Topic
How to Calculate Qualified Business Asset Investment (QBAI)
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As U.S. taxation of controlled foreign corporations (CFCs) becomes more complex, it’s normal for taxpayers and practitioners to have questions on Internal Revenue Code (IRC) Section 951A – the global intangible low-taxed income (GILTI) rules and IRC Section 250 – the foreign-derived intangible income (FDII) deduction.
Figuring qualified business asset investment (QBAI) is a crucial step in both the GILTI and FDII calculations. For even the most seasoned tax and accounting professionals who are well-versed in the significance of QBAI, calculating QBAI can present a challenge – especially since the terminology is different depending on whether you’re calculating QBAI for GILTI or FDII.
This article aims to answer some frequently asked questions about the QBAI calculation process, providing a clear roadmap to navigate this complex tax code section.
What is the qualified business asset investment exemption for GILTI?
Under GILTI rules, a CFC’s QBAI is its average quarterly basis in depreciable tangible property used in a trade or business.
IRC Section 951A contains the GILTI rules, which serve to neutralize the incentive for taxpayers to shift income outside of the U.S. to low- or no-tax jurisdictions.
GILTI rules require U.S. shareholders of CFCs to include GILTI in gross income each year – a requirement known as the GILTI inclusion.
There are a few definitions practitioners need to understand to calculate QBAI and GILTI:
- A shareholder’s GILTI inclusion = the excess of the shareholder’s pro rata share of net CFC tested income over its net deemed tangible income return (net DTIR).
- A shareholder’s net CFC tested income = the aggregate pro rata share of tested income from each CFC minus the aggregate pro rata share of tested loss from each CFC (but never less than zero)
- Net deemed tangible income return (DTIR) = 10% of the shareholder’s pro rata share of aggregate QBAI of its CFCs minus specified interest expense
Only tested income CFCs can have QBAI. If the CFC is in an overall tested loss position, no portion of the CFC’s assets, regardless of the income generated, can be considered QBAI.
How does the QBAI exemption impact the calculation of the GILTI?
The QBAI exemption attempts to limit U.S. taxation of foreign gross income to income that is easy to move to low-tax countries. Typically, this includes intangible intellectual property, such as patents for technology, software, or medicine.
While GILTI still ensures U.S. companies don’t escape taxation of profits easily shifted to low-tax jurisdictions, many companies have factories and operations outside the U.S. not for tax avoidance purposes but to be close to their customers or well-established supply chains. QBAI ensures they’re not punished simply for having operations or tangible property abroad.
What types of assets qualify for the QBAI exemption under GILTI?
Assets that qualify for the QBAI exemption under GILTI rules include specified tangible property used in the CFC’s trade or business and for which a deduction is allowed under Section 167. This can include buildings, machinery, and equipment.
What is the qualified business asset investment exemption for FDII?
Generally, a U.S. corporation’s income can be divided into regular income and FDII. FDII, which is taxed at a lower rate, is the excess foreign-derived deduction eligible income (FDDEI) over a fixed return on depreciable tangible property used in a corporation’s trade or business.
For FDII calculation purposes, QBAI is essentially a pool of all tangible assets used to generate deduction eligible income (DEI). The FDII is the amount which bears the same ratio to the deemed intangible income (DII) of such corporation as the FDDEI bears to the DEI. The DII is the excess DEI of the corporation over 10% of the QBAI amount.
The FDII deduction incentivizes domestic corporations to operate their businesses in the U.S. rather than in foreign jurisdictions. This incentive is a lower effective tax rate on income derived from foreign sales of tangible and intangible products to customers in foreign countries and services provided to customers in foreign countries.
FDII rules allow corporations to claim a 37.5% deduction, resulting in a permanent tax benefit and a 13.125% effective tax rate through December 31, 2025. After that date, the deduction drops to 21.875%, resulting in an effective tax rate of 16.406%.
Determining the FDII deduction is complex and involves the following:
- Compute foreign-derived income/deductions
- Compute deductions-eligible income
- Allocate deductions between foreign-derived and nonforeign-derived income
- Compute QBAI
- Compute GILTI
- Compute Section 250 deductions limitations
What types of assets qualify for the QBAI exemption under FDII?
Assets that qualify for the QBAI exemption under FDII rules include depreciable, tangible property used in a trade or business to produce DEI, such as buildings, plants, equipment, and machinery.
Land, intangible property, and assets that do not produce DEI are not eligible.
How do changes in the QBAI exemption amount impact the FDII deduction?
Generally, a reduction in a company’s QBAI amount increases its FDII by 10% of the reduction amount.
How do you calculate QBAI?
Now that we’ve covered what the QBAI exemption is, how do you calculate it? Here’s a step-by-step guide to this essential aspect of international tax planning.
- Identify applicable assets. QBAI is the average of a taxpayer’s aggregate adjusted basis in specified tangible property. So, the first step is to identify the specified tangible property that qualifies as QBAI. This includes property used in a trade or business to produce DEI (tested income when calculating GILTI for a CFC). Common examples include machinery, buildings, and equipment. QBAI does not include land, intangible property, or assets that do not produce DEI.
- Determine the adjusted basis. For each qualifying asset, determine the adjusted basis, which is generally the cost of the property minus any accumulated depreciation. However, it’s important to note that the depreciation used for tax purposes is not the depreciation used for the purposes of calculating QBAI. For GILTI purposes, basis calculations use the alternative depreciation system (ADS).
- Calculate the average basis. The QBAI is not based on a year-end figure but rather an average. For each applicable asset, calculate the average adjusted basis for the taxable year. This is done by averaging the quarterly adjusted bases of the assets at the close of each quarter.
- Aggregate the averages. Once you calculate the average basis for each asset, aggregate these averages to determine the total QBAI. As a caveat, only tested income CFCs can have QBAI. If the CFC is in an overall tested loss position, no portion of the CFC’s assets, regardless of the income generated, can be considered QBAI.
What are the reporting requirements for claiming the QBAI exemption?
There are no specific requirements for claiming a QBAI exemption. The QBAI exemption is reported on line 7a of Form 8993, Section 250 Deduction for Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI). The IRS Instructions for Form 8993 explain how to calculate QBAI.
The QBAI of each CFC also needs to be reported on Schedule A (Form 8992): Schedule of Controlled Foreign Corporation (CFC) Information to Compute Global Intangible Low-Taxed Income (GILTI), as well as Form 5471 (Rev. December 2023) (irs.gov).
Failing to file Form 8992 or provide complete information can result in hefty penalties.
What are the potential risks or drawbacks of using the QBAI exemption?
Using the QBAI exemption is not optional – it’s one of the steps required in calculating both GILTI and FDII.
However, several situations can increase the complexity of QBAI calculations. The following are a few potential situations that could complicate calculating QBAI.
How does the QBAI exemption apply to short tax years?
The requirement to use a quarterly average can complicate calculations, especially if a domestic corporation has a tax year that is less than 12 months. In that case, the company’s QBAI equals the aggregate bases in its specified tangible property at the end of each full quarter divided by four (the number of quarters in a year) plus the aggregate bases in the specified tangible property at the end of each short quarter, multiplied by the number of days in the short quarter divided by 365 (the number of days in a year).
How does the QBAI exemption apply to dual-use property?
Under GILTI rules, the specified tangible property of a domestic corporation includes the adjusted basis of “dual-use property” – property that produces gross tested income and income that is not gross tested income.
When specified tangible property produces directly identifiable income, the dual-use ratio is calculated using that property’s gross tested income and total gross income. If the specified tangible property does not produce directly identifiable income, the dual-use ratio is the CFC’s total gross tested income compared to its total gross income.
For FDII purposes, the specified tangible property of a domestic corporation includes the adjusted basis of dual-use property based on the same proportion that the DEI bears to the total gross income produced.
How does the QBAI exemption apply to holding an interest in a partnership?
For foreign and domestic corporations owning an interest in a partnership, its QBAI is increased by its share of the partnership’s adjusted basis in its specified tangible property.
How does the QBAI exemption address foreign currency translations?
Because GILTI is computed at the U.S. shareholder level, the QBAI of a CFC that uses a functional currency other than the U.S. dollar must be translated into U.S. dollars.
The appropriate exchange rate for calculating QBAI under GILTI rules is the average exchange rate for the foreign corporation’s taxable year.
How does the QBAI exemption address related-party transactions?
The QBAI anti-abuse rule provides that if a domestic corporation transfers property to a related party and leases the same or substantially similar property from any related party, the corporation will be treated as owning the transferred property for QBAI computations. The holding period is deemed to be the latter of the beginning of the term of the lease date or the date of transfer of the property, until the earlier of the end of the lease term or the end of the recovery period of the property.
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