DESCRIPTION OF H.R. __

(THE “FSC REPEAL AND EXTRATERRITORIAL 

INCOME EXCLUSION ACT OF 2000”)

Scheduled for Markup 

By the

HOUSE COMMITTEE ON WAYS AND MEANS

on July 27, 2000

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

July 27, 2000

JCX-87-00
(i)

CONTENTS

Page

I. INTRODUCTION ............................................... 1

II. OVERVIEW OF PRESENT-LAW FOREIGN SALES CORPORATION

RULES ........................................................ 2

III. DESCRIPTION OF H.R. __, THE “FSC REPEAL AND 

EXTRATERRITORIAL INCOME EXCLUSION ACT OF 2000” ....... 5
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

 WTO, United States – Tax Treatment for “Foreign Sales Corporations,” Report of the

Panel, October 8, 1999, p. 334.

3

 This document may be cited as follows: Joint Committee on Taxation, Description of

H.R. __ (The “FSC Repeal and Extraterritorial Income Exclusion Act of 2000”) (JCX-87-00),

July 27, 2000.

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I. INTRODUCTION

In July 1998, the European Union1

 requested that a World Trade Organization (“WTO”)

dispute panel determine whether the foreign sales corporation regime of sections 921 through

927 of the Internal Revenue Code (“the Code”) complies with WTO rules, including the

Agreement on Subsidies and Countervailing Measures. A WTO dispute settlement panel was

established in September, 1998, to address these issues. On October 8, 1999, the panel ruled that

the foreign sales corporation regime was not in compliance with WTO obligations. The dispute

settlement panel specified that “FSC subsidies must be withdrawn at the latest with effect from 1

October 2000.”2 On February 24, 2000, the WTO Appellate Body affirmed the lower panel’s

ruling.

This document,3

 prepared by the staff of the Joint Committee on Taxation, provides an

overview of present law relating to foreign sales corporations. This document also provides a

description of H.R. __, the “FSC Repeal and Extraterritorial Income Exclusion Act of 2000,”

scheduled for markup in the House Committee on Ways and Means on July 27, 2000.
4

 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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II. OVERVIEW OF PRESENT-LAW FOREIGN SALES CORPORATION RULES

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.4

 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.

Foreign Sales Corporations

The income of an eligible foreign sales corporation 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 foreign sales corporation out of certain

earnings.

A foreign sales corporation must be located and managed outside the United States, and

must perform certain economic processes outside the United States. A foreign sales corporation

is often owned by a U.S. corporation that produces goods in the United States. The U.S.

corporation either supplies goods to the foreign sales corporation for resale abroad or pays the

foreign sales corporation a commission in connection with such sales. The income of the foreign

sales corporation, a portion of which is exempt from U.S. tax under the foreign sales corporation

rules, equals the foreign sales corporation's gross markup or gross commission income, less the

expenses incurred by the foreign sales corporation. The gross markup or the gross commission is

determined according to specified pricing rules.

A foreign sales corporation generally is not subject to U.S. tax on its exempt foreign trade

income. The exempt foreign trade income of a foreign sales corporation is treated as foreignsource income which is not effectively connected with the conduct of a trade or business within

the United States.
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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 foreign sales corporation’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 foreign sales corporation is defined as the foreign sales

corporation'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 foreign sales

corporation, (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 foreign sales

corporation for use by any member of a controlled group of which the foreign sales corporation 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 foreign sales corporation by a related person (or a

commission is paid by a related person to a foreign sales corporation with respect to export

property), the income with respect to the export transactions must be allocated between the

foreign sales corporation and the related person. The taxable income of the foreign sales

corporation 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 foreign sales corporation's foreign trade income that is treated as exempt

foreign trade income depends on the pricing rule used to determine the income of the foreign

sales corporation. If the amount of income earned by the foreign sales corporation is based on

section 482 pricing, the exempt foreign trade income generally is 30 percent of the foreign trade

income the foreign sales corporation derives from a transaction. If the income earned by the

foreign sales corporation is determined under one of the two formulas specified in the foreign

sales corporation provisions, the exempt foreign trade income generally is 15/23 of the foreign

trade income the foreign sales corporation derives from the transaction.
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A foreign sales corporation 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 foreign sales corporation 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 foreign sales corporation 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.
5

 Under the proposal, deductions are determined without regard to this limitation and

then allocated to the excluded extraterritorial income.

6

 Certain foreign withholding taxes determined on a gross basis are fully allocated to

nonqualifying foreign trade income.

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III. DESCRIPTION OF H.R. __

(THE “FSC REPEAL AND EXTRATERRITORIAL

INCOME EXCLUSION ACT OF 2000”)

Description of Proposal

Repeal of the foreign sales corporation rules

The proposal repeals the present-law foreign sales corporation rules. 

Exclusion of extraterritorial income

The proposal provides that gross income for U.S. tax purposes does not include

extraterritorial income. Deductions allocated to such excluded income generally are disallowed.5

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.6

 An

exception from this general rule is provided for extraterritorial income that is not “qualifying

foreign trade income.”

The proposal 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

corporate and individual alternative minimum tax purposes. 

Qualifying foreign trade income

Under the proposal, qualifying foreign trade income is the amount of gross income that,

when excluded, would result in a reduction of taxable income by (1) 1.2 percent of the “foreign

trading gross receipts” derived by the taxpayer from the transaction, (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 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. If a taxpayer uses 1.2 percent of foreign trading gross receipts to determine

the amount of qualifying foreign trade income, no other related person will have qualifying

foreign trade income with respect to that transaction. 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
7

 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. 

-6-

cooperating with an international boycott. 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.

Foreign trading gross receipts

Under the proposal, “foreign trading gross receipts” are gross receipts derived from

certain activities in connection with “qualifying foreign trade property” in which certain

economic processes take place outside 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 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 the United States, or (5) for the performance of

certain managerial services for unrelated persons. 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 United States. 

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 foreign tax credits in

lieu of the exclusion as a means of avoiding double taxation. 

Foreign economic processes

Under the proposal, gross receipts from a transaction are foreign trading gross receipts

eligible for exclusion from the U.S. tax base, only if certain economic processes take place

outside the United States. The economic processes requirement is satisfied if the taxpayer (or

any person acting under a contract with the taxpayer) participates outside the United States in the

solicitation, negotiation, or making of the contract relating to such transaction and incurs a

specified amount of foreign direct costs attributable to the transaction.7 The categories of

activities that may qualify as foreign direct costs are: (1) advertising and sales promotion; (2) the

processing of customer orders and the arranging for delivery; (3) certain transportation; (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. The economic processes requirement is treated as

satisfied (solely for the purpose of determining whether gross receipts are foreign trading gross

receipts) if any related person has satisfied the economic processes requirement. An exception
8

 “United States” includes Puerto Rico for these purposes because Puerto Rico is

included in the customs territory of the United States.

9

 The intangibles that are treated as excluded property under the proposal 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.

-7-

from the foreign economic processes requirement is provided for taxpayers with foreign trading

gross receipts for the year of $5 million or less. 

Qualifying foreign trade property

Under the proposal, 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 the United

States that is held primarily for sale, lease, or rental, in the ordinary course of a trade or business,

for direct use, consumption, or disposition outside the United States.8

 In addition, not more than

50 percent of the fair market value of such property can be attributable to articles manufactured,

or other value added, outside the United States.

The proposal would exclude 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,9

 (3) oil and gas, (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.

With respect to property that is manufactured outside the United States, rules are

provided to ensure consistent U.S. tax treatment with respect to manufacturers. The proposal

requires that property manufactured outside 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, or (4) a partnership or other pass-thru entity

all of the partners or owners of which are described (1), (2), or (3) above. 

Foreign trade income

Under the proposal, “foreign trade income” is the taxable income of the taxpayer

(determined without regard to the exclusion of extraterritorial income) attributable to foreign

trading gross receipts. Certain dividends paid deductions of cooperatives are disregarded in

determining foreign trade income for this purpose. 
-8-

Foreign sale and leasing income

Under the proposal, “foreign sale and leasing income” is the amount of the taxpayer’s

foreign trade income (with respect to a transaction) that is (1) properly allocable to activities that

constitute foreign economic processes (as described above), or (2) derived by the taxpayer from

the lease or rental of qualifying foreign trade property for use by the lessee outside the United

States. In addition, income properly allocable to certain intangibles is excluded for this purpose.

Other rules

The proposal provides an election for certain foreign corporations to be treated as

domestic corporations. Such election is available for (1) a foreign corporation that manufactures

property in the ordinary course of such corporation’s trade or business, and (2) a foreign

corporation if substantially all of the gross receipts of such corporation reasonably may be

expected to be foreign trading gross receipts. 

The proposal 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. 

The proposal provides a limitation with respect to the sourcing of foreign trade income

applicable to transactions (involving the sale of property) giving rise to foreign trading gross

receipts. 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. 

The proposal also provides that qualifying foreign trade property that is located outside

the United States and that is held for lease or rental, in the ordinary course of a trade or business,

for use by the lessee outside the United States is not taken into account for interest allocation

purposes. 

Effective Date

In general

The proposal would be effective for transactions entered into after September 30, 2000. 

In addition, no corporation may elect to be a foreign sales corporation after September 30, 2000.
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Transition rules

In the case of transactions involving a foreign sales corporation that is in existence on

September 30, 2000, the proposal would not apply to transactions in the ordinary course of

business by the foreign sales corporation before January 1, 2002. In addition, the proposal would

not apply to transactions in the ordinary course of business after December 31, 2001, if such

transactions are entered into by a foreign sales corporation that is in existence on September 30,

2000, and such transactions are pursuant to a binding contract (with the foreign sales corporation)

that is in effect on September 30, 2000, and all times thereafter. Notwithstanding the transition

period for foreign sales corporations in existence on September 30, 2000, such foreign sales

corporations may elect to have the rules of the proposal apply in lieu of the rules applicable to

foreign sales corporations. A consistency rule, however, requires related parties to apply either

the rules of the proposal or the rules applicable to foreign sales corporations to transactions

involving the same property.