For those parties that are already utilizing an IC-DISC, or have much interest in pursuing one, there may be a few details that have been overlooked during the implementation of, or research regarding, this tax incentive. Here, we will discuss some of the nuances that commonly go overlooked, but are vital to properly maintaining and utilizing the IC-DISC. These nuances include application of the no-loss rule, treatment of returns and the redetermination period.
The most prevalent limitation on the IC-DISC benefit concerns the taxable income of the entity exporting property. This limitation is more commonly referred to as the “no-loss rule”. At its most evident, this rule stipulates that a taxpayer cannot pay into the IC-DISC an amount that would cause the exporting company to realize a taxable loss. The company can pay an amount into the IC-DISC that drives the taxable income to zero, but no further. Many are unaware, though, that the no-loss rule exists at two levels: at the company-wide level, as well as at the transactional level. The application for the no-loss rule at the transactional level only truly becomes apparent after grouping products/transactions and the calculation of the foreign trade income (FTI) has been completed. Once the FTI has been calculated for each line item, depending on the company’s grouping methodology, it becomes evident which of these items contribute to the benefit and which ones do not.
Treatment of returns, allowances and discounts is not a topic specifically covered in the language governing the IC-DISC, which has led many to conduct these studies without ever accounting for these items appropriately or at all for that matter. Incorrect treatment with regard to returns, allowances and discounts is most prevalent among taxpayers that use transactional grouping for the transfer price calculation. Most commonly, a company recognizes returns, price adjustments, and, in a few instances, discounts as separate invoices from the original sale. The proper method of treatment for these line items is imperative to deriving the correct commission amount. Otherwise, an artificial inflation of the transactions’/products’ profitability results, thus overstating a company’s benefit.
Because it ultimately appears on a tax return, the IC-DISC commission must be computed on a tax basis. However, due to the statutory deadline for an estimated payment to be made within 60 days of the DISC’s year-end, many companies utilize this estimate as a final commission amount for efficiency and ease. Most companies are finalizing financials during this time and thus do not have tax financials available at this time. The commission must be adjusted to a tax basis once the return is drafted and a 90 day redetermination period begins at this point. Any adjustments resulting from the finalization of the commission can be addressed during this 90 day timeframe.
In conclusion, these three nuances, among others, exist in the realm of using IC-DISC entities. Ensuring that these items are treated properly is important, as not doing so can lead to the IC-DISC losing its tax free status and benefit, as well as possible fines.