Export Tax Incentives (Portfolio 934)

Tax Management Portfolio, Export Tax Incentives, examines the history of export tax incentives under the Internal Revenue Code and then discusses the rules pertaining to interest-charge domestic international sales corporations (IC DISCs), which currently constitute the only export tax incentive under the Code.

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The IC DISC rules are a remnant from the DISC rules, which were originally enacted by the Revenue Act of 1971 and then significantly revised by the Deficit Reduction Act of 1984.

Two other former regimes are also discussed. The first is the foreign sales corporation (FSC) rules, an export tax incentive which was enacted by the Deficit Reduction Act of 1984 and repealed by the FSC Repeal and Extraterritorial Income Exclusion Act of 2000. By utilizing a FSC, a U.S. exporter typically was able to obtain a tax benefit equal to a 15% exemption (or more) from federal tax (and, in many cases, state income tax) on its export profits.
Lastly, the portfolio discusses the extraterritorial income (ETI) rules, an export tax incentive which was enacted by the FSC Repeal and Extraterritorial Income Exclusion Act of 2000 and repealed by the American Jobs Creation Act of 2004. The ETI rules provided a tax benefit generally similar to that provided under the FSC rules. The repeal of the ETI regime was generally effective for transactions occurring after December 31, 2004, but transition rules provided for a two-year phase-out of the provisions, as well as continued benefits applicable to exports sold under existing binding contracts. The ETI (and FSC) binding contract provisions were repealed by the Tax Increase Prevention and Reconciliation Act of 2005.

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Export Tax Incentives was authored by the following experts. 
Mark Thompson, B.S. (Accounting), University of Wisconsin – LaCrosse; partner in the International Tax Group of Deloitte Tax LLP with responsibility for the International Tax Compliance practice.

Terri LaRae, Master of Business Taxation, University of Minnesota; partner in the International Tax Group of Deloitte Tax LLP with responsibility for the International Tax Quantitative Consulting Services (IT.QCS) practice, oversight of the U.S. VAT practice and membership on Deloitte's CEO Advisory Committee and Tax Advisory Group.


Detailed Analysis

I. Prior Export Tax Incentives Under the Code

A. Domestic International Sales Corporations (DISCs)

1. Origin of DISCs

2. Demise of DISCs

B. Foreign Sales Corporations (FSCs)

1. Origin of FSCs

2. Demise of FSCs

C. The Extraterritorial Income (ETI) Regime

1. Origin of ETI Regime

2. Demise of ETI Regime

II. The Current Export Tax Incentive - Interest-Charge DISCs (IC DISCs)

A. Origin of IC DISCs

B. Overview of IC DISCs

C. How IC DISCs Work

D. Qualification as an IC DISC

E. Qualified Export Property

F. Qualified Export Receipts

1. Qualifying and Non-Qualifying Receipts

2. Qualifying Receipts Comparison

III. The FSC Rules (1984-2000)

A. Introduction

1. Background

2. Summary of FSC Rules

a. Taxation of the FSC and Its Shareholder

b. Foreign Trading Gross Receipts

c. General Requirements

d. Foreign Management and Economic Processes Requirements

(1) Foreign Management

(2) Foreign Economic Processes

e. FSC Commission Determination

(1) Combined Taxable Income Method

(2) Marginal Costing

(3) Gross Receipts Methods

(4) Grouping Alternatives

(5) Redetermination and Amended Returns

f. Other Requirements

(1) Export Property

(2) Foreign Destination

(3) U.S. Content

B. FSC Defined - Threshold Tests

1. Overview

2. FSC Defined

a. Incorporation or Characterization as Corporation

b. Location in Eligible U.S. Possession or Qualifying Foreign Country

c. Not More Than 25 Shareholders

d. No Preferred Stock

e. Office in Qualifying Jurisdiction

f. Maintenance of Books of Account

g. Maintenance of § 6001 Records

h. Nonresident Member of the Board of Directors

i. No DISC Within the Same Controlled Group

j. FSC Election

(1) Election of FSC or Small FSC Status

(2) Termination of an FSC or Small FSC Election

3. Taxable Year of an FSC

C. Foreign Trading Gross Receipts and Export Property

1. Overview

2. Foreign Trading Gross Receipts

3. Export Property Defined

a. U.S.-Source Requirement

(1) Manufactured or Produced

(2) Within the United States

(3) A Person Other Than an FSC

b. Destination Test

(1) In General

(2) Proof of Compliance

c. U.S. Content Requirement

4. Excluded Property

5. Software

6. Carrying Charges and Investment Income

a. In General

b. Carrying Charges

(1) Definition

(2) 60-Day (Normal Payment Period) Rule

(3) Application to Commission FSCs

(4) Imputed Carrying Charges

(5) Payment of Commissions to an FSC

c. Calculation of Unstated Carrying Charges

(1) Transaction-by-Transaction Method

(2) Optional Averaging Method

d. Investment Income

D. Foreign Management and Foreign Economic Processes Requirements

1. Overview

2. Foreign Management Requirement

a. Meetings of Boards of Directors and Shareholders

b. Maintenance of Principal Bank Account

c. Disbursement of Dividends, Legal and Accounting Fees, Salaries

3. Foreign Economic Processes Requirement

a. In General

b. Activities Performed on Behalf of an FSC

c. Burden of Proof

4. Foreign Sales Participation Test

a. In General

b. Participation Outside the United States

c. Grouping Rules

(1) Contract Groupings

(2) Customer Groupings

(3) Product or Product Line Groupings

(4) Product or Product Line Groupings Within Customer or Contract Groupings

d. Specific Rules

(1) Solicitation (Other than Advertising)

(2) Negotiation

(3) Making of the Contract

5. Foreign Direct Costs Tests

a. In General

b. Direct Costs

c. 50% and 85% Tests

d. Domestic Direct Costs

e. Grouping Rules

f. Advertising and Sales Promotion

(1) Advertising

(a) Definition

(b) Direct Costs

(c) Location

(2) Sales Promotion

(a) Definition

(b) Direct Costs

(c) Location

g. Processing of Customer Orders and Arranging for Delivery

(1) Processing Customer Orders

(a) Definition

(b) Direct Costs

(c) Location

(2) Arranging for Delivery

(a) Definition

(b) Direct Costs

(c) Location

h. Transportation

(1) Definition

(2) Direct Costs

(3) Location

i. Determination and Transmittal of Final Invoice or Statement of Account and Receipt of Payment

(1) Determination and Transmittal of Final Invoice

(a) Definition

(b) Special Grouping Rule

(c) Final Invoice

(d) Statement of Account

(e) Direct Costs

(f) Location

(2) Receipt of Payment

(a) Definition

(b) Direct Costs

(c) Location

j. Assumption of Credit Risk

(1) In General

(2) Assumption-Loss Method

(3) Insurance-Expense Methods

(4) Direct Costs

(5) Location

(6) Debts That Became Uncollectible

E. Transfer Pricing Rules

1. Administrative Transfer Pricing Rules

a. Necessity of Administrative Transfer Pricing Rules

b. Overview

(1) 23% of CTI Method

(2) 1.83% of FTGR Method

(3) Redetermination

2. FSC Eligibility to Use Administrative Pricing Rules

3. Grouping Transactions to Qualify for Administrative Pricing Rules

4. Compensation of FSC's Agent

a. General Rule

b. Special Election

(1) General Rule

(2) Problems with the Special Election

c. Activities Performed by Others

d. Military Sales

e. Insufficient Compensation

5. Computation of Transfer Price

a. Grouping of Transactions

b. 1.83% of FTGR Method

c. 23% of CTI Method

d. § 482 Method

e. Marginal Costing

(1) Computation

(a) Grouping Under Marginal Costing

(b) No-Loss Rules

(2) Examples

F. Foreign Trade Income Definition

G. Taxation of an FSC

1. Taxation at the FSC Level

a. Categories of FSC Income

(1) Exempt FTI

(a) Administrative Pricing Rules

(b) Arm's-Length Pricing or § 482

(c) Special Rule for Qualified Cooperatives

(2) Non-Exempt FTI

(3) Carrying Charges and Investment Income

(4) Other Income

b. Taxation of Income Derived by an FSC

(1) Exempt FTI

(2) Nonexempt FTI Where Administrative Pricing Rules Applied

(3) Nonexempt FTI Where Administrative Pricing Rules Not Applied

(4) Effectively Connected Income

(5) Investment Income and Carrying Charges

(6) Other Income

(7) Allocation of Deductions

2. Shareholder Level Taxation

a. Distributions to Domestic Corporate Shareholders

(1) Distributions Out of Exempt and § 923(a)(3) Nonexempt FTI

(2) Distributions Out of § 923(a)(2) Nonexempt FTI and Income Other Than Qualifying Interest and Carrying Charges

b. Distributions to U.S. Resident and U.S. Citizen Noncorporate Shareholders

c. Distributions to Foreign Corporations and Nonresident Alien Individuals

(1) Exempt and Nonexempt FTI

(2) Investment Income, Carrying Charges, and Other Income

d. Distributions by Former FSC

3. Examples

a. CTI of USCo and the FSC

b. Transfer Price and FSC Profit

c. FTI of the FSC

d. Taxable Income of USCo

e. Taxation of FTI

f. Shareholder Level Taxation

g. Overview of the Corporate and Shareholder Level Taxation of FTI of the FSC and Its Parent-Related Supplier Under the Facts of the Example

4. Foreign Tax Credits and Deductions

a. Foreign Tax Credits

(1) FSC Level: Section 906

(2) Domestic Corporate Shareholders: Section 902

(3) Withholding Taxes: Section 901(b)

b. Denial of Deduction

c. Special Limitations on Foreign Tax Credits

(1) Section 904 Separate Limitation Rules

(2) Special FSC Sourcing Rules for the § 904 Limitation

(3) Resourcing Rule

H. Other Special FSC Taxation Rules

1. Subpart F

2. FPHC and PHC Considerations

3. Passive Foreign Investment Company (PFIC) Rules

4. Treaty Benefits

5. Application of Alternative Minimum Tax

6. Gains from Sales or Exchanges of FSC Stock

7. International Boycotts, Bribes, Kickbacks to Foreign Officials

I. Shared FSCs

1. Background

2. Tax Treatment

J. Special Rules

1. Qualified Cooperatives

a. In General

b. Administrative Pricing Rules

c. Taxation of a Qualified Cooperative's FTI

(1) Corporate-Level Taxation

(2) Shareholder-Level Taxation

2. Sales of Military Property

a. Foreign Direct Cost Test

b. Exempt FTI Attributable to Sales of Military Property

K. Small FSCs

1. Qualification

2. Limitation on Tax Benefit

3. Use of the Administrative Pricing Rules

L. FSC Reporting Requirements

M. FSC-to-ETI Transition Rules

1. Effective Dates of Transition Period

2. Special Rule for Transactions Pursuant to a Binding Contract

3. Transition Issues

IV. The ETI Rules (2000-2004)

A. Background

B. Summary of the ETI Rules

1. In General

2. Requirements for ETI Exclusion

3. Other Considerations

a. Pass-Through Entities

b. Net Operating Loss (NOL) Taxpayers

c. Alternative Minimum Tax (AMT)

d. Military Property

4. Use of ETI Exclusion by Foreign Corporations

C. Rules Pertaining to the Repeal of the ETI Rules

1. Transition Rules

2. Binding Contract Relief

3. Revocation of Election To Be Treated as a Domestic Corporation

4. Impact on Source of Income

D. Form 8873


Working Papers

Table of Worksheets

Worksheet 1 Conference Report to Accompany H.R. 4170, the Deficit Reduction Act of 1984, H.R. Rep. No. 861, 98th Cong., 2d Sess. 968-977 (1984)

Worksheet 2 Explanation of Technical Corrections to the Tax Reform Act of 1984 and Other Recent Legislation (Title XVIII of H.R. 3838), Prepared by the Staff of the Joint Committee on Taxation, 100th Cong., 1st Sess. 178-187 (May 13, 1987)

Worksheet 3 Joint Committee on Taxation Description of Foreign Sales Corporation Provisions and Extraterritorial Income Exclusion (Feb. 25, 2002)

Worksheet 4 T.D. 7983, 1984-2 C.B. 151 - Transition Rules for DISCs and FSCs

Worksheet 5 T.D. 7992, 1985-1 C.B. 246 - Installment Treatment of Certain Deemed Distributions to DISC Shareholders

Worksheet 6 T.D. 8125, 1987-1 C.B. 231 - Foreign Management and Foreign Economic Processes Requirements of a Foreign Sales Corporation

Worksheet 7 T.D. 8126, 1987-1 C.B. 184 - FSC Transfer Pricing Rules, Distribution, Foreign Tax Credit and Other Special Rules for FSCs

Worksheet 8 T.D. 8127, 1987-1 C.B. 222 - FSC General Rules, Requirements, Definitions, and Special Rules

Worksheet 9 T.D. 8340, 1991-1 C.B. 4 - Adjusted Current Earnings, Foreign Sales Corporations

Worksheet 10 Form 1120-FSC, U.S. Income Tax Return of a Foreign Sales Corporation

Worksheet 11 Schedule P (Form 1120-FSC), Transfer Price or Commission

Worksheet 12 Form 8279, Election To Be Treated as a FSC or as a Small FSC

Worksheet 13 Form 4876-A, Election To Be Treated as an Interest Charge DISC

Worksheet 14 Form 8404, Interest Charge on DISC-Related Deferred Tax Liability

Worksheet 15 Form 8873, Extraterritorial Income Exclusion

Worksheet 16 Tax Accounting: An Integrated Case Study for a FSC




Legislative History:

Treasury Regulations:

Treasury Rulings: