These are frequently asked questions on the topic of the IC-DISC and United States Exporting of Computer Software, Internet Sales and Licenses as a major tax savings tool. We thank our member Richard Lehman for his expertise and answers to these often asked questions.
Will a customer of company that is exporting through a DISC know that there is a DISC involved in the transaction?
Answer: The existence of the DISC will be transparent to the export company’s customers. The exporter will continue to operate its business in the same manner and its employees will continue to perform the company’s manufacturing, sales, billing, shipping and collection functions. The fact that there is a commission agreement between the exporter and the DISC will not have to be disclosed to the exporter’s customers and no documentation provided to the customers will need to indicate the existence of or services deemed provided by the DISC.
What is the definition of “Export Property” that will qualify for DISC treatment?
Answer: Export property means property: Manufactured, produced, grown or extracted in the United States; held for sale, lease or rental, in the ordinary course of business, for use, consumption or disposition outside the United States; and Not more than 50% of the fair market value of which is attributed to articles imported into the United States.
What are the requirements to establish a DISC corporation?
Answer:
- A corporation taxable as a corporation must be formed under the laws of any State or the District of Columbia to be the IC-DISC.
- The corporation must have only one class of stock and minimum capital of $2,500. The IC-DISC shareholders may be related to the IC-DISC.
- The IC-DISC must take a tax election to be an IC-DISC that must be filed with the Internal Revenue Service within 90 days after the beginning of the tax year of the IC-DISC.
- The IC-DISC must maintain separate books and records.
- The IC-DISC must have at least 95% or more of its gross receipts considered to be Qualified Receipts resulting from the DISC’s export activities. The transaction must be pursuant to the terms of a contract entered into with a purchaser by the DISC or by the principal at any time or by any other person and assigned to the DISC or the principal at any time prior to the shipment of such property to the purchaser.
- The IC-DISC must have at least 95% or more of its assets considered to be Qualified Export Receipts.
What are the tax benefits to be gained by using a DISC?
Answer: The tax benefits of the IC-DISC come in two separate fashions. The IC-DISC shareholders may leave the IC-DISC profits in the IC-DISC and defer taxation until actual distribution of the profits or the IC-DISC may distribute profits to its shareholders like any other corporation. Since IC-DISC distributions are considered “qualified dividends”, they are subject to a maximum tax of 20%. Thus the magic of the IC-DISC is to provide both tax deferral and to apply a 20% maximum dividend tax rate to profits that would otherwise be taxable in the U.S. taxpayer’s highest brackets that can range as high as 50% when city, state and federal income taxes are calculated.
What methods of pricing may be used to determine the amount that can be paid to a DISC?
Answer:
Gross Receipts Methods
Under the gross receipts method of pricing, the transfer price for a sale by the related supplier to the DISC is the price as a result of which the taxable income derived by the DISC form the sale will not exceed the sum of (i) 4 percent of the qualified export receipts of the DISC derived from the sale of the export property and (ii) 10 percent of the export promotion expenses of the DISC attributable to such qualified export receipts.
Taxable Income Method
Under the combined taxable income method of pricing, the transfer price for a sale by the related supplier to the DISC is the price as a result of which the taxable income derived by the DISC from the sale will not exceed the sum of (i) 50 percent of the combined taxable income of the DISC and its related supplier attributable to the qualified export receipts form such sale and (ii) 10 percent of the export promotion expenses of the DISC attributable to such qualified export receipts.
Arm’s Length Method
If the rules of the preceding paragraphs are inapplicable to a sale or a taxpayer does not choose to use them, the transfer price for a sale by the related supplier to the DISC is to be determined on the basis of the sale price actually charged but subject to the rules provided by the rules of sale between related parties.
Have questions? Contact Richard Lehman.
Richard S. Lehman is a graduate of Georgetown Law School and obtained his Master’s degree in taxation from New York University. He has served as a law clerk to the Honorable William M. Fay, U.S. Tax Court and as Senior Attorney of the Interpretative Division in the Chief Counsel’s Office of the Internal Revenue Service in Washington D.C., the IRS’s internal law firm.
Mr. Lehman has had extensive experience with all areas of the Internal Revenue code that apply to American taxpayers and nonresident aliens and foreign corporations investing or conducting business in the United States, as well as U.S. citizens and domestic corporations investing abroad.
Mr. Lehman regularly works with law firms, accountants, businesses and individuals struggling to find their way through the complexities of the tax law.
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