Reduce Your Income Tax Rate on Export Sales and Other International Tax Issues

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Today’s Topics

IC-DISC (Interest Charge – Domestic International Sales Corporation)

Transfer Pricing Regulations on Sales to Foreign Subsidiaries

Foreign Bank Account and Financial Account Reporting (“FBAR”)

IC-DISC

Jesse WutkeeSenior ManagerGALLINA LLPEmail: jwutkee@gallina.comPhone: (916) 784-7800www.gallina.com

IC-DISCInterest Charge-Domestic International Sales Corporation

Background & Overview of IC-DISC

Last surviving export incentive available for U.S. manufacturers and distributors.

IC-DISC statutes were introduced by Congress in 1971 and further amended in 1984.

Jobs and Growth Tax Relief Reconciliation Act of 2003– 2003 Act established “Qualified Dividends”– Qualified Dividends taxed at 15% as opposed to 35%– Dividends paid by IC-DISC qualify as Qualified Dividends– Paid by domestic entity

• Holding period is met– 60 days within 120 day period test

IC-DISC made permanent 2013.

What is an IC-DISC?

An IC-DISC is a C Corporation that elects to be an IC-DISC, which is a non-taxable entity for federal tax purposes and some states (not including California).– Election must be made within 90 days of incorporation on Form

4879-A.

This C Corporation acts as a commission agent for the related domestic exporter/supplier.

The commission is paid by the related supplier to the IC-DISC and is calculated using the inter-company pricing rules set forth by the Internal Revenue Code and Treasury Regulations.

What is the Benefit of an IC-DISC?

The commission paid to the IC-DISC by the related supplier is an ordinary dividend, which results in a 40.5% tax savings to the related supplier.– 40.5% tax rate is the highest rate, subject to new 3.8% net investment tax and

additional 0.9% Medicare tax on earned income.

The IC-DISC pays a Qualified Dividend to its shareholders that is taxed at 23.8%.

The next result is a 16.7% tax savings.

Generally, the commission paid to the IC-DISC and the dividend paid to the IC-DISC shareholders are the same, not withstanding state income taxes.

IC-DISCShareholder Owned(C or S Corporation)

Shareholder

U.S. ExportCorporation

Customer

IC-DISCCommission Payment

Dividend

Export sales

Services

IC-DISCS-CorporationOwned

Shareholder

U.S. ExportCorporation

Customer

IC-DISCCommission Payment

Export sales

Services

Dividend

IC-DISC Requirements

One class of common shares with par or stated value of at least $2,500,

95% Qualified Export Receipts,

95% Qualified Export Assets,

Maintains separate books and records,

Must pay reasonable estimated dividend to shareholders within 60 days of IC-DISC year end.

Who Can Benefit From an IC-DISC?

Any privately held U.S. manufacturer or distributor that delivers goods outside of the U.S. that are manufactured, produced, grown, or extracted within the U.S.

Foreign markets include Canada and Mexico, but do not include Puerto Rico or other U.S. territories.

C and S Corporations as well as Partnerships/LLCs can benefit

Who Can Benefit From an IC-DISC (continued)?

Architects and engineering firms that design real estate and infrastructure projects outside the U.S.

Distributors of products manufactured within the U.S.– Both manufacturer AND distributor can benefit– Documentation requirements apply

95% Qualified Export Receipts

Qualified Export Receipts include the following:– Sales of export property or commission

generated by such sale,– Leases of export property (not to related party),– Related and subsidiary services (examples

include freight and installation fees),– Architectural and engineering services for

projects located outside the U.S.

Sale of Export Property Export property must be manufactured, produced, grown, or extracted (MPGE)

within the U.S. by a person other than the IC-DISC.– IC-DISC cannon produce products– Must meet one of the following:

• 20% of conversion costs are incurred within the U.S.,• Substantial transformation within the U.S., or• Manufacturing in U.S. generally constitutes manufacturing.

Export property must be ultimately delivered outside of the U.S.– Producer can sell to distributor who ultimately delivers product outside the U.S.

• Both the producer and distributor will have qualified export property.• Burden of proof on producer in distributor sale.

50% U.S. Content– Not more than 50% of the fair market value of export property may be attributable to

foreign components.– Labor in U.S. and conversion costs are U.S. source for 50% U.S. content rule.– 50% test denominator is sales, NOT total costs.

Examples of Export Property Manufacturer produces product within U.S. and delivers to Canada.

Manufacturer produces product within U.S. and sells to distributor within U.S. and distributor delivers to Japan.

Fishing boat catches (extracts) fish within U.S. waters and delivers to Canada.

Scrap metal company shreds equipment used within the U.S. and exports processed scrap to India.

Architectural firm designs museum that is built in Korea.

95% Qualified Export Assets

95% of the assets of the IC-DISC entity must be qualified export assets.

Qualified export assets include the following:– Trade receivables (IC-DISC commission receivable)– Sufficient working capital to operate the IC-DISC,

and– Export property (buy-sell IC-DISC).

IC-DISC Commission Calculation

IC-DISC commission is calculated using inter-company pricing rules set forth under Treasury Regulation §1.994-1.

Each of the inter-company pricing rules are subject to very complex limitations and grouping rules set forth the Treasury Regulations, IRS rulings, and judicial decisions. – Such complex limitations can also be advantageous.

IC-DISC Commission Calculation (continued)

4% Gross Receipts Method– Limited to Combined Taxable Income (CTI)

• CTI calculated under Treas. Reg. §1.861-8 to 17• Not limited to CTI• Special rule under Treas. Reg. §1.994-1(e)(1)(ii)

50% Full-Cost CTI

50% Marginal Cost CTI– Congressional intent was to assist exporters in penetrating foreign markets.– Limited to Product Overall Profit Percentage (OPP)– OPP can be calculated at the following levels:

• Product or part number• Product line• Company-wide within 2-digit NAICS Code

Commission Calculation Example - Aggregate

Export Transaction

Gross Receipts COGS Gross

Margin SG&A CTI

1 5,000 4,000 1,000 700 300

2 7,500 7,000 500 1,000 (500)

3 2,500 500 2,000 500 1,500

Total 15,000 11,500 3,500 2,200 1,3004% Gross Receipts

600(15,000 * 4%)

50% FC CTI $650(1,300 * 50%)

Transaction by Transaction (TxT) Optimization

Export Transaction

Gross Receipts COGS Gross

Margin SG&A CTI Transaction Commission

1 5,000 4,000 1,000 700 300 200 (4% G.R.)

2 7,500 7,000 500 1,000 (500) 0 (Loss Transaction)

3 2,500 500 2,000 500 1,500 750 (50% FC CTI)

Total 15,000 11,500 3,500 2,700 1,300

Total TxT Commission

$95046% Increase using TxT Optimization – Compared to previous slide

Filing Requirements for IC-DISC

IC-DISC must file Form 1120-IC-DISC and supporting schedules on an annual basis.– Form 1120-IC-DISC is due 8 ½ months after year-end of IC-

DISC.• No extensions permitted

– Supporting Schedules Include:• Schedule K – Shareholders Statement of IC-DISC Distributions• Schedule P – Intercompany Transfer Price or Commission• Schedule Q – Borrower’s Certificate of Compliance with Rules for

Producers Loans (applies only to deferral)• Form 8404 – Interest Charge on DISC-Related Deferred Tax Liability

– Interest is paid by taxpayer, not IC-DISC (applies only to deferral)

• Form 5472 may be required for foreign shareholders (as of 2012)

Deemed v. Actual Distributions of the IC-DISC

Deemed distribution must be distributed in year earned by the IC-DISC

The following are required deemed distributions:– 1/17 of income attributable to shareholders who are C

Corporations– 50% of income related to sales of military property– Income that relates to participation in a boycott against

Israel– Income that is in excess of $10,000,000 of sales that

generated the IC-DISC income

Any Questions?

?

Transfer Pricing

Mark BellowsTax PartnerGALLINA LLPEmail: mbellows@gallina.comPhone: (916) 784-7800Twitter: RE_Const_CPAwww.gallina.com

Transfer Pricing

The pricing of goods and services on transactions between related entities.

In theory, transfer price should match arm’s length pricing.

Internal Revenue Code Section 482.– Secretary may reallocate income or expenses in

order to prevent evasion of taxes or to clearly reflect income.

Applies to both inbound and outbound transactions.

Transfer Pricing (cont.)

Documentation required. The “binder.” GALLINA can assist with studies,

preparation of the binder, and strategy.

Inbound Transfer Pricing Example

Larry Taylor Contracting, Inc.Fact Set

$USD

U.S. Revenue $10,000,000

Window Frames

$5,000,000

Chinese Tax Rate

10%

U.S. Tax Rate

35%

• U.S. based window subcontractor

• Importing from China

Before (without transfer pricing)

Larry Taylor Contracting, Inc.

Buying semi-finished frames$500 per frame10,000 unitsTotal- $5M per year

Chinese Supplier

Semi-finished frames

Revenue- $10MExpense- $5MTaxable income- $5M

After (with transfer pricing)

Larry Taylor Contracting, Inc.

Buying semi-finished frames$650 per frame10,000 unitsTotal- $6.5M per year

Buying semi-finished frames$500 per frame10,000 unitsTotal- $5.0M per year

China Supplier

Larry’s Subsidiary

Semi-finished frames

Semi-finished frames

Revenue- $10MExpense- $6.5MTaxable income- $3.5M

Before (w/o TP) $USD After (w/ TP) $USD

U.S. Revenue 10,000,000$ U.S. Revenue 10,000,000$

U.S. Expenses 5,000,000$ U.S. Expenses 6,500,000$

U.S. Net Income 5,000,000$ U.S. Net Income 3,500,000$

U.S. Tax (35%) 1,750,000$ U.S. Tax (35%) 1,225,000$

China Revenue 6,500,000$

China Expenses 5,000,000$

China Net Income 1,500,000$

China Tax (10%) 150,000$

Worldwide Total Tax 1,750,000$ Worldwide Total Tax 1,375,000$

Tax Savings 375,000$

One-time Set-up Fee 50,000$

GALLINA Annual Fee 40,000$

Client's Net Savings Yr. 1 285,000$

Client's Net Savings Yr. X 335,000$

Transfer Pricing Inbound Example

Transfer Pricing Inbound Example

Outbound Transfer Pricing ExampleACME Manufacturing, Inc.

Fact Set

$USD

Component Sales

$50,000,000

Expenses

$25,000,000

Chinese Tax Rate

10%

U.S. Tax Rate

35%

Selling Electrical Components to China

Before (without transfer pricing)

Selling electrical components$1,000 per component50,000 units per yearTotal- $50M revenue annually

Chinese Buyer

Electricalcomponents

ACME Manufacturing, Inc.

Revenue- $50MExpense- $25MTaxable income- $25M

After (with transfer pricing)

Selling electrical components$700 per component50,000 unitsTotal- $35M per year

Selling electrical components$1,000 per frame50,000 unitsTotal- $50M per yearElectrical

components

Chinese Buyer

ACME’s Subsidiary

Electricalcomponents

ACME Manufacturing, Inc.

Revenue- $35MExpense- $25MTaxable income- $10M

Before (w/o TP) $USD After (w/ TP) $USD

U.S. Revenue 50,000,000$ U.S. Revenue 35,000,000$

U.S. Expenses 25,000,000$ U.S. Expenses 25,000,000$

U.S. Net Income 25,000,000$ U.S. Net Income 10,000,000$

U.S. Tax (35%) 8,750,000$ U.S. Tax (35%) 3,500,000$

China Revenue 50,000,000$

China Expenses 35,000,000$

China Net Income 15,000,000$

China Tax (10%) 1,500,000$

Worldwide Total Tax 8,750,000$ Worldwide Total Tax 5,000,000$

Tax Savings 3,750,000$

One-time Set-up Fee 50,000$

GALLINA Annual Fee 100,000$

Client's Net Savings Yr. 1 3,600,000$

Client's Net Savings Yr. X 3,650,000$

Transfer Pricing Outbound Example

Transfer Pricing Outbound Example

Any Questions?

?

FBAR Filing Requirements

Robby WalkerPartnerGALLINA LLPEmail: rwalker@gallina.comPhone: (916) 784-7800www.gallina.com

FinCEN Form 114 – Foreign Bank Account Report (“FBAR”)

Created in 1970 – Bank Secrecy Act– The Bank Secrecy Act of 1970 requires U.S. persons to file

reports and keep certain records of information about their foreign accounts.

Amendments in 2004 – New Penalties for Non-Willful Violations, Stronger Willful Penalties.

Amendments in 2011 – Some New Clarifications and Modifications of Terms.

June 30th, 2013 – Switch from Form TD F 90-22.1 to FinCEN Form 114, which must be filed electronically.

FBAR: Who Must File (The basics)

A U.S. PERSON that has a FINANCIAL INTEREST or SIGNATORY AUTHORITY over FOREIGN FINANCIAL ACCOUNTS if the aggregate value of the foreign financial accounts EXCEEDS $10,000 at any time during the calendar year.

The FBAR must be filed electronically by the Treasury Department on or before June 30 of the year following the reporting year.

There is no extension available for filing an FBAR.

FBAR: Who Must File (U.S. Person)

U.S. citizens, U.S. residents, U.S. entities, including but not limited to, corporations,

partnerships, or limited liability companies created or organized in the United States or under the laws of the United States, and

Trusts or estates formed under the laws of the United States

FBAR: Who Must File (Financial Interest or Signatory Authority)

Owner of record or holder of legal title, regardless of whether the account is maintained for the benefit of the United States person or for the benefit of another person; or

Owner of record or holder of legal title is one of the following:– Agent, Nominee, Person Acting on Behalf of U.S. Person.– Owns directly or indirectly MORE THAN 50% of value or

voting power of any corporation.– Partnership interest in greater than 50% of profits or capital.– Trust if beneficiary has MORE THAN 50% present beneficial

interest.

FBAR: Who Must File (Financial Interest or Signatory Authority… continued)

Signature Authority– A U.S. person has account signature authority if

that person can control the disposition of money or other property in the account by direct communication (whether in writing or otherwise) to the bank or other financial institution that maintains the financial account.

Spouses and minor children are often required to file an FBAR as well.

FBAR: Who Must File (Foreign Financial Accounts)

1. Foreign: Outside the U.S.i. Foreign Branches of U.S. Banks = Foreignii. U.S. Branches of Foreign Banks = Non-Foreign

2. Financial Accountsi. Checking, Deposit, Savings, Securities, Brokerage, Demand, Time

Depositii. Commodity Futures or Options Accountiii. Insurance Policy with Cash Value (whole life insurance)

a) Note: a very complicated analysis, foreign countries have vastly different insurance arrangements.

b) Foreign Insurance Excise Tax may Applyiv. Annuity Policy with Cash Valuev. Shares in a Mutual Fund or Similar Pooled Fund

FBAR: Who Must File (Foreign Financial Accounts)

Question:– Are online gambling accounts and virtual

currencies foreign accounts?• i.e. PokerStars, FirePay, and PartyPoker

FBAR: Penalties

Civil penalty of $10,000 per violation– If there is reasonable cause for the failure and

the balance in the account is properly reported, no penalty will be imposed.

Willfully failing to report an account may be subject to a civil penalty equal to the greater of $100,000 or 50% of the balance in the account at the time of the violation and be subject to risk of criminal prosecution.

FBAR: Voluntary Disclosure Program (“OVDP”)

Enables noncompliant taxpayers to resolve their tax liabilities and minimize their chance of criminal prosecution. – Generally 27.5% of highest aggregate balance.

IRS issued revised frequently asked questions regarding the revamped OVDP in July 2014

Reduced penalties if you enter the OVDP– Avoid the following civil penalties

• Foreign Information Penalties: larger of $100,000 or 50% of account balance

• Fraud Penalties: 75% of unpaid tax

– Avoid criminal prosecution• Fail to file an FBAR: up to 10 years in prison and criminal penalties up to

$500,000

FBAR: Statistics

Number of FBAR Filings1991: 116,6002001: 177,1512004: 217,6992009: 534, 043

– Note: More current numbers are not available.

Foreign Asset Disclosure –FATCA—Form 8938

Part of the 2010 HIRE Act– A U.S. taxpayer that holds an interest in a

“specified foreign financial asset” must attach to their tax return Form 8938 Statement of Foreign Financial Assets if the aggregate value of specified foreign financial assets exceeds certain dollar thresholds.

– No Form 8938 for businesses… yet

Other Foreign Tax Filings

1. Form 926 – U.S. Transferor of Property to a Foreign Corporation

2. Form 2555 – Foreign Earned Income Exclusion

3. Form 5471 - Information Return of U.S. Persons With Respect to Certain Foreign Corporations

4. Form 5472 - Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business

5. Form 8865 - Return of U.S. Persons With Respect to Certain Foreign Partnerships

6. Form 8858 - Information Return of U.S. Persons With Respect To Foreign Disregarded Entities

7. Form 3520 – Return for Foreign Trusts and Receipt of Certain Foreign Gifts

8. Form 3520-A - Annual Information Return of Foreign Trust With a U.S. Owner

Any Questions?

?