New IRS Publication on Foreign Derived Intangible Income (FDII)

 Disclaimer  

Treasury just issued some new authority on "Foreign Derived Intangible Income" ("FDII") that I think is very interesting.  

Generally, FDII is taxed at more favorable rates than regular income (13.125% rather than 21%), so the more income that qualifies as FDII, the lower the tax rate paid by the company.  Moreover, because the cash income from such sale can be used to fund domestic expenses, the taxpayer may be able to create a situation where some of it's income is taxed at 13.125%, but its deductions generate a benefit at 21%.

That means that if a Protocol Sponsor sells tokens for cash, and generates taxable income that is FDII, and then uses that cash to pay deductible expenses that are not allocated to FDII, that Sponsor may effectively shelter 37.5% of other income (e.g., gain on distributions of tokens to shareholders).  So for example, if a Sponsor sold tokens for $100 that qualified as FDII, it would owe $13.13 in tax.  If it then distributed another $100 of Tokens to its shareholders as a dividend, it would owe another $21 of tax, but that tax might be reduced to zero when the $100 sales proceeds are used to pay US employees -- so the tax on the distribution is now effectively only $13.3 (21% of 62.5% of the distribution).

Before this publication, it was hard to know when token proceeds might be FDII.  Under the law, proceeds from from the sale of property are only FDII if the sale is both (a) to any person who is not a United States person and (b) for foreign use.

It has never been clear to me how a Protocol Sponsor would know if a foreign buyer of tokens was going to use the tokens outside the US, or what kind of use was required (simply holding it in a wallet accessed from outside the US? using the tokens to acquire services or goods that are located outside the US? pledging the tokens to secure loans to be used in a foreign business? selling the tokens to other non-US people?) 

On June 28, 2021, a unit in the Dept. of the Treasury called the "LB&I Concept Unit" published a document titled, "IRC 250 Deduction: Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI)"

In that document, the authors say, "Foreign use means any use, consumption, or disposition which is
not within the U.S."  From that, I take it that the foreign use doesn't have to be primary or continuous or even significant.  It says "any use", and that should mean that any sale of a Token to a genuine non-US person (other than a foreign entity formed by a US person in order to purchase tokens only purchasable by non-US people) should constitute "use" and should therefore cause the income from the sale of the Tokens to be FDII.

Of course this particular publication is not authority, it can't be sited in a court, and it may well change, but I thought the statement was interesting and potentially very helpful.

Comments

Post a Comment

Popular posts from this blog

Should I sell my Tokens and realize a loss before year end?

Disclaimer     I have now been asked almost a dozen times about the "Wash Sale Rules" and whether token holders should sell and repurchase tokens before year end. The Wash Sale rules (IRC Section 1091) provide that if you sell a security at a loss and repurchase a substantially identical security within 30 days, your loss will be disallowed (and added to your tax basis in the purchased security). People have been hearing that the Wash Sale rule doesn't apply to tokens because the IRS has not designated tokens as securities.  (Remember that the characterization of tokens as securities by the SEC or as something else by the CFTC is not relevant for tax law purposes.  Tokens may be securities for some purposes and not for others.) If that's true, you could sell your BTC today and buy back BTC an hour later and trigger a loss that you can use to offset capital gain (or up to $3,000 of ordinary income) from some other source. That's a very reasonable argument...
Read more

1. So you want to do an ICO

Disclaimer The number of token offerings through ICOs or otherwise that have crossed my desk in the last 12 months has exploded.  Many of those transactions have been put together with such speed that corporate structure and tax treatment are an afterthought with expensive consequences.  Even now, most of the focus seems to be on the securities law treatment of Tokens.  The following is a brief outline of some issues that are worth considering -- primarily in order to avoid adverse tax issues for founders, issuers and investors.  Following posts will discuss different structures mentioned below in greater detail. Before we get to actual structures, however, it's important to understand what kinds of adverse things can happen to you.  Many people think that selling Tokens should be taxed the same way as a stock sale is taxed -- but there is a specific Internal Revenue Code section that provides stock sales are tax free -- and it doesn't apply to Token sales. ...
Read more

Taxes on Token Sales (in particular CA State taxes)

Disclaimer  Assuming you have successfully designed a Token Network and are selling Tokens (whether directly or through SAFTs) you need to determine where you owe tax and at what rate. The new federal rules  (Section 14202 of the Tax Cuts and Jobs Act) may provide significant benefits to Token sellers who can show that their income from Token sales is "foreign derived" (a reduced rate to 13.125%).  Unfortunately, the term "foreign derived" is not well defined and its unclear if Token sellers merely need to prove that the buyers have a foreign address or will need to show actual foreign residence and use, but it's worth watching and tracking whatever information you have on buyers. Fortunately, the California rule is more straight forward and may offer some opportunities. It says that the income from sales of intangible property may be allocated instate (subject to CA tax) and out of state (not subject to CA tax) as follows: "Sales from intangible ...
Read more