On September 6, 2024, the IRS Office of Associate Chief Counsel (International) released a chief counsel advice memorandum (CCA 202436009) concluding that income from services rendered to the U.S. government may qualify the foreign-derived intangible income (FDII) deduction, if the services benefit foreign operations of the U.S. government. U.S. government contractors that support overseas operations should review their process for classifying service contracts to ensure income eligible for the FDII deduction is consistently identified.

The advice memorandum analyzes the application of the FDII rules to a U.S. defense contractor remotely performing consulting services that benefit employees located at a U.S. Department of Defense (DoD) military base in a foreign country. The memorandum confirms the IRS position on two issues for which existing guidance arguably lacked clarity. First, the memorandum concludes that, when the U.S. government acts in a commercial capacity as a purchaser of services, the U.S. government constitutes a "person" for purposes of the FDII deduction. Second, the memorandum confirms that, under the "general services" rules in the FDII regulations, the U.S. government may be a "business recipient" located outside the United States, if the service benefits a U.S. government office, base, or other fixed location outside the United States. Based on this analysis, the memorandum concludes that the specific defense contractor's services qualified as general services provided to a business recipient located outside the United States, and the associated income qualified as foreign-derived deduction eligible income (FDDEI). 

Although the memorandum addresses narrow technical issues, the tax implications are significant. The DoD operates at least 128 overseas bases in at least 51 different countries, with more than 225,000 million active duty military, reserve, and civilian personnel assigned abroad. The U.S. Department of State operates more than 270 diplomatic missions worldwide, with nearly 60,000 civil service, foreign service, and local employees located overseas. In total, at least 27 federal agencies perform work overseas. Taxpayers should evaluate every service contract with a federal agency with overseas activity. Even if a service contract broadly benefits the worldwide operations of the agency, the FDII regulations may allocate part of that benefit to the agency's specific operations outside the United States. 

For more information, please contact:

Jeffrey M. Tebbs, jtebbs@milchev.com, 202-626-1480

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