use, then the entire fungible mass is for a foreign use, and if the seller does not establish that 10 percent or more of the sale of a fungible mass is for a foreign use, then no portion of the fungible mass is for a foreign use.

Intangible Property

The proposed regulations generally provide that intangible property is considered sold for a foreign use in proportion to the revenue generated by the property from exploitation outside the United States. Under Prop. Reg. § 1.250(b)-4(e)(2)(i), a sale of intangible property rights providing for exploitation both within the United States and outside of the United States is for a foreign use in proportion to the revenue generated from exploitation outside the United States over total revenue generated from the exploitation of the intangible property. For intangible property used in the manufacture, sale, or distribution of a product, the intangible property is treated as exploited at the location of the end user when the product is sold to the end user.

Under Prop. Reg. § 1.250(b)-4(e)(3)(i), a seller establishes the extent to which a sale of intangible property in exchange for periodic payments is for a foreign use by obtaining one or more of the following types of documentation with respect to the sale: (a) a written statement from the recipient providing the amount of the annual revenue from sales or sublicenses of the intangible property or sales of products with respect to which the intangible property is used that is generated as a result of exploitation of the intangible property outside the United States and the total amount of revenue from such sales or sublicenses worldwide; (b) a binding contract for the sale of the intangible property that provides that the intangible property can be exploited solely outside the United States; (c) audited financial statements or annual reports of the recipient stating the amount of annual revenue earned within the United States and outside the United States from sales of products with respect to which the intangible property is used; or (d) any statements or documents used by the seller and the recipient to determine the amount of payment due for exploitation of the intangible property if those statements or documents provide reliable data on revenue earned within the United States and outside the United States.

Under Prop. Reg. § 1.250(b)-4(e)(3)(iii), a seller establishes the extent to which a sale of intangible property in exchange for a lump sum payment 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 exploiting the intangible property. To be considered reasonable, the projections must be consistent with the financial data and projections used by the seller to determine the price it sold the intangible property to the foreign person.

2. FDDEI Services

The proposed regulations subdivide general services into two subgroups based on the recipient of the rendered service: (1) general services provided to a consumer, described in Prop. Reg. § 1.250(b)-5(d)(1), and (2) general services provided to a business recipient, described in Prop. Reg. §1.250(b)-5(e)(1). Under Prop. Reg. § 1.250(b)-5(b)(1), income from the rendering of a general service to either a consumer or business recipient is treated as FDDEI only if the consumer or business recipient is “located outside the United States.”

Prop. Reg. § 1.250(b)-5(d)(2) provides that a consumer is located wherever such individual resides when the service is performed. Under Prop. Reg. § 1.250(b)-5(e)(2)(i), a business recipient is considered located outside the United States to the extent that the renderer's gross income derived from such service is allocated to the business recipient's non-U.S. operations. Prop. Reg. § 1.250(b)-5(e)(2)(ii) clarifies that a business recipient is treated as having operations in any location where it maintains an office or other fixed place of business.

Under Prop. Reg. § 1.250(b)-5(d), a renderer of a general service to a consumer establishes that such consumer is located outside the United States if the renderer obtains one or more of the following types of documentation with respect to the consumer: (a) a written statement by the consumer indicating that the consumer resides outside the United States when the service is provided, or (b) any valid identification issued by a foreign government or an agency thereof that is typically used for identification purposes.

Under Prop. Reg. § 1.250(b)-5(e)(3), a renderer of a general service to a business recipient establishes that such business recipient is located outside the United States only if the renderer obtains one or more of the following types of documentation: (a) a written statement from the business recipient that specifies the locations of the operations of the business recipient that benefit from the service; (b) a binding contract that specifies the locations of the operations of the business recipient that benefit from the service; (c) documentation obtained in the ordinary course of the provision of the service that specifies the locations of the operations of the business recipient that benefit from the service; or (d) publicly available information that establishes the locations of the operations of the business recipient.

The proposed regulations provide additional rules in Prop. Reg. § 1.250(b)-5(d)(e)(2)(i)(A) to evaluate the location of a business recipient's operations that benefit from a rendered service, where such rules are dependent on whether the service rendered provides a benefit to specific locations of the business recipient's operations or to all locations of the business recipient's operations. If the service provides a benefit to specific locations of the business recipient's operations, the associated gross income derived by the renderer in rendering the service is FDDEI to the extent the benefit conferred at such specific locations is conferred on business operations of the recipient located outside the United States. If the renderer cannot obtain reliable information regarding the specific location of the business recipient's operations receiving a benefit, or if the service confers a benefit on all of the recipient's operations, gross income of the renderer is allocated ratably to all of the business recipient's operations at the time the service is rendered. The documentation obtained pursuant to Prop. Reg. § 1.250(b)-5(e)(3) for documenting the location of a business recipient of services must also support the renderer's allocation of income in the above rule.

3. Small Businesses and Small Transactions

The proposed regulations provide alternative documentation requirements for certain “small businesses” (i.e., a seller of property or renderer of services that receives less than $10,000,000 in gross receipts during a prior taxable year), and certain “small transactions” (i.e., a seller of property or renderer or services that receives less than $5,000 in gross receipts from a single recipient during a taxable year).

Under Prop. Reg. § 1.250(b)-4(c)(2)(ii)(A) (for small businesses), a seller may establish the status of any recipient of property as a foreign person for a taxable year if the seller's shipping address for the recipient is outside the United States. Additionally, under Prop. Reg. § 1.250(b)-4(c)(2)(ii)(B) (for small transactions), a seller may establish the status of any recipient as a foreign person for such taxable year if the seller's shipping address for the recipient is outside the United States.

Prop. Reg. § 1.250(b)-4(d)(3)(ii) provides a similar alternative documentation standard for small businesses and small transactions to establish that the sale of general property is for a foreign use.

Similarly, Prop. Reg. § 1.250(b)-4(e)(3)(ii) provides an alternative documentation standard for small businesses and small transactions to establish the location of a consumer or business recipient as outside the United States with regard to the provision of general services. These rules substitute the shipping address of the recipient with the billing address for the consumer or business recipient of the rendered services.

4. Reliability of Documentation

With respect to each of the above documentation requirements, including the documentation requirements for small businesses and small transactions, the proposed regulations also provide a reliability standard for the acquired documentation. Prop. Reg. § 1.250(b)-3(d) provides that documentation is reliable only if: (a) as of the FDII filing date (i.e., the date, including extensions, by which the seller or renderer is required to file an income tax return), the seller or renderer does not know and does not have reason to know that the documentation is unreliable or incorrect; (b) the documentation is obtained by the seller or renderer by the FDII filing date with respect to the sale or service; and (c) the documentation is obtained no earlier than one year before the date of the sale or service. 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 or reliability of the documentation.

Additionally, the proposed regulations provide that for taxable years beginning prior to 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, or a recipient of a general service is located outside the United States, provided that such documentation meets the reliability requirements described above. For this purpose, the proposed regulations provide that reasonable documentation includes, but is not limited to, documents described in or similar to the documents described in Prop Reg. §§ 1.250(b)-4(c)(2), (d)(3), and (e)(3) and 1.250(b)-5(d)(3) and (e)(3) and also includes the documentation described in the special rules for small businesses and small transactions in Prop. Reg. §§ 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 these special rules.

Treasury Explanation

Among other things, the preamble provides that the proposed regulations “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.”

Treasury and the IRS recognized in the preamble that the proposed regulations were designated as “economically significant” by the Office of Management and Budget's Office of Information and Regulatory Affairs (“OIRA”). As a result of this designation, Treasury and the IRS were required to consider and address options for mitigating taxpayer burden. Thus, the preamble 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.”

As further provided in the preamble,

“[o]verly 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. [. . .] 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.”

With respect to sales of certain fungible mass property, the preamble provides that, “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.”

Comments are requested regarding whether Treasury and the IRS should provide a definition of “know” and “reason to know” in the regulations.

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.

ACT Recommendations

If Treasury and the IRS decline to follow ACT recommendation¹, either in whole or in part, ACT recommends the following:

Reasons for ACT Recommendations

With respect to ACT recommendation 1, above, Treasury and the IRS stated in the preamble that they “aimed to propose rules that would not alter economic decisions” with respect to transactions under which taxpayers might obtain section 250 benefits. However, the proposed regulations contain documentation requirements that, in some instances, are unrealistic, will not be possible to satisfy, and/or impose substantial administrative and compliance burdens on the IRS, taxpayers, and buyers. For example, the documentation requirements require statements and analyses that buyers will often be unable or unwilling to supply. Buyers may wish to keep confidential their contracts with U.S. sellers and service renderers. Buyers may also be unable or unwilling, based on confidentiality concerns, to provide a statement regarding their revenue from intangible exploitation within or outside the United States. Thus, the documentation requirements might deprive many taxpayers of FDII benefits for which they are eligible under the statute. They also might, in some cases, discourage foreign buyers from doing business with U.S. companies, contrary to the purpose of TCJA to promote economic growth and make U.S. firms more competitive.³

As described above, the proposed regulations were designated by OIRA as economically significant, requiring an analysis of the burden on taxpayers and potential mitigating options. The Special Analysis of the proposed regulations discusses the application of Executive Orders 13563 and 12866 and the corresponding agency requirements to conduct a costs and benefits analysis. It further stresses the importance of quantifying both costs and benefits. Treasury attempted in the proposed regulations to “balance the need for rigorous documentation to ensure compliance with the desire to minimize administrative burden and costs to taxpayers.” Treasury also acknowledged in the preamble that “overly burdensome documentation requirements might shift transactions to sellers that do not need or cannot use the FDII deduction, [. . .] may discourage foreign persons from transacting with a U.S. seller or renderer, [. . . and] may lead to abuse.” When discussing the documentation requirements, the Special Analysis says that “[i]n general, the types of documentation listed are readily accessible to most taxpayers.” It then notes that to reduce burdens, relief is provided to small businesses. A high-level quantification of this burden reduction for small businesses is estimated within the Regulatory Flexibility Act Special Analysis section, but the analysis does not quantify the remaining burden imposed on larger entities that are ineligible for the small business relief provisions. The documentation requirements for larger businesses, including those with many thousands or millions of transactions within a tax year, will be substantial, if even feasible, and the Special Analysis is inadequate in meeting the quantification requirements of the Executive Orders. Thus, as a threshold matter, ACT requests that each of its above recommendations (1) through (9) be considered options under the Special Analysis for reducing taxpayer burdens and further requests that a more thoughtful quantification of the costs and benefits be conducted to be consistent with the objectives of the Executive Orders. In particular, this analysis should recognize that much of the required documentation is not, in fact, readily available to many large taxpayers with a substantial number of transactions that are otherwise eligible for the section 250 deduction.

Moreover, in consideration of the “need for rigorous documentation to ensure compliance . . . [while attempting . . .] to minimize administrative burden and costs to taxpayers,” Treasury specifically decreased the documentation burden for certain small businesses, small transactions, and sales of a fungible general property, as well as provided relief similar to that provided to small businesses and for small transactions for all transactions occurring in taxable years beginning prior to March 4, 2019; however, after this date, taxpayers not meeting the small business and small transaction exceptions are required to comply with the “rigorous” documentation requirements described in the proposed regulations.

Treasury indicated that the proposed regulations are intended to allow taxpayers to rely on documents already obtained in the normal course of business “in some cases.” In contrast, and as described above, many or most of the documents that satisfy the documentation requirements are not obtained in the ordinary course of business, e.g., a valid identification of the buyer issued by a foreign government, or a written statement that specifies the locations of the operations of a business recipient that benefits from purchased services. Taxpayers who are unable to obtain one of the enumerated forms of documentation from all buyers, e.g., those who sell general property to vast numbers of individual consumers, are unfairly handicapped, and may be required to make significant changes to their contracts and bookkeeping to ensure proper documentation. Buyers, in return for their cooperation, may extract quid pro quos from U.S. sellers. Congress evidenced no intent that such hurdles be created to obtain FDII benefits.⁴ ACT's recommendations, above, are intended to provide the balance Treasury and the IRS seek between an appropriate level of burden on taxpayers, as intended by OIRA, and the need for sufficient documentation to ensure compliance.

With respect to ACT recommendation 1, above, ACT believes that providing for all taxpayers, regardless of size, the documentation rules currently provided in the proposed regulations to small businesses and small transactions should adequately prevent FDDEI treatment from being obtained in domestic use, domestic location, and domestic buyer situations, while allowing taxpayers to claim the FDII benefits that Congress intended them to have. Further, ACT's recommendation would allow taxpayers to use a recipient's billing address to establish its status as a foreign person if the property sold is not shipped. Because the FDDEI sales, licenses, and services generally are provided to unrelated parties, the opportunity for abuse would be limited if the small business and small transaction rules were available to all. The reliability rules for documentation, including the “know or reason to know” rule, should adequately police these recommended documentation rules.

With respect to ACT recommendation 2, above, some taxpayers may be unable to obtain one of the enumerated documents by the FDII filing date because they are dependent on their buyers to timely provide many of the enumerated documents. ACT recognizes that a grace period for obtaining the applicable documentation cannot continue indefinitely, and therefore recommends a 36-month deadline. Such a rule would ease the time pressure to obtain documents from uncooperative third parties, taking into account the practical reality of having to rely on unrelated parties to timely obtain the enumerated documentation.

With respect to ACT recommendation 3, above, the use in the U.S. withholding tax context of IRS-designed forms to establish the status and classification of payment recipients that are entitled to reduced withholding tax rates is established and familiar and will reduce the compliance burden on taxpayers and foreign recipients, and the administrative burden on IRS examiners. This standardization of documentation to establish key facts has also, in the experience of some ACT Members, reduced audit controversies regarding U.S. withholding taxes, in contrast, for example, with audits of R & E credit claims where no standardized documentation exists. The proposed regulations, in contrast with ACT's recommendation, set forth a diverse range of documents that must be provided by foreign buyers and service recipients, most of which will be unfamiliar to them and to taxpayers and, as previously discussed, may be difficult or impossible to obtain from these foreign customers. ACT believes IRS Forms now used for U.S. withholding tax purposes can be readily adapted for FDII documentation purposes. The current forms are also frequently conveyed electronically to U.S. withholding agents, a major convenience that could be carried over to the FDII area. Standardized IRS documents would also, from a tax accounting perspective, streamline the establishment of reserves for uncertain tax positions under ASC 470, and make it easier to demonstrate substantiation and controls in preparation of the tax provision. The reliability rules for documentation in the regulations will apply to the standardized IRS documents, as do broadly similar reliability rules in the US withholding tax context.

With respect to ACT recommendation 4, above, and as described previously, Treasury has indicated that the proposed regulations are intended to allow taxpayers to rely on documents already obtained in the normal course of business, yet many or most of the documents that satisfy the proposed documentation requirements would not be available in the ordinary course of business. ACT recommendation 4 would permit taxpayers who cannot obtain one of the enumerated forms of documentation to satisfy the documentation requirements with documents generated in the ordinary course of business. The preamble provides that for taxable years beginning before the proposed regulations were published, taxpayers “may use any reasonable documentation maintained in the ordinary course of business [. . . which] includes, but is not limited to, documents described [in the proposed regulations]” (emphasis added). The preamble further provides that reasonable documentation prior to the regulations being published includes the documentation described for small businesses and small transactions. Thus, Treasury has acknowledged that alternative documentation may be reasonable and reliable. ACT believes that documentation generated in the ordinary course of business should, ipso facto, satisfy the documentation requirements, subject, as all the documentation rules are, to the documentation reliability requirements. Alternatively, ACT believes that the supplementation of standard invoice language, as described above, could adequately establish foreign customer status, foreign use, service recipient location, and the place services are conferred eliminating the need to obtain any additional documentation from foreign buyers and service recipients. This would greatly simplify the process of establishing eligibility for the FDII deduction and eliminate the practical barriers, discussed elsewhere in this letter, to obtaining the documentation required by the proposed regulations. This approach would also, from a tax accounting perspective, streamline the establishment of reserves for uncertain tax positions under ASC 740, and make it easier to demonstrate substantiation and controls in preparation of the tax provision. ACT believes that other reasonable alternative documentation might also be accepted. A non-exclusive list of such documentation is provided in our recommendation.

With respect to recommendations 5 and 6, above, the rules under Prop Reg. § 1.250(b)-4(e)(3) for determining whether a foreign business recipient is located outside the United States apply if a service recipient has operations in one or more offices or fixed places of business both within the United States and outside the United States. In ACT's view, if the service recipient's locations are all located outside the United States, all of the renderer's services should be treated as provided to a person in a foreign location, without having to allocate benefits between the recipient's locations. In contrast, Prop. Reg. § 1.250(b)-5(e)(3)(i)(A) requires that the statement from the business recipient specify the location of all of the operations of the business recipient that benefit from the service and support the allocation of income attributable to the benefit conferred on each of those locations.

If the business recipient has locations both within and outside the United States, the rules under Prop Reg. § 1.250(b)-4(e)(2)(i)(A)-(B) for determining the extent of benefit allocated to the service recipient's foreign locations place a heavy compliance burden on taxpayers to gather detailed information about their business recipients' business operations that the recipient may not have or may not be willing to provide. Allowing taxpayers to rely on a written statement from the business recipient indicating the amount of benefit for services rendered allocable to its U.S. office or other U.S. fixed place of business demands less detail from the service recipient. A check on this approach is that the recipient would typically be expected to file an IRS Form 1120F and, therefore, the recipient already would have determined the extent to which its U.S. office or fixed place of business generated income, and the IRS can examine the Form 1120F.

With respect to recommendation 7, above, some taxpayers in certain instances may find that statistical sampling and similar methods will greatly reduce compliance burdens where they can be appropriately used to analyze and substantiate the adequacy of the documentation received. Rev. Proc. 2011-42 provides IRS guidance on when it is appropriate to use statistical sampling and the methodology and procedures required for a statistical sample to be considered valid. The government would be in a position to more efficiently administer the FDII regime, and taxpayers' compliance costs would be reduced by the use of statistical sampling. For example, statistical sampling should be appropriate, and may be desirable to a taxpayer, when a taxpayer has thousands of customers or transactions which produce income eligible for FDII treatment. Statistical sampling could also be used by a taxpayer to determine whether documentation is adequate and contains a sufficient amount of detail to meet the applicable requirements (such as documentation obtained to substantiate that sales are to foreign a person, sales are for foreign use, or the provision of services is to persons, or with respect to property, located outside the United States) and to substantiate a taxpayer's amount of revenue eligible for deduction, among other things. For example, consider a taxpayer who sells general property (that is not sold as a fungible mass) to hundreds of thousands of consumers. While requesting the required information from the consumers may not be difficult, determining (1) that the documentation has been obtained from each consumer for each sale, (2) that the contents of that documentation are adequate, and (3) that the reliability requirements are met with respect to every document might consume an inordinate amount of employee time and may not be possible in light of other business constraints. The use of statistical sampling and similar methods would not excuse U.S. persons electing these methods from obtaining the required documentation from every buyer. Consistent with Rev. Proc. 2011-42, the IRS could not require taxpayers to use statistical sampling or similar methods.⁵

With respect to ACT recommendation 8, above, when selling or licensing intangible property, it is a common business practice to sell or license a “bundle” of intangible property. This bundle of property rights may represent all, or almost all, of the intangible property necessary for the purchaser to manufacture, market, and sell the product to which the intangible property relates. For example, a company may provide a foreign unrelated party with (i) intangible property relating to the manufacturing of a product such as a patent, (ii) intangible property relating to the design of such product, and (iii) copyrights, trademarks, and patents relating to the sale of such product.

In such cases, the parties may not specify the price or value of each piece of intangible property in the bundle or the location(s) where each piece of intangible property will be used. Generally speaking, the parties may not specifically assign values to each piece because there may be significant value to having all the intangible property in the bundle available for use together. In other words, the purchase or license of one piece within the bundle may have less value without the other pieces. For example, the license of intangible property used in manufacturing a product is worth relatively little if the licensee-manufacturer does not also obtain the trademarks and patent rights necessary to market and sell the product. Because the product may be sold both within and outside the United States in large volumes, with the relative values of the intangible property in the bundle potentially varying from one country of sale to another, neither party may be able to determine the value of each intangible property in the bundle.

In these cases, sellers, licensors, buyers, and licensees should not be required to perform expensive functional analyses or similar types of studies to establish the precise extent to which individual items of the bundled intangible property generate revenue from exploitation outside the United States. Occasionally, when sales or licenses of bundled intangible property occur, the seller or licensor has competent authority or advance pricing agreements in place that may be relevant for determining foreign use.

Sellers and licensors of bundled intangible property may sometimes have detailed vertical knowledge of their industries, including the approximate number and location of potential purchasers or licensees of the relevant IP rights, the volume of the products and services that will be manufactured or rendered, respectively, using the bundled intangible property, the location of markets for these products and services, etc. This knowledge may allow some sellers and licensors to estimate, with a high degree of accuracy, the portion of payments attributable to exploitation of the bundle outside the United States. Furthermore, prior competent authority or advance pricing agreements (if any) may also be instructive. There may be no practical means of establishing the degree of foreign use of these bundles of intangible property rights (other than those described in this paragraph).

Regulatory Authority for Recommendations

Adopting the ACT recommendations is within Treasury's broad authority under section 250(c) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section [250].”

In addition, with respect to recommendation 7, Rev. Proc. 2011-42 sets forth IRS rules generally regarding the use and evaluation of statistical samples and sampling estimates.

B. Ordering of Sections 163(j), 172(a), and 250

Proposed Regulation

The proposed regulations provide the following five-step ordering rule for applying sections 163(j), 172(a), and 250:

Treasury Explanation

The preamble to the proposed regulations states that Treasury and the IRS considered different approaches to the ordering rule and believed that the rule provided to taxpayers in the proposed regulations was consistent with the statutory language of sections 163(j), 172, and 250.

ACT Recommendation

ACT recommends Treasury and the IRS provide a transition rule for losses generated in taxable years beginning before January 1, 2018 under which the utilization of these losses as carryovers to taxable years beginning after December 31, 2017 would not reduce the amount of section 250 deduction available in the carryto year. In calculating the amount of pre-TCJA NOL carryover to a post-TCJA taxable year under section 172(b)(2), the modification under section 172(d)(9) would not be taken into account.

Reasons for ACT Recommendation

The purpose of the section 250 deduction is to equalize the taxation, at a rate lower than 21 percent, of intangible income earned in the United States on foreign market sales and services and intangible income earned by foreign subsidiaries. The taxable income limitation lowers the deduction in a manner Congress may not have contemplated. Reducing taxable income by NOL carryovers to determine the taxable income limitation will further lower the section 250 deduction, arguably thwarting Congressional intent.

Under the circumstances, a transition rule is appropriate. Other changes made by the TCJA to the NOL carryover rules (e.g., the 80-percent limitation) in section 172 contain transition rules. These section 172 NOL changes apply only to NOLs arising in taxable years beginning after December 31, 2017. See, e.g., TCJA sections 13302(a)(1) and (2). Thus, NOLs arising in years before the TCJA became effective and carried forward to years after the TCJA became effective are not subject to these TCJA changes.

As a matter of logic and equity, the same transition rule should apply to the proposed regulations' ordering rule for NOL carryover deductions under section 172 and section 250 deductions. That ordering rule, consistent with other statutory amendments relating to section 172, should not apply to NOLs arising in taxable years beginning before January 1, 2018 and carried forward to taxable years beginning on or after such date. As noted, this ordering rule, like the new 80 percent limitation on NOL deductions, is unfavorable to taxpayers and could not have been anticipated at the time the pre-TCJA NOLs arose. These are the paradigmatic cases for transition relief.

In numerous cases, Treasury and the IRS have provided appropriate transition rules in regulations without an express statutory or legislative history statement, or contemplation, that these transition rules would be included in regulations. See, e.g., the safe harbor allowing the provision of online software to customers to be treated as a qualifying disposition in the now codified temporary regulations under section 199, the two-year deferral period for advance payments related to the sale of goods under Treas. Reg. § 1.451-1, the similar one-year deferral period for services and other income provided in Rev. Proc. 2004-35, the transitional period for the treatment of translation gains and losses provided under Treas. Reg. §§ 1.987-5 and 1.989(c)-1, and, in the TCJA context, the exception under new Prop. Reg. § 1.904-2(j)(2)(ii) that permits taxpayers to assign unused foreign taxes that were paid or accrued in the pre-2018 separate category for general category income to the post-2017 separate category for foreign branch category income to the extent they would have been assigned to that separate category if the taxes had been paid or accrued in a post-2017 tax year. There are several other examples in the foreign tax credit area under older tax reform acts. Thus, there is ample precedent for providing in the final regulations the transition rule that ACT recommends.

Regulatory Authority for Recommendation

Adopting the ACT recommendation is within Treasury's broad authority “to prescribe regulations or other guidance necessary or appropriate to carry out the provisions of this section [250].”

C. Foreign Use of General Property (Prop. Reg. §§ 1.250(b)-3(b)(3) and 1.250(b)-4(d)(2))

Proposed Regulations

Prop. Reg. § 1.250(b)-4(b) provides that a FDDEI sale means a sale of (i) general property or (ii) intangible property that is sold (1) to a foreign person, and (2) for a foreign use. Prop. Reg. § 1.250(b)-3(b)(3) defines “general property” to mean any property other than (i) intangible property, (ii) a security (as defined in section 475(c)(2)), or (iii) a commodity (as defined in section 475(e)(2)(B) through (D)). For these purposes, the term “commodity” excludes actively traded property described in section 475(a)(2)(A) (i.e., the commodity itself), but includes derivatives and other instruments therein. Thus, the sale of such securities and derivatives does not generate FDDEI.

Prop. Reg. § 1.250(b)-4(d)(2) provides that, except for the special rule for transportation property (discussed below), a sale of general property is for a foreign use if either of the following two conditions are met: (i) the property is not subject to domestic use within three years of the date of delivery; or (ii) the property is subject to manufacture, assembly, or other processing outside of the United States before any domestic use of the property. Property is subject to manufacture, assembly, or other processing if either: (a) the property is physically and materially changed; or (b) the property is incorporated as a component into a second product, and the fair market value of the property when it is delivered to the recipient does not constitute 20 percent or more of the fair market value of the second product upon its completion.

Treasury Explanation

The preamble explains that the manufacturing, assembly, or other processing rule for the purposes of determining foreign use of property:

“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.”

The preamble does not address the three-year rule.

Treasury and the IRS have requested comments on the supply chain implications of the foreign use rules for general property.

ACT Recommendations

Reasons for ACT Recommendations

Regarding ACT recommendation 1, above, as a threshold matter, the requirement that property not subject to manufacture outside the United States not be subject to domestic use within three years of delivery appears to conflict with the statute. The statute, which merely requires that property be sold “for foreign use,” can reasonably be read as providing that any foreign use (rather than only foreign use) would be sufficient to satisfy the foreign use requirement of section 250(b)(4)(A)(ii).

Even ignoring this statutory language, assuming that property sold to a foreign person is not subject to further manufacture outside the United States prior to domestic use, the requirement that such property not be subject to domestic use within three years of delivery to the buyer places a unworkable burden on taxpayers to track the use of such property after the sale when the property is sold to an unrelated person. Taxpayers will not have this capability without the complete cooperation and assistance from the buyers who may be unable or unwilling to provide it. A demand by the seller that the buyer-seller contract provide for such cooperation and assistance may be unsuccessful and, in any event, will likely require potentially costly seller concessions. Further, contractual re-negotiations may not be possible before the first FDII filing date. This three-year rule could have a chilling effect on sales by domestic taxpayers to foreign buyers, contrary to Congress' intent in enacting section 250.

Another major issue raised by the three-year rule is that taxpayers must file their returns reporting income for the year of sale well before the three-year period has elapsed. Taxpayers presumably would have to amend their returns to obtain penalty protection if they are able to determine that property they sell becomes subject to domestic use after the FDII filing date but before the end of the three-year period, even if they do not know or have reason to know that the property will become subject to domestic use as of the FDII filing date. Such a rule has the potential to increase substantially the number of amended returns that may be filed, burdening taxpayers and the IRS, that are both struggling to absorb the largest tax reform bill in decades.

As an example, consider a large U.S. corporation with thousands of Year 1 sales of property that qualify as FDDEI sales as of the FDII filing date. If the corporation discovers that just one such sale of property is subject to domestic use within three years of the FDII filing date, it appears the corporation must amend its Year 1 return upon such discovery to avoid facing potential penalties. What is the result if the corporation then discovers a year later (during the three-year period) that a second sale becomes subject to domestic use after the FDII filing date, and so forth? It appears a second amended return for Year 1 must be filed to avoid facing potential penalties. ACT's recommendation adequately protects the Government against improper claims of FDII benefits without subjecting taxpayers and IRS agents to a cumbersome, unrealistic, and labor-intensive look-back regime.

Regarding ACT recommendation 2, above, including hedges (within the meaning of section 1221(b)(2)(A)(i)) of general property in the definition of general property ensures a clear reflection of FDDEI. In general, a hedging transaction under section 1221(b)(2)(A)(i) is a transaction that manages price or currency risk on ordinary property to be held by the taxpayer. This can include (but is clearly not limited to) commodities held as inventory by the taxpayer (under section 1221(a)(1)) and commodities consumed as supplies in the production of general property under section 1221(a)(7).

In both cases, hedging gains and losses affect the taxpayer's economic return with respect to the general property to which the hedges relate. These hedges may be currently excluded from the definition of general property by virtue of the exclusion for commodity derivatives under Prop. Reg. § 1.250(b)-3(b)(3). Excluding these gains and losses from the computation of FDDEI where such gains and losses arise from commodity hedges (as the proposed regulations currently suggest) would result in the potential overstatement or understatement of a taxpayer's FDDEI because these hedges — themselves bi-lateral contracts that may not themselves have “foreign use” — affect the taxpayer's economic return on its general property that produces FDDEI.

The IRS and Treasury have exercised regulatory authority in a variety of other contexts to match the gains and losses from hedging transactions to the underlying property to which they relate. These include, but are not limited to, altering timing (under Treas. Reg. § 1.446-4), character (under Treas. Reg. § 1.1221-2), sourcing (under Treas. Reg. § 1.861-9(b)), subpart F characterization (under Treas. Reg. § 1.954-2(a)(4)), and treatment for section 965 purposes (under Treas. Reg. § 1.965-1(f)(13) and (14) — including a special commodities rule). All of these rules employ “matching principles” to ensure that the gains and losses are matched to the category to which they relate to clearly reflect income. Most importantly, including hedges of general property in the definition of general property and matching the gains and losses to the category of income (FDDEI or not, as relevant) does not present a risk of abuse because (1) the taxpayer is not guaranteed income or loss on any particular hedging transaction; and (2) clear reflection of income principles ensure that the hedges are appropriately matched to the income to which the transactions relate.

Regulatory Authority for Recommendations

Adopting the ACT recommendations is within Treasury's authority to interpret the section 250(b)(4)(A)(ii) phrase “property . . . which the taxpayer establishes to the satisfaction of the Secretary is for a foreign use.” Adopting the ACT recommendations is also within Treasury's broad authority under section 250(c) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section [250].”

D. FDDEI Sales of Transportation Property (Prop. Reg. § 1.250(b)-4(d)(2)(iv))

Proposed Regulations

Prop. Reg. § 1.250(b)-4(d)(2)(iv) provides a special rule for determining whether a sale of “transportation property” — defined as aircraft, railroad rolling stock, vessels, motor vehicles, or similar property that provides a mode of transportation and is capable of traveling internationally — is for a foreign use. The rule provides a predominant use test such that international transportation property generally is sold wholly for a foreign use if, during the three-year period beginning from the date of delivery, 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 the property are traversed outside the United States.

Treasury Explanation

As provided in the preamble, “[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.”

ACT Recommendations

Reasons for ACT Recommendations

As to ACT recommendation 1, above, the reasons for this ACT recommendation to delete the three-year look back rule for sales of transportation property are the same as the reasons for its recommendation to delete the three-year rule for sales of general property.

As to ACT recommendation 2, above, under the proposed regulations, taxpayers receive no FDDEI treatment on the sale of transportation property to a foreign person if the predominant use test is not met. If the taxpayer can reasonably establish the percentage of foreign use in a foreign location to the satisfaction of the Secretary and so elects, the percentage of income that is FDDEI should be determined by bifurcating in lieu of the predominant use standard. The predominant use test is simply a rule of convenience and can be favorable to taxpayers that pass the test. However, the predominant use test also creates a “cliff” effect, depriving some taxpayers selling transportation property of all FDDEI benefit, even when their foreign use is close to the percentage establishing predominant foreign use in the proposed regulations. Taxpayers that sell transportation property may be in a good position, based on their industry or practices (e.g., travel logs or any information required by law or regulation), to prove the location of assets or persons during the tax year. Removing all FDDEI treatment from the sale of transportation property that a taxpayer can establish has spent, for example, 49 percent of its time and 99 percent of its mileage outside the United States (and would thus fail the proposed regulations' predominant use test) seems unnecessarily harsh and arbitrary.

As to ACT recommendation 3, above, under the regulations, international transportation property includes only aircraft, railroad rolling stock, vessels, motor vehicles, or similar property that provides a mode of transportation and is capable of traveling internationally. Although not completely clear, one could read the proposed regulations to exclude parts of international transportation property (e.g., engines, wheels, electronic equipment) from the definition of international transportation property because they do not provide a “mode” of transportation and, thus, apparently may qualify for FDDEI treatment only under the rules for sales of general property.

Under the rules for sale of general property, parts of transportation property are considered for foreign use if they meet the three-year rule that ACT recommends be deleted. As indicated above, ACT recommends that, in lieu of the three-year rule in the proposed regulations, general property should be considered for foreign use if the taxpayer neither knows or has reason to know, as of the FDII filing date, that the property will be used domestically within three years of the date of delivery. Income from the sale of parts of transportation property also qualify for FDII benefits as general property if they are subject to manufacture, assembly or other processing outside the United States before there is a domestic use. Under Prop. Reg. § 1.250(b)-4(d)(2)(iii), the part is considered subject to manufacture, assembly or other processing if (i) it is subject to a physical and material change or (ii) at the time of its sale, it has a fair market value less than 20 percent of the fair market value of the property into which it is incorporated upon that property's completion — the physical and material change or incorporation as a component needs to take place outside the United States.

Many or most parts of U.S.-produced transportation property may not undergo a physical and material change when added into an aircraft, vessel, etc., and some of these parts may have a high fair market value compared to the fair market value of the aircraft, vessel, etc., upon its completion, or may be sold to a foreign person for installation on transportation property located in the United States. Also, given the parts may be used in international transportation, in certain contexts some taxpayers may be unable to demonstrate that they do not know or have reason to know, as of the FDII filing date, that there will be “no domestic use” within three years of the date of delivery (if the proposed recommendation to the general property rule is adopted) or that there is in fact “no domestic use” within three years of the date of delivery (if the proposed recommendation is not adopted) Thus, there is a material risk that the sale of such property, without the adoption of ACT's recommendation, will receive no FDDEI benefit.

ACT finds no policy reason for distinguishing between sellers of international transportation property and sellers of parts of international transportation property. With regards to sellers of parts of international transportation property, the part is being used to serve foreign markets to the same extent as the finished product and will go wherever the finished product goes. Thus, ACT believes that sellers of a part of finished transportation property should be subject to the same foreign use rules as sellers of finished transportation property. Treasury and the IRS recognized that, due to the unique nature of international transportation property — that it may travel both within and outside the United States and thus may be subject to domestic use within three years of the date of delivery — such property would often fail the foreign use tests of Prop. Reg. § 1.250(b)-4(d)(2) relating to general property and thus needed a separate rule for determining foreign use. Similarly, parts of international transportation property, by their nature, generally are subject to the same concern described above. As a result, it is appropriate to apply the international transportation property rule to parts that are used in international property, if such parts do not meet the foreign use requirements under the general property rules.

Regulatory Authority for Recommendations

Adopting ACT's recommendations is within Treasury's authority to interpret section 250(b)(4)(A)(ii)'s phrase “property . . . which the taxpayer establishes to the satisfaction of the Secretary is for a foreign use.” Adopting the ACT recommendation is also within Treasury's broad authority under section 250(c) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section [250].”

E. Transportation Services (Prop. Reg. §§ 1.250(b)-5(b)(5) and 1.250(b)-5(h))

Proposed Regulations

The proposed regulations divide services into transportation services, property services, proximate services, and general services. Prop. Reg. § 1.250(b)-5(c)(7) defines a service as a “transportation service” if the service is provided “to transport a person or property using aircraft, railroad rolling stock, vessel, motor vehicle, or any similar mode of transportation.”

Prop. Reg. § 1.250(b)-5(b)(5) provides that a transportation service is a FDDEI service if provided to a recipient, or with respect to property, located outside the United States, determined based on both origin and destination. Prop. Reg. § 1.250(b)-5(h) provides that a transportation service is provided to a recipient, or with respect to property, located outside the United States if both the origin and destination of the service are outside the United States. However, if either, but not both, of the origin or the destination are outside the United States, 50 percent of the transportation service is considered provided to a recipient, or with respect to property, located outside the United States.

Treasury Explanation

The preamble to the proposed regulations provides:

“[b]asing 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.”

ACT Recommendation

ACT recommends that the final regulations provide an elective method in which taxpayers can choose either (i) the 50-percent FDDEI treatment currently provided for cross-border transportation services by the proposed regulations, or (ii) a bifurcation method under which the FDDEI treatment of income from the service is based on actual time or mileage. If the bifurcation method is elected, the burden would be placed on the taxpayer to substantiate the facts to the satisfaction of the Secretary.

Reasons for ACT Recommendation

The proposed regulations provide a predominant use test based on both time and miles traversed for purposes of determining whether a sale of transportation property is a FDDEI sale. This rule acknowledges that, generally, transportation property's movement can be tracked. Similarly, the movement of property being used to provide transportation services can generally be tracked. For taxpayers that are able to track services and property, an election should exist that allows them to bifurcate between domestic use and foreign use for purposes of section 250. When taxpayers do not have this capability, or using this capability is unduly burdensome, taxpayers may rely on the rule as written in the proposed regulations and have 50 percent of the income qualify as FDDEI.

Regulatory Authority for Recommendation

Adopting the ACT recommendations is within Treasury's authority to interpret section 250(b)(4)(B)'s phrase “services provided by the taxpayer . . . to any person, or with respect to property, not located within the United States.” Adopting the ACT recommendations is also within Treasury's broad authority under section 250(c) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section [250].”

F. Ratio of FDDEI to DEI (Prop. Reg. § 1.250(b)-1(c)(13))

Proposed Regulation

Prop. Reg. § 1.250(b)-1(c)(13) provides that the “foreign-derived ratio” (i.e., the ratio of FDDEI to DEI) cannot exceed one.

Treasury Explanation

The preamble states that:

“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 is capped at 1.0”

The preamble further states that:

“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).”

ACT Recommendations

Reasons for ACT Recommendations

Regarding ACT's first recommendation, as recognized in the preamble, expense apportionment or the attribution of cost of goods sold may result in FDDEI greater than DEI. As seen above, the preamble contains a numerical example illustrating this fact. Nonetheless, the preamble states, “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.” FDDEI and DEI are statutorily defined terms. ACT does not believe that Treasury and the IRS have the authority to define FDDEI more narrowly than the statute does. Under the statute, if FDDEI exceeds DEI, the foreign-derived ratio mathematically exceeds 1.0. There is no evidence Congress contemplated a different result. Elsewhere, if Congress intends a ratio not to exceed 1.0, it has stated so. Section 904(a) provides a clear example. It is true that FDDEI is definitionally a subset of DEI, but it does not follow that in particular cases, losses cannot cause a taxpayer's FDDEI to exceed its DEI, as the preamble recognizes.

Regarding ACT's second recommendation, similar product line approaches have been used in prior foreign business regimes (e.g., Treas. Reg. §§ 1.994-1(c) and 1.994-2(b)), and thus ACT believes that determining income by product line or line of business basis is appropriate under the FDII regime. If Treasury and the IRS do not allow a product line or line of business calculation of FDII, the income from foreign related sales in product line A could be reduced or eliminated by losses from domestic sales in product line B, which would inappropriately reduce the FDII attributable to product line A determined on a standalone basis. In this regard, if a taxpayer has a non-FDDEI domestic loss, such loss will reduce the taxpayer's DEI (while not affecting the taxpayer's FDDEI) which could reduce the overall dollar amount of the FDII deduction relative to the overall amount of sales income. By contrast, under the GILTI regime, the computation of the section 250 deduction does not distinguish between types of tested income (such as from products sold in the CFC's country vs. outside the CFC's country) and thus is not impacted by aggregating all losses allocable to tested income (instead of allocating particular losses to particular types of tested income, for example, on a separate product line basis). Rather, the aggregate amount of losses allocable to tested income reduces the amount of the section 250 deduction in proportion to the reduction in the GILTI inclusion. In order to achieve the tax parity envisioned by Congress with the creation of the FDII and GILTI regimes, it would be appropriate from a policy perspective to allow separate product line or line of business calculations of FDII because such calculations would mitigate the detrimental effect of including non-FDDEI losses from one product line or line of business against FDDEI losses in another product line or line of business.

Moreover, a product line and line of business approach to calculating FDII creates a schedular system for FDII. A schedular system calculates taxable income separately for different subsets of income. There are many schedular systems in the tax law, some taxpayer-favorable, some taxpayer-unfavorable. See, e.g., section 199, and the separate foreign tax credit limitation baskets of section 904(d) and their overall foreign loss, overall domestic loss, and separate limitation loss recapture rules in sections 904(f) and (g). A schedular system is appropriate for a set of tax rules if needed to achieve the policy purpose of those rules. In enacting the FDII regime, Congress implemented an important policy of reducing the tax incentive to locate intellectual property outside the United States. Attainment of that policy purpose is curtailed if domestic losses are allowed to “cross over” and reduce FDII-eligible income, contrary to a schedular approach. As it is, ACT respectfully submits that a number of the proposed regulations' provisions fail to advance the policy purpose of the FDII regime, e.g., the taxable income limitation as interpreted in the regulations and several features of the documentation rules. A product line and line of business approach would mitigate the impact of those features of other FDII rules that impede the intended policy objective and would make the FDII incentive to locate intellectual property in the United States more robust.

Regulatory Authority for Recommendations

Adopting the ACT recommendations is within Treasury's broad authority under section 250(c) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section [250].”

G. FDDEI Sales of Intangible Property (Prop. Reg. § 1.250(b)-4(e)(2))

Proposed Regulations

Prop. Reg. § 1.250(b)-4(e)(2) provides that intangible property is considered sold for a foreign use only to the extent the intangible property generates revenue from exploitation outside the United States. In situations where the intangible property is exploited both within and outside the United States, the sale of such property is for a foreign use in proportion to the revenue generated from exploitation of the property outside the United States over the total revenue generated from exploitation of the property. For intangible property used in the development, manufacture, sale, or distribution of a product, the intangible property is treated as exploited at the location of the end user after the product is sold to the end user.

Prop. Reg. § 1.250(b)-4(e)(2)(ii) provides that, when the intangible property is sold in exchange for periodic payments, the extent to which the sale is for a foreign use is determined annually based on the actual revenue earned by the recipient for the taxable year in which the payment is received. In the case of lump sum payment sales, Prop. Reg. § 1.250(b)-4(e)(2)(iii) provides that the extent to which the sale is for a foreign use is determined based on the ratio of the total net present value of the revenue the seller would have reasonably expected to earn from the intangible property's exploitation outside the United States to the total net present value they would have reasonably expected to earn from the intangible property's exploitation (both within and outside the United States).

Treasury Explanation

As provided in the preamble, “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 the development, manufacture, sale, or distribution.”

The preamble states that the special rule for lump sum sales is provided because “it may be difficult or impossible to know the location where revenue will be generated when the sale occurs.”

The preamble also refers to the rule for sales of general property subject to manufacturing, assembly, or other processing outside the United States. Treasury and the IRS then provide that “[i]ntangible 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.”

Treasury and the IRS have, however, requested comments on whether a rule for intangible property similar to the rule provided in Prop. Reg. § 1.250(b)-4(d)(2)(i)(B) — providing that a sale of general property is for a foreign use if it is subject to manufacture, assembly, or other processing outside the United States before the property is subject to a domestic use — is appropriate.

ACT Recommendations

Reasons for ACT Recommendations

With respect to ACT recommendation 1, intangible property is a broad term and encompasses a wide range of property. Providing the same treatment for all sales and licenses of intangible property based on the location of the end user fails to recognize that some types of intangible property can be “used” prior to the sale to the ultimate customer. In this regard, certain intangible property may be used only to develop or manufacture a product (for example, the ingredients or methods used to create a beverage) while other intangible property may be used in the sale of a product (for example, a brand name or trademark). Providing one rule for all intangible property used in the development, manufacture, distribution, or sale or license of a product does not consider the different nature of these types of intangible property.

With respect to ACT recommendation 1(a), because manufacturing IP may not be incorporated into the product, it may not ever be “used” by the consumer. Rather, it is used by the recipient who uses such property to manufacture the product. As described above, in situations where general property is sold or licensed and is subject to further manufacture outside the United States, the foreign use requirement is met. ACT views this as analogous to the sale or license of manufacturing IP. Thus, ACT recommends that sales or licenses of such intangible property to unrelated parties be for foreign use if the manufacturing of the product, as determined using the principles provided for sales of general property, occurs outside the United States.

Consider the following example. Assume DC, a U.S. corporation, sells intangible property to a foreign unrelated party, A, and that A uses the intangible property in the manufacture of a cog. A then sells the cog to a U.S. corporation, Z, which incorporates the cog into a clock face. Z then sells the clock face to a second foreign unrelated party, B, that incorporates the clock face into a grandfather clock. The grandfather clock is then sold by B to a third foreign unrelated party, C. C then sells the grandfather clocks to consumers located both within and outside the United States. As currently written, it is unclear whether the “end user” of the cog is A, Z, B, C, or the consumers located within and outside the United States. Under the ACT recommendation, the final regulations would clarify that the end user is the manufacturer of the cog, A, who used the intangible property to manufacture the cog.

In our view, with respect to the sale or license of manufacturing IP, the rule requiring tracking to end users is inconsistent with footnote 1522 of the Conference Report, which, in its description of foreign use, provides an example indicating that property is sold for a foreign use if sold to a foreign person and subject to further manufacturing by such person outside the United States. A narrow interpretation of this footnote would create inconsistent treatment when, for example, the taxpayer sells raw materials versus licenses manufacturing IP to an unrelated foreign person to manufacture a product using the purchased raw material and licensed manufacturing IP. In such case, the raw materials would be sold for a foreign use because they are subject to manufacture, assembly, or other processing outside the United States prior to any domestic use, but the intangible property would not be considered sold for a foreign use if the end users of the property for which the intangible property was used in the development, manufacture, sale, or distribution were located in the United States when such property was purchased.

ACT recognizes that Treasury and the IRS have determined that additional requirements should be met in order for sales of general property to foreign related parties to be for foreign use. ACT also recognizes that taxpayers will have more detailed information on the customers of related parties than on customers of unrelated parties. Thus, in the context of a related party sale or license of manufacturing IP, ACT recommends that a sale or license of manufacturing IP to a foreign related party is for foreign use if the product created through the use of the manufacturing IP is sold to a foreign person for foreign use (similar to the rules provided in the proposed regulations for sales of general property to a foreign related party).

With respect to ACT recommendation 1(b), in the case of a sale or license of intangible property (regardless of its type), the proposed regulations require tracking to where the product benefitting from the intangible is purchased or used by the end user. ACT recognizes that this may be appropriate for sales or licenses of certain types of intangible property used with respect to the distribution and/or sale of a product (i.e., marketing IP). However, the proposed regulations do not define the term “end user.” Thus, it is unclear how far along the supply chain the product must be tracked. The further along the chain the “end user” is, the less available, and less reliable, the information will be for purposes of establishing that the end user is located outside the United States when the product is sold. Also, cooperation from the developer, seller, or distributor to track will likely diminish with more remote end users.

Importantly, the tracking described above puts a heavy and impractical burden on taxpayers to obtain from unrelated foreign parties detailed, and often unavailable, information regarding the locations of their customers. The unrelated foreign developers, manufacturers, sellers, and distributors of the products may be unwilling or unable to perform such tracking or to obtain the required information, or may require expensive commercial concessions from the U.S. seller or licensor in return. The tracking rule could discourage some foreign persons from doing business with the U.S. licensors and sellers of intangible property and thereby frustrate Congress' intent in the TCJA to promote economic growth. Thus, rather than having to rely on information from foreign counterparties, ACT recommends that taxpayers be allowed to use other means, such as statistical sampling, to determine the location of “end users” with respect to marketing IP.

With respect to ACT recommendation 2, as described above, it is common business practice to transfer a bundle of intangible property rather than individual patents, trademarks, etc. Further, taxpayers may not ascribe specific values to the various intangible property rights included in the bundle. In such cases, where separate intangible property rights are not separately accounted for in the agreement between the parties, ACT recommends that taxpayers be allowed to elect between (i) characterizing the entire bundle based on the predominant character of the bundle (i.e., manufacturing IP or marketing IP) and (ii) bifurcating the income between manufacturing IP and marketing IP using any reasonable method.

With respect to ACT recommendations 3 and 4, following footnote 1522 of the Conference Report, the regulations provide that general property sold to an unrelated foreign person for manufacture, assembly, etc. is for a foreign use regardless of the fact that the finished product might be sold in the United States. There is no such rule regarding the sale or license of intangible property that is used in further manufacturing, in the provision of services, or in enhancing the value of the intangible property for further sublicensing, which leaves uncertain where the intangible property is being exploited in such situations. The use of purchased or licensed intangible property in the provision of services, or enhancing the value of the intangible property for further sublicensing or sale, should be viewed similarly to using such intangible property in connection with manufacturing goods. See Recommendation 1(a). In all cases, the value of the intangible property enhances the value of the manufactured goods, services, and intangible adapted for foreign use, provided to third-party customers. Footnote 1522's logic applies to all three situations.

Regulatory Authority for Recommendations

Adopting the ACT recommendations is within Treasury's authority to interpret section 250(b)(4)(A)(ii)'s phrase “property . . . which the taxpayer establishes to the satisfaction of the Secretary is for a foreign use.” Adopting the ACT recommendations is also within Treasury's broad authority under section 250(c) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section [250].”

H. QBAI Anti-Abuse Rules (Prop. Reg. § 1.250(b)-2(h))

Proposed Regulations

Prop. Reg. § 1.250(b)-2(h)(1) disregards certain transfers and leasebacks of specified tangible property to a related party (whose QBAI would not be taken into account in calculating the corporation's deemed tangible income return (“DTIR”). The transfer and leaseback is disregarded if the transferring corporation leases the same or substantially similar property from a related party (whose QBAI would not be taken into account in calculating the corporation's DTIR) within the two-year period beginning one year before the transfer; and a principal purpose of the transfer and leaseback is reducing the transferor's DTIR. Such a related party whose QBAI would not be taken into account in calculating the corporation's DTIR can be, for example, a foreign corporation.

A transaction is per se treated as having a principal purpose of reducing the transferor's DTIR if the transfer and the leaseback both occur within a six-month period. Prop. Reg. § 1.250(b)-2(h)(2) provides a similar rule for unrelated party transactions if they are subject to a “structured arrangement.” A structured arrangement exists if (i) the reduction in the domestic corporation's DTIR is a material factor in the pricing of the arrangement, or (ii) based on all facts and circumstances, the reduction in the domestic corporation's DTIR is a principal purpose of the arrangement.

Treasury Explanation

The preamble states that “[i]n 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.”

ACT Recommendations

Reasons for ACT Recommendations

Taxpayers who entered into binding commitments prior to the publication of the proposed regulations could not have known that the QBAI anti-abuse rule would be included in the proposed regulations. Historically, when Congress, Treasury, and the IRS issue new, more restrictive rules relating to agreements, such rules frequently contain a “binding commitment” transition rule out of fairness to taxpayers.⁶

ACT recommends that the final regulations amend the proposed regulations to provide that if the transfer and the leaseback occur within six months of one another, there is a rebuttable presumption that such transaction was undertaken with a principal purpose of reducing the transferor's DTIR, rather than per se treatment of the transaction as having been undertaken with such purpose. This will allow taxpayers who engage in such transactions in their ordinary course of business the opportunity to show that such transaction was not entered into with a principal purpose of reducing their QBAI.

Regulatory Authority for Recommendations

Adopting the ACT recommendations is within Treasury's broad authority under section 250(c) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section [250].”

I. Property Services (Prop. Reg. § 1.250(b)-5(c)(5))

Proposed Regulations

Prop. Reg. § 1.250(b)-5(c)(5) provides that a service, other than a transportation service, is considered a “property service” if it is 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. For these purposes, substantially all of the service will be considered performed at the property's location if more than 80 percent of the time providing the service is spent at or near the location of the property.

In order for a property service to give rise to FDDEI, the property must be located outside the U.S. for the full duration of the period during which the service is performed.

Treasury Explanation

Comments are requested 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.

ACT Recommendations

Reasons for ACT Recommendations

Consistent with Treasury's request for comments, ACT recommends that the final regulations provide a proration and/or safe harbor exception for property that is located in the United States temporarily during the service period. Other FDDEI sales and services rules bifurcate between U.S. and foreign locations and permit FDDEI treatment for the proportionate period of foreign location. By contrast, the property service rule creates a “cliff” effect such that property spending one percent of the service period within the United States results in a loss of 100 percent of FDDEI benefits. In some cases, property must sometimes be in the United States for maintenance or repairs. In other cases, due to the nature of the property or the particular type of property service, it may be impractical or physically impossible for the property to be located outside of the United States at all times while the service is being performed even though the business recipient is located at all times during the service period in a foreign jurisdiction. Accordingly, the final section 250 regulations should allow FDDEI treatment for a prorated portion of such services.

ACT also recommends that the final regulations clarify that manufacturing services are not property services, but rather property services include only services performed with respect to completed property. If manufacturing services are treated as property services, domestic toll manufacturers may receive no FDDEI treatment for providing a manufacturing service to a foreign business recipient by performing toll manufacturing in the United States; in contrast, a contract manufacturer operating in the United States that sells the completed manufactured property to an unrelated foreign person for foreign use would potentially receive full FDDEI treatment on a FDDEI sale under the rules for sales of general property in Prop. Reg. § 1.250(b)-4(d). ACT believes there is no policy reason to treat these taxpayers in a dissimilar manner given both are performing manufacturing services in the United States and toll manufacturing and contract manufacturing are both common arrangements in supply chains.

With respect to ACT's third recommendation, because a property service is a FDDEI service only if the service takes place outside the United States, taxpayers providing such service may potentially be deemed to operate a branch in the country in which the service occurs. This result would subject the property services income to tax in that country. It is contrary to the purpose of the section 250 deduction, which does not apply to foreign branch income, to provide a FDII-eligibility rule the satisfaction of which could result in foreign branch income being excluded from FDDEI. Taken to its logical conclusion, if a property service that is treated under the current rules as a FDDEI service (i.e., a property service performed outside the United States) resulted in foreign branch income, the income would be excluded from FDDEI, despite the service being a FDDEI service.

Thus, income received for the provision of a property service outside the United States should not be treated as foreign branch income.

Regulatory Authority for Recommendations

Adopting the first and second ACT recommendations is within Treasury's broad authority to interpret section 250(b)(4)(B)'s phrase “services provided by the taxpayer . . . to any person, or with respect to property, not located within the United States.” The third recommendation is within Treasury's authority to interpret the term “foreign branch income” used in sections 250(b)(3)(A)(i)(VI) and 904(d)(2)(J). The recommendations are also within Treasury's broad authority under section 250(c) to “prescribe such regulations as may be necessary or appropriate to carry out the provisions of this section [250].”

J. FDDEI Related Party Sales (Prop. Reg. §1.250(b)-6(c))

Proposed Regulations

Sales to foreign related parties may qualify as FDDEI sales if a related party either sells or uses the purchased property in an “unrelated party transaction” (e.g., a sale of the property received by the foreign related party to an unrelated foreign party for foreign use).

Under Prop. Reg. §1.250(b)-6(c) if, as of the FDII filing date, an unrelated party transaction has not occurred, the foreign related party sale is included in DEI but not FDDEI. If an unrelated party transaction occurs after the FDII filing date, an amended return is required to claim FDII benefits from the foreign related party sale.

Treasury Explanation

Treasury and the IRS have requested comments regarding whether alternatives should be considered in lieu of requiring the filing of an amended return.

ACT Recommendations

Reasons for ACT Recommendations

With respect to ACT recommendation 1, above, based on a literal reading, the proposed regulations do not appear to provide FDDEI treatment to the sale of property to a foreign related person for further manufacture outside the United States if the property is then sold back to the original U.S. seller for additional manufacture in the United States, even if the property is then again sold ー by the original U.S. seller or a U.S affiliate ー to an unrelated foreign person for foreign use. Denying FDDEI treatment to the first (but not ultimate) outbound sale would result in disparate treatment for U.S. companies that engage in multiple related-party sales compared to those that engage in one step versus multiple-step sales to unrelated foreign persons for foreign use.

With respect to ACT recommendation 2, above, when the ultimate sale for foreign use to an unrelated foreign person occurs in a year following the year of the initial sale, a timing issue arises with respect to when the deduction on the initial sale may be claimed. Because all sellers in the sales process are related, and the U.S. parent controls the process, it will be in a good position to know which products would be sold and qualify for foreign use in the two year period following the date of the initial sale. Its historical market experience and the manner in which its affairs are ordered (e.g., sales to a related foreign distributor located in country X are only distributed to unrelated country X customers) will also help the U.S. parent in this regard.

Thus, as of the FDII filing date of the year of the initial sale, the U.S. parent should normally have a reasonable expectation whether or not the ultimate sale to an unrelated foreign person will occur within the two year period following the date of the initial sale. If the U.S. parent reasonably expects it will, it should be permitted to claim the FDII benefit on the initial sale on the return for the year of the initial sale. Deferral of the initial sale deduction instead would in some cases necessitate the filing of an amended return. The amended return would apply to the tax year in which the initial sale by the U.S. person to the related foreign person took place once the sale is made to the ultimate foreign customer. The need for filing an amended return would complicate the application of this provision for taxpayers and the IRS.

Regulatory Authority for Recommendations

Adopting the ACT recommendations is within Treasury's broad authority under section 250(c) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section [250].”

K. Definition of Foreign Branch Income (Prop. Reg. § 1.250(b)-1(c)(11))

Proposed Regulations

Prop. Reg. § 1.250(b)-1(c)(11) defines foreign branch income by reference to Prop. Reg. § 1.904-4(f), the branch foreign tax credit (“FTC”) basket definition, but also includes income from 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.

Treasury Explanation

Treasury did not provide a rationale for expanding the definition of foreign branch income for section 250 purposes. The expansion means that more branch income can reduce the section 250 deduction than can increase the branch basket FTC limitation.

ACT Recommendations

Reasons for ACT Recommendations

The expansion of the definition of foreign branch income for section 250 purposes, but not for foreign tax credit purposes, creates an obvious asymmetry. This asymmetry may produce results that are unfavorable to the taxpayer, or unfavorable to the government. For example, if a taxpayer has excess credits in its branch basket, the section 250 modification to the branch income definition provides no additional branch basket income to absorb them, while it potentially reduces the section 250 deduction by increasing branch income under that section. By contrast, the government may be disadvantaged where the section 250 definition of branch income reduces the section 250 deduction but the taxpayer does not increase excess limitation in an already excess limitation branch basket and has excess credits in the general basket. ACT does not believe Treasury and the IRS intentionally created this asymmetry, but rather Treasury and the IRS more likely were concerned that the foreign branch basket definition in the proposed FTC regulations was too narrow and took their first opportunity — in the section 250 regulations — to expand the definition. ACT's expectation is that the section 250 and FTC basket definitions will be conformed in the final FTC, or final section 250, regulations.

Regulatory Authority for Recommendations

ACT respectfully submits that Treasury and the IRS lack the statutory authority to define branch income differently for section 250 and section 904 purposes.

In the TCJA, Congress created the foreign branch FTC basket, and gave Treasury broad authority to define its contents. However, Congress dictated in section 250(b)(3)(VI) that foreign branch income for section 250 purposes be defined as it is in section 904(d)(2)(J), the branch basket provision. Thus, branch income for section 250 purposes is to be the same as branch income for section 904 purposes.

Treasury and IRS should exercise their authority under section 250(c) to carry out Congress' intent that foreign branch income be defined identically for purposes of sections 250 and 904.

L. Proximate Services (Prop. Reg. §§ 1.250(b)-5(c)(6) and 1.250(b)-5(f))

Proposed Regulations

The proposed regulations divide services into four major categories: (1) transportation services, (2) property services, (3) proximate services, and (4) general services. Prop. Reg. § 1.250(b)-5(c)(6) provides that a service is considered a “proximate service” if it is not a transportation service or property service and “substantially all of the service is performed in the physical presence of the recipient or, in the case of a business recipient, its employees.” For this purpose, substantially all means more than 80 percent.

Prop. Reg. § 1.250(b)-5(f) provides that a proximate service is provided to a recipient located outside the United States, and is thus a FDDEI service, if the proximate service is performed outside the United States. If a proximate service is performed partly within and partly outside the United States, a proportionate amount corresponding to the portion of time the renderer spends providing the service outside the United States is treated as provided to a recipient located outside the United State.

Treasury Explanation

N/A

ACT Recommendations

Reasons for ACT Recommendations

For purposes of applying the rules regarding general services provided to a business recipient, Prop. Reg. § 1.250(b)-5(e)(4) provides that a reference to a business recipient includes a reference to any related party of such business recipient. Given the nature of many business relationships, it is not uncommon for business recipients to pay for services that are provided to their related parties rather than to them directly. Also, sometimes employees serving a group of companies may all be employed by one group member. ACT does not believe there is a policy reason for treating a business recipient's related parties as qualifying service recipients for purposes of the general service rules but not for purposes of determining whether a service is a proximate service.

Finally, see section II.I., above, for the rationale for ACT's second recommendation that income from the provision of a proximate service not be treated as foreign branch income for purposes of section 250.

Regulatory Authority for Recommendations

Adopting the first ACT recommendation is within Treasury's broad authority to interpret section 250(b)(4)(B)'s phrase “services provided by the taxpayer . . . to any person, or with respect to property, not located within the United States.” Adopting the second ACT recommendation is within Treasury's authority to interpret the term “foreign branch income” used in sections 250(b)(3)(A)(i)(VI) and 904(d)(2)(J). The recommendations are also within Treasury's broad authority under section 250(c) to prescribe such regulations as may be necessary or appropriate to carry out the provisions of section 250.

M. Subcontracted Services

Proposed Regulations

The Proposed Regulations do not provide rules regarding services performed by a subcontractor.

Treasury Explanation

N/A

ACT Recommendations

Reasons for ACT Recommendations

With respect to ACT recommendation 1, above, there is no clear indication in the statute or proposed regulations that general agency or subcontractor principles do not apply for purposes of section 250. Example 4 under Prop. Reg. § 1.250(b)-5(e)(5) (which involves a U.S. principal that engages a service provider to assist the U.S. principal in providing services to a foreign person) may indicate that a U.S. person may derive FDDEI through the use of a subcontractor, but this is not entirely clear. A key principle governing the FDII regime is to encourage creation and maintenance of intellectual property, as well as manufacturing, within the U.S. When a U.S. principal provides services to a foreign person, or with respect to property, through a subcontractor or an agent, such U.S. principal still maintains the intellectual property in the U.S. consistent with the policy governing the FDII regime. In addition, the FDII benefit to the U.S. company providing the service through a subcontractor or agent will be appropriately proportionate to the value it provides, as any arm's length payment made to the subcontractor or agent presumably has the effect of reducing FDII benefit.

With respect to ACT recommendation 2, above, see section II.I., above, for the rationale for ACT's recommendation that the income from the provision of a proximate service not be treated as foreign branch income for purposes of section 250.

Regulatory Authority for Recommendations

Adopting the ACT recommendations is within Treasury's broad authority to interpret section 250(b)(4)(B)'s phrase “services provided by the taxpayer . . . to any person, or with respect to property, not located within the United States.” Adopting the ACT recommendations is also within Treasury's broad authority under section 250(c) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section [250].”

III. CONCLUSION

We understand that a number of details would need to be addressed if Treasury and the IRS accept the comments set forth above. ACT member companies and their advisors have identified a number of these detailed drafting issues and have given some thought as to how they might be addressed. ACT representatives would welcome the opportunity to meet with Treasury and the IRS to discuss any of the above recommendations.