Transcript CHAPTER XXXVII IC-DISC, FSC, ETI ACT

CHAPTER XXXVII
IC-DISC, FSC, ETI ACT, AJCA
Interest Charge Domestic
International Sales Corporation (ICDISC)
Foreign Sales Corporation (FSC)
Extraterritorial Income Exclusion Act
of 2000 (ETI Act)
American Job Creation Act of 2004
(AJCA)
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Interest Charge Domestic International
Sales Corporation (IC-DISC)
(1) Definition of an IC-DISC
 IC-DISC is formed as domestic subsidiary by a
parent company or exporter for Deferral of income
tax on its export earnings.
 IC-DISC not taxed on its income but pays an interest
charge on deferred tax liability at the U. S. Treasury
Bill rate with annual maturities.
 Shareholders pay income tax on dividends at a lower
tax rate than ordinary income tax rate, when the
income is actually (or deemed) distributed.
• Deferral can be indefinite.
• Net export income from qualified export receipts
exceeding $10 million a year is deemed distributed.
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Interest Charge Domestic International
Sales Corporation (IC-DISC)
 IC-DISC can buy from parent company and export.
 Intercompany Transfer Pricing Rules under Section 482 of
the Internal Revenue Code are applied.
 IC-DISC act as commission export agent for a
parent exporter.
• IC-DISC’s taxable income from its export sales may
not exceed the greatest of:
– 4 % of qualified export receipts on IC-DISC’s sale
plus 10 percent of export promotion expenses.
– 50% of IC-DISC's and parent company's combined
taxable export income plus 10 percent of export
promotion expenses.
– Taxable income based on the sale price actually
charged.
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Interest Charge Domestic International
Sales Corporation (IC-DISC)
• When an IC-DISC is set up as a direct
subsidiary of a U.S. S-Corporation or U.S. LLC,
– IC-DISC can distribute its deferred income as a
dividend taxable at 15 percent, thus converting 35
percent ordinary income to 15 percent dividend
income for shareholders.
– If an IC-DISC is owned through a closely-held C
Corporation, it should be formed under the CCorporation’s individual shareholders to take
advantage of 15 percent dividend.
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Interest Charge Domestic International
Sales Corporation (IC-DISC)
(1) Definition of an IC-DISC (continued)
 In 1971, U.S. enacted DISC tax provisions, which
allowed exporters to establish domestic subsidiaries
which would receive the tax deferral normally
available only to foreign entities.
 The objection to the DISC as a U.S. export subsidy
by the European Community (EC) from 1972
 DISC was changed to Interest Charge DISC by the
1984 Tax Reform Act.
 Must be incorporated under the laws of a State or DC
 Corporation must elect to be an IC-DISC by filing a
Form 4876-A with the Internal Revenue Service
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Interest Charge Domestic International
Sales Corporation (IC-DISC)
(2) Qualification Conditions
 At least 95 percent of its gross receipts
during the tax year are qualified as export
receipts
 At the end of the tax year, the adjusted basis
of its qualified export assets is at least 95
percent of all its adjusted assets.
 It has one class of stock, and its outstanding
stock has a par value of at least $2,500 on
each day of the tax year.
 It keeps separate books and records.
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Interest Charge Domestic International
Sales Corporation (IC-DISC)
(2) Qualification Conditions (continued)
 Its tax year must conform to the tax year of
the shareholder (or shareholder group) who
has the highest voting power.
 Its election to be treated as an IC-DIDC is in
effect
Not required to perform substantial business
functions. Most IC-DISCs are paper
corporations without own employees or offices.
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Interest Charge Domestic International
Sales Corporation (IC-DISC)
(3) Advantages of an IC-DISC
 Deferral of U. S. income taxes on export
earnings. Can be indefinite; Not taxable until
the income is actually distributed
 Interest charge on deferred income taxes at
the U.S. Treasury Bill rate with annual
maturities, which is much lower than
commercial rates.
 IC-DISC is not taxed at the corporate level. It
file an information tax return. No double
taxation.
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Interest Charge Domestic International
Sales Corporation (IC-DISC)
(3) Advantages of an IC-DISC (continued)
 In case IC-DISC is commission agent IC-DISC,
the exporter deduct commission from its
ordinary income but the IC-DISC pays no tax
on the commission
 When dividends are distributed to parent
exporter, it pays income tax on dividends at
the capital gains rate of 15 percent instead of
higher tax on ordinary income
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Foreign Sales Corporation (FSC)
 A foreign corporation set up by a U.S. corporation in
a foreign country or a U.S. possession approved by
the U.S. Treasury Department
 A corporate tax exemption on a portion of export
earnings.
 Became effective January 1, 1985. Replaced DISC.
This change was made to accommodate claims by
the GATT members, specially the European
Community (EC) that the DISC was a prohibited
export subsidy for exports
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Foreign Sales Corporation (FSC)
 An FSC had to be incorporated in one of the
U.S. possessions and countries approved by
the U.S. Treasury such as four U.S. territories
and 25 nations (mostly Caribbean nations).
 The FSC received a corporate tax exemption
equivalent to 15 percent of the corporate tax
that would otherwise be paid on the export
earnings. Based on maximum corporate tax
bracket at 35%, a net tax saving of an FSC
was a 5.25% (35% x 15%) of the export
earnings.
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Foreign Sales Corporation (FSC)
 European Union’s petition with the World
Trade Organization(WTO) to rule the FSC is
an illegal export subsidy by the U.S.
 In March 2000, the WTO adopted rulings of
its Dispute Settlement Panel and Appellate
Body which found the FSC provision of U.S.
tax law on tax exemption on export income
to be a prohibited government subsidy in
violation of SCM Agreement (Agreement on
Subsidies and Countervailing Measures) of
the WTO.
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Extraterritorial Income Exclusion
Act of 2000 (ETI Act)
 To comply with the WTO’s final rulings
against the FSC, on November 15, 2000, the
United States enacted the FSC Repeal and
Extraterritorial Income Exclusion Act of 2000
(ETI Act).
 ETI Act repealed the FSC provisions and
excludes extraterritorial income from gross
income for U.S. tax purposes. Income
originating outside the United States is
placed outside the taxing jurisdiction of the
United States.
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Extraterritorial Income Exclusion
Act of 2000 (ETI Act)
 The Act’s exclusion of income applies to all
foreign income not only from export sales
but also any other sales and treats all tax
payers alike without regard to whether the
income is earned by a U.S. person or a
foreigner.
 By excluding extraterritorial income from
gross income for tax purposes, the ETI Act
parallels the foreign-source income excluded
under most territorial tax systems,
particularly those employed by European
Union’s member states.
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Extraterritorial Income Exclusion
Act of 2000 (ETI Act)
 On November 17, 2000, the EU commenced a
WTO dispute, alleging that the ETI Act failed
to eliminate the problems that the WTO had
found with the FSC provisions.
 EU also requested authority from the WTO to
impose trade sanctions on $4.043 billion
worth of U.S. exports, the amount of the
export subsidy.
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Extraterritorial Income Exclusion
Act of 2000 (ETI Act)
 On January 29, 2002, the WTO adopted
rulings by its Dispute Settlement Panel and
Appellate Body which also found the ETI Act
to be WTO-inconsistent. As a result of this
action, the arbitration automatically resumed.
 The WTO rules on August 30, 2003 that the
European Union is entitled to impose $4.043
billion in trade sanctions as a result of the
Foreign Sales Corporation provisions of U.S.
tax law
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Extraterritorial Income Exclusion
Act of 2000 (ETI Act)
 The United States contended that sanctions
should have been limited to $1 billion based
on the actual impact of the FSC provisions
on EU commercial interests.
 On March 2, 2004, EU announced it imposes
retaliatory tariffs at 5% on U.S. exports with a
1 percent increase every month until they
reach a maximum level of 17% in March 2005
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American Job Creation Act of 2004
(AJCA)
 In October, 2004, U.S. enacted the American
Job Creation Act of 2004 (AJCA) which
• lowered the corporate income tax rate for
manufacturers from 35 percent to 32 percent
• repealed the FSC and the ETI Act tax provisions
of the U.S. tax code.
• took effect on January 1, 2005. The European
Union’s extra tariff rate on U.S. exports to Europe
became 12 percent in October, 2004
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American Job Creation Act of 2004
(AJCA)
 European Union announced on October 25,
2004 that it decided to lift heavy punitive
tariffs on U.S. exports on January 1, 2005,
when the U.S. American Job Creation Act of
2004 would take effect, unless the WTO rules
otherwise.
 Punitive extra tariffs started in March were
estimated to be $300 million in 2004 alone.
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American Job Creation Act of 2004
(AJCA)
• Punitive tariffs were indeed lifted on January 1, 2005
• In October, 2005, a WTO dispute settlement body ruled
against the U.S. AJCA’s grandfather rule and transitional
phase out of the FSC and ETI benefits for 3 years.
• EU Trade Commissioner, Peter Mandelson, said, “ The
U.S. now has 3 months to act to avoid the re-imposition
of retaliatory measures in this case.”
• U.S. Congress backed down and repealed the
grandfathered benefits in the Tax Increase Prevention
and Reconciliation Act signed by President George Bush
in May, 2006.
• The European Union (EU) has not reintroduced the
punitive tariffs against the U. S. products.
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