Understanding Export Tax Benefits
The Section 956 export exception.
November 14, 2011
Besides the Interest Charge Domestic International Sales Corporation (IC-DISC), there are several little-known export exceptions and exemptions under the Internal Revenue Code (IRC) that offer export tax benefits to United States (U.S.) companies with a foreign presence. These export exceptions and exemptions present exporters with an opportunity to bring trapped Section 956 funds back into the U.S. without Subpart F exposure, use the foreign tax credits accumulating offshore and lower the international effective tax rate. This article focuses on the Section 956 export exception.
Exception for Investment in Export Inventory Property
General Rules for Investing in U.S. Inventory Property Under Sec. 956
Sec. 956(c)(2)(B) provides an exception from the definition of U.S. property for “property located in the U.S., which is purchased in the U.S. for export to or use in, foreign countries.”
The regulations state that if a property qualifies under the general rule, it is to be determined on the basis of the facts and circumstances, but that a property which constitutes “export trade assets” within the meaning of Sec. 971(c)(2) and Treasury Reg. Sec. 1.971-1(c)(3) will automatically qualify as export property for purposes of Sec. 956(c)(2)(B) (Treasury Reg. Sec. 1.956-2(b)(1)(iv)).
The reference in the regulations to “export trade assets” within the meaning of Sec. 971(c)(2) is to “inventory of export property held for use, consumption or disposition outside the United States.” Under the applicable Export Trade Corporation rules, there must be a “clear intent” on the part of the customer foreign currency accounts (CFC) to “dispose of the property for use, consumption or disposition outside the United States” by the CFC's customers. The Sec. 971(c) regulations also contain a presumption to the effect that if property is held in the United States during a CFC's taxable year and is exported from the U.S. during the following year, it will generally qualify as export property. On the other hand, the indefinite warehousing of such property in the U.S. will generally cause the property not to be classified as export property.
The Sec. 956(c)(2)(B) exemption for export property should be available if the property has been purchased within the U.S. and title has been passed to the CFC but export of the property has not yet taken place. In this regard, Sec. 956(c)(2)(B) contains no tests regarding the amount of value added to the property in the manufacturing process that takes place within the U.S.. In addition, it appears irrelevant whether the seller of the export property is a U.S. person or even whether it has an office or place of business within the U.S.
The Sec. 956(c)(2)(B) exception on its face does not appear to apply to property that the CFC manufactured in the U.S. for export. This is because the exception only applies to property that the CFC purchased for export.
Profit on the Sale of Export Inventory — Subpart F
As explained above, the direct investment of the CFC in export inventory located in the U.S. should not trigger current income inclusion under Sec. 956. However, if the property is purchased from a related person, then Sec. 954 may come into play. For Subpart F income purposes, generally, the following are considered related with respect to a CFC:
The term control means more than 50 percent ownership. This ownership can be direct or by attribution. In the case of a corporation, control means ownership of stock possessing more than 50 percent of either the total combined voting power of all classes of the corporation's voting stock or the total value of the corporation's stock. In the case of a partnership, estate or trust, control means ownership of more than 50 percent of the value of the beneficial interests in that entity.
The purchase and sale of export inventory may be treated as a foreign-based company sales income under Sec. 954(d) if the CFC purchases inventory from a related person and sells the inventory for use, consumption or disposition outside of its country of incorporation. In this case the gross profit earned on the sale after all the appropriate deductions have been apportioned and allocated to it will be considered Subpart F and as such it will be taxed currently to CFC’s U.S. shareholders.
Interest on a Loan — Subpart F
A loan against export inventory should not trigger current income inclusion under Sec. 956. However, interest earned on the loan may be treated as foreign personal holding company income (FPHCI) unless an exception applies. Sec. 954(h) provides an exception to FPHCI for certain income derived in the active conduct of a banking, financing or similar business by a CFC predominantly engaged in the active conduct of such a business and which conducts substantial activity with respect to such business. This exception is set to expire for taxable years of foreign corporation beginning before January 1, 2012.
Other exceptions to FPHCI which could be relevant are the de minimis rule of Sec. 954(b)(3)(A) or the high tax kick-out rule of Sec. 954(b)(4)).
Statement Required Under Sec. 956
The regulations provide that if a CFC holds U.S. property that is described in Sec. 956(c)(1) but, falls within one of the exceptions described in Sec. 956(c)(2), the U.S. shareholder must attach to their federal income tax return a statement describing all of the CFC's U.S. property with a breakdown into the four categories of Sec. 956(c)(1) and a further breakdown into the categories of Sec. 956(c)(2) (Treasury Reg. Sec. 1.956-2(b)(2)).
For additional information about Section 956 and the other export exceptions and exemptions under the IRC, please attend the Export Exceptions and Exemptions Under the IRC on November 15, 2011.
Joseph G. Englert is president and founder of San Francisco, Calif-based Export-Assist, Inc. He formerly worked at the U.S. Department of Commerce and teaches trade finance seminars for the Foreign Commercial Service Division, International Trade Administration and the Office of Import Administration.