"Active" FSCs (and IC-DISCs) may qualify for double tax benefits.

• Author: Major, Bill
• Position: Foreign sales corporation, interest-charge domestic international sales corporation

The post-NAFTA era has led to additional opportunities for U.S. companies to export products, particularly for entrepreneurial trading companies. Federal income tax law currently provides several tax reduction or deferral incentives for U.S. companies to make export sales, the most common of which is the foreign sales corporation (FSC). If a taxable U.S.-based export trading company currently organized as a C corporation (or as a limited liability company (LLC) taxable as a corporation) properly structures and actively operates as a qualified FSC, the company's qualifying export sales may obtain up to twice the normal Federal tax benefits available to most FSCs. This may mean a permanent Federal tax reduction of up to 30% on income from exporting.

The typical FSC operates as the commission agent of a related U.S. taxpayer that produces export goods. Every time the related U.S. taxpayer makes a qualifying export sale, the FSC earns a commission for having participated in the sale. The U.S. taxpayer can deduct the full commission, while the FSC only pays Federal tax on part of the commission. The safe haven rules to determine the maximum FSC commission generally yield a 15% permanent Federal tax exemption on export income otherwise earned by a C corporation.

Unlike the preceding situation, export trading companies purchase products directly from unrelated parties to sell to their customers. Because there is no related party supplying the export products, the regular rules do not apply. If the export trading company is operated as an active FSC, its maximum export profit is determined by its ability to "buy low and sell high," and not by the safe haven rules. Under Secs. 923(a)(2) and 291(a)(4)(A), an active FSC (whose only shareholders are C corporations) can qualify for a 30% permanent Federal tax exemption on qualifying export profits from the sales of products considered to have at least 50% U.S. content.

The table on page 541 illustrates how the double benefits are achieved. Obtaining these benefits depends on proving that the FSC is truly a separate operating entity. This means the FSC should directly execute contracts with suppliers and customers, have its own bank account, purchase inventory directly from unrelated suppliers, take legal title to inventory, have its own employees and bear administrative costs allocable to export activities. When related parties provide employees or services to the FSC, the Sec. 482 rules must be...