United States

Department of

Agriculture

Agricultural

Cooperative

Service

ACS

Research Report

Number 52

Using Export Companies

to Expand Cooperatives’

Foreign Sales
Abstract

Using Export Companies

to Expand Cooperatives’ Foreign Sales

Arvin R. Bunker

Tracey L. Kennedy

Agricultural Economists

Cooperative Marketing and Purchasing Division

Agricultural Cooperative Service

U.S. Department of Agriculture

Washington, D.C. 20250

Many agricultural cooperatives can expand foreign sales by using export

management companies (EMC’s). Small cooperatives may find foreign markets

too costly and time consuming to penetrate without EMC help. Larger

cooperatives may use EMC’s for sales in selected foreign markets or to enhance

sales of particular products. Services offered by EMC’s and typical fees are

discussed along with some guidelines for selecting an EMC.

Key words: Export, export management company, export trading company,

agricultural cooperatives, export performance.

ACS Research Report 52

December 1985
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Contents

Highlights

Types of Companies and Definitions

Description of Companies

Typical Services Provided by Exporting Companies

Products Handled

Market Coverage

Fees, Margins, and Costs

Ownership and Financial Structure

Advantages of an EMC or ETC

Disadvantages of an EMC or ETC

References

Appendix A: Export Trading Company Act of 1982

Appendix B: Tax Reform Act of 1984:

Foreign Sales Corporations

15 Appendix C: Quick Reference chart for FSC’s

. . .

111
Export management companies (EMC’s) can help cooperatives expand

exports. Historically, EMC’s have assisted export operations of domestic

companies in two major ways. First, as a commission house the EMC finds the

foreign buyer, negotiates the sales terms, prepares export documentation, and

arranges ocean freight. Financing and risk of collections, however, remain with

the seller. Second, the EMC does all of the above, plus accepts collection and

financing risk. To the supplier, the sale is like a domestic sale. Today, the second

method is used almost exclusively.

EMC’s exist under many names. Export trading company (ETC) is most

common. Regardless of name, most companies provide services characteristic

of either type of company.

Some specialized types of companies exist. These include Title II (antitrust

exemptions for groups of exporters) and Title III (banks with equity ownership)

export trading companies. Foreign sales corporations (FSC’s) are foreign-based

companies handling U.S. exports that receive beneficial Federal income tax

rates on export earnings. Most domestic international sales

corporations (DISC’s) were replaced with FSC’s, but some small ones still exist.

DISC’s also generate Federal income tax benefits for U.S. exporters. WebbPomerene associations provide limited antitrust exemptions for groups of U.S.

exporters. Only a handful of these associations remain active. EMC’s or ETC’s

may establish FSC’s, DISC’s or Webb-Pomerene associations.

EMC’s or ETC’s can be broadly classified into three groups. One group

primarily handles processed food products such as those on grocery store

shelves, or ready for use by institutional buyers. This group has the largest

number of companies. A second group specializes in fresh fruit and vegetables.

This is the smallest group of companies. A third group handles primarily bulk

agricultural commodities such as grains, oilseeds, and products. This group has

the largest dollar value of exports and is dominated by large multinational

companies.

This study focuses on the first two groups of companies. The third group is

characterized by large economies of scale in trading operations, and exports in a

much different manner from the first two groups.

Most export companies are small, with revenues under $10 million and fewer

than 20 employees. Despite few employees, most companies provide a wide

range of export services. Their major contribution to the export process is long

experience in international trade, and many contacts with potential foreign

buyers. A typical export company has been in business 15 to 20 years, and has

principal traders with more than 20 years’ experience. It is common for a small

export company to have contacts with 100 or more foreign buyers, and purchase

products from 20 to 80 sources. Larger companies may sell to more than 200

buyers.

While export companies may be located anywhere, most are concentrated at

port cities. Fresh fruit and vegetables exporters are concentrated near

production areas to facilitate grower contact and inspect produce.

Export companies seldom conduct formal market development. They rely on

experience and extensive contacts with foreign buyers to test new products.

iv
Products requiring long-term development or much training or consulting on how

to handle, process, or use will be avoided by many export companies.

Export companies claim they will trade with any country. As a practical

matter, most companies conduct most trade in a few regions. This regional focus

usually arises from how exporters establish markets. Export companies with

regional marketing rights to a major branded product emphasize complementary

products in those same markets. Buyers encourage this by asking exporters

handling the branded product to supply it with other products. This also saves on

transaction and transportation costs.

Exporters continually search for new products to export. They are most

interested in high-quality, nationally advertised products. Buyers with access to

U.S. food service magazines often request that exporters supply advertised

products.

Most exporters prefer exclusive rights to export a product. Exclusive rights

may free the exporter from the cut-throat price competition that may otherwise

occur. Pricing freedoms thus gained may be marginal, however, because other

exporters may procure the product from domestic wholesalers and export to the

same market. If a product requires much market development, the exporter may

require exclusive rights to protect against the high costs of developing sales.

Marketing agreements of 1 to 3 years are common.

Exporters usually acquire goods from the supplier much like a domestic sale.

The exporter takes title to the goods, prepares documentation, and ships to the

foreign buyer. The exporter assumes risk of collections and may provide shortterm financing, Typical margins for this service range from 4 to 7 percent of

product value. Unprocessed fruit and vegetable exporters usually have margins

of 1.5 to 4 percent. Large sales of processed products may also have margins

between 1.5 to 4 percent. Products requiring additional services or requiring

long-term market development may require significantly higher fees.

Exporters not assuming risk of collections nor providing interim financing

usually charge lower fees, Fees for established products with moderate sales

volume range from 2 to 4 percent. Large sales with minimal services typically

carry fees near 1 percent.

There are several advantages to using export companies. Perhaps the most

significant is faster foreign market penetration with a lower initial investment and

less risk. Small suppliers may not be able to effectively export without using

these companies. Other advantages include lower costs to some markets,

quicker payment for goods exported, distribution to more markets, and nearby

expert advice if export problems develop.

Likewise, there are several disadvantages to using export companies. The

supplier has less control over handling, distribution, and pricing of its exports.

Large suppliers may find it less costly to conduct their own export operations.

Some exporters serve only a few markets, and a supplier exporting to many

markets may need several export companies. Also, many export companies are

not well equipped to do market development of new or specialized products.

Finally, low margins on food products may make some exporters give preference

to other products. Even within the food group, more highly processed products

usually carry larger margins, and may receive more attention from export

companies.

‘5
Using Export Companies to Expand

Cooperatives’ Foreign Sales

Arvin R. Bunker

Tracey 1. Kennedy

Agricultural Economists

Cooperative Marketing and Purchasing Division

Export companies come in all sizes, types, and configurations.

In addition, most companies calling themselves by a particular

name often perform services typical of companies referring to

themselves by other names. In short, the company name may

not always indicate services performed.

TYPES OF COMPANIES AND DEFINITIONS

Historically, the two most common types of export companies

are export management companies (EMC’S) and export

trading companies (ETC’S). The latter is the most important

in exporting food and agricultural products.

Other organizations arising out of trade-related legislation are

aimed at facilitating exports or providing export incentives.

These include domestic international sales corporations

(DISC’s), foreign sales corporations (FSC’s), ETC’s

organized under the Export Trading Company Act of 1982,

and Webb-Pomerene Associations. Export trading and export

management companies may also be organized as or be a

member of one of these types of companies. Highlights of

these types of organizations follow.

The terminology describing an EMC or an ETC is changing.

Today, many more companies call themselves ETC’s even

though they still function occasionally as a commission agent.

Even though a company may call itself one name or the other,

it usually provides services typical of either type.

Export Management Companies (EMC’s)

Traditionally, the export management company, as the name

implies, managed exports for other companies and did not

take title to goods or trade for their own account. The EMC

acted as the export department for another company, taking

over most of the technical export responsibilities.’ The EMC

found buyers in foreign markets, negotiated the sale including

delivery and payment terms, prepared export documentation,

handled document transmittal, collected from the buyer, and

remitted funds to the supplier. The EMC usually was paid

‘U S Department of Commerce, U.S. Export Management Companies,

Washington, DC, 1981, p. 189. Some publications refer to export

management companies as a type of export representative. For two

definitions, see National Association of Export Companies, Inc.

(NAEC), A Profile of the Export Trading Company Industry, New York,

NY.. 1981. D. 3. and Hay Associates. A Studvro Determine the Feasibilitv

of the Expiri Trading Co&puny Concept, unpiblished report to the U.S.”

Departmeni of Commerce, March 1977.

commission but may also have received a salary, a retainer

plus commission, or other compensation negotiated in

advance with the supplier. Payment risk and title, however,

usually remained with the supplier, the EMC being only an

intermediary.

In exporting food products, EMC commission arrangements

are declining and account for only a small percentage of sales.

Both suppliers and exporters now prefer that the EMC take

title to goods and accept the accompanying risks.

Export Trading Companies (ETC’s)

Export trading companies are characterized as principals in

export of goods and services. They purchase product from

suppliers, often on similar terms as for domestic sales, export

the product, and then collect from buyers. They conduct all

export-related activities plus assume title and payment risk.

Compensation for their services comes from the difference

between buying and selling prices the ETC is able to negotiate.

ETC’s are sometimes referred to as export distributors.*

The Export Trading Company Act of 1982 established rules

under which U.S. companies can join io export goods and

services. The Act differs from prior legislation, the WebbPomerene Act, in that it allows banking interests to have

equity investments in trading companies (Title II). In

addition, the Act provides limited antitrust protection by

giving qualified ETC’s prior clearance to engage in specified

export trade activities (Title III). Any exporter may apply for

antitrust certification. The legislation defines export trading

companies in broad terms, so ETC’s under the Act may not

resemble the types of ETC’s described above. Requirements

to set up regulations governing Title II and Title III ETC’s are

reviewed in appendix A.

Foreign Sales Corporations (FSC’s) and Domestic

international Sales Corporations (DISC’s)

As part of the Deficit Reduction Act of 1984, Congress made

significant changes to the DISC. DISC’s were essentially paper

corporations allowing exporters to postpone a portion of their

Federal income tax on exports. Changing from DISC’s to

FSC’s was primarily in response to complaints from several

foreign countries that DISC rules created an illegal export

2U.S. Department of Commerce, 1981, p. 189.
subsidy under terms of the General Agreement on Tariffs and

Trade. In most cases, DISC’s are replaced with FSC’s.

An FSC is a new legal entity providing tax incentives to

exporters. Under the legislation, a portion of foreign trade

income of an FSC is exempt from U.S. income tax. To obtain

the exemption, an FSC must meet certain requirements.

Unlike a DISC, the FSC must be a foreign corporation and

meet certain economtc ac!ivities tests. FSC provisions and

regulations are reviewed in appendices B and C.

Other Export Associations

Webb-Pomerene associations allow U.S. suppliers to join to

fix prices and allocate market shares when exporting. Only a

few associations have existed and most have been inactive

over long periods of time. These associations may apply for

certification under the Export Trading Company Act.

Although Webb-Pomerene associations may still be formed,

the number of associations will probably decline.

Terminology Used in this Report

This report focuses on EMC’s and ETC’s as two generalized

forms of export trading companies. Today they are essentially

the same. The term EMC is sometimes used to refer to

companies exporting under commission arrangements with

title and acting as principals in the export transaction. The

term “exporter” or “export company” is used to refer to both

types of companies. Export companies organized under the

Export Trading Company Act with banks as equity

participants or with antitrust certification, will be referred to as

Title II and Title III ETC’s, respectively.

Export management and export trading companies handle a

wide variety of products and services. The description that

follows focuses on those that export agricultural and food

products. References to “all exporters” means those handling

all products, including nonagricultural as well as agricultural

and food products.

ETC’s Are Most Common

The ETC is by far the most important type of exporting

arrangement for agricultural and food exports. With

agriculture and food commodities, including many nonfood

consumer goods typically found in supermarkets, almost all

transactions are conducted on a buy/sell basis. Few

commission sales still occur. In most cases, both the export

company and supplier prefer a buy/sell relationship.

Taking title provides the exporter complete control over

shipment, documentation, and collections. Suppliers prefer

this arrangement, which resembles a domestic sale, because it

allows them overseas distribution of their products without

the costs and risks of exporting.

Even if approached by a supplier to work on a commission

basis, most export companies are reluctant to do so, as they

feel suppliers may eventually “quit” the export company to

supply directly markets developed by that exporter.

To be sure, most export companies will, if requested, provide

management services for commission, but report they are

seldom asked to do so.

DESCRIPTION OF COMPANIES

Location

While exporting companies are spread throughout the United

States, most are in port cities. For agricultural and food

products, there is some concentration of companies in New

York, New Orleans, Los Angeles, and San Francisco. In

general, export company offices may be located anywhere. An

important exception is that a California location is preferred

for fresh fruit and vegetable exporters to Pacific rim countries.

Oflice location should not affect performance as long as the

location permits efficient international communications.

International travel is easier from large cities and remote

location may reduce direct contact with foreign buyers. Travel

by employees of the exporting company in a remote location

would also be more difficult, but for the two to five trips per

year typical for each trader, the inconvenience and extra cost

are small.

Age

Most exporting companies have considerable trade

experience. Spiewak and Maritz reported 36 percent of all

exporters had been in business 20 or more years and 62

percent had been in business 10 or more years.3

Principal owners and traders usually have many years of

experience in international trade. Most companies in business

10 or fewer years have principal owners with many more years

of international trade experience.

Despite the longevity of many traders, there is significant

entry and exit by companies in the industry. Because of the

low cost of entry, there will always be new small exporting

companies. Many companies are closely tied to one or a few

principal traders and may go out of business or be absorbed by

other companies when a principal trader leaves. However,

there is some evidence of a trend toward larger exporting

companies.

‘Spiewak and Maritz, p. 6.

2
Revenues

Most exporters are small. In 1983, two-thirds of exporters had

annual revenues of less than $5 million4 Only 2 percent had

revenues exceeding $50 million. Exporters handling

agricultural commodities and food products usually have

larger gross revenues than export companies handling

manufactured products, but they also have smaller margins.

Even so, many successful and well established export

companies specializing in agricultural and food exports have

annual gross revenues of less than $10 million.

contact is an employee or an independent agent.

Employees

In line with their small revenues, most export companies have

few employees. A minimum size for effective operations

seems to be two or three traders and associated clerical

assistance. Some companies may have a few more but only the

largest companies would have 20 or more employees.

Foreign Offices and Contacts

Export companies rely on extensive foreign contacts, but few

maintain foreign offtces. In fact, the reason these companies

exist is they are specialists in identifying opportunities for

trade in foreign markets. They have contacts in many

countries and have extensive experience in identifying

products that will sell in foreign markets. For products that

appear promising, exporting companies usually know or can

find importers or distributors willing to test market the

product in their countries.

Developing Foreign Markets

Few export companies conduct formal foreign market

research and development. Most rely on their own and their

agent’s extensive knowledge of specific markets to identify

opportunities and position products. Significant market

development efforts are dependent of the foreign distributor

or importer, which often limits market development to

products that can quickly generate large sales. New products

requiring large amounts of training or consulting on how to

handle, process, or use are unlikely to receive serious

consideration. Larger export companies are more likely to

undertake market development efforts, but even their efforts

may be limited for some products.

Only a few larger export companies have overseas employees

or offtces. Having foreign employees, however, does no

necessarily mean an exporter will dedicate much time to

longrun market development programs. The low export

margins for agricultural and food products usually do not

allow such expenditures regardless of whether the foreign

Some companies may provide foreign warehousing and

distribution services, but this has little bearing on whether the

exporter would be willing to undertake longrun market

development.

Number of Suppliers and Customers

Exporting companies typically obtain export products from

many suppliers, and supply product to many foreign

customers. It is common for a small food exporting company

to purchase products from 20 to 80 sources and to sell to a

hundred or more buyers. Large exporters may deal with 100

to 200 suppliers and an equal number of buyers.

Usually a large percentage of product traded by either large or

small exporters is accounted for by a few suppliers and a few

buyers. A typical small exporting company may have 5 to 20

suppliers and an equal number of buyers that account for a

two-thirds or larger share of the business. Spiewak and Maritz

reported 63 percent of all exporters had 60 percent or more of

their business represented by the top 5 suppliers.’ It is typical

for an export company to have several major branded

products it distributes to markets in one or more regions.

Orders for less than a full shipping container load of branded

products are filled out with a variety of other products. Some

of these may be products the exporter normally ships, or it

may be products the importer has requested.

TYPICAL SERVICES PROVIDED

BY EXPORTING COMPANIES

Table 1 indicates services offered by all export companies.

Locating and training foreign distributors, agents, and buyers

is the most frequent service offered. Other frequently offered

services include setting or recommending prices, conducting

market research, foreign language assistance, credit analysis,

participation in trade shows, and arranging for servicing

products overseas.

Companies exporting food and agricultural products offer

similar services, but some less frequently than indicated in

table 1. For example, 91 percent of all export companies

reported “always” or “sometimes” offering foreign language

assistance. Agricultural products, however, are purchased

from the U.S. supplier much like a domestic sale, with the

export company handling documentation, shipping, and

collection arrangements. The U.S. supplier has little need for

foreign language assistance.

For similar reasons, exporters seldom provide credit

4Spiewak and Maritz, p. 7. %piewak and Maritz, p. 13.
Table 1 -Frequency of services provided

by all export companies

Service Always

Sometimes Never

Locating distributors, agents, buyers

Setting or recommending prices

Market research’

Providing insurance

Acting as own freight forwarder

or shipper

Advertising assistance

Assisting in developing packaging

and labels

Modifying products

Foreign language assistance’

Credit analysis’

Participating in trade shows’

Training of distributors and/or agents’

Arranging for servicing products

overseas’

Arranging licensing for foreign

manufacturing’

Arranging warehousing’

Warehousing in own U.S. facilities’

Warehousing in own facilities abroad’

Percent

62 14

62 31

50 42

46 32

46 39

37 42

27 51

10 55

56 35

55 33

39 50

6 37

36 47

9 9

17 52

19 34

10 21

4

5

6

20

32

20

20

33

6

10

9

13

14

41

29

45

66

Source: Spiewak and Maritz, p. 16.

’ Companies exporting agricultural and food products provide these

services less frequently than indicated here.

information to suppliers, although they routinely conduct

credit analysis for in-house use. Exporters will, however,

supply credit information to suppliers they represent on a

commission basis.

Participation in trade shows is usually a minor activity for

exporters of agricultural and food products. Most participate

in occasional shows, often at the request of a supplier or

foreign importer.

Agricultural and food products seldom require training of

foreign distributors or agents because importers are usually

familiar with these products before ordering. If requested by

importers, export companies will provide product literature

obtained from the supplier. Agricultural and food products

usually do not require servicing of products overseas.

Most export companies handle export documentation inhouse, but still retain services of freight forwarders for special

documents such as consular invoices, and for document

transmittal. Some exporters can prepare documents in less

time than it takes to transmit the information to a forwarder.

Companies exporting food and agricultural products seldom

perform the last four licensing and warehousing functions in

table 1. There are few requests to license foreign processing of

food products. Most exporting companies indicate they are

willing to assist in licensing requests but are seldom asked.

Foreign warehousing services are seldom provided by

exporters, except for a few larger traders. Likewise, few

exporting companies own or operate domestic warehouse

facilities. Many companies will, however, arrange for U.S. port

warehousing if desired by the supplier. In the food industry, it

is more common for suppliers to deliver products to dockside

and provide temporary warehousing if necessary. With

container shipments, dockside warehousing should seldom be

needed.

PRODUCTS HANDLED

Export companies usually specialize in a few, related products,

although, as mentioned, they may deal in a large number of

different products by request of customers and suppliers. In

the food and agriculture sector, exporting companies have

specialized in three major areas. These are processed food

products; fresh fruits and vegetables, including nuts; and bulk

grains, oilseeds, and related products.

Processed Food Products

Processed food product companies are the largest group. Their

expertise lies in exporting products in consumer-ready

packages for retail sale and in institutional food service

products. Headquarters location may be less important for this

group than for the other two.

This group of companies has a strong preference for wellestablished regionally or nationally branded consumer

products. Foreign buyers with access to American trade and

food industry magazines often see products advertised that

they believe will sell in the markets they serve and often

request these products by brand. Brand name requests are

often used to assure product quality.

Because of strong brand preference by foreign buyers, there is

intense competition by export companies to obtain trading

rights to these products. Successful exporters in the processed

food products group usually have obtained representation

rights to one or more nationally advertised products. The

exporting companies may represent the product worldwide,

although it is more common to represent it in selected regions.

Although desired, the export company may not have

exclusive rights even in the markets it serves.

Exports companies having exclusive rights to a nationally

branded product are more willing to incur expenses and take

time needed to conduct market development in foreign

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markets. If a significant expenditure of time and money is

expected, an export company may require a long agreement

or, occasionally, a retainer. Extended marketing agreements

are usually for 1 to 3 years, with the shorter periods being

more common. Terms of an agreement can be quite flexible

and are subject to negotiation with each supplier, and perhaps

in each region or market. Marketing agreements are usually

contained in letters of understanding. Formal written

contracts are seldom prepared, except where large market

development expenditures are likely to be incurred by the

exporter.

Fresh Fruits, Vegetables, and Nuts

Companies that export fresh agricultural products tend to be

located near production areas. The largest concentration in the

United States is in California, and within California in the San

Francisco Bay area.

While still important, brand identification is less a factor for

fresh than for processed products. Products are often

purchased based on U.S. Department of Agriculture grades

specified in the sales contract. Branded products, however, are

sometimes requested by buyers to help ensure quality.

Companies that export fresh products make significant efforts

to ensure consistent product quality to buyers. Larger

companies often employ field inspectors to examine product

at packing houses. Buyers may request product from particular

packers that have reputations for high quality. Ofcourse, price

must be competitive.

Bulk Grains, Oilseeds, and Related Products

While fewest in number, these companies are largest in

volume of sales. This sector is dominated by large

multinational export companies. Economics of scale preclude

small companies from having anything but a peripheral role in

exports of grains and oilseeds.

Other Commodities

Two commodities that do not fit neatly into the above

classifications are cotton and rice. Several exporting

companies specialize in cotton exporting. While U.S. cotton is

usually exported as a bulk, unprocessed agricultural product,

marketing requirements for quality usually make selling

methods more like processed food products than bulk grains

and oilseeds.

Several regional cotton marketing cooperatives make export

sales ofcotton through Amcot, a joint marketing agency. This

joint arrangement provides centralized representation by

Amcot personnel in foreign markets, while each individual

cooperative continues individual merchandising by its home

sales staff.

Rice may be marketed as a processed food product or as a bulk

grain. When marketed like a processed food product, rice is

usually packaged in bags, and often shipped in containers.

Many export sales are prepackaged for retail consumer or

institutional use. Ocean shipping is often via scheduled ocean

liners. Sales contracts specify specific qualities, and are usually

in smaller lots than bulk grains. Because trading methods are

the same, some exporting companies handling processed

foods also handle rice exports. These companies are usually

the larger exporters.

When rice is marketed as a bulk grain, it may be bulk loaded

into ships but is usually bagged. Sales quantities are usually

large. Ocean shipping is typically via charter ships. Exporters

of bulk grains and oilseed often market bulk rice as well.

Support by the Supplier

Regardless of product exported, companies that buy and sell

for their own account and those that sell on commission stress

the need for support from suppliers. Even though the trading

company may take title and bear the risk of delivery and

collections, it is important that a supplier cooperate with

respect to product quality, continuity of supply, and label

content. The supplier needs to be willing to modify product or

packaging or shipping schedules, or other items to adapt to

foreign market preferences. This requires the supplier be

committed to exporting for the long term.

MARKET COVERAGE

Regardless of size or location, most export companies are

willing to trade with any country. As a practical matter,

however, many companies, especially smaller ones, conduct

most trade in a few regions. There are several reasons. First,

export companies having regional marketing rights to a major

branded product will emphasize marketing of complimentary

products in those same markets. This occurs naturally because

many buyers request an exporting company handling the

branded product to supply it with other food and consumer

products. Economics of scale in transportation and document

preparation also encourage sales of different products to the

same market.

A second major reasons companies today operate in only a few

markets is because under current economic conditions, some

regions are only limited importers. Europe, for example, is a

limited market for many U.S. food products. Much of Latin

America lacks sufficient foreign exchange for imports. Certain

Middle Eastern and Pacific Rim countries are the most

important importers of processed food products from the

United States. Many export companies are active in these

markets.

While export companies in general are willing to trade with

any country, they might not market a particular product in a

5
particular country. For most exporters, the nature of the

product to be exported is the most important criterion in

deciding to promote a product. If the product is a high-quality,

nationally advertised product the company believes will sell,

the exporter may undertake to introduce it not only in the

markets it currently exports to, but in other markets as well.

The “right” product may very well be the entry vehicle for the

exporter into new markets.

It is difficult for the exporter to find high-quality products with

sufficient sales potential to establish new markets. Even if

discovered, the exporter will likely face intense competition

from other companies that are seeking market rights to the

same product.

Not all export companies are equally skilled or have as many

contacts as others. A U.S. processor or producer seeking an

exporting company should determine which exporter or

combination of exporters can best represent it in markets

where it believes its product will sell.

Most, but not all, exporters prefer exclusive rights to a

product in as many markets as they can effectively serve.6

Exclusive marketing rights may free the exporter from cutthroat price competition that may otherwise occur. Pricing

freedoms thus gained may be marginal, however, because

other exporters can likely procure the product from

wholesalers and brokers and sell in the same market.

Exclusive rights agreements are usually longer term

agreements and may pose some risks for both exporter and

supplier. If the product is not successful, the exporter may not

be able to drop the line and handle competitors’ products.

Likewise, if the exporter with exclusive rights does not

effectively promote the product, the supplier may not be able

to select another exporter. In summary, granting exclusive

marketing rights has potential to improve profit levels, but

risks are involved for both.

FEES, MARGINS, AND COSTS

Nearly all export companies handling food and agricultural

products trade for their own account. The exporter procures

product from the supplier at domestic wholesale prices or a

lower negotiated price; for example, domestic wholesale price

less domestic sales overhead. Terms are usually either free on

board (f.o.b.1 manufacturing plant, in which case the exporter

will arrange to have a container shipped to the plant for

loading, or f.o.b. or free along side (f.a.s.1 port, in which case

the supplier pays freight to port.

6Exclusive marketing rights means a supplier sells to only one

exporter for a particular market. Likewise, the exporter does not sell

competing products in that market.

Export companies trading food and agricultural products on

their own account typically work with small margins compared

with companies exporting nonagricultural products.’ Most of

these companies try to obtain margins of 4 to 7 percent.

Unprocessed fruit and vegetable exporters usually have lower

margins, typically 1.5 to 4 percent. Large-volume sales may

also obtain lower margins.

Exporters trading for their own account usually accept risk of

delivery and collections. Product damaged or lost in transit is

usually covered by insurance. Political and commercial risks

are also usually assumed by the exporter, although in some

cases these can be insured. Exporters usually assume risks for

losses based on documentation, and customs problems. Some

exporters also assume the risk of labeling and assuring that

products meet quality and safety standards in the importing

country.*

Risk of product quality may or may not be assumed by the

exporter. Claims against product arriving in poor quality will

likely be made against the transportation company, the

exporter, or both depending on the circumstances of the

situation. Exporters, however, will usually look to suppliers

for satisfaction of claims against product quality.

Fresh fruit and vegetable exporters often obtain U.S.

Department of Agriculture inspection certificates for their

products. Claims against product arriving in poor quality may

be defended based on the USDA certificate. If not successful,

an exporter will still look to the supplier for redress of any

losses suffered because of product quality.

Interim financing-financing between the time the exporter

must pay the supplier and the time the exporter can collect

from the buyer-is usually assumed by the exporter. If interim

financing needs are especially large, exporters may discount

receivables at commercial banks.

In certain circumstances, export companies still work on a

commission basis. This was more common in the past and

several suppliers with longstanding export management

company arrangements retain those relationships.

Export companies acting as commission agents negotiate

‘Margins as referred to in the next few paragraphs equal selling price

to foreign buyer less the sum of procurement price paid to supplier,

transportation costs, and ocean freight insurance costs. Other exporter

costs such as documentation, communications, salaries, short-term

interim financing costs, and office overhead are paid out of margins.

*Assuming risk of labeling and antiboycott restrictions is an important

service provided by trading companies doing business in some Middle

Eastern countries. Trading companies with extensive experience in

these areas will usually assume risk of product labeling. If they are

buying and selling on their own account, they then assume risk of

complying with antiboycott legislation.

6
appropriate fees with supplying companies. Fees can vary

widely depending on services rendered and risks accepted.

Most fees for established products with moderate sales

volume range from 2 to 4 percent of sales value. If sales or

transactions are large and services needed are minimal, fees

are typically near 1 percent. Fees are usually negotiated and

remain in force over an agreed time period. In some cases,

however, fees are negotiated for individual sales.

If significant additional services are needed or if the exporter

is to accept payment or credit risk, then fees can be much

higher. In these cases, fees of 5 to 7 percent of sales value are

common.

Even these higher fees will purchase only a limited amount of

market development services. If a product appears promising

for successful sales in foreign markets, an export company

may be willing to accept a moderate fee level in exchange for a

longer term commitment by the supplier. Usually, however,

only larger export companies are willing to risk much market

development work in exchange for long-term marketing

agreements.

OWNERSHIP AND FINANCIAL STRUCTURE

Most exporting companies are small and closely held,

independent corporations. The principal owners often are also

the principal traders. These companies usually have salaried

clerical employees. Few companies own or operate foreign

businesses or have foreign employees. Most have extensive

contacts with foreign businesses but these relationships

seldom contain formal ties of ownership or decisionmaking

authority.

Larger companies usually have a more complex structure.

Almost all are closely held corporations. Owners are often

“CEO’s,” “vice presidents,” or “managers.” Despite these

titles, these people are usually traders also, although they do

not involve themselves in details of every transaction as do

owners of smaller companies. Nevertheless, they still interact

personally with suppliers and buyers. In addition to owners,

traders on staff may be salaried, paid on commission, or a

combination of each. Clerical employees are salaried.

Larger companies have more formalized relationships in

foreign countries. Some own or operate warehouses to handle

foreign inland distribution while others have foreign offices.

The primary function of foreign employees is to supervise

sales and service in that region, and to provide sales leads. A

secondary function, but one that is critical in some situations,

is to provide market and credit intelligence. Companies with

foreign employees often rely on them as part of their risk

management.

With the exception of salaries, overhead costs are usually

small, consisting primarily of office rent, supplies,

communications, and travel. Of these, travel and

communications are usually the largest.

ADVANTAGES OF AN EMC OR ETC

Many small- to medium-sized cooperatives should consider

using export management or trading companies to promote

foreign sales. Often these companies can provide better

services than in-house staff. Even larger cooperatives may

find their services useful in some situations.

When deciding on an export company, some major

differences should be noted between export management or

an export trading company. For companies exporting food and

agricultural products, the preference is usually an export

trading company.

Lower Initial Investment

Most suppliers utilize export companies as an opportunity to

expand markets without incurring development costs and

risks. In most cases, companies can make domestic sales to an

ETC without learning marketing skills or taking risks in

foreign markets. As foreign sales of their products begin to

increase, many companies reevaluate the trading company

relationship to determine if an in-house exporting effort

would be profitable.

Initial investment costs may be required also to modify ’

products for foreign markets. An experienced trader should

be able to identify needed changes early in the export effort.

Distribution to More Markets

For suppliers new to international trade, export companies

can provide faster access to more foreign markets than the

supplier. The strength of export companies is their extensive

contacts with foreign distributors, many of whom are willing

to try new products in their markets. Also, except for the

smallest and very specialized companies, exporters can place

products in several markets within a short period. A new

product can penetrate a market rapidly.

Less Risk

Export companies usually have long experience in the

markets they serve and they are aware of business customs

and import regulations. This experience avoids expensive

marketing mistakes made by many companies new to

exporting. Some foreign countries have unusually difficult

import regulations. Exporting companies that take title to the

goods they export accept this risk, which they can usually do

with less expense than the supplier.

7
U.S. export regulations sometimes increase risk for exporters.

The antiboycott legislation for exports to Arabic countries

poses significant risks for U.S. companies not familiar with the

regulations. Also, export licensing regulations for sensitive

products to certain centrally planned countries are less

complex than antiboycott regulations but are being changed.

Lower Exporting Costs for Some Markets

Economies of scale in exporting are significant for some

commodities and some functions. Consolidating shipments to

reduce shipping costs as well as selling costs is a major reason

export companies continue to exist. For small or infrequent

exports, an export company is usually less expensive than if

the supplier tried to do its own exporting. Exporters’

- 2%iIinotiar cos&mr ~~nnklnm_br~S’rney’aIre~~y serve-is

relatively low.

Exporting Specialists on Call

Although exporting companies typically buy product from

suppliers as if the sale were a domestic transaction, suppliers

occasionally receive questions or product inquiries from

foreign importers. Export companies usually will assist the

supplier responding to these inquiries. Also, export

companies will assist in modifying or preparing the supplier’s

product to be more attractive in foreign markets.

Avoiding Expensive Traders

For export markets with limited growth potential, an

experienced international trader will not necessarily be able to

expand sales. A projection of significant long-term sales

should be made before hiring such a person.

Money Received Sooner

Selling through an export company makes the transaction

much like a domestic transaction, thus avoiding international

delays in receiving payment. Collecting from foreign buyers

can be a lengthy process. Usual float time (the time between

shipping the goods and receiving payment) for letter of credit

is about 5 to 10 days. Float times for sight draft, cash against

documents, or other terms are usually 30 to 60 days.

Transactions that encounter difficulties may take significantly

longer to collect. Export trading companies usually provide

this interim financing, covering their cost out of the difference

between their buying and selling prices.

DISADVANTAGES OF AN EMC OR ETC

Handling and Distribution

Products requiring specialized handling and care or extensive

training for foreign buyers may not receive adequate service

from some export companies. Exporters vary in their ability to

handle new or nontraditional products. A supplier with

unusual needs should contact several exporters to determine

which may best provide special services. In some cases, a

supplier may find it easier to train its own product specialists

to make foreign sales than train export company personnel in

product use and special handling requirements.

Pricing and Merchandising Technique

Proper pricing and merchandising are important to establish

the reputation of a brand as a premium quality product.

Improper merchandising technique may diminish brand

identity, resulting in lower margins to exporters. Selling direct

from supplier to foreign distributor enhances the ability to

-zotra~rm’cr~~~~~ng~~cn.mques ada prices: h/lost export

companies will work closely with the supplier in establishing

pricing policy.

Limited Market Development

Most export companies work on slim margins and are usually

reluctant to conduct long-term market development work

without additional compensation. Additional compensation

usually is sought in exclusive long-term marketing

agreements. Even so, most exporting companies rely on

foreign distributors to test the market. Suppliers would have

little control of test marketing procedures and feedback may

be distorted by passing through one or more traders.

Higher Costs with Large Guantities

Suppliers with large shipments to particular markets can save

money having their own export department. Often, however,

although sales are large enough in one market to justify an inhouse department, exports to many other markets may be

small and best suited for handling through an outside

company. Competition forces exporting companies to adjust

their fees to the size of a sale, or to the quantity of annual

sales.

Less Motivated to Promote Low Margin Products

As any well-managed company would, export companies

focus attention on those sales that they expect to carry the

highest profit margin. Food products tend to be lower margin

products than other manufactured products. Within the food

group, more highly processed products tend to carry larger

margins, and hence may receive more attention from export

companies.

Limited Geographic Coverage

Although most export companies have skills to export to any

country, in fact many only provide services in specific regions.

Their ability to successfully export a supplier’s product may

8
vary significantly. The success of an export company is often

dependent on the distributors it serves in foreign markets. To

enter new markets, an export company may not necessarily be

more successful than the supplier itself, particularly if the

export company has not been active in that market.

FSC Legislation

Selling through a U.S.-based export company may preclude

the supplier from directly taking tax advantages of a foreign

sales corporation (FSC). If the exporter handles the

supplier’s product through an FSC, then the supplier may not

also assign the same sale through its own FSC. Both supplier

and exporter may operate FSC’s, but any one sale may be

reported only under one FSC. It is anticipated that export

companies will establish FSC’s, and tax benefits that accrue

may be partially passed on to suppliers in the form of higher

prices.

Limited Service by Some Companies

Most export companies offer exporting services in a rather

limited spectrum, both with respect to the functions they

perform, and the products and markets they actively serve. A

few of the larger companies offer more services, for which

they usually must obtain a greater margin on sales.

References

1. Chew, Ralph, “Export Trading Companies: Current

Legislation, Regulation and Commercial Bank Involvement,”

Columbia Journal of World Business, Columbia University,

Winter 1981, pp. 42-27.

2. Hay Associates, “A Study to Determine the Feasibility of

the Export Trading Company Concept as a Viable Vehicle for

Expansion of United States Exports,” Contract number 6

36234, U.S. Department of Commerce, Washington, DC,

1977.

3. Kennedy, Tracey L., Agricultural Exports by Cooperatives,

1980, ACS Service Report 26, U.S. Department of

Agriculture, Washington, DC, 1982.

4. National Association of Export Companies, Inc., “A Profile

of the Export Trading Company Industry,” New York, NY,

July 1981.

5. Spiewak, Roy J., and Kristine H. Maritz, Export

Management Companies-A New Look at a Changing Industry,

Coopers & Lybrand, Washington, DC, 1984.

6. U.S. Department of Commerce, Export Trading Companies -

Contact Facilitation Service Directory, International Trade

Administration, Washington, DC, 1984.

7. U.S. Department of Commerce, Export Trading Company

Guidebook, International Trade Administration, Washington,

DC, 1984.

8. U.S. Department of Commerce, U.S. Exhort Management

Companies, International Trade Administration, Washington,

DC, 1981.

9
Appendlx A: Export Trading Company Act of 1982

The Export Trading Company Act of 1982 allows U.S.

businesses to join for the purpose of exporting. This Act

differs from past legislation in that it allows banking and

service entities to have an equity interest in export trading

companies. In addition, the Act provides limited antitrust

immunity for approved export activities. The intent of these

provisions is to increase U.S. exports by making U.S. products

more competitive in world markets. The Act is further

designed to encourage small- and medium-sized firms in

particular to begin exporting or to enhance existing export

activities.

The Export Trading Company Act does not supersede the

Webb-Pomerene Act. Exporters may still register as WebbPomerene associations, although that legislation does not

provide prior clearance to exempt activities from antitrust

laws and does not allow for the export of services. WebbPomerene associations may invest in ETCs and may apply for

certification under ETC regulations.

Prior to the passage of the Act, restrictive banking regulations

and uncertainties in antitrust laws inhibited the development

ofjoint exporting organizations by combinations of producers,

manufacturers, banks, and export service companies. The Act

provides some relief from these impediments by allowing

banks to invest in ETCs, by providing limited antitrust

protection in the performance of specified trade activities and

by providing for the export of services.

Permitted Activities

An ETC is allowed to perform any or all services related to

exporting, including market research, promotion, export

financing, warehousing, shipping, insurance, documentation,

distribution, currency transactions, and market intelligence.

An ETC can take title to the goods it exports or act as a

commission agent, and can provide services to nonmembers

on a fee basis.

It may be necessary to engage in certain other trade activities

to gain access to certain markets. Accordingly, ETC’s are also

allowed to engage in importing and other trade activities such

as barter or countertrade arrangements. It should be noted,

however, that the Federal Reserve Board requires that Title II

ETC’s (ETC’S with bank equity) conduct countertrade

activities only “where necessary or useful in the conduct of an

export trading company’s primary business of exporting, so

that the revenues generated by the nonexporting activities

should not exceed the export trading company’s export

revenues.“9

9U.S. Department of Commerce, ETC Guidebook, 1984.

Bank Participation

Title II of the Act, the Bank Export Services Act, relieves

restrictions on banking practices by allowing equity

investments in ETC’s by bank holding companies, banker’s

banks, and Edge Act Corporations.1o

These types of banking institutions, subject to the approval of

the Federal Reserve Board, may own as much as 100 percent

of the stock in an ETC, as long as the total investment in all

ETC’s by a particular bank is limited to 5 percent of the bank’s

capital and surplus. Loans to ETC’s are limited to 10 percent

of the bank’s capital and surplus.

Title II also makes provisions for export financing by directing

the Eximbank to develop loan guarantee programs for ETC’s

and other exporters. It is intended that small- and mediumsized businesses, minority businesses, and agricultural

concerns be the primary beneticiaries of those loan

guarantees.

Export trading companies formed under Title II with banks as

investors must be organized principally to export with at least

50 percent of their business being derived from export

activities.

Antitrust Certification

Title III of the Export Trading Company Act is known as

Export Trade Certificates of Review and provides limited

antitrust protection through a review procedure that gives

qualified ETCs or any other exporter prior clearance to engage

in specified trade activities. An ETC is certified by the

Department of Commerce, with concurrence of the Justice

Department if it can establish that it:

1. Will not substantially lessen competition or restrain trade in

the U.S. or restrain the export trade of a U.S. competitor.

2. Will not unreasonably enhance, stabilize, or depress prices

in the U.S.

3. Will not constitute an unfair method of competition.

4. Will not result in the sale or resale in the U.S. of the

exported goods or services.

“Bank holding companies own at least 25 aercent ofanv bank and are

registered with the Federal Reserve Board’(FRB) unde; the Bank

Holding Company Act. Banker’s banks are individual banks whose

only clients are other banks. Small banks form them to offer services

they could not offer independently. Allowing banker’s banks to

participate in ETC’s should encourage regional and small bank

investment in joint ventures. Edge Act Corporations are chartered,

supervised, and examined by the FRB to engage in foreign or

international banking or financial operations.

1 0
Once the certificate is issued, the ETC will generally be

exempt from civil and criminal liability under Federal and

State antitrust laws. However, private parties may sue for

actual damages on the ground that the conduct failed to

comply with the four eligibility standards listed above. Prior to

the ETC Act, private parties could sue for treble damages in

such cases. If the holder of the certificate prevails in such a

suit, he may recover the costs of defending against the suit,

including reasonable attorney’s fees.

of information related to application. Any information

officially submitted in connection with an application for a

certificate of review is exempt from disclosure under the

Freedom of Information Act. In addition, the applicant is

allowed to draft his own summary for the required publication

in the Federal Register.

There is no minimum export requirement for nonbank

ETC’s, but only export activities are eligible for certification

under Title III, even if exporting is a small part of a company’s

total business.

Only export conduct and conduct related to provision of

export trade facilitation services is eligible for certification

under Title III. This includes technology licensing, but not

overseas investment.

Certification Procedure

Any “person” can apply for an export trade certificate of

review. “Person” is defined in Title II as:

1. Any individual who is a resident of the U.S.;

2. A partnership formed under the laws of any State or the

U.S.;

3. State or local government entity;

4. A corporation (profit or nonprofit) formed under the laws

of any State or the U.S.;

5. Any association or combination, by contract or other

arrangement, between or among such persons;

6. Foreign persons can apply as members of a U.S. trading

entity.

The U.S. Department of Commerce’s Office of Export

Trading Company Affairs offers free preapplication

counseling to exporters applying for an export trade certificate

of review.

Once an application has been submitted, the Department has

5 days to review the application for completeness before it is

deemed submitted. Once it is deemed submitted, Commerce

has 90 days to issue or decline to issue a certificate. Commerce

can extend the 90-day limit only with the applicant’s consent.

Application for a certificate of review involves the disclosure

to the Government of business plans, and other financial and

commercial information that could be deemed confidential.

However, steps have been taken to protect the confidentiality

11
Appendix B: Tax Reform Act of 1984;

Foreign Sales Corporations

The Tax Reform Act of 1984 amended the Internal Revenue

Code to provide for the establishment of Foreign Sales

Corporations (FSC). This legislation was drafted in response

to objections made by U.S. trading partners in the General

Agreement on Tariffs and Trade (GATT) that DISC’s

constituted illegal tax subsidies for exports. The FSC incentive

requires the exporter to be incorporated and have economic

activity outside U.S. customs territory, thereby not violating

GATT antisubsidy rules. Transactions by the FSC must satisfy

certain managerial and economic tests. The legislation

provides alternatives for smaller exporters in the form of

“small FSCs” and “interest-charge DISC’s”

The Act exempts a portion of export income of a qualified

foreign sales corporation from Federal income tax. In

addition, a domestic corporation is allowed 100 percent

dividends-received deduction for dividends distributed from

the FSC out of earnings attributable to certain foreign trade

income. This eliminates corporate level tax for a portion of the

income from exports.

FSC rules replacing DISCS became effective January I, 1985,

and included transition rules allowing deferred tax on income

of a DISC meeting qualification requirements as of December

3 1, 1984, to be forever forgiven when actually distributed.

Qualification as an FSC

To qualify for preferential tax treatment, a corporation must

meet the statutory definition of an FSC and satisfy the tests

for foreign management and economic processes.

Foreign Presence Test

A corporation must tile an election to become an FSC with the

Internal Revenue Service and satisfy each of the following

“foreign presence” requirements:

1. An FSC must be a corporation chartered under laws in a

jurisdiction outside U.S. customs territory. This includes any

U.S. possession except Puerto Rico (i.e., Guam, the Virgin

Islands, American Samoa, and the Northern Mariana

Islands), countries with an exchange of information

agreement with the U.S. that meets standards of the

Caribbean Basin legislation (section 274(h) (6)(C)), and

approved foreign countries with which the U.S. has an

agreement for the exchange of tax information. Approved

countries include: Australia, Austria, Barbados, Belgium,

Canada, Denmark, Egypt, Finland, France, West Germany,

Iceland, Ireland, Jamaica, South Korea, Malta, Morocco,

Netherlands, New Zealand, Norway, Pakistan, Philippines,

South Africa, Sweden, and Trinidad and Tobago.

2. An FSC may not have more than 25 shareholders at

anytime during the taxable year. Directors holding shares

required to be owned by a resident of the country under whose

laws the FSC is organized are not counted as shareholders for

this requirement.

3. An FSC may not have any preferred stock outstanding

during the taxable year. The FSC is allowed to create more

than one class of common stock so long as none of the rights

of a class of stock has the effect of avoidance of Federal

income tax.

4. An FSC must maintain a “permanent” office location in an

approved country outside the U.S.

5. The foreign office must maintain a permanent set of books

that must include invoices, quarterly income statements, and

a year-end balance sheet of the FSC. The FSC must maintain

similar records in the U.S.

6. At least one member of the FSC’s board of directors must

be a resident of the country under whose laws the FSC is

organized, but this person may be a U.S. citizen.

7. The FSC may not be a member of a controlled group of

corporations that includes a DISC.

Foreign Management Requirement

There are three requirements to satisfy the stipulation that the

management of an FSC during the taxable year take place

outside the United States:

1. All meetings of the FSC’s board of directors and

shareholders must be held outside the U.S.

2. The principal bank account of the FSC must be maintained

outside the U.S. during the taxable year.

3. Payment of dividends, legal and accounting fees, and

salaries of officers and members of the board of directors must

be disbursed out of bank accounts of the FSC maintained

outside the U.S.

Management activities need not be performed in the country

where the FSC is organized, unless required by local law. They

need only be performed outside the U.S.

Foreign Economic Processes Requirements

An FSC, except for a small FSC, must meet two requirements

related to foreign economic processes to qualify an export

transaction for a tax exemption:

1. The FSC must participate outside the U.S. in the solicitation

(other than advertising), negotiation, or making of a contract

12
relating the particular export transaction. Any one of these

could be performed by a foreign agent. The Senate Finance

Committee Report defines the above three terms as:

Solicitation-communication either by telephone, telegraph,

mail or in person by the FSC to a specific, targeted, potential

customer regarding a transaction. Negotiationcommunication by the FSC to a customer or potential

customer of the terms of sale, such as the price, credit,

delivery, or other specification. Making of contractperformance of any of the elements necessary to complete a

sale such as making an offer or accepting the offer, making

written confirmation of oral agreement, or specifying

additional contract terms. The location of solicitation,

negotiation, or making of the contract is determined by the

place where the activity is initiated by the FSC or its agent.”

2. Specific percentages of certain transaction costs incurred by

the FSC or its agent with respect to the particular export

transaction must be “foreign direct costs,” which are costs

incurred by the FSC for activities it or its agent performs

outside the U.S.

This second test can be satisfied if the foreign direct costs

incurred by the FSC account for at least 50 percent of the total

direct costs of all, or 85 percent of the direct costs of any two of

the following categories of activities:

1. Advertising and sales promotion;

2. Processing of customer orders and arranging for delivery of

export property;

3. Transportation of the export property to the customer;

4. Determination and transmittal of a final invoice or

statement of account and receipt of payment;

5. Assumption of credit risk.

Foreign Trade Income and Foreign Trading Gross Receipts

The statutory definition of foreign trade income, as set forth

in FSC regulations, is gross income of the FSC that is

attributable to foreign trading gross receipts. The cost of goods

sold is subtracted from foreign trading gross receipts to arrive

at foreign trade income. This includes profits earned by the

FSC from exports and commissions earned by the FSC from

products and services exported by others.

Foreign Trading Gross Receipts

Foreign trading gross receipts are earnings generated by the

FSC from:

“Senate Committee on Finance, “Explanation of S. 2062,” U.S.

Senate, Washington, DC, 1984.

1. Sale or exchange of export property.

2. Lease or rental of export property for use by the leasee

outside the U.S.

3. Services which are related and subsidiary to any sale,

exchange, lease, rental or other disposition of export property.

4. Engineering or architectural services for construction

projects located outside the U.S.

5. Managerial services for an unrelated FSC or DISC.

To qualify as export property, the product must meet all three

criteria as follows:

1. Property manufactured, produced, grown, or extracted in

the U.S. by a person other than an FSC;

2. Is held primarily for sale, lease, or rental by or to an FSC for

direct use, consumption, or disposition outside the U.S., and;

3. Does not have more than 50 percent import component.

Some types of exports do not qualify as foreign trading gross

receipts. These include:

1. Income from export of property or services for use in the

U.S., or use by the U.S. or one of its instrumentalities and is

required by law.

2. Income from a transaction made by a subsidy from the U.S.

3. Receipts from another FSC that is a member of the same

group of controlled corporations.

4. Half of the gross receipts attributable to disposition of

military property and related services.

5. Investment income including dividends, interest, royalties,

annuities, rents (except rental of export property outside

U.S.), gain from sale of stock, securities, futures transactions,

and gain from disposition of interest in an estate or trust; and

carrying charges.

Determining Exempt and Nonexempt

Foreign Trade Income

The FSC’s foreign trade income is separated into exempt and

nonexempt portions according to two administrative pricing

rules or to an arm’s_length pricing rule. The FSC may select

the most desirable of the two administrative pricing rules to

determine exempt foreign trade income. These are:

1. One and eighty-three hundreths percent of foreign trading

gross receipts, except that the amount cannot exceed 46

13
percent of the amount allowed if the combined taxable income

method was used.

2. Twenty-three percent of the combined taxable income of

the FSC and the related supplier.

To be able to use the administrative pricing rules, however,

the FSC or a person under contract to the FSC must perform

all of the five activities listed for the “direct cost test” and the

three activities listed for the “sales activity test” for the

foreign economic process requirement (see above). Unlike

the foreign economic process test, however, these activities

may be performed inside as well as outside the U.S.

With administrative pricing rules, 15/23 of foreign trade

income is exempt from U.S income tax if the FSC has

corporate shareholders, otherwise 16/23 is exempt.

Foreign trade income may also be based on arm’s_length

pricing subject to Internal Revenue Code section 482. Using

this method, 30 percent of foreign trade income is exempt

from U.S. income tax if the FSC has corporate shareholders,

otherwise 32 percent if exempt.

An FSC is restricted in the use of foreign tax credits and

deduction for foreign taxes paid on exempt foreign trade

income. Thus, only foreign countries with low tax rates are

desirable locations for the FSC.

The domestic corporation is entitled to 100 percent dividend

received deduction for dividends paid by an FSC from foreign

trade income. Some restrictions apply here to earnings from

the use of the arm’s_length pricing method.

Cooperative Provisions

The FSC legislation includes provisions for special treatment

of cooperatives exporting members’ products. The provisions

allow the combined taxable income of the cooperative and the

FSC to be computed without taking into account patronage

dividends, per-unit retain allocations, and certain deductions

for nonpatronage distributions under section 1382. Thus the

cooperative does not have to distribute income attributable to

exempt foreign income in order to benefit from the corporate

level tax exemption on that income. This rule applies only to

the cooperative shareholder of the FSC and not to members

and patrons who may also be cooperatives.

The rules also provide that foreign trade income, other than

exempt foreign trade income will be treated as exempt income

to FSC, if it is distributed currently to the cooperative

shareholder. If not distributed currently, that income will be

taxed at the FSC level. Distributions from the FSC to the

cooperative shareholder that are attributable to foreign trade

income treated as exempt foreign trade income will not be

included in the taxable income of the cooperative. Thus,

nonexempt foreign trade income will be taxed at the member

level and treated as a single level of tax as provided for under

Subchapter T.

These rules are available to agricultural cooperatives only if

the income of the cooperative eligible for the FSC incentive is

based on arm’s_length transactions between the cooperative

and its members or patrons.

Small FSC

Recognizing that small exporters may have difficulty

complying with the foreign presence and economic activity

requirements, the bill provides two options to eligible small

businesses, the small FSC and the interest-charge DISC.

A small FSC must file an election to become a small FSC and

must satisfy foreign presence requirements (Le.,

incorporation outside U.S. customs territory), but is not

required to meet the foreign management and economic

processes tests. However, in determining exempt foreign

trade income, gross trading receipts in excess of $5 million for

the taxable year are not taken into account. A small FSC

exceeding the $5 million limit may choose the gross receipts to

which the limitation is allocated. That is, a small FSC may

choose to allocate the most profitable sales to satisfy the

limitation.

The administrative pricing rules for regular FSC’s also apply

to small FSC’s.

Interest-Charge DISC

Another alternative is the interest-charge DISC. In this case,

exporters continue using a DISC or may start a new DISC to

receive tax benefits on up to $10 million in export sales, but

must pay an interest charge on accumulated tax deferrals

occurring after the effective date of the legislation. The

interest charge is at Treasury bill rates and is deductible by

DISC shareholders as a business expense.

The incremental rule relating to base period exports is

eliminated for interest-charge DISCS and the deferral for

export income of up to $10 million will be 94 percent for

corporate shareholders. The deferral for individual

shareholders is unclear at this time, but will be at least 94

percent.

Qualified export income in excess of $10 million is deemed

distributed. Thus, the DISC is not disqualified, but the excess

receipts are not eligible for deferral. In addition, DISC’s and

DISC shareholders may not be or be a part of an FSC.

14
z

APPENDIX C: QUICK REFERENCE CHART ON FOREIGN SALES CORPORATION

FOREIGN SALES CORPORATION

Organizations

I

Foreign trading gross receipts

-FSC

-Small FSC (sales r-under $5 million)

-Interest charge DISC

(sales under $10

million)

r’ Election (FSC only)

-90 days before FSC

taxable year begins

-All directors

approve in writing

:oreign presence

est (FSC only)

Incorporated in

approved foreign

country or U.S.

possession’

Not more than 25

shareholders*

No preferred

stock3

Maintain foreign

office with books

of accoun‘t.4 Also

keep books in U.S.

At least one director a non-U.S.

resident at all

times. May be US.

citizen

Not a member of a

controlled group of

corporations of

which a DISC is a

member

I

Qualifying receipts

-Sale or exchange of

export property

-Lease or rental of export

property for use outside

U.S.

-Services related and subsidiary to sale or lease

-Engineering and architectural services for

construction

.Managerial services for

unrelated FSC or DISC

Jon-qualifying receipts

Export of property or

services for:

-Ultimate use in U.S.

-Use by U.S. or instrumentality and required

by law

-Transaction accomplished by subsidy from U.S.

Receipts from other FSC

that is member of same

group of controlled Corp.

Investment income or

carrying charge8

I

Export property

-Manufactured, produced

grown, or extracted in

U.S. by person other

than FSC

-Held primarily for sale,

lease, or rental by or to

a FSC for direct use

outside U.S.’

-Import portion under 50%

Foreign management test

(For transactions

throughout year. Not

required of small FSC)

These activities must

take place outside U.S.:

-All board of director and shareholder

meetings outside U.S.

.Principal bank

account maintained

outside U.S.

.All dividends, legal

and accounting fees,

salaries of officers

and directors

disbursed from bank

account outside U.S.

Foreign economic process tests

(For each transaction. Not

required of small FSC.)

I

Test A: Sales activity

FSC, or person under contract to

participate outside U.S. in:

-Solicitation other than advertising (communication by phone,

telegraph, mail or in person to

specific targeted customer)

-Negotiation (communication of

sales terms - price, credit, etc.)

-Making of contract (offering,

accepting offer, issuing written

confirmation, etc.)

Sales test may be applied to

group of transactions if all

conditions below are satisfied

-Fungible or substantially

similar commodities

-Sold by 1 contract to 1 customer

-Contract for 1 year or less

-FSC or agent performs 1 of 3

sales activities for at least

1 sale

I

rest B: Foreign direct costs

SC or contractor incurs costs

nside or outside U.S. for either

50% of all costs of 5 items, or

85% of costs of any 2 of 5 items

>ost items are:

Advertise and sales promotion’

Process orders and arrange

delivery’

Transportation’

Determine and transmit final

invoice or account statement and

receipt of payment”

Assume credit risk”

RX’s foreign trade income fFT/I

FSC derives taxable income from sale of

export property under 2 administrative

or 1 arm’+length pricing rules”

A. Administrative pricing rules

FSC derives taxable income not exceeding

greatest of:

-1.83% of foreign trading gross receipts

(FTGR) but limited to 46% of combined

taxable income (CTI), or

-23% of CTI of FSC and related

supplier attributable to FTGR

To use administrative pricing rules, FSC

or person under contract must perform all

sales activities and all 5 foreign

direct cost activities either inside or

outside U.S.

B. Arm’s_length pricing

Taxable income is based on arm’s_length

price subject to Internal Revenue Code

section 482

Exempt foreign trade income

-With administrative pricing rules, 15/23

of foreign trade income is exempt if FSC

has Corp. shareholders, 16123 otherwise

-With arm’s_length pricing rules, 30% is

exempt if FSC has Corp. shareholders,

32% otherwise

-Deductions of FSC’s expenses will be

allocated between exempt and non-exempt

foreign trade income

-U.S. corporations allowed 100% dividends

received deduction for FSC’s distributed

earnings13

-FSC not allowed foreign tax credits

against US. tax. U.S. possessions can

not tax FSC’s before January 1, 1987.
I

I

Non-export property

.Leased by FSC for use by

member of controlled group of

corporations of which FSC

is a member

.Intangible property: patents,

inventions, models, designs,

formulas, some copyrights, goodwill, trademarks, brands, etc.

.Oil or gas and primary products

-Prohibited exports under Sec. 3

of export Administration Act 1979

-Property designated by President

as being in short supply

I

Cooperative principles

FSC with qualifying cooperative shareholder may retain profits (allocated to

that cooperative’s products) as entirely

exempt at the FSC level.14 Upon repatriation of profits, the otherwise exempt

portion of FSC profit may be retained

without taxation by the cooperative and

used as working capital. Remaining profit

is allocated to members by patronage.

i-The FSC must be incorporated under laws of a jurisdiction outside U.S. customs territory. This includes U.S. possessions except Puerto Rico, countries

that meet standards of Caribbean Basin legislation (Section 274(h)(6)(C)), or countries with an income tax information exchange treaty approved by

Treasury. Approved countries include Australia, Austria, Barbados, Belgium, Canada, Denmark, Egypt, Finland, France, West Germany, Iceland, Ireland,

Jamaica, South Korea, Malta, Morocco, Netherlands, New Zealand, Norway, Pakistan, Philippines, South Africa, Sweden and Trinidad and Tobaggo. U.S.

possessions, which may not tax foreign trade income of an FSC prior to January 1, 1967, include Guam, American Samoa, Commonwealth of Northern

Mariana Islands. and Virgin Islands.

P-Directors holding shares required to be owned by a resident of the country under whose laws the FSC is organized are not counted as shareholders for

this purpose.

s-Multiple classes of common stock are allowed provided it does not enable a taxpayer to avoid federal income tax.

&Permanent books of account shall include as a minimum all invoices, quarterly income statement, and year-end balance sheet.

B-Investment income” means dividends, interest, royalties, annuities, rents (except export property), gains from sale or exchange of stock or securities,

gains from futures transactions (except bonafied hedging transactions), gains from sale or other disposition of interest in estate or trust. Carrying

charges” means the same as normally used in domestic commerce or as may be defined by Treasury regulations as any amount in excess of the price

for an immediate cash sale and any other unstated interest.” Section 927(d)(l)(B).

&Rule applies regardless of purchaser’s nationality, fob point, place of title passage, or whether property is for use by purchase or for resale.

T-Advertising means an appeal related to specific product or product line and directed at part or all potential customers. Sales promotion is an appeal

made in person to potential export customers for sale of specific product or product line at a trade show or annual customer meeting. This may include

the cost of the trade show or meeting but excluding salaries or commissions of direct sales persons.

s-Processing customer orders means notifying related supplier of the order and of requirements for delivery. Arranging for delivery means taking needed

steps to ship as required by order including clerks salaries, telephone, telegraph, and documentation costs but excluding packaging, crating, and similar pre-transportation costs and shipping costs. Delivery may occur inside or outside U.S.

e-Transportation includes transport costs during period the FSC owns the export property. FSC has no transport cost if customer pays transport directly.

Amount of direct costs treated as foreign direct costs is determined by the ratio of mileage outside U.S. to total mileage. For fungible commodities, total

direct costs include only those transportation costs incurred after goods have been identified to a contract.

lo-Determination and transmittal means assembly of final invoice or statement of account and forwarding document to customer. Final invoice is the

invoice upon which payment is made or receipt for payment issued. Statement of account means a summary statement to customer giving status of transaction occurring within an accounting period net exceeding one taxable year. Cost of office supplies and equipment, clerical salaries, mail, etc., directly

attributable to assembly and transmittal of invoice or statement constitute direct costs for this activity. Engineering or cost accounting functions involved

in establishing price are not included. Receipt of payment means crediting FSC’s bank account with proceeds of the transaction. Payments received in

the U.S. may be transferred immediately to bank account of FSC outside U.S. Direct costs include expenses of FSC in maintaining bank account.

ii-FSC is considered to bear economic risk of non-payment‘if it contractually bears such risk and if either 1, a debt becomes uncollectible or 2, an addition is made to the bad debt reserve of the FSC in at least 1 year within a 3-year period.

In-These rules apply to sale of export property. Treasury may prescribe regulations defining taxable toreign trade income arising from commissions, rentals, and other types of FSC income.

Is-The 100% dividends-received exemption is not allowed for non-exempt foreign trade income under arm’s_length pricing and for any other income other than foreign trade income, investment income, and carrying charges.

IcComputation of combined taxable income under FSC administrative pricing rule does not take into account patronage dividends, per-unit retain allocations, or certain nonpatronage distributions.
U.S. Department of Agriculture

Agricultural Cooperative Service

Agricultural Cooperative Service (ACS) provides research, management, and

educational assistance to cooperatives to strengthen the economic position of

farmers and other rural residents. It works directly with cooperative leaders and

Federal and State agencies to improve organization, leadership, and operation

of cooperatives and to give guidance to further development.

The agency (1) helps farmers and other rural residents develop cooperatives to

obtain supplies and services at lower cost and to get better prices for products

they sell: (2) advises rural residents on developing existing resources through

cooperative action to enhance rural living; (3) helps cooperatives improve services and operating efficiency: (4) informs members, directors, employees, and

the public on how cooperatives work and benefit their members and their communities; and (5) encourages international cooperative programs.

ACS publishes research and educational materials and issues Furmer Cooperutivc~s magazine. All programs and activities are conducted on a nondiscriminatory basis, without regard to race, creed, color, sex, or national origin.