Tax incentives for exporters.

• Author: Granberg, Michael W.

Given the inevitable repeal of the extraterritorial income (ETI) exclusion and the current 15% tax rate on corporate dividends, companies that export property should consider the advantages of using an interest charge domestic international sales corporation (IC-DISC). As discussed below, in many cases, the IC-DISC will provide greater tax benefits.

The ETI Exclusion

The ETI provisions exclude a portion of income earned from certain export sales. The most basic application of the Sec. 941(a)(1) ETI rules generates an exclusion of the greater of (1) 1.2% of gross receipts from export sales or (2) 15% of the net income from export sales. The result is a reduction in the tax rate applicable to income from export sales, in the range of 5%-10%.

The ETI exclusion applies to export sales of "qualifying foreign trade property," defined by Sec. 943(a)(1) as property manufactured, produced, grown or extracted that does not consist of foreign content exceeding 50% of its fair market value. Also, under Sec. 942(b) and (c), for entities with annual export sales in excess of $5 million, certain economic processes must occur outside the U.S. for gross receipts from export sales to qualify for the ETI exclusion.

IC-DISC

An IC-DISC is a domestic corporation whose income is derived predominantly from export sales and rentals. The IC-DISC itself is not subject to income tax; however, the shareholders can be taxed on the IC-DISC's income on an actual or constructive distribution. The exporter (generally a closely held C corporation, an S corporation, limited liability company (LLC) or partnership) pays commissions to the IC-DISC, which is owned by the exporter's shareholders or partners.

Because dividend distributions to a C shareholder are taxed at normal corporate tax rates, the double tax attributable to IC-DISC earnings results in a combined corporate and individual tax rate on IC-DISC taxable distributions of approximately 43.9% (0.34 + ((1-0.34) X (1.15)). Alternatively, when an IC-DISC; is owned directly by individuals, the company's income permanently avoids corporate taxation. Besides avoiding corporate level tax, dividend distributions to individual IC DISC shareholders will generally be subject to tax at the current 15% rate, provided the Sec. 1 (h) requirements are satisfied.

Qualification

To qualify as an IC-DISC, a corporation must meet the following requirements under Sec. 992(a):

1. At least 95% of its gross receipts are qualified export...