On January 10, 2025, the Internal Revenue Service (IRS) released a private letter ruling (PLR 202502002) that constitutes the first item of administrative guidance applying the rules for determining the extent to which a general service qualifies for the foreign-derived intangible income (FDII) deduction. The ruling concludes that general services income earned by a domestic corporation qualified as foreign-derived deduction eligible income (FDDEI), notwithstanding that the foreign recipient utilized the services to manufacture products that were sold back into the U.S. market by a related U.S. distributor. The analytical framework illustrated in the ruling may provide valuable insight to multinational taxpayers applying the FDII regulations to complex internal supply chains. 

General services to a business recipient qualify for FDII to the extent the services benefit the business recipient's operations outside the U.S. To determine which operations of a business recipient benefit from the service, the FDII regulations require the taxpayer to apply principles from the section 482 controlled service transaction regulations (Treas. Reg. § 1.482-9). In the ruling, two U.S. affiliates perform research and development (R&D) services for a related foreign operating company. The R&D services facilitate the development of product intangible property (IP), which is owned exclusively by the foreign operating company. The foreign operating company manufactures products outside the United States using the product IP and then sells those products to distributors, including a related U.S. distributor that sells the products in the U.S. market on a limited risk basis. Although the U.S. distributor is "potentially a business recipient" of the research services, the IRS rules that the U.S. distributor does not benefit from the R&D services for purposes of the FDII deduction. In reaching this conclusion, the ruling emphasizes that the U.S. distributor pays an arm's length price for the finished products developed from the product IP and does not have any ownership interest in the IP that is enhanced by the R&D services. 

For more information, please contact:

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

Candice C. James, cjames@milchev.com, 202-626-5810

Katherine Lewis, klewis@milchev.com, 202-626-5894

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