How Are Stewardship Expenses Accounted for FDII?

Stewardship expenses are an important consideration in the context of U.S. tax laws, particularly when dealing with Foreign-Derived Intangible Income (FDII). These expenses generally refer to costs incurred by a parent company for overseeing its subsidiaries or related entities, such as legal, regulatory, or administrative functions that protect the parent’s investment in those entities. The allocation and apportionment of these expenses are critical for tax purposes, especially when determining the Foreign Tax Credit (FTC) and FDII benefits.

Definition of Stewardship Expenses

Stewardship expenses are defined under the transfer pricing regulations as costs related to shareholder activities that do not directly benefit the subsidiary or related entity but are necessary for the parent company to manage its investment. These include activities like maintaining legal compliance, regulatory filings, and ensuring corporate governance across subsidiaries. Importantly, stewardship expenses are distinct from “supportive” or “duplicative” expenses, which directly benefit the subsidiary.

How Stewardship Expenses Affect FDII

FDII is a tax incentive introduced under the Tax Cuts and Jobs Act (TCJA) to encourage U.S. companies to sell goods and services abroad by offering a lower effective tax rate on foreign income derived from intangible assets. However, when calculating FDII, stewardship expenses must be properly allocated and apportioned because they reduce the amount of income subject to the FDII deduction.

1. Allocation of Stewardship Expenses:
   Under IRS regulations, stewardship expenses must be allocated to all types of income derived from ownership interests in foreign and domestic entities. This includes dividends and other income inclusions such as Subpart F, GILTI, and other foreign-sourced income. For FDII purposes, these expenses are allocated based on their factual connection to specific entities or regions.
2. Apportionment of Stewardship Expenses:
   Once stewardship expenses are allocated, they must be apportioned using a method similar to how interest expense is apportioned. This typically involves using the tax book value of the taxpayer’s interest in each entity. However, unlike interest expenses, stewardship expenses are not fungible, meaning they cannot be easily spread across all income categories without considering their factual connection.

Impact on FDII Calculation

When calculating FDII, U.S. companies must reduce their foreign-derived income by any stewardship expenses that have been allocated to foreign-sourced income. This can reduce the overall benefit of the FDII deduction because it lowers the amount of qualifying foreign-derived intangible income.

For example:

• If a U.S. parent company incurs significant stewardship expenses related to overseeing its foreign subsidiaries, these costs will be allocated against foreign-derived income.
• As a result, the company’s FDII deduction may be reduced because fewer profits qualify for the lower tax rate.

Best Practices for Managing Stewardship Expenses in FDII

To optimize tax benefits under FDII while accounting for stewardship expenses:

• Companies should conduct comprehensive studies of their Selling, General & Administrative (SG&A) expenses to accurately identify which costs qualify as stewardship.
• It’s important to ensure that only genuinely allocable stewardship expenses are deducted from foreign-derived income.
• Companies may also want to explore alternative apportionment methods that better reflect their business structure and minimize unnecessary reductions in FDII benefits.