ic disc: mastering intricacies of the federal tax for...

Presenting a live 110‐minute webinar with interactive Q&A

IC‐DISC: Mastering Intricacies of the Federal IC DISC: Mastering Intricacies of the Federal Tax Incentive for Exporters Overcoming Compliance Challenges to Maximize Tax Benefits

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, DECEMBER 15, 2010

Today’s faculty features:

Tom Miller, Partner, BKD LLP, Indianapolis

Jerry Ogle, President, Ogle International Tax Advisors, Bradenton, Fla.

Neal Block Senior Counsel Baker & McKenzie ChicagoNeal Block, Senior Counsel, Baker & McKenzie, Chicago

J Mark Loyd, Member, Greenebaum Doll & McDonald, Louisville, Ky.

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IC‐DISC: Mastering Intricacies of the F d l T I ti f E t Federal Tax Incentive for Exporters Webinar

Dec. 15, 2010

Tom Miller, BKD [email protected]

Mark Loyd, Greenebaum Doll & [email protected]

Jerry Ogle, Ogle International Tax [email protected]

Neal Block, Baker & [email protected]

Today’s Program

Background On IC-DISCs And Tax Benefits[Mark Loyd]

Slide 6 – Slide 17

Structural Issues When Working With IC-DISCs[Tom Miller]

Implementing Ownership Structures For IC-DISCs Slide 27 – Slide 49


[Neal Block]

Pricing Rules And Annual Compliance By IC-DISCs[Jerry Ogle]


BACKGROUND ON IC DISCS Mark Loyd, Greenebaum Doll & McDonald

BACKGROUND ON IC‐DISCS AND TAX BENEFITS

IC-DISC

Background and tax benefits of IC-DISCs

How the IC-DISC came to be How the IC-DISC came to be

General review of tax benefits of IC-DISCs

Future prospects for IC DISCs given scheduled expirations at Future prospects for IC-DISCs, given scheduled expirations at year-end

• Why it may be prudent to continue setting up IC-DISCs y y p g pdespite seeming uncertainty

GREENEBAUM DOLL & McDONALD PLLC … BREAKTHROUGH LAW

7

How IC-DISCs Came To Be

What is an IC-DISC?

– An “interest charge-domestic international sales corporation”g p

– A U.S. corporation may elect for federal income tax purposes to be treated as an IC-DISC by filing IRS Form 4876-A (El ti t B T t d I t t Ch DISC)(Election to Be Treated as an Interest Charge DISC)


8

How IC-DISCs Came To Be (Cont.)

1971: Congress enacted DISC provisions

U.S. tax on DISC income was deferred until it was repatriated.p

1970s – 1980s: European Union (EU) challenged DISCs as 1970s 1980s: European Union (EU) challenged DISCs as allegedly violating General Agreement on Tariffs and Trade (GATT).


9


1984: Congress Enacted foreign sales corporation (FSC) provisions.g g p ( ) p

FSC provided U.S. exporters with a partial U.S. tax exemption for export income.

DISC was modified to allow deferral of annual maximum of $10 million of export receipts but interest charges on deferral.


10


2000: Congress repeals FSC tax scheme and enacts extraterritorial g pincome exclusions (ETIs)

1990s – 2000s: FSC/ETI also challenged by EU, but IC-DISC was not challenged


11


2003: Congress enacts favorable divided tax rates for individualsg

Tax rate drops from 35% to 15%

Dec. 31, 2010: Favorable divided tax rates are set to expire!


12

General Review Of Tax Benefits Of IC-DISCSOf IC DISCS

Key pointsy p

An IC-DISC is a corporation.

An IC-DISC is not subject to federal income tax [IRC 991]An IC DISC is not subject to federal income tax [IRC 991].

An IC-DISC pays dividends to its shareholders.


13

General Review Of Tax Benefits Of IC-DISCS (Cont )Of IC DISCS (Cont.)

Typical IC-DISC StructureTypical IC-DISC StructureINDIVIDUAL

Distributes Business

S Corporation

100%Distributes Business & Dividend Income

ExportsS Corporation

100%Dividend

Exports

Commission$ $

IC-DISC

Dividend $


14

General Review Of Tax Benefits Of IC-DISCS (Cont )Of IC DISCS (Cont.)

Deferral of federal income tax

Acts like a loan

– A maximum of $10 million of DISC income can be deferred.

– $10 million @ 28% = $2.8 million in tax

– Each 1% difference between the IC-DISC interest charge and t ’ t f it l i t t t i th t $28 000taxpayer’s cost of capital interest rate is worth up to $28,000

– Interest rate play


15

General Review Of Tax Benefits Of IC-DISCS (Cont.)( )

Individual Trade/Business IC-DISC SavingsIncome Dividend

Income Tax Rate 2010 35% 15% 20%2011 + 35% 35% 0%

FICA/SECA OADSI Rate 12.4% 0% 12.4%FICA/SECA HI Rate * 2.9% * 0% * 2.9%

+ Potential State Tax Savings Potential State Tax Savings

* 2013 Medicare Surtax of 0. 9% Goes into Effect and Dividend Income Subject to Tax


16

Continued Viability Of IC-DISCS

Potential extension of favorable dividend rates Proposals could set dividend rate at capital gains rate – 20%

Potential repeal of Obamacare Potential repeal of Obamacare

Continuing FICA/SECA OADSE savings


17

STRUCTURAL ISSUES WHEN Tom Miller, BKD LLP

STRUCTURAL ISSUES WHEN WORKING WITH IC‐DISCS

IC DISC I i i l S UIC‐DISC: Initial Set‐Up

• Commission DISC vs. buy/sell DISC

• Domestic corporation (C corporation)

M t b d ti ti i t d d th ― Must be a domestic corporation incorporated under the laws of any state or the District of Colombia

― Determine state tax implicationsp

• Single class of stock

• $2,500 capital

― Required by last day to elect IC-DISC status

19

IC DISC I i i l S U (C )IC‐DISC: Initial Set‐Up (Cont.)

• Form 4876-A election

Fil ithi 90 d f th b i i f t ― File within 90 days from the beginning of tax year or inception of entity

• Establish books and records by the end of first year of operation

20

IC DISC A l M iIC‐DISC: Annual Maintenance

• 95% qualified gross receipts test

• 95% qualified export assets test

$2 500 it l h d f t • $2,500 capital on each day of tax year

• Timely payment of commission to IC-DISC

• File IC DISC income tax return• File IC-DISC income tax return

• Maintain IC-DISC books

• International boycott reportingInternational boycott reporting

21

IC‐DISC: Annual Maintenance (Cont.)

• 95% qualified gross receipts test

― Qualified gross receipts are at least 95% of IC-DISC gross receipts for the year.

― Qualified gross receipts

― Sale, exchange or other disposition of export property

― Lease or rental of export property used outside of U.S.

― Related and subsidiary services

― E g engineering and architectural servicesE.g., engineering and architectural services

― Other receipts to consider

― Sales made to U.S. distributors

― Sales made to foreign disregarded entities

22


• 95% qualified export asset test

― At least 95% qualified export assets at year-end are qualifiedqualified.

• Categories of export assets

― Export propertyp p p y

― Working capital

― Only amount necessary for required working capital

― Commission receivable

― Stock or securities of related foreign export corporation

23


• Commission payment

― Payment of at least 50% of the estimated final commission within 60 days of IC-DISC’s year-end (March 2 calendar within 60 days of IC DISC s year end (March 2, calendar year).

• Any unpaid commission must be paid with 90 days of finalization.

• File IC-DISC return (Form 1120-IC-DISC)

Due within 8 ½ months of year end (e g Sept 15)― Due within 8 ½ months of year-end (e.g., Sept. 15)

• Maintain IC-DISC books and records

24

P bl ?Problems?• Failure to file Form 4876-A timelyy

― 9100 relief

• Distribution needed to meet qualification requirements

― Deficiency distribution

― Failure to meet 95% qualified export asset test and 95% qualified gross receipts test, as well as timely paying q g p , y p y gcommission

― Equal to amount of taxable income attributed to the non-qualified portionqualified portion

― Deemed reasonable cause if paid on or before 15th day of ninth month after year

― If paid after, interest in the amount equal to 4.5% of distribution (§992(c)(2)(b))

25

O h I T C idOther Issues To Consider• Ownership issues• Ownership issues

― Tax-exempt entities

― Income categorized as unrelated business taxable income

― Form 990T filing requirement

― Non-resident alien

Di ib i d ff i l d i― Distribution treated as effectively connected income

― Form 1040NR filing requirement

― Foreign corporationForeign corporation

• International boycott reporting

― Sales to countries listed by Secretary of Treasury as associated i h b f I lwith boycott of Israel

― Form 5713 filing requirement26

IMPLEMENTING OWNERSHIP Neal Block, Baker & McKenzie

STRUCTURES FOR IC‐DISCS

Overview Of This Section

– Privately-held company: C Corp, S Corp, partnership, LLC taxed as a partnershiptaxed as a partnership

– Publicly traded C Corp

– Individual retirement account (IRA) and Roth IRA– Individual retirement account (IRA) and Roth IRA

– Estate planning, executive compensation

T t b fit– Treaty benefits

– Sourcing benefits

©2010 Baker & McKenzie LLP - 28

Privately Held CompanyC Corporation

Dividends to “C” Corp Shareholders subject to corporate tax at approximately

Privately-Held Company

– Dividends to C Corp Shareholders subject to corporate tax at approximately 35%

– Recommended that IC-DISC be owned directly by the individual shareholders f th C ti th id d bl t ti d i di id dof the C corporation so they can avoid double taxation and receive dividends

at 15% capital gains rate

Individual Shareholders

U S C Corp IC DISC


IC-DISC Dividend 15%

U.S. – C Corp Exporter

(Related Supplier)

IC-DISC Commission

35%

IC-DISC


Where Exporter Shareholder include C Corporations, or Tax Exempt Entities, alternative structures may be used for their ownership.

Privately Held CompanyPrivately-Held CompanyS Corporation and LLC

– Dividends pass through the corporation to the shareholders and areDividends pass through the corporation to the shareholders, and are deferred from taxes and receive dividends taxed at the 15% capital gains rate.

U S E t


IC DISC C i i 35%

U.S. Exporter(S Corp.)

C it l G i Di id d 15%IC-DISC Commission: 35%

IC-DISC

Capital Gains Dividend: 15%


Privately Held Company (Cont )Partnership Owned by S Corporation

Di id d th h th t hi t th t

Privately-Held Company (Cont.)

– Dividends pass through the partnership to the partners and shareholders of the S corporations and taxed at the 15% capital gains ratep g

Individuals Public Shareholders

Partnershipsand/or S Corps

Deemed Exporter

C Corp DPAD

IC-DISC

15% Div. 35% Commission DeductionExporting

Partnership


Publicly Traded Corporation DeferralPublicly-Traded Corporation - Deferral

C CORP

IC-DISC Receivables & Commission

Up To $10 Million DeductionCommission

IC-DISC

Up to $10 Million Deferred


Publicly-Traded Corporation$– IC-DISC may defer from taxation 16/17 of best $10

million of gross receipts. The balance is deemed distributed to its shareholders.

– Large exporters that generate substantial export receivables can sell the receivables to the IC DISC at areceivables can sell the receivables to the IC-DISC at a discount. The discount income qualifies as qualified export receipts.


Publicly-Traded Corporation (Cont.)– Deferred income becomes a low-cost, pre-tax source of

funds for export working capital and financing international sales.

– As much as $10 million may be generated from discount income and 16/17 deferred from tax (i e $1 of discountincome and 16/17 deferred from tax (i.e., $1 of discount income = $1 of gross receipts).

– Additional deferral is available by use of non-qualified assets for up to 5% of total DISC assets.


P bli l T d d C ti (C t )Example I

Publicly-Traded Corporation (Cont.)

Assume:

An IC-DISC owned by a C Corp. in 2004 receivescommissions for export sales and earns discount incomefrom factoring export receivables of $8 million. It earns a20% or $.4 million commission on the best $2 million ofsales. The IC-DISC is tax-exempt and is allowed toretain income attributable to the best $10 million of grossreceipts. The balance of gross receipts over $10 millionis deemed distributed to the IC-DISC’s shareholders asa dividend. Use of the IC-DISC results in a $2.77 million


tax savings as follows:

P bli l T d d C ti (C t )Example I (Cont.)


Discount income $ 8.00 millionCommission on best $2 million of sales 40 millionCommission on best $2 million of sales .40 million

Total IC-DISC income before deemed distribution $ 8.40 million

Less 1/17 deemed distribution .50 million

Total income to be retained $ 7.90 million

Tax Savings @ 35% $ 2 77 million


Tax Savings @ 35% $ 2.77 million

P bli l T d d C ti (C t )Example I (Cont.)


Interest charge imposed on IC-DISC shareholder on tax savings (based upon One Year Treasury Bill rate)g ( p y )

Assume tax savings in 2010 $ 2.77 millionInterest rate on One Year Treasury Bill

in Sept. 2011 2%*in Sept. 2011 2%

Interest charge payable when IC-DISCshareholder’s 2011 return due (2012) $ 55 400 Taxshareholder s 2011 return due (2012) $ 55,400 Tax

benefit from interest deduction -$55,400 @ 35% 19,390

N t t f i t t h $ 36 010


Net cost of interest charge $ 36,010*Assumed Rate

P bli l T d d C ti (C t )

Example II


Example II

MAXIMUM BENEFIT FROM DISCOUNT INCOMEMAXIMUM BENEFIT FROM DISCOUNT INCOME

Assume:

$10 million of discount income $10.00 millionLess 1/17 deemed distribution 85 millionLess 1/17 deemed distribution .85 million

Net $ 9.15 million[C b i d b lif i i t f t 5% f t t l i t ]


[Can be increased by non-qualifying receipts for up to 5% of total receipts.]

P bli l T d d C ti (C t )Example II (Cont )

Publicly-Traded Corporation (Cont.)Example II (Cont.)

Tax benefit $10 million @ 35% $ 3.20 million

Interest Charge:

$3.2 million saved at 2% $ 64,000

Tax benefit from interest deduction – $64,000 @ 35% 22,400

Net cost of interest charge $ 41,600


BeneficiaryRoth IRA – 0 Tax

Regular IRA Regular TaxRegular IRA – Regular Tax

IRA0 Tax

C CORPC CorporateTax Rates on

Corporate Tax Rateson IC-DISC Dividends

0 Taxon C Dividends

Tax Rates onIC-DISC Dividends

IC-DISC


IC DISC

IRA IC-DISC BenefitsUse Of C Corp To Own IC-DISC Stock

– Allows dividends from IC-DISC to be taxed to C Corp at corporate rates of 15% - 35%

– Dividends from C Corp to IRA tax-free

– Assets invested by IRA tax-freessets ested by ta ee

– Distributions taxed when distributed by regular IRA distributions, tax-free when distributed by Roth IRA

– May be combined with IRS direct ownership of IC-DISC stock


IRA IC-DISC BenefitsIRA Ownership Of IC-DISC

– Accumulated IC-DISC income taxed at corporate rates 15-35% when distributed

– Assets in IRA invested tax-free

– Multiple IRA structure could reduce total tax on IC-DISC dividends

– Use of LLC owned by IRA to avoid custodian involvement

– Roth IRA distributions not taxed to beneficiaries

– Cases pending on whether excise tax on excess contributions is applicable


Estate Planning And ExecutiveEstate Planning And Executive Compensation

– Estate planning: Ownership of IC-DISC stock in different proportions than exporting company stock can remove IC-p p p g p yDISC dividends from estate. Rev. Rul. 81-54 may result in gift tax exposure.

– Executive compensation and succession: IC-DISC dividends can be paid to designated employees who own IC DISC stock but do not have to be the sameIC-DISC stock but do not have to be the same shareholders of the parent company. May avoid safe harbor pricing requirements; can be used as a parent stock


purchase plan.

Foreign International SalesForeign International Sales Corporation (FISC)

IC-DISC

FISC– FISC: Owned more than 50% by IC-DISC– FISC dividends: Qualified IC-DISC export receipts (count toward best

$10 illi f i t )

FISC

$10 million of gross receipts)– Generally same activities qualify as IC-DISC regarding export

property and related and subsidiary services– 95% qualified export assets and gross receipts tests– No safe harbor pricing– Recommend when qualifying activities subject to low tax and


Recommend when qualifying activities subject to low tax and otherwise would be subpart F income

Foreign Individual, Partnership Or Trust* StructureTrust* Structure

Foreign Individual, Partnership, or Trust

15% Capital Gains

DISC Related Supplier

pRate**

ppCommission

35% deduction


* Trust not taxed as a corporation.** Possible treaty rate same as following treaty country corporation structure

Treaty Country Corporation StructureTreaty Country Corporation Structure

Treaty Country C Corp.

Div. @ TreatyW/H Rate

(5% or less)

DISC Related SupplierCommission

35% deduction


Treaty Benefits(Ownership Of A DISC By A Treaty Country Corporation)

– Sect. 996(g) classifies IC-DISC dividends as effectively connected with the conduct of a trade or business in the U.S. through a permanent establishment. his would likelyU.S. through a permanent establishment. his would likely result in foreign corporation shareholder of a DISC being subject to tax on DISC dividends at up to 35% tax.

– Sect. 996(g) is in conflict with most treaties, which prevent taxation of a treaty country corporation in the absence of an actual permanent establishment (i.e., the mere existence of p ( ,a U.S. subsidiary is not sufficient for U.S. taxation of dividends to parent as effectively connected income through a permanent establishment)


through a permanent establishment).

Treaty Benefits(Ownership Of A DISC By A Treaty Country Corporation, Cont.)

– Under the later-in-time theory, treaties executed after June 1984 therefore may prevent 996(g) from applying.

– IC-DISC dividends may thus be subject to zero tax or taxed at the treaty rate on dividendsat the treaty rate on dividends.

– If a foreign owner of DISC is an individual, the 15% tax rate on DISC dividends should apply, even if there is no treatyon DISC dividends should apply, even if there is no treaty benefit.


Sourcing Benefits

– Sect. 861(a)(1)(D) treats IC-DISC dividends attributable to qualified export receipts as foreign source income to U.S. shareholders.shareholders.

– IC-DISC dividends are presently in a separate basket (Sect. 904(d) passive basket).

– Opportunity exists to put foreign taxes into IC-DISC to create and increase foreign source income limitations:

(a) From U.S. title passage

(b) From FISCs


PRICING RULES AND ANNUAL Jerry Ogle, Ogle International Tax Advisors

COMPLIANCE BY IC‐DISCS

Ogle International Tax Advisors offers IC DISC consulting services.In addition, our spectrum of international tax services can provide

An IC-DISC can act as a buy-sell entity or a commission-based entity.

international tax services can provide assistance in the areas of :

Foreign business investments -structure active business investments in offshore

In any event, the transfer price between the IC-DISC and related supplier must be calculated under one of the three following methods:

subsidiaries to minimize U.S. and host country taxation. Analysis of the U.S. CFC and PFIC rules for individual investors.

Offshore profits importing -

4% gross receipts

50% combined taxable income (CTI)p p g

plan for the repatriation of active foreign profits.

Foreign tax systems -analyze host country deductions, exemptions and incentives

Sect. 482

exemptions, and incentives, including foreign tax credits with host country tax advisors.

Miami OfficeWaterford Business ParkMiami, Florida 33126(T) 305.671.3179 (F) 305.402.0552

Corporate Office8130 Lakewood Main St, Suite 208Bradenton, Florida 34202(T) 941.361.1147 (F) 941.827.9929

For more information on our servicesPlease contact us at our offices or visit us at our websitewww.ogleintltax.com

51

Under both the 4% gross receipts and 50% CTI methods, the DISC does not need to perform any economic functions or have any employees.

Under both the 4% gross receipts and 50% CTI methods, the DISC can increase its commission by 10% of its export promotion expenses (EPEs), if the DISC is a buy-sell DISC vs. a commission DISC y[Reg. 1.994-1(a)(2) and Computervision Corp v. Comm (96 T.C. 652)].

EPEs include general administrative and selling g gexpenses, certain freight paid to U.S.-flagged carriers, packaging costs, and design and label costs for export products incurred by the DISC.

(Note: EPEs paid by a related party can qualify, if a contract existed between the related party earmarking the EPEs for the buy-sell DISC before the transaction took place.)




52

The pricing method chosen is required on a transaction-by-transaction basis (TxT); however, an y ( )annual election can be made to group transactions in accordance with products or product lines.

Neither the gross receipts method nor the CTI method may be applied in a way that causes, in any taxable year, a loss to the related supplier. There is a special rule that allows the 4% gross receiptsspecial rule that allows the 4% gross receipts method to apply where the overall profit percentage is not exceeded [Reg. 1.994-1(e)(1)(ii)].




53

When utilizing the CTI method, overhead costs generally are allocated between export and domestic

l b d d t il d l [R 1 861 8]sales, based on detailed rules [Reg. 1.861-8].

However, if the profit margin on export products is less than profit margin on worldwide sales of theless than profit margin on worldwide sales of the same products, then marginal costing rules may be applied to allocate only marginal or variable costs against export receipts under the CTI method [Reg. 1 994-2]1.994 2].

Overall, the CTI method generally produces a larger benefit than the gross receipts method, when

t h t th 8% fit tiexports have a greater-than-8% profit ratio.




54

Related Supplier Income Statement Before IC DISC Commission

Domestic Sales 300Export Sales 100Domestic COGS (150)Domestic COGS (150)Export COGS (50)

GP 200GP 200

Overhead (100)

Taxable Income 100 25%




55

DISC Commission CalculationMethod 4% CTIExport 100 100COGS (50)

GP 50

Overhead (25)

Net Income 25Net Income 25

Total Commission 4 12.50




56

Initial IC-DISC election is made on Form 4876-A within 90 days of the start of the taxable year (must be signed y y ( gby all shareholders).

A Form 1120 IC-DISC is required to be filed annually b f th 15th d f th i th th f ll i thon or before the 15th day of the ninth month following the

close of the tax year.

Attached will be Schedule K Shareholder’s Attached will be Schedule K, Shareholder s Statement of IC-DISC Distributions (indicates actual and deemed distributions that are taxable)




57

A Form 8404 must be filed by all IC-DISC shareholders on or before the original due date of their tax returns (no extensions are permitted)tax returns (no extensions are permitted).

Form 8404 requires any deferred interest-related costs to be paid (estimated tax payments are not required on a quarterly basis).required on a quarterly basis).

Deferred interest is calculated on hypothetical tax based on ordinary rates vs. qualified dividend rates.

Form 8404 anticipates that estimates are likely needed, and amended procedures are outlined in form instructions.

Various states have different state income tax filings required.




58

The DISC must make an initial estimate of the commission at the end of the year, and the related supplier must pay the commission within 60 days of the close of the year [Reg. 1.994-1(e)(3)(i)].y [ g ( )( )( )]

Reasonable estimate requires at least 50% Payment should generally be in cash to avoid non-compliance risk [TSI, Inc. v. US (977 F.2d 424) and Thomas Int’l Ltd v US (773 F 2d 300)]Thomas Int l Ltd v US (773 F.2d 300)]. True-up commission requires payment in 90 days.

Failure to optimize available methods such as TxT, marginal costing o erhead allocation nder CTI EPEmarginal costing, overhead allocation under CTI, EPE and factoring of qualified export-related accounts receivable [Rev. Rul. 75-430]




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