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An FSC and a parent with an NOL form a powerful tax-reducing team.

An increasing number of foreign-owned U.S. companies have exporting operations. This is particularly common in recently acquired groups and groups bought to supply a foreign parent.

It would not normally be recommended that a foreign parent own a foreign sales corporation (FSC), since foreign shareholders do not get the FSC dividends received deduction allowed to U.S. corporate FSC shareholders. The tax rate on distributed earnings from exports through a foreign-owned FSC is therefore higher than if the FSC were owned by a foreign company's U.S. subsidiary.

This general rule does not apply if the foreign company has a net operating loss (NOL) carryover. Foreign parents acquire NOL carryovers that they otherwise cannot use from a number of possible sources:

[] Losses under the Foreign Investment in Real Property Tax Act - common in the last two years.

[] Accumulated operating losses, from real estate that did not generate enough gain to eliminate the losses.

[] Discontinued branch operations resulting from post-1986 incorporation to avoid the branch profits tax.

[] Discontinued branch operations after a U.S. group was acquired.

[] U.S. research and development operations that have been conducted through a branch.

Foreign clients that may benefit from the idea described below can be identified through these sources.

Consider the structure on page 174. The FSC commission is a deduction for the exporter. The FSC's tax on the commission is only one-third of what the exporter would pay. A dividend from that FSC is fully taxable to the foreign parent, but the NOL carryover can be used against it. The FSC dividend does not create effectively connected earnings and profits for branch profits tax purposes, so the foreign parent's tax is not increased beyond the normal corporate regular tax or alternative minimum tax (which it will pay because the NOL can use up only 90% of income).

This structure increases an FSC's Federal tax benefit over that of the standard FSC structure (in which the FSC is owned by the U.S. exporter). Since the comparative savings comes from withholding tax, the savings is biggest when the withholding tax rate on dividends from the U.S. exporting subsidiary is highest, that is, when there is no income tax treaty with the foreign parent's country.

In looking for taxpayers that might benefit from this idea, it should be remembered that post-1975 NOLs carry over for 15 years, and foreign taxpayers may have, for example, shut down a U.S. operation so long ago they had forgotten about the loss carryover.

Caution: Depending on the specific facts, two issues could be raised by this ownership arrangement. First, the IRS has held that companies acting as mere buying agents for a foreign parent did not engage in transactions qualifying as export sales for domestic international sales corporation (DISC) benefits. FSCs qualify for benefits in the same kinds of transactions as DISCs, and the Service could take a similar position against an FSC.

Second, on different facts, the IRS has asserted that conducting transactions through a DISC is the same as a de facto distribution made by the U.S. exporter to its owners. That position applied to the structure set out above could lead to an assertion by the Service that withholding tax should be imposed on some amount. These issues can be avoided if they are considered in advance.
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Title Annotation:foreign sales corporation, net operating loss
Author:Reynolds, Bruce W.
Publication:The Tax Adviser
Date:Mar 1, 1993
Words:555
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