FSC provisions: licensing computer software.

In technical advice memorandum 9344002, the IRS concluded that a company that licensed computer software for reproduction outside the United States did not qualify for foreign sales corporation (FSC) benefits because it failed to meet several key tests. The IRS also ruled on the foreign management requirement of the FSC provisions.

FSCs are foreign corporations formed either in U.S. possessions or in certain countries with which the United States has exchange-of-information agreements. U.S. companies use FSCs to exempt from U.S. tax a portion of income earned by exporting property. To qualify for the exemption, a FSC and the export property must satisfy the requirements of tax code sections 921 through 927. (For more information on FSCs, see "Tax Incentives for Small Exporters," JofA, Oct.93, page 39.)

Management requirement. One requirement is that a FSC must be managed outside the United States. This mandates, among other things, that a FSC

1. Maintain throughout the taxable year a principal bank account outside the United States.

2. Disburse by its tax return's filing date any dividends, legal and accounting fees and officer or board member salaries for the taxable year from bank accounts outside the United States.

In the case before the IRS, a FSC opened a bank account in a U.S. possession but did not deposit funds in the account for over two years. During this time, the FSC's parent made any necessary payments on behalf of the FSC and was reimbursed when funds were deposited in the account.

* Issue no. 1. Was the principal bank account requirement satisfied? The IRS concluded the tax code and regulations did not require funds to be deposited in the account, only that the account be opened and maintained on the bank's books and records.

* Issue no. 2. Did the FSC satisfy the disbursement requirement? While recognizing the disbursement requirement technically was not satisfied, the IRS effectively waived this requirement by invoking a good-faith exception in the regulations.

Export property requirements. In addition to the requirements related to the FSC itself, the export property must satisfy certain requirements to qualify for FSC benefits. The tax code specifically excludes certain property, such as copyrights, from qualifying as export property. Thus, royalty income from copyright sales or licensing generally is not eligible for FSC benefits. However, the tax code and regulations provide an exception for copyrights of "films, tapes, records or similar reproductions for commercial or home use."

* Issue no. 3. Did licensing a master copy of computer software for reproduction and sale outside the United States qualify for FSC benefits under this exception? Citing the legislative history of a related provision, the IRS concluded the exception was intended to apply only to the entertainment industry. Therefore, licensing a master copy of computer software did not qualify.

Observation: Although the IRS concluded FSC benefits were not available for licensing a master copy of computer software, it may be possible to claim FSC benefits on the export of the software itself--provided it is not accompanied by a right to reproduce.

Marianne Burge, CPA, international tax partner, Kenneth Kral, CPA, international tax partner, and Jack Serota, Esq., international tax manager, at Price Waterhouse, New York City.