ic-disc strategies: mastering the complex operational...
TRANSCRIPT
IC-DISC Strategies: Mastering the Complex Operational Challenges Anticipating IRS Audit Risks, Calculating Commissions, and Tackling Computational Intricacies
TUESDAY, MAY 6, 2014, 1:00-3:00 pm Eastern
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IC-DISC Strategies: Mastering the Complex Operational Challenges
Neal Block, Baker & McKenzie
May 6, 2014
Jerry Jonckheere, Plante Moran
Jerry Ogle, Ogle International Tax Advisors
Today’s Program
Fundamental Concepts Of IC-DISCs
[Jerry Jonckheere]
Implementing Various Ownership Structures For IC-DISCs
[Neal Block]
Compliance And Reporting By IC-DISCs
[Jerry Ogle]
Slide 6 – Slide 24
Slide 25 – Slide 66
Slide 67 – Slide 79
FUNDAMENTAL CONCEPTS OF IC-DISCs
Jerry Jonckheere, Plante Moran
7
Domestic International Sales
Corporations (DISCs)
Background and tax benefits of DISCs
General review of tax benefits of DISCs
How the DISC came to be
Requirements of a DISC
Initial requirements
Annual requirements
Export property
Other considerations
8
Domestic International Sales
Corporations (DISCs)
DISC benefit arises as follows:
Commissions paid to a DISC reduce taxable profit of related supplier
corporation deductions at ordinary rates)
DISC is tax-exempt entity – Sect. 991 income can be deferred
DISC dividends received by individual shareholders are qualified
dividends taxed at the capital gains rate Income can be taxed at lower capital gain tax rates
9
Commission reduces taxable profit
passed through to S corporation
shareholder (up to 39.6% tax
savings).
DISC is not subject to tax.
S corporation shareholders pay
20% tax on DISC dividends.
Shareholders may be subject to an
interest charge for the tax deferral
on DISC earnings not distributed
General Review Of DISCs:
Pass-Through Structure
Shareholders
S Corporation
DISC
Commission Dividend
10
General Review Of DISCs:
C Corporation Structure
Commission reduces taxable
profit of C corporation (up to
35% tax savings)
DISC is not subject to tax
C corporation shareholders pay
tax at 20% on DISC dividend
Shareholders are subject to an
interest charge for the tax
deferral on DISC earnings not
distributed
Shareholders
DISC
Commission
Dividend
C Corporation
11
How DISCs Came To Be
1971: Congress enacted DISC provisions
U.S. tax on DISC income was deferred until it was repatriated
1970s – 1980s: European Union (EU) challenged DISCs as allegedly violating
General Agreement on Tariffs and Trade (GATT)
1984: Congress enacted foreign sales corporation (FSC) provisions
FSCs exempted a percentage of export income from income tax
DISC was modified to allow deferral of DISC income from annual
maximum of $10 million of export receipts but interest charges on
deferral (the DISC became the IC-DISC)
12
How DISCs Came To Be (Cont.)
Late 1990s: European Union (EU) members complain to World Trade
Organization (WTO) that FSC represents an illegal export subsidy, but DISC
was not challenged
2000: Congress repeals FSC tax scheme and enacts extraterritorial income
exclusion (ETI or EIE); EU immediately lodged complaints
2003: Congress enacts favorable dividend tax rates for individuals
Tax rate on qualified dividends drop from 35% to 15%, creating an
opportunity for permanent savings
13
How DISCs Came To Be (Cont.)
2004: Congress repealed ETI
2006: IRS becomes aware of DISC planning and is looking for revenue
raising provisions and proposes legislation to treat DISC dividends as not
qualified but the legislation is not passed
2007: Repeal of capital gain rate for DISC dividends is proposed but not
passed.
Dec 31, 2012: Favorable dividend tax rates were to sunset but legislation
extends favorable qualified dividend rate
Rate increased from 15% to 20%
14
DISC Initial Set-Up
Commission DISC vs. buy/sell DISC
Domestic corporation (C corporation)
Must be a domestic corporation incorporated under the laws of any
state or the District of Colombia
Determine state tax implications
Single class of stock
$2,500 capital
Required by last day to elect IC-DISC status
15
DISC Initial Set-Up (Cont.)
Form 4876-A election
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
16
DISC Annual Maintenance
95% qualified gross receipts test
95% qualified export assets test
$2,500 capital on each day of tax year
Timely payment of commission to IC-DISC
File IC-DISC income tax return
Maintain IC-DISC books
International boycott reporting
17
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
Dividends from related foreign export corporation
Interest on obligations that are qualified export assets
E.g., producer’s loans
Engineering and architectural services
18
DISC Annual Maintenance (Cont.)
95% qualified gross receipts test (Cont.)
Other receipts to consider
Sales made to U.S. distributors
Sales made to foreign disregarded entities
Excluded receipts
Export property is for ultimate use in the U.S.
The sale, lease, etc. is accomplished by a subsidy of the U.S. government.
The export property is for the use by the US government, where the use
is required by law or regulation.
19
DISC Annual Maintenance (Cont.)
95% qualified export asset test
At least 95% qualified export assets at year-end are qualified.
Categories of export assets
Export property
Working capital
Only amount necessary for required working capital
Commission receivable
Stock or securities of related foreign export corporation
Producer’s loans
20
DISC Annual Maintenance (Cont.)
Commission payment
Payment of initial commission estimate within 60 days of DISC’s year-
end (March 2, calendar year).
Any unpaid commission must be paid within 90 days of finalization.
Unpaid amount cannot be more than original estimate – i.e., estimate
must be at least 50% of final.
File IC-DISC return (Form 1120-IC-DISC)
Due within 8 ½ months of year-end
Maintain IC-DISC books and records
21
Export Property For DISC (1.993-3)
Manufactured, produced, grown or extracted in the U.S. by a person
other than a DISC
Held primarily for sale, lease or rental for direct use, consumption or
disposition outside the U.S.
Not more than 50% of fair market value of the export property can be
attributable to foreign content.
Consider qualified export property sold to U.S. distributors
22
Other Considerations
DISC commission reduces QPAI deduction.
Relates to the deduction for domestic production activities
DISC commission reduces profit on foreign title transfer sales. [Sect.
863(b)]
May reduce foreign tax credit limitation
Provide for deferred tax on accumulated DISC income (FAS 109/APB 23)
State income tax considerations
23
Problems?
Failure to file Form 4876-A timely
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
commission
Equal to amount of taxable income attributed to the non-
qualified portion
Deemed reasonable cause if paid on or before 15th day of ninth
month after year or within 90 days of an IRS request
If paid after, interest in the amount equal to 4.5% of distribution
[§992(c)(2)(b)]
Slide Intentionally Left Blank
UPDATED IC-DISC OWNERSHIP STRUCTURES AND SAVING THE DISQUALIFIED DISC
Neal Block, Baker & McKenzie
©2014 Baker & McKenzie LLP - 26
Overview of this Section
Structuring
– Privately-held company: C Corp, S Corp, partnership, LLC taxed as a partnership
– Closely Held and Publicly-traded “C” corporation deferral
– Individual Retirement Account (IRA) and Roth IRA
– Estate planning, executive compensation
– Treaty benefits
– Sourcing benefits Saving The Disqualified DISC
– 9100 Relief
– Additional Qualified Assets and Additional Liabilities
– Deficiency Distribution
©2014 Baker & McKenzie LLP - 27
C Corporation
– Dividends to “C” Corp Shareholders subject to corporate tax at approximately
35%
– Recommended that IC-DISC be owned directly by the individual shareholders
of the C corporation so they can avoid double taxation and receive dividends
at 23.8% capital gains rate
Where Exporter Shareholder include C Corporations, or Tax Exempt Entities, alternative structures may
be used for their ownership.
IC-DISC Ownership Structures
Privately-Held Company
U.S. – C Corp
Exporter
(Related Supplier)
IC-DISC
Commission
35%
IC-DISC
Individual Shareholders
IC-DISC Dividend 23.8%
©2014 Baker & McKenzie LLP - 28
Privately-Held Company
S Corporation and LLC
– Dividends pass through the corporation to the shareholders and are
deferred from taxes and receive dividends taxed at the 23.8% capital
gains rate
IC-DISC Commission
39.6%
IC-DISC
U.S. Exporter
(S Corp.)
Capital Gains Dividend – 23.8%
Individual Shareholders
©2014 Baker & McKenzie LLP - 29
Partnership Owned by LLC or S Corporation
– Dividends pass through the partnership to the partners
and shareholders of the S corporations and taxed at the
15% capital gains rate
IC-DISC
23.8% Div.
Partnerships
and/or S Corps
Privately-Held Company
Individuals
39.6% Commission
Deduction Exporting
Partnership
Deemed Exporter
C Corp DPAD
Public Shareholders
©2014 Baker & McKenzie LLP - 30
Putting Supply Chain Activity
in One Exporting Partnership
BEFORE
A sells to B ($10 profit) B sells to C (10 Profit) C exports and pays rent to D
Only C’s Export Profit Less D Payment qualifies
for DISC benefits.
Manufacturing
A
B
C
D
Exports and pays
DISC a commission
Further
Manufacturing
Pays
Rent
Sale
Sale
Leases Space to C
DISC
AFTER
A
B
C
D
©2013 Baker & McKenzie LLP - 31
ABCD
Partnership
DISC
DISC
Commission
on Total Profit
of ABCD
©2013 Baker & McKenzie LLP - 32
Closely Held and Publicly-Traded
Corporation - Deferral
IC-DISC Receivables &
Commission
IC-DISC
Up to $10 Million
Deferred
C CORP
Up To $10 Million Deduction
©2013 Baker & McKenzie LLP - 33
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 who generate substantial export
receivables can sell the receivables to the IC-DISC at a
discount. The discount income qualifies as qualified export
receipts.
©2013 Baker & McKenzie LLP - 34
Publicly-Traded Corporation
– 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 discount
income = $1 of gross receipts)
– Additional deferral is available by use of non-qualified
assets up to 5% of total DISC assets and non-qualified
gross receipts up to 5% of gross receipts
©2014 Baker & McKenzie LLP - 35
Example I Assume: An IC-DISC owned by a “C” Corp. in 2012 receives
commissions for export sales and earns discount income from factoring export receivables of $8 million. It earns a 20% or $.4 million commission on the best $2 million of sales. The IC-DISC is tax exempt and is allowed to retain income attributable to the best $10 million of gross receipts. The balance of gross receipts over $10 million is deemed distributed to the IC-DISC’s shareholders as a dividend. Use of the IC-DISC results in a $2.77 million tax savings as follows:
Publicly-Traded Corporation
©2014 Baker & McKenzie LLP - 36
Example I (cont.)
Discount income $ 8.00 million
Commission 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
Publicly-Traded Corporation
©2014 Baker & McKenzie LLP - 37
Example I (cont.)
Interest charge imposed on IC-DISC shareholder on tax
savings (based upon One Year Treasury Bill rate)
Assume tax savings in 2013 $ 2.77 million
Interest rate on One Year Treasury Bill
in Sept. 2013 1%*
Interest charge payable when IC-DISC
shareholder’s 2013 return due (2014) $ 27,700 Tax benefit from interest deduction -
$27,700 @ 35% 9,695
Net cost of interest charge $ 18,005
*Assumed Rate
Publicly-Traded Corporation
©2014 Baker & McKenzie LLP - 38
Example II
MAXIMUM BENEFIT FROM DISCOUNT INCOME
Assume:
$10 million of discount income $10.00 million
Less 1/17 deemed distribution .85 million
Net $ 9.15 million
[Can be increased by non-qualifying receipts up to 5% of total receipts]
Publicly-Traded Corporation
©2014 Baker & McKenzie LLP - 39
Example II (cont.)
Tax benefit $10 million @ 35% $ 3.20 million
Interest Charge:
$3.2 million saved at 1%* $ 32,000
Tax benefit from interest
deduction – $32,000 @ 35% 11,200
Net cost of interest charge $ 20,800
*Assumed
Publicly-Traded Corporation
©2014 Baker & McKenzie LLP - 40
Beneficiary Roth IRA – 0 Tax
Regular IRA – Regular Tax
IRA
C CORP
C Corporate
Tax Rates on
IC-DISC Dividends
IC-DISC
Corporate Tax Rates
on IC-DISC Dividends
0 Tax
on C Dividends
©2014 Baker & McKenzie LLP - 41
IRA IC-DISC Benefits
Use of C Corp To Own IC-DISC Stock
– Allows dividends from IC-DISC to be taxed to C corporation at corporate rates of 15% - 35%
– Dividends from C corporation to IRA tax-free
– Assets invested by IRA tax-free
– 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
©2014 Baker & McKenzie LLP - 42
IRA IC-DISC Benefits
IRA 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 DISC commissions can be disallowed using substance v. form and if Excise tax on DISC commissions is applicable: Hellweg, T.C. Memo. 1211-58 and Ohsman, T.C. Memo. 1211-98 upheld no excise tax on Roth IRA/DISC structure and appeals dismissed. Two cases pending, one DISC and one FSC, cross motions for summary judgment expected to be filed in DISC case soon.
Slide Intentionally Left Blank
©2014 Baker & McKenzie LLP - 44
Estate Planning and Executive
Compensation
– Estate Planning: Ownership of IC-DISC stock in different proportions
than exporting company stock can remove IC-DISC dividends from
estate. Rev. Rul. 81-54 may result in gift tax exposure, but Hellweg
decision effectively held Rev. Rul. 81-54 inapplicable. All gift tax cases
have been dismissed, but could be resurrected if the Service is
successful in pending cases.
– 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 same shareholders of the parent company. May avoid
safe harbor pricing requirements. Can be used as a type of employee
stock purchase plan.
©2014 Baker & McKenzie LLP - 45
Foreign International Sales Corporation
(FISC)
– FISC: Owned more than 50% by IC-DISC
– FISC Dividends: Qualified IC-DISC export receipts [count towards best $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 otherwise would be subpart F income
IC-DISC
FISC
©2014 Baker & McKenzie LLP - 46
Foreign Individual, Partnership, or
Trust* Structure [Must be disclosed on 1120 IC-DISC Returns]
Foreign Individual,
Partnership, or Trust
DISC Related Supplier
23.8% Capital Gains
Rate**
Commission
35% deduction
*Trust not taxed as a corporation.
**Possible treaty rate.
©2014 Baker & McKenzie LLP - 47
Treaty Country Corporation Structure
Treaty Country
C Corp.
DISC Related Supplier
Div. @ Treaty
W/H Rate
(5% or less)
Commission
35% deduction
©2014 Baker & McKenzie LLP - 48
Treaty Benefits (Ownership of a DISC by a Treaty Country Corporation)
– Section 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. This would likely result in foreign corp. shareholder of a DISC being subject to tax on DISC dividends at up to 35% tax.
– Section 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 a U.S. subsidiary is not sufficient for U.S. taxation of dividends to parent as effectively connected income through a permanent establishment).
©2014 Baker & McKenzie LLP - 49
Treaty Benefits (Ownership of a DISC by a Treaty Country Corporation)
(Continued)
– Under the later-in-time theory, treaties executed after June 1984, therefore, may prevent 996(g) from applying
– IC-DISC dividends may thus be taxed at treaty rate on dividends
– If foreign owner of DISC is an individual, the 23.8% tax rate on DISC dividends should apply even if no treaty benefit
– Treaty Country taxation of DISC dividends must also be taken into account
©2014 Baker & McKenzie LLP - 50
Sourcing Benefits
– Section 861(a)(1)(D) treats IC-DISC dividends attributable to qualified export receipts as foreign source income to U.S. shareholders.
– IC-DISC dividends are presently in a separate basket (Section 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.
Saving the Disqualified DISC
1. A DISC will not qualify as a DISC if its election [form 4876-A] is not
filed timely, generally within 90 days of incorporation date. Also
capital stock of $2500 par stated value must be validly issued by
the date the election is due.
2. 95% of the DISC’s assets on the last day of the taxable year must
be qualified export assets or the DISC will be disqualified.
3. 95% of the gross receipts for the year must be qualified export
receipts or the DISC will be disqualified. In the case of a
Commission DISC the qualified export receipts are those of its
related supplier’s sales. Generally this test is commonly met since
the DISC commissions are virtually always based on qualified
export receipts. In addition, Treas. Reg. § 1.993-6(e)(2)
51
provides that if the DISC commission agreement excludes
non-qualified gross receipts, they will not be taken into
account. The Tax Court in a split decision has held that this
provision may not be relied upon where an actual commission
has been paid on non-qualifying gross receipts. See Hughes
International Sales Corporation v. Commissioner, 100 T.C.
293 (1993). The Internal Revenue Service, however, has
informally held that the intent of the regulation was that the
provision not allow for non-qualified gross receipts to be
taken into account and has allowed them to be excluded.
52
CONSEQUENCES
– If election is not timely filed, no DISC benefit in the year of
incorporation and until a valid election is timely filed.
– So-called section 9100 relief may allow for a late election if
granted by the Service for reasonable cause.
– 9100 Relief commonly granted, but filing fee can be
expensive (around $8,000).
©2014 Baker & McKenzie LLP - 53
If a DISC is disqualified, the accumulated DISC income
(deferred income) is deemed distributed over 2 times the
number of years the DISC has been in existence up to 10
years. See Section 995(b)(2). The first deemed distribution
is the year following the year of disqualification.
54
The DISC income for the year of disqualification, except as
discussed later, does not qualify for DISC benefits. It can
be either reallocated to the related supplier under section
482 or left in the DISC at the discretion of the Internal
Revenue Service. If left in the DISC the income is taxed as
ordinary corporate income at corporate rates. See Addison
Int’l., Inc. v. Commissioner, 90 T.C. 1207 (1988); aff’d 887
F.2d 660 (6th Cir. 1989); Jet Research, Inc. v.
Commissioner, T.C. Memo. 1990-463.
55
If the qualified export assets are not substantially below the
95% amount, it may be possible to examine the underlying
transactions to find additional qualifying gross receipts or
additional DISC income in an amount which would make the
95% test met. This could be done by a redetermination of the
DISC income before the filing of the DISC’s return. Under
Treas. Reg. § 1.994-1(e)(5), the resulting additional
receivable generally would be a qualified export asset at the
end of the prior taxable year if paid within 90 days of the
redetermination.
56
Deficiency Distribution May Be Available
1. The rules for a deficiency distribution may be found at Treas.
Reg. § 1.992-3 and provide that (1) an otherwise disqualified
DISC under the 95% qualified gross receipts test may
distribute an amount equal to the income attributable to the
non-qualified gross receipts and (2) that a DISC that is not
qualified under the 95% qualified export assets test may
distribute an amount equal to the total amount of the non-
qualified assets for the taxable year. If a deficiency
distribution is made for a taxable year, the DISC is qualified
for that year. Deficiency distributions may be made for more
than one taxable year.
57
2. The distribution is taxed as a current year’s distribution, but if
made, will qualify the DISC year as a qualified DISC for the
year in which it missed either the 95% qualified export assets
test or the 95% gross receipts test.
3. The deficiency distribution and the year for which it is made
must be labelled as such at the time it is made and
notification made to the Internal Revenue Service and DISC
shareholders that the distribution is a deficiency distribution.
4. It may be made in cash or other property.
58
5. There must be reasonable cause for the failure to meet the
95% test, but the similar standard for failure to make the
DISC election timely has been lax. Generally, it appears that
lack of sufficient knowledge of the DISC rules and regulations
or simple negligence will be considered as reasonable cause.
Our experience has been that if a deficiency distribution is
made before an audit has commenced, the deficiency
distribution will not be challenged.
Prior agreement of the Service for a deficiency distribution is
not required.
59
a. So long as a deficiency distribution is made by the time
the DISC’s return for the year of disqualification is due,
there is no penalty attached to the deficiency distribution.
Rather, the distribution is taxed either as dividend income,
return of capital or capital gains depending on the DISC’s
earnings and profits for the year of the distribution.
b. After the first DISC return is due subsequent to the year of
disqualification, a 4-1/2% interest charge per year is
imposed upon the DISC making a deficiency distribution
for each year or partial year that the non-qualified assets
are retained in the DISC’s possession or the assets
attributable to non-qualified gross receipts are not
considered to be distributed.
60
c. Since the DISC is a tax exempt entity, the interest charge will
not reduce DISC taxes, but will reduce its accumulated DISC
income.
d. If the same asset remains on the DISC’s books for more than
one taxable year, only that amount will be required to be
distributed in qualifying the initial year and future years.
Further, only one 4-1/2% of the amount which remains on
hand in future years is required for each year the DISC
remains disqualified, i.e., if an amount is paid out, for
example, after the second consecutive year of
disqualification, the deficiency interest for the first year of
disqualification would be the three years of deficiency interest
for the original amount. The 4-1/2% amount will not be again
imposed on the same amount to qualify the second year.
61
For example, if the only disqualified asset is $100 in years one and two, a $100 deficiency distribution and an interest charge of 4-1/2% on the $100 for three years can qualify the DISC for both the first and second year.
e. There is no tracing of assets required for the deficiency distribution. All that is required is an amount equal to the disqualified amount being distributed. This should allow for capital contributions to be made to the DISC for the purposes of allowing it to make the deficiency distribution. (Since the deficiency distribution is designed to remove non-qualified assets from the DISC’s balance sheet, allowing for the contribution of capital for the purpose of making a deficiency distribution is consistent with that result.)
62
f. If the statute of limitations has run for a year in which a
DISC has not been qualified, it may be desirable not to
make a deficiency distribution for that year.
i. A DISC does not lose its election to be treated as a
DISC unless it is not qualified as a DISC for five
consecutive years. A deficiency distribution in one
of those years should allow the DISC election to
remain in effect for all five years in that period. See
Treas. Reg. § 1.992-2(e)(3).
63
ii. Under section 992(a)(2), a DISC which is
disqualified which has not timely received a
statutory notice of deficiency is not allowed to take
the position that it was not a qualified DISC.
Further, if the Service does not attempt to disqualify
the DISC, it will remain as a qualified DISC for all
purposes of the Code. See Treas. Reg. § 1.992-
1(g). Unfortunately, the claims court and the
Federal Court of Appeals has held that the failure to
qualify can only be used by the Service against a
taxpayer, not by a taxpayer in its favor. See
Stokely-Van Camp, Inc. v. Commissioner, 974 F.2d
1319 (Fed. Cir. 1992).
64
Clean DISC/Dirty DISC
There are no limitations on the number of related DISCs.
If a DISC may have qualification problems, a new DISC
may be incorporated for future years. This may lessen
the audit risk for the prior years.
65
Slide Intentionally Left Blank
COMPLIANCE AND REPORTING BY IC-DISCs
Jerry Ogle, Ogle International Tax Advisors
Ogle International Tax Advisors
offers IC DISC consulting services.
In addition, our spectrum of
international tax services can provide
assistance in the areas of :
Foreign business investments -
structure active business
investments in offshore
subsidiaries to minimize U.S. and
host country taxation. Analysis of
the U.S. CFC and PFIC rules for
individual investors.
Offshore profits importing -
plan for the repatriation of active
foreign profits.
Foreign tax systems -
analyze host country deductions,
exemptions, and incentives,
including foreign tax credits with
host country tax advisors.
Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
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An IC-DISC can act as a buy-sell entity or a commission-based entity.
In any event, the transfer price between the IC-DISC and related supplier must be calculated under one of the three following methods:
4% gross receipts
50% combined taxable income (CTI)
Sect. 482
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida 34202 (T) 941.361.1147 (F) 941.827.9929
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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 [Reg. 1.994-1(a)(2) and Computervision Corp v. Comm (96 T.C. 652)].
EPEs include general administrative and selling expenses, 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.)
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
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The pricing method chosen is required on a
transaction-by-transaction basis (TxT); however, an
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 receipts
method to apply where the overall profit percentage
is not exceeded [Reg. 1.994-1(e)(1)(ii)].
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida 34202 (T) 941.361.1147 (F) 941.827.9929
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When utilizing the CTI method, overhead costs generally are allocated between export and domestic 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 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].
Overall, the CTI method generally produces a larger benefit than the gross receipts method, when exports have a greater-than-8% profit ratio.
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida 34202 (T) 941.361.1147 (F) 941.827.9929
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Related Supplier Income Statement Before IC DISC
Commission
Domestic Sales 300
Export Sales 100
Domestic COGS (150)
Export COGS (50)
GP 200
Overhead (100)
Taxable Income 100 25%
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida 34202 (T) 941.361.1147 (F) 941.827.9929
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DISC Commission Calculation
Method 4% CTI
Export 100 100
COGS (50)
GP 50
Overhead (25)
Net Income 25
Total Commission 4 12.50
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida 34202 (T) 941.361.1147 (F) 941.827.9929
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Starting with the 2013 tax year, Section 1411 provides that a
3.8% “Net Investment Income Tax” (NIIT) applies to Net
Investment Income.
For joint taxpayers, the tax applies to the lesser of:
Net Investment Income, or
The excess of “modified adjusted gross income” over
$250,000
Dividends are generally subject to the NIIT. In certain factual
situations, a reasonable position may exist to treat dividends
from an active buy sell IC DISC as not subject to the NIIT.
However, a March 10, 2014 BNA article by Lydia Beyoud
provided the following quote from David Kirk, attorney from the
Office of Chief Counsel at IRS, at the Federal Bar Association
Conference:
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida 34202 (T) 941.361.1147 (F) 941.827.9929
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For the purposes of calculating income that may be excluded from NII tax, practitioners and
taxpayers should also keep in mind the interplay between activities considered to be “derived
in the ordinary course of a trade or business” and the working capital rule, Kirk said.
The IRS has received a number of questions on what happens when a partnership owns a
corporation underneath it. Even if a partnership acquires C corporate stock in a proximately
related business, if they are receiving dividends, the income will continue to be treated as
dividends, he said.
“Even if you could say that these businesses are so proximately related to each other that it is
derived in ordinary course of a trade or business under case law, or whatever it is that you can
find” to support your claim, “you step into the working capital rule of 1411(c)(3),” which cross
references § 469(e)(1)(B), as well as additional rules on ways in which an item is derived in
the ordinary course of trade or business for purposes of § 469, Kirk said.
“The only way you are getting dividends out is if you are a dealer” in stock or financial
instruments, he said. Entities that own domestic corporations or an interest-charge domestic
international sales corporation (IC-DISC) will fall into the category of businesses unable to
exclude their dividends from a subsidiary or “brother-sister” structure from NII, said Kirk.
“Dividends coming out will always be dividends; interest the same way,” he said.
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida 34202 (T) 941.361.1147 (F) 941.827.9929
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In the Preamble for Treasury Decision 9644, 78 FR
72393-72449, Section 1.469-2T(c)(3)(ii)(D) was cross
referenced as guidance for when dividends could be
“derived in the ordinary course” of a trade or business.
Section 993(e)(3)(B) provides the notion of how
transactions related to a DISC can be in furtherance of
transactions giving rise qualified exports. Consider whether an individual that wholly owns an S Corporation
which in turn wholly owns an active buy sell disc could reasonably
argue that the NIIT should not apply to IC DISC dividends because
the DISC dividends are part of the S Corporation’s trade or business
and the individual materially participates in both businesses?
Overall, any position that involves DISC dividends not
being subject to the NIIT should carefully consider
potential penalties and the inherent uncertainty with
newly enacted taxes.
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida 34202 (T) 941.361.1147 (F) 941.827.9929
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Initial IC-DISC election is made on Form 4876-A within
90 days of the start of the taxable year (must be signed
by all shareholders).
A Form 1120 IC-DISC is required to be filed annually
on or before the 15th day of the ninth month following the
close of the tax year.
Attached will be Schedule K, Shareholder’s
Statement of IC-DISC Distributions (indicates actual
and deemed distributions that are taxable)
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida 34202 (T) 941.361.1147 (F) 941.827.9929
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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).
Form 8404 requires any deferred interest-related costs to be paid (estimated tax payments are not 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.
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Miami Office Waterford Business Park Miami, Florida 33126 (T) 305.671.3179 (F) 305.402.0552
Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida 34202 (T) 941.361.1147 (F) 941.827.9929
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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)].
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)].
True-up commission requires payment in 90 days.
Failure to optimize available methods such as TxT, marginal costing, overhead allocation under CTI, EPE and factoring of qualified export-related accounts receivable [Rev. Rul. 75-430]
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