Export Tax Incentives - Brief Article

The FSC Repeal and Extraterritorial Income Exclusion Act of 2000 repealed the foreign sales corporation rules and replaced them with new tax rules regarding foreign sales.

The Act should produce the same tax benefits as FSCs, simply in a different format. Like FSCs, the Act reduces the related supplier's effective federal tax rate by 5.25 percent, but does so by exempting 15 percent of qualifying foreign income from taxation.

EC CHALLENGE

The Act evolved from a European Communities' successful challenge before the World Trade Organization, in which it contended that FSCs established special tax treatments that were inconsistent with U.S. obligations under the 1994 GATT and related trade agreements. The WTO held that these illegal provisions must be eliminated prior to Oct. 1, 2000. The U.S. and EC subsequently negotiated an extension until the Act could be approved by Congress and signed into law.

The EC informed the United States that it does not believe the Act complies with the WTO ruling on FSCs. The WTO is reviewing the EC's request. If the WTO agrees, the EC could request immediate sanctions, which could unilaterally increase annual trade tariffs on U.S. exports by approximately $4 billion. The WTO's decision could be finalized by late this summer. Meanwhile the IRC provides for FSC benefits to continue through 2001 concurrent with eligible relief under the Act.

NEW BENEFITS FOR FOREIGN TRANSACTIONS

The Act provides a number of very important new benefits for foreign transactions. Unlike FSCs, which required establishing a foreign corporation along with additional administrative costs, the Act excludes income from taxation. Accordingly, individuals are eligible to exclude income from all sources including sole proprietorships and pass-through entities. Additionally, the excluded income is exempt from alternative minimum tax.

To qualify, the income must be qualified foreign trade income, which is generated from transactions involving qualifying foreign trade property. IRC Sec. 943 defines QFTP as property that is:

* Manufactured, produced, grown or extracted within or outside the United States;

* Held primarily for sale, lease or rental, in the ordinary course of trade or business for direct use, consumption or disposition outside the United States; and

* Not more than 50 percent of the fair market value of which is attributable to articles manufactured, produced, grown or extracted outside the United States; and direct costs for labor (determined under the principles of 263A) performed outside the United States. Congress has determined the value of imported goods to be their customs' value upon importation.

Consistent with the FSC rules, services associated with the sale, lease and rental of QFTP; engineering and architectural services; and managerial services qualify as QFTP. However, like with FSCs, not all property qualifies. Essentially if the export property qualified under FSC rules, then it should qualify under the Act. At this time, the U.S. Treasury has not published regulations; and subsequent review of the applicable code sections and any published regulations is advised prior to making a final determination about whether or not property qualifies.

Similar to the FSC provisions, there are foreign economic processes that must be met to qualify for the Act's benefits. A number of established offshore management companies are established to facilitate the compliance of these processes. There is an exemption from these processes for small exporters that export less than $5 million. This exemption enhances the Act's benefits to the startup and infrequent exporter.

Benefits are claimed by using Form 8873 and transferring the resulting excluded income onto the appropriate filing form (1120, 1040, etc.). Since the Act's effective date is Oct. 1, 2000, its benefits are available on 2000 tax returns. The Act prohibits "double dipping" with FSC benefits. Additionally, the Act does not apply if an IC-DISC is a member of the taxpayer's controlled group.

For taxpayers with FSCs, benefits continue through Dec. 31, 2001 and for FSCs with qualified contracts in force prior to Sept. 30, 2000, FSC benefits continue for the period under contract. For most FSCs, strategies should be in place to properly wind up FSC operations. Your FSC management company can provide information and suggestions on how to properly close your FSC.

Daniel D. Morris, CPA, is a partner with Morris & D'Angelo in San Jose, He is the author of the Foundation course "Export Tax Incentives--The End of FSC, Rebirth of IC-DISC, and the Implementation of EIE," and co-founder of VeraSage Institute. You can contact Morris at [email protected].

COPYRIGHT 2001 California Society of Certified Public Accountants
COPYRIGHT 2001 Gale Group