IC-DISC Benefits Enhanced with Foreign Shareholders

by Bilzin Sumberg Baena Price & Axelrod LLP
Contact

Since the reduction in the individual tax rate on qualified dividends in 2004, the Interest Charge Domestic Sales Corporation (“IC-DISC”) has become an attractive vehicle to obtain a tax incentive for exporting U.S.-produced goods.  For individual U.S. and foreign taxpayers, the use of an IC-DISC reduces tax liability by converting a portion of the export income, normally taxable at ordinary income rates of up to 39.6%, into qualified dividend income, generally taxable at rates up to 20%.  For foreign taxpayers residing in treaty jurisdictions, however, the benefits may be even greater. If the dividends are subject to a relatively low rate in the foreign jurisdiction, a foreign individual could reap a considerable tax benefit by reducing the taxable income of the U.S. exporter company, while receiving dividends subject to tax at a reduced rate under the treaty.

IC-DISCS Generally

An IC-DISC is a tax-exempt domestic corporation generally set up by the exporter company to receive commissions on the exporter company’s sales.  The IC-DISC is required to maintain a separate bank account, keep separate accounting records, and file an annual U.S. income tax return.  It is not, however, required to maintain an office, employees, own tangible assets, or perform any services.  The types of businesses that typically benefit from an IC-DISC structure are manufacturers that directly export their products, manufacturers that sell component parts that are included in exported products, and architectural and engineering firms that work on projects that will be constructed abroad (even though the services may be performed in the United States).

Qualifying as an IC-DISC

To qualify as an IC-DISC a domestic corporation must file an election with the IRS to be treated as an IC-DISC for U.S. federal income tax purposes.  In addition, the corporation must have only a single class of stock, maintain a minimum capitalization of $2,500 of authorized and issued shares, and meet an annual qualified export receipts test and a qualified export assets test.  In order to meet the qualified export receipts and qualified export assets tests, at least 95% of the IC-DISC’s gross receipts and assets must be related to the export of U.S. manufactured property whose value is at least 50% attributable to U.S.-produced content.  Engineering and architectural services related to construction projects outside the United States may also generate qualified export receipts.

IC-DISC Tax Benefits

Under an IC-DISC structure, an exporter company sets up an IC-DISC owned either by the exporter company itself (if it is a flow-through entity) or by the shareholders of the exporter company (if it is a corporation).  The exporter company pays commissions to the IC-DISC equal to the higher of: (i) 4% of the gross receipts from qualified exports, or (ii) 50% of the net income from qualified exports.  The commissions are tax-deductible to the exporter company and can be used to reduce the exporter’s taxable income at rates up to 39.6%.  The IC-DISC, as a tax-exempt entity, pays no tax on the commission income. 

The IC-DISC can then either defer taxation on the commission income (up to $10,000,000) or distribute the income to its shareholders.  If the income is deferred, the IC-DISC shareholders are required to pay only a nominal interest charge to the IRS with respect to taxes that are deferred on the IC-DISC’s income.  Alternatively, the IC-DISC can distribute the commission income to its shareholders as a dividend.  If those shareholders are U.S. individual taxpayers, they will be subject to tax at the qualified dividend rate of up to 20% (plus an additional 3.8% tax which applies to net investment income if the taxpayer’s adjusted gross income exceeds certain thresholds). 

IC-DISC Taxation of Foreign Persons

Foreign persons are generally subject to U.S. federal income tax in one of two ways.  First, if a foreign person carries on a trade or business in the United States, U.S. federal income tax is imposed on all taxable income that is effectively connected with that U.S. trade or business (“ECI”). In addition, income of a foreign person which is not effectively connected with a U.S. trade or business is subject to U.S. federal income tax if it is considered to be from sources within the United States and is of certain classes of income known as “fixed or determinable, annual or periodical” (“FDAP”) income.  FDAP income includes, for example, interest, dividends, rents, and royalties.

By definition, foreign persons are subject to tax on FDAP income only if it is U.S.-source income.  Likewise, even when a foreign person carries on a trade or business in the United States, foreign-source income is generally not treated as ECI as long as property is sold for use outside of the United States.   Thus, under many circumstances, foreign-source income escapes taxation completely.  While Section 861(a)(2)(D) treats dividends received from DISCs that are attributable to export sales as foreign source income for U.S. shareholders for foreign tax credit purposes, Section 996(g) provides that in the case of a foreign shareholder, all DISC distributions are treated as ECI earned through a permanent establishment and derived from sources within the United States.  Consequently, dividends received by foreign shareholders from an IC-DISC will be subject to tax at the usual marginal tax rates applicable to U.S. taxpayers, which means that foreign individuals are eligible for the same qualified dividend rates of up to 20%.  

Tax treaty provisions may, however, apply to reduce dividend taxation, in many cases to as low as 5%.  There is nothing in the IC-DISC provisions or the legislative history which specifically states that the IC-DISC rules are intended to override subsequent federal income tax treaties.  A number of treaties have since come into effect containing provisions that are inconsistent with the IC-DISC concept of deemed permanent establishment.  Under those treaties, there can be no permanent establishment in the absence of an actual physical presence in the United States.  As a result, the language in the IC-DISC rules which deems a foreign person to have a permanent establishment in the United States may be inconsistent with the treaty and thus overruled by the treaty.  Whether a specific treaty overrides the IC-DISC deemed permanent establishment rule must be determined on a case-by-case basis.  If the treaty’s language does prevent a permanent establishment, the treaty’s regular dividend provisions should apply, which would reduce the U.S. income tax on dividends to as low as 5%.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Bilzin Sumberg Baena Price & Axelrod LLP | Attorney Advertising

Written by:

Bilzin Sumberg Baena Price & Axelrod LLP
Contact
more
less

Bilzin Sumberg Baena Price & Axelrod LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.