“Given the time constraints on the Congress, I think [the proposed new rules are] a very commendable result,” says James E. Rose Jr., senior vice president of taxes and government affairs at Tupperware Corp., in Orlando, and chairman of the tax and budget policy committee of the National Association of Manufacturers (NAM). “While the form of the tax benefit is very different, the existing benefits are largely mirrored in the new approach. Companies that benefited from FSCs will still benefit, and there’s a slight but welcome expansion for some companies manufacturing abroad.”
Companies will no longer be required to establish offshore entities to funnel sales through, or fuss with administrative transfer pricing rules for goods sold through those entities. Instead, the rules create a new category of general income called “qualifying foreign trade income,” which can be earned either through exports or through sales from an overseas manufacturing facility. All types of business entities, including sole proprietorships and S corporations, will be able to benefit from the tax break.
A portion of the qualifying foreign trade income would be exempt from U.S. taxes by an amount calculated in one of three ways: first, by 1.2 percent of a company’s gross foreign trade receipts; second, by 15 percent of the company’s foreign trade income; or third, by 30 percent of a company’s foreign sales and leasing income. Like the previous rules, this version includes the performance of many professional services–managerial services as well as engineering and architectural services–on projects outside the United States. Exceptions as to what kinds of property can generate qualifying income will be carried over from current law, including oil and gas, related-party transactions, and most intangibles.
The test for foreign manufactured goods qualifying for the exemption is twofold. First, no more than 50 percent of the value of foreign-manufactured goods can be derived from foreign inputs or foreign labor, similar to the domestic-content rules now in place for FSCs. Second, the manufacturer must be a domestic U.S. corporation, an individual subject to U.S. tax, a foreign company that elects to be subject to U.S. tax, or a partnership or pass-through entity owned by a combination of the aforementioned taxpayers. (A drawback is that income included in this category will not be allowed to qualify for foreign tax credit calculations, so taxpayers will need to be thoughtful about applying the new rules to income from various international operations, so as to minimize excess foreign tax credits.)
The bottom line: a reduction in companies’ federal tax rate from 35 percent to 29.2 percent on such qualifying income. Just how broadly the benefit will be adopted, however, is difficult to predict, along with the effect on federal tax revenues. “Budget estimates are just that, estimates, and this could be low or high,” says Ken Kies, comanaging partner in the Washington, D.C., national tax-services practice of PricewaterhouseCoopers. “It’s especially hard to predict, due to the interaction with the tax laws of other countries and our own treatment of other international income. So, we won’t know how applicable this will be for several years, until after companies have had a chance to use the new rules.”