Can you minimize an exporter's tax by timing FSC dividends?

• Author: Getz, C.J.
• Position: Foreign sales corporation

Under normal circumstances, foreign sales corporations (FSCs) should pay regular annual dividends to their parent corporations. Failure to do so causes adverse tax consequences, with investment income being considered earned by the FSC. Since an FSC owned by a related supplier can pay dividends by offsetting journal entries, dividends are easy for most FSCs to pay. (Other FSCs must pay the dividends in cash.)

An exception to this general rule may be an FSC whose parent is temporarily in an alternative minimum tax (AMT) position. Delaying the FSC dividend defers an increase to adjusted current earnings (ACE), which may save current AMT.

Regular tax effect

If an FSC dividend is deferred from one regular tax year to another regular tax year, the total tax cost to the parent will usually increase. The accumulation of profits in the FSC will generate investment income (usually interest income), a portion of which is double taxed when remitted to the parent.

FSC dividends attributable to foreign trade income (both the 15/23 portion on which the FSC is exempt from tax and the nonexempt portion) have no regular corporate income tax effect. A U.S. corporate parent is entitled to a 100% dividends received deduction for FSC dividends from earnings attributable to its foreign trade income (Sec. 245(c)(1)(A)).

If an FSC does not pay dividends, it will begin to accumulate cash or, if a parent does not pay commissions to a commission FSC, an increasing accounts receivable balance. Either of these will cause an FSC to have investment income.

Accumulated cash would almost certainly either be invested by the FSC or "borrowed" by the parent. Interest or dividends will be earned on the invested cash, or interest will be imputed by Sec. 7872. If the parent does not pay an FSC commission by the due date of the FSC's U.S. income tax return, interest on the unpaid balance must be accrued from that date (Temp. Regs. Sec. 1.925(a)1T(e)(3)).

FSC shareholders are entitled only to an 80% dividends received deduction for FSC dividends from investment or nonqualified trading income (70% if less than 20% owned) (Sec. 245(c)(1)(B)). The remaining 20% is doubly taxed (in full at the FSC level, and again in part at the shareholder level, because of the limited dividends received deduction). Since this intercompany interest is not economic income, the tax paid on it is especially undesirable. With this potential for double taxation, an FSC shareholder should strive to...