IC-DISC Strategies: Mastering the Complex Operational Challenges

Transcription

1 IC-DISC Strategies: Mastering the Complex Operational Challenges Anticipating IRS Audit Risks, Calculating Commissions, and Tackling Computational Intricacies THURSDAY, FEBRUARY 12, 2015, 1:00-2:50 pm Eastern IMPORTANT INFORMATION This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at x10 (or x10). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Record verification codes presented throughout the seminar. If you have not printed out the Official Record of Attendance, please print it now. (see Handouts tab in Conference Materials box on left-hand side of your computer screen). To earn Continuing Education credits, you must write down the verification codes in the corresponding spaces found on the Official Record of Attendance form. Complete and submit the Official Record of Attendance for Continuing Education Credits, which is available on the program page along with the presentation materials. Instructions on how to return it are included on the form. To earn full credit, you must remain connected for the entire program. WHOM TO CONTACT For Additional Registrations: -Call Strafford Customer Service x10 (or x10) For Assistance During the Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.

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4 IC-DISC Strategies: Mastering the Complex Operational Challenges Thursday, Feb. 12, 2015 Neal Block Baker & McKenzie Jerry Jonckheere Plante & Moran Jerry Ogle Ogle International Tax Advisors

5 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 5

6 Today s Program Fundamental Concepts Of IC-DISCs [Jerry Jonckheere] Slide 7 Slide 25 Implementing Various Ownership Structures For IC-DISCs [Neal Block] Slide 26 Slide 69 Compliance And Reporting By IC-DISCs [Jerry Ogle] Slide 70 Slide 82

7 Jerry Jonckheere, Plante Moran FUNDAMENTAL CONCEPTS OF IC-DISCs

8 Domestic International Sales Corporations (DISCs) Background and tax benefits of DISCs General review of tax benefits of DISCs How the DISC came to be Requirements of a DISC Initial requirements Annual requirements Export property Other considerations 8

9 Domestic International Sales Corporations (DISCs) DISC benefit arises as follows: Commissions paid to a DISC reduce taxable profit of related supplier corporation deductions at ordinary rates) DISC is tax-exempt entity Sect. 991 income can be deferred DISC dividends received by individual shareholders are qualified dividends taxed at the capital gains rate Income can be taxed at lower capital gain tax rates 9

10 General Review Of DISCs: Pass-Through Structure Commission reduces taxable profit passed through to S corporation shareholder (up to 39.6% tax savings). Shareholders DISC is not subject to tax. S corporation shareholders pay 20% tax on DISC dividends. Shareholders may be subject to an interest charge for the tax deferral on DISC earnings not distributed Commission S Corporation DISC Dividend 10

11 General Review Of DISCs: C Corporation Structure Commission reduces taxable profit of C corporation (up to 35% tax savings) DISC is not subject to tax C corporation shareholders pay tax at 20% on DISC dividend Shareholders are subject to an interest charge for the tax deferral on DISC earnings not distributed Shareholders C Corporation DISC Commission Dividend 11

12 How DISCs Came To Be 1971: Congress enacted DISC provisions U.S. tax on DISC income was deferred until it was repatriated 1970s 1980s: European Union (EU) challenged DISCs as allegedly violating General Agreement on Tariffs and Trade (GATT) 1984: Congress enacted foreign sales corporation (FSC) provisions FSCs exempted a percentage of export income from income tax DISC was modified to allow deferral of DISC income from annual maximum of $10 million of export receipts but interest charges on deferral (the DISC became the IC-DISC) 12

13 How DISCs Came To Be (Cont.) Late 1990s: European Union (EU) members complain to World Trade Organization (WTO) that FSC represents an illegal export subsidy, but DISC was not challenged 2000: Congress repeals FSC tax scheme and enacts extraterritorial income exclusion (ETI or EIE); EU immediately lodged complaints 2003: Congress enacts favorable dividend tax rates for individuals Tax rate on qualified dividends drop from 35% to 15%, creating an opportunity for permanent savings 13

14 How DISCs Came To Be (Cont.) 2004: Congress repealed ETI 2006: IRS becomes aware of DISC planning and is looking for revenue raising provisions and proposes legislation to treat DISC dividends as not qualified but the legislation is not passed 2007: Repeal of capital gain rate for DISC dividends is proposed but not passed. Dec 31, 2012: Favorable dividend tax rates were to sunset but legislation extends favorable qualified dividend rate Rate increased from 15% to 20% 14

15 Commission DISC vs. buy/sell DISC DISC Initial Set-Up Domestic corporation (C corporation) Must be a domestic corporation incorporated under the laws of any state or the District of Colombia Determine state tax implications Single class of stock $2,500 capital Required by last day to elect IC-DISC status 15

16 DISC Initial Set-Up (Cont.) Form 4876-A election File within 90 days from the beginning of tax year or inception of entity Establish books and records by the end of first year of operation 16

17 DISC Annual Maintenance 95% qualified gross receipts test 95% qualified export assets test $2,500 capital on each day of tax year Timely payment of commission to IC-DISC File IC-DISC income tax return Maintain IC-DISC books International boycott reporting 17

18 DISC Annual Maintenance (Cont.) 95% qualified gross receipts test Qualified gross receipts are at least 95% of IC-DISC gross receipts for the year. Qualified gross receipts: Sale, exchange or other disposition of export property Lease or rental of export property used outside of U.S. Related and subsidiary services Dividends from related foreign export corporation Interest on obligations that are qualified export assets E.g., producer s loans Engineering and architectural services 18

19 DISC Annual Maintenance (Cont.) 95% qualified gross receipts test (Cont.) Other receipts to consider Sales made to U.S. distributors Sales made to foreign disregarded entities Excluded receipts Export property is for ultimate use in the U.S. The sale, lease, etc. is accomplished by a subsidy of the U.S. government. The export property is for the use by the US government, where the use is required by law or regulation. 19

20 DISC Annual Maintenance (Cont.) 95% qualified export asset test At least 95% qualified export assets at year-end are qualified. Categories of export assets Export property Working capital Only amount necessary for required working capital Commission receivable Stock or securities of related foreign export corporation Producer s loans 20

21 DISC Annual Maintenance (Cont.) Commission payment Payment of initial commission estimate within 60 days of DISC s yearend (March 2, calendar year). Any unpaid commission must be paid within 90 days of finalization. Unpaid amount cannot be more than original estimate i.e., estimate must be at least 50% of final. File IC-DISC return (Form 1120-IC-DISC) Due within 8 ½ months of year-end Maintain IC-DISC books and records 21

22 Export Property For DISC ( ) Manufactured, produced, grown or extracted in the U.S. by a person other than a DISC Held primarily for sale, lease or rental for direct use, consumption or disposition outside the U.S. Not more than 50% of fair market value of the export property can be attributable to foreign content. Consider qualified export property sold to U.S. distributors 22

23 Other Considerations DISC commission reduces QPAI deduction. Relates to the deduction for domestic production activities DISC commission reduces profit on foreign title transfer sales. [Sect. 863(b)] May reduce foreign tax credit limitation Provide for deferred tax on accumulated DISC income (FAS 109/APB 23) State income tax considerations 23

24 Problems? Failure to file Form 4876-A timely 9100 relief Distribution needed to meet qualification requirements Deficiency distribution Failure to meet 95% qualified export asset test and 95% qualified gross receipts test, as well as timely paying commission Equal to amount of taxable income attributed to the nonqualified portion Deemed reasonable cause if paid on or before 15th day of ninth month after year or within 90 days of an IRS request If paid after, interest in the amount equal to 4.5% of distribution [ 992(c)(2)(b)] 24

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26 Neal Block, Baker & McKenzie UPDATED IC-DISC OWNERSHIP STRUCTURES AND SAVING THE DISQUALIFIED DISC

27 Overview of this Section Structuring Privately-held company: C Corp, S Corp, partnership, LLC taxed as a partnership Closely Held and Publicly-traded C corporation deferral Individual Retirement Account (IRA) and Roth IRA Estate planning, executive compensation Treaty benefits Sourcing benefits 9100 Relief Saving The Disqualified DISC Additional Qualified Assets and Additional Liabilities Deficiency Distribution 2015 Baker & McKenzie LLP - 27

28 IC-DISC Ownership Structures C Corporation Dividends to C Corp Shareholders subject to corporate tax at approximately 35% Recommended that IC-DISC be owned directly by the individual shareholders of the C corporation so they can avoid double taxation and receive dividends at 23.8% capital gains rate U.S. C Corp Exporter (Related Supplier) Privately-Held Company Individual Shareholders IC-DISC Commission 35% IC-DISC Dividend 23.8% IC-DISC Where Exporter Shareholder include C Corporations, or Tax Exempt Entities, alternative structures may be used for their ownership Baker & McKenzie LLP - 28

29 IC-DISC Ownership Structures C Corporation Privately-Held Company Dividends to C Corp Shareholders subject to corporate tax at approximately 35% Recommended that IC-DISC be owned directly by the individual shareholders of the C corporation so they can avoid double taxation and receive dividends at 23.8% capital gains rate Individual Shareholders IC-DISC Dividend 23.8% U.S. C Corp Exporter (Related Supplier) IC-DISC Commission 35% IC-DISC Where Exporter Shareholder include C Corporations, or Tax Exempt Entities, alternative structures may be used for their ownership Baker & McKenzie LLP - 29

30 S Corporation and LLC Privately-Held Company Dividends pass through the corporation to the shareholders and are deferred from taxes and receive dividends taxed at the 23.8% capital gains rate Individual Shareholders U.S. Exporter (S Corp.) IC-DISC Commission 39.6% IC-DISC Capital Gains Dividend 23.8% 2015 Baker & McKenzie LLP - 30

31 Privately-Held Company Partnership Owned by LLC or S Corporation DISC Dividends pass through the partnership to the partners and shareholders of the S corporations and taxed at the 23.8% capital gains rate Individuals Public Shareholders Partnerships and/or S Corps 23.8% Div. IC-DISC 39.6% Commission Deduction C Corp DPAD Exporting Partnership Deemed Exporter 2015 Baker & McKenzie LLP - 31

32 Putting Supply Chain Activity in One Exporting Partnership BEFORE A sells to B ($10 profit) B sells to C (10 Profit) C exports and pays rent to D Sale Sale Pays Rent A B C D Manufacturing Further Manufacturing Exports and pays DISC a commission Leases Space to C DISC Only C s Export Profit Less D Payment qualifies for DISC benefits Baker & McKenzie LLP - 32

33 AFTER A B C D ABCD Partnership DISC DISC Commission on Total Profit of ABCD 2015 Baker & McKenzie LLP - 33

34 Closely Held and Publicly-Traded Corporation - Deferral C CORP Up To $10 Million Deduction IC-DISC Receivables & Commission Up to $9.1 Million Deferred* *Plus non-qualified receipts Baker & McKenzie LLP - 34

35 Publicly-Traded Corporation IC-DISC may defer from taxation 16/17 of best $10 million of gross receipts. The balance is deemed distributed to its shareholders. Large exporters who generate substantial export receivables can sell the receivables to the IC-DISC at a discount. The discount income qualifies as qualified export receipts Baker & McKenzie LLP - 35

36 Publicly-Traded Corporation Deferred income becomes a low-cost, pre-tax source of funds for export working capital and financing international sales As much as $10 million may be generated from discount income and 16/17 deferred from tax (i.e. $1 of discount income = $1 of gross receipts) Additional deferral is available by use of non-qualified assets up to 5% of total DISC assets and non-qualified gross receipts up to 5% of gross receipts 2015 Baker & McKenzie LLP - 36

37 Example I Assume: Publicly-Traded Corporation An IC-DISC owned by a C Corp. in 2014 receives commissions for export sales and earns discount income from factoring export receivables of $8 million. It earns a 20% or $.4 million commission on the best $2 million of sales. The IC-DISC is tax exempt and is allowed to retain income attributable to the best $10 million of gross receipts. The balance of gross receipts over $10 million is deemed distributed to the IC-DISC s shareholders as a dividend. Use of the IC-DISC results in a $2.77 million tax savings as follows: 2015 Baker & McKenzie LLP - 37

38 Example I (cont.) Publicly-Traded Corporation Discount income Commission on best $2 million of sales $ 8.00 million.40 million Total IC-DISC income before deemed distribution Less 1/17 deemed distribution $ 8.40 million.50 million Total income to be retained Tax 35% $ 7.90 million $ 2.77 million 2015 Baker & McKenzie LLP - 38

39 Example I (cont.) Publicly-Traded Corporation Interest charge imposed on IC-DISC shareholder on tax savings (based upon One Year Treasury Bill rate) Assume tax savings in 2014 $ 2.77 million Interest rate on One Year Treasury Bill in Sept %* Interest charge payable when IC-DISC shareholder s 2015 return due (2016) $ 27,700 Tax benefit from interest deduction - 35% 9,695 Net cost of interest charge $ 18,005 *Assumed Rate 2015 Baker & McKenzie LLP - 39

40 Example II MAXIMUM BENEFIT FROM DISCOUNT INCOME Assume: Publicly-Traded Corporation $10 million of discount income $10.00 million Less 1/17 deemed distribution.85 million Net $ 9.15 million [Can be increased by non-qualifying receipts up to 5% of total receipts] 2015 Baker & McKenzie LLP - 40

41 Publicly-Traded Corporation Example II (cont.) Tax benefit $9.1 35% $ 3.20 million Interest Charge: $3.2 million saved at 1%* $ 32,000 Tax benefit from interest deduction 35% 11,200 Net cost of interest charge $ 20,800 *Assumed 2015 Baker & McKenzie LLP - 41

42 Beneficiary Roth IRA 0 Tax Regular IRA Regular Tax Corporate Tax Rates on IC-DISC Dividends IRA C CORP C Corporate Tax Rates on IC-DISC Dividends 0 Tax on C Dividends IC-DISC 2015 Baker & McKenzie LLP - 42

43 IRA IC-DISC Benefits Use of C Corp To Own IC-DISC Stock Allows dividends from IC-DISC to be taxed to C corporation at corporate rates of 15% - 35% Dividends from C corporation to IRA tax-free Assets invested by IRA tax-free Distributions taxed when distributed by regular IRA distributions tax free when distributed by Roth IRA May be combined with IRS direct ownership of IC-DISC stock 2015 Baker & McKenzie LLP - 43

44 IRA IC-DISC Benefits IRA Ownership of IC-DISC Accumulated IC-DISC income taxed at corporate rates 15-35% when distributed Assets in IRA invested tax-free Multiple IRA structure could reduce total tax on IC-DISC dividends Use of LLC owned by IRA to avoid custodian involvement Roth IRA distributions not taxed to beneficiaries Cases pending on whether DISC commissions can be disallowed using substance v. form and if Excise tax on DISC commissions is applicable: Hellweg, T.C. Memo and Ohsman, T.C. Memo upheld no excise tax on Roth IRA/DISC structure and appeals dismissed. Two cases pending, one DISC and one FSC. Cross motions for summary judgment filed in DISC case and trial held in FSC case Baker & McKenzie LLP - 44

45 Estate Planning and Executive Compensation Estate Planning: Ownership of IC-DISC stock in different proportions than exporting company stock can remove IC-DISC dividends from estate. Rev. Rul may result in gift tax exposure, but Hellweg decision effectively held Rev. Rul inapplicable. All gift tax cases have been dismissed, but could be resurrected if the Service is successful in pending cases. Executive Compensation and Succession: IC-DISC dividends can be paid to designated employees who own IC-DISC stock but do not have to be the same shareholders of the parent company. May avoid safe harbor pricing requirements. Can be used as a type of employee stock purchase plan Baker & McKenzie LLP - 45

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47 Foreign International Sales Corporation (FISC) FISC: Owned more than 50% by IC-DISC FISC Dividends: Qualified IC-DISC export receipts [count towards best $10 million of gross receipts] Generally same activities qualify as IC-DISC regarding export property and related and subsidiary services 95% qualified export assets and gross receipts tests No safe harbor pricing IC-DISC FISC Recommend when qualifying activities subject to low tax and otherwise would be subpart F income 2015 Baker & McKenzie LLP - 47

48 Foreign Individual, Partnership, or Trust* Structure [Must be disclosed on 1120 IC-DISC Returns] Foreign Individual, Partnership, or Trust 23.8% Capital Gains Rate** DISC Related Supplier Commission 35% deduction *Trust not taxed as a corporation. **Possible treaty rate Baker & McKenzie LLP - 48

49 Treaty Country Corporation Structure Treaty Country C Corp. Treaty W/H Rate (5% or less) DISC Commission 35% deduction Related Supplier 2015 Baker & McKenzie LLP - 49

50 Treaty Benefits (Ownership of a DISC by a Treaty Country Corporation) Section 996(g) classifies IC-DISC dividends as effectively connected with the conduct of a trade or business in the U.S. through a permanent establishment. This would likely result in foreign corp. shareholder of a DISC being subject to tax on DISC dividends at up to 35% tax. Section 996(g) is in conflict with most treaties which prevent taxation of a treaty country corporation in the absence of an actual permanent establishment (i.e., the mere existence of a U.S. subsidiary is not sufficient for U.S. taxation of dividends to parent as effectively connected income through a permanent establishment) Baker & McKenzie LLP - 50

51 Treaty Benefits (Ownership of a DISC by a Treaty Country Corporation) (Continued) Under the later-in-time theory, treaties executed after June 1984, therefore, may prevent 996(g) from applying IC-DISC dividends may thus be taxed at treaty rate on dividends If foreign owner of DISC is an individual, the 23.8% tax rate on DISC dividends should apply even if no treaty benefit Treaty Country taxation of DISC dividends must also be taken into account 2015 Baker & McKenzie LLP - 51

52 Sourcing Benefits Section 861(a)(1)(D) treats IC-DISC dividends attributable to qualified export receipts as foreign source income to U.S. shareholders. IC-DISC dividends are presently in a separate basket (Section 904(d) Passive Basket). Opportunity exists to put foreign taxes into IC-DISC to create and increase foreign source income limitations: (a) From U.S. title passage (b) From FISCs Baker & McKenzie LLP - 52

53 Saving the Disqualified DISC 1. A DISC will not qualify as a DISC if its election [form 4876-A] is not filed timely, generally within 90 days of incorporation date. Also capital stock of $2500 par stated value must be validly issued by the date the election is due % of the DISC s assets on the last day of the taxable year must be qualified export assets or the DISC will be disqualified % of the gross receipts for the year must be qualified export receipts or the DISC will be disqualified. In the case of a Commission DISC the qualified export receipts are those of its related supplier s sales. Generally this test is commonly met since the DISC commissions are virtually always based on qualified export receipts Baker & McKenzie LLP - 53

54 4. In addition, Treas. Reg (e)(2) provides that if the DISC commission agreement excludes non-qualified gross receipts, they will not be taken into account. The Tax Court in a split decision has held that this provision may not be relied upon where an actual commission has been paid on nonqualifying gross receipts. See Hughes International Sales Corporation v. Commissioner, 100 T.C. 293 (1993). The Internal Revenue Service, however, has informally held that the intent of the regulation was that the provision not allow for non-qualified gross receipts to be taken into account and has allowed them to be excluded Baker & McKenzie LLP - 54

55 CONSEQUENCES IF ELECTION NOT TIMELY FILED If election is not timely filed, no DISC benefit in the year of incorporation and until a valid election is timely filed. So-called section 9100 relief may allow for a late election if granted by the Service for reasonable cause Relief commonly granted, but filing fee can be expensive (around $9,800 currently) Baker & McKenzie LLP - 55

56 If a DISC is disqualified, the accumulated DISC income (deferred income) is deemed distributed over 2 times the number of years the DISC has been in existence up to 10 years. See Section 995(b)(2). The first deemed distribution is the year following the year of disqualification Baker & McKenzie LLP - 56

57 The DISC income for the year of disqualification, except as discussed later, does not qualify for DISC benefits. It can be either reallocated to the related supplier under section 482 or left in the DISC at the discretion of the Internal Revenue Service. If left in the DISC the income is taxed as ordinary corporate income at corporate rates. See Addison Int l., Inc. v. Commissioner, 90 T.C (1988); aff d 887 F.2d 660 (6 th Cir. 1989); Jet Research, Inc. v. Commissioner, T.C. Memo Baker & McKenzie LLP - 57

58 If the qualified export assets are not substantially below the 95% amount, it may be possible to examine the underlying transactions to find additional qualifying gross receipts or additional DISC income in an amount which would make the 95% test met. This could be done by a redetermination of the DISC income before the filing of the DISC s return. Under Treas. Reg (e)(5), the resulting additional receivable generally would be a qualified export asset at the end of the prior taxable year if paid within 90 days of the redetermination Baker & McKenzie LLP - 58

59 Deficiency Distribution May Be Available 1. The rules for a deficiency distribution may be found at Treas. Reg and provide that (1) an otherwise disqualified DISC under the 95% qualified gross receipts test may distribute an amount equal to the income attributable to the non-qualified gross receipts and (2) that a DISC that is not qualified under the 95% qualified export assets test may distribute an amount equal to the total amount of the non-qualified assets for the taxable year. If a deficiency distribution is made for a taxable year, the DISC is qualified for that year. Deficiency distributions may be made for more than one taxable year Baker & McKenzie LLP - 59

60 2. The distribution is taxed as a current year s distribution, but if made, will qualify the DISC year as a qualified DISC for the year in which it missed either the 95% qualified export assets test, the 95% gross receipts test, or both. 3. The deficiency distribution and the year for which it is made must be labelled as such at the time it is made and notification made to the Internal Revenue Service and DISC shareholders that the distribution is a deficiency distribution. 4. It may be made in cash or other property Baker & McKenzie LLP - 60

61 5. There must be reasonable cause for the failure to meet the 95% test, but the similar standard for failure to make the DISC election timely has been lax. Generally, it appears that lack of sufficient knowledge of the DISC rules and regulations or simple negligence will be considered as reasonable cause. Our experience has been that if a deficiency distribution is made before an audit has commenced, the deficiency distribution will not be challenged. Prior agreement of the Service for a deficiency distribution is not required. Nor is there any fee to be paid to the Internal Revenue Service for the privilege of making a deficiency distribution Baker & McKenzie LLP - 61

62 a. So long as a deficiency distribution is made by the time the DISC s return for the year of disqualification is due, there is no penalty attached to the deficiency distribution. Rather, the distribution is taxed either as dividend income, return of capital or capital gains depending on the DISC s earnings and profits for the year of the distribution. b. After the first DISC return is due subsequent to the year of disqualification, a 4-1/2% interest charge per year is imposed upon the DISC making a deficiency distribution for each year or partial year that the non-qualified assets are retained in the DISC s possession or the assets attributable to non-qualified gross receipts are not considered to be distributed Baker & McKenzie LLP - 62

63 c. Since the DISC is a tax exempt entity, the interest charge will not reduce DISC taxes, but will reduce its accumulated DISC income. d. If the same asset remains on the DISC s books for more than one taxable year, only that amount will be required to be distributed in qualifying the initial year and future years. Further, only one 4-1/2% of the amount which remains on hand in future years is required for each year the DISC remains disqualified, i.e., if an amount is paid out, for example, after the second consecutive year of disqualification, the deficiency interest for the first year of disqualification would be the three years of deficiency interest for the original amount. The 4-1/2% amount will not be again imposed on the same amount to qualify the second year Baker & McKenzie LLP - 63

64 For example, if the only disqualified asset is $100 in years one and two, a $100 deficiency distribution and an interest charge of 4-1/2% on the $100 for three years can qualify the DISC for both the first and second year. e. There is no tracing of assets required for the deficiency distribution. All that is required is an amount equal to the disqualified amount being distributed. This should allow for capital contributions to be made to the DISC for the purposes of allowing it to make the deficiency distribution. (Since the deficiency distribution is designed to remove non-qualified assets from the DISC s balance sheet, allowing for the contribution of capital for the purpose of making a deficiency distribution is consistent with that result.) 2015 Baker & McKenzie LLP - 64

65 f. If the statute of limitations has run for a year in which a DISC has not been qualified, it may be desirable not to make a deficiency distribution for that year. i. A DISC does not lose its election to be treated as a DISC unless it is not qualified as a DISC for five consecutive years. A deficiency distribution in one of those years should allow the DISC election to remain in effect for all five years in that period. See Treas. Reg (e)(3) Baker & McKenzie LLP - 65

66 ii. Under section 992(a)(2), a DISC which is disqualified which has not timely received a statutory notice of deficiency is not allowed to take the position that it was not a qualified DISC. Further, if the Service does not attempt to disqualify the DISC, it will remain as a qualified DISC for all purposes of the Code. See Treas. Reg (g). Unfortunately, the claims court and the Federal Court of Appeals has held that the failure to qualify can only be used by the Service against a taxpayer, not by a taxpayer in its favor. See Stokely-Van Camp, Inc. v. Commissioner, 974 F.2d 1319 (Fed. Cir. 1992) Baker & McKenzie LLP - 66

67 Clean DISC/Dirty DISC There are no limitations on the number of related DISCs. If a DISC may have qualification problems, a new DISC may be incorporated for future years. This may lessen the audit risk for the prior years Baker & McKenzie LLP - 67

68 THANK YOU Neal J. Block Baker & McKenzie LLP 300 East Randolph Street Suite 5000 Chicago, Illinois ( (312) (312) neal.block@bakermckenzie.com Baker & McKenzie LLP is a member of Baker & McKenzie International, a Swiss Verein North American Tax Practice Group Your Trusted Tax Counsel 2015 Baker & McKenzie LLP

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70 Jerry Ogle, Ogle International Tax Advisors COMPLIANCE AND REPORTING BY IC-DISCs

71 Ogle International Tax Advisors offers IC DISC consulting services. In addition, our spectrum of international tax services can provide assistance in the areas of : Foreign business investments - structure active business investments in offshore subsidiaries to minimize U.S. and host country taxation. Analysis of the U.S. CFC and PFIC rules for individual investors. Offshore profits importing - plan for the repatriation of active foreign profits. An IC-DISC can act as a buy-sell entity or a commission-based entity. In any event, the transfer price between the IC-DISC and related supplier must be calculated under one of the three following methods: 4% gross receipts 50% combined taxable income (CTI) Sect. 482 Foreign tax systems - analyze host country deductions, exemptions, and incentives, including foreign tax credits with host country tax advisors. For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

72 Under both the 4% gross receipts and 50% CTI methods, the DISC does not need to perform any economic functions or have any employees. Under both the 4% gross receipts and 50% CTI methods, the DISC can increase its commission by 10% of its export promotion expenses (EPEs), if the DISC is a buy-sell DISC vs. a commission DISC [Reg (a)(2) and Computervision Corp v. Comm (96 T.C. 652)]. EPEs include general administrative and selling expenses, certain freight paid to U.S.-flagged carriers, packaging costs, and design and label costs for export products incurred by the DISC. (Note: EPEs paid by a related party can qualify, if a contract existed between the related party earmarking the EPEs for the buy-sell DISC before the transaction took place.) For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

73 The pricing method chosen is required on a transaction-by-transaction basis (TxT); however, an annual election can be made to group transactions in accordance with products or product lines. Neither the gross receipts method nor the CTI method may be applied in a way that causes, in any taxable year, a loss to the related supplier. There is a special rule that allows the 4% gross receipts method to apply where the overall profit percentage is not exceeded [Reg (e)(1)(ii)]. For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

74 When utilizing the CTI method, overhead costs generally are allocated between export and domestic sales, based on detailed rules [Reg ]. However, if the profit margin on export products is less than profit margin on worldwide sales of the same products, then marginal costing rules may be applied to allocate only marginal or variable costs against export receipts under the CTI method [Reg ]. Overall, the CTI method generally produces a larger benefit than the gross receipts method, when exports have a greater-than-8% profit ratio. For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

75 Related Supplier Income Statement Before IC DISC Commission Domestic Sales 300 Export Sales 100 Domestic COGS (150) Export COGS (50) GP 200 Overhead (100) Taxable Income % For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

76 DISC Commission Calculation Method 4% CTI Export COGS (50) GP 50 Overhead (25) Net Income 25 Total Commission For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

77 Starting with the 2013 tax year, Section 1411 provides that a 3.8% Net Investment Income Tax (NIIT) applies to Net Investment Income. For joint taxpayers, the tax applies to the lesser of: Net Investment Income, or The excess of modified adjusted gross income over $250,000 Dividends are generally subject to the NIIT. In certain factual situations, a reasonable position may exist to treat dividends from an active buy sell IC DISC as not subject to the NIIT. However, a March 10, 2014 BNA article by Lydia Beyoud provided the following quote from David Kirk, attorney from the Office of Chief Counsel at IRS, at the Federal Bar Association Conference: For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

78 For the purposes of calculating income that may be excluded from NII tax, practitioners and taxpayers should also keep in mind the interplay between activities considered to be derived in the ordinary course of a trade or business and the working capital rule, Kirk said. The IRS has received a number of questions on what happens when a partnership owns a corporation underneath it. Even if a partnership acquires C corporate stock in a proximately related business, if they are receiving dividends, the income will continue to be treated as dividends, he said. Even if you could say that these businesses are so proximately related to each other that it is derived in ordinary course of a trade or business under case law, or whatever it is that you can find to support your claim, you step into the working capital rule of 1411(c)(3), which cross references 469(e)(1)(B), as well as additional rules on ways in which an item is derived in the ordinary course of trade or business for purposes of 469, Kirk said. The only way you are getting dividends out is if you are a dealer in stock or financial instruments, he said. Entities that own domestic corporations or an interest-charge domestic international sales corporation (IC-DISC) will fall into the category of businesses unable to exclude their dividends from a subsidiary or brother-sister structure from NII, said Kirk. Dividends coming out will always be dividends; interest the same way, he said. For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

79 In the Preamble for Treasury Decision 9644, 78 FR , Section T(c)(3)(ii)(D) was cross referenced as guidance for when dividends could be derived in the ordinary course of a trade or business. Section 993(e)(3)(B) provides the notion of how transactions related to a DISC can be in furtherance of transactions giving rise qualified exports. Consider whether an individual that wholly owns an S Corporation which in turn wholly owns an active buy sell disc could reasonably argue that the NIIT should not apply to IC DISC dividends because the DISC dividends are part of the S Corporation s trade or business and the individual materially participates in both businesses? Overall, any position that involves DISC dividends not being subject to the NIIT should carefully consider potential penalties and the inherent uncertainty with newly enacted taxes. For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

80 Initial IC-DISC election is made on Form 4876-A within 90 days of the start of the taxable year (must be signed by all shareholders). A Form 1120 IC-DISC is required to be filed annually on or before the 15 th day of the ninth month following the close of the tax year. Attached will be Schedule K, Shareholder s Statement of IC-DISC Distributions (indicates actual and deemed distributions that are taxable) For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

81 A Form 8404 must be filed by all IC-DISC shareholders on or before the original due date of their tax returns (no extensions are permitted). Form 8404 requires any deferred interest-related costs to be paid (estimated tax payments are not required on a quarterly basis). Deferred interest is calculated on hypothetical tax based on ordinary rates vs. qualified dividend rates. Form 8404 anticipates that estimates are likely needed, and amended procedures are outlined in form instructions. Various states have different state income tax filings required. For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)

82 The DISC must make an initial estimate of the commission at the end of the year, and the related supplier must pay the commission within 60 days of the close of the year [Reg (e)(3)(i)]. Reasonable estimate requires at least 50% Payment should generally be in cash to avoid noncompliance risk [TSI, Inc. v. US (977 F.2d 424) and Thomas Int l Ltd v US (773 F.2d 300)]. True-up commission requires payment in 90 days. Failure to optimize available methods such as TxT, marginal costing, overhead allocation under CTI, EPE and factoring of qualified export-related accounts receivable [Rev. Rul ] For more information on our services Please contact us at our offices or visit us at our website Corporate Office 8130 Lakewood Main St, Suite 208 Bradenton, Florida (T) (F) Miami Office Waterford Business Park Miami, Florida (T) (F)