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
- 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
- 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
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
Income Exclusion Act
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
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
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.
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.