@053 CHAP 8

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        ³      FOREIGN SALES CORPORATIONS (FSC'S)      ³
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The Foreign Sales Corporation (FSC) entity that has been
permitted as a result of the Tax Reform Act of 1984 is some-
what similar to a DISC, but may be too great of an adminis-
trative burden for it to be worthwhile for a small business
to set up.  Unlike a DISC, an FSC cannot be a mere dummy or
paper corporation set up in the U.S.  Instead, it must meet
all of the following requirements:

     .  It must be a foreign corporation, incorporated
        in a foreign country that, in general, has ar-
        rangements to swap tax information with the IRS,
        or in a U.S. possession;

     .  There can be no more than 25 shareholders in
        an FSC;

     .  An FSC cannot issue preferred stock;

     .  It must maintain a foreign office, at which
        there is a permanent set of tax records, in-
        cluding invoices of sales;

     .  The FSC's board of directors must include at
        least one person who is not a resident of the
        United States (although the non-resident can be
        a U.S. citizen); and

     .  An FSC cannot be part of a controlled group of
        corporations that also includes a DISC.  That
        is, you can set up either an FSC or a DISC, but
        you can't have both.

Large FSCs are also subject to additional stringent require-
ments such as being managed outside the U.S. and satisfying
various tests with respect to carrying on economic activi-
ties outside the United States.  Fortunately, these foreign
management and "foreign economic process" requirements do
not apply to small FSCs, which are FSCs with $5 million or
less in foreign trade gross receipts per year.

The amount of export income that can be shifted to an FSC
is usually limited to 1.83% of gross foreign trading re-
ceipts (versus 4% for a DISC) or 23% of the combined pro-
fit of the U.S. parent company and the FSC on an export
sale (versus 50% for a DISC), whichever is greater.  How-
ever, the profit under the gross receipts method is limi-
ted to twice the amount of the combined profit on the sale.

Once the FSC's tentative taxable income for the year has
been determined under the above rule, 15/23 of such income
is treated as exempt, and is not taxable even if distrib-
uted to the parent U.S. corporation.  Tax must be paid by
the FSC on the remaining 8/23 of its income.  Thus, to the
extent export profits can be shifted to an FSC, the tax
rate on on such income will only be about 1/3 (8/23) of
the normal effective corporate tax rate, a major saving.