@104 CHAP 8 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴커 쿏OMESTIC INTERNATIONAL SALES CORPORATIONS (DISC)� 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴켸 If your business is one of the many small U.S. firms that sells goods or services overseas, you may be able to quali- fy for a tax export subsidy by setting up a Domestic Inter- national Sales Corporation (DISC). In general, a DISC will allow you to accumulate profits earned from export sales in a specially-treated corporation that does not pay tax on those profits. Tax on these export profits is deferred un- til the DISC pays out (if ever) such profits to its owners. In the meantime, it is possible for the DISC to, in effect, lend the funds back to its related supplier company. Note that since the Tax Reform Act of 1984, DISCs have been obsolete for larger companies, since DISC gross receipts in excess of $10 million are fully taxable since 1985. Howev- er, for small exporters, DISCs may be preferable (as well as much simpler to set up and operate) than the new "For- eign Sales Corporations" (FSCs) that have largely replaced them, at least for the first few years of operation. Also, interest must now be paid to the IRS on the tax liability that has been deferred as a result of the existence of the DISC tax deferrals. A DISC is essentially just a "dummy" corporation that has no employees and does not carry on any sort of business, except on paper. The tax law allows a U.S. company that has "qualified export receipts" to set aside part of its profits on the export transactions by paying a so-called sales commission to a DISC. As a corporation without any employees, the DISC does not actually do anything to earn the commission; your firm merely pays the DISC the largest commission permitted by the tax law on each qualifying ex- port sale it makes. (It is usually advisable to have a written commission agreement between your firm and the DISC for legal purposes, although not required for tax purposes.) The commission that can be paid to the DISC on an export sale is the larger of 4% of the gross sales price on an export sale or 50% of the profit on the sale (so long as the commission does not create a loss on the sale for your firm). In addition, the DISC's commission income can be increased by 10% of certain export promotion expenses, if any, incurred by the DISC. As you might have guessed, there are some rather elaborate tax accounting rules which determine how much profit you have on an export sale, for purposes of computing the DISC's maximum commission. The tax benefits for your business arise from the fact that you or your business owns the DISC stock, and the commis- sions your business pays to the DISC are deducted from the business's taxable income, while the DISC pays no tax on income it receives. However, about 6% (1/17th) of the DISC's income each year is taxed to its corporate (but not individual) sharehol- ders, so the DISC should usually pay about 6% of its income back as a dividend to the business that owns the stock of the DISC (which is usually, but not necessarily, your cor- poration that paid the DISC the commissions). Thus, 16/17, or about 94% of the income that is shifted to the DISC as export sales commissions escapes federal income tax indef- initely, until the DISC either pays out the accumulated income as dividends or is disqualified and loses its status as a DISC. For deferred DISC income that has accumulated after 1984, each DISC shareholder must compute the amount of additional tax it would pay each year if all the de- ferred DISC income were taxed and pay the IRS interest on the deferred tax. This interest should usually be tax- deductible if paid by a corporation. The interest rate is based on the going rate for 1-year T-bills, which is usually a quite favorable (that is, low) rate. Conceptually, having a DISC can be thought of as taking $100 out of your left-hand pocket and putting it in your right-hand pocket, and taking a $100 deduction. However, you have to put back $6 of the $100 into your left-hand pocket and report it as income, so it's really only a net deduction of $94. You do not have to pay tax on the $94 that remains in your right-hand pocket as long as you leave it there. In fact, there are even legal ways in which you can borrow the $94 and put it back in the left-hand pocket (your business!) without paying tax on it, thus having your cake and eating it, too. The only fly in the ointment is that as long as you keep deferring tax on the $94, you must pay interest to the IRS on the tax deferred (but at a low interest rate--equal to the average interest rate on one- year Treasury bills, which were down to about 3% as of early 1993). An interesting tax planning wrinkle if you set up a DISC is to put some or all of the stock of the DISC in the hands of your children. Once they are 14 years old (if under 14, their income gets taxed at your marginal tax rate), part of the deferred income in the DISC can be paid out as divi- dends and taxed to the children in their low tax brackets. Thus, in effect, you business could "skim" off part of its profits by paying commissions to the DISC which would then be taxed at a low rate to your children when distributed as dividends. This would almost be like paying tax-deductible dividends out of your incorporated business to your child- ren, a very nice bit of tax planning (and your business doesn't even have to be incorporated, only the DISC does). @CODE: HI 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� � HAWAII TAX TREATMENT OF DISC'S AND FSC'S � 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� Hawaii follows the federal tax treatment of DISCs, includ- ing the federal provisions regarding interest charge DISCs, provided that the DISC is organized in Hawaii and has its principal place of business in the state of Hawaii. How- ever, Hawaii has NOT adopted the federal Foreign Sales Cor- poration (FSC) provisions that provide special federal tax treatment to FSCs and their shareholders.