An under-utilized tax incentive for exporters.

• Author: Lysenko, Jonathan
• Position: TAX

While the international tax profession debates the latest proposals for tax reform, companies do not need to await the outcome to take advantage of certain international tax-planning opportunities. For exporters in the United States, there is a long-standing, but underutilized planning opportunity that can reduce tax on qualified export sales by 20 percent.

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These export tax benefits are available by setting-up an Interest Charge Domestic International Sales Corporation (IC-DISC)--a standalone U.S. corporation that serves as a conduit for export sales. Here's how it works: The U.S. exporter receives a 35 percent deduction on commissions it pays to the IC-DISC; and the IC-DISC shareholders pay only a 15 percent dividend tax when the income is distributed--resulting in a 20 percent tax savings.

The IC-DISC originated more than 35 years ago. As originally envisioned--for both public and private companies--the IC-DISC tax incentive is intended to provide tax deferral on certain export income (such as commission income related to the selling functions of the IC-DISC).

There is a limit to the amount that can be deferred each year; an IC-DISC can only defer commission income on up to $10 million of export sales annually. Many export companies use the deferral benefit today to accumulate income in the IC-DISC and then lend it back at favorable rates. The IC-DISC shareholder pays a reasonable low "interest charge" on deferred IC-DISC income.

In 2003, when the dividend rates for individuals were temporarily lowered to 15 percent, the IC-DISC became a vehicle for closely held and private companies to convert IC-DISC commission income from 35 percent taxed ordinary income to 15 percent taxed dividend income.

To obtain the "dividend benefit," the IC-DISC is set up directly under the individual shareholder or under an S Corporation. The exporter gets a 35 percent deduction on the commission income it pays to the IC-DISC, and the IC-DISC shareholder picks up this income immediately as a dividend at a 15 percent rate--a permanent tax savings of 20 percent.

The favorable dividend rate expires on Jan. 1, 2010, so the 15 percent rate is only valid on distributions paid in 2009.

Qualifying for IC-DISC Benefits

In general IC-DISC benefits are available for export products of U.S. manufacturers and exporters and for certain export services of U.S. architects and engineers. There are three requirements for a product to be considered an "export product" and eligible for IC-DISC benefits:

1) the manufacturing test--the exported product must be manufactured or produced in the U.S.;

2) the destination test--the ultimate delivery, use, consumption must be offshore; and

3) the foreign content test--the product must not have more than 50 percent foreign content. In applying these tests, the following is useful:

1. Manufacturers. a U.S. manufacturer qualifies for the IC-DISC benefit if any of the following three "manufacturing" tests are met: the product undergoes a substantial transformation...