Individual Raises Issues With FDII, GILTI Regs

June 14, 2019

I. Establishing Foreign Person and Foreign Use for Sales of Finished Goods

A. Sales of finished goods to end-user customers

• Issue: In the case of a sale of general property that is a finished good to an end-user customer located outside the United States (either online or in a retail store), the foreign person and foreign use requirements included in the proposed regulations present the following issues —

  • It is not commercially feasible to ask the customer to prove or represent (i) foreign status (under Prop. Reg. §1.250(b)-4(c)(2)(i)), or (ii) that the finished good will not be subject to “any use” in the United States within three years of delivery (under Prop. Reg. §1.250(b)-4(d)(2)(i)(A)).

  • Documentation of shipment outside the United States to establish foreign use (under Prop. Reg. §1.250(b)-4(d)(3)(i)(C)) does not appear to encompass an on-the-spot sale to an end-user customer (e.g., in a retail store).

  • The special rule for small transactions (under Prop. Reg. §§1.250(b)-4(c)(2)(ii)(B) and 1.250(b)-4(d)(3)(ii)(B)), even if expanded, is not a viable solution because (i) it does not appear to encompass an on-the spot sale to an end-user customer (because there is no shipping address); and (ii) more fundamentally, it would be highly burdensome, if not impossible, for a seller to track annual finished good revenue on a per-customer basis.

• Proposed solutions: Provide a rule for a sale to an end-user customer of general property that is a finished good (“End-User Finished Good Rule”). Under the End-User Finished Good Rule, a finished good is treated as sold to a foreign person for foreign use if it is sold to an end-user customer and either (i) the finished good is shipped to the end-user customer outside the United States, or (ii) the sale is concluded and delivery is made to the end-user customer outside the United States. More specifically —

  • Revise Prop. Reg. §§1.250(b)-4(c)(2) and 1.250(b)-4(d)(3) to provide that documentation of foreign person status and foreign use includes either (i) the shipping address for the end-user customer is outside the United States, or (ii) a receipt, invoice, or other documentation that the sale was concluded and delivery was made to the end-user customer outside the United States.

  • Revise Prop. Reg. §1.250(b)-4(d)(2) to provide that, absent actual knowledge of the seller to the contrary at the time of the sale, a sale to an end-user customer of general property that is a finished good is for a foreign use if either (i) the shipping address for the end-user customer is outside the United States, or (ii) the sale is concluded and the finished good is delivered to the end-user customer outside the United States.

  • Definitions:

    • An “end-user customer” would be defined as any consumer (defined in Prop. Reg. §1.250(b)-5(c)(3)) or business recipient (defined under Prop. Reg. §1.250(b)-5(c)(2)) that purchases a finished good for their own use or consumption (i.e., not for (i) resale or (ii) further manufacture, assembly, or other processing within the meaning of Prop. Reg. §1.250(b)-4(d)(2)(iii)).

    • A “finished good” would be defined as general property that is sold to an end-user customer without further manufacture, assembly, or other processing (within the meaning of Prop. Reg. §1.250(b)-4(d)(2)(iii)).

B. Sales of finished goods to unrelated foreign intermediaries

• Issues: In the case of a sale of general property that is a finished good to an unrelated foreign intermediary with contractual rights to sell only to end-user customers located outside the United States, the foreign use requirements in the proposed regulations present the following issues —

  • The seller should not be required to demonstrate a lack of a reason to know that the finished good will be subject to “any use” in the United States by either the unrelated foreign intermediary, or an end-user customer of the unrelated foreign intermediary, within three years of delivery (i.e., the “three-year rule” under Prop. Reg. §1.250(b)-4(d)(2)(i)(A)).

  • In such a case, a binding contract between the seller and unrelated foreign intermediary providing that the unrelated foreign intermediary's intended use is for a foreign use (under Prop. Reg. §1.250(b)-4(d)(3)(i)(B)) should be adequate documentation, but it is unclear how this documentation rule interacts with the three-year rule.

• Proposed solution: Provide a rule for a sale to an unrelated foreign intermediary of general property that is a finished good (“Foreign Intermediary Rule”). Under the Foreign Intermediary Rule, a finished good is treated as sold for foreign use if it is sold to an unrelated foreign intermediary that is contractually restricted against selling to end-user customers located in the United States. More specifically —

  • Revise Prop. Reg. §1.250(b)-4(d)(2) to provide that, absent actual knowledge of the seller to the contrary at the time of the sale, a sale to an unrelated foreign intermediary of general property that is a finished good is for a foreign use if, under a binding contract, the unrelated foreign intermediary's rights are geographically limited to selling (directly or through another unrelated foreign intermediary) to end-user customers located outside the United States.

  • Definitions:

    • An “unrelated foreign intermediary” would be defined as a foreign unrelated party (defined in Prop. Reg. §1.250(b)-6(b)(2)) that purchases a finished good and sells it to an end-user customer (directly or through another unrelated foreign intermediary) without further manufacture, assembly, or other processing (within the meaning of Prop. Reg. §1.250(b)-4(d)(2)(iii)).

    • See above for definitions of “end-user customer” and “finished good.”

II. Establishing Foreign Use for Intangible Property Licensed to Make and Sell Finished Goods

• Issue: Under Prop. Reg. §1.250(b)-4(e)(2)(i), a sale of intangible property is for foreign use only to the extent the intangible property generates revenue from exploitation outside the United States. For intangible property used in the development, manufacture, sale or distribution of a product, exploitation occurs at the location of the end-user when the product is sold to the end-user. If this foreign use exploitation rule is retained, it should be clarified to address the following issues —

  • In the case of a license of rights to make and sell finished goods to customers located outside the United States, it is unclear how the foreign use exploitation rule applies where a related licensee sells a finished good to an unrelated foreign intermediary (rather than directly to an end-user).

  • If, under a binding contract, an unrelated foreign intermediary's rights are geographically limited to selling to end-user customers located outside the United States, the licensee should not be required to trace the finished goods through to end-user customers or demonstrate a lack of a reason to know that the unrelated foreign intermediary will sell to end-user customers located in the United States (which would be in violation of the contract).

• Proposed solution: If the foreign use exploitation rule is retained, clarify Prop. Reg. §1.250(b)-4(e)(2)(i) to provide that, with respect to a sale to an unrelated foreign intermediary of a finished good, exploitation occurs outside the United States if, under a binding contract, the unrelated foreign intermediary's rights are geographically limited to selling (directly or through another unrelated foreign intermediary) to end-user customers located outside the United States.

  • See above for definitions of “end-user customer,” “unrelated foreign intermediary,” and “finished good.”