[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\
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\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'').
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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.
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\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.
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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\
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\6\ Report of the Panel at 334.
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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.
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\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.
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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.
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\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.''
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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\
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\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.