Chapter 11 - Outbound
International Sale of Goods
Choices for export sales entity arrangements:
1) U.S. sales office/export subsidiary
2) Foreign country subsidiary
3) Independent local agent
4) Dependent local agent
5) Internet – websites
Cf, the prior discussion of inbound U.S. sales/
business investment (& tax nexus).
Tax Exposure in the Foreign
1) No foreign country tax exposure if no
representative office in the jurisdiction – but, dependent upon local country tax
2) Tax liability arises if a local agent exists,
unless agent is “independent” of U.S. principal.
3) Foreign country tax liability arises for a local country subsidiary
(but a possible jurisdictional exception exists if the corporate “place of mind
and management” is elsewhere).
U.S. Foreign Tax Credit
Assuming foreign country income tax jurisdiction does exist – the U.S. tax
planning objective is to limit foreign income taxes to assure that no excess
foreign tax credits arise.
Consider: (1) §904(d)(1)(B) general limitation basket & (2) §904(d)(3)
U.S. income tax multiple objectives are to generate income
as: (1) foreign source, (2) low taxed in the foreign country, &
(3) in the FTC “general limitation” category.
Possible Impact of an Income Tax
For the U.S. taxpayer the foreign country income tax result may be
moderated by a bilateral income tax treaty between (1) the foreign destination
country and (2) the U.S. (or, perhaps, between an intermediary third
jurisdiction and the destination country).
Query: Does a P.E. exist? However, a foreign country
may impose less extensive tax jurisdiction than under tax treaty (e.g.,
using a “participation exemption” system). P.887.
Application of a Bilateral U.S. Income
1) Business profits allocation – Art. 7(1) - determination
of the amount of business profits subject to foreign country income tax.
2) P. 886. Amount of income subject to tax - choices
are: (a) only that income attributable to the P.E., or (b) a “limited
force of attraction” rule, similar to U.S. rules (or an unlimited force
of attraction rule).
3) Income tax deduction available for expenses?
Tax Treaty Concept of “Permanent
P. 887. A “permanent establishment” is a fixed place of
business for engaging in industrial or commercial activity. See U.S. Model
Treaty, Article 5(1).
How distinguish between a “dependent” and an “independent” agent?
Art. 5(5) & (6).
Remember the Taisei Fire case (U.S. Tax Court) in the
inbound reinsurance context where the agent had multiple principals.
Income Tax Treaty Interpretation
1) OECD Commentary (p. 895) - under
continual revision by OECD. 2014 Model.
2) U.S. Treasury Dept. (unilateral?)
“Technical Explanation” of a particular bilateral U.S.
income tax treaty (& the 2016 U.S. Model Tax Treaty).
3) Court decisions in the U.S. and other
jurisdictions (e.g., Taisei, concerning definition of an “independent
Cosmos, U.S. corporation, makes export sales to independent
distributor in S. Korea that buys from Cosmos and resells for its own
account. Cosmos has no sales office in S. Korea. Minimal contacts in S.
Korea. Cosmos P.E in S. Korea? No. Article 9 (p.890).
Is income realized by Cosmos on these sales subject to S. Korea
income tax? No, since no P.E. Independent distributor is not
a P.E. of Cosmos.
Orders Accepted in Country
Cosmos employees had (and exercised) authority to accept orders
when visiting the distributor in South Korea.
P.E. would exist in S. Korea because Cosmos employees are deemed to be persons
acting on behalf of Cosmos – they have and habitually exercise authority to
conclude sales contracts in the name of Cosmos. Article 9(4)(a). P.
Greece treaty (p.
Distributor in Greece and Cosmos export division employees had no
authority to negotiate a sale but only to solicit and accept orders
on the standard terms and conditions of sale as required by the Cosmos.
Greece treaty, Article II(1), requires that an agent
(including an employee?) must have authority to negotiate and conclude
contracts for foreign enterprise before being a P.E.
Agents as P.E.? Mfg. Reps.
What is the possible authority (without P.E. status) if an agent
is in Belgium or South Korea?
Agent as independent only if legally and economically
independent of the principal.
What is the degree of control by the principal in these
situations? Limited control?
Agents here seem to be independent (do they have their own risk of
loss?) And, they are not subject to comprehensive control or detailed
Market Research - Purchasing
Market research and purchasing offices established
in South Korea and Greece:
1) S. Korea treaty - (a) Article 9(3)(d) & (e) market
research/advertising and purchasing office does not create a P.E.
2) Greece treaty - No counterpart of Article 9(3). See Article
II(1) re possible income taxation for advertising (but not purchases – Article
Locally manufactured components are resold by the Cosmos offices
to Belgian or Greek manufacturers.
1) S. Korea - See Article 9(5)(b) (p. 891) indicating that the
Article 5(3)(d) exemption does not apply if all or part of the goods
purchased in S. Korea are sold by Cosmos for use, consumption or disposition in
2) Greece - same result. See Article II(1).
Engineers in S.Korea &Greece
Offices with staffs of engineers to
(a) provide advice to potential customers
and (b) provide after-sales warranty services.
1) S. Korea treaty - no explicit exemption from P.E.
characterization & these services are not of a preparatory or
2) No exemption under the Greece treaty.
P.E.s in both situations? Probably.
Warehouses in All Countries
Are warehouses exempt from a P.E. classification and
deliveries are made to distributors?
1) Belgium treaty - Article 5(4)(a), yes (p.892)
2) S. Korea treaty - Article 9(3)(a), yes (p.890)
3) Greece treaty - Article II(1)(i) – a warehouse is not
excluded from P.E. classification (note: an agent with a “stock of goods”).
Products shipped for local processing before delivery to local
distributors who purchase under export orders accepted in the U.S.
Exclusion from P.E. definition for a stock of goods belonging to
the enterprise for processing by another enterprise?
Belgium treaty Article 5(4)(c).
Cf., S. Korea treaty, Art. 9(5), a P.E. exists if items are sold
for consumption in S. Korea.
Products shipped for local processing before being delivered to
Belgium (Art. 5(4)(a)) & S. Korea (Art. 9(3)(a)) treaties - no
Greece treaty – a P.E. exists without regard to where the
products are sold (Article II(1)).
Subsidiaries of U.S. Parent Co.
Subsidiaries as permanent establishments of Cosmos? These
subsidiaries act as “independent distributors.” A subsidiary is not
regarded as a P.E. of Cosmos under any of the three treaties:
S. Korea Treaty,
OECD Commentary, see p. 896.
Subsidiaries as Agents
Subsidiaries function as agents of Cosmos and employees of
subsidiaries regularly negotiate export sale contracts and enter into contracts
on behalf of Cosmos for commissions paid to subsidiaries. Sales are made
directly by Cosmos to local customers.
If subsidiaries function as Cosmos agents and exercise
authority specified, P.E. status for Cosmos.
Belgium Treaty, Article 5(5); S. Korea Treaty, Article
9(4)(a), Greece Treaty, Article II(1).
“Force of Attraction” Rule
Cosmos has three divisions: radios, refrigerators, and toys.
Toy division has sales offices in Belgium, S. Korea and Greece. Other two
divisions handle sales by solicitation in country but home office acceptance of
orders. Each toy division's sales offices constitute a P.E.
Impact on other income? Greece, Art. III(1) - “force of attraction” rule
applies; Others - attributable income only is taxed; Belgium Treaty,
Art. 7(1); S. Korea, Art. 8(1).
Treaty Income Definition
Tax treaty impact – controls the amount of:
1) Includible gross income; and,
2) Expenses (including non-local country expenses
G&A, etc. expenses).
Belgium: Art. 7(2)
S. Korea: Art. 8(2)
Greece: Art. III(2), “profits” means deductions?
U.S. architectural firm designed Belgian, S. Korea and Greece
motels - design activities occurred in its U.S. offices. Temporary offices at
building sites with employees of U.S. firm responsible for supervision. Project
completed within one year.
Income tax exposure in foreign country? (1) 12 months rule
in the treaty? Belgium, Art. 5(3)(a);
(2) S. Korea, Art. 9(2)(h)& 3(f) – 6 months rule;
(3) no provision in the Greece treaty.
Electronic Commerce & P.E.
Computer equipment as a P.E. where located in a foreign
country. Fixed situs? Where goods are shown or returns are
What if no tangible connection with a country?
Distinction between (1) computer equipment and (2) software for
purposes of establishing P.E.?
Distinction between a website & a server. P.902.
Treat independent service provider (ISP) as not an agent for the
Website on a server maintained by an unrelated ISP in
Brazil. Orders are transmitted to U.S. from the website. Orders
will be filled from U.S.
fixed business place in Brazil for Cosmos.
the ISP is an “agent,” then the status of the agent’s activities would be as “preparatory
and auxiliary” (since not concluding contracts binding on Cosmos).
Website Acceptance in Brazil
Website accepts orders and the customer tenders payment
(credit card info) to the website.
Website then issues electronic delivery instructions to the U.S.
Website is not an “agent.” Need for a “human agent”
under OECD rules? Is a computer program OK to establish tax
status? Correct result if the website is established and controlled by
Cosmos and orders are completed there?
Should this be P.E. status?
Manufacturer Owns the Server
Cosmos owns the server in Brazil.
The server will be treated as a “fixed place of business” in
Brazil. The activities include accepting orders, being beyond preparatory
and auxiliary activities.
Therefore, the server will constitute a P.E. in Brazil.
[Remember that a “P.E.” is a tax treaty term and Brazil actually
has no income tax treaty with U.S.]
Bermuda based server
Cosmos owns, maintains and operates the server located in Bermuda
(where no income tax applies).
Therefore, the server cannot be a fixed place of business in
Brazil. Therefore, no P.E. of Cosmos exists in Brazil.
But, should the server’s physical location be the controlling
factor (or be irrelevant) in this context?
Physical Status Controlling?
Should a website and server located outside the destination
country be treated as precluding P.E. status for purposes of tax jurisdiction
in the destination country?
Too much emphasis on traditional jurisdictional concepts?
What is the comparable situation in the U.S. concerning state
Use of Export Corporation -U.S. Tax
Choices: 1) U.S. corporation, including a special
purpose U.S. subsidiary.
2) Foreign corporation - including a third country
corporation. Can be categorized as a CFC for Subpart F purposes.
3) Previously, (a) FSC (or, earlier, DISC; note, however,
the “interest-charge DISC” is still available); or, (b) gross income
(ETI) exclusion (i.e., prior Code §114), all determined to be illegal.
Use of Foreign Export
Foreign organized corporation is not subject to U.S. income tax,
except for its U.S. source income.
Assume foreign source income (for U.S. income tax purposes)
is received for:
1) Services performed at a location outside the United
2) Sale of inventory if the title passes outside the United
Locate this activity in a low-tax third country?
Pay a commission for the sales activities rendered in the
If related entity: Issue concerning an appropriate §482
allocation for the services rendered.
Avoid having any activities of the foreign corporation conducted
in the United States. But, possible Subpart F exposure for these sales
activities (FBC sales income).
Purchase and Sale
Purchase at arm's length price and then sell outside the United
States, i.e., “buy-sell.”
§862(a)(6) re sourcing rule outside U.S.
Title passage test under Reg. §1.861-7(c).
(i.e., where does the title pass to the buyer?).
Passage of title at the port of destination?
How assure complying with “terms of the deal”?
Might have FBC sales income for Subpart F.
Impact of CFC Rules
Defining foreign base company sales income status - §954(d).
Possible issue concerns whether the “manufacture” of the product by the
foreign subsidiary (CFC) has occurred to enable an escape from the “FBC sales
Note: Dave Fischbein Mfg. Co. case.,
p.911. Significant major assembly by the Belgian sub. is treated as manufacturing
in Belgium and, therefore, as not causing FBC sales income (even though not 20%
of the value is contributed).
Sales & Manufacturing Branch
§954(d)(2), i.e., the “branch rule”.
What objective of establishing a sales branch outside the
country where the manufacturing occurs? (or, a manufacturing branch?)
Effect of “branch rule” treatment is to cause the “deemed
subsidiary” to be treated (for Subpart F) as (1) a wholly owned subsidiary of
U.S. corporation, (2) a CFC, and (3) a party to the sales transaction,
with FBC sales income generated.
But, apply a “tax rate disparity test.”
Rev. Rul. 75-7 (p.917) revoked by Rev.
CFC incorporated in country M. CFC purchased metal ore in
U.S. and Canada from related persons. Conversion of ore by CFC under
contract with an unrelated foreign corp. in Country O. Only
contractual relationships between CFC and the unrelated foreign corporation.
Here foreign (contract manufacturer) corp. treated by IRS as a
branch – for purposes of “branch rule.”
But, a higher income tax rate in the sales co. country
makes the branch rule not applicable here!
Ashland Oil, Inc.
Issues concerning foreign branch rule:
1) Does the §954(d)(2) branch rule apply to a “contract
manufacturing” arrangement between a CFC (Liberian sub) and an unrelated
corporation (Belgian contract manufacturer)? Not in this situation - no “branch”
existed (per Tax Court).
And, no tax avoidance here (high Belgium tax).
2) Is the “manufacturing branch” rule in the regulations
invalid? Not determined in this case, since determining that no
Revoking Rev. Rul. 75-7 and holding that activities of a contract
manufacturer can not be attributed to a CFC for purposes of the branch
rule for determining FBCSI status.
Also, holding that the manufacturing activity can not
be treated as undertaken by the CFC if contract manufacturing for the
FBCSI rule of §954(d)(2), i.e., taxpayer can not assert attribution.
Correct position by IRS? Was Ashland a “facts &
“Substantial Contribution” Test p.930
Revised regulations provide for a “substantial contribution” test
to determine whether the participation of taxpayer (through its
employees) with the contract manufacturer should cause the branch rule to
be invoked for those activities as to taxpayer.
Test: Appropriate to treat contract manufacturing as
being done by a CFC?
See Reg. §1.954-3(a)(4)(iv), p. 932.
2009 FBCSI Regulations
T.D. 9438 (2-2-2009); See Reg. §1.954-3(a)(4)(iv)(b).
Re: Contract manufacturing arrangements.
CFC substantial contributions made by the CFC to the manufacture
process can include: (1) Oversight, (2) Material selection, (3)
Management of manufacturing costs, (4) Control of manufacturing logistics, (5)
Quality control, (6) Product design.
Sales branch §954(d)(2)
U.S. corp has manufacturing subsidiary in the Netherlands
and this Dutch sub establishes its branch office in Switzerland.
Swiss branch handles sales of Dutch manufactured products to
non-Dutch customers. Tax rate disparity exists (e.g., less than 90
percent of higher rate – or more than a 5% rate differential).
Applicability of the foreign branch rule when goods are (1)
manufactured in the Netherlands and (2) sold by Swiss branch? Yes & FBC
Prob. 2 - §954(d)(2)
Alternative situation of:
1) Dutch manufacturing branch of a
2) Swiss organized CFC. The Swiss corporation handles
the sales of products manufactured by the manufacturing branch based in the
Reg. §1.954-3(b)(1)(ii) applies a reverse tax-rate disparity
test. The manufacturing branch is treated as a separate wholly owned
sub. for purposes of the Subpart F rule & Swiss corp. has FBC sales income.
U.S. parent; Bermuda sub.
Mexico contract manufacturer (CM) for the Bermuda sub with the
Bermuda sub having significant participation in activities of the
Mexican based contract manufacturer.
Because of these activities by the Bermuda sub the Bermuda sub’s
income on sales to U.S. parent does not produce foreign base company
sales income. Bermuda sub is a “manufacturer” for this purpose.
a) Singapore is involved in the manufacturing by CM-C to
treat Singapore as providing a substantial contribution.
b) Distinction between the employee of CFC and the parent
corp. for purposes of the substantial contribution test.
c) Independent contractor causing Singapore as to not being
deemed to be making a substantial contribution?
Multiple Sales & Mfg.
Multiple sales and manufacturing branches are treated as separate
for purposes of applying:
1) Branch allocation of income rule, and
2) tax-rate disparity test.
Other Tax Savings Using Foreign Export
1) Organize a 50-50 corporation - no CFC status.
10-50 rule for FTC and “look-through” rule.
2) Manufacture in the country of incorporation - the Fischbein
3) Generate low/no taxed foreign source & correct FTC basket
income, so as to moderate the impact of the foreign tax credit limitation
4) Use foreign tax haven base company to reduce the foreign
Export Tax Incentives
1) Domestic International Sales Corporations
(or DISC) regime eliminated – but remaining is the “interest-charge DISC.”
2) Foreign Sales Corporation (FSC) eliminated.
3) Extraterritorial Income Exclusion, including
favorable transition rules, eliminated.
All declared illegal under GATT.
2004 Act: §199 – deduction (up to nine percent) for “qualified
production activities” income.
Prior Tax Incentive - The Foreign Sales
Prior Domestic International Sales Corporations (or DISC) Regime
Code §991-994; Revenue Act of 1971
Deferral of a diminishing portion of the income derived from
qualified export sales.
1984 – Remaining DISC provisions limited to small DISCs for
deferral only of taxable income attributable to a maximum of $10 million of
qualified export receipts.
Tax Incentive System for Exports
Year 2000 enactment -
FSC replaced with a gross income exclusion for “extraterritorial
U.S. manufacturers can permanently exclude a portion of their
WTO declares illegal export subsidy.
Repeal of transition rules also held to be illegal.
Prior Tax Treatment of FSCs
Code §§921-927 and Code §291(a)(4).
Permanent exemption of a portion of the export income from U.S.
FSC must be a foreign corporation with a substantial presence
FSC operates as a wholly owned sub of the U.S. parent and sells
U.S. goods produced by the U.S. parent or an affiliate.
Formal FSC Qualification Requirements
1) Foreign corporation - in qualified foreign country or a U.S.
Exchange of information agreement with the foreign country or
adequate exchange of information provision in the applicable income tax
treaty. U.S.V.I. or Barbados
2) Number of shareholders - not more than 25.
FSC Requirements continued
3) No preferred stock, but more than one class of common is
4) At least one nonresident director. What if death?
May be a nonresident U.S. citizen.
5) Maintain a foreign office. Computer diskette OK to
establish a foreign office?
6) U.S. location for tax records.
7) Election to be treated as a FSC.
Treatment of FSC Income
Exemption for a portion of the FSC's "foreign trade
Must be gross income attributable to "foreign trading gross
1) Management of the FSC carried on outside the United States and
2) Economic processes from which the income is earned take place
outside the United States.
Defining Foreign Trading Gross Receipts
1) Sale of export property
2) Lease of export property
3) Services concerning export property
4) Engineering and architecture for foreign construction projects
5) Managerial services for unrelated FSC or DISC
Defining Export Property
Export property is property manufactured in U.S. from majority of
U.S. components. Code §927(a)(1).
Exclusions from export property when:
1) ultimate use in the U.S.
2) use by U.S. Government
3) U.S. subsidized transaction
4) receipts from another FSC
Foreign Management Test
1) Meetings of Board of Directors and shareholders occurring
outside the U.S.
2) Principal bank account in a country where “exchange of
information” rules are satisfied.
3) Dividends, legal and accounting fees, and officers and
directors compensation paid from this account.
Foreign Economic Processes Test
Economic processes to generate the income must be located outside
the United States.
1) Participation in the solicitation (other than advertising), the
negotiation or the making of the contract relating to the transaction.
2) At least 50 percent of the direct costs attributable to the
transaction for five categories of sales-related activities.
Foreign Direct Costs Requirement
a) advertising and sales promotion.
b) processing of customer orders and arranging for delivery.
c) transportation to the customer.
d) preparation and sending of the final invoice or the statement
of account and the receipt of payment.
e) assumption of the credit risk.
Defining Foreign Trade Income Amount
Pricing rules where the purchase of goods is by the FSC from its
U.S. parent corporation:
1) Arm's length pricing - Code §482.
2) Administrative pricing rules. Statutory pricing rules.
Code §925(a)(1) and (2).
Taxation of the FSC
Exempt foreign trade income treated as foreign source income not
effectively connected with the conduct of a trade or business within the United
States. Code § 921(a).
Remaining income treated as effectively connected with the conduct
of a trade or business in the United States. Code § 921(d).
Taxation of FSC Shareholders
1) U.S. corporation is entitled to a 100 percent dividends
received deduction for distributions from E&P attributable to foreign trade
income, other than Code § 923(a)(2) non-exempt income.
2) Exemption from foreign base company sales income rules for the
exempt foreign taxed income--Code § 951(e).
Interest Charge DISC
Deferral of tax on taxable income attributable to $10 million or
less of qualified export receipts for each tax year.
Interest charge imposed on the shareholders of the DISC.
Taxable income of the DISC attributable to qualified export
receipts that exceed $10 million is deemed distributed but the DISC is not
ADM argument that 4 percent of qualified export receipts from
agricultural exports is permitted in establishing the transfer price for
determining DISC taxable income.
ADM position that even if combined taxable income from the export
transactions is zero it can still allocate four percent of the gross to the
Held: no such allocation permitted.
Need not meet the
(i) foreign management and
(ii) foreign economic processes requirements
Up to $5 million gross receipts limitation.
If exceeding $5 million, can then pick the $5 million receipts to
which this limitation is allocated.
Financing of Exports
Export financing interest is excluded from a separate basket for
passive income for FTC purposes.
Included in the general limitation basket.