U.S. taxation of intellectual property has become astoundingly more complex after the Tax Cuts and Jobs Act. The new rules are so complex that the IRS and Treasury are still figuring out the details of how they operate. Some important clarifying guidance has been issued recently, but more guidance and regulations are needed. The IRS has until June 2019 — 18 months after the act went into effect in December 22, 2017 — to issue regulations for them to be retroactive. This is a tight deadline considering the voluminous guidance that is needed.
A number of the new rules under the act specifically target the taxation of IP. Significant changes related to IP taxation include a new tax on certain global income earned by foreign subsidiaries and a new tax incentive for certain foreign-derived income earned by U.S. corporations. The law also reduced the corporate tax rate to 21 percent, compared with the previous top corporate tax rate of 35 percent. This generally makes the United States a more competitive location in which to operate and own IP than in the past.
The U.S. has historically had a worldwide system of taxation, where income earned by a U.S. taxpayer is subject to U.S. tax regardless of whether it is earned inside or outside the U.S. Most countries do not tax worldwide income, but rather have a territorial system that only taxes residents on the income earned in the country.
Although it was originally suggested that the act would move the U.S. to a territorial system to be in line with international taxation norms, and to make the country a more attractive place for multinational businesses to operate, the reality is that the U.S. still taxes worldwide income, unlike all other major countries.
Foreign-Derived Intangible Income Tax Incentive
The act created a new tax rule intended to encourage companies to have “foreign derived intangible income” earned in the U.S. Under the new rules, the tax rate on FDII, which is income arising from U.S. taxpayers selling or licensing property, including IP, or providing services to foreigners, can be reduced from the standard corporate tax rate of 21 percent to a favorable corporate tax rate of 13.125 percent. Specifically, FDII is defined as certain income derived in connection with (1) property that is sold, leased, licensed or otherwise exchanged or disposed by the U.S. taxpayer to a non-U.S. person for a foreign use, or (2) services provided by the U.S. taxpayer to a person located outside the United States.
If a U.S. corporation sells or licenses goods (including IP) to a foreign related party, the income should generally qualify as FDII if the property is ultimately sold to an unrelated foreign person, used to make property sold to an unrelated foreign person or used in providing services to an unrelated foreign person outside of the U.S. However, if, for example, a U.S. corporation sells IP to an unrelated party for further development within the U.S., the IP is not treated as sold for a foreign use even if the IP subsequently has a foreign use.
Even though FDII is labeled as a “foreign derived intangible income” tax provision, the new category of income is actually much broader. FDII generally applies to income from exports of goods and services, not just income from IP. FDII is not like a patent box tax incentive, which typically requires IP ownership and development in the country to qualify for the reduced tax rate.
New Global Intangible Low-Tax Income Tax
The act also added a unique U.S. tax on worldwide income of foreign subsidiaries called “global intangible low-taxed income.” GILTI results in the immediate U.S. taxation of certain foreign income earned through controlled foreign corporations — known as CFCs, which are entities that are more than 50 percent owned by 10 percent U.S. shareholders. The GILTI rule is also broadly drafted and is not limited to intangibles, despite what the name “global intangible low-taxed income” indicates. The GILTI tax is a significant revenue raiser that helped pay for other tax changes in the act, including the decrease in the corporate tax rate.
The purpose of GILTI is to subject U.S. shareholders of CFCs to a minimum U.S. tax if the CFC’s foreign income is taxed at a rate below 13.125 percent. GILTI generally results in a 10.5 percent minimum U.S. tax, in addition to any foreign taxes paid, on all foreign income after giving effect to a routine return on tangible property. Under the GILTI tax rules, the U.S. continues to use a worldwide system of taxation.
The new GILTI tax also reduces the benefit of using IP holding company CFCs to defer U.S. tax on global income. As a result, GILTI has the biggest impact on industries with low tangible property ownership when compared to revenues, such as the technology sector and the pharmaceutical industry, where companies rely heavily on IP in manufacturing and selling their products or delivering their services.
Taxation of Moving IP Offshore
The act also made certain changes that make it more costly to transfer IP outside the United States. Previously, certain otherwise tax-free transfers of patents, know-how, copyrights, trademarks, franchises, licenses and other similar IP created a taxable deemed royalty in the U.S., resulting in a tax cost in the U.S. to transferring IP offshore. The act added goodwill, going concern value and workforce in place to the list of IP that is subject to the deemed royalty, creating an additional tax cost to moving IP offshore.
This change, coupled with the provisions discussed above, serve as a disincentive to transferring U.S.-owned IP abroad.
Even with the act’s changes to international tax rules, multinational corporations generally do not benefit from bringing any offshore IP back to the U.S. The U.S. tax rate on income from IP owned abroad under GILTI is approximately 10.5 percent, while IP owned in the U.S. is taxed at a higher 13.125 percent tax rate under FDII.
In addition, FDII is unlikely to be a provision that a company can rely on in its long-term planning. A shift in political leadership in the U.S. could easily result in a higher FDII rate. In order to balance the budget to get the act passed, Congress has already opted to increase the FDII rate in 2026 to 16.4 percent. It is also uncertain how long the FDII incentive will remain. FDII might be deemed an impermissible export subsidy by the World Trade Organization, and the U.S. could decide to remove the FDII benefit at any time. It generally would be inadvisable to restructure your IP ownership or operations based on an expected FDII benefit.
Furthermore, the act of bringing IP back into the U.S. through a related party sale would likely trigger additional foreign income that could be subject to GILTI taxation. For example, sale of IP that has dramatically increased in value by a holding company in a low-tax jurisdiction could result in additional income that is GILTI. Foreign taxes could also apply to this IP transfer, which could significantly add to the cost of onshoring the IP. Additionally, as discussed above, once the IP is in the U.S. it could be very costly to offshore it in the future.
The act has drastically changed the landscape of U.S. IP taxation. Although streamlining of taxation and simplicity of the U.S. tax code were promoted as the reasons the act was necessary, in reality the law increased the complexity of the U.S. tax rules significantly. As a result, any past IP tax planning should be carefully re-evaluated.