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A General Overview
U.S. companies selling or providing services overseas are often at a disadvantage compared to competing foreign companies, often as a result of the U.S. tax code and government regulation. The U.S. corporate tax rate is higher than most industrialized Countries, and with limited exception, earnings to foreign subsidiaries are taxed at the high corporate rate, perhaps, but not in all circumstances, with tax credits for foreign taxes paid under an applicable income tax Treaty.
This Newsletter does not discuss how companies manufacturing overseas may take advantage of tax deferral under different rules (See my Newsletter on Subpart F rules). These tax-deferral rules and the DISC benefits are a constant discussion in Congress, but the IC-DISC seems to have broad support.
The IC-DISC ("DISC") - which means "Interest Charge Domestic International Sales Corporation", provides a relatively straightforward and time-tested tax saving opportunity for companies which export goods or certain services. The DISC is available to all business structures, including "C" corporations, partnerships and limited liability companies, and to sole proprietorships. It is usually structured as a separate corporate entity, but it is not required to have employees or an office; it can be a "paper entity" in many circumstances. The DISC will not qualify as an "S" corporation, but an "S" corporation can be a shareholder of the DISC. The IC-DISC can be owned by the business principals, or by their trusts or heirs, or by a pension plan, to provide estate planning and retirement opportunities
If the DISC is a "C" corporation, the most common structure, DISC income can be distributed as qualified dividend income at the current low tax rate. The tax savings of a "C" corporation DISC to a company and its owners can exceed 29%. Unless the income is actually distributed as a dividend, or deemed distributed, the shareholder of the DISC will pay a nominal interest rate on such undistributed income.
The DISC must keep its own bookkeeping records. It can take title to export goods and act as an export agent, or act only as a commission agent. A DISC is not required to provide specific services, but it can do so; for example, it might be used for promotional purposes, or as a "factor" to purchase receivables. Expert advice to structure these services is critical.
The DISC is not taxed on commissions it receives, but export sales in excess of $10mm are not eligible for commission payments. Commissions left in a DISC set up as a "C" corporation are subject to a modest interest charge, tied to Treasury Bill Rates.
The DISC benefits are generally available for sales of "qualified" export property", rents from foreign sources for the use of export property, services related to export sales or rents, and engineering and architectural services to foreign customers. In limited circumstances loans can qualify. For example, the DISC could lend accumulated funds to the exporting company, which can deduct the interest payments to the DISC.
"Qualified export property" is strictly defined, and cannot, for example, have more than 50% of foreign content. And, 95% of the gross receipts of the DISC must be from "qualified "export receipts. "Qualified" export receipts can include loans to foreign producers, accounts receivable, and even temporary investments. The "property" must be held primarily for sale or lease in the ordinary course of business, for use outside the U.S. Documentary proof of DISC requirements is required.
The following example is an illustration of how the DISC can work, and it is not intended as an exact formula:
Gross receipts from foreign sales: $5mm
Net income: $1mm
50% of export net income $500,000
4% of net income (alternate formula) $200,000
IC-DISC commission $500,000
Fed Tax saving (35%) $175,000
The ultimate possible tax savings to the DISC shareholders could be over $148,000.
Most importantly, commissions can be paid to a DISC only after it is formed; retroactive payments are not allowed. Within 90 days of creating the DISC, IRS form 4876-A is filed to elect DISC status.
The IC-DISC is a time-tested arrangement, but Legal and accounting advice are of course critical. Qualified accounting firms and/or companies specializing in DISC structuring should be consulted to maximize DISC benefits.
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