Future of export tax benefits.

• Author: Moore, Philip E.
• Position: Foreign sales corporations

Since its introduction in 1984, the major tax benefit for U.S. exporting companies has become an industry of its own--the foreign sales corporation (FSC). This export incentive was intended to replace the domestic international sales corporation (DISC) and satisfy the "substance" requirements of the General Agreement on Tariffs and Trade (GATT). However, in 1997, the European Union (EU) challenged the legality of the FSC as an export tax benefit, complaining formally to the World Trade Organization (WTO) to force the U.S to remove this "illegal export subsidy," as violative of WTO agreements. On Feb. 24, 2000, the WTO issued its final decision, declaring the FSC an illegal export subsidy under WTO agreements and asking the U.S. to terminate the FSC by Oct. 1,2000 or face a trade war with the EU. The U.S. had to act quickly to avoid that conflict.

The FSC Repeal and Extraterritorial Income Exclusion Act of 2000

On July 27, 2000, the House Ways and Means Committee introduced H.R. 4986, a bill to replace the FSC with a new exclusion from gross income for extraterritorial income. This legislation is intended to be in compliance with the WTO decision (as well as the Oct. 1, 2000 deadline) and provide U.S. tax savings similar to the FSC regime.

The proposal repeals existing Secs. 921-927 as of Sept. 30, 2000, with transition rules allowing any FSC in existence on that date to continue operating until (1) Dec. 31, 2001 or (2) contracts entered into prior to Oct. 1, 2000 expire. Instead of the partial tax exclusion provided under FSC rules, the new system adopts a complete tax exclusion for "extraterritorial income" (EI) under new Sec. 114. The exclusion would apply to qualified foreign trade income (QFTI), as defined in new Secs. 941-943. These new rules retain many of the familiar attributes of the FSC, such as determination of profits on a transactional basis, marginal costing principles, foreign economic process requirements (FEP) and safe-haven administrative pricing rules. The percentages of excluded income are practically identical to the results under the FSC rules. For example, the new legislation allows QFTI to be the larger of 1.2% of foreign trading gross receipts (FTGR) or 15% of foreign trade income, limited to two times 1.2% of FTGR. Under the FSC rules, comparable percentages were 1.83% and 23%, subject to a tax exclusion of 65.217%, which exempts 1.19% of FTGR or 15% of foreign trade income.

Advantages of this proposed legislation...