Cross Border Finance Lawyer

This blog addresses topics that will help businesses navigate U.S. laws and regulations governing matters that can create great opportunity and risk for any financial transaction that crosses borders.

About The Author

Benjamin Snipes, Esq. specializes in international commerce, taxation and investment, especially the U.S. tax implications of cross-border business activity.  He advises publicly-traded and private companies in commercial transactions, global regulatory compliance, and international tax.

He is particularly interested in international corporate tax, U.S. Federal securities law, U.S. taxation of international shipping, governmental business development programs, and international finance.

ARTICLES

These publications do not constitute legal advise.  Further information regarding this notice.

Federal Income Tax Exemption Analysis

By Benjamin Snipes, Esq., 2012/02/09

Readers advising or working for foreign governmental institutions should note that on November 2, 2011 the IRS proposed new regulations under §897. These changes allow government-owned entities and public international organizations (PIOs) to hold an interest in U.S. real property, while still maintaining their overall tax exempt status for non-commercial, investment income. The rules prior to this change classified any government controlled entity or PIO that had a net lease or owned U.S. real property a “commercial entity” whose U.S. investment income would be subject to U.S. taxation.

However, even under the proposed regulations, government controlled entities or PIOs will still lose their U.S. tax exemption for U.S. investments if a preponderance of their real estate and business assets consists of U.S. real property. The U.S. federal income taxation of these entities now largely depend on how much U.S. real property they own and what other commercial activities they perform.

Foreign government controlled entities or PIOs must be mindful that even if they maintain tax exempt status, under §1445 (FIRPTA) any gain received from the sale of the U.S. property will be subject to U.S. federal withholding or income taxes. Buyers of U.S. real property from any foreign sellers must automatically withhold 10 percent of the sale price, unless the foreign seller meets an exception provided under U.S. law or treaty or elects to be treated as a domestic U.S. corporation. Thus, U.S. federal taxation of the gain on U.S. property will depend on whether the governmentally controlled entities or PIOs are treated as resident in the U.S. and the terms of any applicable treaties.

U.S. state and local government rules and regulations applicable to these matters often differ substantially with those of the U.S. federal government, depending on where the U.S. real property is located. The reader should consult with a tax advisor regarding the state, local, or municipal sales, property or use taxes related to the planned acquisition and use of U.S. real property in addition to the federal rules.

The American Business and Export Credit Agencies

By Benjamin Snipes, Esq, 2012/02/2

This article introduces the role of export credit agencies, otherwise referred to as “ECAs,” to US-based businesses looking to enter foreign markets. The US ECAs include the Overseas Private Investment Corporation (OPIC) and Export-Import Bank (EXIM). US persons interested in using the services of US ECAs should understand that they often provide credit indirectly in the form of loan guarantees to private lenders, rather than through direct loans to businesses. Also, ECAs often provide far more services than direct or indirect credit to businesses looking  abroad, because they exist for the public purpose of expanding cross border business overall. Beyond financing, ECAs also provide various forms of insurance to cover risks unique to cross border business, such as political risk insurance to cover trade in countries with unstable governments.
The political justification for governmentally backed trade agencies is largely nationalistic. Free trade principles argue that nations create the greatest utility through the free exchange of goods absent governmental intervention[1]. However, in an imperfect world where governmental ECAs and sovereign wealth funds have an increasing influence on the global economy, the USA like many other nations supports domestic exports through its ECAs.

ECAs are still public enterprises, however, and must provide their programs within certain mandates. For example, OPIC’s stated mission is to both solve critical world challenges and advance US foreign policy. The EXIM’s mission is to provide trade financing not otherwise provided in the private sector and enhance US companies’ commercial competitiveness. While the services of  ECAs do interfere to some extent with non-governmental market function, their stated aim is to provide services not otherwise adequately found in the private sector to further humanitarian or nationalistic goals. In a world where most major trading partners use their ECAs extensively, the US’s use of ECAs  in its international trade commitments makes sense. It allow the US and its exporters to at least match the market distorting aspects of international ECAs, and resolve otherwise unmet financing needs.

IC-DISCS: Producer’s Loans and Aggregate Deferral Limits

By Benjamin Snipes, Esq., 2012/01/26

This is the last in a series of articles describing a combination of resources available to small and medium sized US-based businesses exporting to foreign markets, through a range of US tax incentives and governmental financial and insurance products.

Last week, we discussed IC-DISC tax benefits for C-corporations and pass-through entities, and I will conclude by addressing “Producer’s Loans” and deferral limits.

Congress created an additional benefit to forming IC-DISCs in its taxation of the loans, termed “Producer’s Loans”, which are issued by IC-DISCs. A Producer’s Loan is the IC-DISC’s retained income, which may be loaned back to the affiliated exporting company. The exporting company may not only use this loan without actually distributing it, but may also deduct the interest paid for the Producer’s Loan as IC-DISC qualified export receipts. The exporting company affiliated with an IC-DISC, either as a parent or under common ownership, may decrease its cost of capital by borrowing against the retained, untaxed earnings of the IC-DISC by way of the Producer’s Loan. The interest paid back to the IC-DISC will receive the same benefits as the other qualified export receipts allocated to it, thereby providing the deferral and distribution benefits described above.

Finally, while the US tax code generally restricts the qualified export receipts eligible for IC-DISC tax exemption and deferral to an aggregate of $10,000,000, the IC-DISC may increase that limit through other types of export related income. These additional categories of income include the sale of export related receivables by the exporter to the IC-DISC and promotional activities the IC-DISC may perform on the exporter’s behalf on a cost plus 10% basis.

This series described the U.S. sponsored tax benefits available for U.S. exporters to defer and reduce US taxes on their export related income by forming an IC-DISC. I addressed ways to maximize the gains available through proper legal structuring and accounting of export transactions through the IC-DISC, which and benefit small and medium businesses by producing more available capital and higher returns to shareholders.

An Introduction to US Governmentally Sponsored Tax, Finance and Insurance Benefits for U.S. Exporters: C corporations and pass-through entities

By Benjamin Snipes, Esq., 2012/01/19

 A C corporation forming an IC-DISC will only receive tax benefits, other than deferrals, if the IC-DISC distributes its income back to individual shareholders. This can be done directly or through a pass-through entity.

In fact, on a strictly dollar basis, a C corporation would be worse off with an IC-DISC, since it must pay an interest charge on the deferred income in addition to the corporate level taxes it already pays. This interest charge must be weighed against the company’s cost of capital in relation to deferring taxes on the IC-DISC’s income, which is naturally greater than the T-Bill rate for every private corporation. This benefit is strengthened by the fact that a C corporation can currently employ the deferred, retained earnings of the IC-DISCs in the form of a low cost “Producer’s Loan”, which I will discuss next week.

Alternatively, an IC-DISC can be formed by a pass-through entity or as a sister company to the exporting company by its shareholders, to achieve greater tax benefits from the IC-DISC.

When formed by the exporter’s shareholders so that the IC-DISC’s dividends will be distributed back to them, the tax benefit will lie in the difference between the qualified individual dividend rate of 15% and the exporter’s corporate tax rate on that income, as well as the removal of the second of level of taxation at the corporate level. This same effect may be obtained through direct ownership of the IC-DISC by the exporting corporation, if the exporter is itself a pass-through entity such as a partnership or S corporation. However, for the balance of this discussion, we will describe the structure as if the IC-DISC is directly owned by shareholders, since the consequences apply equally under both scenarios.

People often quote the US corporate tax rate to be an automatic 35%, but it is in fact a graduated marginal rate that only consistently applies a 35% rate to taxable corporate income of $18,333,333 or more. Marginal rates are graduated so the effective corporate tax rates range from 15% to 35% on incomes below $18,333,333. The table below shows the exact distribution of these ranges:

Corporate Taxable Income Brackets	Corporate Tax Rate Range per Bracket
0 to 50,000	15%
50,000 to 75,000	15% to 18.33%
75,000 to 100,000	18.33% to 22.25%
100,000 to 335,000	22.25% to 34%
335,000 to 10,000,000	34%
10,000,000 to 15,000,000	34% to 34.33%
15,000,000 to 18,333,333	34.33% to 35%
18,333,333 and up	35%

As one can see, the IC-DISC tax benefit of a lower 15% qualified dividend rate only exists for a corporation’s marginal taxable income above $50,000, which then gradually increases to 20% (35% – 15%) for corporate taxable income exceeding $18,333,333.

The tax gain above $50,000 in taxable income described above must be tempered against a real possibility that the qualified dividend rates will not be extended past 2012. Given the tax debates occurring in Washington, determining future dividend tax rates is currently a guessing game. Nonetheless, when one considers that the IC-DISC’s parent income will be taxed again at the shareholder level if retained by the parent exporting corporation, the case for the IC-DISC is compelling whether or not individual shareholders receive the qualified dividend rate.

For example, qualified export receipts received by the IC-DISC below $10,000,000 will not be taxed at the IC-DISC level, and will only be taxed when distributed to the individual shareholders. Otherwise, without the IC-DISC subsidiary, the IC-DISC income would have been taxed twice, once at the marginal corporate rates in the parent company’s hands and again in the individual shareholders’ hands. The IC-DISC effectively collapses two levels of taxation into one, at the marginal individual rate. The savings occur in the difference between the individual marginal tax rate on the income, or whatever rate is applicable to the dividend income for individuals, and the marginal corporate tax rate then in effect.

So presuming again that the current qualified dividend rate applies, and the marginal corporate tax rates remain the same, the potential IC-DISC gains add up to quite a bit more than 20% in  the elimination of the corporate layer of taxation.

To quantify this, the maximum marginal corporate tax rate of 35% combined with a 15% shareholder level taxation equals a total taxation of 44.75% ((0.35X + (.65X *.15))/X). For marginal corporate income at $50,000 or more, the tax benefit for using an IC-DISC for qualified export receipts will gradually increase to 29.75% (44.75% – 15%) at marginal corporate income of $18,333,333 or more.

Of course, the specific tax benefit depends on what the exact rates are. Ultimately, however, the savings inherent in  reducing two levels of taxation into one will apply regardless of what specific rates Congress ultimately sets for individually received dividends and corporate income.

An Introduction to US Governmentally Sponsored Tax, Finance and Insurance Benefits for U.S. Exporters: Tax Effects of IC-DISC Income to the Exporter and IC-DISC Shareholders

By Benjamin Snipes, Esq., 2012/01/12

Last week, I discussed some of the technicalities of qualifying an IC-DISC and the processes of accounting for qualified receipts. Once the IC-DISC is formed and qualified, it can then broker export transactions or buy/sell the exported products with  foreign purchasers. The US producer will pay the IC-DISC a commission or have the IC-DISC generate a buy/sell margin with the foreign sales. Either way, the US tax code directs the deferred earnings the IC-DISC may receive by a formula, and the exporter may deduct if paying commissions, under three the separate methods I described in my last post.

Generally, IC-DISC dividend distributions are the same as all other dividends under the Code. So, both individual IC-DISC shareholders and shareholders receiving the IC-DISC distributions through a pass-through entity, will receive the favorable 15% tax rate for “qualified” dividend income under §1(h)(11) of the Code.

While a corporate IC-DISC shareholder may deduct the sales commissions it pays to the IC-DISC, it may not otherwise deduct the IC-DISC dividends under the dividend received deduction rules of §243 of the Code. This section prevents multiple layers of corporate tax from applying between parent and subsidiary companies.

Ultimately IC-DISC benefits reside in either tax deferral for corporate, pass-through, or individual shareholders, or a reduced tax rate and elimination of  second levels of corporate taxation for individual recipients of IC-DISC dividends. The tax benefits for individual IC-DISC shareholders can be quite significant, however, in that it  removes the double taxation that would  occur on  income if it was first received by the exporting corporation before it was  distributed to the exporting corporation’s shareholders.

IC-DISC Formation and Accounting

By Benjamin Snipes, Esq., 2011/12/29

A US exporting corporation forms an IC-DISC in one of two ways. It incorporates a subsidiary for the sole purpose of serving as the IC-DISC, or the individual shareholders form the IC-DISC as a commonly controlled sister entity to the exporting corporation.

The IC-DISC must meet certain minimal capitalization requirements. It must elect its status as an IC-DISC by filing a Form 4876-A with the IRS up to 90 days before the beginning of the tax year for the IC-DISC corporation.

An exporting company qualifies an IC-DISC through two criteria: a “qualified export receipts test” and a “qualified export assets test.”

1. The qualified export receipts test measures whether 95 percent or more of the IC-DISC’s gross receipts during the tax year includes income from the sale, lease, servicing or management of exports, or construction-related services outside the US. This income may also include indirect income on export related assets, such as dividends from an export controlled foreign corporation or interest on export related debt.[1]
2. The qualified export assets test measures whether 95 percent of the “adjusted basis” of the IC-DISC’s assets were “qualified export assets.” Qualified export assets include property with at least 50% US content that directly or indirectly contributes to the production of the qualified export receipts.

Once the exporter establishes a qualified IC-DISC, the exporter calculates the maximum amount it may deduct for qualified export receipt income paid to an IC-DISC by one of three methods, which are the greater of:

1. 4% of qualified export receipts of the IC-DISC, plus 10% of export promotion expenses;
2. 50% of combined taxable income of the exporting corporation and IC-DISC, plus 10% of export promotion expenses; or
3.  100% of the IC-DISC’s taxable income based on the actual sales price of the exported products, subject to adjustments under the §482 transfer pricing rules.

An IC-DISC may use any of these three methods for calculating its qualified export receipts, and may also apply these methods along product, industry, trade usage, or transactional lines to maximize the IC-DISCs benefits. Transactional level IC-DISC calculations may significantly increase the IC-DISC benefit by maximizing the above ratios through alternative groupings of revenue and expenses.

The US tax code subdivides IC-DISC income into

1. accumulated income,
2. previously taxed income, and
3. other earnings and profits.

The IRS deems any income earned by IC-DISCs that does not qualify for tax deferral as “deemed” distributed dividends in the tax year in which the IC-DISC earns it. It is then taxed as the as received dividends. These deemed distributed dividends increase the IC-DISC’s account for previously taxed income, but do not otherwise reduce the reported taxable earnings and profits. The remaining accumulated IC-DISC income constitutes qualified export income on which US taxes may be deferred so long as the IC-DISC company retains the income, and the IC-DISC’s shareholders pay the related interest charges for the deferral.

When sold, the IC-DISC will be taxed on the gain or loss realized on property that is not “qualified export assets.” Further, when the IC-DISC’s shareholders sell the IC-DISC’s stock, the shareholders will recognize gain as a dividend notwithstanding any other provision of the US tax code.

US Governmentally Sponsored Tax, Finance and Insurance Benefits for U.S. Exporters: IC DISCs

By Benjamin Snipes, Esq., 2012/12/15

This article describes a combination of resources available to small and medium sized US-based businesses exporting to foreign markets, through a range of US tax incentives and governmental financial and insurance products. Many small to medium size businesses do not utilize these governmental resources at all, or at least not to the extent they otherwise could, so I am going to outline some of these options in a series of posts.

I’ll start today with a brief history of DISCs and the tax benefits they offer US exporters. Congress first created Domestic International Sales Corporations (DISCs) in 1971 as special purpose companies. This distinction allows US exporting companies to legally defer and reduce taxes on export related income. Congress was hoping to promote economic growth, as well as create tax parity with foreign exporters receiving value added tax benefits on border taxes.  Congress and the IRS eventually eliminated the tax benefits of DISCs to large US exporters. Other nations complained over the intervening decades that DISCs violate WTO agreements prohibiting governmental market interference. An income tax regime referred to as “IC-DISCs” is the current result of the WTO dispute process provided by the US government  that allows U.S. exporters to defer recognition on a maximum of $10,000,000 in “qualified export receipts,” which may be calculated under a several different formulas.

The term “IC-DISC” originates from the 1984 Deficit Reduction Act (DEFRA) that added an “Interest Charged” component to the DISC regime. An IC-DISC modifies the DISC structure by levying a small tax in the form of an interest charge at the US T-Bill rate on the deferred income held within the IC-DISC, which is currently a fraction of a percent.

Individuals and pass-through entities form most IC-DISCs directly, because IC-DISC income may be received by individuals at the 15% qualified dividends rate. The most recent 2008 IRS statistics report that out of the approximately 1,917 IC-DISCs, 86.1% of them were majority-owned by individuals, partnerships, trusts, estates, or S corporations. IC-DISCs received $4.7B in gross receipts, with $4.5 in deferred taxable income1.

US exporters benefit from IC-DISCs primarily through two mechanisms. First, they allow the indefinite deferral of taxation on qualified US export receipts, subject to a negligible interest charge. Second, they enable companies to both deduct payments to IC-DISCs and distribute that income to common shareholders of the exporting company and IC-DISC at the 15% qualified dividend rate. While the favorable 15% qualified dividend rate may not be provided by Congress in the future, this distribution benefits IC-DISC owners regardless by effectively bypassing corporate level taxation on the IC-DISC income, and allowing for a single level of taxation on income in the hands of individual shareholders.

Cross-Border Finance Lawyer

By Benjamin Snipes, Esq., 2012/12/15

The U.S.laws related to international finance and the taxation of financial transactions create interesting challenges for those managing ventures that cross U.S. borders. The U.S. frequently enacts or amends sweeping legislation directed at the financing and taxation of cross-border transactions. These laws and regulations make the management and execution of international business somewhat treacherous without experience and professional guidance.

This blog addresses topics that will help businesses navigate U.S. laws and regulations governing matters that can create great opportunity and risk for any transaction that uses finance and crosses borders.

IMPORTANT NOTICE TO READERS

The information contained on this blog is not legal advice.  It is provided only as general information, and may or may not reflect the most up-to-date legal developments.  This information is not provided in the course of, and receipt of it does not constitute, an attorney-client relationship.  It certainly does not substitute for obtaining legal advice from a licensed attorney.  Legal advice should take into account the specific facts and circumstances applicable to each individual situation.  Viewing this site and reading this blog does not create an attorney-client relationship between you and our firm.  Likewise, sending me an email does not create an attorney-client relationship between you and the firm.   While I would be happy to hear from you, Flott & Co. PC cannot represent you until we have determined that doing so will not be a conflict of interest.  The only way for you to initiate legal representation with the firm is to call me at (703) 525-5110 (X123).  If and when Flott & Co. PC enters into an engagement agreement with you, you will be a client of the firm, at which time we will be able to exchange information freely.

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