Maximizing FSC benefits for software companies.

• Author: Duke, Cullen A.
• Position: Foreign sales corporations

The foreign sales corporation (FSC) rules under Secs. 921-927 provide a partial tax exemption on profits from the sale of export property. Export property is generally defined as property produced in the United States for sale or use outside the United States. Under Temp. Regs. Sec. 1.927(1)-1T(f)(3), standardized mass marketed computer software is considered export property, if it is not accompanied by a right to reproduce for external use.

Example 1: Under a software arrangement, software company X licences a mainframe utility software package for $50,000 to foreign licensee. L. This license allows L perpetual use of the software product. X also provides a maintenance contract for $25,000 per year for five years, under which L will be entitle to technical support and any new versions, updates or enhancements of the basic product released during the term of the maintenance contract.

Assuming the $50,000 software package in the example is standardized, mass marketed and not accompanied by a right to reproduce, it is clear that a FSC benefit may be obtained. What is not particularly obvious, and is often overlooked, is the possibility of obtaining additional (and often substantial) FSC benefit on the $25,000 annual maintenance contract.

Generally speaking, services do not qualify for FSC benefit unless they are related and subsidiary to the export sale. Temp. Regs. Sec. 1.924(a)-1T(d)(3) defines related services to include "warranty service, maintenance service, repair service, and installation service." Further, a service is related to a sale of export property if:

(i) The service is of the type customarily and usually furnished with the type of transaction in the trade or business ... and (i) The contract to furnish the service - (A) is expressly provided for in ... the contract of sale ..., (B) is entered into on or before the date which is 2 years after the date on which the contract under which the sale ... was entered into,... or (C) is a renewal of the services contract described in ... (A) and (B) . . . .

Under Temp. Regs. Sec. 1.924(a)-1T(d)(4), services are subsidiary to a sale of export property only if it is reasonably expected, at the time of the sale, that the gross receipts from all related services will not exceed 50% of the sum of the gross receipts from the sale and the gross receipts from related services. In determining gross receipts from services, all services within a 10-year period after the sale are generally...