Baker McKenzie Suggests Changes to FDII, GILTI Regs

May 7, 2019

Mr. David Kautter
Assistant Secretary for Tax Policy
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220

Mr. L.G. “Chip” Harter
Deputy Assistant Secretary
International Tax Affairs
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220

Mr. Charles P. Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, D.C. 20224

Mr. Michael Desmond
Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, D.C. 20224

Re: REG-104464-18 Proposed FDII Regulations

Dear Sirs:

On March 6, 2019, the United States Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “IRS” or “Service”) published in the Federal Register proposed regulations (the “Proposed Regulations”)¹ with respect to the deductions for foreign-derived intangible income (“FDII”) and global intangible low-taxed income (“GILTI”) in Section 250 of the Code.² In the preamble to the Proposed Regulations (the “Preamble”), Treasury and the Service requested comments “on all aspects of the proposed rules” for purposes of determining which changes should be incorporated in the final regulations (the “Final Regulations”).³ Baker & McKenzie respectfully submits this letter in response to the request for comments. We also respectfully request a public hearing on the Proposed Regulations and would appreciate the opportunity to testify at the hearing.

Overview of the FDII Deduction

The Tax Cuts and Jobs Act (the “TCJA” or “Act”) enacted new Section 250, which provides a 37.5% deduction against a domestic corporation's FDII.⁴ FDII is the portion of a domestic corporation's “intangible income, determined on a formulaic basis, that is derived from serving foreign markets.”⁵ FDII equals the product of a domestic corporation's “deemed intangible income” and the ratio of the corporation's “foreign-derived deduction eligible income” (“FDDEI”) to the corporation's “deduction eligible income” (“DEI”).⁶

“Deemed intangible income” is defined as the excess (if any) of the corporation's “deduction eligible income” over its “deemed tangible income return.”⁷ Deduction eligible income is the corporation's gross income, less: (1) subpart F income; (2) GILTI; (3) financial services income as defined by Section 904(d)(2)(D); (4) dividend income from a controlled foreign corporation (“CFC”); (5) domestic oil and gas extraction income; and (6) foreign branch income as defined by Section 904(d)(2)(J).⁸ This adjusted gross income amount is decreased by any deductions properly allocable to such gross income.⁹

The domestic corporation's “deemed tangible income return” equals 10% of the corporation's “qualified business asset investment” (“QBAI”).¹⁰ QBAI is defined as the aggregate of the corporation's adjusted bases in “specified tangible property” that is depreciable (as defined by Section 167) and used in its trade or business.¹¹ “Specified tangible property” means any tangible property used in the production of DEI.¹² The domestic corporation's QBAI is calculated as the average of the adjusted bases of the tangible property at the close of each quarter of the taxpayer's taxable year.¹³

FDDEI is defined as DEI derived in connection with property sold by the taxpayer to any person who is not a United States person that the taxpayer “establishes to the satisfaction of the Secretary is for a foreign use.”¹⁴ For this purpose, the terms “sold,” “sells,” and “sale” should be read as including any lease, license, exchange, or other disposition.¹⁵ “Foreign use” is defined as “any use, consumption, or disposition which is not within the United States.”¹⁶ Income derived in connection with services provided to any person, or with respect to property, which the taxpayer establishes to the satisfaction of the Secretary is not located within the United States, also falls within the definition of FDDEI.¹⁷

The Final Regulations Should Provide a Foreign Use Test for International Transportation Property That Is Administrable and Consistent with Congressional Intent

International transportation property only satisfies the foreign use requirement if it meets two conditions: during the three year period from the date of its delivery, (i) the property is located outside the United States more than 50% of the time; and (ii) more than 50% of the miles traversed in the use of the property are traversed outside the United States (the “Transportation Property Foreign Use Test”).¹⁸

As discussed below, for purposes of determining FDDEI, we recommend that Treasury and the IRS, in the Final Regulations, adhere to the “any use” standard for property sales by (i) modifying the percentage requirement for the Transportation Property Foreign Use Test and (ii) reducing the measurement period for the Transportation Property Foreign Use Test to one year.

The Final Regulations Should Adhere to the “Any Use” Standard for Property Sales Established by Congress

In the context of a sale of property, as mentioned above, the term FDDEI means, in part, property “which the taxpayer establishes to the satisfaction of the Secretary is for a foreign use.”¹⁹ Congress defines “foreign use” for purposes of FDDEI as “any use, consumption, or disposition which is not within the United States.”²⁰ Congress's use of the term “any” is consistent with its intent that FDII include all income derived by United States corporations from serving foreign markets.²¹ For purposes of determining FDDEI, if the Final Regulations define foreign use based on predominant or primary use standards, this would contradict Congress's intent to provide a benefit with respect to all income earned from serving foreign markets and, further, would impact taxpayers' decision-making processes as to whether certain investments should be made by a domestic corporation or, instead, its foreign affiliate.

In defining “foreign use,” Congress made a conscious decision to add the word “any,” as opposed to a more stringent modifier such as “primary use” or “predominant use.”²² When the word “any” — which the dictionary defines in part as “unmeasured or unlimited in amount, number, or extent”²³ — modifies a term in a statute, the modified term necessarily must have its broadest possible meaning. This principle has been repeatedly emphasized by the courts — where “any” modifies a term in a statute or regulation, the modified term should be given a “sweeping definition”²⁴ because the word “any” “conclusively demonstrates” a broad Congressional intent that the modified term be “without restriction or limitation.”²⁵ If Congress desired to establish a limitation in this context, it knew how to do so. Therefore, in the instant case, Congress's chosen standard — “any use” — must be respected.

Finally, the Proposed Regulations appear to contemplate a broad meaning of “any use” in defining “domestic use.” The Proposed Regulations define general property as property other than (i) intangible property; (ii) a security; or (iii) a commodity.²⁶ The Proposed Regulations then provide that an item of general property is for a foreign use if, in part, the property is not subject to a domestic use within three years of the date of delivery.²⁷ A “domestic use” for such purposes is defined, in pertinent part, as “any use, consumption, or disposition within the United States.”²⁸ The Proposed Regulations do not further describe what constitutes “any use” in the domestic context, which implicitly suggests that the term “any use” is intentionally left vague in order to sweep in potential domestic uses of the general property. Thus, the “any domestic use” language in the Proposed Regulations is further confirmation that the term “any” should be construed as broadly as possible in determining what is a “foreign use.”

The Final Regulations Should Modify the Percentage Requirement for the Transportation Property Foreign Use Test

The language used in the Transportation Property Foreign Use Test in the Proposed Regulations is very similar, and in some cases nearly identical, to the language used for purposes of physical presence tests under other current and former regulations.²⁹ All of these other current and former regulations were issued with respect to statutes that articulated a much more stringent physical presence standard (e.g., predominant use) as compared to the “any use” standard set forth in Section 250(b)(5)(A). In the context of those regulations, such 50% thresholds were appropriate because, in order for an item to be “primarily”³⁰ or “predominantly”³¹ used in a certain way, it necessarily must be used in such way more than 50% of the time.

The “any use” standard used in Section 250(b)(5)(A) is a far less stringent standard than the “primary use” or “predominant use” standards that were required by other statutory schemes. Accordingly, the threshold percentages used for purposes of FDII should be lower than 50%. Given the conscious drafting choice made by Congress, it is inappropriate for the “any use” standard to use the exact same percentage thresholds as were generally used for purposes of a “primary use” or “predominant use” standard. Thus, we recommend that the Final Regulations change the 50% time or miles threshold to 20%. A 20% time or miles threshold is appropriate because it comports with the intent of the statute that “foreign use” be interpreted broadly. Furthermore, there is precedent for Treasury using a transportation-property-specific physical presence test that deviates from the 50% thresholds³² and, with respect to aircraft specifically, the Code currently provides for a lower percentage threshold for testing aircraft use in other contexts.³³ Lastly, because a 20% threshold already is used in the Proposed Regulations for purposes of the “component rule,”³⁴ Treasury and the IRS should be comfortable with applying that threshold elsewhere in the FDII regulations.

For similar reasons, the Final Regulations should also amend the Transportation Property Foreign Use Test to make it disjunctive. All of the other regulations that articulate a transportation-property-specific physical presence test use a disjunctive test, not a conjunctive test. In other words, a taxpayer could satisfy the relevant test by demonstrating that a particular item of transportation property satisfied the 50% of time requirement or, alternatively, satisfied the 50% of miles requirement — a taxpayer was not required to show that such property satisfied both the 50% of time requirement and the 50% of miles requirement. A conjunctive test sets a higher burden for the taxpayer, which is inappropriate given that the burden in the FDII context should be less difficult to satisfy than the burden for tested property where “primary use” or “predominant use” requirements apply.

The Final Regulations Should Reduce the Measurement Period for the Transportation Property Foreign Use Test to One Year

An item of international transportation property would only satisfy the Transportation Property Foreign Use Test under the Proposed Regulations if the thresholds set forth therein are met during the three year period following delivery of the property. At present, with respect to the sale of an item of international transportation property, a taxpayer may effectively only satisfy the Transportation Property Foreign Use Test, including the three year requirement thereunder, through: (i) a written statement from the recipient or a related party that the recipient intends to satisfy the Transportation Property Foreign Use Test; or (ii) a binding contract with the recipient where the recipient agrees to satisfy the Transportation Property Foreign Use Test.

The three year period in the Proposed Regulations lacks a statutory basis and imposes an unnecessary burden on taxpayers. We recommend that Treasury reduce that measurement period to one year. A one year period more appropriately balances Treasury's need for a consistent standard that it can apply to all taxpayers to demonstrate foreign use of international transportation property without imposing undue burdens on taxpayers.

In describing the choices that were made in formulating the documentation requirements, Treasury and the IRS provide, in part, that they “aimed to propose rules that would not alter economic decisions.”³⁵ Along those lines, certain options were dismissed, such as rules requiring a taxpayer to submit documentation to the IRS in advance of a potential FDDEI transaction, because they could potentially affect normal business transactions.³⁶ We support Treasury's goal of issuing rules that do not alter economic decisions, but believe that the three year period in the Proposed Regulations does not achieve that goal.

In the context of sales of international transportation property, there are customer sensitivities associated with providing written statements or agreeing to contractual language certifying the ultimate location where a purchased item will be used. These customer sensitivities are exacerbated for certain customers who, for security reasons, may be unwilling to certify their intended use of a purchased item over a long-term time horizon because of concerns that the IRS may later share such information with their home country. As an example, a customer located in a politically unstable country may be unwilling to certify that it intends to use a particular aircraft in a certain way for three years because the customer may be concerned that the certification would be shared with either the government of the politically unstable country or another third party.

Further, because current contracting processes do not generally include a provision specifying the amount of time for which the customer intends to use the property, and because any certification only benefits the United States taxpayer's/seller's ability to claim an FDII deduction, customers may be reluctant to agree to provide this information. As a result, the three year measurement period conflicts with Treasury and the IRS's policy goal of articulating documentation requirements which do not alter the parties' economic decisions or influence normal business transactions.

A customer may be willing to agree to provide a written statement for a shorter measurement period, and we believe that a one year period is more than enough to demonstrate that property meets the statutory requirements to qualify for FDII. From a practical standpoint, the ultimate use of a purchased item generally should not change between such property's first and third years in service, and so a three year measurement period is unnecessary. A one year measurement period is appropriate because (i) it protects against potential customer security concerns; (ii) it comports with Treasury and the IRS's policy goal of not altering normal business transactions through the documentation requirements as customers may be more amenable to certifying a foreign use over a shorter timeframe when the expected use of the relevant property is better known; (iii) certain other regulations that have previously articulated a transportation-property-specific physical presence test have tested property on an annual (single year) basis³⁷; and (iv) in the event the intended use of the relevant property changes prior to the FDII filing date,³⁸ the “reason to know” standard³⁹ already protects against the risk that ineligible property generates FDDEI.

In light of the above, in order to reduce the risk that the documentation requirements affect the economic decisions of the parties, and to avoid imposing unnecessary burdens on taxpayers, Treasury should amend Prop. Treas. Reg. § 1.250(b)-4(d)(2)(iv) to read “during the one year period from the date of delivery” as opposed to “during the three year period from the date of delivery.”⁴⁰

The Final Regulations Should Ease the Administrative Burden of Establishing Foreign Use

In order to further Treasury and the IRS's objectives of easing the administrative burden associated with the documentation requirements, we respectfully request that the Final Regulations (i) remove or amend the “The Date of Sale” condition in the Proposed Regulations; and (ii) allow taxpayers to establish foreign use with documents that are created in the ordinary course of the taxpayer's business.

The Final Regulations Should Remove or Amend the “The Date of the Sale” Condition in the Proposed Regulations

The Proposed Regulations provide that a seller may only rely on a document for purposes of establishing foreign use if such document is “reliable” within the meaning of Prop. Treas. Reg. § 1.250(b)-3(d), which sets forth three conditions for reliability (the “Reliable Documentation Requirement”): (i) as of the FDII filing date, the seller “does not know and does not have reason to know” that the documentation is unreliable or incorrect; (ii) the documentation is obtained by the seller by the FDII filing date with respect to the sale; and (iii) the documentation is obtained no earlier than one year before the “date of the sale” (the “DS Condition”).

In order to avoid the unintended consequences associated with the DS Condition, as discussed below, we respectfully request that Treasury remove such rule in the Final Regulations.⁴¹ In the alternative, we propose that Treasury, in the Final Regulations, amend the DS Condition and provide that documentation be obtained no earlier than one year before the contract under which the property is sold is executed, as opposed to no earlier than one year before the “date of the sale.”

As an initial matter, the DS Condition deviates from the past and current practice of Treasury and the IRS with respect to documentation requirements. As an example, under Chapter 3 of the Code, certain nonresident aliens and foreign corporations are subject to withholding tax at a 30% rate on income they receive from United States sources which constitutes “interest” on the gross amount paid.⁴² A taxpayer subject to the withholding regime generally must file a withholding certificate, or Form W-8EXP, to (i) establish that it is not a United States person; (ii) claim that it is the beneficial owner of the income for which Form W-8EXP is given; and (iii) if such taxpayer is a foreign government, international organization, foreign central bank of issue, foreign tax-exempt organization, foreign private foundation, or government of a United States possession, claim a reduced rate of, or exemption from, withholding.⁴³

The regulations under Section 1441 provide that certain withholding certificates and associated documentary evidence shall remain valid indefinitely absent a change in circumstances making the information on the required documentation incorrect. The regulations also provide that certain other withholding certificates will remain valid until “the earlier of the last day of the third calendar year following the year in which the withholding certificate is signed or the day that a change in circumstances occurs that makes any information on the certificate incorrect.”⁴⁴ The instructions to Form W-8EXP similarly provide that “a Form W-8EXP remains in effect indefinitely until a change of circumstances makes any information provided on the form incorrect[,]” and that in some cases “Form W-8EXP will remain valid only for a period starting on the date the form is signed and ending on the last day of the third succeeding calendar year.” This demonstrates that, in other circumstances, Treasury permits taxpayers to rely on documentation for a longer period while remaining comfortable that the documentation is still current. In some cases, the relevant period is for three years, and in others, it is an indefinite period as long as circumstances do not change and make the information on the documentation incorrect.

If Treasury retains the DS Condition in the Final Regulations, Treasury should clarify when “the date of the sale” occurs. The Proposed Regulations do not define the phrase “the date of the sale.” Case law provides that a “sale is completed and ownership rights transfer to the buyer when the buyer acquires the 'benefits and burdens of ownership.'”⁴⁵ Whether ownership rights have transferred to the buyer is a factual inquiry “based on the intent of the parties as evidenced by the written agreements read in light of the attendant facts and circumstances.”⁴⁶ Under certain circumstances, the date of the sale may be the date of delivery of the relevant property.⁴⁷ However, the date of delivery may precede the date of the sale⁴⁸ and, in other instances, the date of the sale may precede the date of delivery.⁴⁹

A legally binding contract springs into existence as of its effective date. The effective date of the contract is generally the date that the contract is executed, which in turn is generally the date that the contract is signed.⁵⁰ In certain cases, the date that a contract is executed may also be the date that the sale is completed. In such cases, it should not be difficult for the taxpayer-seller to determine when the DS Condition has been satisfied. In other cases, however, the date of contract execution and the date of the sale may occur on different dates, perhaps even years apart.⁵¹

In light of the above, in order to avoid the unintended consequences associated with the DS Condition, we respectfully recommend that Treasury remove the DS Condition in the Final Regulations. Presumably, for purposes of the Reliable Documentation Requirement, the DS Condition was added to ensure that taxpayers do not rely on “stale” documentation to establish that a particular sale of property was for a foreign use. However, we believe that there are other ways that Treasury can prevent taxpayers from relying on “stale” documentation for purposes of demonstrating FDII eligibility.

In the alternative, Treasury should amend Prop. Treas. Reg. § 1.250(b)-3(d)(3) to provide that “the documentation is obtained no earlier than one year before the date of execution of the contract under which the property is sold.” Given that the date a contract is signed is generally at or near the date of contract execution (the date the contract takes legal effect), this rule will ensure that taxpayers are able to use binding contracts that precede the date of the sale for purposes of satisfying the foreign use requirement.

The Final Regulations Should Expand the List of Documentation Establishing Foreign Use of Property to Include Documents Created or Collected in the Ordinary Course of the Taxpayer's or Recipient's Business

The Final Regulations should provide that, with respect to general property and international transportation property, any document typically created in the ordinary course of the taxpayer's business, which establishes to the satisfaction of the Commissioner that the relevant property is for a foreign use, is sufficient. Under the Proposed Regulations, in order to establish foreign use, many taxpayers and their customers would need to produce documentation which serves no purpose other than compliance with the FDII regulations.⁵² Thus, the list of documentation in the Proposed Regulations should be expanded to include:

All of the documents listed above are prepared or gathered in the ordinary course of the taxpayer's or recipient's business and, for legitimate non-tax reasons, establish the location or intended use of property. A commercial invoice is an extension of the binding contract between a seller and the recipient of property. The Proposed Regulations already provide that a binding contract between the seller and the recipient of property that provides that the intended use of such property is for a foreign use will establish the foreign use of such property.⁵³ Because a commercial invoice is issued pursuant to a binding contract, where an invoice indicates foreign use of the property, such invoice should be considered a sufficient form of documentation.

Under the Proposed Regulations, a taxpayer may establish that an item of general property is for a foreign use through documentation of shipment of the general property to a location outside the United States.⁵⁴ We recommend expanding the documentation of shipment provision to include tax documents and to establish foreign use of international transportation property. Tax documentation, whether prepared for establishing exemption from tax or declaring liability, implicitly involves a declaration by the taxpayer about the intended use of the relevant property. For international transportation property, documentation of shipment and related documentation — such as customs forms and import licenses — are equally probative of foreign use as compared to similar documentation in the case of general property. This is the case because special regulatory regimes exist that generally apply to items of international transportation property and preclude or restrict their usage — e.g., enforcement of safety and emissions standards for motor vehicles or cabotage rules restricting intra-jurisdictional commercial aviation and shipping — as well as the nature of the items that are sold — e.g., large, high-value items that are difficult (if not impossible) to move across borders without triggering non-tax regulatory consequences — generally ensure that an item of international transportation property that is delivered outside the United States will be for a foreign use.⁵⁵

Documentation of registration with a foreign government indicates that a foreign government has exerted jurisdiction over the property. International conventions and United States domestic laws typically limit the domestic use of property registered outside of the United States. This approach is appropriate for international transportation property because (i) transportation is a highly regulated area where other government entities already apply rules that can demonstrate “foreign use” for FDII purposes; (ii) Treasury has previously relied on aircraft registrations for purposes of a transportation-property-specific physical presence test in the regulations;⁵⁶ and (iii), finally, as discussed above, there are customer sensitivities around providing written statements or agreeing to contractual language certifying the ultimate use of a purchased item of transportation property. For example, the United States imposes similar restrictions on the domestic operations of foreign vessels.⁵⁷ As another example, in the United States, “cabotage” rules provide that foreign-registered commercial aircraft cannot travel between two points within the United States, other than as part of a through trip involving travel to or from a foreign destination.⁵⁸ The cabotage rules severely hamper a foreign-registered commercial aircraft's ability to engage in significant revenue-generating travel within the United States. Therefore, there are sound policy reasons for allowing the foreign registration of aircraft and other international transportation property sold to foreign persons to be one method of establishing foreign use.

Statements provided by the recipient to the seller for purposes of warranty, after-market services, insurance, or similar services typically indicate the location or, with respect to international transportation property, the “base of operations” of the relevant property. The term “base of operations” refers, for example, to the home port of a ship, the hangar location of an aircraft, and the principal storage location for a railcar. The base of operations of large international transportation property indicates the domicile of such property and, thus, the site of a material portion of its use. United States manufacturers of international transportation property are serving foreign markets when they sell such property to a foreign person and that person maintains a foreign base of operations for the property. Therefore, the Final Regulations should provide that documentation evidencing a foreign base of operations is sufficient to establish foreign use.

The “catch-all” category at the end of the above list is necessary because certain industry-specific documentation provides clear evidence of foreign use. For example, in the context of aircraft, there are certain types of commonly used documents that should be sufficient to establish foreign use: (i) a copy of a standard airworthiness certificate,⁵⁹ which is delivered to the foreign customer with the completed aircraft; or (ii) certain filings made on the International Registry⁶⁰ that relate to an aircraft's foreign use. A catch-all category also relieves Treasury and the IRS of the burden of continuously issuing additional guidance clarifying which documentation sufficiently establishes foreign use in response to changes in documentation or taxpayer practices. Finally, there is precedent for using a catch-all category in the context of other place of use tests. For example, there is a catch-all category under Section 993 for purposes of establishing the country of ultimate destination for certain sales of property.⁶¹

Treasury Should Provide that FDDEI Services Include Maintenance, Repair, or Similar Services Performed on Property Temporarily in the United States

In the Proposed Regulations, Treasury and the IRS requested “comments on whether to consider an exception for property that is located in the United States temporarily solely for purposes of the performance of certain services, such as maintenance or repairs.”⁶² We recommend that Treasury and the IRS include such an exception in the Final Regulations. Such an exception would be consistent with the statutory requirements and would reduce the risk that taxpayers would shift the location where they provide such services to outside the United States. More specifically, we recommend that Treasury and the IRS, in the Final Regulations, provide that upkeep services (e.g., maintenance, repairs) — performed with respect to property that is temporarily located in the United States — constitute FDDEI services where the relevant property was sold for a foreign use within the meaning of Prop. Treas. Reg. § 1.250(b)-4(d)(2).

An Exception for Property Temporarily in the United States Is Consistent with the Statute

As the legislative history makes clear, Congress intended for taxpayers to be eligible for an FDII deduction for intangible income earned “from serving foreign markets.”⁶³ This intent is reflected in the statutory language in Section 250(b)(4)(B), which provides that FDDEI includes DEI derived in connection with “services provided. . . to any person, or with respect to property, not located within the United States.” Notably, the statute provides a disjunctive test (services provided to any person or with respect to property) and does not specify when the person or property that receives the services must be located outside the United States. Nothing in the statute or the legislative history indicates that Congress intended to limit eligibility for the FDII deduction for services provided to persons or with respect to property always — and exclusively — located outside the United States.

This statutory language makes particular sense in the context of certain intended beneficiaries of the FDII deduction. For example, assume a manufacturer, M, produces transportation property (e.g., an aircraft or marine vessel) in the United States which is then sold to a customer, C, which uses the transportation property almost exclusively outside the United States. Further assume that the facilities where M manufactured the transportation property generally are the same facilities where M typically provides maintenance services to its customers, makes repairs, and conducts other similar services because that is where equipment and qualified employees are located. Once those services are completed, the transportation property again fulfills its use as international transportation property outside the United States. In this scenario, if C's transportation property is serviced in the United States, it should still meet the requirements of Section 250(b)(4)(B), notwithstanding a temporary stop in the United States for repairs.

An Exception for Property Temporarily in the United States Will Incentivize United States Taxpayers to Keep Jobs in the United States

If Treasury and the IRS do not provide an exception for property temporarily located in the United States, United States taxpayers would have a perverse incentive to provide repair, maintenance, and other similar services outside the United States. For example, the manufacturer of international transportation property described above would have an incentive to stop providing these services for foreign-use property in the United States facility where the property was manufactured and, instead, may be incentivized to establish a CFC to provide these services in the future. If the United States taxpayer established a CFC to provide repair and maintenance services for foreign-use property at a location outside the United States, the United States taxpayer and shareholder of that CFC generally would be entitled to a GILTI deduction for the associated intangible income.

This anomalous result cannot be what Congress intended and further supports providing an exception in the Final Regulations. We do not believe that Treasury and IRS intended this result, either, and that this is an unintended consequence of not including an exception in the Proposed Regulations. Treasury and the IRS have described GILTI and FDII as related provisions, and there is no valid policy reason that would support permitting a United States taxpayer to claim a GILTI deduction for services provided by its CFC when the United States taxpayer would not be able to claim an FDII deduction if it provided the same services directly.

Treasury Should Revise the Proposed Regulations that Apply to Determine Where a Business Recipient of General Services Is Located to Account for Mobile Property

The Proposed Regulations categorize a general service provided to a business recipient located outside the United States as an FDDEI service.⁶⁴ Although we generally support this rule, as currently drafted, it fails to take into account facts that are specific to mobile property. We recommend that Treasury and the IRS revise the Proposed Regulations to provide that general services, furnished with respect to mobile property, also qualify as FDDEI services.

General services are provided to a business recipient located outside the United States to the extent that gross income derived by the renderer is allocated to the business recipient's operations outside the United States.⁶⁵ The Proposed Regulations provide that the location of the business recipient's operations is determined based on whether the business recipient “is treated as having operations in any location where it maintains an office or other fixed place of business.”⁶⁶ While this rule may work in many circumstances, it may prevent general services provided with respect to mobile property — such as aircraft or ships — from qualifying as FDDEI services because, by its very nature, mobile property has no “office or other fixed place of business.”⁶⁷

United States taxpayers regularly provide services remotely with respect to mobile property outside the United States. For example, a United States taxpayer may provide programming, navigation, or communication services remotely to aircraft, satellites, or marine vessels operating outside of the United States. Aircraft, satellites, and marine vessels are not stationary and presumably cannot have a fixed place of business, but they may operate continuously and regularly outside of the United States. As a result, general services provided with respect to mobile property should qualify as FDDEI services even though the non-United States place of business is not a single, stationary location.

Moreover, if the Final Regulations are not revised to account for general services provided with respect to mobile property, the same anomalous — and, we believe, unintended — result described above could occur whereby a United States service provider that performs services through a CFC will qualify for a GILTI deduction and receive a more favorable tax consequence than a United States service provider that performs such services directly.

Treasury and the IRS could revise the Proposed Regulations in at least two ways to adopt our recommendation that Final Regulations clarify that general services provided with respect to mobile property qualify as FDDEI. First, Treasury and the IRS could revise the Final Regulations to specify that a service is provided to a business recipient located outside the United States if, and to the extent that, the service is not furnished to a business recipient that is located within the United States. By effectively inverting the language currently used in the Proposed Regulations, Treasury and the IRS could include services provided with respect to mobile property within the scope of the rule without expanding its application. Second, Treasury and the IRS could clarify Prop. Treas. Reg. § 1.250(b)-5(e)(2)(ii) by providing that, where operations routinely occur on the ocean, in international airspace, or in outer space, such operations are treated as being outside the United States.

* * *

Baker & McKenzie is grateful for the opportunity to provide comments on the Proposed Regulations, and we hope that the above comments will be taken into account in revising the Proposed Regulations. We look forward to the prospect of commenting on further developments with respect to the FDII deduction. If you would like to discuss any of the recommendations in this letter or any other points, please contact Alexandra Minkovich at (202) 452-7015.

Sincerely,

Baker & McKenzie LLP
Washington, DC

CC:
Mr. Douglas Poms (International Tax Counsel)
Mr. Kenneth Jeruchim, Office of the Associate Chief Counsel (International)
Ms. Michelle A. Monroy, Office of the Associate Chief Counsel (Corporate)
Mr. Austin Diamond-Jones, Office of the Associate Chief Counsel (Corporate)