Manufacturers & Distributors ARTICLE -

The IC-DISC

An overlooked tax break that could be your big break

Target Audience: Manufacturing and Distributing Companies, M&D Industry, Research and Development Companies, International Exporters

President Obama’s pledge to cut tax benefits on income generated overseas sent waves of anxiety through the manufacturing community last year. Even though at press time the tax proposal seems to be on the back burner (presumably because of a large lobbying push against the proposal by the business community), the announcement sparked increased interest in interest charge–domestic international sales corporations (IC-DISCs). By forming an IC-DISC, your manufacturing company may realize substantial tax savings on export-sales income.

IC-DISC tax benefits

Although this tax incentive has been a part of the tax code for nearly four decades (see the sidebar “Evolution of the IC-DISC”), it’s often been ignored, presumably in the presence of more attractive tax initiatives related to income generated overseas.

The general concept of an IC-DISC is fairly simple. A U.S. manufacturer establishes a “shell” company — an IC-DISC — and then pays its IC-DISC a percentage of the company’s export revenue, also known as commissions. Commissions can be up to 4% of an exporter’s qualified export receipts, or 50% of their taxable income — whichever is higher.

Because an IC-DISC is tax-exempt, the company doesn’t pay taxes on these commissions. Distributions of commissions to shareholders are subject to the 15% capital gains tax rate. Therefore, based on the ordinary 35% tax rate, the manufacturer can enjoy a 20% tax break on the commission paid to the IC-DISC.

A company can also choose not to immediately distribute IC-DISC earnings to shareholders, instead deferring these earnings by lending them back to the exporting company. With interest rates at historic lows, many companies are incorporating IC-DISC deferrals into their growth strategies.

Even though deferral-fund usage restrictions apply, companies that use IC-DISC loan money for research and development (R&D) may enjoy additional tax breaks thanks to R&D tax incentives. Exporting companies should keep in mind, however, that they can defer only the predetermined commission percentage — 4% of exporters’ qualified export receipts, or 50% of their taxable income — of up to $10 million in annual income.

Manufacturers also can get creative, using IC-DISCs in a number of other financial and operational strategies. For example, naming employees shareholders of IC-DISCs can help motivate them to work toward higher export sales.

IC-DISCs also can be used as a means to facilitate succession planning, such as using them to generate cash to help shareholders pursue buyout plans or allowing family members to benefit from export income by being named as IC-DISC owners.

Exporting companies should talk to their international tax advisors about ways to maximize tax benefits related to IC-DISCs by converting them into more substantial entities through activities such as export-related promotions and advertising.

IC-DISC specifics

Several qualifications must be met for an IC-DISC to be legal and worthwhile for manufacturers:

• Companies must sell “export property” to qualify. The definition of export property is goods that are manufactured in the United States; held for sale, lease, rental, consumption or distribution outside the United States; and contain at least 50% U.S.-manufactured content.
• An IC-DISC must be formed under the laws of any state or the District of Columbia; have only one class of stock; have a minimum capital of $2,500; and have owners that are the same owners of the exporting company, family members of company owners or key staff members of the exporting company. For privately held C corporations, individual stakeholders should be the IC-DISC’s owners to avoid being taxed twice.
• An IC-DISC must have a gross income that’s 95% qualified export receipts.

Finally, bear in mind that an IC-DISC doesn’t need assets, office space or employees, but must maintain records separate from those of its relevant exporting company.

Is an IC-DISC right for you?

If your manufacturing company generates export-sales income, an IC-DISC may be a viable option. But before taking action, consult with a manufacturing accountant to learn more about IC-DISC-related strategies.

Evolution of the IC-DISC

The interest charge–domestic international sales corporation (IC-DISC) isn’t an obscure tax loophole. The first incarnation of IC-DISC, the domestic international sales corporation (DISC), was enacted in 1971. It allowed companies that sold products overseas to set up DISCs and defer taxes on commissions paid to the DISCs until dividends were paid to shareholders. But by loaning income generated overseas to a DISC’s U.S.-operated headquarters, rather than using it to directly benefit shareholders, DISCs were able to avoid paying these taxes indefinitely while also avoiding interest.

The European Union cried “foul,” arguing that allowing U.S. companies to defer taxes indefinitely, with no interest charges, went against the General Agreement on Tariffs and Trade. After several years of challenges and negotiations, the United States amended the DISC provision to include an interest charge, and limited the amount of IC-DISC commission that may be deferred, to create the IC-DISC structure as we know it today.

Find out how our M&D accountants can add value to your business. Email us or call us at 1 (888) 875-9770.

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