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UNITED STATES
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US Foreign Sales Corporations

Foreign Sales Corporations

Under legislation dating from 1984, which was eventually declared unacceptable by the World Trade Organization after a complaint from the European Union, the US Internal Revenue Code authorized the establishment of foreign sales corporations (FSCs), being corporate entities in foreign jurisdictions through which US manufacturing companies could channel exports. 15% of the revenue concerned was exempted from corporation tax, meaning (at 35% tax) that companies kept 5.25% more of their revenue.  


The TRA of 1984 replaced DISCs with FSC provisions to counter arguments from major trading partners that the DISC provisions constituted an illegal export subsidy under the General Agreement on Tariffs and Trade. FSCs are exempt from US tax on a portion of export income. The exempt income is generally at least 15% of the combined taxable income (CTI) earned by the FSC and its related supplier from qualified exports.

A FSC is a corporation that has met all of the following tests:

  • It must be a corporation created or organized under the laws of a qualifying foreign country or a US possession. A qualifying foreign country is a foreign country that meets the exchange of information requirements of the law. A US possession is defined in the law to include Guam, American Samoa, the Commonwealth of the Northern Mariana Islands, and the US Virgin Islands, but not Puerto Rico.
  • It must have no more than 25 shareholders at any time during the tax year.
  • It must not have preferred stock outstanding at any time during the tax year.
  • During the tax year, it must maintain an office in a qualifying foreign country or a U..possession and maintain a set of permanent books of account at that office. Also, it must maintain at a location in the United States the books and records required to sufficiently establish the amount of gross income, deductions, credits, or other matters required to be reported on its tax return.
  • At all times during the tax year, it must have at least one director who is not a resident of the United States.
  • It must not be a member, at any time during the tax year, of a controlled group of which a DISC is a member.
  • The FSC tax year must conform to the tax year of the principal shareholder who, at the beginning of the FSC's tax year, has the highest percentage of voting power.
  • It must have elected to be a FSC or a small FSC by filing Form 8279, Election To Be Treated as a FSC or as a Small FSC, at any time during the 90-day period immediately preceding the beginning of the taxable year or during the first 90 days of its taxable year if the FSC is a new corporation.

Foreign trading gross receipts (FTGR) are gross receipts of a FSC that has met certain foreign management and foreign economic process requirements. These receipts must be from the sale, lease, or rental of export property for use outside the United States or for an engineering or architectural services for a construction project located outside the United States. An FSC (other than a small FSC) is treated as having FTGR for the tax year only if the management of the FSC takes place outside the United States. These management activities include:

  • Meetings of the board of directors and shareholders.
  • Disbursement of cash dividends, outside legal and accounting fees, salaries of officers, and salaries or fees of directors out of the principal bank account.
  • Maintaining the principal bank account at all times during the tax year.

There are some other production and content requirements; however the FSC is by now largely of historical interest only since the regime was abolished in response to EU and WTO pressure in 2000.

A very high proportion of qualifying companies made use of the FSC legislation, typically through tax-exempt companies in the US Virgin Islands, the Bahamas, Barbados and Bermuda.

After the World Trade Organization (WTO) finally ruled in early 2000 that the FSC constituted an illegal trading subsidy, the US passed replacement legislation called The Extra-Territorial Income Exclusion Act.

This in turn was ruled illegitimate by the WTO, and after much to-ing and fro-ing, including the imposition of permitted tariffs by the EU during 2004 on many US imports, US President George W Bush finally signed a law in late 2004 which repealed the FSC-ETI legislation in favour of broader tax reliefs.

Extra-Territorial Income Exclusion Act

The FSC Repeal and Extraterritorial Income Exclusion Act of 2000 effectively 'repatriated' the FSC tax break and extended it to all types of entity with qualifying foreign sales, including 'S' corporations and LLCs, which were previously excluded. Foreign companies which are US taxpayers could also use the tax break, which was not the case previously. There are rules requiring a certain proportion of US-manufactured content and a certain proportion of foreign costs; and foreign tax credits on the goods concerned are not available to a participating entity. Actual manufacture can take place either inside or outside the US.

The amount of the tax saving was the same as before under the new rules, but the total foregone by the Government was more, because a wider range of companies could take part.

As under the previous law, the benefit applied to exports and a 50% US-content rule remained. Those features caused the new regime to continue to resemble an export tax subsidy. In response, the Administration pointed to the elimination of administrative transfer pricing rules. The argument was disingenuous because the separate company requirement of the FSC and DISC legislation had been eliminated. Without the need for two companies – a manufacturing company and a sales company – no need existed for transfer pricing rules.

The EU did not accept the new legislation as conforming with WTO rules, and after a long series of hearings and appeals, the WTO ruled definitively against the ETI rules in late 2002. The EU then prepared a list of US products on which it intended to apply sanctions in the form of countervailing duties, and obtained the WTO's permission for such action, which it finally put into effect in early 2004 in the absence of a substantial change in the ETI regime.

After much to-ing and fro-ing, US President George W Bush finally signed a law in late 2004 which repealed the FSC-ETI legislation in favour of broader tax reliefs.

Remedial US Legislation

Various proposals were put forward to end the export subsidy system, including various bills introduced in Congress. One of these was the 'American Competitiveness and Corporate Accountability Act' drawn up by Republican chairman of the House Ways and Means Committee, Bill Thomas in 2002. However, it was felt by industry that the measures did not do enough to compensate for the extra tax burden which would be shouldered by US companies with overseas interests. The bill was dropped after a lobbying campaign by major corporations such as Boeing and Caterpillar.

The more popular Job Protection Bill, proposed by House Ways and Means Committee members Charles Rangel (a Democrat), and Philip Crane (a Republican) offered to give firms tax "brownie points" whilst also lowering the rate of corporate tax payable on foreign earnings. The Job Protection Act of 2003 would have repealed the FSC/ETI tax program and replaced it with a corporate rate deduction for domestic manufacturers. This would have meant that firms with 100% of their production based in the US would see a 3.5% reduction in corporate tax on export-generated profits to 31.5%. A sliding scale would be introduced according to a firm's ratio of domestic/international production.

“We all agree that we must repeal the FSC/ETI exemption and replace it with a WTO-compliant solution. The issue is how best to do it. Our plan will bring US tax laws into compliance with WTO rules, as well as provide incentives for domestic job creation by US companies and foreign subsidiaries operating in U.S. territory. That is a crucial component to any good solution,” Crane said. “Any revenues raised from the repeal of FSC/ETI should be used to encourage companies to maintain and expand their operations in the United States. This bill is about protecting and creating jobs and allowing US manufacturers to remain competitive in the global marketplace.”

“The United States need to comply with our international commitments, but we should do so in a way that preserves American jobs. If we want our nation to be strong, we must remember the importance of these three words: ‘Made in USA.’ The products may change - today we produce more software and high-tech machinery than textiles and stereos - but keeping a healthy manufacturing base remains vital to our national interest,” Rangel said.

The composite tax-package legislation of May, 2003 also incorporated a short-term substitute for the ETI legislation in the form of a provision that reduces tax on the repatriated foreign earnings of US corporations to 5.25% for a period of one year. The bill also contained measures that will allow US multinationals to more easily take advantage of foreign tax credits.

The European Union became impatient with the long-drawn-out efforts in the US Congress to respond to the WTO's banning of the FSC and ETI regimes and put in place counter tariffs in March 2004 on a range of US goods, starting at a rate of 5%. This was designed to rise in 1% increments every month until the EU became satisfied that appropriate action had been taken by US lawmakers.

The United States had aimed to complete the replacement legislation before the European Union imposed the retaliatory tariffs. However the European Union still objected to a proposed three-year transitional period before the new legislation came fully into force. "We have already waited for three years to get the legislation repealed," Arancha Gonzalez, spokeswoman for EU Trade Commissioner at the time, Pascal Lamy, observed at a news conference, continuing: "an extra three-year period could not be acceptable to us."

Chairman of the Senate Finance Committee Charles Grassley refuted the EU's claim over the transitional period, arguing that the new proposals removed the obligation on a firm to physically export goods before qualifying for the tax break. "I would think the European Union would have some appreciation for the extent of this undertaking and show some restraint and patience," said the Iowa Republican said. "The imposition of sanctions now will only contribute to soften the economic recovery and slow economic growth worldwide."

The FSC and ETI regimes were finally abolished by the American Jobs Creation Act 2004. See here for an account of the Act and its consequences in 2005.

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