Tax planning for expanding craft brewers.
When Developing New Brews, Secure Research And Development Credits
To incentivize innovation, the Code provides a tax credit for "research and development" costs. The phrase "research and development" may convey lab coats and Ph.Ds. But the tax credit is much broader. The type of innovation eligible for the credit includes developing new food and beverage products and new methods for improving the food and beverage production process. Thus, when a brewer experiments with a new seasonal brew, wages paid to the brewer's employees for their time formulating and testing the recipe form part of the research and development credit base, and so does the cost of supplies used to perfect the brew. Likewise, wages and supply costs incurred to improve the production process (for instance, experimenting with the amount of hops necessary to keep beer fresh and balance flavor) are part of the credit base.
Once obtained, the credit becomes a valuable asset. The amount of the credit can equal as much as ten percent of a taxpayer's research and development expenses. The simplest and most direct way to monetize the credit is to claim it dollar-for-dollar against current tax. However, if a brewer does not currently have taxable income, the credit can be carried forward for up to twenty years, and such credits are often an attractive asset to potential buyers when negotiating the sale of the brewery.
To substantiate their entitlement to the credit, breweries should consider modifying their accounting systems to ensure research and development costs are captured and segregated from other expenses. Such best practice accounting will ensure that the brewery retains the benefit of the credit if the IRS audits the issue.
When Self-Distributing, Consolidate Income To Maximize Deductions
To encourage the creation of jobs in the United States, section 199 of the Internal Revenue Code allows a U.S. manufacturer a valuable deduction for "domestic production activities." Although subject to several limitations, the deduction can reach as high as nine percent of a taxpayer's taxable income. Most brewers know that brewing beer qualifies as "domestic production" under section 199 so that, when a brewery sells beer to a third-party distributor, the income from the sale qualifies for the deduction.
As brewers grow, however, some begin self-distributing. Often, for regulatory purposes, the brewer forms a separate, sister entity to distribute beer produced by the brewery entity. Under this structure, a brewery entity ("Brewer") will sell beer to a sister distributing entity ("Distributor"), which will then resell the beer to bars, restaurants, package stores, and other retail sellers. However, a taxpayer only qualifies for the section 199 deduction if it produces the goods it sells. In the above structure, Distributor doesn't produce the beer it sells--it buys it from its sister entity, Brewer--so it isn't eligible for the deduction.
However, proper planning can extend the deduction to Distributor's income. In particular, Distributor is treated for purposes of the section 199 deduction as if it produced the beer it sells if it "consolidates" with Brewer. Depending on the combined enterprises' structure and regulatory-licensing requirements, this consolidation can be structured in several ways. If Brewer is a passthrough entity (e.g., partnership, S corporation, or limited liability company), the entities can be combined through the use of entities that are disregarded for tax purposes. In effect, any activities that take place inside of such companies are treated for tax purposes as if conducted by their parent. Similarly, if Brewer is a C corporation, Distributor can be formed as a member of a "consolidated group" of C corporations with Distributor. Through such structures, Brewery and Distributor can segregate their activities for regulatory purposes, but combine the company's operations for tax purposes. As a result, Distributor's sales will gain the benefit of the domestic production deduction.
When Selling Abroad, form an IC-DISC
Congress enacted the "IC-DISC" regime to encourage the export of goods produced in the United States. (IC-DISC stands for Interest Charge-Domestic International Sales Corporation.) By forming and implementing an IC-DISC structure, a brewery can indefinitely defer taxation on up to $10 million each year in income from export sales. The deferred tax is paid when the IC-DISC's shareholders sell their stock in the company. Although the IC-DISC's shareholders are charged interest from the IRS on the deferred tax, the interest rate is usually not as great as the present value benefit of deferring tax. Further, the IC-DISC's income from export sales in excess of $10 million can be converted from ordinary income (taxable at a rate up to 39.6%) into dividend income (taxable at a rate up to 20%).
The IC-DISC rules are very technical, but the structure is conceptually simple. An IC-DISC is a formed as a C corporation and is owned pro rata by the owners of the brewery. The IC-DISC qualifies for the deferral and conversion benefits if it meets certain requirements that are designed to ensure that it functions mainly as an exporter. For instance, ninety-five percent of the IC-DISC's gross receipts must be derived from exporting, and ninety-five percent of its property (measured by bases) must be export property. Although these tests are restrictive, they are not difficult to meet for a well implemented and managed IC-DISC structure. Once established, an IC-DISC can act either as a commissioned sales agent for a brewer's foreign sales or as a buy-sell foreign distributor. As either a sales agent or a foreign distributor, a portion of the income that would inure to the brewery is diverted to the IC-DISC, which is eligible for the deferral and conversion benefits described above.
Circular 230 Disclosure: 31 C.F.R. Part 10, [section] 10.35, requires us to notify you that any tax advice in this memo was not intended to be used, and cannot be used, for the purpose of avoiding penalties.
Dustin Covello is a tax attorney. He has helped multinational brewers structure their operations to minimize worldwide and U.S. tax. He is based out of Philadelphia at the law firm of Chamberlain Hrdlicka. Dustin can be contacted by e-mail at: email@example.com.
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|Publication:||Modern Brewery Age|
|Date:||Jan 15, 2014|
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