Foreign sales corporations.

On March 27, 1992, Tax Executives Institute filed the following comments with the U.S. Department of the Treasury, the chairs of the congressional tax-writing committees, and the staff of the Joint Committee on Taxation on two issues relating to foreign sales corporations (FSCS): (i) the requirement for Joint Committee review of FSC refund claims; and (ii) the effect of the estimated tax provisions on FSCS and their related suppliers. The Institute's comments were prepared under the aegis of its International Tax Committee, whose chair is Raymond G. Rossi of Intel Corp.

I am writing on behalf of Tax Executives Institute concerning two issues relating to foreign sales corporations (FSCs): (i) the requirement for Joint Committee review of FSC refund claims; and (ii) the effect of the estimated tax provisions on FSCs and their related suppliers.

Joint Committee Review

Procedure

As you know, section 6405(a) of the Internal Revenue Code provides that no refund of any income tax in excess of $1 million may be made until after the expiration of 30 days of the date upon which a report, giving the name of the taxpayer, the amount of the refund, and a summary of the facts and decision by the Secretary of the Treasury, is submitted to the Joint Committee on Taxation. Although the Joint Committee has streamlined its procedures over the last few years and Congress has raised the statutory threshold for review, delays invariably result from the IRS's preparation and processing of the materials for review. The requirement for Joint Committee review of refund claims creates special problems for FSCs. The problems stem from the manner in which the incomes of the FSC and its related supplier are calculated under the Code.

In general, a portion of a FSC's income is exempt from tax if certain conditions are met. The exemption is available with respect to income allocated to the FSC under special transfer-pricing rules based on either optional administrative rules or the arm's-length pricing rules under section 482 of the Code. Under the administrative pricing rules, transfer prices must be set so that the FSC's taxable income will not exceed the greater of (i) 23 percent of the combined taxable income (CTI) of the FSC and its related supplier (generally its U.S. parent) attributable to foreign trading gross receipts derived from the sale of property by the FSC, or (ii) 1.83 percent of the gross receipts derived from the sale of property by the FSC. A decrease in the FSC's taxable income will almost invariably increase the income of its related supplier and vice versa. Thus, any overpayment of tax by a FSC will be offset by an underpayment of tax by its related supplier.

Although FSCs must file U.S. tax returns, as foreign corporations they cannot join their U.S. parent in filing a consolidated return. Thus, a FSC must separately file a corporate tax return and is considered a separate reporting entity for purposes of IRS returns processing and Joint Committee review.

The requirement for Joint Committee review of FSC refunds merely delays issuance of the refund without serving any tax policy goal. Consider, for example, a decrease in the FSC's commission of $8,455,883. Such an adjustment will reduce the FSC's taxes by $1 million $8,455,883 X 8/23 X 34%). At the same time, the related supplier will have a tax increase of $2,875,000 ($8,455,883 X 34%). Because Joint Committee review is required for refunds claimed by each separate reporting entity, the FSC must seek Joint Committee review of its $1 million refund claim ae even though the government in such circumstances is more than "made whole" by the concomitant adjustment in the tax liability of the FSC's related supplier.

In these circumstances, we believe that section 6405 should be amended to exempt refunds sought by foreign sales corporations from Joint Committee review. Such an exemption would reduce administrative burdens and delays for both the government and the taxpayer. It is a simplification effort that can be accomplished without any effect on the government's revenues.

Estimated Tax Penalty

A related issue involves the "penalty" effect of the estimated tax provisions on FSCs and their related suppliers. In addition to filing a separate corporate tax return, a FSC must also separately pay estimated taxes. The estimated tax rules effectively operate as a "Catch-22" for FSCs and their related suppliers.

The problems in the FSC estimated tax area are twofold. First, CTI is often not susceptible to accurate calculation until after the close of the taxable year, particularly if grouping or marginal costing is used. Temp. Reg. [section] 1.925(a)-1T(e)(4) permits a FSC and its related supplier to recalculate the amount of foreign trading gross receipts at any time prior to the expiration of the statute of limitations for the taxable year. If this provision is utilized, CTI will obviously change after year-end ae long after estimated tax payments would have been made.

A similar problem exists with respect to the tax payments required to accompany extension of time requests for filing income tax returns. Under Treas. Reg. [section] 1.6081-3, a taxpayer (including a FSC) may receive an automatic six-month extension to file its tax return, if at least 90 percent of the tax liability is paid by the original due date. Because of the problems inherent in calculating CTI, it is difficult (if not impossible) to accurately determine the amount of tax owed by a FSC by the original due date of the return.

As with the FSC refund claim discussed above, any underpayment of tax by the FSC will invariably be offset by a reciprocal overpayment by its related supplier, and vice versa. There is thus no policy or revenue basis for penalizing the underpaying entity.

TEI believes that the estimated tax provision should be amended so that no estimated tax penalties, failure-to-pay penalties, or interest charges would be imposed if no such penalties and interest would be due on a net basis with respect to FSC commissions when the payments of both the FSC and its related supplier are taken into account.(1)

As the professional organization representing more than 4,800 tax executives throughout the United States and Canada, TEI is pleased to submit these comments on the procedure for Joint Committee review of refund claims and the FSC estimated tax penalty. If you have any questions concerning this letter, please feel free to contact Raymond G. Rossi, chair of the Institute's International Tax Committee at [phone] or Mary L. Fahey of the Institute's professional staff at [phone].

(1) We recognize that matching estimated tax payments of FSCs and their related suppliers may complicate the processing of the returns by the IRS. We suggest, however, that a simplified procedure could be developed that would not require the IRS to physically "match" the returns of the FSC and its related supplier. For example, Form 2220 (Underpayment of Estimated Tax by Corporations) could be revised to permit the FSC or supplier to show an overpayment of estimated tax by the other entity. We have suggested such a procedure to the IRS and would be pleased to work with that organization in developing alternative approaches.