Reduce Your Income Tax Rate on Export Sales and Other International Tax Issues GALLINA LLP Largest accounting firm (most CPAs) in the Sacramento region One of the10 largest accounting firms in the State of California and a top 100 firm nationally and growing Full service Several teams of specific industry specialists 2014 Corporate Citizen of the Year recipient from the Boy Scouts of America, Golden Empire Council 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 Wutkee Senior Manager GALLINA LLP Email: [email protected] Phone: (916) 784-7800 www.gallina.com IC-DISC Interest 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 ICDISC, 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 ICDISC 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-DISC Shareholder Owned (C or S Corporation) Shareholder U.S. Export Corporation Export sales Customer Commission Payment IC-DISC Services IC-DISC S-Corporation Owned Shareholder U.S. Export Corporation Export sales Customer Commission Payment Services Dividend IC-DISC 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 intercompany 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 1,300 4% Gross Receipts 50% FC CTI 600 (15,000 * 4%) $650 (1,300 * 50%) Transaction by Transaction (TxT) Optimization 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) 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 Transaction Commission 200 (4% G.R.) $950 46% 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 ICDISC. • 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 Bellows Tax Partner GALLINA LLP Email: [email protected] Phone: (916) 784-7800 Twitter: RE_Const_CPA www.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 Fact Set $USD Larry Taylor Contracting, Inc. • U.S. based window subcontractor • Importing from China U.S. Revenue $10,000,000 Window Frames $5,000,000 Chinese Tax Rate 10% U.S. Tax Rate 35% Before (without transfer pricing) Larry Taylor Contracting, Inc. Buying semi-finished frames $500 per frame 10,000 units Total- $5M per year Semi-finished frames Revenue- $10M Expense- $5M Taxable income- $5M Chinese Supplier After (with transfer pricing) Larry Taylor Contracting, Inc. Semi-finished frames Buying semi-finished frames $650 per frame 10,000 units Total- $6.5M per year Revenue- $10M Expense- $6.5M Taxable income- $3.5M China Supplier Buying semi-finished frames $500 per frame 10,000 units Total- $5.0M per year Semi-finished frames Larry’s Subsidiary Transfer Pricing Inbound Example Transfer Pricing Inbound Example Before (w/o TP) $USD U.S. Revenue $ 10,000,000 U.S. Expenses $ U.S. Net Income U.S. Tax (35%) Worldwide Total Tax After (w/ TP) $USD U.S. Revenue $ 10,000,000 5,000,000 U.S. Expenses $ 6,500,000 $ 5,000,000 U.S. Net Income $ 3,500,000 $ 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 $ 1,375,000 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 $ 1,750,000 Outbound Transfer Pricing Example ACME Manufacturing, Inc. Selling Electrical Components to China Fact Set $USD Component Sales $50,000,000 Expenses $25,000,000 Chinese Tax Rate 10% U.S. Tax Rate 35% Before (without transfer pricing) ACME Manufacturing, Inc. Selling electrical components $1,000 per component 50,000 units per year Total- $50M revenue annually Electrical components Revenue- $50M Expense- $25M Taxable income- $25M Chinese Buyer After (with transfer pricing) ACME Manufacturing, Inc. Electrical components Selling electrical components $700 per component 50,000 units Total- $35M per year Revenue- $35M Expense- $25M Taxable income- $10M Chinese Buyer Selling electrical components $1,000 per frame 50,000 units Total- $50M per year Electrical components ACME’s Subsidiary Transfer Pricing Outbound Example Transfer Pricing Outbound Example 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 $ 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 Worldwide Total Tax $ 8,750,000 Any Questions? ? FBAR Filing Requirements Robby Walker Partner GALLINA LLP Email: [email protected] Phone: (916) 784-7800 www.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 NonWillful 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 = Foreign ii. U.S. Branches of Foreign Banks = Non-Foreign 2. Financial Accounts i. Checking, Deposit, Savings, Securities, Brokerage, Demand, Time Deposit ii. Commodity Futures or Options Account iii. 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 Apply iv. Annuity Policy with Cash Value v. 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 Filings 1991: 116,600 2001: 177,151 2004: 217,699 2009: 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. 2. 3. 4. 5. 6. 7. 8. Form 926 – U.S. Transferor of Property to a Foreign Corporation Form 2555 – Foreign Earned Income Exclusion Form 5471 - Information Return of U.S. Persons With Respect to Certain Foreign Corporations Form 5472 - Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business Form 8865 - Return of U.S. Persons With Respect to Certain Foreign Partnerships Form 8858 - Information Return of U.S. Persons With Respect To Foreign Disregarded Entities Form 3520 – Return for Foreign Trusts and Receipt of Certain Foreign Gifts Form 3520-A - Annual Information Return of Foreign Trust With a U.S. Owner Any Questions? ?