[House Report 106-845]
[From the U.S. Government Publishing Office]



106th Congress                                                   Report
                        HOUSE OF REPRESENTATIVES
 2d Session                                                     106-845

======================================================================



 
      FSC REPEAL AND EXTRATERRITORIAL INCOME EXCLUSION ACT OF 2000

                                _______
                                

 September 13, 2000.--Committed to the Committee of the Whole House on 
            the State of the Union and ordered to be printed

                                _______
                                

    Mr. Archer, from the Committee on Ways and Means, submitted the 
                               following

                              R E P O R T

                             together with

                    DISSENTING AND ADDITIONAL VIEWS

                        [To accompany H.R. 4986]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Ways and Means, to whom was referred the 
bill (H.R. 4986) to amend the Internal Revenue Code of 1986 to 
repeal the provisions relating to foreign sales corporations 
(FSCs) and to exclude extraterritorial income from gross 
income, having considered the same, report favorably thereon 
with an amendment and recommend that the bill as amended do 
pass.

                                CONTENTS

                                                                   Page
  I. Summary and Background...........................................9
          A. Purpose and Summary.................................     9
          B. Background and Need for Legislation.................    10
          C. Legislative History.................................    10
 II. Explanation of the Bill.........................................10
          A. Repeal of FSC Provisions and Exclusion for 
              Extraterritorial Income............................    10
III. Votes of the Committee..........................................35
 IV. Budget Effects of the Bill......................................35
          A. Committee Estimates of Budgetary Effects............    35
          B. Statement Regarding New Budgetary Authority and Tax 
              Expenditures.......................................    36
          C. Cost Estimate Prepared by the Congressional Budget 
              Office.............................................    36
  V. Other Matters to Be Discussed Under the Rules of the House......38
          A. Committee Oversight Findings and Recommendations....    38
          B. Summary of Findings and Recommendations of the 
              Committee on Governmental Reform...................    38
          C. Constitutional Authority Statement..................    38
          D. Information Relating to Unfunded Mandates...........    38
          E. Applicability of House Rule XXI5(b).................    38
          F. Tax Complexity Analysis.............................    39
 VI. Changes in Existing Law Made by the Bill as Reported............39
VII. Dissenting and Additional Views.................................63

  The amendment is as follows:
  Strike all after the enacting clause and insert the 
following:

SECTION 1. SHORT TITLE.

  (a) Short Title.--This Act may be cited as the ``FSC Repeal and 
Extraterritorial Income Exclusion Act of 2000''.
  (b) Amendment of 1986 Code.--Except as otherwise expressly provided, 
whenever in this Act an amendment or repeal is expressed in terms of an 
amendment to, or repeal of, a section or other provision, the reference 
shall be considered to be made to a section or other provision of the 
Internal Revenue Code of 1986.

SEC. 2. REPEAL OF FOREIGN SALES CORPORATION RULES.

  Subpart C of part III of subchapter N of chapter 1 (relating to 
taxation of foreign sales corporations) is hereby repealed.

SEC. 3. TREATMENT OF EXTRATERRITORIAL INCOME.

  (a) In General.--Part III of subchapter B of chapter 1 (relating to 
items specifically excluded from gross income) is amended by inserting 
before section 115 the following new section:

``SEC. 114. EXTRATERRITORIAL INCOME.

  ``(a) Exclusion.--Gross income does not include extraterritorial 
income.
  ``(b) Exception.--Subsection (a) shall not apply to extraterritorial 
income which is not qualifying foreign trade income as determined under 
subpart E of part III of subchapter N.
  ``(c) Disallowance of Deductions.--
          ``(1) In general.--Any deduction of a taxpayer allocated 
        under paragraph (2) to extraterritorial income of the taxpayer 
        excluded from gross income under subsection (a) shall not be 
        allowed.
          ``(2) Allocation.--Any deduction of the taxpayer properly 
        apportioned and allocated to the extraterritorial income 
        derived by the taxpayer from any transaction shall be allocated 
        on a proportionate basis between--
                  ``(A) the extraterritorial income derived from such 
                transaction which is excluded from gross income under 
                subsection (a), and
                  ``(B) the extraterritorial income derived from such 
                transaction which is not so excluded.
  ``(d) Denial of Credits for Certain Foreign Taxes.--Notwithstanding 
any other provision of this chapter, no credit shall be allowed under 
this chapter for any income, war profits, and excess profits taxes paid 
or accrued to any foreign country or possession of the United States 
with respect to extraterritorial income which is excluded from gross 
income under subsection (a).
  ``(e) Extraterritorial Income.--For purposes of this section, the 
term `extraterritorial income' means the gross income of the taxpayer 
attributable to foreign trading gross receipts (as defined in section 
942) of the taxpayer.''
  (b) Qualifying Foreign Trade Income.--Part III of subchapter N of 
chapter 1 is amended by inserting after subpart D the following new 
subpart:

              ``Subpart E--Qualifying Foreign Trade Income

                              ``Sec. 941. Qualifying foreign trade 
                                        income.
                              ``Sec. 942. Foreign trading gross 
                                        receipts.
                              ``Sec. 943. Other definitions and special 
                                        rules.

``SEC. 941. QUALIFYING FOREIGN TRADE INCOME.

  ``(a) Qualifying Foreign Trade Income.--For purposes of this subpart 
and section 114--
          ``(1) In general.--The term `qualifying foreign trade income' 
        means, with respect to any transaction, the amount of gross 
        income which, if excluded, will result in a reduction of the 
        taxable income of the taxpayer from such transaction equal to 
        the greatest of--
                  ``(A) 30 percent of the foreign sale and leasing 
                income derived by the taxpayer from such transaction,
                  ``(B) 1.2 percent of the foreign trading gross 
                receipts derived by the taxpayer from the transaction, 
                or
                  ``(C) 15 percent of the foreign trade income derived 
                by the taxpayer from the transaction.
        In no event shall the amount determined under subparagraph (B) 
        exceed 200 percent of the amount determined under subparagraph 
        (C).
          ``(2) Alternative computation.--A taxpayer may compute its 
        qualifying foreign trade income under a subparagraph of 
        paragraph (1) other than the subparagraph which results in the 
        greatest amount of such income.
          ``(3) Limitation on use of foreign trading gross receipts 
        method.--If any person computes its qualifying foreign trade 
        income from any transaction with respect to any property under 
        paragraph (1)(B), the qualifying foreign trade income of such 
        person (or any related person) with respect to any other 
        transaction involving such property shall be zero.
          ``(4) Rules for marginal costing.--The Secretary shall 
        prescribe regulations setting forth rules for the allocation of 
        expenditures in computing foreign trade income under paragraph 
        (1)(C) in those cases where a taxpayer is seeking to establish 
        or maintain a market for qualifying foreign trade property.
          ``(5) Participation in international boycotts, etc.--Under 
        regulations prescribed by the Secretary, the qualifying foreign 
        trade income of a taxpayer for any taxable year shall be 
        reduced (but not below zero) by the sum of--
                  ``(A) an amount equal to such income multiplied by 
                the international boycott factor determined under 
                section 999, and
                  ``(B) any illegal bribe, kickback, or other payment 
                (within the meaning of section 162(c)) paid by or on 
                behalf of the taxpayer directly or indirectly to an 
                official, employee, or agent in fact of a government.
  ``(b) Foreign Trade Income.--For purposes of this subpart--
          ``(1) In general.--The term `foreign trade income' means the 
        taxable income of the taxpayer attributable to foreign trading 
        gross receipts of the taxpayer.
          ``(2) Special rule for cooperatives.--In any case in which an 
        organization to which part I of subchapter T applies which is 
        engaged in the marketing of agricultural or horticultural 
        products sells qualifying foreign trade property, in computing 
        the taxable income of such cooperative, there shall not be 
        taken into account any deduction allowable under subsection (b) 
        or (c) of section 1382 (relating to patronage dividends, per-
        unit retain allocations, and nonpatronage distributions).
  ``(c) Foreign Sale and Leasing Income.--For purposes of this 
section--
          ``(1) In general.--The term `foreign sale and leasing income' 
        means, with respect to any transaction--
                  ``(A) foreign trade income properly allocable to 
                activities which--
                          ``(i) are described in paragraph (2)(A)(i) or 
                        (3) of section 942(b), and
                          ``(ii) are performed by the taxpayer (or any 
                        person acting under a contract with such 
                        taxpayer) outside the United States, or
                  ``(B) foreign trade income derived by the taxpayer in 
                connection with the lease or rental of qualifying 
                foreign trade property for use by the lessee outside 
                the United States.
          ``(2) Special rules for leased property.--
                  ``(A) Sales income.--The term `foreign sale and 
                leasing income' includes any foreign trade income 
                derived by the taxpayer from the sale of property 
                described in paragraph (1)(B).
                  ``(B) Limitation in certain cases.--Except as 
                provided in regulations, in the case of property 
                which--
                          ``(i) was manufactured, produced, grown, or 
                        extracted by the taxpayer, or
                          ``(ii) was acquired by the taxpayer from a 
                        related person for a price which was not 
                        determined in accordance with the rules of 
                        section 482,
                the amount of foreign trade income which may be treated 
                as foreign sale and leasing income under paragraph 
                (1)(B) or subparagraph (A) of this paragraph with 
                respect to any transaction involving such property 
                shall not exceed the amount which would have been 
                determined if the taxpayer had acquired such property 
                for the price determined in accordance with the rules 
                of section 482.
          ``(3) Special rules.--
                  ``(A) Excluded property.--Foreign sale and leasing 
                income shall not include any income properly allocable 
                to excluded property described in subparagraph (B) of 
                section 943(a)(3) (relating to intangibles).
                  ``(B) Only direct expenses taken into account.--For 
                purposes of this subsection, any expense other than a 
                directly allocable expense shall not be taken into 
                account in computing foreign trade income.

``SEC. 942. FOREIGN TRADING GROSS RECEIPTS.

  ``(a) Foreign Trading Gross Receipts.--
          ``(1) In general.--Except as otherwise provided in this 
        section, for purposes of this subpart, the term `foreign 
        trading gross receipts' means the gross receipts of the 
        taxpayer which are--
                  ``(A) from the sale, exchange, or other disposition 
                of qualifying foreign trade property,
                  ``(B) from the lease or rental of qualifying foreign 
                trade property for use by the lessee outside the United 
                States,
                  ``(C) for services which are related and subsidiary 
                to--
                          ``(i) any sale, exchange, or other 
                        disposition of qualifying foreign trade 
                        property by such taxpayer, or
                          ``(ii) any lease or rental of qualifying 
                        foreign trade property described in 
                        subparagraph (B) by such taxpayer,
                  ``(D) for engineering or architectural services for 
                construction projects located (or proposed for 
                location) outside the United States, or
                  ``(E) for the performance of managerial services for 
                a person other than a related person in furtherance of 
                the production of foreign trading gross receipts 
                described in subparagraph (A), (B), or (C).
        Subparagraph (E) shall not apply to a taxpayer for any taxable 
        year unless at least 50 percent of its foreign trading gross 
        receipts (determined without regard to this sentence) for such 
        taxable year is derived from activities described in 
        subparagraph (A), (B), or (C).
          ``(2) Certain receipts excluded on basis of use; subsidized 
        receipts excluded.--The term `foreign trading gross receipts' 
        shall not include receipts of a taxpayer from a transaction 
        if--
                  ``(A) the qualifying foreign trade property or 
                services--
                          ``(i) are for ultimate use in the United 
                        States, or
                          ``(ii) are for use by the United States or 
                        any instrumentality thereof and such use of 
                        qualifying foreign trade property or services 
                        is required by law or regulation, or
                  ``(B) such transaction is accomplished by a subsidy 
                granted by the government (or any instrumentality 
                thereof) of the country or possession in which the 
                property is manufactured, produced, grown, or 
                extracted.
          ``(3) Election to exclude certain receipts.--The term 
        `foreign trading gross receipts' shall not include gross 
        receipts of a taxpayer from a transaction if the taxpayer 
        elects not to have such receipts taken into account for 
        purposes of this subpart.
  ``(b) Foreign Economic Process Requirements.--
          ``(1) In general.--Except as provided in subsection (c), a 
        taxpayer shall be treated as having foreign trading gross 
        receipts from any transaction only if economic processes with 
        respect to such transaction take place outside the United 
        States as required by paragraph (2).
          ``(2) Requirement.--
                  ``(A) In general.--The requirements of this paragraph 
                are met with respect to the gross receipts of a 
                taxpayer derived from any transaction if--
                          ``(i) such taxpayer (or any person acting 
                        under a contract with such taxpayer) has 
                        participated outside the United States in the 
                        solicitation (other than advertising), the 
                        negotiation, or the making of the contract 
                        relating to such transaction, and
                          ``(ii) the foreign direct costs incurred by 
                        the taxpayer attributable to the transaction 
                        equal or exceed 50 percent of the total direct 
                        costs attributable to the transaction.
                  ``(B) Alternative 85-percent test.--A taxpayer shall 
                be treated as satisfying the requirements of 
                subparagraph (A)(ii) with respect to any transaction 
                if, with respect to each of at least 2 subparagraphs of 
                paragraph (3), the foreign direct costs incurred by 
                such taxpayer attributable to activities described in 
                such subparagraph equal or exceed 85 percent of the 
                total direct costs attributable to activities described 
                in such subparagraph.
                  ``(C) Definitions.--For purposes of this paragraph--
                          ``(i) Total direct costs.--The term `total 
                        direct costs' means, with respect to any 
                        transaction, the total direct costs incurred by 
                        the taxpayer attributable to activities 
                        described in paragraph (3) performed at any 
                        location by the taxpayer or any person acting 
                        under a contract with such taxpayer.
                          ``(ii) Foreign direct costs.--The term 
                        `foreign direct costs' means, with respect to 
                        any transaction, the portion of the total 
                        direct costs which are attributable to 
                        activities performed outside the United States.
          ``(3) Activities relating to qualifying foreign trade 
        property.--The activities described in this paragraph are any 
        of the following with respect to qualifying foreign trade 
        property--
                  ``(A) advertising and sales promotion,
                  ``(B) the processing of customer orders and the 
                arranging for delivery,
                  ``(C) transportation outside the United States in 
                connection with delivery to the customer,
                  ``(D) the determination and transmittal of a final 
                invoice or statement of account or the receipt of 
                payment, and
                  ``(E) the assumption of credit risk.
          ``(4) Economic processes performed by related persons.--A 
        taxpayer shall be treated as meeting the requirements of this 
        subsection with respect to any sales transaction involving any 
        property if any related person has met such requirements in 
        such transaction or any other sales transaction involving such 
        property.
  ``(c) Exception From Foreign Economic Process Requirement.--
          ``(1) In general.--The requirements of subsection (b) shall 
        be treated as met for any taxable year if the foreign trading 
        gross receipts of the taxpayer for such year do not exceed 
        $5,000,000.
          ``(2) Receipts of related persons aggregated.--All related 
        persons shall be treated as one person for purposes of 
        paragraph (1), and the limitation under paragraph (1) shall be 
        allocated among such persons in a manner provided in 
        regulations prescribed by the Secretary.
          ``(3) Special rule for pass-thru entities.--In the case of a 
        partnership, S corporation, or other pass-thru entity, the 
        limitation under paragraph (1) shall apply with respect to the 
        partnership, S corporation, or entity and with respect to each 
        partner, shareholder, or other owner.

``SEC. 943. OTHER DEFINITIONS AND SPECIAL RULES.

  ``(a) Qualifying Foreign Trade Property.--For purposes of this 
subpart--
          ``(1) In general.--The term `qualifying foreign trade 
        property' means property--
                  ``(A) manufactured, produced, grown, or extracted 
                within or outside the United States,
                  ``(B) held primarily for sale, lease, or rental, in 
                the ordinary course of trade or business for direct 
                use, consumption, or disposition outside the United 
                States, and
                  ``(C) not more than 50 percent of the fair market 
                value of which is attributable to--
                          ``(i) articles manufactured, produced, grown, 
                        or extracted outside the United States, and
                          ``(ii) direct costs for labor (determined 
                        under the principles of section 263A) performed 
                        outside the United States.
        For purposes of subparagraph (C), the fair market value of any 
        article imported into the United States shall be its appraised 
        value, as determined by the Secretary under section 402 of the 
        Tariff Act of 1930 (19 U.S.C. 1401a) in connection with its 
        importation, and the direct costs for labor under clause (ii) 
        do not include costs that would be treated under the principles 
        of section 263A as direct labor costs attributable to articles 
        described in clause (i).
          ``(2) U.S. taxation to ensure consistent treatment.--Property 
        which (without regard to this paragraph) is qualifying foreign 
        trade property and which is manufactured, produced, grown, or 
        extracted outside the United States shall be treated as 
        qualifying foreign trade property only if it is manufactured, 
        produced, grown, or extracted by--
                  ``(A) a domestic corporation,
                  ``(B) an individual who is a citizen or resident of 
                the United States,
                  ``(C) a foreign corporation with respect to which an 
                election under subsection (e) (relating to foreign 
                corporations electing to be subject to United States 
                taxation) is in effect, or
                  ``(D) a partnership or other pass-thru entity all of 
                the partners or owners of which are described in 
                subparagraph (A), (B), or (C).
        Except as otherwise provided by the Secretary, tiered 
        partnerships or pass-thru entities shall be treated as 
        described in subparagraph (D) if each of the partnerships or 
        entities is directly or indirectly wholly owned by persons 
        described in subparagraph (A), (B), or (C).
          ``(3) Excluded property.--The term `qualifying foreign trade 
        property' shall not include--
                  ``(A) property leased or rented by the taxpayer for 
                use by any related person,
                  ``(B) patents, inventions, models, designs, formulas, 
                or processes whether or not patented, copyrights (other 
                than films, tapes, records, or similar reproductions, 
                and other than computer software (whether or not 
                patented), for commercial or home use), goodwill, 
                trademarks, trade brands, franchises, or other like 
                property,
                  ``(C) oil or gas (or any primary product thereof),
                  ``(D) products the transfer of which is prohibited or 
                curtailed to effectuate the policy set forth in 
                paragraph (2)(C) of section 3 of Public Law 96-72, or
                  ``(E) any unprocessed timber which is a softwood.
        For purposes of subparagraph (E), the term `unprocessed timber' 
        means any log, cant, or similar form of timber.
          ``(4) Property in short supply.--If the President determines 
        that the supply of any property described in paragraph (1) is 
        insufficient to meet the requirements of the domestic economy, 
        the President may by Executive order designate the property as 
        in short supply. Any property so designated shall not be 
        treated as qualifying foreign trade property during the period 
        beginning with the date specified in the Executive order and 
        ending with the date specified in an Executive order setting 
        forth the President's determination that the property is no 
        longer in short supply.
  ``(b) Other Definitions and Rules.--For purposes of this subpart--
          ``(1) Transaction.--
                  ``(A) In general.--The term `transaction' means--
                          ``(i) any sale, exchange, or other 
                        disposition,
                          ``(ii) any lease or rental, and
                          ``(iii) any furnishing of services.
                  ``(B) Grouping of transactions.--To the extent 
                provided in regulations, any provision of this subpart 
                which, but for this subparagraph, would be applied on a 
                transaction-by-transaction basis may be applied by the 
                taxpayer on the basis of groups of transactions based 
                on product lines or recognized industry or trade usage. 
                Such regulations may permit different groupings for 
                different purposes.
          ``(2) United states defined.--The term `United States' 
        includes the Commonwealth of Puerto Rico. The preceding 
        sentence shall not apply for purposes of determining whether a 
        corporation is a domestic corporation.
          ``(3) Related person.--A person shall be related to another 
        person if such persons are treated as a single employer under 
        subsection (a) or (b) of section 52 or subsection (m) or (o) of 
        section 414, except that determinations under subsections (a) 
        and (b) of section 52 shall be made without regard to section 
        1563(b).
          ``(4) Gross and taxable income.--Section 114 shall not be 
        taken into account in determining the amount of gross income or 
        foreign trade income from any transaction.
  ``(c) Source Rule.--Under regulations, in the case of qualifying 
foreign trade property manufactured, produced, grown, or extracted 
within the United States, the amount of income of a taxpayer from any 
sales transaction with respect to such property which is treated as 
from sources without the United States shall not exceed--
          ``(1) in the case of a taxpayer computing its qualifying 
        foreign trade income under section 941(a)(1)(B), the amount of 
        the taxpayer's foreign trade income which would (but for this 
        subsection) be treated as from sources without the United 
        States if the foreign trade income were reduced by an amount 
        equal to 4 percent of the foreign trading gross receipts with 
        respect to the transaction, and
          ``(2) in the case of a taxpayer computing its qualifying 
        foreign trade income under section 941(a)(1)(C), 50 percent of 
        the amount of the taxpayer's foreign trade income which would 
        (but for this subsection) be treated as from sources without 
        the United States.
  ``(d) Treatment of Withholding Taxes.--
          ``(1) In general.--For purposes of section 114(d), any 
        withholding tax shall not be treated as paid or accrued with 
        respect to extraterritorial income which is excluded from gross 
        income under section 114(a). For purposes of this paragraph, 
        the term `withholding tax' means any tax which is imposed on a 
        basis other than residence and for which credit is allowable 
        under section 901 or 903.
          ``(2) Exception.--Paragraph (1) shall not apply to any 
        taxpayer with respect to extraterritorial income from any 
        transaction if the taxpayer computes its qualifying foreign 
        trade income with respect to the transaction under section 
        941(a)(1)(A).
  ``(e) Election To Be Treated as Domestic Corporation.--
          ``(1) In general.--An applicable foreign corporation may 
        elect to be treated as a domestic corporation for all purposes 
        of this title if such corporation waives all benefits to such 
        corporation granted by the United States under any treaty. No 
        election under section 1362(a) may be made with respect to such 
        corporation.
          ``(2) Applicable foreign corporation.--For purposes of 
        paragraph (1), the term `applicable foreign corporation' means 
        any foreign corporation if--
                  ``(A) such corporation manufactures, produces, grows, 
                or extracts property in the ordinary course of such 
                corporation's trade or business, or
                  ``(B) substantially all of the gross receipts of such 
                corporation may reasonably be expected to be foreign 
                trading gross receipts.
          ``(3) Period of election.--
                  ``(A) In general.--Except as otherwise provided in 
                this paragraph, an election under paragraph (1) shall 
                apply to the taxable year for which made and all 
                subsequent taxable years unless revoked by the 
                taxpayer. Any revocation of such election shall apply 
                to taxable years beginning after such revocation.
                  ``(B) Termination.--If a corporation which made an 
                election under paragraph (1) for any taxable year fails 
                to meet the requirements of subparagraph (A) or (B) of 
                paragraph (2) for any subsequent taxable year, such 
                election shall not apply to any taxable year beginning 
                after such subsequent taxable year.
                  ``(C) Effect of revocation or termination.--If a 
                corporation which made an election under paragraph (1) 
                revokes such election or such election is terminated 
                under subparagraph (B), such corporation (and any 
                successor corporation) may not make such election for 
                any of the 5 taxable years beginning with the first 
                taxable year for which such election is not in effect 
                as a result of such revocation or termination.
          ``(4) Special rules.--
                  ``(A) Requirements.--This subsection shall not apply 
                to an applicable foreign corporation if such 
                corporation fails to meet the requirements (if any) 
                which the Secretary may prescribe to ensure that the 
                taxes imposed by this chapter on such corporation are 
                paid.
                  ``(B) Effect of election, revocation, and 
                termination.--
                          ``(i) Election.--For purposes of section 367, 
                        a foreign corporation making an election under 
                        this subsection shall be treated as 
                        transferring (as of the first day of the first 
                        taxable year to which the election applies) all 
                        of its assets to a domestic corporation in 
                        connection with an exchange to which section 
                        354 applies.
                          ``(ii) Revocation and termination.--For 
                        purposes of section 367, if--
                                  ``(I) an election is made by a 
                                corporation under paragraph (1) for any 
                                taxable year, and
                                  ``(II) such election ceases to apply 
                                for any subsequent taxable year,
                        such corporation shall be treated as a domestic 
                        corporation transferring (as of the 1st day of 
                        the first such subsequent taxable year to which 
                        such election ceases to apply) all of its 
                        property to a foreign corporation in connection 
                        with an exchange to which section 354 applies.
                  ``(C) Eligibility for election.--The Secretary may by 
                regulation designate one or more classes of 
                corporations which may not make the election under this 
                subsection.
  ``(f) Rules Relating to Allocations of Qualifying Foreign Trade 
Income From Shared Partnerships.--
          ``(1) In general.--If--
                  ``(A) a partnership maintains a separate account for 
                transactions (to which this subpart applies) with each 
                partner,
                  ``(B) distributions to each partner with respect to 
                such transactions are based on the amounts in the 
                separate account maintained with respect to such 
                partner, and
                  ``(C) such partnership meets such other requirements 
                as the Secretary may by regulations prescribe,
        then such partnership shall allocate to each partner items of 
        income, gain, loss, and deduction (including qualifying foreign 
        trade income) from any transaction to which this subpart 
        applies on the basis of such separate account.
          ``(2) Special rules.--For purposes of this subpart, in the 
        case of a partnership to which paragraph (1) applies--
                  ``(A) any partner's interest in the partnership shall 
                not be taken into account in determining whether such 
                partner is a related person with respect to any other 
                partner, and
                  ``(B) the election under section 942(a)(3) shall be 
                made separately by each partner with respect to any 
                transaction for which the partnership maintains 
                separate accounts for each partner.
  ``(g) Exclusion for Patrons of Agricultural and Horticultural 
Cooperatives.--Any amount described in paragraph (1) or (3) of section 
1385(a)--
          ``(1) which is received by a person from an organization to 
        which part I of subchapter T applies which is engaged in the 
        marketing of agricultural or horticultural products, and
          ``(2) which is designated by the organization as allocable to 
        qualifying foreign trade income in a written notice mailed to 
        its patrons during the payment period described in section 
        1382(d), shall be treated as qualifying foreign trade income of 
        such person for purposes of section 114. The taxable income of 
        the organization shall not be reduced under section 1382 by 
        reason of any amount to which the preceding sentence applies.''

SEC. 4. TECHNICAL AND CONFORMING AMENDMENTS.

          (1) The second sentence of section 56(g)(4)(B)(i) is amended 
        by inserting before the period ``or under section 114''.
          (2) Section 245 is amended by adding at the end the following 
        new subsection:
  ``(d) Certain Dividends Allocable to Qualifying Foreign Trade 
Income.--In the case of a domestic corporation which is a United States 
shareholder (as defined in section 951(b)) of a controlled foreign 
corporation (as defined in section 957), there shall be allowed as a 
deduction an amount equal to 100 percent of any dividend received from 
such controlled foreign corporation which is distributed out of 
earnings and profits attributable to qualifying foreign trade income 
(as defined in section 941(a)).''
          (3) Section 275(a) is amended--
                  (A) by striking ``or'' at the end of paragraph 
                (4)(A), by striking the period at the end of paragraph 
                (4)(B) and inserting ``, or'', and by adding at the end 
                of paragraph (4) the following new subparagraph:
                  ``(C) such taxes are paid or accrued with respect to 
                qualifying foreign trade income (as defined in section 
                941).'', and
                  (B) by adding at the end the following new sentence: 
                ``A rule similar to the rule of section 943(d) shall 
                apply for purposes of paragraph (4)(C).''
          (4) Paragraph (3) of section 864(e) is amended--
                  (A) by striking ``For purposes of'' and inserting:
                  ``(A) In general.--For purposes of'', and
                  (B) by adding at the end the following new 
                subparagraph:
                  ``(B) Assets producing exempt extraterritorial 
                income.--For purposes of allocating and apportioning 
                any interest expense, there shall not be taken into 
                account any qualifying foreign trade property (as 
                defined in section 943(a)) which is held by the 
                taxpayer for lease or rental in the ordinary course of 
                trade or business for use by the lessee outside the 
                United States (as defined in section 943(b)(2)).''
          (5) Section 903 is amended by striking ``164(a)'' and 
        inserting ``114, 164(a),''.
          (6) Section 999(c)(1) is amended by inserting ``941(a)(5),'' 
        after ``908(a),''.
          (7) The table of sections for part III of subchapter B of 
        chapter 1 is amended by inserting before the item relating to 
        section 115 the following new item:

                              ``Sec. 114. Extraterritorial income.''

          (8) The table of subparts for part III of subchapter N of 
        chapter 1 is amended by striking the item relating to subpart E 
        and inserting the following new item:

                              ``Subpart E. Qualifying foreign trade 
                                        income.''

          (9) The table of subparts for part III of subchapter N of 
        chapter 1 is amended by striking the item relating to subpart 
        C.

SEC. 5. EFFECTIVE DATE.

  (a) In General.--The amendments made by this Act shall apply to 
transactions after September 30, 2000.
  (b) No New FSCs; Termination of Inactive FSCs.--
          (1) No new fscs.--No corporation may elect after September 
        30, 2000, to be a FSC (as defined in section 922 of the 
        Internal Revenue Code of 1986, as in effect before the 
        amendments made by this Act).
          (2) Termination of inactive fscs.--If a FSC has no foreign 
        trade income (as defined in section 923(b) of such Code, as so 
        in effect) for any period of 5 consecutive taxable years 
        beginning after December 31, 2001, such FSC shall cease to be 
        treated as a FSC for purposes of such Code for any taxable year 
        beginning after such period.
  (c) Transition Period for Existing Foreign Sales Corporations.--
          (1) In general.--In the case of a FSC (as so defined) in 
        existence on September 30, 2000, and at all times thereafter, 
        the amendments made by this Act shall not apply to any 
        transaction in the ordinary course of trade or business 
        involving a FSC which occurs--
                  (A) before January 1, 2002, or
                  (B) after December 31, 2001, pursuant to a binding 
                contract--
                          (i) which is between the FSC (or any related 
                        person) and any person which is not a related 
                        person, and
                          (ii) which is in effect on September 30, 
                        2000, and at all times thereafter.
        For purposes of this paragraph, a binding contract shall 
        include a purchase option, renewal option, or replacement 
        option which is included in such contract and which is 
        enforceable against the seller or lessor.
          (2) Election to have amendments apply earlier.--A taxpayer 
        may elect to have the amendments made by this Act apply to any 
        transaction by a FSC or any related person to which such 
        amendments would apply but for the application of paragraph 
        (1). Such election shall be effective for the taxable year for 
        which made and all subsequent taxable years, and, once made, 
        may be revoked only with the consent of the Secretary of the 
        Treasury.
          (3) Related person.--For purposes of this subsection, the 
        term ``related person'' has the meaning given to such term by 
        section 943(b)(3) of such Code, as added by this Act.
  (d) Special Rules Relating to Leasing Transactions.--
          (1) Sales income.--If foreign trade income in connection with 
        the lease or rental of property described in section 
        927(a)(1)(B) of such Code (as in effect before the amendments 
        made by this Act) is treated as exempt foreign trade income for 
        purposes of section 921(a) of such Code (as so in effect), such 
        property shall be treated as property described in section 
        941(c)(1)(B) of such Code (as added by this Act) for purposes 
        of applying section 941(c)(2) of such Code (as so added) to any 
        subsequent transaction involving such property to which the 
        amendments made by this Act apply.
          (2) Limitation on use of gross receipts method.--If any 
        person computed its foreign trade income from any transaction 
        with respect to any property on the basis of a transfer price 
        determined under the method described in section 925(a)(1) of 
        such Code (as in effect before the amendments made by this 
        Act), then the qualifying foreign trade income (as defined in 
        section 941(a) of such Code, as in effect after such 
        amendments) of such person (or any related person) with respect 
        to any other transaction involving such property (and to which 
        the amendments made by this Act apply) shall be zero.

                       I. SUMMARY AND BACKGROUND


                         A. Purpose And Summary


                                Purpose

    The bill, H.R. 4986, the ``FSC Repeal and Extraterritorial 
Income Exclusion Act of 2000,'' repeals the foreign sales 
corporation provisions of the Internal Revenue Code to comply 
with decisions of a World Trade Organization dispute panel and 
Appellate Body regarding a dispute brought before the World 
Trade Organization (``WTO'') by the European Union. To retain a 
competitive balance for U.S. businesses that compete in the 
world market, the bill modifies the taxation of foreign trade 
income to comply with the standards set forth in the decisions 
of the WTO dispute panel and Appellate Body.

                                Summary

    H.R. 4986 repeals sections 921 through 927 of the Internal 
Revenue Code of 1986 (``the Code''). These sections of the Code 
relate to foreign sales corporations (``FSCs'').
    H.R. 4986 provides that gross income for U.S. tax purposes 
does not include extraterritorial income. Deductions allocated 
to such excluded income generally are disallowed. Because the 
exclusion of such extraterritorial income is a means of 
avoiding double taxation, no foreign tax credit is allowed for 
income taxes paid with respect to such excluded income. An 
exception from this general rule is provided for 
extraterritorial income that is not qualifying foreign trade 
income.
    In general, H.R. 4986 is effective for transactions entered 
into after September 30, 2000, and no corporation may elect to 
be a FSC after September 30, 2000.

                 B. Background and Need for Legislation

    In July 1998, the European Union \1\ requested that a WTO 
dispute panel determine whether the FSC regime of sections 921 
through 927 of the Code complies with WTO rules, including the 
Agreement on Subsidies and Countervailing Measures. A WTO 
dispute settlement panel (``the Panel'') was established in 
September, 1998, to address these issues. On October 8, 1999, 
the Panel ruled that the FSC regime was not in compliance with 
WTO obligations.\2\ The Panel specified that ``FSC subsidies 
must be withdrawn at the latest with effect from 1 October 
2000.'' \3\ On February 24, 2000, the Appellate Body affirmed 
the lower panel's ruling.\4\
---------------------------------------------------------------------------
    \1\ The European Union comprises Austria, Belgium, Denmark, 
Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, 
Netherlands, Portugal, Spain, Sweden and the United Kingdom. Canada and 
Japan made third-party submissions to the subsequently established 
dispute settlement panel in support of the European Union position.
    \2\ United States--Tax Treatment for ``Foreign Sales 
Corporations,'' Report of the Panel, October, 8, 1999 (``Panel 
Decision'').
    \3\ Panel Decision at 334.
    \4\ United States--Tax Treatment for ``Foreign Sales 
Corporations,'' Report of the Appellate Body, February 24, 2000 
(``Appellate Body Decision'').
---------------------------------------------------------------------------

                         C. Legislative History

    The Committee on Ways and Means marked up the provisions of 
the bill on July 27, 2000, and approved the provisions, with an 
amendment, on July 27, 2000, by a roll call vote of 34 yeas and 
1 nay, with a quorum present.

                      II. EXPLANATION OF THE BILL


 A. Repeal of FSC Provisions and Exclusion for Extraterritorial Income


                              Present Law

Summary of U.S. income taxation of foreign persons

    Income earned by a foreign corporation from its foreign 
operations generally is subject to U.S. tax only when such 
income is distributed to any U.S. persons that hold stock in 
such corporation. Accordingly, a U.S. person that conducts 
foreign operations through a foreign corporation generally is 
subject to U.S. tax on the income from those operations when 
the income is repatriated to the United States through a 
dividend distribution to the U.S. person.\5\ The income is 
reported on the U.S. person's tax return for the year the 
distribution is received, and the United States imposes tax on 
such income at that time. An indirect foreign tax credit may 
reduce the U.S. tax imposed on such income.
---------------------------------------------------------------------------
    \5\ A variety of anti-deferral regimes impose current U.S. tax on 
income earned by a U.S. person through a foreign corporation. The Code 
sets forth the following anti-deferral regimes: the controlled foreign 
corporation rules of subpart F (secs. 951-954), the passive foreign 
investment company rules (secs. 1291-1298), the foreign personal 
holding company rules (secs. 551-558), the personal holding company 
rules (secs. 541-547), the accumulated earnings tax rules (secs. 531-
537), and the foreign investment company rules (sec. 1246). Detailed 
rules for coordination among the anti-deferral regimes are provided to 
prevent a U.S. person from being subject to U.S. tax on the same item 
of income under multiple regimes.
---------------------------------------------------------------------------

Foreign sales corporations

    The income of an eligible FSC is partially subject to U.S. 
income tax and partially exempt from U.S. income tax. In 
addition, a U.S. corporation generally is not subject to U.S. 
tax on dividends distributed from the FSC out of certain 
earnings.
    A FSC must be located and managed outside the United 
States, and must perform certain economic processes outside the 
United States. A FSC is often owned by a U.S. corporation that 
produces goods in the United States. The U.S. corporation 
either supplies goods to the FSC for resale abroad or pays the 
FSC a commission in connection with such sales. The income of 
the FSC, a portion of which is exempt from U.S. tax under the 
FSC rules, equals the FSC's gross markup or gross commission 
income, less the expenses incurred by the FSC. The gross markup 
or the gross commission is determined according to specified 
pricing rules.
    A FSC generally is not subject to U.S. tax on its exempt 
foreign trade income. The exempt foreign trade income of a FSC 
is treated as foreign-source income that is not effectively 
connected with the conduct of a trade or business within the 
United States.
    Foreign trade income other than exempt foreign trade income 
generally is treated as U.S.-source income effectively 
connected with the conduct of a trade or business conducted 
through a permanent establishment within the United States. 
Thus, a FSC's income other than exempt foreign trade income 
generally is subject to U.S. tax currently and is treated as 
U.S.-source income for purposes of the foreign tax credit 
limitation.
    Foreign trade income of a FSC is defined as the FSC's gross 
income attributable to foreign trading gross receipts. Foreign 
trading gross receipts generally are the gross receipts 
attributable to the following types of transactions: the sale 
of export property; the lease or rental of export property; 
services related and subsidiary to such a sale or lease of 
export property; engineering and architectural services for 
projects outside the United States; and export management 
services. Investment income and carrying charges are excluded 
from the definition of foreign trading gross receipts.
    The term ``export property'' generally means property (1) 
which is manufactured, produced, grown or extracted in the 
United States by a person other than a FSC, (2) which is held 
primarily for sale, lease, or rental in the ordinary course of 
a trade or business for direct use or consumption outside the 
United States, and (3) not more than 50 percent of the fair 
market value of which is attributable to articles imported into 
the United States. The term ``export property'' does not 
include property leased or rented by a FSC for use by any 
member of a controlled group of which the FSC is a member; 
patents, copyrights (other than films, tapes, records, similar 
reproductions, and other than computer software, whether or not 
patented), and other intangibles; oil or gas (or any primary 
product thereof); unprocessed softwood timber; or products the 
export of which is prohibited or curtailed. Export property 
also excludes property designated by the President as being in 
short supply.
    If export property is sold to a FSC by a related person (or 
a commission is paid by a related person to a FSC with respect 
to export property), the income with respect to the export 
transactions must be allocated between the FSC and the related 
person. The taxable income of the FSC and the taxable income of 
the related person are computed based upon a transfer price 
determined under section 482 or under one of two formulas.
    The portion of a FSC's foreign trade income that is treated 
as exempt foreign trade income depends on the pricing rule used 
to determine the income of the FSC. If the amount of income 
earned by the FSC is based on section 482 pricing, the exempt 
foreign trade income generally is 30 percent of the foreign 
trade income the FSC derives from a transaction. If the income 
earned by the FSC is determined under one of the two formulas 
specified in the FSC provisions, the exempt foreign trade 
income generally is 15/23 of the foreign trade income the FSC 
derives from the transaction.
    A FSC is not required or deemed to make distributions to 
its shareholders. Actual distributions are treated as being 
made first out of earnings and profits attributable to foreign 
trade income, and then out of any other earnings and profits. 
Any distribution made by a FSC out of earnings and profits 
attributable to foreign trade income to a foreign shareholder 
is treated as U.S.-source income that is effectively connected 
with a business conducted through a permanent establishment of 
the shareholder within the United States. Thus, the foreign 
shareholder is subject to U.S. tax on such a distribution.
    A U.S. corporation generally is allowed a 100 percent 
dividends-received deduction for amounts distributed from a FSC 
out of earnings and profits attributable to foreign trade 
income. The 100 percent dividends-received deduction is not 
allowed for nonexempt foreign trade income determined under 
section 482 pricing.

                           Reasons for Change

In general

    On February 24, 2000, the Appellate Body, over the 
objections of the United States, upheld the finding of the 
Panel that had found that the FSC provisions of sections 921 
through 927 of the Code constitute a prohibited export subsidy 
under the WTO Agreement on Subsidies and Countervailing 
Measures and under the Agreement on Agriculture. The Panel 
specified that ``FSC subsidies must be withdrawn at the latest 
with effect from 1 October 2000.'' \6\
---------------------------------------------------------------------------
    \6\ Report of the Panel at 334.
---------------------------------------------------------------------------
    The purpose of this legislation is to comply with the 
recommendations and rulings of the Panel and the Appellate 
Body, as adopted by the WTO Dispute Settlement Body, in the 
dispute before the World Trade Organization entitled United 
States--Tax Treatment for ``Foreign Sales Corporations,'' WT/
DS108/R, WT/DS108/AB/R, Report of the Panel, as modified by the 
Appellate Body, adopted March 20, 2000.
    The legislation complies with the Panel and Appellate Body 
Decisions by repealing the FSC provisions of the Code, thereby 
eliminating the measures which the Panel and Appellate Body 
found to be prohibited export subsidies. The legislation makes 
fundamental adjustments to the Code that move the U.S. tax 
system in the direction of many European tax systems by 
incorporating certain of the territorial features of those 
systems.
    Before turning to the details of this legislation, however, 
the Committee feels compelled to make certain observations 
regarding the history of the FSC dispute, the actions of the 
European Union in initiating the dispute, and the decision of 
the Appellate Body. The origins of this dispute go back many 
years, and arise, in part, out of certain fundamental 
differences between tax systems. There are two basic types of 
income tax systems: (1) a residence-based (or ``worldwide'') 
system; and (2) a territorial system. Under a worldwide system, 
such as that of the United States, all of the income earned by 
a resident (e.g., a corporation incorporated in one of the 
fifty states or the District of Columbia) is subject to tax, 
regardless of where that income is earned. Under a territorial 
system, such as those of a number of European countries, only 
income earned within the borders of the taxing jurisdiction is 
subject to tax. In practice, neither the United States nor the 
member states of the European Union employ a ``pure'' 
territorial system or a ``pure'' worldwide system, as most 
countries employ some combination of the two concepts.
    It is important to note that each type of system generally 
uses a different method to avoid double taxation of foreign-
source income. Although this is an oversimplification, in a 
worldwide system, the ``credit method'' typically is used; that 
is, a tax credit is provided for taxes paid to foreign 
governments on income earned abroad. In a territorial system, 
the ``exemption method'' is used; that is, income earned abroad 
is simply not subject to tax. While tax policy arguments can be 
used to justify the superiority of one method over the other, 
both methods are accepted internationally, and it also is 
accepted internationally that a country is free to use either 
method or both. However, it also is recognized 
internationally--and, as the Committee understands it, was 
acknowledged by the European Union in the course of the FSC 
dispute--that the exemption method tends to result in exports 
being taxed more favorably than comparable domestic 
transactions.
    Turning to the history of the FSC dispute, in 1971, the 
United States enacted the Domestic International Sales 
Corporation (``DISC'') legislation, which provided a special 
tax exemption for exports. The European Communities challenged 
the DISC in the General Agreement on Tariffs and Trade 
(``GATT''), alleging that it constituted an export subsidy 
because it resulted in exports being taxed more favorably than 
comparable domestic transactions. In response, the United 
States challenged the tax regimes of Belgium, France and the 
Netherlands, alleging that the use of the exemption method by 
those countries constituted an export subsidy because it also 
resulted in exports being taxed more favorably than comparable 
domestic transactions. In 1976, a GATT panel ruled against the 
DISC provisions, but also ruled against the European regimes, 
finding, as a factual matter, that those regimes did tax 
exports more favorably than comparable domestic transactions.
    Following the issuance of the panel rulings, those rulings 
languished unadopted as the European Communities refused to 
accept that their regimes provided export subsidies. The 
European Communities' criticisms of the panel rulings, however, 
focused on the panel's legal reasoning, not on the panel's 
factual findings that the European regimes taxed exports more 
favorably than comparable domestic transactions. Eventually, 
the disputes were resolved based on the negotiation of an 
``Understanding'' which was adopted by the GATT Council in 
1981. Essentially, this Understanding--elements of which 
already had been incorporated into the Tokyo Round Subsidies 
Code--provided that countries did not provide an export subsidy 
when they refrained from taxing foreign-source income, even if 
this resulted in exports being taxed more favorably than 
comparable domestic transactions. The European countries in 
question interpreted the Understanding as overruling the panel 
and sanctioning their use of the exemption method. 
Subsequently, using the principles set forth in the 
Understanding as a guide, the United States enacted the FSC 
legislation, the objective being to reap the export-enhancing 
benefits of the exemption method.
    Many years later, the European Union abruptly challenged 
the FSC provisions in the WTO. Notwithstanding the fact that 
the FSC provisions were intended to emulate certain elements of 
a territorial tax system--namely, the use of the exemption 
method--the Panel and the Appellate Body ruled that the manner 
in which the United States sought to achieve this objective 
conflicted with the rules of the WTO Agreement on Subsidies and 
Countervailing Measures (``SCM Agreement'') and the Agreement 
on Agriculture. However, neither body said that the use of the 
exemption method itself was an impermissible one, nor did 
either body rule that a WTO member may not maintain a tax 
regime that includes features of both worldwide and territorial 
tax systems. What the Committee is intending to do with this 
legislation is once again to incorporate elements of a 
territorial tax system into the U.S. system of worldwide 
taxation, this time in a manner which does not conflict with 
WTO rules.
    Turning to the actions of the European Union in this 
dispute, it is the Committee's understanding that this dispute 
did not arise out of private sector complaints, but instead was 
initiated by the European Union primarily as a response to its 
losses in the so-called ``bananas'' and ``beef'' disputes. 
Indeed, it is the Committee's understanding that during the 
course of this dispute, European Union officials failed, when 
asked, to provide a single example of actual commercial harm 
suffered by a European firm as a result of the FSC provisions. 
In light of this, the Committee finds the European Union's 
decision to walk away from the 1981 Understanding deeply 
troubling and provocative as well as threatening to the 
international trading system.
    Notwithstanding these concerns, the United States has moved 
quickly to comply with the decisions of the Panel and Appellate 
Body. With the adoption of this legislation, the United States 
will have met the short deadline set by the Panel under the 
pressures and constraints of an election year. More 
significantly, in order to comply with a decision that 
significantly affects issues of national tax policy, the United 
States has made fundamental modifications to its tax structure, 
including features that are common to many European tax 
systems. The Committee hopes and expects that the European 
Union will regard this legislation as a faithful and 
responsible implementation of the WTO rulings in this dispute, 
understanding that each WTO member enjoys a sovereign right to 
decide its own system of taxation within the parameters of its 
international obligations. The Committee also hopes and expects 
that the European Union will appreciate the extremely 
detrimental consequences which a prolongation of this dispute 
would bring both to our bilateral relations and the successful 
functioning of the multilateral trading system. The Committee 
expects the United States to strongly pursue its rights under 
the WTO, including, as appropriate, the initiation of cases 
challenging tax systems that exclude certain income from 
taxation.
    The Committee strongly believes that the substantial 
modification to U.S. tax law provided in this bill is WTO 
compliant. While the Committee believes it is important for all 
nations to honor their trade agreements and the obligations 
those agreements may impart, the Committee also believes it is 
important that U.S. business interests not be foreclosed from 
opportunities abroad because of differences in the tax laws in 
the United States compared to tax laws in other countries. 
Indeed, the Committee believes that the WTO was not established 
to conform and restructure tax systems of contracting parties.

Compliance with WTO rulings

    In its ruling, the Panel raised the following objections to 
the FSC provisions of the Code. First, the Panel found that 
``but for'' the existence of the FSC provisions, revenue that 
otherwise would be fully taxable under the Code enjoyed a lower 
rate of taxation. Thus, the Panel found the FSC provisions to 
be a subsidy because partial tax exemptions accorded by the FSC 
provisions represented, in its view, a forgoing of ``government 
revenue that is otherwise due.'' Second, the Panel found that 
the FSC provisions constituted a prohibited export subsidy 
because only exports receive preferential tax treatment.
    The Administration has informed the Committee that the 
European Union has expressed additional concerns regarding the 
FSC provisions, even though they were not addressed in the 
Appellate Body Decision or Panel Decision. Among the European 
Union's many allegations are that the FSC administrative 
pricing rules violated the arm's-length pricing provisions of 
the Subsidies Agreement and that the FSC structure encouraged 
the use of tax havens.
    The Committee believes the approach of H.R. 4986 complies 
with the Appellate Body and Panel Decisions and modifies the 
U.S. tax system in a WTO-consistent manner. In addition, the 
legislation addresses other concerns raised by the European 
Union that were not decided by the Panel or Appellate Body. The 
legislation complies with the WTO decisions by repealing the 
FSC provisions of the Code, thereby eliminating the FSC 
subsidies issue. Furthermore, the replacement regime achieves 
WTO-consistency. The legislation responds to both of the 
determinative findings in the Panel and Appellate Body 
Decisions--(1) the conclusion that the FSC constitutes a 
``subsidy,'' and (2) the conclusion that it constitutes an 
``export contingent subsidy.'' The legislation also goes 
further than the decisions and addresses additional concerns 
raised by the European Union by eliminating the use of 
administrative pricing rules to establish transfer prices and 
by eliminating the arguable encouragement for the use of tax 
haven entities.
            FSC repeal
    The Committee believes that H.R. 4986 complies with the 
deadline set by the Panel, upheld by the Appellate Body, that 
``FSC subsidies must be withdrawn at the latest with effect 
from 1 October 2000.'' The legislation repeals the FSC 
provisions thereby eliminating the subsidy at issue in the 
Panel Decision. By repealing the FSC provisions, the United 
States has withdrawn what the WTO has found to be a subsidy.
             H.R. 4986 confers no ``subsidy''
    The Panel and Appellate Body ruled that the FSC provisions 
constitute a ``subsidy'' because ``government revenue that is 
otherwise due'' is forgone. The Appellate Body has acknowledged 
that a WTO member has the sovereign right to not tax certain 
categories of income, whether foreign or domestic. Indeed, pure 
territorial tax systems exclude all foreign source income, 
including export income, from tax. WTO rules do not compel 
members to adopt pure territorial tax regimes. Accordingly, the 
United States, like European Union countries with territorial 
tax systems (whether pure territorial systems or partial 
territorial systems) must be free to elect not to tax certain 
categories of income.
    In determining whether revenue forgone is ``otherwise 
due,'' the Panel, in an analysis upheld by the Appellate Body, 
examined ``the fiscal treatment that would be applicable `but 
for' the measures in question.''\7\ The Appellate Body, in 
reviewing the Panel Decision, stated that ``[t]here must * * * 
be some defined, normative benchmark against which a comparison 
can be made between the revenue actually raised and the revenue 
that would have been raised `otherwise.' '' Thus, the 
appropriate analysis requires the identification of a 
prevailing standard of taxation for a particular category of 
income and a determination of whether this standard is applied 
consistently to income falling within that category.
---------------------------------------------------------------------------
    \7\ The Appellate Body considered the ``but for'' test a ``sound 
basis for comparison because it is not difficult to establish in what 
way the foreign-source income of a FSC would be taxed `but for' the 
contested measure.'' However, the Appellate Body cautioned that ``we 
have certain abiding reservations about applying any legal standard, 
such as this `but for' test, in the place of the actual treaty 
language.'' The Appellate Body observed that the application of a ``but 
for'' test is most effective when there is a general rule that applies 
formally to the revenues in question, absent the contested measures.
---------------------------------------------------------------------------
    The Panel ruled that the FSC provisions excepted certain 
types of income from the Code's general rule that worldwide 
income is taxable and, thus, from the taxes that would be due 
in the absence of the FSC provisions. The Appellate Body, 
however, confirmed that a WTO member is free to determine how 
broadly to assert its general taxing authority and ``has the 
sovereign authority to tax any particular categories of revenue 
it wishes.'' The Appellate Body Decision also specifically 
stated that a WTO member is ``free not to tax any particular 
categories of revenues.''
    H.R. 4986 modifies the general rule of U.S. taxation by 
fundamentally amending the definition of gross income. Under 
the Code, the definition of ``gross income'' defines the outer 
boundaries of U.S. income taxation. The bill excludes income 
derived from certain activities performed outside the United 
States, referred to as ``extraterritorial income,'' from the 
definition of gross income and, thus, modifies the extent to 
which the United States seeks to tax such income. This new 
general rule thus becomes the normative benchmark for taxing 
income derived in connection with certain activities performed 
outside the United States. This general rule applies to foreign 
trade income, whether the goods are manufactured in the United 
States or abroad--a substantially broader category of income 
than that which was exempted from tax under the FSC provisions. 
The Committee believes that it is important that the activities 
giving rise to excludable extraterritorial income involve real 
economic activity, or ``economic processes,'' performed outside 
the United States. The Committee also believes that it is 
appropriate to except certain forms of extraterritorial income 
from the exclusion; however, the Committee emphasizes that the 
taxation of certain forms of extraterritorial income are 
exceptions to the general rule of not taxing extraterritorial 
income.
    The Committee emphasizes that, consistent with the 
Appellate Body Decision, the United States is exercising its 
sovereign authority not to tax a category of revenue. Because 
of this substantive change in U.S. income taxation, the 
exclusion of extraterritorial income becomes the United States' 
general rule with respect to this category of income. 
Therefore, the exclusion of such income from taxation does not 
constitute revenue forgone that is otherwise due and, 
accordingly, does not give rise to a ``subsidy'' within the 
meaning of the WTO rules.
            H.R. 4986 does not provide ``export-contingent'' benefits
    In addition to ensuring that the FSC replacement regime is 
not a ``subsidy,'' the Committee believes that, in order to 
ensure WTO compatibility, it is important that the new regime 
not confer export-contingent benefits.\8\ To achieve this goal, 
the Committee has relied on the WTO Appellate Body's 
interpretation of the meaning of ``contingent'' for purposes of 
the Agreement on Subsidies and Countervailing Measures in 
crafting this legislation.\9\ It is the Committee's intent and 
belief that the exclusion of extraterritorial income from U.S. 
gross income is not dependent on such income arising from 
export activities. Accordingly, the Committee has determined 
that it is appropriate to treat all foreign sales alike, 
whether the goods were manufactured in the United States or 
abroad. A taxpayer would receive the same U.S. tax treatment 
with respect to its foreign sales regardless of whether it 
exports. As a result, the exclusion for certain 
extraterritorial income is not ``conditional'' or ``dependent'' 
on whether an entity exports; therefore, it clearly is not 
export contingent.
---------------------------------------------------------------------------
    \8\ Under Article 3.1(a) of the Agreement on Subsidies and 
Countervailing Measures, subsidies contingent, in law or in fact, 
whether solely or as one of several other conditions, upon export 
performance, are prohibited. This standard is met when the facts 
demonstrate that the granting of a subsidy, without having been made 
legally contingent upon export performance, is in fact tied to actual 
or anticipated exportation or export earnings. However, the mere fact 
that a subsidy is granted to enterprises which export shall not for 
that reason alone be considered to be an export subsidy within the 
meaning of this provision.
    \9\ See Canada--Measures Affecting the Export of Civilian Aircraft; 
see also Canada--Certain Measures Affecting the Automotive Industry. In 
these cases, the WTO Appellate Body has found the term ``contingent'' 
to have its ordinary meaning of ``conditional'' or ``dependent for its 
existence on something else.''
---------------------------------------------------------------------------
    The Committee emphasizes that the extraterritorial income 
excluded by this legislation from the scope of U.S. income 
taxation is parallel to the foreign-source income excluded from 
tax under most territorial tax systems. Under neither the U.S. 
tax system as modified by this legislation nor many European 
tax systems is the income excluded from taxation limited to 
income earned through exporting. At the same time, under both 
systems, exporting is one way to earn foreign source income 
that is excluded from taxation, and exporters under both 
systems are among those who can avail themselves of the 
limitations on the taxing authority of both systems. While 
exporters may be among those who are eligible for the 
exclusion, this fact does not make that exclusion ``export 
contingent.'' If it did, every general exclusion from tax 
applicable to, among others, exporters would become a 
prohibited export subsidy.
            Addressing other European Union concerns
    The Administration has informed the Committee that during 
the course of the WTO litigation and subsequent consultations 
with European Union officials, the European Union also raised 
certain issues relating to the FSC rules that the Panel and 
Appellate Body did not consider. In this regard, the European 
Union argued that the administrative pricing rules used to 
determine the amount of exempt income generated by FSCs were in 
violation of the arm's-length transfer price provisions in the 
SCM Agreement. In addition, the European Union alleged that the 
companies established as FSCs were essentially ``sham'' 
corporations and that the FSCs were often located in tax haven 
countries.
    The Committee wants to be clear that because neither the 
Panel nor the Appellate Body made recommendations with respect 
to these complaints, the United States is under no obligation 
to address these issues. Nonetheless, the Committee believes 
that there is some benefit to be achieved by removing these 
issues as a source of contention. In addition, the Committee 
believes that addressing these issues provides an opportunity 
to simplify the administration of the tax law as well as 
corporate record keeping.
    First, unlike the FSC regime, the bill does not require the 
use of a separate foreign entity such as the FSC. Therefore, it 
cannot be argued that the new legislation encourages the 
formation of ``sham'' corporations in tax-haven jurisdictions. 
Second, because there is no separate entity required, there are 
no transfers required between related domestic and foreign 
companies. The administrative pricing rules are therefore 
eliminated as transfer pricing mechanisms. If there are 
transfers between related parties, general arm's-length 
principles apply. Further, the Committee notes that the 
elimination of the need for a separate foreign entity 
simplifies the administration of the tax law from the 
perspective of both the IRS and the taxpayer.

Conclusion

    The Committee believes that this legislation complies with 
the WTO decisions and honors U.S. obligations under the WTO. 
The Committee is of the view that repealing the FSC provisions 
provides an opportunity to revise the Code in a manner that 
rationalizes tax treatment for extraterritorial income. The 
Committee is confident that, should the bill be challenged in 
WTO dispute settlement proceedings, the legislation would 
withstand scrutiny under the trade agreements. The Committee 
contrasts the timely and thorough action by the United States 
represented by this legislation with the response of certain 
foreign nations to findings of other WTO dispute settlement 
panels in recent cases involving trade in beef and bananas--
findings dealing with pure trade issues and not with the 
fundamental nature of a country's tax regime.
    It is the Committee's sincere hope that through this 
legislation the United States will be able to resolve this 
dispute.

                       Explanation of Provisions

Repeal of the FSC rules

    The bill repeals the present-law FSC rules found in 
sections 921 through 927 of the Code.

Exclusion of extraterritorial income

    The bill provides that gross income for U.S. tax purposes 
does not include extraterritorial income. Because the exclusion 
of such extraterritorial income is a means of avoiding double 
taxation, no foreign tax credit is allowed for income taxes 
paid with respect to such excluded income. Extraterritorial 
income is eligible for the exclusion to the extent that it is 
``qualifying foreign trade income.'' Because U.S. income tax 
principles generally deny deductions for expenses related to 
exempt income, otherwise deductible expenses that are allocated 
to qualifying foreign trade income generally are disallowed.
    The bill applies in the same manner with respect to both 
individuals and corporations who are U.S. taxpayers. In 
addition, the exclusion from gross income applies for 
individual and corporate alternative minimum tax purposes.

Qualifying foreign trade income

    Under the bill, qualifying foreign trade income is the 
amount of gross income that, if excluded, would result in a 
reduction of taxable income by the greatest of (1) 1.2 percent 
of the ``foreign trading gross receipts'' derived by the 
taxpayer from the transaction,\10\ (2) 15 percent of the 
``foreign trade income'' derived by the taxpayer from the 
transaction, or (3) 30 percent of the ``foreign sale and 
leasing income'' derived by the taxpayer from the transaction. 
The amount of qualifying foreign trade income determined using 
1.2 percent of the foreign trading gross receipts is limited to 
200 percent of the qualifying foreign trade income that would 
result using 15 percent of the foreign trade income. 
Notwithstanding the general rule that qualifying foreign trade 
income is based on one of the three calculations that results 
in the greatest reduction in taxable income, a taxpayer may 
choose instead to use one of the other two calculations that 
does not result in the greatest reduction in taxable income. 
Although these calculations are determined by reference to a 
reduction of taxable income (a net income concept), qualifying 
foreign trade income is an exclusion from gross income. Hence, 
once a taxpayer determines the appropriate reduction of taxable 
income, that amount must be ``grossed up'' for related expenses 
in order to determine the amount of gross income excluded.\11\
---------------------------------------------------------------------------
    \10\ The term ``transaction'' means (1) any sale, exchange, or 
other disposition; (2) any lease or rental, and (3) any furnishing of 
services.
    \11\ For an example of these calculations, see the General Example, 
below.
---------------------------------------------------------------------------
    If a taxpayer uses 1.2 percent of foreign trading gross 
receipts to determine the amount of qualifying foreign trade 
income with respect to a transaction, the taxpayer or any other 
related persons will be treated as having no qualifying foreign 
trade income with respect to any other transaction involving 
the same property.\12\ For example, assume that a manufacturer 
and a distributor of the same product are related persons. The 
manufacturer sells the product to the distributor at an arm's-
length price of $80 (generating $30 of profit) and the 
distributor sells the product to an unrelated customer outside 
of the United States for $100 (generating $20 of profit). If 
the distributor chooses to calculate its qualifying foreign 
trade income on the basis of 1.2 percent of foreign trading 
gross receipts, then the manufacturer will be considered to 
have no qualifying foreign trade income and, thus, would have 
no excluded income. The distributor's qualifying foreign trade 
income would be 1.2 percent of $100, and the manufacturer's 
qualifying foreign trade income would be zero. This limitation 
is intended to prevent a duplication of exclusions from gross 
income because the distributor's $100 of gross receipts 
includes the $80 of gross receipts of the manufacturer. Absent 
this limitation, $80 of gross receipts would have been double 
counted for purposes of the exclusion. If both persons were 
permitted to use 1.2 percent of their foreign trading gross 
receipts in this example, then the related-person group would 
have an exclusion based on $180 of foreign trading gross 
receipts notwithstanding that the related-person group really 
only generated $100 of gross receipts from the transaction. 
However, if the distributor chooses to calculate its qualifying 
foreign trade income on the basis of 15 percent of foreign 
trade income (15 percent of $20 of profit), then the 
manufacturer would also be eligible to calculate its qualifying 
foreign trade income in the same manner (15 percent of $30 of 
profit).\13\ Thus, in the second case, each related person may 
exclude an amount of income based on their respective profits. 
The total foreign trade income of the related-person group is 
$50. Accordingly, allowing each person to calculate the 
exclusion based on their respective foreign trade income does 
not result in duplication of exclusions.
---------------------------------------------------------------------------
    \12\ Persons are considered to be related if they are treated as a 
single employer under section 52(a) or (b) (determined without taking 
into account section 1563(b), thus including foreign corporations) or 
section 414(m) or (o).
    \13\ The manufacturer also could compute qualifying foreign trade 
income based on 30 percent of foreign sale and leasing income.
---------------------------------------------------------------------------
    Under the bill, a taxpayer may determine the amount of 
qualifying foreign trade income either on a transaction-by-
transaction basis or on an aggregate basis for groups of 
transactions, so long as the groups are based on product lines 
or recognized industry or trade usage. Under the grouping 
method, the Committee intends that taxpayers be given 
reasonable flexibility to identify product lines or groups on 
the basis of recognized industry or trade usage. In general, 
provided that the taxpayer's grouping is not unreasonable, it 
will not be rejected merely because the grouped products fall 
within more than one of the two-digit Standard Industrial 
Classification codes.\14\ The Secretary of the Treasury is 
granted authority to prescribe rules for grouping transactions 
in determining qualifying foreign trade income.
---------------------------------------------------------------------------
    \14\ By reference to Standard Industrial Classification codes, the 
Committee intends to include industries as defined in the North 
American Industrial Classification System.
---------------------------------------------------------------------------
    Qualifying foreign trade income must be reduced by illegal 
bribes, kickbacks and similar payments, and by a factor for 
operations in or related to a country associated in carrying 
out an international boycott, or participating or cooperating 
with an international boycott.
    In addition, the bill directs the Secretary of the Treasury 
to prescribe rules for marginal costing in those cases in which 
a taxpayer is seeking to establish or maintain a market for 
qualifying foreign trade property.
            Foreign trading gross receipts
    Under the bill, ``foreign trading gross receipts'' are 
gross receipts derived from certain activities in connection 
with ``qualifying foreign trade property'' with respect to 
which certain ``economic processes'' take place outside of the 
United States. Specifically, the gross receipts must be (1) 
from the sale, exchange, or other disposition of qualifying 
foreign trade property; (2) from the lease or rental of 
qualifying foreign trade property for use by the lessee outside 
of the United States; (3) for services which are related and 
subsidiary to the sale, exchange, disposition, lease, or rental 
of qualifying foreign trade property (as described above); (4) 
for engineering or architectural services for construction 
projects located outside of the United States; or (5) for the 
performance of certain managerial services for unrelated 
persons. Gross receipts from the lease or rental of qualifying 
foreign trade property include gross receipts from the license 
of qualifying foreign trade property. Consistent with the 
policy adopted in the Taxpayer Relief Act of 1997,\15\ this 
includes the license of computer software for reproduction 
abroad.
---------------------------------------------------------------------------
    \15\ The Taxpayer Relief Act of 1997, Public Law 105-34.
---------------------------------------------------------------------------
    Foreign trading gross receipts do not include gross 
receipts from a transaction if the qualifying foreign trade 
property or services are for ultimate use in the United States, 
or for use by the United States (or an instrumentality thereof) 
and such use is required by law or regulation. Foreign trading 
gross receipts also do not include gross receipts from a 
transaction that is accomplished by a subsidy granted by the 
government (or any instrumentality thereof) of the country or 
possession in which the property is manufactured.
    A taxpayer may elect to treat gross receipts from a 
transaction as not foreign trading gross receipts. As a 
consequence of such an election, the taxpayer could utilize any 
related foreign tax credits in lieu of the exclusion as a means 
of avoiding double taxation. It is intended that this election 
be accomplished by the taxpayer's treatment of such items on 
its tax return for the taxable year. Provided that the 
taxpayer's taxable year is still open under the statute of 
limitations for making claims for refund under section 6511, a 
taxpayer can make redeterminations as to whether the gross 
receipts from a transaction constitute foreign trading gross 
receipts.
            Foreign economic processes
    Under the bill, gross receipts from a transaction are 
foreign trading gross receipts only if certain economic 
processes take place outside of the United States. The foreign 
economic processes requirement is satisfied if the taxpayer (or 
any person acting under a contract with the taxpayer) 
participates outside of the United States in the solicitation 
(other than advertising), negotiation, or making of the 
contract relating to such transaction and incurs a specified 
amount of foreign direct costs attributable to the 
transaction.\16\ For this purpose, foreign direct costs include 
only those costs incurred in the following categories of 
activities: (1) advertising and sales promotion; (2) the 
processing of customer orders and the arranging for delivery; 
(3) transportation outside of the United States in connection 
with delivery to the customer; (4) the determination and 
transmittal of a final invoice or statement of account or the 
receipt of payment; and (5) the assumption of credit risk. An 
exception from the foreign economic processes requirement is 
provided for taxpayers with foreign trading gross receipts for 
the year of $5 million or less.\17\
---------------------------------------------------------------------------
    \16\ The foreign direct costs attributable to the transaction 
generally must exceed 50 percent of the total direct costs attributable 
to the transaction, but the requirement also will be satisfied if, with 
respect to at least two categories of direct costs, the foreign direct 
costs equal or exceed 85 percent of the total direct costs attributable 
to each category.
    \17\ For this purpose, the receipts of related persons are 
aggregated and, in the case of pass-through entities, the determination 
of whether the foreign trading gross receipts exceed $5 million is made 
both at the entity and at the partner/shareholder level.
---------------------------------------------------------------------------
    The foreign economic processes requirement must be 
satisfied with respect to each transaction and, if so, any 
gross receipts from such transaction could be considered as 
foreign trading gross receipts. For example, all of the lease 
payments received with respect to a multi-year lease contract, 
which contract met the foreign economic processes requirement 
at the time it was entered into, would be considered as foreign 
trading gross receipts. On the other hand, a sale of property 
that was formerly a leased asset, which was not sold pursuant 
to the original lease agreement, generally would be considered 
a new transaction that must independently satisfy the foreign 
economic processes requirement.
    A taxpayer's foreign economic processes requirement is 
treated as satisfied with respect to a sales transaction 
(solely for the purpose of determining whether gross receipts 
are foreign trading gross receipts) if any related person has 
satisfied the foreign economic processes requirement in 
connection with another sales transaction involving the same 
qualifying foreign trade property.
            Qualifying foreign trade property
    Under the bill, the threshold for determining if gross 
receipts will be treated as foreign trading gross receipts is 
whether the gross receipts are derived from a transaction 
involving ``qualifying foreign trade property.'' Qualifying 
foreign trade property is property manufactured, produced, 
grown, or extracted (``manufactured'') within or outside of the 
United States that is held primarily for sale, lease, or 
rental,\18\ in the ordinary course of a trade or business, for 
direct use, consumption, or disposition outside of the United 
States.\19\ In addition, not more than 50 percent of the fair 
market value of such property can be attributable to the sum of 
(1) the fair market value of articles manufactured outside of 
the United States plus (2) the direct costs of labor performed 
outside of the United States.\20\
---------------------------------------------------------------------------
    \18\ In addition, consistent with the policy adopted in the 
Taxpayer Relief Act of 1997, computer software licensed for 
reproduction is considered as property held primarily for sale, lease, 
or rental.
    \19\ ``United States'' includes Puerto Rico for these purposes 
because Puerto Rico is included in the customs territory of the United 
States.
    \20\ For this purpose, the fair market value of any article 
imported into the United States is its appraised value as determined 
under the Tariff Act of 1930. In addition, direct labor costs are 
determined under the principles of section 263A and do not include 
costs that would be treated as direct labor costs attributable to 
``articles,'' again applying principles of section 263A.
---------------------------------------------------------------------------
    The Committee understands that under current industry 
practice, the purchaser of an aircraft contracts separately for 
the aircraft engine and the airframe, albeit contracting with 
the airframe manufacturer to attach the separately purchased 
engine. The Committee intends that an aircraft engine be 
qualifying foreign trade property (assuming that all other 
requirements are satisfied) if (1) it is specifically designed 
to be separated from the airframe to which it is incorporated 
without significant damage to either the engine or the 
airframe, (2) it is reasonably expected to be separated from 
the airframe in the ordinary course of business (other than by 
reason of temporary separation for servicing, maintenance, or 
repair) before the end of the useful life of either the engine 
or the airframe, whichever is shorter, and (3) the terms under 
which the aircraft engine was sold were directly and separately 
negotiated between the manufacturer of the aircraft engine and 
the person to whom the aircraft will be ultimately delivered. 
By articulating this application of the foreign destination 
test in the case of certain separable aircraft engines, the 
Committee intends no inference with respect to the application 
of any destination test under present law or with respect to 
any other rule of law outside this bill.\21\
---------------------------------------------------------------------------
    \21\ See, e.g., sections 927(a)(1)(B) and 993(c)(1)(B).
---------------------------------------------------------------------------
    The bill excludes certain property from the definition of 
qualifying foreign trade property. The excluded property is (1) 
property leased or rented by the taxpayer for use by a related 
person, (2) certain intangibles,\22\ (3) oil and gas (or any 
primary product thereof), (4) unprocessed softwood timber, (5) 
certain products the transfer of which are prohibited or 
curtailed to effectuate the policy set forth in Public Law 96-
72, and (6) property designated by Executive order as in short 
supply. In addition, it is the intention of the Committee that 
property that is leased or licensed to a related person who is 
the lessor, licensor, or seller of the same property in a 
sublease, sublicense, or sale to an unrelated person for the 
ultimate and predominate use by the unrelated person outside of 
the United States is not excluded property by reason of such 
lease or license to a related person.
---------------------------------------------------------------------------
    \22\ The intangibles that are treated as excluded property under 
the bill are: patents, inventions, models, designs, formulas, or 
processes whether or not patented, copyrights (other than films, tapes, 
records, or similar reproductions, and other than computer software 
(whether or not patented), for commercial or home use), goodwill, 
trademarks, trade brands, franchises, or other like property. Computer 
software that is licensed for reproduction outside of the United States 
is not excluded from the definition of qualifying foreign trade 
property.
---------------------------------------------------------------------------
    With respect to property that is manufactured outside of 
the United States, rules are provided to ensure consistent U.S. 
tax treatment with respect to manufacturers. The bill requires 
that property manufactured outside of the United States be 
manufactured by (1) a domestic corporation, (2) an individual 
who is a citizen or resident of the United States, (3) a 
foreign corporation that elects to be subject to U.S. taxation 
in the same manner as a U.S. corporation, or (4) a partnership 
or other pass-through entity all of the partners or owners of 
which are described in (1), (2), or (3) above.\23\
---------------------------------------------------------------------------
    \23\ Except as provided by the Secretary of the Treasury, tiered 
partnerships or pass-through entities will be considered as 
partnerships or pass-through entities for purposes of this rule if each 
of the partnerships or entities is directly or indirectly wholly-owned 
by persons described in (1), (2), or (3) above.
---------------------------------------------------------------------------
            Foreign trade income
    Under the bill, ``foreign trade income'' is the taxable 
income of the taxpayer (determined without regard to the 
exclusion of qualifying foreign trade income) attributable to 
foreign trading gross receipts. Certain dividends-paid 
deductions of cooperatives are disregarded in determining 
foreign trade income for this purpose.
            Foreign sale and leasing income
    Under the bill, ``foreign sale and leasing income'' is the 
amount of the taxpayer's foreign trade income (with respect to 
a transaction) that is properly allocable to activities that 
constitute foreign economic processes (as described above). For 
example, a distribution company's profit from the sale of 
qualifying foreign trade property that is associated with sales 
activities, such as solicitation or negotiation of the sale, 
advertising, processing customer orders and arranging for 
delivery, transportation outside of the United States, and 
other enumerated activities, would constitute foreign sale and 
leasing income.
    Foreign sale and leasing income also includes foreign trade 
income derived by the taxpayer in connection with the lease or 
rental of qualifying foreign trade property for use by the 
lessee outside of the United States. Income from the sale, 
exchange, or other disposition of qualifying foreign trade 
property that is or was subject to such a lease \24\ (i.e., the 
sale of the residual interest in the leased property) gives 
rise to foreign sale and leasing income. Except as provided in 
regulations, a special limitation applies to leased property 
that (1) is manufactured by the taxpayer or (2) is acquired by 
the taxpayer from a related person for a price that was other 
than arm's length. In such cases, foreign sale and leasing 
income may not exceed the amount of foreign sale and leasing 
income that would have resulted if the taxpayer had acquired 
the leased property in a hypothetical arm's-length purchase and 
then engaged in the actual sale or lease of such property. For 
example, if a manufacturer leases qualifying foreign trade 
property that it manufactured, the foreign sale and leasing 
income derived from that lease may not exceed the amount of 
foreign sale and leasing income that the manufacturer would 
have earned with respect to that lease had it purchased the 
property for an arm's-length price on the day that the 
manufacturer entered into the lease. For purposes of 
calculating the limit on foreign sale and leasing income, the 
manufacturer's basis and, thus, depreciation would be based on 
this hypothetical arm's-length price. This limitation is 
intended to prevent foreign sale and leasing income from 
including profit associated with manufacturing activities.
---------------------------------------------------------------------------
    \24\ For this purpose, such a lease includes a lease that gave rise 
to exempt foreign trade income under the FSC provisions.
---------------------------------------------------------------------------
    For purposes of determining foreign sale and leasing 
income, only directly allocable expenses is taken into account 
in calculating the amount of foreign trade income. In addition, 
income properly allocable to certain intangibles is excluded 
for this purpose.

General Example

    The following is an example of the calculation of 
qualifying foreign trade income.
    XYZ Corporation, a U.S. corporation, manufactures property 
that is sold to unrelated customers for use outside of the 
United States. XYZ Corporation satisfies the foreign economic 
processes requirement through conducting activities such as 
solicitation, negotiation, transportation, and other sales-
related activities outside of the United States with respect to 
its transactions. During the year, qualifying foreign trade 
property was sold for gross proceeds totaling $1,000. The cost 
of this qualifying foreign trade property was $600. XYZ 
Corporation incurred $275 of costs that are directly related to 
the sale and distribution of qualifying foreign trade property. 
XYZ Corporation paid $40 of income tax to a foreign 
jurisdiction related to the sale and distribution of the 
qualifying foreign trade property. XYZ Corporation also 
generated gross income of $7,600 (gross receipts of $24,000 and 
cost of goods sold of $16,400) and direct expenses of $4,225 
that relate to the manufacture and sale of products other than 
qualifying foreign trade property. XYZ Corporation also 
incurred $500 of overhead expenses. XYZ Corporation's financial 
information for the year is summarized as follows:

----------------------------------------------------------------------------------------------------------------
                                                                       Total      Other property     QFTP \25\
----------------------------------------------------------------------------------------------------------------
Gross receipts..................................................      $25,000.00      $24,000.00       $1,000.00
Cost of goods sold..............................................       17,000.00       16,400.00          600.00
                                                                 -----------------------------------------------
Gross income....................................................        8,000.00        7,600.00          400.00
Direct expenses.................................................        4,500.00        4,225.00          275.00
Overhead expenses...............................................          500.00  ..............  ..............
                                                                 -----------------------------------------------
Net income......................................................        3,000.00  ..............  ..............
----------------------------------------------------------------------------------------------------------------
\25\ ``QFTP'' refers to qualifying foreign trade property.

    Illustrated below is the computation of the amount of 
qualifying foreign trade income that is excluded from XYZ 
Corporation's gross income and the amount of related expenses 
that are disallowed. In order to calculate qualifying foreign 
trade income, the amount of foreign trade income first must be 
determined. Foreign trade income is the taxable income 
(determined without regard to the exclusion of qualifying 
foreign trade income) attributable to foreign trading gross 
receipts. In this example, XYZ Corporation's foreign trading 
gross receipts equal $1,000. This amount of gross receipts is 
reduced by the related cost of goods sold, the related direct 
expenses, and a portion of the overhead expenses in order to 
arrive at the related taxable income.\26\ Thus, XYZ 
Corporation's foreign trade income equals $100, calculated as 
follows:
---------------------------------------------------------------------------
    \26\ Overhead expenses must be apportioned in a reasonable manner 
that does not result in a material distortion of income. In this 
example, the apportionment of the $500 of overhead expenses on the 
basis of gross income is assumed not to result in a material distortion 
of income and is assumed to be a reasonable method of apportionment. 
Thus, $25 ($500 of total overhead expenses multiplied by 5 percent, 
i.e., $400 of gross income from the sale of qualifying foreign trade 
property divided by $8,000 of total gross income) is apportioned to 
qualifying foreign trading gross receipts. The remaining $475 ($500 of 
total overhead expenses less the $25 apportioned to qualifying income) 
is apportioned to XYZ Corporation's other income.

Foreign trading gross receipts................................ $1,000.00
Cost of goods sold............................................    600.00
                    --------------------------------------------------------------
                    ____________________________________________________

Gross income..................................................    400.00
Direct expenses...............................................    275.00
Apportioned overhead expenses.................................     25.00
                    --------------------------------------------------------------
                    ____________________________________________________

Foreign trade income..........................................    100.00

    Foreign sale and leasing income is defined as an amount of 
foreign trade income (calculated taking into account only 
directly-related expenses) that is properly allocable to 
certain specified foreign activities. Assume for purposes of 
this example that of the $125 of foreign trade income ($400 of 
gross income from the sale of qualifying foreign trade property 
less only the direct expenses of $275), $35 is properly 
allocable to such foreign activities (e.g., solicitation, 
negotiation, advertising, foreign transportation, and other 
enumerated sales-like activities) and, therefore, is considered 
to be foreign sale and leasing income.
    Qualifying foreign trade income is the amount of gross 
income that, if excluded, will result in a reduction of taxable 
income equal to the greatest of (1) 30 percent of foreign sale 
and leasing income, (2) 1.2 percent of foreign trading gross 
receipts, or (3) 15 percent of foreign trade income. Thus, in 
order to calculate the amount that is excluded from gross 
income, taxable income must be determined and then ``grossed 
up'' for allocable expenses in order to arrive at the 
appropriate gross income figure. First, for each method of 
calculating qualifying foreign trade income, the reduction in 
taxable income is determined. Then, the $275 of direct and $25 
of overhead expenses, totaling $300, attributable to foreign 
trading gross receipts is apportioned to the reduction in 
taxable income based on the proportion of the reduction in 
taxable income to foreign trade income. This apportionment is 
done for each method of calculating qualifying foreign trade 
income. The sum of the taxable income reduction and the 
apportioned expenses the respective qualifying foreign trade 
income (i.e., the amount of gross income excluded) under each 
method, as follows:

------------------------------------------------------------------------
                                    1.2% FTGR     15% FTI     30% FS&LI
                                       \27\         \28\         \29\
------------------------------------------------------------------------
Reduction of taxable income:
    1.2% of FTGR (1.2%          12.00  ...........  ...........
     $1,000).....................
    15% of FTI (15%       ...........        15.00  ...........
     $100).......................
    30% of FS&LI (30%     ...........  ...........        10.50
     $35)........................
Gross-up for disallowed expenses:
    $300  ($12/$100)....        36.00  ...........  ...........
    $300  ($15/$100)....  ...........        45.00  ...........
    $275  ($10.50/$100)   ...........  ...........        28.88
     \30\........................
                                  --------------------------------------
      Qualifying foreign trade           48.00        60.00       39.38
       income....................
------------------------------------------------------------------------
\27\ ``FTGR'' refers to foreign trading gross receipts.
\28\ ``FTI'' refers to foreign trade income.
\29\ ``FS&LI'' refers to foreign sale and leasing income.
\30\ Because foreign sale and leasing income only takes into account
  direct expenses, it is appropriate to take into account only such
  expenses for purposes of this calculation.

    In the example, the $60 of qualifying foreign trade income 
is excluded from XYZ Corporation's gross income (determined 
based on 15 percent of foreign trade income).\31\ In connection 
with excluding $60 of gross income, certain expenses that are 
allocable to this income are not deductible for U.S. Federal 
income tax purposes. Thus, $45 ($300 of related expenses 
multiplied by 15 percent, i.e., $60 of qualifying foreign trade 
income divided by $400 of gross income from the sale of 
qualifying foreign trade property) of expenses are 
disallowed.\32\
---------------------------------------------------------------------------
    \31\ Note that XYZ Corporation could choose to use one of the other 
two methods notwithstanding that they would result in a smaller 
exclusion.
    \32\ The $300 of allocable expenses includes both the $275 of 
direct expenses and the $25 of overhead expenses. Thus, the $45 of 
disallowed expenses represents the sum of $41.25 of direct expenses 
plus $3.75 of overhead expenses. If qualifying foreign trade income was 
determined using 30 percent of foreign sale and leasing income, the 
disallowed expenses would include only the appropriate portion of the 
direct expenses.

----------------------------------------------------------------------------------------------------------------
                                                                 Other                   Excluded/
                                                                property       QFTP      disallowed     Total
----------------------------------------------------------------------------------------------------------------
Gross receipts..............................................   $24,000.00    $1,000.00  ...........  ...........
Cost of goods sold..........................................    16,400.00       600.00  ...........  ...........
                                                             ---------------------------------------------------
Gross income................................................     7,600.00       400.00      (60.00)     7,940.00
Direct expenses.............................................     4,225.00       275.00      (41.25)     4,458.75
Overhead expenses...........................................       475.00        25.00       (3.75)       496.25
                                                             ---------------------------------------------------
Taxable income..............................................  ...........  ...........  ...........     2,985.00
----------------------------------------------------------------------------------------------------------------

    XYZ Corporation paid $40 of income tax to a foreign 
jurisdiction related to the sale and distribution of the 
qualifying foreign trade property. A portion of this $40 of 
foreign income tax is treated as paid with respect to the 
qualifying foreign trade income and, therefore, is not 
creditable for U.S. foreign tax credit purposes. In this case, 
$6 of such taxes paid ($40 of foreign taxes multiplied by 15 
percent, i.e., $60 of qualifying foreign trade income divided 
by $400 of gross income from the sale of qualifying foreign 
trade property) is treated as paid with respect to the 
qualifying foreign trade income and, thus, is not creditable.
    The results in this example are the same regardless of 
whether XYZ Corporation manufactures the property within the 
United States or outside of the United States through a foreign 
branch. If XYZ Corporation were an S corporation or limited 
liability company, the results also would be the same, and the 
exclusion would pass through to the S corporation owners or 
limited liability company owners as the case may be.

Other rules

            Foreign-source income limitation
    The bill provides a limitation with respect to the sourcing 
of taxable income applicable to certain sale transactions 
giving rise to foreign trading gross receipts. This limitation 
only applies with respect to sale transactions involving 
property that is manufactured within the United States. The 
special source limitation does not apply when qualifying 
foreign trade income is determined using 30 percent of the 
foreign sale and leasing income from the transaction.
    This foreign-source income limitation is determined in one 
of two ways depending on whether the qualifying foreign trade 
income is calculated based on 1.2 percent of foreign trading 
gross receipts or on 15 percent of foreign trade income. If the 
qualifying foreign trade income is calculated based on 1.2 
percent of foreign trading gross receipts, the related amount 
of foreign-source income may not exceed the amount of foreign 
trade income that (without taking into account this special 
foreign-source income limitation) would be treated as foreign-
source income if such foreign trade income were reduced by 4 
percent of the related foreign trading gross receipts.
    For example, assume that foreign trading gross receipts are 
$2,000 and foreign trade income is $100. Assume also that the 
taxpayer chooses to determine qualifying foreign trade income 
based on 1.2 percent of foreign trading gross receipts. Taxable 
income after taking into account the exclusion of the 
qualifying foreign trade income and the disallowance of related 
deductions is $76. Assume that the taxpayer manufactured its 
qualifying foreign trade property in the United States and that 
title to such property passed outside of the United States. 
Absent a special sourcing rule, under section 863(b) (and the 
regulations thereunder) the $76 of taxable income would be 
sourced as $38 U.S. source and $38 foreign source. Under the 
special sourcing rule, the amount of foreign-source income may 
not exceed the amount of the foreign trade income that 
otherwise would be treated as foreign source if the foreign 
trade income were reduced by 4 percent of the related foreign 
trading gross receipts. Reducing foreign trade income by 4 
percent of the foreign trading gross receipts (4 percent of 
$2,000, or $80) would result in $20 ($100 foreign trade income 
less $80). Applying section 863(b) to the $20 of reduced 
foreign trade income would result in $10 of foreign-source 
income and $10 of U.S.-source income. Accordingly, the 
limitation equals $10. Thus, although under the general 
sourcing rule $38 of the $76 taxable income would be treated as 
foreign source, the special sourcing rule limits foreign-source 
income in this example to $10 (with the remaining $66 being 
treated as U.S.-source income).
    If the qualifying foreign trade income is calculated based 
on 15 percent of foreign trade income, the amount of related 
foreign-source income may not exceed 50 percent of the foreign 
trade income that (without taking into account this special 
foreign-source income limitation) would be treated as foreign-
source income.
    For example, assume that foreign trade income is $100 and 
the taxpayer chooses to determine its qualifying foreign trade 
income based on 15 percent of foreign trade income. Taxable 
income after taking into account the exclusion of the 
qualifying foreign trade income and the disallowance of related 
deductions is $85. Assume that the taxpayer manufactured its 
qualifying foreign trade property in the United States and that 
title to such property passed outside of the United States. 
Absent a special sourcing rule, under section 863(b) the $85 of 
taxable income would be sourced as $42.50 U.S. source and 
$42.50 foreign source. Under the special sourcing rule, the 
amount of foreign-source income may not exceed 50 percent of 
the foreign trade income that otherwise would be treated as 
foreign source. Applying section 863(b) to the $100 of foreign 
trade income would result in $50 of foreign-source income and 
$50 of U.S.-source income. Accordingly, the limitation equals 
$25, which is 50 percent of the $50 foreign-source income. 
Thus, although under the general sourcing rule $42.50 of the 
$85 taxable income would be treated as foreign source, the 
special sourcing rule limits foreign-source income in this 
example to $25 (with the remaining $60 being treated as U.S.-
source income).\33\
---------------------------------------------------------------------------
    \33\ The foreign-source income limitation provisions also apply 
when source is determined solely in accordance with section 862 (e.g., 
a distributor of qualifying foreign trade property that is manufactured 
in the United States by an unrelated person and sold for use outside of 
the United States).
---------------------------------------------------------------------------
            Treatment of withholding taxes
    The bill generally provides that no foreign tax credit is 
allowed for foreign taxes paid or accrued with respect to 
qualifying foreign trade income (i.e., excluded 
extraterritorial income). In determining whether foreign taxes 
are paid or accrued with respect to qualifying foreign trade 
income, foreign withholding taxes generally are treated as not 
paid or accrued with respect to qualifying foreign trade 
income.\34\ Accordingly, the bill's denial of foreign tax 
credits would not apply to such taxes. For this purpose, the 
term ``withholding tax'' refers to any foreign tax that is 
imposed on a basis other than residence and that is otherwise a 
creditable foreign tax under sections 901 or 903.\35\ It is 
intended that such taxes would be similar in nature to the 
gross-basis taxes described in sections 871 and 881.
---------------------------------------------------------------------------
    \34\ With respect to the withholding taxes that are paid or accrued 
(a prerequisite to the taxes being otherwise creditable), the provision 
in the bill treats such taxes as not being paid or accrued with respect 
to qualifying foreign trade income.
    \35\ This also would apply to any withholding tax that is 
creditable for U.S. foreign tax credit purposes under an applicable 
treaty.
---------------------------------------------------------------------------
    If, however, qualifying foreign trade income is determined 
based on 30 percent of foreign sale and leasing income, the 
special rule for withholding taxes is not applicable. Thus, in 
such cases foreign withholding taxes may be treated as paid or 
accrued with respect to qualifying foreign trade income and, 
accordingly, are not creditable under the bill.
            Election to be treated as a U.S. corporation
    The bill provides that certain foreign corporations may 
elect, on an original return, to be treated as domestic 
corporations. The election applies to the taxable year when 
made and all subsequent taxable years unless revoked by the 
taxpayer or terminated for failure to qualify for the election. 
Such election is available for a foreign corporation (1) that 
manufactures property in the ordinary course of such 
corporation's trade or business, or (2) if substantially all of 
the gross receipts of such corporation reasonably may be 
expected to be foreign trading gross receipts. For this 
purpose, ``substantially all'' is based on the relevant facts 
and circumstances.
    In order to be eligible to make this election, the foreign 
corporation must waive all benefits granted to such corporation 
by the United States pursuant to a treaty.\36\ Absent such a 
waiver, it would be unclear, for example, whether the permanent 
establishment article of a relevant tax treaty would override 
the electing corporation's treatment as a domestic corporation 
under this provision. A foreign corporation that elects to be 
treated as a domestic corporation is not permitted to make an S 
corporation election. The Secretary is granted authority to 
prescribe rules to ensure that the electing foreign corporation 
pays its U.S. income tax liabilities and to designate one or 
more classes of corporations that may not make such an 
election.\37\ If such an election is made, for purposes of 
section 367 the foreign corporation is treated as transferring 
(as of the first day of the first taxable year to which the 
election applies) all of its assets to a domestic corporation 
in connection with an exchange to which section 354 applies.
---------------------------------------------------------------------------
    \36\ The waiver of treaty benefits applies to the corporation 
itself and not, for example, to employees of or independent contractors 
associated with the corporation.
    \37\ For example, the Secretary of the Treasury may prescribe rules 
to prevent ``per se'' corporations under the entity-classification 
rules from making such an election.
---------------------------------------------------------------------------
    If a corporation fails to meet the applicable requirements, 
described above, for making the election to be treated as a 
domestic corporation for any taxable year beginning after the 
year of the election, the election will terminate. In addition, 
a taxpayer, at its option and at any time, may revoke the 
election to be treated as a domestic corporation. In the case 
of either a termination or a revocation, the electing foreign 
corporation will not be considered as a domestic corporation 
effective beginning on the first day of the taxable year 
following the year of such termination or revocation. For 
purposes of section 367, if the election to be treated as a 
domestic corporation is terminated or revoked, such corporation 
is treated as a domestic corporation transferring (as of the 
first day of the first taxable year to which the election 
ceases to apply) all of its property to a foreign corporation 
in connection with an exchange to which section 354 applies. 
Moreover, once a termination occurs or a revocation is made, 
the former electing corporation may not again elect to be taxed 
as a domestic corporation under the provisions of the bill for 
a period of five tax years beginning with the first taxable 
year that begins after the termination or revocation.
    For example, assume a U.S. corporation owns 100 percent of 
a foreign corporation. The foreign corporation manufactures 
outside of the United States and sells what would be qualifying 
foreign trade property were it manufactured by a person subject 
to U.S. taxation. Such foreign corporation could make the 
election under this provision to be treated as a domestic 
corporation. As a result, its earnings no longer would be 
deferred from U.S. taxation. However, by electing to be subject 
to U.S. taxation, a portion of its income would be qualifying 
foreign trade income.\38\ The requirement that the foreign 
corporation be treated as a domestic corporation (and, 
therefore, subject to U.S. taxation) is intended to provide 
parity between U.S. corporations that manufacture abroad in 
branch form and U.S. corporations that manufacture abroad 
through foreign subsidiaries. The election, however, is not 
limited to U.S.-owned foreign corporations. A foreign-owned 
foreign corporation that wishes to qualify for the treatment 
provided under the bill could avail itself of such election 
(unless otherwise precluded from doing so by Treasury 
regulations).
---------------------------------------------------------------------------
    \38\ The sourcing limitation described above would not apply to 
this example because the property is manufactured outside of the United 
States.
---------------------------------------------------------------------------
            Shared partnerships
    The bill provides rules relating to allocations of 
qualifying foreign trade income by certain shared partnerships. 
To the extent that such a partnership (1) maintains a separate 
account for transactions involving foreign trading gross 
receipts with each partner, (2) makes distributions to each 
partner based on the amounts in the separate account, and (3) 
meets such other requirements as the Treasury Secretary may 
prescribe by regulations, such partnership then would allocate 
to each partner items of income, gain, loss, and deduction 
(including qualifying foreign trade income) from such 
transactions on the basis of the separate accounts. It is 
intended that with respect to, and only with respect to, such 
allocations and distributions (i.e., allocations and 
distributions related to transactions between the partner and 
the shared partnership generating foreign trading gross 
receipts), these rules would apply in lieu of the otherwise 
applicable partnership allocation rules such as those in 
section 704(b). For this purpose, a partnership is a foreign or 
domestic entity that is considered to be a partnership for U.S. 
Federal income tax purposes.
    Under the bill, any partner's interest in the shared 
partnership is not taken into account in determining whether 
such partner is a ``related person'' with respect to any other 
partner for purposes of the bill's provisions. Also, the 
election to exclude certain gross receipts from foreign trading 
gross receipts must be made separately by each partner with 
respect to any transaction for which the shared partnership 
maintains a separate account.
            Certain assets not taken into account for purposes of 
                    interest expense allocation
    The bill also provides that qualifying foreign trade 
property that is held for lease or rental, in the ordinary 
course of a trade or business, for use by the lessee outside of 
the United States is not taken into account for interest 
allocation purposes.
            Distributions of qualifying foreign trade income by 
                    cooperatives
    Agricultural and horticultural producers often market their 
products through cooperatives, which are member-owned 
corporations formed under Subchapter T of the Code. At the 
cooperative level, the bill provides the same treatment of 
foreign trading gross receipts derived from products marketed 
through cooperatives as it provides for foreign trading gross 
receipts of other taxpayers. That is, the qualifying foreign 
trade income attributable to those foreign trading gross 
receipts is excluded from the gross income of the cooperative. 
Absent a special rule, however, patronage dividends or per-unit 
retain allocations attributable to qualifying foreign trade 
income paid to members of cooperatives would be taxable in the 
hands of those members. The Committee believes that this would 
disadvantage agricultural and horticultural producers who 
choose to market their products through cooperatives relative 
to those individuals who market their products directly or 
through pass-through entities such as partnerships, limited 
liability companies, or S corporations. Accordingly, the bill 
provides that the amount of any patronage dividends or per-unit 
retain allocations paid to a member of an agricultural or 
horticultural cooperative (to which Part I of Subchapter T 
applies), which is allocable to qualifying foreign trade income 
of the cooperative, is treated as qualifying foreign trade 
income of the member (and, thus, excludable from such member's 
gross income). In order to qualify, such amount must be 
designated by the organization as allocable to qualifying 
foreign trade income in a written notice mailed to its patrons 
not later than the payment period described in section 1382(d). 
The cooperative cannot reduce its income (e.g., cannot claim a 
``dividends-paid deduction'') under section 1382 for such 
amounts.
            Certain dividends allocable to qualifying foreign trade 
                    income
    Under the bill, a U.S. corporation may claim a 100 percent 
dividends-received deduction with respect to any dividend that 
is distributed out of earnings and profits of a controlled 
foreign corporation (as defined in section 957), but only if 
such dividend is attributable to qualifying foreign trade 
income. Only U.S. corporations that are also U.S. shareholders 
(as defined in section 951(b)) are eligible for this 100 
percent dividends-received deduction.

Gap period before administrative guidance is issued

    The Committee recognizes that there may be a gap in time 
between the enactment of the bill and the issuance of detailed 
administrative guidance. It is intended that during this gap 
period before administrative guidance is issued, taxpayers and 
the Internal Revenue Service may apply the principles of 
present-law regulations and other administrative guidance under 
sections 921 through 927 to analogous concepts under the bill. 
Some examples of the application of the principles of present-
law regulations to the bill are described below. These limited 
examples are intended to be merely illustrative and are not 
intended to imply any limitation regarding the application of 
the principles of other analogous rules or concepts under 
present law.
            Marginal costing and grouping
    Under the bill, the Secretary of the Treasury is provided 
authority to prescribe rules for using marginal costing and for 
grouping transactions in determining qualifying foreign trade 
income. It is intended that similar principles under present-
law regulations apply for these purposes.\39\
---------------------------------------------------------------------------
    \39\ See, e.g., Treas. Reg. sec. 1.924(d)-1(c)(5) and (e); Treas. 
Reg. sec. 1.925(a)-1T(c)(8); Treas. Reg. sec. 1.925(b)-1T.
---------------------------------------------------------------------------
            Excluded property
    The bill provides that qualifying foreign trade property 
does not include property leased or rented by the taxpayer for 
use by a related person. It is intended that similar principles 
under present-law regulations apply for this purpose. Thus, 
excluded property does not apply, for example, to property 
leased by the taxpayer to a related person if the property is 
held for sublease, or is subleased, by the related person to an 
unrelated person and the property is ultimately used by such 
unrelated person predominantly outside of the United 
States.\40\ In addition, consistent with the policy adopted in 
the Taxpayer Relief Act of 1997, computer software that is 
licensed for reproduction outside of the United States is not 
excluded property. Accordingly, the license of computer 
software to a related person for reproduction outside of the 
United States for sale, sublicense, lease, or rental to an 
unrelated person for use outside of the United States is not 
treated as excluded property by reason of the license to the 
related person.
---------------------------------------------------------------------------
    \40\ See Treas. Reg. sec. 1.927(a)-1T(f)(2)(i). The bill also 
provides that oil or gas or primary products from oil or gas are 
excluded from the definition of qualifying foreign trade property. It 
is intended that similar principles under present-law regulations apply 
for these purposes. Thus, for this purpose, petrochemicals, medicinal 
products, insecticides, and alcohols are not considered primary 
products from oil or gas and, thus, are not treated as excluded 
property. See Treas. Reg. sec. 1.927(a)-1T(g)(2)(iv).
---------------------------------------------------------------------------
            Foreign trading gross receipts
    Under the bill, foreign trading gross receipts are gross 
receipts from, among other things, the sale, exchange, or other 
disposition of qualifying foreign trade property, and from the 
lease of qualifying foreign trade property for use by the 
lessee outside of the United States. It is intended that the 
principles of present-law regulations that define foreign 
trading gross receipts apply for this purpose. For example, a 
sale includes an exchange or other disposition and a lease 
includes a rental or sublease and a license or a 
sublicense.\41\
---------------------------------------------------------------------------
    \41\ See Treas. Reg. sec. 1.924(a)-1T(a)(2).
---------------------------------------------------------------------------
            Foreign use requirement
    Under the bill, property constitutes qualifying foreign 
trade property if, among other things, the property is held 
primarily for lease, sale, or rental, in the ordinary course of 
business, for direct use, consumption, or disposition outside 
of the United States.\42\ It is intended that the principles of 
the present-law regulations apply for purposes of this foreign 
use requirement. For example, for purposes of determining 
whether property is sold for use outside of the United States, 
property that is sold to an unrelated person as a component to 
be incorporated into a second product which is produced, 
manufactured, or assembled outside of the United States will 
not be considered to be used in the United States (even if the 
second product ultimately is used in the United States), 
provided that the fair market value of such seller's components 
at the time of delivery to the purchaser constitutes less than 
20 percent of the fair market value of the second product into 
which the components are incorporated (determined at the time 
of completion of the production, manufacture, or assembly of 
the second product).\43\
---------------------------------------------------------------------------
    \42\ Foreign trading gross receipts eligible for exclusion from the 
tax base do not include gross receipts from a transaction if the 
qualifying foreign trade property is for ultimate use in the United 
States.
    \43\ See Treas. Reg. sec. 1.927(a)-1T(d)(4)(ii).
---------------------------------------------------------------------------
    In addition, for purposes of the foreign use requirement, 
property is considered to be used by a lessee outside of the 
United States during a taxable year if it is used predominantly 
outside of the United States.\44\ For this purpose, property is 
considered to be used predominantly outside of the United 
States for any period if, during that period, the property is 
located outside of the United States more than 50 percent of 
the time.\45\ An aircraft or other property used for 
transportation purposes (e.g., railroad rolling stock, a 
vessel, a motor vehicle, or a container) is considered to be 
used outside of the United States for any period if, for the 
period, either the property is located outside of the United 
States more than 50 percent of the time or more than 50 percent 
of the miles traveled in the use of the property are traveled 
outside of the United States.\46\ An orbiting satellite is 
considered to be located outside of the United States for these 
purposes.\47\
---------------------------------------------------------------------------
    \44\ See Treas. Reg. sec. 1.927(a)-1T(d)(4)(v).
    \45\ See Treas. Reg. sec. 1.927(a)-1T(d)(4)(vi).
    \46\ Id.
    \47\ Id.
---------------------------------------------------------------------------
            Foreign economic processes
    Under the bill, gross receipts from a transaction are 
foreign trading gross receipts eligible for exclusion from the 
tax base only if certain economic processes take place outside 
of the United States. The foreign economic processes 
requirement compares foreign direct costs to total direct 
costs. It is intended that the principles of the present-law 
regulations apply during the gap period for purposes of the 
foreign economic processes requirement including the 
measurement of direct costs. The Committee recognizes that the 
measurement of foreign direct costs under the present-law 
regulations often depend on activities conducted by the FSC, 
which is a separate entity. The Committee is aware that some of 
these concepts will have to be modified when new guidance is 
promulgated as a result of the bill's elimination of the 
requirement for a separate entity.

                             Effective Date

 In general

    The bill is effective for transactions entered into after 
September 30, 2000. In addition, no corporation may elect to be 
a FSC after September 30, 2000.
    The bill also provides a rule requiring the termination of 
a dormant FSC when the FSC has been inactive for a specified 
period of time. Under this rule, a FSC that generates no 
foreign trade income for any five consecutive years beginning 
after December 31, 2001, will cease to be treated as a FSC.

 Transition rules

    The bill provides a transition period for existing FSCs and 
for binding contractual agreements. The new rules do not apply 
to transactions in the ordinary course of business\48\ 
involving a FSC before January 1, 2002. Furthermore, the new 
rules do not apply to transactions in the ordinary course of 
business after December 31, 2001, if such transactions are 
pursuant to a binding contract between a FSC (or a person 
related to the FSC on September 30, 2000) and any other person 
(that is not a related person) and such contract is in effect 
on September 30, 2000, and all times thereafter. For this 
purpose, binding contracts include purchase options, renewal 
options, and replacement options that are enforceable against a 
lessor or seller (provided that the options are a part of a 
contract that is binding and in effect on September 30, 2000).
---------------------------------------------------------------------------
    \48\ The mere entering into of a single transaction, such as a 
lease, would not, in and of itself, prevent the transaction from being 
in the ordinary course of business.
---------------------------------------------------------------------------
    Similar to the limitation on use of the gross receipts 
method under the bill's operative provisions, the bill provides 
a rule that limits the use of the gross receipts method for 
transactions after the effective date of the bill if that same 
property generated foreign trade income to a FSC using the 
gross receipts method. Under the rule, if any person used the 
gross receipts method under the FSC regime, neither that person 
nor any related person will have qualifying foreign trade 
income with respect to any other transaction involving the same 
item of property.
    Notwithstanding the transition period, FSCs (or related 
persons) may elect to have the rules of the bill apply in lieu 
of the rules applicable to FSCs. Thus, for transactions to 
which the transition rules apply, taxpayers may choose to apply 
either the FSC rules or the amendments made by this bill, but 
not both.

                       III. VOTES OF THE COMMITTEE

    In compliance with clause 3(b) of rule XIII of the Rules of 
the House of Representatives, the following statements are made 
concerning the votes of the Committee on Ways and Means in its 
consideration of the bill, H.R. 4986.

                        MOTION TO REPORT THE BILL

    The bill, H.R. 4986, was ordered favorably reported, with 
an amendment by a roll call vote of 34 yeas to 1 nay (with a 
quorum being present). The vote was as follows:

----------------------------------------------------------------------------------------------------------------
            Representatives                 Yea       Nay            Representatives             Yea       Nay
----------------------------------------------------------------------------------------------------------------
Mr. Archer.............................        X              Mr. Rangel....................        X
Mr. Crane..............................        X              Mr. Stark.....................                  X
Mr. Thomas.............................        X              Mr. Matsui....................        X
Mr. Shaw...............................        X             Mr. Coyne......................  ........
Mrs. Johnson...........................        X              Mr. Levin.....................        X
Mr. Houghton...........................        X              Mr. Cardin....................  ........
Mr. Herger.............................        X              Mr. McDermott.................        X
Mr. McCrery............................        X             Mr. Kleczka....................  ........
Mr. Camp...............................        X              Mr. Lewis (GA)................        X
Mr. Ramstad............................        X             Mr. Neal.......................        X
Mr. Nussle.............................        X              Mr. McNulty...................        X
Mr. Johnson............................        X              Mr. Jefferson.................        X
Ms. Dunn...............................        X              Mr. Tanner....................        X
Mr. Collins............................        X              Mr. Becerra...................        X
Mr. Portman............................        X              Mrs. Thurman..................        X
Mr. English............................        X              Mr. Doggett...................        X
Mr. Watkins............................        X
Mr. Hayworth...........................        X
Mr. Weller.............................        X
Mr. Hulshof............................        X
Mr. McInnis............................        X
Mr. Lewis (KY).........................        X
Mr. Foley..............................            ........
----------------------------------------------------------------------------------------------------------------

                     IV. BUDGET EFFECTS OF THE BILL


               A. Committee Estimate of Budgetary Effects

    In compliance with clause 3(d)(2) of rule XIII of the Rules 
of the House of Representatives, the following statement is 
made concerning the affects on the budget of the revenue 
provisions of the bill, H.R. 4986, as reported.
    The bill is estimated to have the following effects on 
budget receipts for fiscal years 2001-2005:

ESTIMATED REVENUE EFFECTS OF H.R. 4986, THE ``FSC REPEAL AND EXTRATERRITORIAL INCOME EXCLUSION ACT OF 2000,'' AS
                       REPORTED BY THE COMMITTEE ON WAYS AND MEANS, FISCAL YEARS 2001-2005
                                            [In millions of dollars]
----------------------------------------------------------------------------------------------------------------
           Provision                     Effective           2001     2002     2003     2004     2005    2001-5
----------------------------------------------------------------------------------------------------------------
 Extraterritorial Income         generally ta 9/30/00         -153     -315     -348     -384     -423    -1,623
 Exclusion; FSC Repeal.
----------------------------------------------------------------------------------------------------------------
Note: Details may not add to totals due to rounding.

Legend for ``Effective'' column: ta = transactions after.

    B. Statement Regarding New Budget Authority and Tax Expenditures


Budget authority

    In compliance with clause 3(c)(2) of rule XIII of the Rules 
of the House of Representatives, the Committee states that the 
bill involves no new or increased budget authority.

Tax expenditures

    In compliance with clause 2(c)(2) of rule XIII of the Rules 
of the House of Representatives, the Committee states that the 
revenue-reducing income tax provisions involve increased tax 
expenditures. (See amounts in table in Part IV.A., above.)

      C. Cost Estimate Prepared by the Congressional Budget Office

    In compliance with clause 3(c)(3) of rule XIII of the Rules 
of the House of Representatives, requiring a cost estimate 
prepared by the Congressional Budget Office (CBO), the 
following statement by CBO is provided.

                                     U.S. Congress,
                               Congressional Budget Office,
                                Washington, DC, September 13, 2000.
Hon. Bill Archer,
Chairman, Committee on Ways and Means,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 4986, the FSC 
Repeal and Extraterritorial Income Exclusion Act of 2000. This 
estimate reflects the impact of changes made to the bill after 
it was ordered reported on July 27, 2000.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contact is Erin 
Whitaker.
            Sincerely,
                                          Barry B. Anderson
                                    (For Dan L. Crippen, Director).
    Enclosure.

H.R. 4986--FSC Repeal and Extraterritorial Income Exclusion Act of 2000

    Summary: H.R. 4986 would repeal present-law foreign sales 
corporation (FSC) rules. Under current law, U.S. firms 
generally are subject to U.S. tax on their worldwide income, 
but they are allowed tax credits for a portion of the income 
taxes they pay to foreign governments on that income. Within 
that general framework, U.S. law permits the use of FSCs, 
through which a portion of domestic firms' export income is 
characterized as foreign source and is exempted from U.S. tax. 
Under the proposal, U.S. firms could elect to exclude certain 
qualifying foreign trade income from their taxable income, with 
qualifying foreign trade income defined to include a portion of 
income attributable to sales by U.S. taxpayers. To be eligible 
for the exclusion, firms would not be allowed tax credits for 
income taxes paid to foreign governments on the qualifying 
foreign trade income. Qualifying foreign trade income would be 
calculated by using one of several formulas. The remaining 
portion of income earned from sources abroad would be taxed in 
a similar manner as under current law.
    The Joint Committee on Taxation (JCT) estimates that the 
bill would reduce revenues by $153 million in 2001, by about 
$1.6 billion over the 2001-2005 period, and by about $4.5 
billion over the 2001-2010 period. Because the bill would 
affect receipts, pay-as-you-go procedures would apply.
    H.R. 4986 contains no intergovernmental or private-sector 
mandates as defined in the Unfunded Mandates Reform Act (UMRA) 
and would not affect the budgets of state, local, or tribal 
governments.
    Estimated cost to the Federal Government: The estimated 
budgetary impact of H.R. 4986 is shown in the following table. 
Estimates of all provisions in H.R. 4986 were provided by JCT.

----------------------------------------------------------------------------------------------------------------
                                                                  By fiscal year, in millions of dollars--
                                                           -----------------------------------------------------
                                                              2000     2001     2002     2003     2004     2005
----------------------------------------------------------------------------------------------------------------
                                               CHANGES IN REVENUES
Estimated revenues........................................        0     -153     -315     -348     -384     -423
----------------------------------------------------------------------------------------------------------------
Source: Joint Committee on Taxation

    Pay-as-you-go considerations: The Balanced Budget and 
Emergency Deficit Control Act sets up pay-as-you-go procedures 
for legislation affecting direct spending or receipts. The net 
changes in governmental receipts that are subject to pay-as-
you-go procedures are shown in the following table. For the 
purposes of enforcing pay-as-you-go procedures, only the 
effects in the current year, the budget year, and the 
succeeding four years are counted.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                     By fiscal year, in millions of dollars--
                                                        ------------------------------------------------------------------------------------------------
                                                          2000    2001     2002     2003     2004     2005     2006     2007     2008     2009     2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
Changes in receipts....................................      0     -153     -315     -348     -384     -423     -466     -514     -566     -623     -687
Changes in outlays.....................................                                           Not applicable
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Intergovernmental and private-sector impact: H.R. 4986 
contains no intergovernmental or private-sector mandates as 
defined in UMRA and would not affect the budgets of state, 
local, or tribal governments.
    Previous CBO estimate: On September 8, 2000, CBO 
transmitted a cost estimate for H.R. 4986 as ordered report by 
the House Committee on Ways and Means on July 27, 2000. This 
estimate supercedes that previous estimate, and it reflects 
several changes to the bill that were made after it was ordered 
reported. These changes would further reduce revenues, relative 
to the earlier version of H.R. 4986, by $15 million in 2001, 
$124 million over the 2001-2005 period, and $293 million over 
the 2001-2010 period.
    Estimate prepared by: Erin Whitaker.
    Estimate approved by: G. Thomas Woodward, Assistant 
Director for Tax Analysis.

     V. OTHER MATTERS TO BE DISCUSSED UNDER THE RULES OF THE HOUSE


          A. Committee Oversight Findings and Recommendations

    With respect to clause 3(c)(1) of rule XIII of the Rules of 
the House of Representatives (relating to oversight findings), 
the Committee advises that it was a result of the Committee's 
oversight review of the application of the Federal tax rules 
relating to FSCs in light of the WTO rulings that the Committee 
concluded that it is appropirate and timely to enact the 
revenue provisions included in the bill as reported.

    B. Summary of Findings and Recommendations of the Committee on 
                           Government Reform

    With respect to clause 3(c)(4) of rule XII of the Rules of 
the House of Representatives, the Committee advises that no 
oversight findings or recommendations have been submitted to 
this Committee by the Committee on Government Reform with 
respect to the provisions contained in the bill.

                 C. Constitutional Authority Statement

    With respect to clause 3(d)(1) of rule XIII of the Rules of 
the House of Representatives (relating to Constitutional 
Authority), the Committee states that the Committee's action in 
reporting this bill is derived from Article I of the 
Constitution, Section 8 (``The Congress shall have Power To lay 
and collect Taxes, Duties, Imposts and Excises * * *''), and 
from the 16th Amendment to the Constitution.

              D. Information Relating to Unfunded Mandates

    This information is provided in accordance with section 423 
of the Unfunded Mandates Act of 1995 (P.L. 104-4).
    The Committee has determined that the bill does not impose 
a Federal private sector mandate or a Federal intergovernmental 
mandate on State, local, and tribal governments.

                 E. Applicability of House Rule XXI5(b)

    Rule XXI5(b) of the Rules of the House of Representatives 
provides, in part, that ``No bill or joint resolution, 
amendment, or conference report carrying a Federal income tax 
rate increase shall be considered as passed or agreed to unless 
determined by a vote of not less than three-fifths of the 
Members.'' The Committee has carefully reviewed the provisions 
of the bill, and states that the provisions of the bill do not 
involve any Federal income tax rate increase within the meaning 
of the rule.

                       F. Tax Complexity Analysis

    Section 4022(b) of the Internal Revenue Service Reform and 
Restructuring Act of 1998 (the ``IRS Reform Act'') requires the 
Joint Committee on Taxation (in consultation with the Internal 
Revenue Service and the Department of the Treasury) to provide 
a tax complexity analysis. The complexity analysis is required 
for all legislation reported by the House Committee on Ways and 
Means, the Senate Committee on Finance, or any committee of 
conference if the legislation includes a provision that 
directly or indirectly amends the Code and has ``widespread 
applicability'' to individuals or small businesses.
    The staff of the Joint Committee on Taxation has determined 
that a complexity analysis is not required under section 
4022(b) of the IRS Reform Act because the bill contains no 
provisions that amend the Code and that have widespread 
applicability to individuals or small businesses.

       VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED

  In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (existing law 
proposed to be omitted is enclosed in black brackets, new 
matter is printed in italic, existing law in which no change is 
proposed is shown in roman):

                     INTERNAL REVENUE CODE OF 1986

           *       *       *       *       *       *       *



                       Subtitle A--Income Taxes

           *       *       *       *       *       *       *


                 CHAPTER 1--NORMAL TAXES AND SURTAXES

           *       *       *       *       *       *       *


              Subchapter A--Determination of Tax Liability

           *       *       *       *       *       *       *


                   PART VI--ALTERNATIVE MINIMUM TAX

           *       *       *       *       *       *       *


SEC. 56. ADJUSTMENTS IN COMPUTING ALTERNATIVE MINIMUM TAXABLE INCOME.

  (a) * * *

           *       *       *       *       *       *       *

  (g) Adjustments Based on Adjusted Current Earnings.--
          (1) * * *

           *       *       *       *       *       *       *

          (4) Adjustments.--In determining adjusted current 
        earnings, the following adjustments shall apply:
                  (A) * * *
                  (B) Inclusion of items included for purposes 
                of computing earnings and profits.--
                          (i) In general.--In the case of any 
                        amount which is excluded from gross 
                        income for purposes of computing 
                        alternative minimum taxable income but 
                        is taken into account in determining 
                        the amount of earnings and profits--
                                  (I) * * *

           *       *       *       *       *       *       *

                The preceding sentence shall not apply in the 
                case of any amount excluded from gross income 
                under section 108 (or the corresponding 
                provisions of prior law) or under section 114. 
                In the case of any insurance company taxable 
                under section 831(b), this clause shall not 
                apply to any amount not described in section 
                834(b).

           *       *       *       *       *       *       *


              Subchapter B--Computation of Taxable Income

           *       *       *       *       *       *       *


        PART III--ITEMS SPECIFICALLY EXCLUDED FROM GROSS INCOME

           *       *       *       *       *       *       *


        Sec. 101. Certain death benefits.
     * * * * * * *
        Sec. 114. Extraterritorial income.

           *       *       *       *       *       *       *


SEC. 114. EXTRATERRITORIAL INCOME.

  (a) Exclusion.--Gross income does not include 
extraterritorial income.
  (b) Exception.--Subsection (a) shall not apply to 
extraterritorial income which is not qualifying foreign trade 
income as determined under subpart E of part III of subchapter 
N.
  (c) Disallowance of Deductions.--
          (1) In general.--Any deduction of a taxpayer 
        allocated under paragraph (2) to extraterritorial 
        income of the taxpayer excluded from gross income under 
        subsection (a) shall not be allowed.
          (2) Allocation.--Any deduction of the taxpayer 
        properly apportioned and allocated to the 
        extraterritorial income derived by the taxpayer from 
        any transaction shall be allocated on a proportionate 
        basis between--
                  (A) the extraterritorial income derived from 
                such transaction which is excluded from gross 
                income under subsection (a), and
                  (B) the extraterritorial income derived from 
                such transaction which is not so excluded.
  (d) Denial of Credits for Certain Foreign Taxes.--
Notwithstanding any other provision of this chapter, no credit 
shall be allowed under this chapter for any income, war 
profits, and excess profits taxes paid or accrued to any 
foreign country or possession of the United States with respect 
to extraterritorial income which is excluded from gross income 
under subsection (a).
  (e) Extraterritorial Income.--For purposes of this section, 
the term ``extraterritorial income'' means the gross income of 
the taxpayer attributable to foreign trading gross receipts (as 
defined in section 942) of the taxpayer.

           *       *       *       *       *       *       *


             PART VIII--SPECIAL DEDUCTIONS FOR CORPORATIONS

           *       *       *       *       *       *       *


SEC. 245. DIVIDENDS RECEIVED FROM CERTAIN FOREIGN CORPORATIONS.

  (a) * * *

           *       *       *       *       *       *       *

  (d) Certain Dividends Allocable to Qualifying Foreign Trade 
Income.--In the case of a domestic corporation which is a 
United States shareholder (as defined in section 951(b)) of a 
controlled foreign corporation (as defined in section 957), 
there shall be allowed as a deduction an amount equal to 100 
percent of any dividend received from such controlled foreign 
corporation which is distributed out of earnings and profits 
attributable to qualifying foreign trade income (as defined in 
section 941(a)).

           *       *       *       *       *       *       *


                     PART IX--ITEMS NOT DEDUCTIBLE

           *       *       *       *       *       *       *


SEC. 275. CERTAIN TAXES.

  (a) General Rule.--No deduction shall be allowed for the 
following taxes:
          (1) * * *

           *       *       *       *       *       *       *

          (4) Income, war profits, and excess profits taxes 
        imposed by the authority of any foreign country or 
        possession of the United States if--
                  (A) the taxpayer chooses to take to any 
                extent the benefits of section 901, [or]
                  (B) such taxes are paid or accrued with 
                respect to foreign trade income (within the 
                meaning of section 923(b)) of a FSC[.], or
                  (C) such taxes are paid or accrued with 
                respect to qualifying foreign trade income (as 
                defined in section 941).
        A rule similar to the rule of section 943(d) shall 
        apply for purposes of paragraph (4)(C).

           *       *       *       *       *       *       *


 Subchapter N--Tax Based on Income From Sources Within or Without the 
United States

           *       *       *       *       *       *       *


PART I--SOURCE RULES AND OTHER GENERAL RULES RELATING TO FOREIGN INCOME

           *       *       *       *       *       *       *


SEC. 864. DEFINITIONS AND SPECIAL RULES.

  (a) * * *

           *       *       *       *       *       *       *

  (e) Rules for Allocating Interest, Etc.--For purposes of this 
subchapter--
          (1) * * *

           *       *       *       *       *       *       *

          (3) Tax-exempt assets not taken into account.--[For 
        purposes of]
                  (A) In general.--For purposes of allocating 
                and apportioning any deductible expense, any 
                tax-exempt asset (and any income from such an 
                asset) shall not be taken into account. A 
                similar rule shall apply in the case of the 
                portion of any dividend (other than a 
                qualifying dividend as defined in section 
                243(b)) equal to the deduction allowable under 
                section 243 or 245(a) with respect to such 
                dividend and in the case of a like portion of 
                any stock the dividends on which would be so 
                deductible and would not be qualifying 
                dividends (as so defined).
                  (B) Assets producing exempt extraterritorial 
                income.--For purposes of allocating and 
                apportioning any interest expense, there shall 
                not be taken into account any qualifying 
                foreign trade property (as defined in section 
                943(a)) which is held by the taxpayer for lease 
                or rental in the ordinary course of trade or 
                business for use by the lessee outside the 
                United States (as defined in section 
                943(b)(2)).

           *       *       *       *       *       *       *


        PART III--INCOME FROM SOURCES WITHOUT THE UNITED STATES

        Subpart A. Foreign tax credit.
     * * * * * * *
        [Subpart C. Taxation of foreign sales corporation.]
     * * * * * * *
        Subpart E. Qualifying foreign trade income.

           *       *       *       *       *       *       *


                     Subpart A--Foreign Tax Credit

           *       *       *       *       *       *       *


SEC. 903. CREDIT FOR TAXES IN LIEU OF INCOME, ETC., TAXES.

  For purposes of this part and of sections [164(a)] 114, 
164(a), and 275(a), the term ``income, war profits, and excess 
profits taxes'' shall include a tax paid in lieu of a tax on 
income, war profits, or excess profits otherwise generally 
imposed by any foreign country or by any possession of the 
United States.

           *       *       *       *       *       *       *


          [Subpart C--Taxation of Foreign Sales Corportations

        [Sec. 921. Exempt foreign trade income excluded from gross 
                  income.
        [Sec. 922. FSC defined.
        [Sec. 923. Exempt foreign trade income.
        [Sec. 924. Foreign trading gross receipts.
        [Sec. 925. Transfer pricing rules.
        [Sec. 926. Distributions to shareholders.
        [Sec. 927. Other definitions and special rules.

[SEC. 921. EXEMPT FOREIGN TRADE INCOME EXCLUDED FROM GROSS INCOME.

  [(a) Exclusion.--Exempt foreign trade income of a FSC shall 
be treated as foreign source income which is not effectively 
connected with the conduct of a trade or business within the 
United States.
  [(b) Proportionate Allocation of Deductions to Exempt Foreign 
Trade Income.--Any deductions of the FSC properly apportioned 
and allocated to the foreign trade income derived by a FSC from 
any transaction shall be allocated between--
          [(1) the exempt foreign trade income derived from 
        such transaction, and
          [(2) the foreign trade income (other than exempt 
        foreign trade income) derived from such transaction, on 
        a proportionate basis.
  [(c) Denial of Credits.--Notwithstanding any other provision 
of this chapter, no credit (other than a credit allowable under 
section 27(a), 33, or 34) shall be allowed under this chapter 
to any FSC.
  [(d) Foreign Trade Income, Investment Income, and Carrying 
Charges Treated as Effectively Connected with United States 
Business.--For purposes of this chapter--
          [(1) all foreign trade income of a FSC other than--
                  [(A) exempt foreign trade income, and
                  [(B) section 923(a)(2) non-exempt income,
          [(2) all interest, dividends, royalties, and other 
        investment income received or accrued by a FSC, and
          [(3) all carrying charges received or accrued by a 
        FSC,
shall be treated as income effectively connected with a trade 
or business conducted through a permanent establishment of such 
corporation within the United States. Income described in 
paragraph (1) shall be treated as derived from sources within 
the United States.

[SEC. 922. FSC DEFINED.

  [(a) FSC defined.--For purposes of this title, the term 
``FSC'' means any corporation--
          [(1) which--
                  [(A) was created or organized--
                          [(i) under the laws of any foreign 
                        country which meets the requirements of 
                        section 927(e)(3), or
                          [(ii) under the laws applicable to 
                        any possession of the United States,
                  [(B) has no more than 25 shareholders at any 
                time during the taxable year,
                  [(C) does not have any preferred stock 
                outstanding at any time during the taxable 
                year,
                  [(D) during the taxable year--
                          [(i) maintains an office located 
                        outside the United States in a foreign 
                        country which meets the requirements of 
                        section 927(e)(3) or in any possession 
                        of the United States,
                          [(ii) maintains a set of the 
                        permanent books of account (including 
                        invoices) of such corporation at such 
                        office, and
                          [(iii) maintains at a location within 
                        the United States the records which 
                        such corporation is required to keep 
                        under section 6001,
                  [(E) at all times during the taxable year, 
                has a board of directors which includes at 
                least one individual who is not a resident of 
                the United States, and
                  [(F) is not a member, at any time during the 
                taxable year, of any controlled group of 
                corporations of which a DISC is a member, and
          [(2) which has made an election (at the time and in 
        the manner provided in section 927(f)(1)) which is in 
        effect for the taxable year to be treated as a FSC.
  [(b) Small FSC Defined.--For purposes of this title, a FSC is 
a small FSC with respect to any taxable year if--
          [(1) such corporation has made an election (at the 
        time and in the manner provided in section 927(f)(1)) 
        which is in effect for the taxable year to be treated 
        as a small FSC, and
          [(2) such corporation is not a member, at any time 
        during the taxable year, of a controlled group of 
        corporations which includes a FSC unless such other FSC 
        has also made an election under paragraph (1) which is 
        in effect for such year.

[SEC. 923. EXEMPT FOREIGN TRADE INCOME.

  [(a) Exempt Foreign Trade income.--For purposes of this 
subpart--
          [(1) In general.--The term ``exempt foreign trade 
        income'' means the aggregate amount of all foreign 
        trade income of a FSC for the taxable year which is 
        described in paragraph (2) or (3).
          [(2) Income determined without regard to 
        administrative pricing rules.--In the case of any 
        transaction to which paragraph (3) does not apply, 32 
        percent of the foreign trade income derived from such 
        transaction shall be treated as described in this 
        paragraph. For purposes of the preceding sentence, 
        foreign trade income shall not include any income 
        properly allocable to excluded property described in 
        subparagraph (B) of section 927(a)(2) (relating to 
        intangibles).
          [(3) Income determined with regard to administrative 
        pricing rules.--In the case of any transaction with 
        respect to which paragraph (1) or (2) of section 925(a) 
        (or the corresponding provisions of the regulations 
        prescribed under section 925(b)) applies, \16/23\ of 
        the foreign trade income derived from such transaction 
        shall be treated as described in this paragraph.
          [(4) Special rule for foreign trade income allocable 
        to a cooperative.--
                  [(A) In general.--In any case in which a 
                qualified cooperative is a shareholder of a 
                FSC, paragraph (3) shall be applied with 
                respect to that portion of the foreign trade 
                income of such FSC for any taxable year which 
                is properly allocable to the marketing of 
                agricultural or horticultural products (or the 
                providing of related services) by such 
                cooperative by substituting ``100 percent'' for 
                ``16/23''.
                  [(B) Paragraph only to apply to amounts FSC 
                distributes.--Subparagraph (A) shall not apply 
                for any taxable year unless the FSC distributes 
                to the qualified cooperative the amount which 
                (but for such subparagraph) would not be 
                treated as exempt foreign trade income. Any 
                distribution under this subparagraph for any 
                taxable year--
                          [(i) shall be made before the due 
                        date for filing the return of tax for 
                        such taxable year, but
                          [(ii) shall be treated as made on the 
                        last day of such taxable year.
          [(5) Special rule for military property.--Under 
        regulations prescribed by the Secretary, that portion 
        of the foreign trading gross receipts of the FSC for 
        the taxable year attributable to the disposition of, or 
        services relating to, military property (within the 
        meaning of section 995(b)(3)(B)) which may be treated 
        as exempt foreign trade income shall equal 50 percent 
        of the amount which (but for this paragraph) would be 
        treated as exempt foreign trade income.
          [(6) Cross reference.--

          [For reduction in amount of exempt foreign trade income, see 
        section 291(a)(4).

  [(b) Foreign Trade Income Defined.--For purposes of this 
subpart, the term ``foreign trade income'' means the gross 
income of a FSC attributable to foreign trading gross receipts.

[SEC. 924. FOREIGN TRADING GROSS RECEIPTS.

  [(a) In General.--Except as otherwise provided in this 
section, for purposes of this subpart, the term ``foreign 
trading gross receipts'' means the gross receipts of any FSC 
which are--
          [(1) from the sale, exchange, or other disposition of 
        export property,
          [(2) from the lease or rental of export property for 
        use by the lessee outside the United States,
          [(3) for services which are related and subsidiary 
        to--
                  [(A) any sale, exchange, or other disposition 
                of export property by such corporation, or
                  [(B) any lease or rental of export property 
                described in paragraph (2) by such corporation,
          [(4) for engineering or architectural services for 
        construction projects located (or proposed for 
        location) outside the United States, or
          [(5) for the performance of managerial services for 
        an unrelated FSC or DISC in furtherance of the 
        production of foreign trading gross receipts described 
        in paragraph (1), (2), or (3).
Paragraph (5) shall not apply to a FSC for any taxable year 
unless at least 50 percent of its gross receipts for such 
taxable year is derived from activities described in paragraph 
(1), (2), or (3).
  [(b) Foreign Management and Foreign Economic Process 
Requirements.--
          [(1) In general.--Except as provided in paragraph 
        (2)--
                  [(A) a FSC shall be treated as having foreign 
                trading gross receipts for the taxable year 
                only if the management of such corporation 
                during such taxable year takes place outside 
                the United States as required by subsection 
                (c), and
                  [(B) a FSC has foreign trading gross receipts 
                from any transaction only if economic processes 
                with respect to such transaction take place 
                outside the United States as required by 
                subsection (d).
          [(2) Exception for small fsc.--
                  [(A) In general.--Paragraph (1) shall not 
                apply with respect to any small FSC.
                  [(B) Limitation on amount of foreign trading 
                gross receipts of small FSC taken into 
                account.--
                          [(i) In general.--Any foreign trading 
                        gross receipts of a small FSC for the 
                        taxable year which exceed $5,000,000 
                        shall not be taken into account in 
                        determining the exempt foreign trade 
                        income of such corporation and shall 
                        not be taken into account under any 
                        other provision of this subpart.
                          [(ii) Allocation of limitation.--If 
                        the foreign trading gross receipts of a 
                        small FSC exceed the limitation of 
                        clause (i), the corporation may 
                        allocate such limitation among such 
                        gross receipts in such manner as it may 
                        select (at such time and in such manner 
                        as may be prescribed in regulations).
                          [(iii) Receipts of controlled group 
                        aggregated.--For purposes of applying 
                        clauses (i) and (ii), all small FSC's 
                        which are members of the same 
                        controlled group of corporations shall 
                        be treated as a single corporation.
                          [(iv) Allocation of limitation among 
                        members of controlled group.--The 
                        limitation under clause (i) shall be 
                        allocated among the foreign trading 
                        gross receipts of small FSC's which are 
                        members of the same controlled group of 
                        corporations in a manner provided in 
                        regulations prescribed by the 
                        Secretary.
  [(c) Requirement That FSC be Managed Outside the United 
States.--The management of a FSC meets the requirements of this 
subsection for the taxable year if--
          [(1) all meetings of the board of directors of the 
        corporation, and all meetings of the shareholders of 
        the corporation, are outside the United States,
          [(2) the principal bank account of the corporation is 
        maintained in a foreign country which meets the 
        requirements of section 927(e)(3) or in a possession of 
        the United States at all times during the taxable year, 
        and
          [(3) all dividends, legal and accounting fees, and 
        salaries of officers and members of the board of 
        directors of the corporation disbursed during the 
        taxable year are disbursed out of bank accounts of the 
        corporation maintained outside the United States.
  [(d) Requirement That Economic Processes Take Place Outside 
the United States.--
          [(1) In general.--The requirements of this subsection 
        are met with respect to the gross receipts of a FSC 
        derived from any transaction if--
                  [(A) such corporation (or any person acting 
                under a contract with such corporation) has 
                participated outside the United States in the 
                solicitation (other than advertising), the 
                negotiation, or the making of the contract 
                relating to such transaction, and
                  [(B) the foreign direct costs incurred by the 
                FSC attributable to the transaction equal or 
                exceed 50 percent of the total direct costs 
                attributable to the transaction.
          [(2) Alternative 85-percent test.--A corporation 
        shall be treated as satisfying the requirements of 
        paragraph (1)(B) with respect to any transaction if, 
        with respect to each of at least 2 paragraphs of 
        subsection (e), the foreign direct costs incurred by 
        such corporation attributable to activities described 
        in such paragraph equal or exceed 85 percent of the 
        total direct costs attributable to activities described 
        in such paragraph.
          [(3) Definitions.--For purposes of this subsection--
                  [(A) Total direct costs.--The term ``total 
                direct costs'' means, with respect to any 
                transaction, the total direct costs incurred by 
                the FSC attributable to activities described in 
                subsection (e) performed at any location by the 
                FSC or any person acting under a contract with 
                such FSC.
                  [(B) Foreign direct costs.--The term 
                ``foreign direct costs'' means, with respect to 
                any transaction, the portion of the total 
                direct costs which are attributable to 
                activities performed outside the United States.
          [(4) Rules for commissions, etc.--The Secretary shall 
        prescribe such regulations as may be necessary to carry 
        out the purposes of this subsection and subsection (e) 
        in the case of commissions, rentals, and furnishing of 
        services.
  [(e) Activities Relating to Disposition of Export Property.--
The activities referred to in subsection (d) are--
          [(1) advertising and sales promotion,
          [(2) the processing of customer orders and the 
        arranging for delivery of the export property,
          [(3) transportation from the time of acquisition by 
        the FSC (or, in the case of a commission relationship, 
        from the beginning of such relationship for such 
        transaction) to the delivery to the customer,
          [(4) the determination and transmittal of a final 
        invoice or statement of account and the receipt of 
        payment, and
          [(5) the assumption of credit risk.
  [(f) Certain Receipts not Included in Foreign Trading Gross 
Receipts.--
          [(1) Certain receipts excluded on basis of use; 
        subsidized receipts and receipts from related parties 
        excluded.--The term ``foreign trading gross receipts'' 
        shall not include receipts of a FSC from a transaction 
        if--
                  [(A) the export property or services--
                          [(i) are for ultimate use in the 
                        United States, or
                          [(ii) are for use by the United 
                        States or any instrumentality thereof 
                        and such use of export property or 
                        services is required by law or 
                        regulation,
                  [(B) such transaction is accomplished by a 
                subsidy granted by the United States or any 
                instrumentality thereof, or
                  [(C) such receipts are from another FSC which 
                is a member of the same controlled group of 
                corporations of which such corporation is a 
                member.
        In the case of gross receipts of a FSC from a 
        transaction involving any property, subparagraph (C) 
        shall not apply if such FSC (and all other FSC's which 
        are members of the same controlled group and which 
        receive gross receipts from a transaction involving 
        such property) do not use the pricing rules under 
        paragraph (1) of section 925(a) (or the corresponding 
        provisions of the regulations prescribed under section 
        925(b)) with respect to any transaction involving such 
        property.
          [(2) Investment income; carrying charges.--The term 
        ``foreign trading gross receipts'' shall not include 
        any investment income or carrying charges.

[SEC. 925. TRANSFER PRICING RULES.

  [(a) In General.--In the case of a sale of export property to 
a FSC by a person described in section 482, the taxable income 
of such FSC and such person shall be based upon a transfer 
price which would allow such FSC to derive taxable income 
attributable to such sale (regardless of the sales price 
actually charged) in an amount which does not exceed the 
greatest of--
          [(1) 1.83 percent of the foreign trading gross 
        receipts derived from the sale of such property by such 
        FSC,
          [(2) 23 percent of the combined taxable income of 
        such FSC and such person which is attributable to the 
        foreign trading gross receipts derived from the sale of 
        such property by such FSC, or
          [(3) taxable income based upon the sale price 
        actually charged (but subject to the rules provided in 
        section 482).
Paragraphs (1) and (2) shall apply only if the FSC meets the 
requirements of subsection (c) with respect to the sale.
  [(b) Rules for Commissions, Rentals, and Marginal Costing.--
The Secretary shall prescribe regulations setting forth--
          [(1) rules which are consistent with the rules set 
        forth in subsection (a) for the application of this 
        section in the case of commissions, rentals, and other 
        income, and
          [(2) rules for the allocation of expenditures in 
        computing combined taxable income under subsection 
        (a)(2) in those cases where a FSC is seeking to 
        establish or maintain a market for export property.
  [(c) Requirements for Use of Administrative Pricing Rules.--A 
sale by a FSC meets the requirements of this subsection if--
          [(1) all of the activities described in section 
        924(e) attributable to such sale, and
          [(2) all of the activities relating to the 
        solicitation (other than advertising), negotiation, and 
        making of the contract for such sale, have been 
        performed by such FSC (or by another person acting 
        under a contract with such FSC).
  [(d) Limitation on Gross Receipts Pricing Rule.--The amount 
determined under subsection (a)(1) with respect to any 
transaction shall not exceed 2 times the amount which would be 
determined under subsection (a)(2) with respect to such 
transaction.
  [(e) Taxable Income.--For purposes of this section, the 
taxable income of a FSC shall be determined without regard to 
section 921.
  [(f) Special Rule for Cooperatives.--In any case in which a 
qualified cooperative sells export property to a FSC, in 
computing the combined taxable income of such FSC and such 
organization for purposes of subsection (a)(2), there shall not 
be taken into account any deduction allowable under subsection 
(b) or (c) of section 1382 (relating to patronage dividends, 
per-unit retain allocations, and nonpatronage distributions).

[SEC. 926. DISTRIBUTIONS TO SHAREHOLDERS.

  [(a) Distributions Made First Out of Foreign Trade Income.--
For purposes of this title, any distribution to a shareholder 
of a FSC by such FSC which is made out of earnings and profits 
shall be treated as made--
          [(1) first, out of earnings and profits attributable 
        to foreign trade income, to the extent thereof, and
          [(2) then, out of any other earnings and profits.
  [(b) Distributions by FSC to Nonresident Aliens and Foreign 
Corporations Treated as United States Connected.--For purposes 
of this title, any distribution by a FSC which is made out of 
earnings and profits attributable to foreign trade income to 
any shareholder of such corporation which is a foreign 
corporation or a nonresident alien individual shall be treated 
as a distribution--
          [(1) which is effectively connected with the conduct 
        of a trade or business conducted through a permanent 
        establishment of such shareholder within the United 
        States, and
          [(2) of income which is derived from sources within 
        the United States.
  [(c) FSC Includes Former FSC.--For purposes of this section, 
the term ``FSC'' includes a former FSC.

[SEC. 927. OTHER DEFINITIONS AND SPECIAL RULES.

  [(a) Export Property.--For purposes of this subpart--
          [(1) In general.--The term ``export property'' means 
        property--
                  [(A) manufactured, produced, grown, or 
                extracted in the United States by a person 
                other than a FSC,
                  [(B) held primarily for sale, lease, or 
                rental, in the ordinary course of trade or 
                business, by, or to, a FSC, for direct use, 
                consumption, or disposition outside the United 
                States, and
                  [(C) not more than 50 percent of the fair 
                market value of which is attributable to 
                articles imported into the United States.
        For purposes of subparagraph (C), the fair market value 
        of any article imported into the United States shall be 
        its appraised value, as determined by the Secretary 
        under section 402 of the Tariff Act of 1930 (19 U.S.C. 
        1401a) in connection with its importation.
          [(2) Excluded property.--The term ``export property'' 
        shall not include--
                  [(A) property leased or rented by a FSC for 
                use by any member of a controlled group of 
                corporations of which such FSC is a member,
                  [(B) patents, inventions, models, designs, 
                formulas, or processes whether or not patented, 
                copyrights (other than films, tapes, records, 
                or similar reproductions, and other than 
                computer software (whether or not patented), 
                for commercial or home use), good will, 
                trademarks, trade brands, franchises, or other 
                like property,
                  [(C) oil or gas (or any primary product 
                thereof),
                  [(D) products the export of which is 
                prohibited or curtailed to effectuate the 
                policy set forth in paragraph (2)(C) of section 
                3 of the Export Administration Act of 1979 
                (relating to the protection of the domestic 
                economy), or
                  [(E) any unprocessed timber which is a 
                softwood.
        For purposes of subparagraph (E), the term 
        ``unprocessed timber'' means any log, cant, or similar 
        form of timber.
          [(3) Property in short supply.--If the President 
        determines that the supply of any property described in 
        paragraph (1) is insufficient to meet the requirements 
        of the domestic economy, he may by Executive order 
        designate the property as in short supply. Any property 
        so designated shall not be treated as export property 
        during the period beginning with the date specified in 
        the Executive order and ending with the date specified 
        in an Executive order setting forth the President's 
        determination that the property is no longer in short 
        supply.
          [(4) Qualified cooperative.--The term ``qualified 
        cooperative'' means any organization to which part I of 
        subchapter T applies which is engaged in the marketing 
        of agricultural or horticultural products.
  [(b) Gross Receipts.--
          [(1) In general.--For purposes of this subpart, the 
        term ``gross receipts'' means--
                  [(A) the total receipts from the sale, lease, 
                or rental of property held primarily for sale, 
                lease, or rental in the ordinary course of 
                trade or business, and
                  [(B) gross income from all other sources.
          [(2) Gross receipts taken into account in case of 
        commissions.--In the case of commissions on the sale, 
        lease, or rental of property, the amount taken into 
        account for purposes of this subpart as gross receipts 
        shall be the gross receipts on the sale, lease, or 
        rental of the property on which such commissions arose.
  [(c) Investment Income.--For purposes of this subpart, the 
term ``investment income'' means--
          [(1) dividends,
          [(2) interest,
          [(3) royalties,
          [(4) annuities,
          [(5) rents (other than rents from the lease or rental 
        of export property for use by the lessee outside of the 
        United States),
          [(6) gains from the sale or exchange of stock or 
        securities,
          [(7) gains from futures transactions in any commodity 
        on, or subject to the rules of, a board of trade or 
        commodity exchange (other than gains which arise out of 
        a bona fide hedging transaction reasonably necessary to 
        conduct the business of the FSC in the manner in which 
        such business is customarily conducted by others),
          [(8) amounts includible in computing the taxable 
        income of the corporation under part I of subchapter J, 
        and
          [(9) gains from the sale or other disposition of any 
        interest in an estate or trust.
  [(d) Other Definitions.--For purposes of this subpart--
          [(1) Carrying charges.--The term ``carrying charges'' 
        means--
                  [(A) carrying charges, and
                  [(B) under regulations prescribed by the 
                Secretary, any amount in excess of the price 
                for an immediate cash sale and any other 
                unstated interest.
          [(2) Transaction.--
                  [(A) In general.--The term ``transaction'' 
                means--
                          [(i) any sale, exchange, or other 
                        disposition,
                          [(ii) any lease or rental, and
                          [(iii) any furnishing of services.
                  [(B) Grouping of transactions.--To the extent 
                provided in regulations, any provision of this 
                subpart which, but for this subparagraph, would 
                be applied on a transaction-by-transaction 
                basis may be applied by the taxpayer on the 
                basis of groups of transactions based on 
                product lines or recognized industry or trade 
                usage. Such regulations may permit different 
                groupings for different purposes.
          [(3) United states defined.--The term ``United 
        States'' includes the Commonwealth of Puerto Rico.
          [(4) Controlled group of corporations.--The term 
        ``controlled group of corporations'' has the meaning 
        given to such term by section 1563(a), except that--
                  [(A) ``more than 50 percent'' shall be 
                substituted for ``at least 80 percent'' each 
                place it appears therein, and
                  [(B) section 1563(b) shall not apply.
          [(5) Possessions.--The term ``possession of the 
        United States'' means Guam, American Samoa, the 
        Commonwealth of the Northern Mariana Islands, and the 
        Virgin Islands of the United States.
          [(6) Section 923(a)(2) non-exempt income.--The term 
        ``section 923(a)(2) non-exempt income'' means any 
        foreign trade income from a transaction with respect to 
        which paragraph (1) or (2) of section 925(a) does not 
        apply and which is not exempt foreign trade income. 
        Such term shall not include any income which is 
        effectively connected with the conduct of a trade or 
        business within the United States (determined without 
        regard to this subpart).
  [(e) Special Rules.--
          [(1) Source rules for related persons.--Under 
        regulations, the income of a person described in 
        section 482 from a transaction giving rise to foreign 
        trading gross receipts of a FSC which is treated as 
        from sources outside the United States shall not exceed 
        the amount which would be treated as foreign source 
        income earned by such person if the pricing rule under 
        section 994 which corresponds to the rule used under 
        section 925 with respect to such transaction applied to 
        such transaction.
          [(2) Participation in international boycotts, etc.--
        Under regulations prescribed by the Secretary, the 
        exempt foreign trade income of a FSC for any taxable 
        year shall be limited under rules similar to the rules 
        of clauses (ii) and (iii) of section 995(b)(1)(F).
          [(3) Exchange of information requirements.--For 
        purposes of this title, the term ``FSC'' shall not 
        include any corporation which was created or organized 
        under the laws of any foreign country unless there is 
        in effect between such country and the United States--
                  [(A) a bilateral or multilateral agreement 
                described in section 274(h)(6)(C) (determined 
                by treating any reference to a beneficiary 
                country as being a reference to any foreign 
                country and by applying such section without 
                regard to clause (ii) thereof), or
                  [(B) an income tax treaty which contains an 
                exchange of information program--
                          [(i) which the Secretary certifies 
                        (and has not revoked such 
                        certification) is satisfactory in 
                        practice for purposes of this title, 
                        and
                          [(ii) to which the FSC is subject.
          [(4) Disallowance of treaty benefits.--Any 
        corporation electing to be treated as a FSC under 
        subsection (f)(1) may not claim any benefits under any 
        income tax treaty between the United States and any 
        foreign country.
          [(5) Coordination with possessions taxation.--
                  [(A) Exemption.--No tax shall be imposed by 
                any possession of the United States on any 
                foreign trade income derived before January 1, 
                1987. The preceding sentence shall not apply to 
                any income attributable to the sale of property 
                or the performance of services for ultimate 
                use, consumption, or disposition within the 
                possession.
                  [(B) Clarification that possession may exempt 
                certain income from tax.--Nothing in any 
                provision of law shall be construed as 
                prohibiting any possession of the United States 
                from exempting from tax any foreign trade 
                income of a FSC or any other income of a FSC 
                described in paragraph (2) or (3) of section 
                921(d).
                  [(C) No cover over of taxes imposed on fsc.--
                Nothing in any provision of law shall be 
                construed as requiring any tax imposed by this 
                title on a FSC to be covered over (or otherwise 
                transferred) to any possession of the United 
                States.
  [(f) Election of Status as FSC (and as Small FSC).--
          [(1) Election.--
                  [(A) Time for making.--An election by a 
                corporation under section 922(a)(2) to be 
                treated as a FSC, and an election under section 
                922(b)(1) to be a small FSC, shall be made by 
                such corporation for a taxable year at any time 
                during the 90-day period immediately preceding 
                the beginning of the taxable year, except that 
                the Secretary may give his consent to the 
                making of an election at such other times as he 
                may designate.
                  [(B) Manner of election.--An election under 
                subparagraph (A) shall be made in such manner 
                as the Secretary shall prescribe and shall be 
                valid only if all persons who are shareholders 
                in such corporation on the first day of the 
                first taxable year for which such election is 
                effective consent to such election.
          [(2) Effect of election.--If a corporation makes an 
        election under paragraph (1), then the provisions of 
        this subpart shall apply to such corporation for the 
        taxable year of the corporation for which made and for 
        all succeeding taxable years.
          [(3) Termination of election.--
                  [(A) Revocation.--An election under this 
                subsection made by any corporation may be 
                terminated by revocation of such election for 
                any taxable year of the corporation after the 
                first taxable year of the corporation for which 
                the election is effective. A termination under 
                this paragraph shall be effective with respect 
                to such election--
                          [(i) for the taxable year in which 
                        made, if made at any time during the 
                        first 90 days of such taxable year, or
                          [(ii) for the taxable year following 
                        the taxable year in which made, if made 
                        after the close of such 90 days, and 
                        for all succeeding taxable years of the 
                        corporation. Such termination shall be 
                        made in such manner as the Secretary 
                        shall prescribe by regulations.
                  [(B) Continued failure to be a fsc.--If a 
                corporation is not a FSC for each of any 5 
                consecutive taxable years of the corporation 
                for which an election under this subsection is 
                effective, the election to be a FSC shall be 
                terminated and not be in effect for any taxable 
                year of the corporation after such 5th year.
  [(g) Treatment of Shared FSC's.--
          [(1) In general.--Except as provided in paragraph 
        (2), each separate account referred to in paragraph (3) 
        maintained by a shared FSC shall be treated as a 
        separate corporation for purposes of this subpart.
          [(2) Certain requirements applied at shared fsc 
        level.--Paragraph (1) shall not apply--
                  [(A) for purposes of--
                          [(i) subparagraphs (A), (B), (D), and 
                        (E) of section 922(a)(1),
                          [(ii) paragraph (2) of section 
                        922(a),
                          [(iii) subsections (b), (c), and (e) 
                        of section 924, and
                          [(iv) subsection (f) of this section, 
                        and
                  [(B) for such other purposes as the Secretary 
                may by regulations prescribe.
          [(3) Shared fsc.--For purposes of this subsection, 
        the term ``shared FSC'' means any corporation if--
                  [(A) such corporation maintains a separate 
                account for transactions with each shareholder 
                (and persons related to such shareholder),
                  [(B) distributions to each shareholder are 
                based on the amounts in the separate account 
                maintained with respect to such shareholder, 
                and
                  [(C) such corporation meets such other 
                requirements as the Secretary may by 
                regulations prescribe.]

           *       *       *       *       *       *       *


               Subpart E--Qualifying Foreign Trade Income

        Sec. 941. Qualifying foreign trade income.
        Sec. 942. Foreign trading gross receipts.
        Sec. 943. Other definitions and special rules.

SEC. 941. QUALIFYING FOREIGN TRADE INCOME.

  (a) Qualifying Foreign Trade Income.--For purposes of this 
subpart and section 114--
          (1) In general.--The term ``qualifying foreign trade 
        income'' means, with respect to any transaction, the 
        amount of gross income which, if excluded, will result 
        in a reduction of the taxable income of the taxpayer 
        from such transaction equal to the greatest of--
                  (A) 30 percent of the foreign sale and 
                leasing income derived by the taxpayer from 
                such transaction,
                  (B) 1.2 percent of the foreign trading gross 
                receipts derived by the taxpayer from the 
                transaction, or
                  (C) 15 percent of the foreign trade income 
                derived by the taxpayer from the transaction.
        In no event shall the amount determined under 
        subparagraph (B) exceed 200 percent of the amount 
        determined under subparagraph (C).
          (2) Alternative computation.--A taxpayer may compute 
        its qualifying foreign trade income under a 
        subparagraph of paragraph (1) other than the 
        subparagraph which results in the greatest amount of 
        such income.
          (3) Limitation on use of foreign trading gross 
        receipts method.--If any person computes its qualifying 
        foreign trade income from any transaction with respect 
        to any property under paragraph (1)(B), the qualifying 
        foreign trade income of such person (or any related 
        person) with respect to any other transaction involving 
        such property shall be zero.
          (4) Rules for marginal costing.--The Secretary shall 
        prescribe regulations setting forth rules for the 
        allocation of expenditures in computing foreign trade 
        income under paragraph (1)(C) in those cases where a 
        taxpayer is seeking to establish or maintain a market 
        for qualifying foreign trade property.
          (5) Participation in international boycotts, etc.--
        Under regulations prescribed by the Secretary, the 
        qualifying foreign trade income of a taxpayer for any 
        taxable year shall be reduced (but not below zero) by 
        the sum of--
                  (A) an amount equal to such income multiplied 
                by the international boycott factor determined 
                under section 999, and
                  (B) any illegal bribe, kickback, or other 
                payment (within the meaning of section 162(c)) 
                paid by or on behalf of the taxpayer directly 
                or indirectly to an official, employee, or 
                agent in fact of a government.
  (b) Foreign Trade Income.--For purposes of this subpart--
          (1) In general.--The term ``foreign trade income'' 
        means the taxable income of the taxpayer attributable 
        to foreign trading gross receipts of the taxpayer.
          (2) Special rule for cooperatives.--In any case in 
        which an organization to which part I of subchapter T 
        applies which is engaged in the marketing of 
        agricultural or horticultural products sells qualifying 
        foreign trade property, in computing the taxable income 
        of such cooperative, there shall not be taken into 
        account any deduction allowable under subsection (b) or 
        (c) of section 1382 (relating to patronage dividends, 
        per-unit retain allocations, and nonpatronage 
        distributions).
  (c) Foreign Sale and Leasing Income.--For purposes of this 
section--
          (1) In general.--The term ``foreign sale and leasing 
        income'' means, with respect to any transaction--
                  (A) foreign trade income properly allocable 
                to activities which--
                          (i) are described in paragraph 
                        (2)(A)(i) or (3) of section 942(b), and
                          (ii) are performed by the taxpayer 
                        (or any person acting under a contract 
                        with such taxpayer) outside the United 
                        States, or
                  (B) foreign trade income derived by the 
                taxpayer in connection with the lease or rental 
                of qualifying foreign trade property for use by 
                the lessee outside the United States.
          (2) Special rules for leased property.--
                  (A) Sales income.--The term ``foreign sale 
                and leasing income'' includes any foreign trade 
                income derived by the taxpayer from the sale of 
                property described in paragraph (1)(B).
                  (B) Limitation in certain cases.--Except as 
                provided in regulations, in the case of 
                property which--
                          (i) was manufactured, produced, 
                        grown, or extracted by the taxpayer, or
                          (ii) was acquired by the taxpayer 
                        from a related person for a price which 
                        was not determined in accordance with 
                        the rules of section 482,
        the amount of foreign trade income which may be treated 
        as foreign sale and leasing income under paragraph 
        (1)(B) or subparagraph (A) of this paragraph with 
        respect to any transaction involving such property 
        shall not exceed the amount which would have been 
        determined if the taxpayer had acquired such property 
        for the price determined in accordance with the rules 
        of section 482.
          (3) Special rules.--
                  (A) Excluded property.--Foreign sale and 
                leasing income shall not include any income 
                properly allocable to excluded property 
                described in subparagraph (B) of section 
                943(a)(3) (relating to intangibles).
                  (B) Only direct expenses taken into 
                account.--For purposes of this subsection, any 
                expense other than a directly allocable expense 
                shall not be taken into account in computing 
                foreign trade income.

SEC. 942. FOREIGN TRADING GROSS RECEIPTS.

  (a) Foreign Trading Gross Receipts.--
          (1) In general.--Except as otherwise provided in this 
        section, for purposes of this subpart, the term 
        ``foreign trading gross receipts'' means the gross 
        receipts of the taxpayer which are--
                  (A) from the sale, exchange, or other 
                disposition of qualifying foreign trade 
                property,
                  (B) from the lease or rental of qualifying 
                foreign trade property for use by the lessee 
                outside the United States,
                  (C) for services which are related and 
                subsidiary to--
                          (i) any sale, exchange, or other 
                        disposition of qualifying foreign trade 
                        property by such taxpayer, or
                          (ii) any lease or rental of 
                        qualifying foreign trade property 
                        described in subparagraph (B) by such 
                        taxpayer,
                  (D) for engineering or architectural services 
                for construction projects located (or proposed 
                for location) outside the United States, or
                  (E) for the performance of managerial 
                services for a person other than a related 
                person in furtherance of the production of 
                foreign trading gross receipts described in 
                subparagraph (A), (B), or (C).
        Subparagraph (E) shall not apply to a taxpayer for any 
        taxable year unless at least 50 percent of its foreign 
        trading gross receipts (determined without regard to 
        this sentence) for such taxable year is derived from 
        activities described in subparagraph (A), (B), or (C).
          (2) Certain receipts excluded on basis of use; 
        subsidized receipts excluded.--The term ``foreign 
        trading gross receipts'' shall not include receipts of 
        a taxpayer from a transaction if--
                  (A) the qualifying foreign trade property or 
                services--
                          (i) are for ultimate use in the 
                        United States, or
                          (ii) are for use by the United States 
                        or any instrumentality thereof and such 
                        use of qualifying foreign trade 
                        property or services is required by law 
                        or regulation, or
                  (B) such transaction is accomplished by a 
                subsidy granted by the government (or any 
                instrumentality thereof) of the country or 
                possession in which the property is 
                manufactured, produced, grown, or extracted.
          (3) Election to exclude certain receipts.--The term 
        ``foreign trading gross receipts'' shall not include 
        gross receipts of a taxpayer from a transaction if the 
        taxpayer elects not to have such receipts taken into 
        account for purposes of this subpart.
  (b) Foreign Economic Process Requirements.--
          (1) In general.--Except as provided in subsection 
        (c), a taxpayer shall be treated as having foreign 
        trading gross receipts from any transaction only if 
        economic processes with respect to such transaction 
        take place outside the United States as required by 
        paragraph (2).
          (2) Requirement.--
                  (A) In general.--The requirements of this 
                paragraph are met with respect to the gross 
                receipts of a taxpayer derived from any 
                transaction if--
                          (i) such taxpayer (or any person 
                        acting under a contract with such 
                        taxpayer) has participated outside the 
                        United States in the solicitation 
                        (other than advertising), the 
                        negotiation, or the making of the 
                        contract relating to such transaction, 
                        and
                          (ii) the foreign direct costs 
                        incurred by the taxpayer attributable 
                        to the transaction equal or exceed 50 
                        percent of the total direct costs 
                        attributable to the transaction.
                  (B) Alternative 85-percent test.--A taxpayer 
                shall be treated as satisfying the requirements 
                of subparagraph (A)(ii) with respect to any 
                transaction if, with respect to each of at 
                least 2 subparagraphs of paragraph (3), the 
                foreign direct costs incurred by such taxpayer 
                attributable to activities described in such 
                subparagraph equal or exceed 85 percent of the 
                total direct costs attributable to activities 
                described in such subparagraph.
                  (C) Definitions.--For purposes of this 
                paragraph--
                          (i) Total direct costs.--The term 
                        ``total direct costs'' means, with 
                        respect to any transaction, the total 
                        direct costs incurred by the taxpayer 
                        attributable to activities described in 
                        paragraph (3) performed at any location 
                        by the taxpayer or any person acting 
                        under a contract with such taxpayer.
                          (ii) Foreign direct costs.--The term 
                        ``foreign direct costs'' means, with 
                        respect to any transaction, the portion 
                        of the total direct costs which are 
                        attributable to activities performed 
                        outside the United States.
          (3) Activities relating to qualifying foreign trade 
        property.--The activities described in this paragraph 
        are any of the following with respect to qualifying 
        foreign trade property--
                  (A) advertising and sales promotion,
                  (B) the processing of customer orders and the 
                arranging for delivery,
                  (C) transportation outside the United States 
                in connection with delivery to the customer,
                  (D) the determination and transmittal of a 
                final invoice or statement of account or the 
                receipt of payment, and
                  (E) the assumption of credit risk.
          (4) Economic processes performed by related 
        persons.--A taxpayer shall be treated as meeting the 
        requirements of this subsection with respect to any 
        sales transaction involving any property if any related 
        person has met such requirements in such transaction or 
        any other sales transaction involving such property.
  (c) Exception From Foreign Economic Process Requirement.--
          (1) In general.--The requirements of subsection (b) 
        shall be treated as met for any taxable year if the 
        foreign trading gross receipts of the taxpayer for such 
        year do not exceed $5,000,000.
          (2) Receipts of related persons aggregated.--All 
        related persons shall be treated as one person for 
        purposes of paragraph (1), and the limitation under 
        paragraph (1) shall be allocated among such persons in 
        a manner provided in regulations prescribed by the 
        Secretary.
          (3) Special rule for pass-thru entities.--In the case 
        of a partnership, S corporation, or other pass-thru 
        entity, the limitation under paragraph (1) shall apply 
        with respect to the partnership, S corporation, or 
        entity and with respect to each partner, shareholder, 
        or other owner.

SEC. 943. OTHER DEFINITIONS AND SPECIAL RULES.

  (a) Qualifying Foreign Trade Property.--For purposes of this 
subpart--
          (1) In general.--The term ``qualifying foreign trade 
        property'' means property--
                  (A) manufactured, produced, grown, or 
                extracted within or outside the United States,
                  (B) held primarily for sale, lease, or 
                rental, in the ordinary course of trade or 
                business for direct use, consumption, or 
                disposition outside the United States, and
                  (C) not more than 50 percent of the fair 
                market value of which is attributable to--
                          (i) articles manufactured, produced, 
                        grown, or extracted outside the United 
                        States, and
                          (ii) direct costs for labor 
                        (determined under the principles of 
                        section 263A) performed outside the 
                        United States.
        For purposes of subparagraph (C), the fair market value 
        of any article imported into the United States shall be 
        its appraised value, as determined by the Secretary 
        under section 402 of the Tariff Act of 1930 (19 U.S.C. 
        1401a) in connection with its importation, and the 
        direct costs for labor under clause (ii) do not include 
        costs that would be treated under the principles of 
        section 263A as direct labor costs attributable to 
        articles described in clause (i).
          (2) U.S. taxation to ensure consistent treatment.--
        Property which (without regard to this paragraph) is 
        qualifying foreign trade property and which is 
        manufactured, produced, grown, or extracted outside the 
        United States shall be treated as qualifying foreign 
        trade property only if it is manufactured, produced, 
        grown, or extracted by--
                  (A) a domestic corporation,
                  (B) an individual who is a citizen or 
                resident of the United States,
                  (C) a foreign corporation with respect to 
                which an election under subsection (e) 
                (relating to foreign corporations electing to 
                be subject to United States taxation) is in 
                effect, or
                  (D) a partnership or other pass-thru entity 
                all of the partners or owners of which are 
                described in subparagraph (A), (B), or (C).
        Except as otherwise provided by the Secretary, tiered 
        partnerships or pass-thru entities shall be treated as 
        described in subparagraph (D) if each of the 
        partnerships or entities is directly or indirectly 
        wholly owned by persons described in subparagraph (A), 
        (B), or (C).
          (3) Excluded property.--The term ``qualifying foreign 
        trade property'' shall not include--
                  (A) property leased or rented by the taxpayer 
                for use by any related person,
                  (B) patents, inventions, models, designs, 
                formulas, or processes whether or not patented, 
                copyrights (other than films, tapes, records, 
                or similar reproductions, and other than 
                computer software (whether or not patented), 
                for commercial or home use), goodwill, 
                trademarks, trade brands, franchises, or other 
                like property,
                  (C) oil or gas (or any primary product 
                thereof),
                  (D) products the transfer of which is 
                prohibited or curtailed to effectuate the 
                policy set forth in paragraph (2)(C) of section 
                3 of Public Law 96-72, or
                  (E) any unprocessed timber which is a 
                softwood.
        For purposes of subparagraph (E), the term 
        ``unprocessed timber'' means any log, cant, or similar 
        form of timber.
          (4) Property in short supply.--If the President 
        determines that the supply of any property described in 
        paragraph (1) is insufficient to meet the requirements 
        of the domestic economy, the President may by Executive 
        order designate the property as in short supply. Any 
        property so designated shall not be treated as 
        qualifying foreign trade property during the period 
        beginning with the date specified in the Executive 
        order and ending with the date specified in an 
        Executive order setting forth the President's 
        determination that the property is no longer in short 
        supply.
  (b) Other Definitions and Rules.--For purposes of this 
subpart--
          (1) Transaction.--
                  (A) In general.--The term ``transaction'' 
                means--
                          (i) any sale, exchange, or other 
                        disposition,
                          (ii) any lease or rental, and
                          (iii) any furnishing of services.
                  (B) Grouping of transactions.--To the extent 
                provided in regulations, any provision of this 
                subpart which, but for this subparagraph, would 
                be applied on a transaction-by-transaction 
                basis may be applied by the taxpayer on the 
                basis of groups of transactions based on 
                product lines or recognized industry or trade 
                usage. Such regulations may permit different 
                groupings for different purposes.
          (2) United states defined.--The term ``United 
        States'' includes the Commonwealth of Puerto Rico. The 
        preceding sentence shall not apply for purposes of 
        determining whether a corporation is a domestic 
        corporation.
          (3) Related person.--A person shall be related to 
        another person if such persons are treated as a single 
        employer under subsection (a) or (b) of section 52 or 
        subsection (m) or (o) of section 414, except that 
        determinations under subsections (a) and (b) of section 
        52 shall be made without regard to section 1563(b).
          (4) Gross and taxable income.--Section 114 shall not 
        be taken into account in determining the amount of 
        gross income or foreign trade income from any 
        transaction.
  (c) Source Rule.--Under regulations, in the case of 
qualifying foreign trade property manufactured, produced, 
grown, or extracted within the United States, the amount of 
income of a taxpayer from any sales transaction with respect to 
such property which is treated as from sources without the 
United States shall not exceed--
          (1) in the case of a taxpayer computing its 
        qualifying foreign trade income under section 
        941(a)(1)(B), the amount of the taxpayer's foreign 
        trade income which would (but for this subsection) be 
        treated as from sources without the United States if 
        the foreign trade income were reduced by an amount 
        equal to 4 percent of the foreign trading gross 
        receipts with respect to the transaction, and
          (2) in the case of a taxpayer computing its 
        qualifying foreign trade income under section 
        941(a)(1)(C), 50 percent of the amount of the 
        taxpayer's foreign trade income which would (but for 
        this subsection) be treated as from sources without the 
        United States.
  (d) Treatment of Withholding Taxes.--
          (1) In general.--For purposes of section 114(d), any 
        withholding tax shall not be treated as paid or accrued 
        with respect to extraterritorial income which is 
        excluded from gross income under section 114(a). For 
        purposes of this paragraph, the term ``withholding 
        tax'' means any tax which is imposed on a basis other 
        than residence and for which credit is allowable under 
        section 901 or 903.
          (2) Exception.--Paragraph (1) shall not apply to any 
        taxpayer with respect to extraterritorial income from 
        any transaction if the taxpayer computes its qualifying 
        foreign trade income with respect to the transaction 
        under section 941(a)(1)(A).
  (e) Election To Be Treated as Domestic Corporation.--
          (1) In general.--An applicable foreign corporation 
        may elect to be treated as a domestic corporation for 
        all purposes of this title if such corporation waives 
        all benefits to such corporation granted by the United 
        States under any treaty. No election under section 
        1362(a) may be made with respect to such corporation.
          (2) Applicable foreign corporation.--For purposes of 
        paragraph (1), the term ``applicable foreign 
        corporation'' means any foreign corporation if--
                  (A) such corporation manufactures, produces, 
                grows, or extracts property in the ordinary 
                course of such corporation's trade or business, 
                or
                  (B) substantially all of the gross receipts 
                of such corporation may reasonably be expected 
                to be foreign trading gross receipts.
          (3) Period of election.--
                  (A) In general.--Except as otherwise provided 
                in this paragraph, an election under paragraph 
                (1) shall apply to the taxable year for which 
                made and all subsequent taxable years unless 
                revoked by the taxpayer. Any revocation of such 
                election shall apply to taxable years beginning 
                after such revocation.
                  (B) Termination.--If a corporation which made 
                an election under paragraph (1) for any taxable 
                year fails to meet the requirements of 
                subparagraph (A) or (B) of paragraph (2) for 
                any subsequent taxable year, such election 
                shall not apply to any taxable year beginning 
                after such subsequent taxable year.
                  (C) Effect of revocation or termination.--If 
                a corporation which made an election under 
                paragraph (1) revokes such election or such 
                election is terminated under subparagraph (B), 
                such corporation (and any successor 
                corporation) may not make such election for any 
                of the 5 taxable years beginning with the first 
                taxable year for which such election is not in 
                effect as a result of such revocation or 
                termination.
          (4) Special rules.--
                  (A) Requirements.--This subsection shall not 
                apply to an applicable foreign corporation if 
                such corporation fails to meet the requirements 
                (if any) which the Secretary may prescribe to 
                ensure that the taxes imposed by this chapter 
                on such corporation are paid.
                  (B) Effect of election, revocation, and 
                termination.--
                          (i) Election.--For purposes of 
                        section 367, a foreign corporation 
                        making an election under this 
                        subsection shall be treated as 
                        transferring (as of the first day of 
                        the first taxable year to which the 
                        election applies) all of its assets to 
                        a domestic corporation in connection 
                        with an exchange to which section 354 
                        applies.
                          (ii) Revocation and termination.--For 
                        purposes of section 367, if--
                                  (I) an election is made by a 
                                corporation under paragraph (1) 
                                for any taxable year, and
                                  (II) such election ceases to 
                                apply for any subsequent 
                                taxable year,
                such corporation shall be treated as a domestic 
                corporation transferring (as of the 1st day of 
                the first such subsequent taxable year to which 
                such election ceases to apply) all of its 
                property to a foreign corporation in connection 
                with an exchange to which section 354 applies.
                  (C) Eligibility for election.--The Secretary 
                may by regulation designate one or more classes 
                of corporations which may not make the election 
                under this subsection.
  (f) Rules Relating to Allocations of Qualifying Foreign Trade 
Income From Shared Partnerships.--
          (1) In general.--If--
                  (A) a partnership maintains a separate 
                account for transactions (to which this subpart 
                applies) with each partner,
                  (B) distributions to each partner with 
                respect to such transactions are based on the 
                amounts in the separate account maintained with 
                respect to such partner, and
                  (C) such partnership meets such other 
                requirements as the Secretary may by 
                regulations prescribe,
        then such partnership shall allocate to each partner 
        items of income, gain, loss, and deduction (including 
        qualifying foreign trade income) from any transaction 
        to which this subpart applies on the basis of such 
        separate account.
          (2) Special rules.--For purposes of this subpart, in 
        the case of a partnership to which paragraph (1) 
        applies--
                  (A) any partner's interest in the partnership 
                shall not be taken into account in determining 
                whether such partner is a related person with 
                respect to any other partner, and
                  (B) the election under section 942(a)(3) 
                shall be made separately by each partner with 
                respect to any transaction for which the 
                partnership maintains separate accounts for 
                each partner.
  (g) Exclusion for Patrons of Agricultural and Horticultural 
Cooperatives.--Any amount described in paragraph (1) or (3) of 
section 1385(a)--
          (1) which is received by a person from an 
        organization to which part I of subchapter T applies 
        which is engaged in the marketing of agricultural or 
        horticultural products, and
          (2) which is designated by the organization as 
        allocable to qualifying foreign trade income in a 
        written notice mailed to its patrons during the payment 
        period described in section 1382(d),
shall be treated as qualifying foreign trade income of such 
person for purposes of section 114. The taxable income of the 
organization shall not be reduced under section 1382 by reason 
of any amount to which the preceding sentence applies.

           *       *       *       *       *       *       *


              PART V--INTERNATIONAL BOYCOTT DETERMINATIONS

           *       *       *       *       *       *       *


SEC. 999. REPORTS BY TAXPAYERS; DETERMINATIONS.

  (a) * * *

           *       *       *       *       *       *       *

  (c) International Boycott Factor.--
          (1) International boycott factor.--For purposes of 
        sections 908(a), 941(a)(5), 952(a)(3), and 
        995(b)(1)(F)(ii), the international boycott factor is a 
        fraction, determined under regulations prescribed by 
        the Secretary, the numerator of which reflects the 
        world-wide operations of a person (or, in the case of a 
        controlled group (within the meaning of section 
        993(a)(3)) which includes that person, of the group) 
        which are operations in or related to a group of 
        countries associated in carrying out an international 
        boycott in or with which that person or a member of 
        that controlled group has participated or cooperated in 
        the taxable year, and the denominator of which reflects 
        the world-wide operations of that person or group.

           *       *       *       *       *       *       *


                  VII. DISSENTING AND ADDITIONAL VIEWS

                            DISSENTING VIEWS

    As the only member of the Ways and Means to vote against 
H.R. 4986, the FSC Repeal and Extraterritorial Income Exclusion 
Act of 2000, I must explain the reasons for my vote.
    I believe that this bill will not suffice under the 
scrutiny of the World Trade Organization. H.R. 4986 is as much 
of a subsidy as the current FSC. The entire process was 
undemocratic, constituting backroom consultations with private 
industry and select members of Congress. Finally, the bill is 
expanded and additional taxpayer dollars will be lost under the 
new scheme. It is not right that we ask U.S. taxpayers to pay 
for an export subsidy for large pharmaceutical corporations 
when the U.S. pharmaceutical industry is charging less in 
wealthy foreign markets for the same prescription drugs that 
our seniors are unable to afford here.

                                process

    Select members of the House Ways and Means Committee and 
Senate Finance Committee were consulted on revising the Foreign 
Sales Corporation (FSC) prior to the World Trade Organization's 
October 2000 deadline. In addition, those who will benefit from 
the new subsidy were also consulted--private industry. However, 
there were many members of the Ways & Means Committee who were 
not consulted on the details of the new proposal. This hardly 
reflects the democratic process under which this legislative 
body is supposed to operate.
    I was one of the members who was not consulted on repealing 
and replacing the current FSC for a new plan, yet I was one of 
the members who was here to vote in 1984 to repeal the Domestic 
International Sales Corporation and replace it with the Foreign 
Sales Corporation.

                 benefits to military weapons exporters

    In 1976, I led Congress in voting to decrease the benefit 
to weapons dealers. Therefore, I was dismayed to see that the 
new FSC benefit will actually be expanded to increase the 
benefit of the subsidy to military weapons exporters.
    The U.S. already spends about $8 billion annually to 
subsidize U.S. weapons manufacturers. These subsidies include 
taxpayer-backed loans, grants, and government promotional 
activities that assist U.S. weapons makers to sell their 
products to foreign customers. Under the current Foreign Sales 
Corporation scheme, weapons exporters may qualify for up to 50% 
of the FSC benefit. Under the new scheme, arms dealers will be 
able to reap the full benefit of the subsidy. It is 
incomprehensible that we would allow an industry that already 
receives more than its fair share of pork barrel spending to 
receiving subsidies through the new FSC plan.

                  benefits to pharmaceutical industry

    The pharmaceutical industry is another branch of corporate 
American that clearly does not need an export subsidy at the 
expense of the American taxpayer. H.R. 4986 offers export 
incentives to pharmaceutical companies who sell their products 
to other developed countries for less than the U.S. consumer 
can purchase the exact same drugs.
    Drug companies already reap huge tax benefits that lowered 
their average effective tax rates nearly 40% relative to other 
major U.S. industries from 1990 to 1996. Fortune magazine again 
rated the pharmaceutical industry the most profitable industry 
in 1999. Merck, the richest drug company, had greater profits 
than the entire airline industry and more than twice the 
profits of the engineering-construction industry. Drug spending 
increased more than 15% in 1998, 18% in 1999 and is expected to 
continue to increase at phenomenal rates in the future. Yet, 
studies have shown that American seniors without drug coverage 
often pay about twice as much as people in Canada & Mexico.
    The Ways and Means Committee rejected my amendment which 
would have prohibited pharmaceutical companies from receiving 
the full FSC benefit if they discounted more than 5% to foreign 
consumers relative to U.S. consumers. This amendment simply 
makes sense. It is only fair to the millions of U.S. seniors 
who go without their much needed prescription drugs. Why 
subsidize an industry already receiving huge corporate tax 
credits? We should have exempted pharmaceutical companies from 
the new FSC scheme. The members of the Ways and Means Committee 
chose otherwise. This is an insult not only to American 
seniors, but to all U.S. taxpayers.

                             export subsidy

    Finally, H.R. 4986 does not address the concerns of the WTO 
dispute panel. The new scheme attempts to allay the European 
Unions' concerns by allowing some foreign operations to also 
receive the subsidy. The new scheme eliminates the requirement 
on a firm to sell its exports through a separately chartered 
foreign corporation in order to receive the benefit. The only 
portion that is eliminated is the paper subsidiary. Instead of 
creating a tax haven, U.S. exporters will be able to receive 
the benefit outright. The new scheme doesn't prevent arms 
exporters or any other industry from receiving the entire of 
the subsidy.
    The new scheme essentially leaves the export benefit in 
place but now the U.S. Treasury will forego an additional $300 
million per year to subsidize U.S. exporters. The U.S. Treasury 
will forego more than $3 billion per year to help companies 
like Boeing and R.J. Reynolds peddle their products. Exporters 
will continue to receive a lower tax rate on income from export 
sales than from domestic sales. This is clearly prohibited 
under the WTO Agreement on Subsidies and Countervailing 
Measures.
    It is said commentary on the Ways and Means Committee that 
is willing to fight a WTO ruling all in the name of corporate 
profits but ignores environmental, human rights, and labor 
interests.

                                                        Pete Stark.

                            ADDITIONAL VIEWS

    In what is hardly a model of the way the democratic process 
should operate, this legislation has involved no public 
participation, no hearings, and non involvement of any but a 
handful of Committee members. This bill is basically a product 
of meetings between the Treasury Department and groups that 
will benefit from preferential tax treatment. The Chairman even 
went so far as to attempt to preclude the Committee members 
from making comments or offering amendments. The members were 
even denied the right to question Secretary Eizenstat, the 
principal Administration official responsible for this bill.
    The cost of this legislation to the Treasury, which must be 
paid for by American taxpayers, is between $4 billion and $6 
billion per year, and growing. In response to the European 
community's criticism that tax advantages to American 
businesses are illegal, this legislation seeks to generously 
increase those advantages by $300 million a year.
    With this legislation, the Committee has basically made a 
public policy statement that local stores, which sell groceries 
or clothing to customers within our country, should pay higher 
taxes than multinational corporations, which sell cigarettes or 
machine guns abroad. Contrary to proponents' arguments that 
small and medium sized businesses share significantly in this 
tax break, the Internal Revenue Service Statistics of Income 
Division reports that 78% of FSC tax benefits go to companies 
with assets exceeding $1 billion. Another study based on a 
sample of corporate financial statements published in Tax 
Notes, August 14, 2000, indicates that, ``the top 20% of FSC 
beneficiaries (ranked by size of reported FSC benefit in 1998) 
obtained 87% of the FSC benefits.''
    Moreover, there is substantial question as to the benefits 
that Americans truly will receive from this legislation. The 
Congressional Research Service summarized the most recent 
Treasury analysis of the Foreign Sales Corporation tax benefit 
by concluding that ``[r]epealing this provision would have a 
negligible effect on the trade balance.'' Treasury determined 
that such a repeal would reduce U.S. exports by \3/10\ of one 
percent and U.S. imports by \2/10\ of one percent.

                  encouraging foreign armaments sales

    Because the benefits to ordinary Americans of this costly 
tax advantage are at best remote, every aspect of this law 
deserves the type of scrutiny that was wholly lacking during 
Committee consideration. One glaring example of both what is 
wrong with this legislation and what is wrong with the process 
that produced it is the generosity shown to arms manufacturers. 
Their tax savings are doubled by this bill. The supposed 
justification for such largesse to those who promote arms sales 
abroad was previously rejected by the Treasury Department in 
August 1999:

          We have seen no evidence that granting full FSC 
        benefits would significantly affect the level of 
        defense exports, and indeed, we are given to understand 
        that other factors, such as the quality of the product 
        and the quality and level of support services, tend to 
        dominate a buyer's decision whether to buy a U.S. 
        defense product.

    Ironically, in 1997, the Congressional Budget Office, whose 
director was appointed by Republican leaders had reached a 
similar conclusion:

          U.S. defense industries have significant advantages 
        over their foreign competitors and thus should not need 
        additional subsidies to attract sales. Because the U.S. 
        defense procurement budget is nearly twice that of all 
        Western European countries combined, U.S. industries 
        can realize economics of scale not available to other 
        combined, U.S. industries can realize economics of 
        scale not available to other competitors. The U.S. 
        defense research and development budget is five times 
        that of all Western European countries combined, which 
        ensures that U.S. weapon systems are and will remain 
        technologically superior to those of other suppliers.

    Even the Department of Defense conceded the same in 1994:

          The forecasts support a continuing strong defense 
        trade performance for U.S. defense products through the 
        end of the decade and beyond. In a large number of 
        cases, the U.S. is clearly the preferred provider, and 
        there is little meaningful competition with suppliers 
        from other countries. An increase in the level of 
        support the U.S. government currently supplies is 
        unlikely to shift the U.S. export market share outside 
        a range of 53 to 59 percent of worldwide arms trade.

    In 1999, without the bonanza provided by this bull, U.S. 
defense contractors sold almost $11.8 billion in weapons 
overseas--more than a third of the world's total and more than 
all European countries combined.
    A paper prepared for the Cato Institute in August 1999 by 
William D. Hartung, President's Fellow at the World Policy 
Institute, highlights the bad judgment shown here: ``If the 
government wanted to level the playing field between the 
weapons industry and other sectors, it would have to reduce 
weapons subsidies, not increase them.'' (These subsidies 
include thousands of federal employees at the Pentagon and 
other agencies whose very purpose is to increase arms sales). 
He continued, ``Considering those massive subsidies to weapons 
manufacturers, granting additional tax breaks to an industry 
that is being so pampered by the U.S. government makes no 
sense.''
    With no evidence to warrant its action, the Committee 
rejected fiscal responsibility in favor of wholly unjustified 
preferential tax treatment that means millions in savings to 
defense contractors. This costly decision is also bad for our 
country's true security interests. Instead of subsidizing arms 
promotion, our nation should be encouraging arms control. 
American armaments too often contribute to one arm race after 
another around the globe.
    Doubling this subsidy only encourages the sales of more 
arms overseas and creates more challenges to the maintenance of 
our own ``military superiority''--and, of course, more pressure 
for additional costly increases in the defense budget. As 
Lawrence Korb, President Reagan's Assistant Secretary for 
Defense for Manpower, Reserve Affairs, Installations and 
Logistics, has said:

          It has become a money game: an absurd spiral in which 
        we export arms only to have to develop more 
        sophisticated ones to counter those spread out all over 
        the world * * * It is very hard for us to tell other 
        people--the Russians, the Chinese, the French--not to 
        sell arms, when we are out there peddling and fighting 
        to control the market.

    Former Costa Rican President and 1987 Nobel Peace Prize 
winner, Oscar Arias offers another reason for rejecting the 
Committee's decision to increase the arms subsidy:

          By selling advanced weaponry throughout the world, 
        wealthy military contractors not only weaken national 
        security and squeeze taxpayers at home but also 
        strengthen dictators and human misery abroad.

                                                     Lloyd Doggett.

         ADDITIONAL VIEWS BY MESSRS. DOGGETT, LEWIS, AND STARK

              promoting tobacco related disease and death

    The way in which this legislation was rushed through the 
Committee avoided any explanation as to why American taxpayers 
should continue to subsidize the tobacco industry, whose 
product actually kills one third of the people who use it. The 
Committee ignored the pleas of the American Medical 
Association, the American Cancer Society, the American Heart 
Association, Campaign for Tobacco-Free Kids, and other public 
health groups that tobacco should be denied a tax benefit. It 
also rejected the written request of 97 Members of Congress 
that tobacco be excluded.
    Nicotine addiction represents a public health crisis. 
Within 20 years, almost 10 million people are expected to die 
annually from tobacco-related illnesses. Seventy percent of 
these deaths will occur in the developing countries that are 
being targeted by big tobacco's continued addiction to making 
money at the expense of human lives. In fact, tobacco will soon 
become the leading cause of disease and premature death 
worldwide--bypassing communicable diseases such as AIDS, 
malaria and tuberculosis.
    Instead of being accountable for its deadly products, the 
tobacco industry has responded by conspiring to undermine the 
efforts of the World Health Organization to cope with this 
global pandemic. During recent litigation, Philip Morris was 
forced to produce documents, which can be found at the 
Minnesota Tobacco Document Depository, stating that the company 
sought to ``discredit key individuals'' and ``allocate the 
resources to stop [WHO] in their tracks.'' An August 2000 WHO 
report entitled, Tobacco Company Strategies to Undermine 
Tobacco Control Activities at the World Health Organization 
states:

          The [industry] documents also show that tobacco 
        company strategies to undermine WHO relied heavily on 
        international and scientific exports with hidden 
        financial ties to the industry. Perhaps most 
        disturbing, the documents show that tobacco companies 
        quietly influenced other U.N. agencies and 
        representatives of developing countries to resist WHO's 
        tobacco control initiatives.

    Geoffrey C. Bible, Chairman of Philip Morris, a company 
that has often hidden its malicious tobacco influence through 
its holdings in Kraft Foods, even wrote in 1988 of the ``need 
to think through how we can use our food companies [to help 
governments] with their food problems and give us more balanced 
profile with the government than we now have against WHO's 
powerful influence.''
    The tobacco industry certainly cannot justify the public 
subsidy offered through this proposed legislation. Philip 
Morris, R.J. Reynolds, and Brown and Williamson have acquired 
tremendous marketing expertise from decades of success in 
targeting American children. This offers them tremendous 
advantage over foreign competitors in addicting children around 
the world; they hardly need help from the American taxpayer in 
order to spread death and disease to children in developing 
countries.
    Philip Morris spends millions in American television 
advertising to contend that it no longer markets to youth. It 
finally claims to have abandoned tobacco company billboards, 
transit ads, cartoon characters, cigarette-branded apparel and 
merchandise, paid placement of its products in movies and 
television shows, and most brand sponsorship of team sports and 
entertainment events. But, it has steadfastly declined to apply 
these modest safeguards in its international operations; 
indeed, it relies heavily on these and other tactics to target 
the world's children.
    Both petroleum and unprocessed timber are excluded from 
this legislation. Yet tobacco, the single largest public health 
menace, will continue to be subsidized at a cost of American 
taxpayers of about $100 million per year. This legislation 
constitutes just another way of forcing American taxpayers to 
be partners in this export of death and disease. Little wonder 
that there was so much eagerness to silence discussion of this 
disgrace.

                                   Lloyd Doggett.
                                   Pete Stark.
                                   John Lewis.

                                  
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