copy of the IC-DISC presentation slides

Report
Tax Incentive Strategy for U.S. Exporters:
Interest-Charge DISC
Alabama International Trade Center
Dec 11: Birmingham Business Alliance
Dec 18: Mobile Area Chamber of Commerce
Edward K. Dwyer, CPA &
Alex McGowin, CPA
Mail: P. O. Box 3057 Daphne, AL 36526
Office Address: Stonebrook Business Park
23210 US Hwy 98- Ste A-2
Fairhope, AL 36532
Phone: (251)
401-4010
Phone: (251) 232-7115
E-mail: [email protected]
E-mail: [email protected]
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Today’s Speakers
Alex McGowin
Edward K. Dwyer
• Independent CPA/Int’l Tax Consultant (1990 to present)
• Int’l Tax Partner, KPMG- New Orleans (1984-1990)
• International Tax Associate, Edward K. Dwyer, CPA
(August 2013 to present)
• International Tax Associate, PwC –Houston
August 2013)
(August 2012-
• Director of Taxes, Ocean Drilling & Exploration Co.
(1973-1984)
• Licensed CPA: Alabama
• Member: AICPA, Society of Louisiana CPAs
• B.S. –Finance, University of Mississippi
• Licensed CPA: Louisiana & Alabama
• M.S. –Tax Accounting, University of Alabama
• B.S. –Accounting, Louisiana State University-N.O.
• M.S.- Taxation, University of New Orleans
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Overview of Presentation
• Brief History & Recent Events
• Impact of recent laws on IC-DISCs, i.e. ATRA-rate increases, APA-Medicare tax.
• Overview of the IC-DISC
• Potential benefits of the IC-DISC with an example.
• Federal & State Taxation
• Includes Mississippi, Alabama, and Florida treatment of IC-DISC.
• IC-DISC Requirements
• This will include basic structuring of the IC-DISC and applicable qualifying tests, i.e. gross receipt and asset
tests.
• Intercompany Pricing Rules
• This includes the specific methods allowable for transfer pricing between an IC-DISC and its related supplier
• Export Promotion Expenses
• Final Points
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Tortured History of the DISC
• Congress enacted the domestic international sales corporation provision in 1971 in attempt
to stimulate U.S. exports.
• GATT & WTO controversy
• Foreign Sales Corporation provision (1984)
• Extraterritorial Income Exclusion (2000)
• JGTRRA of 2003 reduced the maximum tax on qualified dividends
• Extraterritorial Income Exclusion repealed in 2004
• IC-DISC (around since 1984)
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Impact of Recent Legislation
• American Taxpayer Relief Act of 2012
• Benefit for 2012 and prior years was simply the 20% rate differential between qualified dividends
(15%) and the top rate of 35% for individuals and corporations.
• New top income tax bracket
• New legislation has added a 39.6% bracket for families making over $450,000 and a new
preferred dividend rate of 20% for the same high income households.
• Healthcare and Reconciliation Act of 2010
• IRC Section 1411: 3.8% tax on unearned income for families with MAGI in excess of $250,000.
• 0.9% additional Medicare tax on earned income for families with employment income in
excess of $250,000.
• Impact on the current benefit of IC-DISC.
• The IC-DISC continues to be a great tax minimization tool. The typical rate differential is now
approximately 16 percentage points assuming the highest applicable tax rates. (39.6% vs.
23.8%)
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INTEREST CHARGE-DOMESTIC
INT’L SALES CORPORATION
(“IC-DISC”)
Two Alternatives:
1. Allows tax deferral within IC-DISC (on a portion of profits from up to $10 Million of
annual receipts) at T-Bill rate so long as profits are invested in expanding exports,
or,
2. IC-DISC may distribute some or all of its earnings as “qualified” dividends, with its
shareholder(s) that are individuals being subject to a maximum Federal tax of 20%
(for families making over $450,000/ $400,000 for individuals)
• As previously discussed, an additional 3.8% Medicare Tax could also apply making the
maximum tax on qualified dividends 23.8%.
• Source: IRC Sections 991-997 and related Treas. Regs.
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IC-DISC: Benefit
1. Qualified Dividends Distributed:
•
IC-DISC = [39.6% x 50% + 23.8% x 50%] of CTI = 7.9%
reduction on overall effective rate(approx. 20% tax
liability reduction):
OR-2. Retain & Reinvest Export Profits:
•
•
50% of profits taxed @ ordinary income rates, and
Tax deferred on 50% of profits with T Bill interest
rate charged on tax deferred
3. OR--May Do Some Of Both
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EXAMPLE: $5 Million Export Sales
w/ 10% Net-to-Gross Profit (2013)***
•
With No IC-DISC:
Taxable:
$500,000
Marginal tax rate:
39.6%
Shareholder tax:
$198,000
With IC-DISC:
Taxable:
IC-DISC:
50% of Profit
• w/ IC-DISC:
158,500
All distributed
• IC-DISC Saves
$39,500
Supplier:
• Effective Rate Reduction:
7.9%
• Tax Savings (7.9/39.6):
*** Subject to top
23.8% dividend rate
(includes Medicare Tax of
3.8%.)
Shareholder tax:
50% of Profit
S Corp. s/h’s:
(39.6%-31.7%)
20%
$500,000
Shareholder tax:
Total tax:
Effective Rate:
(158,500/500,000)
$ 250,000
23.8%
$ 59,500
$ 250,000
39.6%
$99,000
$158,500
31.7%
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Alternative: Retain & Reinvest IC-DISC Earnings in
Export Operations
• Tax is deferred as long as reinvested and IC-DISC continues to qualify.
• Shareholder(s) pay an interest charge on the total tax deferred. (Use
Form 8404 to compute.)
• Measured by “T-Bill” rate of the previous year. (For 2013: 0.14 %--See
Rev. Rul. 2013-24, 2013-49 I.R.B.).
http://www.irs.gov/pub/irs-pdf/f8404.pdf
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IC-DISC STRUCTURE & SETUP
• Closely-held corporation or LLC with S corp. election in effect (or its
individual shareholders)
• Form(s) (or has its S/Hs form) a domestic corporation under state
corporate law.
• That C corp. and its shareholder(s) elect DISC status for it on a timely
Form 4876-A.
• Written consent of all shareholders.
• http://www.irs.gov/pub/irs-pdf/f4876a.pdf
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Alternative
IC-DISC Ownership Structures
Parent-Subsidiary
Individual Owners
Partnership or
S-Corp. or
C Corp.
Brother-Sister
Individual Owners
Partnership or
S-Corp. or
C Corp.
IC-DISC
IC-DISC
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IC-DISC Federal Taxation
• The IC-DISC does not pay any income tax on its taxable income from
the export sales.
• It must file an annual information return on Form 1120-IC DISC.
• It takes profits and pays a dividend back to shareholder company or
individual s/h’s.
• If the shareholder is an S corporation or an LLC, the dividend is
passed-through & taxed at the individual level at maximum current
qualified dividend rate of 23.8 % (Includes 3.8% Medicare Tax)
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State Taxation of IC-DISC
• Alabama
• AL taxes IC-DISCs as if they were ordinary C-Corporations.
• The applicable Alabama code and regulations regarding C-Corporations applies.
(there is no specific language on IC-DISCs).
• Mississippi
• MS also taxes IC-DISCs as if they were ordinary corporations (Miss Reg. 807).
• Therefore it is an eligible corporation for consolidated or combined return purposes
where the entity is a member of an affiliated group.
• Florida
• Respects the federal tax treatment of the IC-DISC. More clearly, it is not a taxable
entity for Florida state tax purposes.
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IC-DISC REQUIREMENTS
• Be a domestic C corporation,
• Have only a single class of stock with a minimum par value of $2,500,
• Make a timely IC-DISC election,
• Within first 90 days following formation of a new IC-DISC.
• Meet the 95% qualifying assets test,
• Meet the 95% qualifying gross receipts test,
• Have a separate set of books, and
• Have its own bank account
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95% QUALIFIED EXPORT
GROSS RECEIPTS TEST
• Sales of certain qualified export property,
• Certain export related dividends and interest,
• Interest income on an obligation arising from “producers’ loan”(s)
and,
• Certain export related managerial services income.
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QUALIFYING GROSS RECEIPTS (CONT’D)
• Income or Commissions from certain “Related and Subsidiary”
Services and,
• Engineering or Architectural Services in connection with construction
projects located or planned for location outside the U.S.
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95% QUALIFYING EXPORT ASSETS TEST
(Applied @ Year End “EOY”)
 Accounts Receivable -export sales of DISC or its Supplier
 “Producer Loans” to related supplier-5 yr. maximum term
 Funds Awaiting Investment
 Obligations of Ex-Im Bank and PEFCO
 Reasonable Working Capital
 These EOY amounts must total at least 95% of the IC-DISCs
total assets at EOY.
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QUALIFYING EXPORT PROPERTY
• Manufactured, produced, grown or extracted in the United States by
a person other than an IC-DISC;
• Is held primarily for:
-- sale, lease or rental
-- for direct use, consumption or disposition outside the United
S
States,
• contain a minimum of 50% U.S. content, and
• not be specifically disqualified as export property.
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Intercompany Pricing Rules
• The income of the IC-DISC is calculated based on the combined
income & expenses related to the export sales of the U.S. exporter
and the IC-DISC
• IC-DISC may be “Buy-Sell DISC” or (more commonly) “Commission
DISC”
• IC-DISC is allowed to earn net income up to the greatest amount
computed using 3 alternative methods:
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Intercompany Pricing Rules (Cont’d.)
1. “4-Percent of Gross Receipts Method,*
2. 50% of Combined Taxable Income (“CTI”) Method* or,
3. Arms’ Length (or “Section 482”) Method.
 Note-- 4% of gross receipts may not exceed 100% of CTI, and
-- Sec. 482 method is only elected if the IC-DISC has full substance.
* +10% of certain “export promotion expenses” incurred by the IC-DISC itself.
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Contractual Arrangements
& Cash-Flows
The “Related
Supplier”
Not a Taxpayer
Cash $$$
(IC-DISC Commission)
Partnership
or S-Corp.
*
Services
IC-DISC
Commission
Agreement
Cash $$$
P/S or S Corp.
S/H’s taxed on
Flow-thru’s income
(Dividends)
* With C corp. as IC-DISC S/H, only deferral is possible (deduction & eventual dividend are
presumed to be at the same corporate rate). But S Corp. or P/S—w/ individuals as owner(s)-creates permanent savings due to rate differential on qualified dividend *** portion of flows .
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THE “50-50” COMBINED TAXABLE INCOME
METHOD
 Under this method, the transfer price for a sale by the exporter to the
IC-DISC is the price as a result of which the income of the IC-DISC will
not exceed the sum of 50% of the combined taxable income of the ICDISC and the exporter and,
• 10% of export promotion expenses of the IC-DISC.
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THE “4-PERCENT” GROSS RECEIPTS METHOD
 Under this method sale by the exporter to the IC-DISC is the price as a
result of which the income of the IC-DISC will not exceed the sum of
4% of the qualified export receipts of the IC-DISC and the exporter,
and
• 10% of the export promotion expenses of the IC-DISC.
**In no case may the 4% of gross receipts method result in a profit to
the DISC greater than 100% of the CTI from the transaction.
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GROSS RECEIPTS OVER
$10 MILLION ANNUALLY
• Exceeding the annual $10,000,000 qualified export receipts cap will
render remainder of the export income as deemed to have been
distributed at the close of the year.
• Not a bad result because of the maximum 23.8% tax rate on qualified
dividends. ***
*** Maximum rate only applies to families with over $450,000 of income.
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Export Promotion Expenses
• Defined: IRC Sec.994(c) & Regs.1.994-1(f).
• Include costs incurred by the DISC for:
--Packaging
--50% of freight on US flagged vessels
--Commissions paid to unrelated persons on export sales
--Other expenses that advance the distribution or sale of export
property for use, consumption, or distribution outside of the
United States.
• This is often not claimed in practice because there are few
US vessels carrying freight and the remaining costs are small
and having a DISC incur them could be disruptive from a
business standpoint.
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“Grouping” Can Be a Powerful Tool When Using
the Administrative Pricing Rules (Treas. Reg. 1.994-1(c)(7))
• Treas. Regulations permit taxpayers to group transactions rather than
compute allowable commission on a transaction-by-transaction basis.
• Permissible groupings include: product, product-line, customer, contract,
country, or other recognized industry or trade usage.
• Groups may be as large as Two-digit “SIC” Code or as narrow as taxpayer
chooses.
• Groupings elections may be made annually and apply for the year made
only.
• Use of grouping elections is most helpful when there is significant
variability in gross profit margin within a company’s export transactions.
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Marginal Costing Rules May Also Be Helpful In
Maximizing IC-DISC Income Under Admin. Pricing Rules
(Treas. Reg. 1.994-2)
• Full-costing is the general rule for computing the inter-company transfer price in
arriving at allowable IC-DISC income from a transaction (or group) of transactions.
• The Treas. Regulations permit the taxpayer to use “marginal” costing, which takes
into account only the direct labor and material costs of a transaction, if the
taxpayer is seeking to “establish” or “maintain” a market abroad for its exports.
-- It is virtually impossible NOT to meet this definition. It is met whenever the
50% CTI method is applied and marginal costing yields a higher result.
• If marginal costing is used, it is limited by the overall profit percentage (“OPPL”) of
the taxpayer’s full-cost taxable income from the global sales of the same product
(or other grouping of transactions). And the same transactions must be grouped
in the same way when computing both the full costing CTI and the OPPL.
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A FEW FINAL POINTS
• Separate set of books and records for IC-DISC is usually a spread sheet
working trial balance with adjusting journal entries.
• Substance relaxation rules for DISC in US Treasury Regs. No DISC
employees required.
• Customers don’t even have to know DISC exists when a Commission
DISC is used.
• IC-DISC enters Commission/Service Agreement with Related Supplier
for most actions.
• Bank Account used for annual check swap and dividends--very little
activity occurs inside the DISC itself.
• DPAD can still be claimed in addition to DISC benefit. BUT each
depends on the amount of the other.
• Must abide by the rules regarding International Boycotts. (Form 5713)
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APPLICABLE FORMS & SCHEDULES
• 1120-IC-DISC
• http://www.irs.gov/pub/irs-access/f1120icd_accessible.pdf
• 1120-IC-DISC-SCH P
• http://www.irs.gov/pub/irs-pdf/f1120idp.pdf
• 1120-IC-DISC-SCH K
• http://www.irs.gov/pub/irs-access/f1120idk_accessible.pdf
• 1120-SCH N- Foreign Operations of US Corps.
• http://www.irs.gov/pub/irs-access/f1120sn_accessible.pdf
• FORM 5713- International Boycott Report
• http://www.irs.gov/pub/irs-pdf/f5713.pdf
RECAP:
• Continued rate differential between qualified
dividends and income with a closely held IC-DISC:
-- Means $$$$ of Permanent Tax Savings
• With Option to Retain and Reinvest Profits in
Expanding Export Business-- Federal Income Tax
Deferred at Attractive T-Bill Rate (0.16 % for 2012)
• Need to Form New Domestic Entity and Make
Elections NOW!!!
• No guarantee IC-DISC provisions will remain in place
beyond 2014.
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Thank You!
Alabama International Trade Center
800-747-2482
http://aitc.ua.edu
Ed Dwyer & Alex McGowin
Mail: P. O. Box 3057 Daphne, AL 36526
Office Address: Stonebrook Business Park
23210 US Hwy 98- Ste A-2
Fairhope, AL 36532
Phone: (251)
401-4010
Phone: (251) 232-7115
E-mail: [email protected]
E-mail: [email protected]
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