Foreign Sales Corporation Act

Summary of Foreign Sales Corporation Act

A component of the Tax Reform Act of 1984, which permits formation of Foreign Sales Corporations (FSC, pronounced “fisk”) as a tax incentive to American exporters, and revises tax treatment of income earned by Domestic International Sales Corporations (read this and related legal terms for further details), DISCs, which have been criticized by many foreign governments as an unlawful export subsidy under the rules of the General Agreement on Tariffs and Trade (read about the GATT for further details). The Foreign Sales Corporation Act of 1984, with effect for taxable years after December 31, 1984, adds new sections 921 through 927 of the Internal Revenue Code, and amends DISC provisions 991 through 997, and section 291 (a) (4) of the Code.

A FSC is a corporation, formed in a foreign country or a U. S. possession other than Puerto Rico, structured so as to derive a corporate tax exemption on a portion of the earnings from the sale of U.S. exports. To qualify for the exemption, the income must arise from the sale of “export property” within the meaning of the Code; i.e., tangible goods having at least 50 percent U. S. content, plus services anciliary to the export of such goods. This includes minerals (other than oil and gas) subject to percentage depletion allowances. Service exports, other than architectural and engineering services for foreign construction projects, and the management of unrelated FSCs, are not eligible.

FSCs can be formed by manufacturers, exporters, and groups; the FSC may have up to twenty-five shareholders, and, so long as there is a legitimate business purpose to do so, may issue different classes of stock. If the FSC buys from an arm’s length purchaser, or uses arm’s length pricing (as prescribed in section 482 I.R.C.), 32 percent of the FSC’s income will be exempt from U. S. income taxes.

If the FSC is related to the supplier of the export property, the FSC will share the profit from the export sale on the basis of 23 percent allocated to the FSC and 77 percent allocated to the supplier. Presuming the FSC performs a required minimum of activity outside the Customs Territory of the U. S. (which includes Puerto Rico), then 16/23 of its 23 percent share of the combined profits will be exempt from U. S. corporate taxes. An alternate method of tax treatment for related party transactions permits a FSC to take 1.83 percent of gross receipts (not to exceed 46 percent of combined income) as its share of combined income, of which 1.27 percent of gross receipts (not to exceed 32 percent of combined income) would be exempt from U. S. corporate income taxes. In addition, a U. S. corporate shareholder is entitled to a 100 percent intercorporate dividend deduction.

With the exception of “small business FSCs”(those having $5 million or less in gross receipts from exports) a FSC must, outside the Customs Territory: maintain an office outside the U. S. (although not necessarily in the jurisdiction where chartered); conduct all meetings of the directors (of whom at least one must be a nonresident of the U. S. or Puerto Rico) and shareholders; effect all dis-bursements for dividends, officers’ salaries, and professional fees; maintain one set of books of account (including invoices); and maintain the principal bank account.

Small business FSCs can be chartered and maintain their offices outside the U. S., have one nonresident of the U. S. or Puerto Rico as a director, and maintain the books of account offshore. All FSCs must make a FSC election with the IRS.

The Foreign Sales Corporation Act requires that a FSC must be based in a U. S. possession (other than Puerto Rico), or in a country which has agreed to exchange tax information with the Internal Revenue Service. At the beginning of 1985, the following foreign countries had entered into such an agreement: Australia, Austria, Barbados, Belgium, Canada, Denmark, Egypt, Finland, German Federal Republic, Iceland, Ireland, Jamaica, Korea (Republic of), Malta, Morocco, Netherlands, New

Zealand, Norway, Pakistan, Philippines, South Africa, Sweden, and Trinidad and Tobago.

The act permits U. S. possessions to impose a tax on FSC income after December 31, 1986.

Under the act, a U. S. exporter may continue an existing DISC or begin a new one, with tax deferral benefits for up to 94 percent of export earnings (up to $ 10 million); the shareholder of a DISC must pay an interest charge, at the Treasury bills rate, on the accumulated tax-deferred income held by the DISC. The tax year of the DISC must be that of its majority shareholder, and a new election for DISC status must be made with the IRS. In addition, all tax liabilities on DISC deferrals accumulated prior to January 1, 1985, were forgiven.

(Main Author: William J. Miller)