Large multinationals do it, even midsized exporters do it--so why shouldn't you take advantage of a tax incentive designed to reduce federal taxes on the profits your company earns from exporting products?
If your company is organized as a regular corporation and your products have 50 percent U.S. content, you can establish a foreign sales corporation (FSC) to lower your income tax rate on the profits you make from selling these products abroad. According to Philip M. Zukowski, national partner in charge of FSCs for KPMG, as more companies rely on overseas markets for growth, FSCs are gaining in popularity.
Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 13 years.
An FSC is essentially a subsidiary of a parent corporation, but its responsibilities are minimal. U.S. exporters can allocate a portion of export profits to their FSC, even though it may not engage in activities. To qualify for FSC treatment, the destination for the products has got to be outside the United States.
Exactly how much tax savings is involved? The normal rate of income tax on export profits for U.S. corporations is 35 percent, says Zukowski. If a company establishes an FSC, its tax burden will be reduced by 15 percent or more, he says. A company can allocate up to 23 percent of its export profits to the FSC, at which level these profits are taxed at a lower rate.
FSCs work best for companies that have "a high volume of export sales and enjoy a high profit margin," says Saul B. Brenner, a tax partner in charge of foreign taxation for New York City accounting firm David Berdon & Co. LLP.
Take the example of a C corporation that produces software and is thinking about establishing an FSC. In its first year of operation, the company has $10 million in sales, of which about $2 million is profit. Of that $2 million, 40 percent is from international sales. If the company sets up an FSC, it could save approximately $40,000 in taxes.
FSC requirements are easier on small companies. If your company has $5 million or less in export sales, tax law says that less business activity has to take place outside the United States to receive the FSC tax benefit. But smaller businesses must still meet some requirements: they must set up an overseas office, store books and records related to export activity and have foreign members on their FSC board of directors. Companies with more than $5 million in sales must meet those requirements as well as others, such as setting up a foreign bank account.
FSCs are generally established in one of several authorized locations. Popular spots are Barbados and the U.S. Virgin Islands because these locations are acceptable under the U.S. tax code and have special rules on the taxing of FSCs. But it's not necessary to actually go to those spots and physically establish an office there. An FSC can have a shared office that is provided as part of a fee arrangement with an FSC service provider. The provider usually has a space allocated to each FSC and stores the required books and records.
For A Price
The catch is the cost involved in establishing and maintaining an FSC. So make sure the tax benefits will be greater than those costs. For example, normal charges for a management firm and other administrative fees can cost from $5,000 to $20,000 or more per year depending on the size of your company and how much you export, Zukowski says. It's possible to set an office up yourself but that would only cost more.
As is often the case with tax benefits, a cloud looms over FSCs, Brenner says. The European Union has charged that FSCs provide unfair subsidies in violation of the rules established by the World Trade Organization. The EU feels FSCs are purely a bookkeeping arrangement with no substance, says Zukowski. As a result, the EU may seek sanctions of $2 billion against the United States.
Congress may eventually have to limit the use of FSCs. Until that happens, don't miss out on an opportunity to save on products heading overseas.
David Berdon & Co., (212) 832-0400, http://www.dberdon.com
KPMG, (305) 913-2652, email@example.com
PricewaterhouseCoopers, 1301 Aventue of the Americas, New York, NY 10019, (212) 596-7000