One of the most important steps a U.S. exporter can take to reduce
federal income tax on export-related income is to set up a Foreign Sales
Corporation (FSC). The tax exemption can be as great as 15% on gross
income from exporting, and the expenses can be kept low through the use of
intermediaries who are familiar with and able to carry out the formal
FSCs can be formed by manufacturers, export intermediaries, or groups of
exporters, such as export trading companies. A FSC can function as a
principal, buying and selling for its own account, or as a commission
agent. It can be related to a manufacturing parent or can be an
independent merchant or broker.
The U.S. exporter sets up a FSC in certain foreign countries or U.S.
possessions to obtain a corporate tax exemption on a portion of its
earnings generated by the sale or lease of export property. A corporation
initially qualifies as a FSC by meeting basic formation tests. A FSC
(unless it is a small FSC) must also meet several foreign management tests
throughout the year. If it complies with those requirements, it is
entitled to an exemption on qualified export transactions in which it
performs the required foreign economic processes.
A FSC must meet each of the following requirements to meet the FSC
definition. The entity must be incorporated and have its main office in
the U.S. Virgin Islands, American Samoa, Guam, the Commonwealth of the
Northern Mariana Islands, or a qualified foreign country. The
Commonwealth of Puerto Rico is included within the definition of the U.S.
and therefore, does not qualify for purposes of the FSC statute. It must
have at least one director who is not a U.S. resident, keep one set of
books of account (including copies or summaries of invoices) at its main
offshore office, have no more than 25 shareholders, have no preferred
stock, and must file a timely election to become a FSC with the IRS. The
FSC also cannot be a member of a group which includes a Domestic
International Sales Corporation.
All of a FSC's shareholders and directors meetings must be held outside
the U.S.; its principal bank account must be maintained outside the U.S.;
and all dividends, legal and accounting fees, officers' salaries, and
directors' fees must be disbursed from a foreign bank account.
FOREIGN ECONOMIC PROCESS REQUIREMENTS
The FSC, or its agent, must comply with two economic process requirements
to earn income exemption from tax for any export transaction.
First, the FSC, or its agent, must participate, outside the U.S., in any
of the following in export transactions: 1) solicitation (other than
advertising), 2) negotiation, or 3) contracting. As a general rule, the
FSC must participate in only one of these three activities to obtain the
FSC tax exemption.
Second, specific percentages of the transaction costs must be "foreign
direct costs," incurred by the FSC for activities it, or its agent,
performs outside the U.S. The activities tested are: advertising and
sales promotion; processing customer orders and arranging for delivery of
the export property; transportation; assembling and transmission of a
final invoice or statement of account and the receipt of payment; and
assumption of credit risk. A FSC meets the foreign direct cost test if
its foreign direct costs are either 50% or more of total direct costs for
these five activities, or are 85% or more of direct costs incurred in each
of any two of the five activities.
The portion of the FSC's gross income from exporting that is exempt from
U.S. corporate taxation is 30% for a corporate held FSC, if it buys from
independent suppliers or contracts with related suppliers at an "arms-
length" price. A FSC supplied by a related entity can use special
administrative pricing rules to compute its tax exemption and achieve
additional tax savings.
SMALL FSCs AND SHARED FSCs
Small FSCs and Shared FSCs are designed to give export incentives to
smaller businesses. The tax benefits of a small FSC are limited by
ceilings on the amount of gross income that is eligible for the benefits.
Small FSCs are the same as FSCs, except that small FSCs must file an
election with the IRS, and have their tax exemption limited to the income
generated by $5 million or less in gross export revenues. Small FSCs do
not have to meet foreign management or foreign economic process
requirements but must fulfill additional requirements to benefit from
administrative pricing rules.
A "shared FSC" is a FSC which is "shared" by 25 or fewer unrelated
exporter "shareholders", so as to reduce the costs while obtaining the
full tax benefit of a FSC. Each exporter-shareholder owns a separate
class of stock and each runs its own business as usual.
States, regional authorities, trade associations, or private businesses
can sponsor a shared FSC for their state's companies, their association's
members, their business's clients or customers, or for U.S. companies in
general. A shared FSC is a means of sharing the cost of a FSC. However,
the benefits and proprietary company information are not shared. The
sponsor and the other exporter-shareholders: do not know who the
exporter's customers are, do not participate in the exporter's profits, do
not participate in the exporter's tax benefits, and are not at risk for
another exporter's debts.
CITATIONS: Taxation of Foreign Sales Corporations (FSCs), 26 U.S.C.
Sections 921-927 (1988), FSC Regulations, 26 C.F.R. Sections 1.921-1T to
CONTACTS: Office of the Chief Counsel for International Commerce (202)
excepted from May 1994, U.S. Commerce Dept. material
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