A Business On Paper

Foreign Affair

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.

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This article was originally published in the February 2000 print edition of Entrepreneur with the headline: A Business On Paper.

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