On-Demand: International Tax Update
October 22, 2020
Our panelists provided an overview of key current international tax developments and potential planning opportunities.
Charles Brezak:Okay. Welcome. Let me just thank Glen for the opportunity, and I wanted to perhaps set out the agenda for this morning so that you understand the sequence, what we'll be covering. We'll start off with my presentation on the Whirlpool case, which is a fairly landmark tax court decision. And then we're going to go to Matt, who will follow up with the High-Tax exception elections. And then he's going to turn it back over to me. I'm going to then cover the issues regarding 163(j) international, as well as BEAT and as well as some other aspects in the regulation that were proposed. And then I'm going to turn it over to Matt, who is going to finish up with city and a couple of other areas. So that's really the agenda. I think that you'll enjoy the insights and discussions that we're having.
And we'll start off with the Whirlpool case. And why are we covering the Whirlpool case? Well, the question is why wasn't the Whirlpool case an earlier decision that was made? Because the Subpart F rules have been around since 1962 and this is the first substantial discussion by a judicial branch to cover the aspects of the branch rule, which up to this point have been fairly esoteric. And therefore, it's a fairly important case in terms of understanding the significance of the branch rule. So as we go through the branch rule, we'll also start to give you an overview of how Subpart F works, so you have a good foundation to understand the implications of the case.
So what happened is that, following the second World War, the US was the main manufacturing engine, would be selling to Europe, selling to Germany, or selling to the Netherlands, but it would set up a subsidiary, who was a US company in Switzerland and they would basically use that company as a foreign base company, which would have nothing to do, really, with where the goods were manufactured or the goods sold. It was stuck in there for tax purposes.
So as a result, in 1962 there was a fairly profound change in the tax law, which was Subpart F. In Subpart F, basically indicates that, notwithstanding that you might have all of the 482 rules covered if you have so-called Subpart F income or foreign based company income. The income would be taxed to the US shareholder regardless. So this was then focused upon to look at a couple of characteristics of Subpart F. One is it had to be a CFC. Number two, you have to have a related party transaction. And then, none of the exceptions apply.
In the case of Whirlpool, we'll be talking about the manufacturing exception. But there is a famous anecdote, which I heard a couple years ago from an international tax counsel from Washington who retired. He said that when they were working through this related party stuff with Subpart F, they went out to dinner and they heard a bunch of tax lawyers on the next table talking about how to avoid Subpart F just by setting up branches. So, as a result, before the ink was even dry they went back to Congress, and [Cole 00:08:10] and his group put in what is called the branch rule. And the branch rule basically says, even if you don't have a CFC and a related party, if you have a branch and you fall within the branch rule, then it has substantially the same effect as a CFC. We're going to create Subpart F income.
Up to that point, and then thereafter, there wasn't a lot of activity, notoriety if you will, because there were a lot of recognition by tax advisors about the branch rule but it was fairly obtuse and fairly academic, and there were a lot of potential exceptions. So there wasn't a lot of activity going on in terms of adjusting for potential exposure to find out where the branch rule might give rise to Subpart F income. That is up to now.
But what happened was, up to this point there were a lot of technical arguments as to whether the branch rule would give rise to Subpart F income, and it was sort of a nice academic discussion. But once the check-the-box rules came in and you had all of these disregarded entities that were branches, hybrid entities that were for foreign purposes were corps. But for US purposes, under check-the-box, you basically multiplied dramatically the number of branches. And since those rules came out in the 1990s, there's been a lot of potential issues that could arise in the branch rule because of branches. And notwithstanding that there hasn't been a lot of notoriety up to now.
So that was the situation up to 2015 when the IRS figured out that this is a big issue with all of the superholding companies, and then they started with international practice unit to get into this. and we go through we will touch upon some of the latest post-2015 pronouncements by the IRS, initiatives of the IRS to deal with this. But Whirlpool is the first comprehensive judicial analysis that gets into the history of the branch rule and how it really applies.
So, for purposes of reference, I wanted to make sure that you could track everything if you wanted to go back and do some extra reading. We don't get extra credit on this presentation, so if you go back on your own and read 954(d)(2), you'll see the branch rule and the regulations, and the citations are there.
So, the whole idea about Whirlpool, and its significance, is that creates Subpart F income, which is in this situation we have a superholding company. And why is it important? Of course, we've been talking about GILTI for the last several years, but Whirlpool is important because it lays out the architecture for the branch rule. And then, of course we know that Subpart F income does not qualify for the section 250 deduction. It's a CFC computation rather than tested income, so the consequences of Subpart F are different than GILTI. And now we have, as Matt will touch upon later, new proposed regulations under the Subpart F High Tax Exception, which when finalized would restrict the use of such exception and create more potential Subpart F income.
And of course you have, like in the case of Whirlpool, which actually dealt with the year 2009 before there were some changes to the manufacturing exception, that you have prior years, prior to GILTI, where Subpart F would be drastically significant, as it was in Whirlpool because you had a $50 million assessment.
So, what is Whirlpool all about? Well, as I mentioned before, you have a US company, and the US company in this case is Whirlpool USA. Prior to its restructuring, it basically had a manufacturing company in Mexico, and the manufacturing company sold to a related company which was in a low tax restriction, and it created potential Subpart F income through that company, which was not the manufacturer but the other entity. So what they did is, they restructured the Mexican operations.
And in order to make sure this tax strategy was successful, basically they had to avoid a couple of potholes in the Subpart F area. One is that they had to make this company in Luxembourg which they set up a manufacturer so that it qualified for the manufacturing exception. And we'll discuss in a diagram how that is going to work. And it did so through a series of contracts, and also that Luxembourg, made sure that it was the owner of the equipment and the raw materials which were manufactured in Mexico, and took the position Luxembourg did that it was a manufacturer.
So then, when ultimately there was a sale to the US, Luxembourg, on that related party sale, could take the position that it was qualified as a manufacturer, even though the manufacturing is done by another unit within the superholding company. Luxembourg was taking the position that it was qualified for the manufacturing exemption because it had all of these other things that it was doing. A lot of this was by paper, with contracts, and therefore that was one piece of it. And then, as indicated, Lux sold the appliances to related companies and had $50 million in income that was exempt from Luxembourg and Mexican taxes.
Well, how did it do that? Well, obviously that took some doing but what did occur was that Luxembourg, and this is maybe common to many of the structures that are in the superholding company, Luxembourg is a territorial system. So as long as the income was attributable to a permanent establishment outside of Luxembourg, the income that Luxembourg owned was not taxable in Luxembourg. And then, what also happened was that in Mexico, they made sure that they qualified for the maquiladora program, and the tax was relatively low, but they made sure that they did qualify and as a result of qualifying, Luxembourg did not have a PE in Mexico. So here you are in a situation where, for Luxembourg purposes, Luxembourg is deemed to not have a PE in Luxembourg and had a PE in Mexico, and therefore under the treaty the income is sourced outside of Luxembourg, and for Mexico, it's not a PE because it satisfies specific little provision of the maquiladora program.
So now what happened was Whirlpool took the position that the income which was taxed at zero in Luxembourg was not foreign based company sales income even though the product that was manufactured was sold to a related company, which is the US and Mexico, because of the manufacturing exception. So that was the strategy, and let's see what happened.
So, we see what happened. And I apologize for the fact that this is a little hard to read. But basically, what this diagram shows is, in example one, this is from the IRS practice unit that they initiated in 2015, and it's basically dealing with the branch rule. And it takes the position that because the Mexico operation was a branch, and because the tax rate in Luxembourg is zero, and the tax that would have been incurred in Mexico is much higher, that there's a rate disparity and the branch rule is coming into play now.
And as a result, and this is important to focus on, even though the Whirlpool position is that Luxembourg is the manufacturer on sales to its US parent and to Mexico, there's another piece which is stepping it apart, which is the branch rule. And the branch rule deals with the relationship between Mexico and Luxembourg as compared to dealing with Luxembourg and the US. And this example one really deals with it and shows that, as a result of this, even though Luxembourg has taken the position that it satisfies the manufacturing exemption, it really does not help on the branch rule.
And on the branch rule, what happens is that because of the rate disparity between Luxembourg and Mexico in this particular situation, that the income from Luxembourg under the branch rule would be Subpart F income because Mexico is treated as selling to Luxembourg, and Luxembourg then is selling, but is selling on behalf of Mexico. So there's a related party transaction in there that is captured by the branch rule. So the branch rule is designed to create a fiction, which is that even though Mexico is really a disregarded entity, to be treated as a related party CFC and Luxembourg can be selling on behalf of it. So here's the structure, just to make sure. We see that Mexico's the DRE, they're the manufacturer and they're basically treated as selling their products to Luxembourg. That creates a related party sale, and Luxembourg then sells to the US, or to anybody because it's buying from a related party, which is Mexico. And again, Mexico is not a CFC but the branch rule makes it a CFC.
So here's the branch rule analysis. In Luxembourg, the income was not taxed based on a ruling that the income was attributable to the Whirlpool Mexico DRE. In Mexico, you didn't have a PE under the maquiladora program. And then what we do right now here on this slide is we show that there is what is called a rate disparity test. And rate disparity test, even if you have a branch, unless you have a rate disparity between the sales operation where it is in Luxembourg, which is zero, and in our case Mexico, which is 17% of the maquila program. If there's a differential which is appreciably different or lower, then the sales entity has a rate which is much lower, which is on our case is under the regulations, less than 90% and at least 5 percentage points less than the rate of tax in Mexico. You meet this rate disparity test, and you basically then create a related party CFC by operation of the branch rule.
So what happened was under the branch rule, Whirlpool Lux is deemed to be the remainder, all the sales income is deemed to be assigned to the sales operation of Luxembourg and they're paying zero tax rate. And therefore, the income in Luxembourg is all Subpart F because it's deemed to be purchased on behalf of the related party, which is Mexico.
So what are the observations? Well I'll just go through a couple of quick observations because of the rate disparity test. The taxpayer's counsel took the position that you should compare the hypothetical rate in Luxembourg before the income was taxed in Luxembourg, which would have been 24%, and the court basically said that's a hypothetical, it's not really what we're going to use. We're going to look at the rate disparity comparing the rate you actually paid in Luxembourg, which is zero, versus the rate in Mexico. So they knocked that out.
And then the court also looked at the legislative intent and cut through a lot of the purely technical arguments of the taxpayer. And in fact, the judge actually took a fairly critical eye to some of the arguments. So when the taxpayer tried to argue that you can't have sales income in this remainder because just have one employee in Luxembourg. They said you can't have it both ways. This is really ridiculous because you're saying you did all this stuff, you're a manufacturer. Now you're saying you don't have any capacity, you don't have substance in Luxembourg. So they knocked that out. So you're going to have a lot of the technical arguments no longer will be respected if this case does not get overturned on appeal.
So now we have also the fact that we have a territorial system, and what really made the judge upset was that they were arguing two different approaches to two different tax restrictions. That there is a PE in Mexico but Mexico, they were arguing it wasn't, but Luxembourg they were saying it is a PE in Mexico. So, this really, I think, irritated the judge and he did come across as being a little upset about some of these arguments. The taxpayer tried to make an argument that the regulations were not valid, but nevertheless the judge made a very learned observation about these regulations and it came across that these regulations were approved by the judge as being a valid exercise of treasury authority.
And then, if you look at some of the stuff that's come out from the large case group. They have an active campaign to look at this. And it was noteworthy that on the 8858, which is the form which is reported a DRE, that there is a specific question, 9 on Schedule G, addressing CFCs with manufacturing and sales DREs. The IRS put a lot of money into this, and we'll see what happens on appeal. It'll be of interest. But now you're going to basically have this LB&I initiative and the question on the 8858 is going to spur many more audits on this issue, so it's going to be much more prominent than it has been.
Charles Brezak: Okay, Lexi? Can I just make a commentary on this? We see that the predominant answer is whether it's Subpart F income. I think that there's a little confusion between the rate disparity test for this purpose, and for the high tax. What we're doing is we're comparing the branch rate, which is let's say in our case where the product is manufactured overseas to the rate in the sales company overseas. So we're comparing two foreign rates rather than the US rate. The US rate will be, as Matt will talk about, comes into play with the high tax exception comparison. So with that, I'll turn it over to Matt, who is going to educate us on the high tax exception.
Matthew Halpern:Thanks Charlie. I think what we're going to do is look at a case study here. This might help drive the point home and work at what we're going to talk about. So in July of this year, 2020, new regulations came out with regards to the GILTI high tax election. And ultimately, it allows taxpayers to elect a GILTI high tax exclusion for the taxable years of foreign corporations that begin after the regulations came out, so July 23rd, 2020. But the good part is that they also allowed a retroactive provision to say that you can go back to tax years beginning after December 31st, 2017 and before July 23rd, 2020. So therefore, really looking at the 2018 and 2019 tax years when GILTI really first came out and started to become an issue.
The regulations had some changes between the proposed and final, one of being this CFC-by-CFC approach, which when Charlie was talking about having different branches in your CFC might have given you a better benefit. Where now you have to look at a tested unit approach, or what they're calling a standard. they also adopted a consistency rule so that you cannot make a GILTI high tax election for one entity but not for another entity. Basically it applies to all of your CFCs and all of your US shareholders. So if you have one majority shareholder making a GILTI high tax exclusion, it's going to affect maybe some of your minority shareholders, which still own at least 10% and still have some effect.
Ultimately, this is going to change, and the IRS came out with, I think, new proposed regulations on the Subpart F high tax election, and trying to make one and the other coincide together. Again, there was always a high tax election for Subpart F, that's always been around. You still have this 90% of the US corporate tax rate to look at. Now you have a GILTI high tax exclusion, which is new, and now they're just trying to figure out a better way to make one and the other almost interchangeable.
There's always considerations with making any high tax election because again, one thing you'd want to look at is your foreign tax credit analysis. We have a couple of points here. Again, one, you're looking at a benchmark rate of 18.9%, which is currently 90% of the US corporate tax rate, which is 21%. And will it stay at 21% come next year? We'll have to just see what happens.
You're looking at a tested unit approach here rather than CFC-by-CFC. So in Charlie's case with Whirlpool, you were looking at different branches and different countries. Those would be considered different tested units, and each having its own tax rate, one might qualify while the other might not. Looking at net operating losses, because again if you have US NOLs you're picking up your GILTI income and maybe utilizing those NOLs. Do you want to make this election so that there's no pickup at all, therefore preserving some of your NOLs? Especially with the CARES Act, which now due to COVID allows you to carry back some of those NOLs a couple of years where we went through a change, you weren't able to, now you can. In anticipation that you do have these losses for 2020 because of COVID.
Again, we were talking about foreign tax credit position and in the GILTI basket which was, again new foreign tax credit basket that came out with the TCGA Act, you can cross credit GILTI tax against other companies' GILTI income, so now if you make a high tax election you will no longer benefit from the taxes in that high jurisdiction. Therefore, to cross credit against another company with maybe a lower tax, in a lower tax jurisdiction. How does that come into play?
The same thing applies with QBAI. If you have a large manufacturing company that has a lot of QBAI, a lot of fixed assets generating the GILTI, you will no longer have that QBAI to reduce the GILTI across the board. It gets proportionally allocated amongst all of your CFCs so there might be some loss there. Another item could be a 163(j), which right now there's a potential group company election that you can make where you can potentially get a better deduction, a larger interest deduction, which would mean a lower GILTI tax and therefore having a higher effective tax rate. So that's something that might take into account.
We say maybe look at, again projections, what do you think the income is going to be over the next three to five years? And we know there's a lot of change in circumstances because of the COVID-19 pandemic and virus going around. So how does that affect your US NOLs? Will the foreign entities have NOLS? Do you want those tested losses to negate any tested income from you other CFCs? Maybe you don't need a high tax election and you're out of it because of your tested losses. And also, future repatriation. So again, with the 245A that came into play. Distributions from foreign corporations in which you own a certain percentage can be excluded from taxable income. So therefore, if you're making a GILTI high tax exclusion, not having any GILTI income, you have untaxed E&T, can you get the 245A deduction when you distribute those funds? And therefore, maybe you're not using any US NOLs. You're not utilizing any foreign tax credits or potentially having any leakage of credits or issues with cross crediting and expense allocation, that you might be losing out some benefit. So there's a couple of different areas you really want to look to see, is it worthwhile to make this election or is it not?
So we're going to look at an example here, where we have a US corporation, P, that owns a Cayman Islands Holding Company. And the Cayman Islands Holding Company, which will be the CFC, owns two disregarded entities. One is going to be in Switzerland, which is the trading company, and the other is a manufacturing company incorporated in China. The manufacturing company sells its production to trading, which then resells to third parties. And obviously, P heard about the Whirlpool case and they want to evaluate their potential Subpart F branch rule analysis and the new GILTI high tax election.
To just kind of show you the structure here, again US corporation owns 100% of Cayman, the CFC, that owns two branches, one in Switzerland, one in China. Now obviously, one thing we know that also came out is when you do have foreign branches, maybe not even legal entities but permanent establishments, you might also have to now file the 8858. So this form 8858 covers not only check-the-box entities that are treated disregard, but if you have permanent establishments which could also be tested units and therefore giving more information to the IRS, more insight on which tested unit you have in one country, what their effective tax rate is versus also another.
So in our situation, we're going to say that trading has tested income, or GILTI income, of $5 million and they're taxed at 10%, or 500,000, and MCorp, the manufacturing entity has tested income of 3 million, but they're taxed at 40% so they have a tax of 1.2 million. So what happens if they make the high tax election?
Well, trading is taxed at less than the 18.9% threshold, therefore the income would be reportable from that economic unit. And a foreign tax credit would be allowed to the extent of 80% of what they pay, assuming it's 100% inclusion, for let's say a $400,000 foreign tax credit. Since MCorp is taxed at more than the 18.9% threshold, they meet the high tax exception. Therefore none of their income is tested income, and therefore you do not get any other foreign tax credits or QBAI, if they had QBAI. So now, we're just looking at our analysis. $5 million plus zero because we're not taking MCorp into account, 10.5% what the US effective tax rate. That's figuring you're getting the 50% GILTI deduction under Section 250 at the 21% rate. So you would have a US tax of 525,000. You would be able to take 80% of the 500,000, or 400 of an FTC, and therefore you have 125,000 residual tax liability.
Now that's from making the high tax election. So in this particular instance, it doesn't sound favorable. So what happens when you don't make the election? So if no election is made, now you're picking up 8 million of income. Again, US effective tax rate of 10.5%, 800,000 US tax. But now you have 1,360,000 of foreign tax credit. That's after your 80% haircut. So now you have zero residual US tax liability. So in this particular instance, because M corporation is taxed at a 40% rate, you're able to cross credit and utilize those foreign tax credits against the underpayment amount from trading, and therefore your foreign tax credit is wiping out your GILTI tax.
Now again, we like to say, looking at your US Net Operating Losses, because again do you want to pick up $8 million or do you want to pick up $5 million? How much NOL would you potentially use in the US. Just something to kind of think about.
So now if we look at a Subpart F high tax analysis, the new current regulations say that in the example there, looking at now potentially utilizing Subpart F income in the sales branch because there is sufficient rate disparity between the sales branch and the manufacturing branch. So now they're looking at a combined CFC rate of 21.25% because of the 1.7 million in total taxes paid over 8 million of total income. So that's higher than the 18.9% threshold.
Now, assuming under these facts that the manufacturing exemption doesn't apply, so therefore manufacturing does have Subpart F income. The Subpart F high tax election is done based on each category of income, foreign based company sales income of the CFC, and in this particular instance, if everything was Subpart F, it would be advantageous to plan into Subpart F because now you're looking at, at the CFC level as opposed to a tested unit level like under GILTI. At the CFC level you're looking at a combined rate of 21.25%, therefore you are in a high tax jurisdiction, let's say. So you can plan in to Subpart F is some instances and use the Subpart F high tax exception to get out of picking up any Subpart F income.
And then the way that the ordering rules work with GILIT is if you have Subpart F income, that would not be GILTI. And Subpart F high exception income would also not fall into GILTI. So generally, GILTI is kind of like a catch-all type of basket. If you don't have Subpart F, you're GILTI. But there is this little midway point that when you do have Subpart F and even if it meets high tax, you would not have GILTI income. So therefore, some companies might want to plan in to Subpart F. And again, if you didn't meet high tax, Subpart F income and foreign tax credit can also be cross credited, whether you're in the passive basket or the general basket.
Now, one thing we are looking at is still, because these are proposed regulations, they're not exactly effective yet, so it's really about planning right now. But what the IRS is looking at is trying to get some consistent rule like the GILTI high tax election. And looking on maybe a tested unit basis. So again, if the IRS decides to go and conform GILTI tested unit with Subpart F tested unit, in our example we kind of have the same situation. And therefore, it might not be advantageous.
So again, this is just something that I see a lot of companies maybe projecting, maybe trying to plan. Should we take the high tax exception under GILTI? Should we do it under Subpart F? Do we have any US NOLs? What's our foreign tax credit position look like? And there's going to be a lot of planning.
Charles Brezak:Okay, thanks Matt. I appreciate the opportunity now to go through some of the regulatory changes as well, in 163(j), BEAT, and Matt will hit FDII. Sounds like a rock group but it's actually the names of regulations. So let's quickly look at 163(j) background. I'm not going to cover all of the aspects of 163(j). I'm really going to be focusing on the various elections so that we are cognizant of the importance of these elections.
In July of 2020, there was a new package of 163(j) regulations. And in that package, they finalized a couple of question in final regs, but as part of the package there are also a new set of proposed regs. So to no one's surprise, the final regs confirm that 163(j), which is the interest limitation, and in the top of that slide we talk about the actual requirements, but the 163(j) interest limitation applies for purposes of computing Subpart F and GILTI, and income effectively connected with a US trade or business. And no one is surprised that that was the ultimate decision that was made after telegraphing their approach in the original proposed regs. But I think that there were major revisions in terms of the elections that were now articulated in the proposed regs, and I just want to hit them briefly.
The new group election, I think is really very important because in the early regulations that were proposed, it talked about a group election, but the group election was really not per se a group election. It was looking at the bottom tier, seeing that it may have excess income that it could use for an interest limitation which would roll up to the company on top of that, ultimately going through the tiers. But it was really like a separate calculation and it was more restrictive and more prone to administrative problems in terms of getting all the information. And certainly, one of the drawbacks was if you had a brother-sister structure, you couldn't really cross any excess ATI that you had, it was really not a pure group situation unless everything was in the same tier.
So now, they relaxed it. This is a big deal because now you look at the group wide, and it doesn't matter if it's a brother-sister, doesn't matter if it's down below or it's the top. Everything's going to be reported as a group, and you just add up all of your elements in your 163(j) and you go from there. So that's a very important change, and it's taxpayer favorable. So we can make that new group election and take advantage of different financial reporting and different entities.
So there allows you now to, if you have excess taxable income in the CFCs, you could roll that up to the higher CFCs and then they could roll up to the US shareholders, which are good. As long as you have a group election in effect, if you have excess limitation you could roll it up to the US shareholders, so that's really good news. Looking for the arrow for the next slide. And we have that. Okay.
And then, the five year binding group election. So now, the point is that you need to make a formal election to do the group election, and that's not simply that you're using a group calculation, you actually have to have a formal election and you can go for that election being bound, binding you for five years. But I think it's important because the earlier version of the proposed regs said it's irrevocable. Now, at least you can change it in five years. But it's hard to visualize a situation that is common that is going to preclude you from making a group election. So I think that's a good thing.
In terms of determination of a CFC group, I think that a lot of the rules now are going to relate to consolidated returns like SRLY, when entities go into the group and out of the group. So that's certainly going to make it a little more complicated, but I think that those people that understood consolidated returns and SRLYs and all of those rules are going to be right at home with these rules.
There's a Safe Harbor election, which allows you to minimize the impact of 163(j) in the foreign area. The problem is that if you go into that election, you cannot get any roll up to the US, so that's a potential disadvantage. And then there is the conformity under the CARES Act, with the limitation going from 30 to 50. I think that this roll up is really important, but you could see that you're going to need to really sharpen your pencil and come up with a calculation as to how this is going to work, and I think that the regs, though, are going to be taxpayer favorable, which is important.
Just a few comments on the BEAT regulations, which is the second segment I'm going to address. Without getting too much into the BEAT architecture when companies go into a group or leave the group, I wanted to talk about the waiver. And of course, the BEAT regulations implemented BEAT, which is sort of a 10% minimum tax if you're a large corporation having at least 500 million of gross receipts for a three year average period, and your erosion percentage, which means that your particular expenses that are targeted for eroding the base, are at least 3% of the total deductions. So if you're in that situation, you have a minimum tax of 10% where you disallow your BEAT deductions.
I think the important point here is that they do allow you to waive the allowable deductions to the extent that waiving it puts you under this 3% erosion percentage. And that's a big deal. So if you were like $1 over the 3% and you said, "Well, I want to waive this deduction because I don't want to be subject to BEAT on everything." This waiver allows you to do that, but we couldn't have it 100% taxpayer favorable. What happens is you could go to amend your return to claim more waiver, and that's allowable, but on the flip side if you want to reduce the about of waiver, they won't let you do that. So I think you have to sharpen your pencil.
They were just concerned that if we did allow a big waiver and then to cut back on the waiver in an amended return, it would be difficult to track. So what you need to do is come up with a bonafide number that you think is going to be the final number as best you can and then, if that's going to bring you under the 3%, then you should really try to make the waiver. So that's an important point. But again, if you go too much they won't let you retract it, so you're going to have a disallowance of expenses, which won't produce any benefit.
Matthew Halpern:I know it might be a little hard to answer the question without going through some of the slides, but we'll try and jump through them fairly quickly here. Down to foreign derived intangible income, or FDII, or F-D-I-I. This was also a new deduction that came out in the Tax Cuts and Jobs Act which helps provide an incentive to US corporations that derive foreign income. So, selling goods to foreign people, or providing services to foreign people, or to the benefit of foreign locations. And ultimately you get a 37.5% deduction on what would be your net foreign income, or your net DEI income, which effectively turns your 21% corporate tax rate to a 13.125% corporate tax rate on that foreign income. Some similarities to the IC-DISC rules, if you're familiar with those, but not as strict tests. You can also still have foreign related parties within the supply chain, whether they be CFCs or other entities that can potentially generate that related party income. Ultimately, you just need to benefit a third party. And if you're corporate partners in a US partnership, or even a foreign partnership that generates foreign income.
That's why one of the answers on the polling question was that partnerships might have to keep track of this, because it does pass through to your corporate partners and they can still potentially benefit from this FDII deduction. So there might be some planning involved, maybe you want to restructure your operation so that your US company from a lower 13% tax rate, as opposed to what the foreign operations might be generating.
Generally, you're going to see foreign derived income from sales, sales of general property or intangible property. It has to be to a foreign person, and has to be for a foreign use. It's all established by obtaining the proper documentation. And you want to make sure that you have the proper documentation in place by the time you file the return to take the deduction. There is a small business exception that might reduce the amount of documentation requirements that you need if you're under 25 million of gross receipts during the prior taxable year, taking any related party transactions into account.
Also, you can benefit from services. Like we said, if there's a provision of service to a person, that's a foreign person or with respect to property that's located outside of the US, you can also benefit from this deduction. So in some instances, you can still have US customers, but if they have foreign operations that you're specifically providing these services to, you can still get this benefit. Again, it comes down to the documentation that details what's the location? Who's the person ultimately receiving the benefit? And you do not need to ultimately establish a branch or a foreign entity to get this benefit, it's all derived from US C corps or LLCs taxed as C corps.
New final regulations came out in July of this year which help ease some of the documentation requirements. Some removals of what a foreign person's status is or foreign use of property, and also the location of certain consumers for general services. They've also relaxed some of the rules for documentation of, again, establishing who is a foreign person or what's a foreign use. It can come down to a billing address or a shipping location, which makes the burden a little bit less cumbersome to the client that's then looking to see if they can benefit from this.
Ultimately, again what you're trying to compare is is it more beneficial to get your 13% rate versus 21. There's no carryover of this FDII benefit. You have to be in a taxable income position in order to qualify for the benefit. If you're in a loss or if you have NOLs, those will come into play to reduce what benefit you might get. There was a lot of coordination between this deduction, the interest expense limitation, and NOLs. The IRS is currently still evaluating that, and they had an example about what order comes where first. And they removed the example and now they are going to try and figure out, maybe should there be some coordination or ordering rule to benefit with all these different deductions and exclusions.
And then just the last point I wanted to mention is, especially with new partnership and partner foreign reporting disclosures. I don't know if anybody's seen that, where do you get a lot of your foreign information when you get a K-1 from a partnership? It's in the footnotes. All footnotes have been somewhat inconsistent. It depends on who the provider is that's preparing the returns and the K-1s. So the IRS has come out with these new K-2 and K-3 schedules to help provide information specific to foreign operations on a more consistent basis. This is going to be applying in 2021, so starting 2021 you're going to have to maintain better records into what your international operations are, as there's to be a plethora of disclosures needed.
And with that, I'm sorry we went a little bit over time, but I hope that you were able to take away some good points and thoughts from our presentation. So thank you.