New rules for taxing extraterritorial income. (Foreign Income & Taxpayers).

Legislation enacted in 2000 repealed the foreign sales corporation rules and permitted U.S. taxpayers to exclude part of their extraterritorial income. This article explains the new provisions, compares them to prior law and explains the ramifications and controversy.

On Nov. 15, 2000, former President Clinton signed into law the FSC Repeal and Extraterritorial Income Exclusion Act of 2000 (Act). The Act repealed the foreign sales corporation (FSC) rules and added new Code provisions allowing U.S. taxpayers to exclude a portion of their extraterritorial income (ETI) from gross income.

In general, ETI may arise when items are produced in the U.S. or abroad for use or consumption outside the U.S. This article describes the new provisions and highlights significant differences between the ETI-exclusion regime and the FSC rules.

Background

In July 1998, the European Union (EU) brought a case in the World Trade Organization (WTO) challenging the FSC rules, arguing that they were a prohibited export subsidy under two WTO trade agreements to which the U.S. is a party. (1) Despite a vigorous defense by the U.S., a WTO Panel in October 1999 agreed with the EU. The WTO Appellate Body (AB) upheld the Panel's ruling in February 2000; it gave the U.S. until Oct. 1, 2000 (later extended until Nov. 17, 2000) to comply with the trade agreements' terms or risk retaliatory sanctions against U.S. goods sold in the EU (such as increased import tariffs). Before the deadline, Congress repealed the FSC rules.

The ETI regime was born against this backdrop. Although it was crafted by Treasury (with business community input) to be WTO-compliant (and Congress believed that it would be compliant), the EU reacted to the Act's passage by quickly bringing another case in the WTO, claiming that the ETI regime (like the FSC rules) was a prohibited export subsidy. The WTO Panel found in favor of the EU again; the decision was upheld on appeal. At press time, a WTO arbitration panel was considering the EU's claim for damages against the U.S. Even though it is unclear how the U.S. will ultimately address the loss and, at the same time, comply with its WTO obligations (as government officials have said it will), ETI remains the law of the land unless and until it is repealed. Accordingly, exporters should understand the ETI regime's requirements and benefits and how they compare to the FSC rules.

FSC Rules

Under Secs. 921-927, in general, an FSC is a foreign corporation established in a qualifying jurisdiction that meets a number of offshore-activity requirements and elects FSC treatment. A portion of an FSC's income from its participation in qualifying export transactions with a U.S. affiliate is characterized as foreign-source income not connected with a U.S. trade or business and not subjected to U.S. tax. An FSC is also generally excluded from subpart F treatment. As a result, the combined income of the FSC and its U.S. affiliate from qualifying export transactions is subject to a U.S. tax rate of 29.75% (or less); had such income been received entirely by the U.S. affiliate, it would have been subject to the usual 35% corporate tax rate. In addition, dividends from an FSC qualify for the 100% dividends-received deduction when paid to a U.S. corporate shareholder. Thus, an FSC may repatriate its earnings to a U.S. parent without incurring further U.S. tax liability. Most FSCs are established in the U.S. Virgin Islands or Barbados and pay no foreign income tax on earnings.

ETI Provisions

The Act repealed the FSC provisions and mandated that no new FSCs be formed after Sept. 30, 2000. For FSCs in existence on that date, the FSC rules apply to transactions occurring before 2002. For then-existing FSCs, the FSC rules continue to apply indefinitely to transactions occurring after Sept. 30, 2000 if pursuant to a binding contract with a third party in effect on that date. Taxpayers could elect (2) to apply the new ETI rules in lieu of the FSC rules beginning Oct. 1, 2000. Unlike the FSC rules, ETI is based on a single-entity concept and does not require formation and operation of a separate special-purpose vehicle.

Under new Sec. 114, added by Act Section 3, gross income does not include ETI, defined in Sec. 114(e) as gross income attributable to foreign trading gross receipts (FTGRs), as defined in new Sec. 942.

Sec. 114(b) provides that ETI that is not "qualifying foreign trade income" (QFTI) is not ETI. Sec. 114(c) denies deductions properly allocable to ETI that a taxpayer excludes from gross income. Similarly, Sec. 114(d) denies foreign tax credits (FTCs) for foreign-income, war-profits and excess-profits taxes incurred on such income.

Under Sec. 941(a)(1) generally, QFTI is gross income from transactions that, if excluded, would result in a reduction of a taxpayer's taxable income, not to exceed the greatest of:

* 30% of the taxpayer's foreign-sale-and-leasing income.

* 1.2% of the taxpayer's FTGR income.

* 15% of the taxpayer's foreign-trade income.

Thus, under the chosen statutory construction, a taxpayer in effect "backs into" the QFTI amount.

According to Sec. 941(a)(1), QFTI determined under the 1.2%-of-gross-receipts method may not exceed twice the amount determined to be QFTI under the 15% method. (Similarly, an FSC that uses the 1.83%-of-gross-income administrative-pricing method cannot take into account more than twice as much income as determined under the 23%-of-combined-taxable-income method.) A taxpayer need not choose the method that results in the highest QFTI. If the 1.2%-of-gross-receipts method is used, no related person may earn QFTI from any transaction involving the same property (similar to an FSC provision essentially designed to prevent "pyramiding" of benefits). Also similar to the FSC rules, Sec. 941(a)(4) and (5) provide regulatory authority mandating the adoption of marginal-costing rules and sanctions for participating in an international boycott or bribery or kickbacks to government officials.

For purposes of the 15% method, Sec. 941(b) defines "foreign trade income" as taxable income attributable to FTGRs. Sec. 942(a) defines FTGRs as gross receipts from:

* A sale, exchange or other disposition of qualifying foreign-trade property (QFTP).

* A lease or rental of QFTP for use outside the U.S.

*Services related and subsidiary to the above activities.

* Performance of managerial services in connection with any of the foregoing activities, if at least 50% of a taxpayer's other FTGRs for the year are derived from those activities.

* Engineering and architectural services for non-U.S, construction projects.

For purposes of the 30% method, Sec. 941(c) defines foreign-sale-and-leasing income as foreign-trade income derived from:

* Soliciting (other than advertising), negotiating or making a contract for a transaction and performing certain other activities outside the U.S. (3)

* Leasing or renting QFTP used by the lessee outside the U.S. (excluding certain intangibles).

* Selling QFTP leased or rented for use outside the U.S.

Sec. 942(a) excludes from FTGRs transactions involving property or services for ultimate use in the U.S. and transactions accomplished by a U.S. government subsidy. Sec. 942(a) also provides that a taxpayer may elect to exclude gross receipts from FTGRs. (4)

Foreign Economic Processes

As with the FSC rules, FTGRs arise from a transaction only if economic processes occur outside the U.S. A taxpayer may undertake the foreign economic processes or have another person perform them under contract. Under Sec. 942(c), a taxpayer meets the economic-processes requirements for a sales transaction if any related person meets them in connection with a sale or other transaction involving the property. Thus, taxpayers claiming ETI benefits may not have to take any additional action to meet the requirements if a foreign affiliate is already doing so. (Taxpayers may wish to contract with an unrelated party to undertake these requirements, even if an affiliate is already undertaking them, to more readily demonstrate compliance to the IRS).

Generally, the taxpayer (or a person engaged by the taxpayer to act on its behalf) must participate outside the U.S. in soliciting (other than advertising), negotiating or making the contract. The foreign direct costs incurred in connection with the transaction must be at least 50% of the total direct costs attributable to the transaction or, alternatively, at least 85% of the direct costs attributable to two activities for which the costs are incurred. "Foreign direct costs" and "total direct costs" are defined in Sec. 942(b) as:

1. Advertising and sales promotion.

2. Processing customer orders and arranging delivery.

3. Transportation outside the U.S. in connection with customer delivery.

4. Determining and transmitting a final invoice or account statement or receiving payment.

5. Assuming credit risk.

The fourth item above departs from the FSC rules, which required .both transmittal and receipt of payment. This is due to the possibility that the person claiming ETI benefits--unlike an FSC--may not have a foreign bank account into which payment might be received. Similarly, the transportation requirement has been adjusted to account for transactions eligible for ETI benefits that may not involve the export of goods from the U.S.

There is no direct equivalent of a small FSC in the ETI regime. Nevertheless, taxpayers with $5 million or less of FTGRs do not have to meet the foreign-economic-processes requirements. All related persons are treated as one person in applying the $5 million limit. In addition, for partnerships, S corporations or other passthrough entities, the $5 million limit is applied to the entity and each partner or shareholder-owner.

Major Departures

Sec. 943(a) defines QFTP as property manufactured, produced, grown or extracted within or outside the U.S., held for sale, lease or rental in the ordinary course of business for direct use, consumption or disposition outside the U.S., if not more than 50% of the fair market value is attributable to both:

1. Articles manufactured, produced, grown or extracted, or other value added, outside the U.S. (determined, in the case of imported articles, under Section 402 of the Tariff Act of 1930).

2. Direct costs for labor (determined under Sec. 263A principles) performed outside the U.S., although such costs do not include costs treated under Sec. 263A as direct labor costs attributable to the articles referred to above.

Thus, articles manufactured, produced, grown or extracted in the U.S. that include imported articles, already include direct labor costs in the imported article's value and will not be taken into account again.

Property manufactured outside the U.S. can qualify for ETI benefits, representing a major departure from the FSC rules, which applied only to exports of U.S.-made items. However, foreign-made property is treated as QFTP if it is manufactured outside the U.S. by:

* A domestic corporation.

* A U.S. citizen or resident individual.

* A foreign corporation that has elected to be taxed as a domestic corporation.

* A partnership or other passthrough entity, all of the partners or owners of which qualify under any of the above categories.

Also similar to the FSC rules, the following property is not treated as QFTP:

* Property leased or rented by a taxpayer for use by a related person.

* Intangible property (other than films, tapes, records or similar reproductions, or certain computer software).

* Oil or gas (or primary products thereof), products that cannot be transferred under EL. 96-72 or unprocessed softwood timber.

* Any property designated in short supply.

Another significant departure from the FSC rules is non-U.S, corporations' ability to claim benefits under the ETI regime. A foreign corporation that manufactures property in the ordinary course of its business (or substantially all of the gross receipts of which are FTGRs) may elect domestic corporation treatment and become eligible for ETI benefits. (5) The election applies for all Code purposes other than subchapter S; as a result, for example, an electing foreign corporation directly owned by a U.S. corporation becomes a member of that U.S. corporation's affiliated group and joins in filing a U.S. consolidated return.

By electing, a foreign corporation waives its right to any U.S. treaty benefits. An election generally remains in effect unless the corporation revokes it. A revocation is effective for tax years beginning after the revocation. An election terminates if the foreign corporation no longer meets either the manufacturing or FTGR requirement; the termination is effective as of the following year. If a corporation's election is revoked or terminated, it may not make another one for five years.

Before considering electing U.S. tax treatment, a foreign corporation must consider the election's other ramifications. For Sec. 367 purposes, an electing foreign corporation will be treated as transferring all of its assets to a domestic corporation in a Sec. 354 exchange. Thus, Sec. 367(b) will apply, requiring recognition of the foreign corporation's "all earnings and profits (E&P) amount." (6) A termination or revocation of the election will be treated for Sec. 367 purposes as the domestic corporation's transfer of all of its property to a foreign corporation in a Sec. 354 exchange. Thus, Sec. 367(a) will apply to the revocation or termination; this would also include the Sec. 367(d) provisions requiring the recognition of the "commensurate with income" amount for a deemed transfer of intangible assets.

Under Sec. 943(b), transactions may be grouped (to the extent provided in regulations) based on product lines or recognized industry or trade usage and may be grouped differently for different purposes. For grouping purposes, "transactions" include sales, exchanges, dispositions, leasing, rental and furnishing of services. Grouping rules also apply for FSC purposes.

Although the business community sought to avoid its inclusion, the ETI regime includes in Sec. 943(C) a rule similar to the FSC provision that limits the foreign-source income a taxpayer can otherwise realize on a qualifying transaction. The FSC limit, however, incorporates the sourcing limit originally devised under the old domestic international sales corporation (DISC) rules. New Sec. 943(c) does not take this path, no doubt to distance itself from the DISC and FSC rules (both of which were challenged for being improper export subsidies). Although the reduction to foreign-source income is determined without reference to an "as if DISC computation," the mechanics for the source reduction to 15% foreign-trade income will be familiar to taxpayers that made the equivalent calculation under the FSC regime. The 1.2%-of-FTGRs rules also contain a foreign-source income reduction, but the calculation is formulary. In either case, the new limits will, in most cases, result in a similar (if not identical) reduction in foreign-source income as under the equivalent FSC rules.

While "shared FSCs" were allowed under the FSC rules, there is no FSC-like special-purpose vehicle to be shared under the ETI regime. Thus, under the Act, certain shared partnerships can earn excluded ETI. According to Sec. 943(f), if:

* A partnership maintains a separate account for applicable transactions for each partner;

* Distributions to each partner are based on the amounts in their respective accounts; and

* The partnership meets any other requirements set forth in regulations; the partnership would have to allocate to the partners their respective items of income, gain, loss and deduction (including QFTI) on the basis of such accounts. The Act also provides special rules for agricultural or horticultural cooperatives.

In addition, under Temp. Regs. Sec. 1.861-12T(g)(1), a U.S. taxpayer is generally not required to allocate or apportion interest expense to FSC stock, at least to the extent such stock is attributable to distributions out of the FSC's foreign-trade income. A different rule applies under the ETI regime, however, because of its single-entity approach. Under the Act, which added new Sec. 864(e)(3)(B), a U.S. taxpayer can exclude certain property when allocating and apportioning interest expense, but only QFTP located outside the U.S. and held for lease or rental in the ordinary course of its business.

Withholding Tax Exception

While generally, no FTCs are allowed for foreign taxes incurred on excluded ETI, Sec. 943(d) provides that foreign withholding taxes are not treated as incurred on excluded ETI determined under either the 1.2% or 15% method. As a result, such a tax can be claimed as a credit. "Withholding tax" is defined broadly and includes any tax imposed on a basis other than residence for which a credit is allowable under Sec. 901 or 903.

Under the Act, an existing FSC that has no foreign-trade income (as defined in pre-Act Sec. 923(b)) for five consecutive years beginning after 2001 will cease to be an FSC as of the sixth year. Thus, it will continue as an FSC during the specified five-year period.

ETI vs. FSC

For a typical U.S. exporter that has been using an FSC to export U.S.-produced property to foreign customers, the ETI rules should (in most cases) provide a substantially similar benefit. In this regard, the definition of QFTP includes property that is qualified export property under the FSC rules; such property should be eligible for ETI, as well as FSC, benefits. Grouping and marginal-costing rules (as well as the ability to calculate benefits on a transaction-by-transaction basis) are comparable.

While there is no transfer price to be calculated for ETI purposes (because there is no separate, FSC-like vehicle whose income must be determined), the amount of ETI that may be excluded under the 1.2%, 15% and 30% methods provided in new Sec. 941(a)(1) should yield comparable bottom-line results to the Sec. 925(a) 1.83%, 23% and arm's-length pricing methods for determining FSC income. Thus, in the case of the typical U.S. exporter, one would expect FSC and ETI benefits to be similar. As noted earlier, both the FSC and ETI regimes provide for a reduction in foreign-source income that might otherwise be realized on export sales; U.S. companies with chronic excess FTCs might not want to use an FSC or ETI for all or a portion of qualifying sales.

Exhibit 1 at right illustrates how the ETI regime provides substantially similar benefits to those offered under the FSC regime.

Nevertheless, there are some meaningful differences even in the "base case" of a U.S. exporter. Unlike the FSC rules, the ETI regime does not reduce the available benefit in the case of military-property sales. Thus, producers and sellers of military property can expect greater benefits under the ETI regime than under the FSC rules. In addition, FSC dividends are taken into account in determining the adjusted current earnings adjustment for alternative minimum tax (AMT) purposes, while ETI benefits are not. Thus, AMT taxpayers (who generally do not benefit from using an FSC) will benefit from the ETI regime.

Also, a taxpayer with net operating losses (NOLs) may want to claim ETI benefits. Finally, only C corporations can realize FSC benefits; ETI benefits are available to individuals, partnerships (including limited liability companies and other hybrids) or corporations.

Beyond the base case of U.S. exporters, the significant differences between the FSC and ETI rules really come into focus. Under the former, property produced outside the U.S. was simply not eligible for benefits; under the latter, much foreign-produced property will be eligible for benefits. For a U.S. person manufacturing or selling qualifying property outside the U.S. for sale to foreign customers through a foreign branch (or a check-the-box "hybrid branch"), the ETI regime provides a better benefit than the FSC rules.

Electing Foreign Corporations

As was described, to qualify for benefits a foreign corporation must elect U.S. corporation treatment and become a U.S. taxpayer. Assuming the foreign corporation is subject to foreign tax at a rate lower than the U.S. rate (and ignoring its home-country FTC or exclusion rules), why would a foreign corporation make the election? As a practical matter, the only foreign corporations likely to consider the election are U.S. subsidiaries, and only in certain circumstances. In this regard, to the extent a foreign subsidiary's earnings are currently being included in its U.S. parent's taxable income under the subpart F anti-deferral rules (e.g., because its income is foreign base-company sales income under Sec. 954(d)), the election would reduce the 35% U.S. tax rate on such income, possibly down to 29.75% or less (depending on the method of calculating the ETI benefit chosen and the extent to which the foreign corporation is incurring (noncreditable) foreign income taxes).

The election could also be attractive to a foreign corporation if the U.S. parent needs to repatriate cash from a low-taxed foreign subsidiary and cannot offset the residual U.S. tax on a dividend from the foreign subsidiary with other, high-taxed foreign earnings. The ability to reduce the otherwise-applicable 35% U.S. rate may be somewhat attractive.

In any case, it appears that making the election would reduce the U.S. tax rate substantially below 35% only if the foreign corporation's foreign tax rate is below 20%, because the foreign taxes incurred would be denied as FTCs.

Of course, the effect of the Sec. 367 rules and the agreement to forgo treaty benefits on the electing foreign corporation must be analyzed to determine whether the election makes sense in a particular case.

The WTO Challenge

As discussed earlier, the EU challenged the ETI regime shortly after enactment, claiming that it violated the U.S's WTO obligations. On Aug. 20, 2001, the original Panel that decided the FSC dispute found in the EU's favor. Specifically, the Panel held that, like the FSC regime before it, the ETI regime also was an illegal subsidy in violation of the Agreement on Subsidies and Countervailing Measures (ASCM), because benefits under the ETI regime were contingent on export performance. Moreover, the Panel found that the ETI regime violated Article III:4 of the General Agreement on Tariff2 and Trade of 1994 (the most-favored-nation clause), because it treated U.S.-produced goods more favorably than foreign-produced goods. Finally, the Panel found that the U.S. also violated its obligations under the ACSM and the Dispute Settlement Understanding to withdraw the FSC benefit by Nov. 1, 2000, because the transitional rules under the ETI regime extended FSC benefits until the end of 2001 for many transactions (and indefinitely for certain long-term contracts).

After a protracted period of uncertainty, the U.S. announced its decision to appeal the Panel's decision in the ETI dispute to the AB on Oct. 15, 2001. The U.S. filed its submission on Nov. 1, 2001. According to the U.S., the Panel erred in its finding that the ETI regime conferred a subsidy and was export-contingent. Finally, the U.S. stated its view that the breadth of the language in the Panel report implicated not only the U.S. tax system, but also the territorial tax systems of many European nations. The AB oral arguments were held in Geneva on Nov. 26, 2001. As a sign of the importance of the ETI dispute to the U.S., the U.S. took the unusual step of sending Deputy Treasury Secretary Kenneth W. Dam to make the opening arguments. (7)

On Jan. 14, 2002, the AB upheld the Panel's conclusions in all major respects. Under an agreement reached in September 2000 between the U.S. and the EU as to the procedures to be followed in the dispute, the AB's decision has automatically reactivated the WTO arbitration process. A WTO arbitrator must now decide on the amount of countermeasures that may be taken by the EU. The arbitrator's decision was expected by the end of March 2002. Once the arbitrator releases its decision, the WTO's Dispute Settlement Body will then authorize the EU to impose countermeasures. The EU will likely seek authorization to suspend its con. cessions to the U.S. (i.e., to increase tariffs on U.S. imports to the EU or request that the U.S. provide compensation by way of reduced tariffs on EU imports to the U.S.). Since the beginning of the FSC dispute, the EU has valued its claim for damages at $4 billion annually, a figure hotly disputed by the U.S.

It is now up to the U.S. to bring its laws into conformity with the WTO agreements allegedly violated. Given the current political and economic climate, however, it appears unlikely that Congress will be able (even if willing) to repeal the ETI regime and devise an acceptable alternative in the near future. In the interim, it is still hoped that a negotiated settlement may be achieved under which, at the least, U.S. taxpayers will be able to continue to use ETI for some period, allowing the U.S. to evaluate its options and adopt alternative legislation. Perhaps the U.S. will seriously consider the possibility of fundamental tax reform (possibly moving to a territorial-type system), mention of which has been gathering momentum since the inception of the FSC/ETI dispute.

Conclusion

Although some uncertainty exists about the ETI regime's future, companies that will realize a dear benefit from adopting ETI during the transition period (rather than continuing to use an FSC) should do so for their 2001 tax year. (8) Companies with NOLs in the current economic environment may desire to adopt ETI for 2001, rather than entirely forgoing current benefits under the FSC rules. In addition, military-property producers and sellers, AMT taxpayers and S corporations, partnerships, proprietors and some foreign corporations are also likely to benefit from using ETI for 2001.

Most taxpayers should find the administrative burdens and costs of using an FSC reduced under ETI, principally because no separate foreign entity is required. (9) In addition, most U.S. exporters are unlikely to find the ETI regime dearly superior to the FSC rules, as the tax savings are likely to be comparable in most cases. For example, as under the FSC regime, exporters with excess FTCs might not want to elect ETI status (because of the required reduction in the foreign-source income from export transactions). (10) On the other hand, ETI may provide less attractive state tax results than the FSC rules, at least under current state laws. Thus, for many, the question of whether to adopt ETI for 2001 or continue to use an FSC will be a comparatively easy one to answer. But 2002 is another matter, as the FSC roles are no longer available to most companies. The fact that ETI may ultimately go away should not deter potential beneficiaries. Until Congress and the President act, ETI is the law of the land.

EXECUTIVE SUMMARY

* The fact that property manufactured outside the U.S. can qualify for ETI benefits represents a major departure from the FSC rules.

* For a typical U.S. exporter that has been using an FSC to export U.S.-produced property to foreign customers, the ETI rules should (in most cases) provide a substantially similar benefit.

* Although the WTO ruled against the U.S. in the ETI case, qualifying taxpayers can continue to use FSC or ETI (and in many cases, a combination) for 2001, and ETI until it is repealed; thus, ETI benefits should continue to be available at least for 2002.

Exhibit 1: ETI vs. FSC regimes

A U.S. manufacturing company exports products to Canada and Mexico.
While the product-line benefit differs based on the best method used,
the benefit under each regime is the same.

Product lines                                A                 B

                                       ETI       FSC      ETI      FSC

FTGRs                                  100       100      100      100
Cost of goods sold                      80        80       70       70
Foreign trade income (FTI)/CTI          10        10        5        5

Exclusion:
1.2% FTGRs/1.83% FTGRs                 1.2      1.83      1.2     1.83
15% FTI/23% CTI                        1.5       2.3     0.75     1.15

FTI limit (2 x 15% or 23%)               3       4.6      1.5      2.3
Greater of amounts                     1.5       2.3      1.2     1.83
FSC exempt portion (15/23)             N/A       1.5      N/A     1.20

Total U.S. tax                        2.98      2.98     1.33     1.33
Tax savings                           0.53      0.53     0.42     0.42

Tax rate reduction                   5.25%     5.25%    8.40%    8.40%

Product lines                                C

                                       ETI       FSC

FTGRs                                  100       100
Cost of goods sold                      90        90
Foreign trade income (FTI)/CTI           2         2

Exclusion:
1.2% FTGRs/1.83% FTGRs                 1.2      1.83
15% FTI/23% CTI                        0.3      0.46

FTl limit (2 x 15% or 23%)             0.6      0.92
Greater of amounts                     0.6      0.92
FSC exempt portion (15/23)             N/A      0.60

Total U.S. tax                        0.49      0.49
Tax savings                           0.21      0.21

Tax rate reduction                  10.50%    10.50%

Editor's note: Mr. Benson is the former Chair of the AICPA Tax Division's International Taxation Technical Resource Panel (TRP). Mr. Kennedy is a current member of the International Taxation TRP.

Authors' note: The authors wish to thank the International Taxation TRP for reviewing this article. Mr. Kennedy also acknowledges the very significant contribution of Rafic Barrage, a Senior Associate in Deloitte & Touche's New York, NY office.

(1) For a detailed background, see Tax Education, "The ETI Dispute ..." p. 328, this issue.

(2) Rev. Proc. 2001-37, IRB 2001-23, 1327, provides guidance on how the election is to be made. Under [section], for transactions occurring after Sept. 30, 2000, a taxpayer may elect to apply the ETI provisions in lieu of the FSC provisions on a transaction-by-transaction basis.

(3) A taxpayer that chooses to calculate QFTI using the 30%-of-foreign-sale-and-leasing-income method will have to calculate its foreign-trade income attributable to such activities performed outside the U.S. (similar to the calculation required for an FSC that computes its income under the Sec. 482 pricing method).

(4) See Rev. Proc. 2001-37, note 2 supra.

(5) Id.

(6) This inclusion is limited to post-Sept. 30, 2000 E&P for foreign corporations that meet certain tests set forth in the statute; however, this exception was targeted at a particular taxpayer and, in practice, may apply to only a handful of companies.

(7) It is customary for the U.S. to send persons from the U.S. Trade Representative's office to argue disputes before the WTO.

(8) As was discussed, with the exception for certain taxpayers, only ETI benefits are available for tax years after 2001; see note 2 supra and the accompanying text. Taxpayers electing ETI benefits for 200l file Form 8873, Extraterritorial Income Exclusion.

(9) This may not be the case, however, for small FSC users.

(10) See Secs. 927(e) and 943(c).

For more information about this article, contact Mr. Benson at [e-mail] or Mr. Kennedy at [e-mail].

David M. Benson, CPA
Partner
Washington International Tax Services Group
Ernst & Young
Washington, DC

John P. Kennedy, CPA
Partner
Tri-state International Tax Services Group
Deloitte & Touche
Parsippany, NJ