Can you minimize an exporter's tax by timing FSC dividends?
An exception to this general rule may be an FSC whose parent is temporarily in an alternative minimum tax (AMT) position. Delaying the FSC dividend defers an increase to adjusted current earnings (ACE), which may save current AMT.
Regular tax effect
If an FSC dividend is deferred from one regular tax year to another regular tax year, the total tax cost to the parent will usually increase. The accumulation of profits in the FSC will generate investment income (usually interest income), a portion of which is double taxed when remitted to the parent.
FSC dividends attributable to foreign trade income (both the 15/23 portion on which the FSC is exempt from tax and the nonexempt portion) have no regular corporate income tax effect. A U.S. corporate parent is entitled to a 100% dividends received deduction for FSC dividends from earnings attributable to its foreign trade income (Sec. 245(c)(1)(A)).
If an FSC does not pay dividends, it will begin to accumulate cash or, if a parent does not pay commissions to a commission FSC, an increasing accounts receivable balance. Either of these will cause an FSC to have investment income.
Accumulated cash would almost certainly either be invested by the FSC or "borrowed" by the parent. Interest or dividends will be earned on the invested cash, or interest will be imputed by Sec. 7872. If the parent does not pay an FSC commission by the due date of the FSC's U.S. income tax return, interest on the unpaid balance must be accrued from that date (Temp. Regs. Sec. 1.925(a)1T(e)(3)).
FSC shareholders are entitled only to an 80% dividends received deduction for FSC dividends from investment or nonqualified trading income (70% if less than 20% owned) (Sec. 245(c)(1)(B)). The remaining 20% is doubly taxed (in full at the FSC level, and again in part at the shareholder level, because of the limited dividends received deduction). Since this intercompany interest is not economic income, the tax paid on it is especially undesirable. With this potential for double taxation, an FSC shareholder should strive to minimize FSC investment income.
If a parent is in an AMT position, paying an FSC dividend may increase current AMT liability. FSC dividends attributable to exempt foreign trade income, although not directly included in AMT income, are included in the parent's ACE (Sec. 56(g)(3)(4)(ii)(I)). Thus, paying an FSC dividend increases ACE and could cause a Sec. 56(g)(1) ACE adjustment that would increase AMT. Even though a parent may not originally be liable for AMT, an ACE adjustment could create AMT liability. Thus, if an FSC defers paying a dividend, the parent's current AMT liability can be minimized.
Any increase in AMT will generate a Sec. 53 minimum tax credit that on a present value basis offsets a portion of the current AMT due to the FSC dividend. (This credit reduces regular tax in later years so the value must be discounted from the time the AMT was originally paid to the time the credit is finally utilized.)
Generally, if the parent's AMT position is temporary (e.g., when utilizing an NOL carryforward), it is advantageous to defer payment of an FSC dividend until a non-AMT year, and pay the double tax cost on the FSC investment income. This tax is generally less than the differences between the current AMT and the present value of the minimum tax credit.
As noted, a deferred dividend, although it may not itself cause an AMT, could still cause an ACE adjustment that increases tentative minimum tax. This increase could defer the utilization of any carryover minimum tax credit from prior years attributable to other AMT paid that could otherwise have been used. This deferral creates a time value of money cost.
If the parent corporation is in a continuous AMT situation for the foreseeable future, deferring an FSC dividend defers AMT. At this point, the issue is whether the double tax on investment is greater than the present value of money saved by deferring AMT to a later year.
The best timing situation can be achieved by deferring the FSC dividend until there are offsetting ACE decreases. Therefore, there would be no additional AMT liability or decrease in the amount of credits that can be used.
From C.J. Getz, CPA, and Bruce W. Reynolds, Esq., Washington, D.C.
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|Title Annotation:||foreign sales corporation|
|Author:||Reynolds, Bruce W.|
|Publication:||The Tax Adviser|
|Date:||Mar 1, 1992|
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