The Internal Revenue Service: helping you finance your exports.
For several years you have been entitled to a tax break on profits generated through exporting. Recognizing the many benefits of exporting, such as increased employment, reduced trade deficit, increased tax revenues, and so forth, Congress enacted legislation in 1986 that provides tax incentives to American exporters. This legislation authorizes exporters to establish a Foreign Sales Corporation (FSC).
Taxs to Be Saved by Forming an FSC
The following example is a simple illustration of how much taxes can be saved with an FSC, assuming $1 million in export sales and a net profit margin of 20 percent. The key factor in the following formula is the net profit margin. The higher the margin, the higher the tax savings. The 5.1 percent savings result from applying the FSC rules which regulate how much of the FSC earnings are taxable.
Export sales $1,000,000 Net-profit percentage x 20% Pretax profit of exports 200,000
Reduction of effective
tax rate x 5.1% Tax Savings $ 10,200
These savings must be compared with what additional costs may be incurred. I'll discuss these costs later. All businesses, especially manufacturers, are constantly looking for ways to increase their net profit margin. A cost cut of as little as .5 percent or more adds to the net profit margin and often makes the difference between the success or failure of a business. Forming an FSC could cut the effective tax rate by more than 5 percent.
Companies That Will Not Benefit
As with any provision in the Internal Revenue Code, the rules tend to be complex and the benefits will not apply to all companies, including the following:
* Companies with no exports. * Companies not currently paying any federal taxes. If your company is currently generating net operating losses (NOLs), defer formation of an FSC until all NOLs have been utilized. * Companies with minimal exports where benefit cannot exceed costs of establishing and maintaining an FSC. * Companies that have or may have excess foreign tax credits. * Corporation that have elected S Corp status will not gain maximum benefit of an FSC.
How to Qualify
An FSC be incorporated outside U.S. customs territory. The U.S. Virgin Islands is a popular location. Several FSC service companies have been formed to assist U.S. exporters. These service companies will take care of all the legal steps required to initially form the FSC and maintain it over the years.
You should seek advice from your CPA and legal counsel as to which FSC service company to consider. The initial fee for this service can range from $1,500 to $5,000 depending on whether you require a large or small FSC, and the annual fee ranges from $500 to $1,500.
Special Help Available to the Utah Exporter
To assist Utah exporters, the Utah Legislature passed legislation authorizing the Utah Division of Economic Development to explore ways of minimizing the costs of taking advantage of these rules. The federal rules allow up to 35 shareholders to own and participate in an FSC referred to as a Shared FSC. Exporters in Utah now have access to a Shared FSC. The tax benefits to each shareholder are based on their exports, net profit margin, and so forth. But through the use of an FSC the costs can be dramatically reduced
Dan Mabey, director of International Business Development in the Utah Division of Economic Development, said the percent of Utah's gross production being exported is a full percentage point below the national average. "Utah businesses have a great opportunity to increase business through exporting. We congratulate those businesses that have caught the vision and have successfully penetrated some of the most difficult markets in the world, namely, Japan, West Germany, and Korea. They proved it can be done."
Mabey further notes, "Over the last several years Utah's rate of increases in export is one of the highest in the nation. We hope that through the increased use of Foreign Sales Corporations, whether shared or not, Utah exporters will profit even to a greater degree from exporting."
Large or Small?
The tax incentives provided by the legislation are a permanent exemption from tax on a portion of the export income attributable to the offshore activities of the FSC.
In addition, the following formation requirements must be satisfied:
* An office must be maintained outside the U.S. * At least one director must reside outside the U.S. * An election to be treated as an FSC must be filed with the Internal Revenue Service. * The FSC's year-end must be the same as that of the shareholders.
A large FSC must also satisfy the following Foreign Management and Economic Processes requirements. A small FSC is not required to meet these requirements, but only $5 million of exports of a small FSC can qualify for the tax benefit. A review of these rules clearly shows the advantage of using a small FSC.
* All meetings of shareholders and directors must be held outside the U.S. * The principal bank account must be maintained outside the U.S. * All dividends, legal and accounting fees, officers' salaries, and directors' fees must be disbursed from a foreign bank account. * There must be foreign participation in the solicitation, negotiation, or making of the contract. * A specified percentage of the following costs must be attributable to activities performed outside the U.S.: advertising and sales promotion, processing orders and arranging delivery, transportation, billing and collection, assumption of credit risk.
The average exporter need not be overly concerned about the technical requirements of and FSC. Again, however, you should seek legal and accounting advice as you evaluate the applicability of the FSC rules and whether to use a small or large FSC.
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|Title Annotation:||a discussion on foreign sales corporation tax incentives - advantages and advice|
|Author:||Lambert, Glen L.|
|Date:||Sep 1, 1991|
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