New FSC grouping regulations: a disappearing opportunity.

• Author: LeSage, Jeffrey C.
• Position: Foreign sales corporation

On March 3, 1998, the IRS issued temporary and proposed regulations that substantially restrict the ability of U.S. taxpayers to maximize their foreign sales corporation (FSC) benefit on amended returns filed after their original extended due date. As a result of these regulations, U.S. exporters generally will have to perform the complex calculations necessary to maximize their FSC benefit before the normal extended due date of their tax return each year. Temp. Regs. Sec. 1.925(a)-1T(c)(8), however, does leave open a brief window for FSC redeterminations on amended returns for open tax years.

Background

U.S. exporters can obtain a permanent reduction in their U.S. corporate income tax liability by using an FSC for their export sales. The amount of that tax reduction depends on the method used to compute the profit allocated to the FSC. The Service's rules provide for several different methods, that can be applied separately to each export sale or in the aggregate to groups of export sales; determination of the optimal FSC profit involves a number of complex interrelated computational choices. In the past, when taxpayers have not applied the best possible method to achieve the maximum FSC benefit on their tax returns as originally filed, they have been allowed to file amended prior-year tax returns (for all years still open) to change the methods used and thereby maximize their FSC benefit.

One of the computational choices is between the two basic administrative pricing methods. The CTI method allows taxpayers to allocate 23% of their net export profit to the FSC. The FTGR method allows taxpayers to allocate 1.83% of their export sales to the FSC. Taxpayers are allowed to choose whichever of these two methods produces the best result, although the FSC's profit resulting from application of the FTGR method is limited to two times the amount resulting from the CTI method. Additionally, taxpayers are permitted to apply the CTI method (or the FTGR limitation on the CTI method) using "marginal costing," which permits the export profit to be computed without considering indirect costs (i.e., deducting only direct materials and direct labor costs).

Further complicating the calculation of the maximum FSC benefit is the choice of whether to apply these methods separately to each separate export transaction, to apply by grouping transactions by product or product line, or to apply them to some combination of separate transaction and grouping bases...