Last Tax Break Standing

With other breaks coming under pressure, companies are showing renewed interest in a lucrative but little-used tax structure that involves setting up a shell company to which it can funnel export revenues.

President Obama’s proposed limit on the tax benefits associated with income generated overseas is likely bad news for most multinational businesses. But there may be some consolation for  companies selling U.S-made goods overseas.  

Experts say they’re seeing renewed interest in a lucrative but little-used export tax break known as the IC-DISC (interest charge – domestic international sales corporation). Although the provision fluctuates in popularity depending on the presence of other tax incentives, it’s been part of the tax code for 37 years.  

The structure, which experts say can pay for itself in months, is a way for closely-held companies to cut taxes and for many others to defer taxes on a cash stash. “It’s the only export tax incentive we still have,” says Jonathan Lysenko, international tax director for Amper, Politziner & Mattia, an accounting firm. “What’s really disappointing is that so few exporters take advantage of it.”

To be sure, there are reasons for caution. Staying within the legal requirements of an IC-DISC requires good controls, and the ephemeral nature of tax legislation may affect the benefits. Finance executives considering establishing IC-DISCs “should carefully monitor the potential for future legislative changes,” says Marc J. Gerson, a tax policy specialist with Miller & Chevalier, a Washington, D.C. law firm, noting that in the past Congress has considered legislation that would change the vehicles’ tax treatment.

Assuming they don’t get the ax this session, though, they may provide some welcome tax relief. For companies that are eligible, an IC-DISC “is a no-brainer in terms of the benefits outweighing costs,” says Larry Harding, CEO of High Street Partners, a consulting firm that helps companies expand internationally.

Here’s how an IC-DISC works: an export manufacturer or distributor sets up a shell company, to which it can funnel a percentage of export revenues annually, creating either a tax deduction or tax deferral for the underlying corporation. Those funds are considered “commissions” and are also largely tax-free to the IC-DISC.

The benefits that follow depend upon how a company chooses to use the provision. In closely held companies, for example, owners may use it to transform ordinary income into dividends-and thus be taxed at a lower rate. In that case, the corporation can receive a 35% tax deduction on the commissions it pays to the shell company. The owners of the company would then decide to have the shell company issue dividends to the shareholders (in many cases, themselves), who would then be taxed at the current rate of 15%. Thus the owners would net a 20 percent tax break, says Lysenko.

Since the amount of revenues that can be deferred is limited, IC-DISCs generally offer savings equal to 10% of a company’s qualified export profits, estimates Ralf Eschenburg, director of international tax services at accounting firm CBIZ MHM.

This benefit may diminish somewhat after 2010, when the 15% rate is slated to increase. But the payback period is short enough that companies may still gain from establishing an IC-DISC now.  Setting up the structure takes about a month, and the costs are relatively cheap, meaning “you could see 10 to 40 times the fees in savings within the first year,” Lysenko says.

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