Foreign-derived intangible income (FDII)

Foreign-Derived Intangible Income is a tax benefit that Congress created through the 2017 Tax Cuts and Jobs ActFederal legislation enacted in 2017 that significantly reformed the U.S. tax code, including provisions for FDII and GILTI.. This provision allows U.S. domestic corporations to pay lower tax rates on certain types of income they earn from foreign customers.

Specifically, FDII applies to income that companies generate from selling products or services overseas when those sales rely heavily on intangible assets. Intangible assetsNon-physical assets such as patents, trademarks, copyrights, and trade secrets that derive value from intellectual property rights. include things like patents, trademarks, copyrights, trade secrets, and other intellectual property that companies develop or own. For example, if a U.S. pharmaceutical company sells patented drugs internationally, or if a software company licenses its programs to foreign customers, that income may qualify for FDII treatment.

Here's how the tax benefit works: Through 2025, eligible corporations can claim a deduction equal to 37.5% of their FDII income. This deduction reduces the effective tax rateThe actual percentage of income paid in taxes after applying all deductions, credits, and other tax benefits. on this income to just 13.125%, significantly lower than the standard corporate tax rateThe statutory tax rate imposed on corporate income, currently 21% for U.S. corporations. of 21%. Starting in 2026, the deduction will decrease to 33.34%, which means the effective tax rate will rise to 14%. While still favorable, this represents a reduction in the tax benefit over time.

FDII works as part of a broader set of international tax reforms that Congress enacted in 2017. The most important companion provision is called Global Intangible Low-Taxed Income, or GILTI. While FDII provides tax benefits for U.S. companies' foreign income, GILTI ensures that U.S. companies pay at least some tax on income earned by their foreign subsidiaries.

Under the GILTI rules, U.S. shareholders of controlled foreign corporations must include their share of the foreign corporation's income in their current U.S. tax returns. This prevents companies from avoiding U.S. taxes by shifting profits to low-tax foreign jurisdictions. The GILTI inclusion is calculated using specific threshold amounts that represent normal returns on the foreign subsidiary's tangible assetsPhysical assets such as property, plant, equipment, and inventory that have measurable value..

Both FDII and GILTI benefits are delivered through the same mechanism in the tax code: the Section 250 deduction. This section allows eligible domestic corporations to claim deductions that reduce their taxable income.

For FDII, as explained above, the deduction reduces the effective tax rate on qualifying foreign-derived income. For GILTI, corporate U.S. shareholders can claim a deduction that partially offsets the income they must include from their controlled foreign subsidiaries.

However, the same entities that are excluded from FDII benefits—regulated investment companiesInvestment companies registered with the SEC under the Investment Company Act of 1940, such as mutual funds., REITs, and S corporationsCorporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.—are also excluded from claiming any Section 250 deductions. The deduction rates for both FDII and GILTI are scheduled to decrease in 2026, making these provisions less generous over time.

Most hedge funds cannot take advantage of FDII benefits because of how they are structured for tax purposes. The vast majority of hedge funds operate as partnerships rather than corporations. This structure allows the fund's profits and losses to "pass through" directly to investors, who then report their share on their individual tax returns. Since the fund itself doesn't pay corporate income tax, it cannot claim corporate tax deductions like FDII.

Only hedge funds that are organized as corporations—which represents a very small portion of the industry—might potentially access FDII benefits. Even then, they would need to meet all the specific requirements for foreign-derived income from intangible assets.

Additionally, certain types of corporations are specifically excluded from FDII eligibility. These include regulated investment companies (such as mutual funds), real estate investment trustsA company that owns, operates, or finances income-generating real estate and trades like a stock on major exchanges. (REITs), and S corporations. This further limits which investment vehicles can benefit from this provision.

Hedge funds may encounter controlled foreign corporation (CFC) rules in certain situations. A CFC is generally a foreign corporation where U.S. persons own more than 50% of the voting power or value. When a U.S. person owns at least 10% of a CFC, they must include various types of the CFC's income in their current U.S. taxable income, even if the CFC doesn't distribute that income.

These CFC rules interact with the Section 250 deduction framework in complex ways. While the rules primarily affect how much foreign income must be included in U.S. taxable income, they also determine eligibility for related deductions and benefits under both the FDII and GILTI provisions.