Foreign Derived Deduction Eligible Income (FDDEI) allows U.S. domestic C corporations to reduce the effective federal tax rate on qualifying foreign sales and services income to approximately 14%. By properly structuring U.S. management companies, intercompany agreements, and documentation, foreign-owned groups can shift eligible profits to the U.S. while complying with strict IRS foreign-use and transfer-pricing requirements.
FDDEI, formerly known as the Foreign Derived Intangible Income (FDII) before the One Big Beautiful Bill Act (OBBBA), offers U.S. domestic C corporations a valuable deduction on certain export-related income and services.
Effective for tax years beginning after Dec. 31, 2025, the FDDEI deduction equals 33.34% of qualified FDDEI, reducing the effective corporate tax rate on that income to approximately 14%. Foreign businesses can leverage this by shifting foreign sales and services income to a U.S. company, even to related parties, as long as IRS requirements are met.
FDDEI is based on the U.S. domestic corporation’s Deduction Eligible Income (DEI) from sales of property to foreign persons for foreign use or services provided to persons or property located outside the U.S.
FDDEI’s Key Requirements
FDDEI applies only to C corporations, not S corporations, partnerships, or individuals.
The income eligible for the deduction must be derived in connection with property sold to a non-U.S. person for foreign use or services provided to a non-U.S. person. The property sold must be for foreign use and the services must benefit operations outside the U.S., and documentation of this must be provided.
Related-party transactions are subject to additional requirements to prevent “round tripping.” An example of round tripping is a domestic corporation providing services to a foreign related party that provides similar services to U.S. customers.
Related-party sales can only qualify if the property is (1) resold by the foreign related party to an unrelated person for foreign use or (2) used by the foreign related party in connection with the sale of property or the provision of services to an unrelated foreign party for foreign use.
Related-party services qualify if they are not substantially similar to a service provided by the related party to a U.S. person. The requirements for this test are (1) less than 60% of the benefit of the related party’s services are to U.S. persons and (2) less than 60% of the price paid for related party’s services are paid by U.S. persons.
Additional U.S. Business Benefits
In addition to the lower tax rate, owning businesses in the U.S. offers many other benefits.
- The U.S. offers excellent intellectual property protection.
- Having businesses in the U.S. provides access to U.S. courts for disputes.
- C-level directors and other managers can live in the U.S.
- Having a business in the U.S. will allow access to U.S. banking, possible funding, and use of the financial systems, such as
- Possible use of the U.S. business for immigrations or visas.
How Can Foreign Businesses Set up a U.S. Management Company for their Foreign Businesses?
For a foreign group to benefit from FDDEI through a U.S. management company, they must:
1. Form a new U.S. domestic C Corporation
Incorporate a new domestic C corporation in any U.S. state by filing Articles of Incorporation with the Secretary of State, obtaining an Employer Identification Number (EIN) from the IRS, and adopting bylaws to govern the company’s internal operations. If there will be multiple shareholders, it is also advisable to establish a shareholders’ agreement and related documents to define the parties’ rights and obligations. As stated above, entity type is critical because only a C corporation is eligible for FDDEI. It is also important to choose the proper state for incorporation based on logistics and tax planning.
2. Ensure the U.S. entity’s ownership and relationship with foreign businesses are clearly documented
The ownership structure and relationship of the U.S. corporation and the foreign businesses must be properly documented. The U.S. corporation may be owned by U.S. persons, foreign persons, or both. It is important to note that related party status is allowed under FDDEI rules for services, as long as the services meet the foreign use requirements and are not substantially similar to services the related party provides to people in the U.S.
3. Draft an intercompany services agreement
Create an arm’s length contract documenting the foreign sale or provision of foreign services. This must include pricing methodology that is compliant with transfer pricing requirements and supports the foreign derived nature of the income.
4. Substantiate FDDEI eligibility
Taxpayers should retain documentation that clearly establishes the customer’s foreign status and that the property sold or services provided were for foreign use.
For property sales, this may include:
- sales contracts and invoices showing the foreign customer’s name and address,
- shipping records such as bills of lading or airway bills,
- export or customs filings,
- customer certifications of foreign use, and,
- for related-party transactions, intercompany agreements and transfer pricing documentation.
For services, relevant records include:
- service agreements,
- invoices,
- deliverables showing the benefit is received outside the U.S.,
- customer certifications, and
- intercompany agreements with transfer pricing support where applicable.
5. Handle compliance and filing
In the U.S., the corporation will need to file Form 1120 to report its income and Form 8993 to claim the FDDEI deduction. It may also need to file Form 5472 or Form 5471, depending on the ownership structure. These filing requirements depend on the nature of the relationship between the owners, and the owners’ tax residences. Aside from this requirement, the corporation must also file any applicable state corporate tax returns and required tax payments and must file statements of information with the secretary of state to remain in good standing.
6. Monitor and adjust
Lastly, tax law is an area of law that changes frequently, as demonstrated by the significant changes introduced by the OBBBA. Because of its high volatility, it is important to monitor and review tax law developments annually to ensure ongoing compliance with up-to-date rules and regulations.
Turning a Complex Tax Incentive Into a Practical Strategy
FDDEI can offer meaningful tax savings, but the rules are technical and highly fact-specific — particularly for foreign-owned groups and related-party transactions. If you have questions about whether FDDEI may apply to your business, or how to structure a compliant U.S. management company, the international tax law lawyers at Hone Maxwell LLP can help evaluate your options and guide you through implementation with confidence. Contact us today.
FDDEI Frequently Asked Questions
Q. Who can benefit from the FDDEI deduction?
A. FDDEI is available only to U.S. domestic C corporations. S corporations, partnerships, and individuals are not eligible. Both U.S.-owned and foreign-owned C corporations may qualify, including U.S. management companies providing services to foreign affiliates, provided the statutory requirements are met.
Q. Do related-party transactions qualify for FDDEI?
A. Yes, but they are subject to heightened scrutiny. Related-party sales and services must meet specific foreign-use rules designed to prevent “round-tripping.” Related-party services cannot be substantially similar to services the foreign affiliate provides to U.S. persons, and detailed documentation is required to substantiate eligibility.
Q. What kind of documentation is required to claim FDDEI?
A. Taxpayers must substantiate both the customer’s foreign status and the foreign use of the property or services. This typically includes contracts, invoices, shipping records, service deliverables, customer certifications, and transfer pricing documentation. Inadequate documentation is one of the most common reasons FDDEI claims are challenged on audit.
[View source.]
