Exporting Manufacturers Gain Tax Savings Potential

Sept. 2, 2012
Goods sold through an IC-DISC must be manufactured, produced, grown, or extracted within the U.S. For example, Canadian wood pulp that is transformed into paper at a plant in the United States would meet that standard.

A closely held U.S. manufacturer with export sales should consider the tax advantages associated with establishing an IC-DISC, or Interest Charge—Domestic International Sales Corporation. Considerable potential tax incentives and the ability to pass on income are two of the benefits. But there are specific requirements for participation.

Export sales from the parent company pass through the IC-DISC, which exists as a separate entity. The parent company pays sales commissions to the IC-DISC, based on either 4 percent of gross receipts or 50 percent of net foreign sales. The commissions are then passed on as dividends to IC-DISC shareholders, who do not have to be parent company shareholders.

Paying commissions to an IC-DISC reduces the parent company’s level of ordinary income—income potentially subject to a 35 percent tax rate. The IC-DISC beneficiaries or individual shareholders are then subject to a 15 percent dividend income tax rate for the payments received.  Up to $10 million per year in export sales can be conducted by the IC-DISC.

Export Sales Requirements
Goods sold through an IC-DISC must be manufactured, produced, grown, or extracted (MPGE) within the United States. That is one of three requirements for qualified export sales.

Various items that undergo “substantial transformations” meet that MPGE requirement. Food purchased from a Mexican entity would meet that requirement if processing and canning functions are performed by a company in the United States. Canadian wood pulp that is transformed into paper at a plant in the United States would likewise meet that MPGE standard.

The second qualified export sales requirement specifies that no more than 50 percent of the fair market value of the goods being sold can be attributable to foreign materials. That provision could bar a manufacturer from qualifying for an IC-DISC if it mostly performs simple assemblies of parts produced in other countries.

The third qualified export sales requirement specifies that the product must be sold or leased for direct use, consumption or disposition outside the United States. Goods sold to a freight forwarder or distributors qualify for IC-DISC commissions if those goods are sold to a foreign customer within one year.

The commission requirements also include a safe harbor provision that applies when conversion costs (direct labor and factory burden, including packaging or assembly) account for 20 percent of the cost of goods sold (COGS) or inventory costs.

Entity Requirements
An IC-DISC must be a U.S. entity with at least $2,500 in capitalization, and it must have a timely election. At least 95 percent of FTGR must be from qualified export sales, and at least 95 percent of total assets must be qualified export assets on the close of each tax year.

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Because IC-DISC shareholders do not have to be parent company shareholders, commissions can be used to provide compensation to company founders, retired employees or past owners. The commissions may also function as bonus payments for parent company employees or shareholders. 

To form an IC-DISC, a manufacturer must carefully evaluate its products and sales, and determine the most advantageous commission methodology. Detailed documentation of sales and commission activities is then required to maintain eligibility. The considerable potential tax incentives and the ability to pass on income, though, make it worthwhile for an exporting manufacturer to further evaluate establishing and sustaining an IC-DISC.

>> Mary K. Thomas, CPA, JD is the partner-in-charge of Weaver’s international services for Weaver, the largest independent accounting firm in the southwest with offices throughout Texas. She can be reached at 972.448.6965 or [email protected].

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