[Senate Report 106-416]
[From the U.S. Government Publishing Office]
106th Congress Report
SENATE
2d Session 106-416
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FSC REPEAL AND EXTRATERRITORIAL INCOME EXCLUSION ACT OF 2000
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September 20, 2000.--Ordered to be printed
_______
Mr. Roth, from the Committee on Finance, submitted the following
R E P O R T
[To accompany H.R. 4986]
[Including cost estimate of the Congressional Budget Office]
The Committee on Finance, to whom was referred the bill
(H.R. 4986) to amend the Internal Revenue Code of 1986 to
repeal the provisions relating to foreign sales corporations
and to exclude extraterritorial income from gross income,
having considered the same, report favorably thereon with an
amendment and recommend that the bill as amended do pass.
CONTENTS
Page
I. Summary and Background............................................2
A. Purpose and Summary................................. 2
B. Background and Need for Legislation................. 2
C. Legislative History................................. 2
II. Explanation of the Bill...........................................3
A. Repeal of FSC Provisions and Exclusion for
Extraterritorial Income............................ 3
III.Budget Effects of the Bill.......................................21
A. Committee Estimates................................. 21
B. Budget Authority and Tax Expenditures............... 23
C. Consultation With the Congressional Budget Office... 23
IV. Votes of the Committee...........................................24
V. Regulatory Impact and Other Matters..............................25
A. Regulatory Impact................................... 25
B. Unfunded Mandates Statement......................... 25
C. Complexity Analysis................................. 25
VI. Changes in Existing Law Made by the Bill, as Reported............25
I. SUMMARY AND BACKGROUND
A. Purpose And Summary
Purpose
The bill, H.R. 4986, the ``FSC Repeal and Extraterritorial
Income Exclusion Act of 2000,'' repeals the foreign sales
corporation provisions of the Internal Revenue Code to comply
with decisions of a World Trade Organization dispute panel and
Appellate Body regarding a dispute brought before the World
Trade Organization (``WTO'') by the European Union. To retain a
competitive balance for U.S. businesses that compete in the
world market, the bill modifies the taxation of foreign trade
income to comply with the standards set forth in the decisions
of the WTO dispute panel and Appellate Body.
Summary
H.R. 4986 repeals sections 921 through 927 of the Internal
Revenue Code of 1986 (``the Code''). These sections of the Code
relate to foreign sales corporations (``FSCs'').
H.R. 4986 provides that gross income for U.S. tax purposes
does not include extraterritorial income. Deductions allocated
to such excluded income generally are disallowed. Because the
exclusion of such extraterritorial income is a means of
avoiding double taxation, no foreign tax credit is allowed for
income taxes paid with respect to such excluded income. An
exception from this general rule is provided for
extraterritorial income that is not qualifying foreign trade
income.
In general, H.R. 4986 is effective for transactions entered
into after September 30, 2000, and no corporation may elect to
be a FSC after September 30, 2000.
B. Background and Need for Legislation
In July 1998, the European Union \1\ requested that a WTO
dispute panel determine whether the FSC regime of sections 921
through 927 of the Code complies with WTO rules, including the
Agreement on Subsidies and Countervailing Measures. A WTO
dispute settlement panel (``the Panel'') was established in
September, 1998, to address these issues. On October 8, 1999,
the Panel ruled that the FSC regime was not in compliance with
WTO obligations.\2\ The Panel specified that ``FSC subsidies
must be withdrawn at the latest with effect from 1 October
2000.'' \3\ On February 24, 2000, the Appellate Body affirmed
the lower panel's ruling.\4\
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\1\ The European Union comprises Austria, Belgium, Denmark,
Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,
Netherlands, Portugal, Spain, Sweden and the United Kingdom. Canada and
Japan made third-party submissions to the subsequently established
dispute settlement panel in support of the European Union position.
\2\ United States--Tax Treatment for ``Foreign Sales
Corporations,'' Report of the Panel, October, 8, 1999 (``Panel
Decision'').
\3\ Panel Decision at 334.
\4\ United States--Tax Treatment for ``Foreign Sales
Corporations,'' Report of the Appellate Body, February 24, 2000
(``Appellate Body Decision'').
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C. Legislative History
The Committee on Finance marked up the provisions of the
bill on September 19, 2000, and approved the provisions, with
an amendment, on September 19, 2000, by a voice vote, with a
quorum present.
II. EXPLANATION OF THE BILL
A. Repeal of FSC Provisions and Exclusion for Extraterritorial Income
Present Law
Summary of U.S. income taxation of foreign persons
Income earned by a foreign corporation from its foreign
operations generally is subject to U.S. tax only when such
income is distributed to any U.S. persons that hold stock in
such corporation. Accordingly, a U.S. person that conducts
foreign operations through a foreign corporation generally is
subject to U.S. tax on the income from those operations when
the income is repatriated to the United States through a
dividend distribution to the U.S. person.\5\ The income is
reported on the U.S. person's tax return for the year the
distribution is received, and the United States imposes tax on
such income at that time. An indirect foreign tax credit may
reduce the U.S. tax imposed on such income.
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\5\ A variety of anti-deferral regimes impose current U.S. tax on
income earned by a U.S. person through a foreign corporation. The Code
sets forth the following anti-deferral regimes: the controlled foreign
corporation rules of subpart F (secs. 951-954), the passive foreign
investment company rules (secs. 1291-1298), the foreign personal
holding company rules (secs. 551-558), the personal holding company
rules (secs. 541-547), the accumulated earnings tax rules (secs. 531-
537), and the foreign investment company rules (sec. 1246). Detailed
rules for coordination among the anti-deferral regimes are provided to
prevent a U.S. person from being subject to U.S. tax on the same item
of income under multiple regimes.
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Foreign sales corporations
The income of an eligible FSC is partially subject to U.S.
income tax and partially exempt from U.S. income tax. In
addition, a U.S. corporation generally is not subject to U.S.
tax on dividends distributed from the FSC out of certain
earnings.
A FSC must be located and managed outside the United
States, and must perform certain economic processes outside the
United States. A FSC is often owned by a U.S. corporation that
produces goods in the United States. The U.S. corporation
either supplies goods to the FSC for resale abroad or pays the
FSC a commission in connection with such sales. The income of
the FSC, a portion of which is exempt from U.S. tax under the
FSC rules, equals the FSC's gross markup or gross commission
income, less the expenses incurred by the FSC. The gross markup
or the gross commission is determined according to specified
pricing rules.
A FSC generally is not subject to U.S. tax on its exempt
foreign trade income. The exempt foreign trade income of a FSC
is treated as foreign-source income that is not effectively
connected with the conduct of a trade or business within the
United States.
Foreign trade income other than exempt foreign trade income
generally is treated as U.S.-source income effectively
connected with the conduct of a trade or business conducted
through a permanent establishment within the United States.
Thus, a FSC's income other than exempt foreign trade income
generally is subject to U.S. tax currently and is treated as
U.S.-source income for purposes of the foreign tax credit
limitation.
Foreign trade income of a FSC is defined as the FSC's gross
income attributable to foreign trading gross receipts. Foreign
trading gross receipts generally are the gross receipts
attributable to the following types of transactions: the sale
of export property; the lease or rental of export property;
services related and subsidiary to such a sale or lease of
export property; engineering and architectural services for
projects outside the United States; and export management
services. Investment income and carrying charges are excluded
from the definition of foreign trading gross receipts.
The term ``export property'' generally means property (1)
which is manufactured, produced, grown or extracted in the
United States by a person other than a FSC, (2) which is held
primarily for sale, lease, or rental in the ordinary course of
a trade or business for direct use or consumption outside the
United States, and (3) not more than 50 percent of the fair
market value of which is attributable to articles imported into
the United States. The term ``export property'' does not
include property leased or rented by a FSC for use by any
member of a controlled group of which the FSC is a member;
patents, copyrights (other than films, tapes, records, similar
reproductions, and other than computer software, whether or not
patented), and other intangibles; oil or gas (or any primary
product thereof); unprocessed softwood timber; or products the
export of which is prohibited or curtailed. Export property
also excludes property designated by the President as being in
short supply.
If export property is sold to a FSC by a related person (or
a commission is paid by a related person to a FSC with respect
to export property), the income with respect to the export
transactions must be allocated between the FSC and the related
person. The taxable income of the FSC and the taxable income of
the related person are computed based upon a transfer price
determined under section 482 or under one of two formulas.
The portion of a FSC's foreign trade income that is treated
as exempt foreign trade income depends on the pricing rule used
to determine the income of the FSC. If the amount of income
earned by the FSC is based on section 482 pricing, the exempt
foreign trade income generally is 30 percent of the foreign
trade income the FSC derives from a transaction. If the income
earned by the FSC is determined under one of the two formulas
specified in the FSC provisions, the exempt foreign trade
income generally is \15/23\ of the foreign trade income the FSC
derives from the transaction.
A FSC is not required or deemed to make distributions to
its shareholders. Actual distributions are treated as being
made first out of earnings and profits attributable to foreign
trade income, and then out of any other earnings and profits.
Any distribution made by a FSC out of earnings and profits
attributable to foreign trade income to a foreign shareholder
is treated as U.S.-source income that is effectively connected
with a business conducted through a permanent establishment of
the shareholder within the United States. Thus, the foreign
shareholder is subject to U.S. tax on such a distribution.
A U.S. corporation generally is allowed a 100 percent
dividends-received deduction for amounts distributed from a FSC
out of earnings and profits attributable to foreign trade
income. The 100 percent dividends-received deduction is not
allowed for nonexempt foreign trade income determined under
section 482 pricing.
Reasons for Change
The Chairman and Ranking Member began a process of
reviewing the international provisions of the Code with
hearings early in the 106th Congress. Among the issues
identified in the testimony was the need to reexamine the U.S.
tax treatment of foreign income.
In the interim, a dispute settlement panel of the WTO found
that the FSC provisions conferred an export subsidy barred by
WTO rules. That decision was affirmed by the WTO Appellate
Body.
This legislation addresses both the broader issue of U.S.
taxation of income derived from foreign sales, i.e.,
``extraterritorial income,'' as well as complying with the WTO
rulings. The legislation repeals the FSC provisions of the Code
that the Panel and Appellate Body found to be prohibited export
subsidies. At the same time, the legislation revises the Code
in a manner that rationalizes tax treatment for
extraterritorial income.
The legislation modifies the general rule of U.S. taxation
by fundamentally amending the definition of gross income. Under
the Code, the definition of ``gross income'' defines the outer
boundaries of U.S. income taxation. The bill excludes income
derived from certain activities performed outside the United
States, referred to as extraterritorial income, from the
definition of gross income and, thus, modifies the extent to
which the United States seeks to tax such income. This new
general rule thus becomes the normative benchmark for taxing
income derived in connection with certain activities performed
outside the United States.
The Committee believes that, in order to ensure WTO
compatibility, it is important that the new regime not confer
export-contingent benefits. Accordingly, the Committee has
determined that it is appropriate to treat all foreign sales
alike. The general exclusion, therefore, applies to foreign
trade income, whether the goods are manufactured in the United
States or abroad--a substantially broader category of income
than that which was exempted from tax under the FSC provisions.
A taxpayer would receive the same U.S. tax treatment with
respect to its foreign sales regardless of whether it exports.
The Committee notes that the extraterritorial income
excluded by this legislation from the scope of U.S. income
taxation parallels the foreign-source income excluded under
most territorial tax systems, particularly those employed by
European Union member states. Under neither the U.S. tax system
as modified by this legislation nor many European tax systems
is the income excluded from taxation limited to income earned
through exporting. At the same time, under both systems,
exporting is one way to earn foreign source income that is
excluded from taxation, and exporters under both systems are
among those who can avail themselves of the limitations on the
taxing authority of both systems.
The Committee believes that this legislation, which
fundamentally changes the U.S. tax treatment of
extraterritorial income, complies with the WTO decisions and
honors U.S. obligations under the WTO.
Explanation of Provisions
Repeal of the FSC rules
The bill repeals the present-law FSC rules found in
sections 921 through 927 of the Code.
Exclusion of extraterritorial income
The bill provides that gross income for U.S. tax purposes
does not include extraterritorial income. Because the exclusion
of such extraterritorial income is a means of avoiding double
taxation, no foreign tax credit is allowed for income taxes
paid with respect to such excluded income. Extraterritorial
income is eligible for the exclusion to the extent that it is
``qualifying foreign trade income.'' Because U.S. income tax
principles generally deny deductions for expenses related to
exempt income, otherwise deductible expenses that are allocated
to qualifying foreign trade income generally are disallowed.
The bill applies in the same manner with respect to both
individuals and corporations who are U.S. taxpayers. In
addition, the exclusion from gross income applies for
individual and corporate alternative minimum tax purposes.
Qualifying foreign trade income
Under the bill, qualifying foreign trade income is the
amount of gross income that, if excluded, would result in a
reduction of taxable income by the greatest of (1) 1.2 percent
of the ``foreign trading gross receipts'' derived by the
taxpayer from the transaction,\6\ (2) 15 percent of the
``foreign trade income'' derived by the taxpayer from the
transaction, or (3) 30 percent of the ``foreign sale and
leasing income'' derived by the taxpayer from the transaction.
The amount of qualifying foreign trade income determined using
1.2 percent of the foreign trading gross receipts is limited to
200 percent of the qualifying foreign trade income that would
result using 15 percent of the foreign trade income.
Notwithstanding the general rule that qualifying foreign trade
income is based on one of the three calculations that results
in the greatest reduction in taxable income, a taxpayer may
choose instead to use one of the other two calculations that
does not result in the greatest reduction in taxable income.
Although these calculations are determined by reference to a
reduction of taxable income (a net income concept), qualifying
foreign trade income is an exclusion from gross income. Hence,
once a taxpayer determines the appropriate reduction of taxable
income, that amount must be ``grossed up'' for related expenses
in order to determine the amount of gross income excluded.\7\
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\6\ The term ``transaction'' means (1) any sale, exchange, or other
disposition; (2) any lease or rental, and (3) any furnishing of
services.
\7\ For an example of these calculations, see the General Example,
below.
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If a taxpayer uses 1.2 percent of foreign trading gross
receipts to determine the amount of qualifying foreign trade
income with respect to a transaction, the taxpayer or any other
related persons will be treated as having no qualifying foreign
trade income with respect to any other transaction involving
the same property.\8\ For example, assume that a manufacturer
and a distributor of the same product are related persons. The
manufacturer sells the product to the distributor at an arm's-
length price of $80 (generating $30 of profit) and the
distributor sells the product to an unrelated customer outside
of the United States for $100 (generating $20 of profit). If
the distributor chooses to calculate its qualifying foreign
trade income on the basis of 1.2 percent of foreign trading
gross receipts, then the manufacturer will be considered to
have no qualifying foreign trade income and, thus, would have
no excluded income. The distributor's qualifying foreign trade
income would be 1.2 percent of $100, and the manufacturer's
qualifying foreign trade income would be zero. This limitation
is intended to prevent a duplication of exclusions from gross
income because the distributor's $100 of gross receipts
includes the $80 of gross receipts of the manufacturer. Absent
this limitation, $80 of gross receipts would have been double
counted for purposes of the exclusion. If both persons were
permitted to use 1.2 percent of their foreign trading gross
receipts in this example, then the related-person group would
have an exclusion based on $180 of foreign trading gross
receipts notwithstanding that the related-person group really
only generated $100 of gross receipts from the transaction.
However, if the distributor chooses to calculate its qualifying
foreign trade income on the basis of 15 percent of foreign
trade income (15 percent of $20 of profit), then the
manufacturer would also be eligible to calculate its qualifying
foreign trade income in the same manner (15 percent of $30 of
profit).\9\ Thus, in the second case, each related person may
exclude an amount of income based on their respective profits.
The total foreign trade income of the related-person group is
$50. Accordingly, allowing each person to calculate the
exclusion based on their respective foreign trade income does
not result in duplication of exclusions.
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\8\ Persons are considered to be related if they are treated as a
single employer under section 52(a) or (b) (determined without taking
into account section 1563(b), thus including foreign corporations) or
section 414(m) or (o).
\9\ The manufacturer also could compute qualifying foreign trade
income based on 30 percent of foreign sale and leasing income.
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Under the bill, a taxpayer may determine the amount of
qualifying foreign trade income either on a transaction-by-
transaction basis or on an aggregate basis for groups of
transactions, so long as the groups are based on product lines
or recognized industry or trade usage. Under the grouping
method, the Committee intends that taxpayers be given
reasonable flexibility to identify product lines or groups on
the basis of recognized industry or trade usage. In general,
provided that the taxpayer's grouping is not unreasonable, it
will not be rejected merely because the grouped products fall
within more than one of the two-digit Standard Industrial
Classification codes.\10\ The Secretary of the Treasury is
granted authority to prescribe rules for grouping transactions
in determining qualifying foreign trade income.
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\10\ By reference to Standard Industrial Classification codes, the
Committee intends to include industries as defined in the North
American Industrial Classification System.
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Qualifying foreign trade income must be reduced by illegal
bribes, kickbacks and similar payments, and by a factor for
operations in or related to a country associated in carrying
out an international boycott, or participating or cooperating
with an international boycott.
In addition, the bill directs the Secretary of the Treasury
to prescribe rules for marginal costing in those cases in which
a taxpayer is seeking to establish or maintain a market for
qualifying foreign trade property.
Foreign trading gross receipts
Under the bill, ``foreign trading gross receipts'' are
gross receipts derived from certain activities in connection
with ``qualifying foreign trade property'' with respect to
which certain ``economic processes'' take place outside of the
United States. Specifically, the gross receipts must be (1)
from the sale, exchange, or other disposition of qualifying
foreign trade property; (2) from the lease or rental of
qualifying foreign trade property for use by the lessee outside
of the United States; (3) for services which are related and
subsidiary to the sale, exchange, disposition, lease, or rental
of qualifying foreign trade property (as described above); (4)
for engineering or architectural services for construction
projects located outside of the United States; or (5) for the
performance of certain managerial services for unrelated
persons. Gross receipts from the lease or rental of qualifying
foreign trade property include gross receipts from the license
of qualifying foreign trade property. Consistent with the
policy adopted in the Taxpayer Relief Act of 1997,\11\ this
includes the license of computer software for reproduction
abroad.
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\11\ The Taxpayer Relief Act of 1997, Public Law 105-34.
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Foreign trading gross receipts do not include gross
receipts from a transaction if the qualifying foreign trade
property or services are for ultimate use in the United States,
or for use by the United States (or an instrumentality thereof)
and such use is required by law or regulation. Foreign trading
gross receipts also do not include gross receipts from a
transaction that is accomplished by a subsidy granted by the
government (or any instrumentality thereof) of the country or
possession in which the property is manufactured.
A taxpayer may elect to treat gross receipts from a
transaction as not foreign trading gross receipts. As a
consequence of such an election, the taxpayer could utilize any
related foreign tax credits in lieu of the exclusion as a means
of avoiding double taxation. It is intended that this election
be accomplished by the taxpayer's treatment of such items on
its tax return for the taxable year. Provided that the
taxpayer's taxable year is still open under the statute of
limitations for making claims for refund under section 6511, a
taxpayer can make redeterminations as to whether the gross
receipts from a transaction constitute foreign trading gross
receipts.
Foreign economic processes
Under the bill, gross receipts from a transaction are
foreign trading gross receipts only if certain economic
processes take place outside of the United States. The foreign
economic processes requirement is satisfied if the taxpayer (or
any person acting under a contract with the taxpayer)
participates outside of the United States in the solicitation
(other than advertising), negotiation, or making of the
contract relating to such transaction and incurs a specified
amount of foreign direct costs attributable to the
transaction.\12\ For this purpose, foreign direct costs include
only those costs incurred in the following categories of
activities: (1) advertising and sales promotion; (2) the
processing of customer orders and the arranging for delivery;
(3) transportation outside of the United States in connection
with delivery to the customer; (4) the determination and
transmittal of a final invoice or statement of account or the
receipt of payment; and (5) the assumption of credit risk. An
exception from the foreign economic processes requirement is
provided for taxpayers with foreign trading gross receipts for
the year of $5 million or less.\13\
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\12\ The foreign direct costs attributable to the transaction
generally must exceed 50 percent of the total direct costs attributable
to the transaction, but the requirement also will be satisfied if, with
respect to at least two categories of direct costs, the foreign direct
costs equal or exceed 85 percent of the total direct costs attributable
to each category.
\13\ For this purpose, the receipts of related persons are
aggregated and, in the case of pass-through entities, the determination
of whether the foreign trading gross receipts exceed $5 million is made
both at the entity and at the partner/shareholder level.
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The foreign economic processes requirement must be
satisfied with respect to each transaction and, if so, any
gross receipts from such transaction could be considered as
foreign trading gross receipts. For example, all of the lease
payments received with respect to a multi-year lease contract,
which contract met the foreign economic processes requirement
at the time it was entered into, would be considered as foreign
trading gross receipts. On the other hand, a sale of property
that was formerly a leased asset, which was not sold pursuant
to the original lease agreement, generally would be considered
a new transaction that must independently satisfy the foreign
economic processes requirement.
A taxpayer's foreign economic processes requirement is
treated as satisfied with respect to a sales transaction
(solely for the purpose of determining whether gross receipts
are foreign trading gross receipts) if any related person has
satisfied the foreign economic processes requirement in
connection with another sales transaction involving the same
qualifying foreign trade property.
Qualifying foreign trade property
Under the bill, the threshold for determining if gross
receipts will be treated as foreign trading gross receipts is
whether the gross receipts are derived from a transaction
involving ``qualifying foreign trade property.'' Qualifying
foreign trade property is property manufactured, produced,
grown, or extracted (``manufactured'') within or outside of the
United States that is held primarily for sale, lease, or
rental,\14\ in the ordinary course of a trade or business, for
direct use, consumption, or disposition outside of the United
States.\15\ In addition, not more than 50 percent of the fair
market value of such property can be attributable to the sum of
(1) the fair market value of articles manufactured outside of
the United States plus (2) the direct costs of labor performed
outside of the United States.\16\
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\14\ In addition, consistent with the policy adopted in the
Taxpayer Relief Act of 1997, computer software licensed for
reproduction is considered as property held primarily for sale, lease,
or rental.
\15\ ``United States'' includes Puerto Rico for these purposes
because Puerto Rico is included in the customs territory of the United
States.
\16\ For this purpose, the fair market value of any article
imported into the United States is its appraised value as determined
under the Tariff Act of 1930. In addition, direct labor costs are
determined under the principles of section 263A and do not include
costs that would be treated as direct labor costs attributable to
``articles,'' again applying principles of section 263A.
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The bill excludes certain property from the definition of
qualifying foreign trade property. The excluded property is (1)
property leased or rented by the taxpayer for use by a related
person, (2) certain intangibles,\17\ (3) oil and gas (or any
primary product thereof), (4) unprocessed softwood timber, (5)
certain products the transfer of which are prohibited or
curtailed to effectuate the policy set forth in Public Law 96-
72, and (6) property designated by Executive order as in short
supply. In addition, it is the intention of the Committee that
property that is leased or licensed to a related person who is
the lessor, licensor, or seller of the same property in a
sublease, sublicense, sale, or rental to an unrelated person
for the ultimate and predominate use by the unrelated person
outside of the United States is not excluded property by reason
of such lease or license to a related person.
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\17\ The intangibles that are treated as excluded property under
the bill are: patents, inventions, models, designs, formulas, or
processes whether or not patented, copyrights (other than films, tapes,
records, or similar reproductions, and other than computer software
(whether or not patented), for commercial or home use), goodwill,
trademarks, trade brands, franchises, or other like property. Computer
software that is licensed for reproduction outside of the United States
is not excluded from the definition of qualifying foreign trade
property.
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With respect to property that is manufactured outside of
the United States, rules are provided to ensure consistent U.S.
tax treatment with respect to manufacturers. The bill requires
that property manufactured outside of the United States be
manufactured by (1) a domestic corporation, (2) an individual
who is a citizen or resident of the United States, (3) a
foreign corporation that elects to be subject to U.S. taxation
in the same manner as a U.S. corporation, or (4) a partnership
or other pass-through entity all of the partners or owners of
which are described in (1), (2), or (3) above.\18\
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\18\ Except as provided by the Secretary of the Treasury, tiered
partnerships or pass-through entities will be considered as
partnerships or pass-through entities for purposes of this rule if each
of the partnerships or entities is directly or indirectly wholly-owned
by persons described in (1), (2), or (3) above.
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Foreign trade income
Under the bill, ``foreign trade income'' is the taxable
income of the taxpayer (determined without regard to the
exclusion of qualifying foreign trade income) attributable to
foreign trading gross receipts. Certain dividends-paid
deductions of cooperatives are disregarded in determining
foreign trade income for this purpose.
Foreign sale and leasing income
Under the bill, ``foreign sale and leasing income'' is the
amount of the taxpayer's foreign trade income (with respect to
a transaction) that is properly allocable to activities that
constitute foreign economic processes (as described above). For
example, a distribution company's profit from the sale of
qualifying foreign trade property that is associated with sales
activities, such as solicitation or negotiation of the sale,
advertising, processing customer orders and arranging for
delivery, transportation outside of the United States, and
other enumerated activities, would constitute foreign sale and
leasing income.
Foreign sale and leasing income also includes foreign trade
income derived by the taxpayer in connection with the lease or
rental of qualifying foreign trade property for use by the
lessee outside of the United States. Income from the sale,
exchange, or other disposition of qualifying foreign trade
property that is or was subject to such a lease \19\ (i.e., the
sale of the residual interest in the leased property) gives
rise to foreign sale and leasing income. Except as provided in
regulations, a special limitation applies to leased property
that (1) is manufactured by the taxpayer or (2) is acquired by
the taxpayer from a related person for a price that was other
than arm's length. In such cases, foreign sale and leasing
income may not exceed the amount of foreign sale and leasing
income that would have resulted if the taxpayer had acquired
the leased property in a hypothetical arm's-length purchase and
then engaged in the actual sale or lease of such property. For
example, if a manufacturer leases qualifying foreign trade
property that it manufactured, the foreign sale and leasing
income derived from that lease may not exceed the amount of
foreign sale and leasing income that the manufacturer would
have earned with respect to that lease had it purchased the
property for an arm's-length price on the day that the
manufacturer entered into the lease. For purposes of
calculating the limit on foreign sale and leasing income, the
manufacturer's basis and, thus, depreciation would be based on
this hypothetical arm's-length price. This limitation is
intended to prevent foreign sale and leasing income from
including profit associated with manufacturing activities.
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\19\ For this purpose, such a lease includes a lease that gave rise
to exempt foreign trade income under the FSC provisions.
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For purposes of determining foreign sale and leasing
income, only directly allocable expenses are taken into account
in calculating the amount of foreign trade income. In addition,
income properly allocable to certain intangibles is excluded
for this purpose.
General example
The following is an example of the calculation of
qualifying foreign trade income.
XYZ Corporation, a U.S. corporation, manufactures property
that is sold to unrelated customers for use outside of the
United States. XYZ Corporation satisfies the foreign economic
processes requirement through conducting activities such as
solicitation, negotiation, transportation, and other sales-
related activities outside of the United States with respect to
its transactions. During the year, qualifying foreign trade
property was sold for gross proceeds totaling $1,000. The cost
of this qualifying foreign trade property was $600. XYZ
Corporation incurred $275 of costs that are directly related to
the sale and distribution of qualifying foreign trade property.
XYZ Corporation paid $40 of income tax to a foreign
jurisdiction related to the sale and distribution of the
qualifying foreign trade property. XYZ Corporation also
generated gross income of $7,600 (gross receipts of $24,000 and
cost of goods sold of $16,400) and direct expenses of $4,225
that relate to the manufacture and sale of products other than
qualifying foreign trade property. XYZ Corporation also
incurred $500 of overhead expenses. XYZ Corporation's financial
information for the year is summarized as follows:
------------------------------------------------------------------------
Other
Total property QFTP \20\
------------------------------------------------------------------------
Gross receipts................ $25,000.00 $24,000.00 $1,000.00
Cost of goods sold............ 17,000.00 16,400.00 600.00
-----------------------------------------
Gross income.............. 8,000.00 7,600.00 400.00
Direct expenses............... 4,500.00 4,225.00 275.00
Overhead expenses............. 500.00
--------------
Net income................ 3,000.00
------------------------------------------------------------------------
\20\ ``QFTP'' refers to qualifying foreign trade property.
Illustrated below is the computation of the amount of
qualifying foreign trade income that is excluded from XYZ
Corporation's gross income and the amount of related expenses
that are disallowed. In order to calculate qualifying foreign
trade income, the amount of foreign trade income first must be
determined. Foreign trade income is the taxable income
(determined without regard to the exclusion of qualifying
foreign trade income) attributable to foreign trading gross
receipts. In this example, XYZ Corporation's foreign trading
gross receipts equal $1,000. This amount of gross receipts is
reduced by the related cost of goods sold, the related direct
expenses, and a portion of the overhead expenses in order to
arrive at the related taxable income.\21\ Thus, XYZ
Corporation's foreign trade income equals $100, calculated as
follows:
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\21\ Overhead expenses must be apportioned in a reasonable manner
that does not result in a material distortion of income. In this
example, the apportionment of the $500 of overhead expenses on the
basis of gross income is assumed not to result in a material distortion
of income and is assumed to be a reasonable method of apportionment.
Thus, $25 ($500 of total overhead expenses multiplied by 5 percent,
i.e., $400 of gross income from the sale of qualifying foreign trade
property divided by $8,000 of total gross income) is apportioned to
qualifying foreign trading gross receipts. The remaining $475 ($500 of
total overhead expenses less the $25 apportioned to qualifying income)
is apportioned to XYZ Corporation's other income.
Foreign trading gross receipts................................ $1,000.00
Cost of goods sold............................................ 600.00
--------------------------------------------------------------
____________________________________________________
Gross income.............................................. 400.00
Direct expenses............................................... 275.00
Apportioned overhead expenses................................. 25.00
--------------------------------------------------------------
____________________________________________________
Foreign trade income...................................... 100.00
Foreign sale and leasing income is defined as an amount of
foreign trade income (calculated taking into account only
directly-related expenses) that is properly allocable to
certain specified foreign activities. Assume for purposes of
this example that of the $125 of foreign trade income ($400 of
gross income from the sale of qualifying foreign trade property
less only the direct expenses of $275), $35 is properly
allocable to such foreign activities (e.g., solicitation,
negotiation, advertising, foreign transportation, and other
enumerated sales-like activities) and, therefore, is considered
to be foreign sale and leasing income.
Qualifying foreign trade income is the amount of gross
income that, if excluded, will result in a reduction of taxable
income equal to the greatest of (1) 30 percent of foreign sale
and leasing income, (2) 1.2 percent of foreign trading gross
receipts, or (3) 15 percent of foreign trade income. Thus, in
order to calculate the amount that is excluded from gross
income, taxable income must be determined and then ``grossed
up'' for allocable expenses in order to arrive at the
appropriate gross income figure. First, for each method of
calculating qualifying foreign trade income, the reduction in
taxable income is determined. Then, the $275 of direct and $25
of overhead expenses, totaling $300, attributable to foreign
trading gross receipts is apportioned to the reduction in
taxable income based on the proportion of the reduction in
taxable income to foreign trade income. This apportionment is
done for each method of calculating qualifying foreign trade
income. The sum of the taxable income reduction and the
apportioned expenses equals the respective qualifying foreign
trade income (i.e., the amount of gross income excluded) under
each method, as follows:
------------------------------------------------------------------------
1.2% 15% FTI 30% FS&LI
FTGR \22\ \23\ \24\
------------------------------------------------------------------------
Reduction of taxable income:
1.2% of FTGR (1.2% * $1,000)...... 12.00
15% of FTI (15% * $100)........... 15.00
30% of FS&LI (30% * $35).......... 10.50
Gross-up for disallowed expenses:
$300 * ($12/$100)................. 36.00
$300 * ($15/$100)................. 45.00
$275 * ($10.50/$100) \25\......... 28.88
---------------------------------
Qualifying foreign trade income. 48.00 60.00 39.38
------------------------------------------------------------------------
\22\ ``FTGR'' refers to foreign trading gross receipts.
\23\ ``FTI'' refers to foreign trade income.
\24\ ``FS&LI'' refers to foreign sale and leasing income.
\25\ Because foreign sale and leasing income only takes into account
direct expenses, it is appropriate to take into account only such
expenses for purposes of this calculation.
In the example, the $60 of qualifying foreign trade income
is excluded from XYZ Corporation's gross income (determined
based on 15 percent of foreign trade income).\26\ In connection
with excluding $60 of gross income, certain expenses that are
allocable to this income are not deductible for U.S. Federal
income tax purposes. Thus, $45 ($300 of related expenses
multiplied by 15 percent, i.e., $60 of qualifying foreign trade
income divided by $400 of gross income from the sale of
qualifying foreign trade property) of expenses are
disallowed.\27\
---------------------------------------------------------------------------
\26\ Note that XYZ Corporation could choose to use one of the other
two methods notwithstanding that they would result in a smaller
exclusion.
\27\ The $300 of allocable expenses includes both the $275 of
direct expenses and the $25 of overhead expenses. Thus, the $45 of
disallowed expenses represents the sum of $41.25 of direct expenses
plus $3.75 of overhead expenses. If qualifying foreign trade income was
determined using 30 percent of foreign sale and leasing income, the
disallowed expenses would include only the appropriate portion of the
direct expenses.
----------------------------------------------------------------------------------------------------------------
Other Excluded/
Property QFTP disallowed Total
----------------------------------------------------------------------------------------------------------------
Gross receipts.............................................. $24,000.00 $1,000.00
Cost of goods sold.......................................... 16,400.00 600.00
--------------------------
Gross income.......................................... 7,600.00 400.00 (60.00) 7,940.00
Direct expenses............................................. 4,225.00 275.00 (41.25) 4,458.75
Overhead expenses........................................... 475.00 25.00 (3.75) 496.25
------------
Taxable income........................................ 2,985.00
----------------------------------------------------------------------------------------------------------------
XYZ Corporation paid $40 of income tax to a foreign
jurisdiction related to the sale and distribution of the
qualifying foreign trade property. A portion of this $40 of
foreign income tax is treated as paid with respect to the
qualifying foreign trade income and, therefore, is not
creditable for U.S. foreign tax credit purposes. In this case,
$6 of such taxes paid ($40 of foreign taxes multiplied by 15
percent, i.e., $60 of qualifying foreign trade income divided
by $400 of gross income from the sale of qualifying foreign
trade property) is treated as paid with respect to the
qualifying foreign trade income and, thus, is not creditable.
The results in this example are the same regardless of
whether XYZ Corporation manufactures the property within the
United States or outside of the United States through a foreign
branch. If XYZ Corporation were an S corporation or limited
liability company, the results also would be the same, and the
exclusion would pass through to the S corporation owners or
limited liability company owners as the case may be.
Other rules
Foreign-source income limitation
The bill provides a limitation with respect to the sourcing
of taxable income applicable to certain sale transactions
giving rise to foreign trading gross receipts. This limitation
only applies with respect to sale transactions involving
property that is manufactured within the United States. The
special source limitation does not apply when qualifying
foreign trade income is determined using 30 percent of the
foreign sale and leasing income from the transaction.
This foreign-source income limitation is determined in one
of two ways depending on whether the qualifying foreign trade
income is calculated based on 1.2 percent of foreign trading
gross receipts or on 15 percent of foreign trade income. If the
qualifying foreign trade income is calculated based on 1.2
percent of foreign trading gross receipts, the related amount
of foreign-source income may not exceed the amount of foreign
trade income that (without taking into account this special
foreign-source income limitation) would be treated as foreign-
source income if such foreign trade income were reduced by 4
percent of the related foreign trading gross receipts.
For example, assume that foreign trading gross receipts are
$2,000 and foreign trade income is $100. Assume also that the
taxpayer chooses to determine qualifying foreign trade income
based on 1.2 percent of foreign trading gross receipts. Taxable
income after taking into account the exclusion of the
qualifying foreign trade income and the disallowance of related
deductions is $76. Assume that the taxpayer manufactured its
qualifying foreign trade property in the United States and that
title to such property passed outside of the United States.
Absent a special sourcing rule, under section 863(b) (and the
regulations thereunder) the $76 of taxable income would be
sourced as $38 U.S. source and $38 foreign source. Under the
special sourcing rule, the amount of foreign-source income may
not exceed the amount of the foreign trade income that
otherwise would be treated as foreign source if the foreign
trade income were reduced by 4 percent of the related foreign
trading gross receipts. Reducing foreign trade income by 4
percent of the foreign trading gross receipts (4 percent of
$2,000, or $80) would result in $20 ($100 foreign trade income
less $80). Applying section 863(b) to the $20 of reduced
foreign trade income would result in $10 of foreign-source
income and $10 of U.S.-source income. Accordingly, the
limitation equals $10. Thus, although under the general
sourcing rule $38 of the $76 taxable income would be treated as
foreign source, the special sourcing rule limits foreign-source
income in this example to $10 (with the remaining $66 being
treated as U.S.-source income).
If the qualifying foreign trade income is calculated based
on 15 percent of foreign trade income, the amount of related
foreign-source income may not exceed 50 percent of the foreign
trade income that (without taking into account this special
foreign-source income limitation) would be treated as foreign-
source income.
For example, assume that foreign trade income is $100 and
the taxpayer chooses to determine its qualifying foreign trade
income based on 15 percent of foreign trade income. Taxable
income after taking into account the exclusion of the
qualifying foreign trade income and the disallowance of related
deductions is $85. Assume that the taxpayer manufactured its
qualifying foreign trade property in the United States and that
title to such property passed outside of the United States.
Absent a special sourcing rule, under section 863(b) the $85 of
taxable income would be sourced as $42.50 U.S. source and
$42.50 foreign source. Under the special sourcing rule, the
amount of foreign-source income may not exceed 50 percent of
the foreign trade income that otherwise would be treated as
foreign source. Applying section 863(b) to the $100 of foreign
trade income would result in $50 of foreign-source income and
$50 of U.S.-source income. Accordingly, the limitation equals
$25, which is 50 percent of the $50 foreign-source income.
Thus, although under the general sourcing rule $42.50 of the
$85 taxable income would be treated as foreign source, the
special sourcing rule limits foreign-source income in this
example to $25 (with the remaining $60 being treated as U.S.-
source income).\28\
---------------------------------------------------------------------------
\28\ The foreign-source income limitation provisions also apply
when source is determined solely in accordance with section 862 (e.g.,
a distributor of qualifying foreign trade property that is manufactured
in the United States by an unrelated person and sold for use outside of
the United States).
---------------------------------------------------------------------------
Treatment of withholding taxes
The bill generally provides that no foreign tax credit is
allowed for foreign taxes paid or accrued with respect to
qualifying foreign trade income (i.e., excluded
extraterritorial income). In determining whether foreign taxes
are paid or accrued with respect to qualifying foreign trade
income, foreign withholding taxes generally are treated as not
paid or accrued with respect to qualifying foreign trade
income.\29\ Accordingly, the bill's denial of foreign tax
credits would not apply to such taxes. For this purpose, the
term ``withholding tax'' refers to any foreign tax that is
imposed on a basis other than residence and that is otherwise a
creditable foreign tax under sections 901 or 903.\30\ It is
intended that such taxes would be similar in nature to the
gross-basis taxes described in sections 871 and 881.
---------------------------------------------------------------------------
\29\ With respect to the withholding taxes that are paid or accrued
(a prerequisite to the taxes being otherwise creditable), the provision
in the bill treats such taxes as not being paid or accrued with respect
to qualifying foreign trade income.
\30\ This also would apply to any withholding tax that is
creditable for U.S. foreign tax credit purposes under an applicable
treaty.
---------------------------------------------------------------------------
If, however, qualifying foreign trade income is determined
based on 30 percent of foreign sale and leasing income, the
special rule for withholding taxes is not applicable. Thus, in
such cases foreign withholding taxes may be treated as paid or
accrued with respect to qualifying foreign trade income and,
accordingly, are not creditable under the bill.
Election to be treated as a U.S. corporation
The bill provides that certain foreign corporations may
elect, on an original return, to be treated as domestic
corporations. The election applies to the taxable year when
made and all subsequent taxable years unless revoked by the
taxpayer or terminated for failure to qualify for the election.
Such election is available for a foreign corporation (1) that
manufactures property in the ordinary course of such
corporation's trade or business, or (2) if substantially all of
the gross receipts of such corporation reasonably may be
expected to be foreign trading gross receipts. For this
purpose, ``substantially all'' is based on the relevant facts
and circumstances.
In order to be eligible to make this election, the foreign
corporation must waive all benefits granted to such corporation
by the United States pursuant to a treaty.\31\ Absent such a
waiver, it would be unclear, for example, whether the permanent
establishment article of a relevant tax treaty would override
the electing corporation's treatment as a domestic corporation
under this provision. A foreign corporation that elects to be
treated as a domestic corporation is not permitted to make an S
corporation election. The Secretary is granted authority to
prescribe rules to ensure that the electing foreign corporation
pays its U.S. income tax liabilities and to designate one or
more classes of corporations that may not make such an
election.\32\ If such an election is made, for purposes of
section 367 the foreign corporation is treated as transferring
(as of the first day of the first taxable year to which the
election applies) all of its assets to a domestic corporation
in connection with an exchange to which section 354 applies.
---------------------------------------------------------------------------
\31\ The waiver of treaty benefits applies to the corporation
itself and not, for example, to employees of or independent contractors
associated with the corporation.
\32\ For example, the Secretary of the Treasury may prescribe rules
to prevent ``per se'' corporations under the entity-classification
rules from making such an election.
---------------------------------------------------------------------------
If a corporation fails to meet the applicable requirements,
described above, for making the election to be treated as a
domestic corporation for any taxable year beginning after the
year of the election, the election will terminate. In addition,
a taxpayer, at its option and at any time, may revoke the
election to be treated as a domestic corporation. In the case
of either a termination or a revocation, the electing foreign
corporation will not be considered as a domestic corporation
effective beginning on the first day of the taxable year
following the year of such termination or revocation. For
purposes of section 367, if the election to be treated as a
domestic corporation is terminated or revoked, such corporation
is treated as a domestic corporation transferring (as of the
first day of the first taxable year to which the election
ceases to apply) all of its property to a foreign corporation
in connection with an exchange to which section 354 applies.
Moreover, once a termination occurs or a revocation is made,
the former electing corporation may not again elect to be taxed
as a domestic corporation under the provisions of the bill for
a period of five tax years beginning with the first taxable
year that begins after the termination or revocation.
For example, assume a U.S. corporation owns 100 percent of
a foreign corporation. The foreign corporation manufactures
outside of the United States and sells what would be qualifying
foreign trade property were it manufactured by a person subject
to U.S. taxation. Such foreign corporation could make the
election under this provision to be treated as a domestic
corporation. As a result, its earnings no longer would be
deferred from U.S. taxation. However, by electing to be subject
to U.S. taxation, a portion of its income would be qualifying
foreign trade income.\33\ The requirement that the foreign
corporation be treated as a domestic corporation (and,
therefore, subject to U.S. taxation) is intended to provide
parity between U.S. corporations that manufacture abroad in
branch form and U.S. corporations that manufacture abroad
through foreign subsidiaries. The election, however, is not
limited to U.S.-owned foreign corporations. A foreign-owned
foreign corporation that wishes to qualify for the treatment
provided under the bill could avail itself of such election
(unless otherwise precluded from doing so by Treasury
regulations).
---------------------------------------------------------------------------
\33\ The sourcing limitation described above would not apply to
this example because the property is manufactured outside of the United
States.
---------------------------------------------------------------------------
Shared partnerships
The bill provides rules relating to allocations of
qualifying foreign trade income by certain shared partnerships.
To the extent that such a partnership (1) maintains a separate
account for transactions involving foreign trading gross
receipts with each partner, (2) makes distributions to each
partner based on the amounts in the separate account, and (3)
meets such other requirements as the Treasury Secretary may
prescribe by regulations, such partnership then would allocate
to each partner items of income, gain, loss, and deduction
(including qualifying foreign trade income) from such
transactions on the basis of the separate accounts. It is
intended that with respect to, and only with respect to, such
allocations and distributions (i.e., allocations and
distributions related to transactions between the partner and
the shared partnership generating foreign trading gross
receipts), these rules would apply in lieu of the otherwise
applicable partnership allocation rules such as those in
section 704(b). For this purpose, a partnership is a foreign or
domestic entity that is considered to be a partnership for U.S.
Federal income tax purposes.
Under the bill, any partner's interest in the shared
partnership is not taken into account in determining whether
such partner is a ``related person'' with respect to any other
partner for purposes of the bill's provisions. Also, the
election to exclude certain gross receipts from foreign trading
gross receipts must be made separately by each partner with
respect to any transaction for which the shared partnership
maintains a separate account.
Certain assets not taken into account for purposes of
interest expense allocation
The bill also provides that qualifying foreign trade
property that is held for lease or rental, in the ordinary
course of a trade or business, for use by the lessee outside of
the United States is not taken into account for interest
allocation purposes.
Distributions of qualifying foreign trade income by
cooperatives
Agricultural and horticultural producers often market their
products through cooperatives, which are member-owned
corporations formed under Subchapter T of the Code. At the
cooperative level, the bill provides the same treatment of
foreign trading gross receipts derived from products marketed
through cooperatives as it provides for foreign trading gross
receipts of other taxpayers. That is, the qualifying foreign
trade income attributable to those foreign trading gross
receipts is excluded from the gross income of the cooperative.
Absent a special rule, however, patronage dividends or per-unit
retain allocations attributable to qualifying foreign trade
income paid to members of cooperatives would be taxable in the
hands of those members. The Committee believes that this would
disadvantage agricultural and horticultural producers who
choose to market their products through cooperatives relative
to those individuals who market their products directly or
through pass-through entities such as partnerships, limited
liability companies, or S corporations. Accordingly, the bill
provides that the amount of any patronage dividends or per-unit
retain allocations paid to a member of an agricultural or
horticultural cooperative (to which Part I of Subchapter T
applies), which is allocable to qualifying foreign trade income
of the cooperative, is treated as qualifying foreign trade
income of the member (and, thus, excludable from such member's
gross income). In order to qualify, such amount must be
designated by the organization as allocable to qualifying
foreign trade income in a written notice mailed to its patrons
not later than the payment period described in section 1382(d).
The cooperative cannot reduce its income (e.g., cannot claim a
``dividends-paid deduction'') under section 1382 for such
amounts.
Gap period before administrative guidance is issued
The Committee recognizes that there may be a gap in time
between the enactment of the bill and the issuance of detailed
administrative guidance. It is intended that during this gap
period before administrative guidance is issued, taxpayers and
the Internal Revenue Service may apply the principles of
present-law regulations and other administrative guidance under
sections 921 through 927 to analogous concepts under the bill.
Some examples of the application of the principles of present-
law regulations to the bill are described below. These limited
examples are intended to be merely illustrative and are not
intended to imply any limitation regarding the application of
the principles of other analogous rules or concepts under
present law.
Marginal costing and grouping
Under the bill, the Secretary of the Treasury is provided
authority to prescribe rules for using marginal costing and for
grouping transactions in determining qualifying foreign trade
income. It is intended that similar principles under present-
law regulations apply for these purposes.\34\
---------------------------------------------------------------------------
\34\ See, e.g., Treas. Reg. sec. 1.924(d)-1(c)(5) and (e); Treas.
Reg. sec. 1.925(a)-1T(c)(8); Treas. Reg. sec. 1.925(b)-1T.
---------------------------------------------------------------------------
Excluded property
The bill provides that qualifying foreign trade property
does not include property leased or rented by the taxpayer for
use by a related person. It is intended that similar principles
under present-law regulations apply for this purpose. Thus,
excluded property does not apply, for example, to property
leased by the taxpayer to a related person if the property is
held for sublease, or is subleased, by the related person to an
unrelated person and the property is ultimately used by such
unrelated person predominantly outside of the United
States.\35\ In addition, consistent with the policy adopted in
the Taxpayer Relief Act of 1997, computer software that is
licensed for reproduction outside of the United States is not
excluded property. Accordingly, the license of computer
software to a related person for reproduction outside of the
United States for sale, sublicense, lease, or rental to an
unrelated person for use outside of the United States is not
treated as excluded property by reason of the license to the
related person.
---------------------------------------------------------------------------
\35\ See Treas. Reg. sec. 1.927(a)-1T(f)(2)(i). The bill also
provides that oil or gas or primary products from oil or gas are
excluded from the definition of qualifying foreign trade property. It
is intended that similar principles under present-law regulations apply
for these purposes. Thus, for this purpose, petrochemicals, medicinal
products, insecticides, and alcohols are not considered primary
products from oil or gas and, thus, are not treated as excluded
property. See Treas. Reg. sec. 1.927(a)-1T(g)(2)(iv).
---------------------------------------------------------------------------
Foreign trading gross receipts
Under the bill, foreign trading gross receipts are gross
receipts from, among other things, the sale, exchange, or other
disposition of qualifying foreign trade property, and from the
lease of qualifying foreign trade property for use by the
lessee outside of the United States. It is intended that the
principles of present-law regulations that define foreign
trading gross receipts apply for this purpose. For example, a
sale includes an exchange or other disposition and a lease
includes a rental or sublease and a license or a
sublicense.\36\
---------------------------------------------------------------------------
\36\ See Treas. Reg. sec. 1.924(a)-1T(a)(2).
---------------------------------------------------------------------------
Foreign use requirement
Under the bill, property constitutes qualifying foreign
trade property if, among other things, the property is held
primarily for lease, sale, or rental, in the ordinary course of
business, for direct use, consumption, or disposition outside
of the United States.\37\ It is intended that the principles of
the present-law regulations apply for purposes of this foreign
use requirement. For example, for purposes of determining
whether property is sold for use outside of the United States,
property that is sold to an unrelated person as a component to
be incorporated into a second product which is produced,
manufactured, or assembled outside of the United States will
not be considered to be used in the United States (even if the
second product ultimately is used in the United States),
provided that the fair market value of such seller's components
at the time of delivery to the purchaser constitutes less than
20 percent of the fair market value of the second product into
which the components are incorporated (determined at the time
of completion of the production, manufacture, or assembly of
the second product).\38\
---------------------------------------------------------------------------
\37\ Foreign trading gross receipts eligible for exclusion from the
tax base do not include gross receipts from a transaction if the
qualifying foreign trade property is for ultimate use in the United
States.
\38\ See Treas. Reg. sec. 1.927(a)-1T(d)(4)(ii).
---------------------------------------------------------------------------
In addition, for purposes of the foreign use requirement,
property is considered to be used by a purchaser or lessee
outside of the United States during a taxable year if it is
used predominantly outside of the United States.\39\ For this
purpose, property is considered to be used predominantly
outside of the United States for any period if, during that
period, the property is located outside of the United States
more than 50 percent of the time.\40\ An aircraft or other
property used for transportation purposes (e.g., railroad
rolling stock, a vessel, a motor vehicle, or a container) is
considered to be used outside of the United States for any
period if, for the period, either the property is located
outside of the United States more than 50 percent of the time
or more than 50 percent of the miles traveled in the use of the
property are traveled outside of the United States.\41\ An
orbiting satellite is considered to be located outside of the
United States for these purposes.\42\
---------------------------------------------------------------------------
\39\ See Treas. Reg. sec. 1.927(a)-1T(d)(4)(iii), (iv), and (v).
\40\ See Treas. Reg. sec. 1.927(a)-1T(d)(4)(vi).
\41\ Id.
\42\ Id.
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Foreign economic processes
Under the bill, gross receipts from a transaction are
foreign trading gross receipts eligible for exclusion from the
tax base only if certain economic processes take place outside
of the United States. The foreign economic processes
requirement compares foreign direct costs to total direct
costs. It is intended that the principles of the present-law
regulations apply during the gap period for purposes of the
foreign economic processes requirement including the
measurement of direct costs. The Committee recognizes that the
measurement of foreign direct costs under the present-law
regulations often depend on activities conducted by the FSC,
which is a separate entity. The Committee is aware that some of
these concepts will have to be modified when new guidance is
promulgated as a result of the bill's elimination of the
requirement for a separate entity.
Effective Date
In general
The bill is effective for transactions entered into after
September 30, 2000. In addition, no corporation may elect to be
a FSC after September 30, 2000.
The bill also provides a rule requiring the termination of
a dormant FSC when the FSC has been inactive for a specified
period of time. Under this rule, a FSC that generates no
foreign trade income for any five consecutive years beginning
after December 31, 2001, will cease to be treated as a FSC.
Transition rules
The bill provides a transition period for existing FSCs and
for binding contractual agreements. The new rules do not apply
to transactions in the ordinary course of business \43\
involving a FSC before January 1, 2002. Furthermore, the new
rules do not apply to transactions in the ordinary course of
business after December 31, 2001, if such transactions are
pursuant to a binding contract between a FSC (or a person
related to the FSC on September 30, 2000) and any other person
(that is not a related person) and such contract is in effect
on September 30, 2000, and all times thereafter. For this
purpose, binding contracts include purchase options, renewal
options, and replacement options that are enforceable against a
lessor or seller (provided that the options are a part of a
contract that is binding and in effect on September 30, 2000).
---------------------------------------------------------------------------
\43\ The mere entering into of a single transaction, such as a
lease, would not, in and of itself, prevent the transaction from being
in the ordinary course of business.
---------------------------------------------------------------------------
Similar to the limitation on use of the gross receipts
method under the bill's operative provisions, the bill provides
a rule that limits the use of the gross receipts method for
transactions after the effective date of the bill if that same
property generated foreign trade income to a FSC using the
gross receipts method. Under the rule, if any person used the
gross receipts method under the FSC regime, neither that person
nor any related person will have qualifying foreign trade
income with respect to any other transaction involving the same
item of property.
Notwithstanding the transition period, FSCs (or related
persons) may elect to have the rules of the bill apply in lieu
of the rules applicable to FSCs. Thus, for transactions to
which the transition rules apply, taxpayers may choose to apply
either the FSC rules or the amendments made by this bill, but
not both. It is also intended that a taxpayer would not be able
to avail itself of the rules of the bill in addition to the
rules applicable to domestic international sales corporations.
III. BUDGET EFFECTS OF THE BILL
A. Committee Estimates
In compliance with paragraph 11(a) of rule XXVI of the
Standing Rules of the Senate, the following statement is made
concerning the estimated budget effects of the provisions of
the bill, H.R. 4986, as reported.
The bill, as reported, is estimated to have the following
effects on budget receipts for fiscal years 2001-2010.
ESTIMATED BUDGET EFFECTS OF H.R. 4986, THE ``FSC REPEAL AND EXTRATERRITORIAL INCOME EXCLUSION ACT OF 2000,'' AS REPORTED BY THE COMMITTEE ON FINANCE
[Fiscal Years 2001-2010, in millions of dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Provision Effective 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2001-05 2001-10
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Extraterritorial Income Exclusion; FSC Repeal...... generally ta 9/30/00 -141 -305 -340 -378 -423 -466 -514 -566 -623 -687 -1,587 -4,443
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Legend for ``Effective'' column: ta = transaction after.
Note: Details may not add to totals due to rounding.
Source: Joint Committee on Taxation.
B. Budget Authority and Tax Expenditures
Budget authority
In compliance with section 308(a)(1) of the Budget Act, the
Committee states that the provisions of the bill as reported
involve no new or increased budget authority.
Tax expenditures
In compliance with section 308(a)(2) of the Budget Act, the
committee states that the revenue-reducing income tax
provisions involve increased tax expenditures (See revenue
table in Part III.A., above.)
C. Consultation With the Congressional Budget Office
In accordance with section 403 of the Budget Act, the
committee advises that the Congressional Budget Office has
submitted a statement on this bill.
U.S. Congress,
Congressional Budget Office,
Washington, DC, September 20, 2000.
Hon. William V. Roth, Jr.,
Chairman, Committee on Finance,
U.S. Senate, Washington, DC.
Dear Mr. Chairman: The Congressional Budget Office has
prepared the enclosed cost estimate for H.R. 4986, the FSC
Repeal and Extraterritorial Income Exclusion Act of 2000.
If you wish further details on this estimate, we will be
pleased to provide them. The CBO staff contact is Erin
Whitaker.
Sincerely,
Barry B. Anderson
(For Dan L. Crippen, Director).
Enclosure.
H.R. 4986.--FSC Repeal and Extraterritorial Income Exclusion Act of
2000
Summary: H.R. 4986 would repeal present-law foreign sales
corporation (FSC) rules. Under current law, U.S. firms
generally are subject to U.S. Tax on their worldwide income,
but they are allowed tax credits for a portion of the income
taxes they pay to foreign governments on that income. Within
that general framework, U.S. law permits the use of FSCs,
through which a portion of domestic firms' export income is
characterized as foreign source and is exempted from U.S. tax.
Under the proposal, U.S. firms could elect to exclude certain
qualifying foreign trade income from their taxable income, with
qualifying foreign trade income defined to include a portion of
income attributable to sales by U.S. taxpayers. To be eligible
for the exclusion, firms would not be allowed tax credits for
income taxes paid to foreign governments on the qualifying
foreign trade income. Qualifying foreign trade income would be
calculated by using one of several formulas. The remaining
portion of income earned from sources abroad would be taxed in
a similar manner as under current law.
The Joint Committee on Taxation (JCT) estimates that the
bill would reduce revenues by $141 million in 2001, by about
$1.6 billion over the 2001-2005 period, and by about $4.4
billion over the 2001-2010 period. Because the bill would
affect receipts, pay-as-you-go procedures would apply.
H.R. 4986 contains no intergovernmental or private-sector
mandates as defined in the Unfunded Mandates Reform Act (UMRA)
and would not affect the budgets of state, local, or tribal
governments.
Estimated cost to the Federal Government: The estimated
budgetary impact of H.R. 4986 is shown in the following table.
Estimates of all provisions in the H.R. 4986 were provided by
JCT.
----------------------------------------------------------------------------------------------------------------
By fiscal year in millions of dollars--
-----------------------------------------------------
2000 2001 2002 2003 2004 2005
----------------------------------------------------------------------------------------------------------------
CHANGES IN REVENUES
Estimated Revenues........................................ 0 -141 -305 -340 -378 -423
----------------------------------------------------------------------------------------------------------------
Source: Joint Committee on Taxation.
Pay-as-you-go consideration: The Balanced Budget and
Emergency Deficit Control Act sets up pay-as-you-go procedures
for legislation affecting direct spending or receipts. The net
changes in governmental receipts that are subject to pay-as-
you-go procedures are shown in the following table. For the
purposes of enforcing pay-as-you-go procedures, only the
effects in the current year, the budget year, and the
succeeding four years are counted.
--------------------------------------------------------------------------------------------------------------------------------------------------------
By fiscal year in millions of dollars--
------------------------------------------------------------------------------------------------
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
Changes in receipts.................................... 0 -141 -305 -340 -378 -423 -466 -514 -566 -623 -687
Changes in outlays..................................... Not applicable
--------------------------------------------------------------------------------------------------------------------------------------------------------
Intergovernmental and private-sector impact: H.R. 4986
contains no intergovernmental or private-sector mandates as
defined in UMRA and would not affect the budgets of state,
local, or tribal governments.
Previous CBO estimate: On September 13, 2000, CBO
transmitted a cost estimate for H.R. 4986 as ordered reported
by the House Committee on Ways and Means on July 27, 2000, with
subsequent amendments provided on September 12, 2000. This
estimate reflects the removal of a provision from the earlier
version of H.R. 4986 which would allow domestic corporations to
receive a tax deduction for certain dividends received from
their foreign subsidiaries. This change would decrease the
reduction in revenues, relative to the earlier version of H.R.
4986, by $12 million in 2001, $36 million over the 2001-2005
period, and $36 million over the 2001-2010 period.
Estimate prepared by: Erin Whitaker.
Estimate approved by: Roberton C. Williams, Deputy
Assistant Director for Tax Analysis.
IV. VOTES OF THE COMMITTEE
In compliance with paragraph 7(b) of rule XXVI of the
Standing Rules of the Senate, the following statements are made
concerning the rollcall votes in the Committee's consideration
of the bill.
MOTION TO REPORT THE BILL
H.R. 4986, the FSC Repeal and Extraterritorial Income
Exclusion Act of 2000, was ordered favorably reported by voice
vote, as amended.
V. REGULATORY IMPACT AND OTHER MATTERS
A. Regulatory Impact
Pursuant to paragraph 11(b) of rule XXVI of the Standing
Rules of the Senate, the Committee makes the following
statement concerning the regulatory impact that might be
incurred in carrying out the provisions of the bill as
reported.
Impact on individuals and businesses
The bill repeals the FSC provisions of the Code and
provides an exclusion from gross income for certain
extraterritorial income.
Impact on personal privacy and paperwork
The bill should not have any adverse impact on personal
privacy. Additional paperwork may be required with the respect
to the application of the new regime to individuals.
B. Unfunded Mandates Statement
This information is provided in accordance with section 423
of the Unfunded Mandates Act of 1995 (P.L. 104-4).
The Committee has determined that the bill does not contain
Federal mandates on the private sector. The Committee has
determined that the bill does not impose a Federal
intergovernmental mandate on State, local, and tribal
governments.
C. Complexity Analysis
Section 4022(b) of the Internal Revenue Service Reform and
Restructuring Act of 1998 (the ``IRS Reform Act'') requires the
Joint Committee on Taxation (in consultation with the Internal
Revenue Service and the Department of the Treasury) to provide
a tax complexity analysis. The complexity analysis is required
for all legislation reported by the House Committee on Ways and
Means, the Senate Committee on Finance, or any committee of
conference if the legislation includes a provision that
directly or indirectly amends the Code and has ``widespread
applicability'' to individuals or small businesses.
The staff of the Joint Committee on Taxation has determined
that a complexity analysis is not required under section
4022(b) of the IRS Reform Act because the bill contains no
provisions that amend the Code and that have widespread
applicability to individuals or small businesses.
VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED
In the opinion of the Committee, it is necessary in order
to expedite the business of the Senate, to dispense with the
requirements of paragraph 12 of Rule XXVI of the Standing Rules
of the Senate (relating to the showing of changes in existing
law made by the bill as reported by the Committee).