The U.S. Virgin Islands: a leading location for foreign sales corporations

Are you an exporter? Would you like to easily and inexpensively increase your profits by approximately 7-14 percent? Are you a shareholder in a Domestic International Sales Corporation (DISC) that will be no longer legal in its present from after Dec. 31, 1984? If you answered yes to any of these questions, then you need to consider forming a Foreign Sales Corporation (FSC) before the end of 1984.

A Foreign Sales Corporation is a foreign corporation not located in the U.S. Customs tone that is allowed to earn some exempt and non-taxable income on its exports from the United States. In most cases, this partial exemption can result in U.S. tax savings of up to 7.4 percent of the profit on the export transaction for a manufacturer/exporter and 14.7 percent for a trading company/exporter. The FSC is required to pay U.S. tax on the balance of its non-exempt income. Trade income dividends by the FSC to its U.S. corporate shareholders are not taxable to them.

The Internal Revenue Code allows exporters to defer some tax on exports by forming DISCs, but they terminate by law at the end of 1984. Alternatively, new U.S. legislation allows the operation of an FSC effective Jan. 1, 1985 with the advantage over the DISC of a permanent tax exemption to the U.S. corporate shareholder. The FSC is allowed to make frequent dividend distributions back to the U.S. shareholders, whereas the DISC has to invest the proceeds in qualified foreign assets. Significantly, American farmers and agricultural cooperatives can benefit from the FSC but not from the DISC.

FSC legislation specifically requires incorporation outside of the U.S. Customs Zone. Permitted places are the U.S. Virgin Islands (USVI), other U.S. possessions except Puerto Rico, and foreign jurisdictions specifically approved by the U.S. government. The permitted U.S. possessions are customs zones separate from the U.S. Customs Zone as well as separate taxing jurisdictions; for FSC purposes they are considered to be foreign.

The U.S. Virgin Islands is rapidly developing into the most probable jurisdiction to organize and manage the thousands of FSC corporations that will be formed by year-end. This is because it is one of a few places presently approved by the IRS and Treasury Department as an FSC location. Under the FSC law, the Virgin Islands cannot tax the FSC on income until 1987. The Virgin Islands legislature is presently considering proposals for a special income tax holiday or partial holiday for the FSC after 1986. There may be only franchise fees as a "toll charge" for allowing the FSC to use the Virgin Islands as a "tax saving" jurisdiction.

The Virgin Islands has many other benefits besides the significant FSC income tax, including:

* A legal system similar to most U.S. states, which is easy and familiar to most American lawyers and accountants

* U.S. currency and no exchange controls

* U.S. mail service, including "Express Mail" courier services

* Major U.S. banks

* English language

* Political stability

* Good telecommunications

* Same time zone as the mainland (Atlantic Standard Time)

* Two international airports with frequent non-stop flights between New York, Miami, and Puerto Rico, and many other direct flights

* Good recreational facilities

* Good meeting and small convention facilities

* Reasonable housing costs

* Tax holidays for business expansion

* Duty-free entry for qualified Virgin Island products into the U.S. Customs Zone under Headnote 3a

* Ideal climate

Savings to the Exporter

An FSC will be able to exempt from U.S. taxation anywhere from 16-30 percent of the profit on the export transaction. (For corporate shareholders, the benefit will be reduced by an additional 1/17.) Those manufacturing companies and qualified service companies that have an FSC will be able to escape U.S. tax on 16 percent of the export profit. Trading companies buying and selling from independent suppliers or at arm's length prices will be exempted from taxation on 32 percent of the profit on the export transaction. Actual tax savings will be dependent on the FSC's U.S. corporate shareholder's tax bracket. At the 46 percent maximum federal corporate rate, the actual potential tax savings turns out to be 7.4 percent or 14.3 percent.

To determine your potential savings per million dollars of exports revenue and sales, refer to the table below and locate your profit margin on sales to see what your tax savings might be at the 46 percent maximum federal corporate tax rate.

In order to qualify for the FSC benefits, the larger exporters must meet certain federal regulations requiring them to do certain things only in the permitted U.S. possessions or other 'approved' foreign countries, and other things anywhere outside the U.S. Customs Zone. As we will discuss later in this article, this distinction gives the exporter substantial flexibility to adjust the FSC required logistics to the present operating organization.

To have your FSC qualify for the U.S. tax benefits through the U.S. Virgin Islands, you must meet the following requirements:

1. Form a Virgin Islands corporation or form a corporation in another acceptable non-U.S. Customs Zone jurisdiction and register it in the U.S. Virgin Islands as a resident corporation,

2. Maintain a permanent office in the U.S. Virgin Islands,

3. Maintain a copy of books and records at this office (as in the United States),

4. Have at least one director at all times during the year who is a U.S. Virgin Islands resident or resident of some other non-U.S. Customs Zone jurisdiction, and

5. The foreign corporation must make a timely election with the U.S. Internal Revenue Service to become an FSC.

These services can be provided by a corporate service film in the Virgin Islands but the FSC election and FSC tax return should be done by U.S. professionals.

There may be up to 25 shareholders in each FSC. There can be different classes of common stock, which can vary by activity to reflect the unique uses of each individuals "FSC trading company" by its cooperating shareholders with different export sales levels.

Small Exporters Benefit

A small FSC is one with gross receipts of less than $5 million. A small exporter can form a small FSC and be excused from the requirements of managing and performing the export logistics outside the United States. Instead, the small FSC or its agent(s) may perform all of its export activities inside the United States and still obtain the tax exemption benefits. Even the paper work can be done at the shareholder's U.S. Customs Zone offices. The small FSC only needs to be a qualified USVI or foreign corporation with a timely FSC election, have a USVI office, maintain "copies" of its books and records in that office, and have one year round director who is a USVI resident.

Managing a Large FSC

The FSC regulations under prepartion will require that, once organized, the FSC with gross sales of $5 million or more be managed and administered outside the U.S. Customs Zone. The directors and shareholders meetings must be held outside the U.S. Customs Zone, the principal bank account(s) must be outside the U.S. Customs Zone, and all dividends, legal and accounting fees, officers and directors salaries must be paid from accounts outside the U.S. Customs Zone.

All these events can take place at the main office in the Virgin Islands or any other non-U.S. Customs Zone location. The FSC must be careful that directors meetings in other places do not cause triggering of taxation in that jurisdiction.

Most FSC assets will be cash and receiveables. The large foreign bank accounts can be totally controlled by officers or employees of the U.S. parent. A U.S. account can be established to facilitate collections of receivables, but these funds must be quickly transmitted to one of the non-U.S. Customs Zone bank accounts in order not to disqualify the FSC. There may be a small account established by the Virgin Islands director to pay for the incidentals.

Requirements for a Large FSC

A large FSC must meet certain requirements concerning foreign activities, otherwise it will not be entitled to the tax exempt benefits. To meet these requirements, a sales process must take place outside the U.S. Customs Zone and a percentage of the transaction costs must be non-U.S. Customs Zone direct costs.

The sales process to be done outside the U.S. Customs Zone by the FSC or its agent consists of any one of the following: solicitation, negotiation, or contract confirmation.

Non-U.S. Customs Zone direct costs are divided into five categories: (1) advertising and promotion expenses; (2) order processing costs, including arranging for delivery and shipment; (3) transportation costs; (4) invoicing and receviables accounting; (5) and credit risk costs.

To qualify as an FSC, at least 50 percent or more of the aggregate of all five of these categories of cost or at least 85 percent of two cost categories must be performed outside the U.S. Customs Zones.

The sales process and direct costs can occur anyplace outside the U.S. Customs Zone. This allows exporters to conveniently locate activities in existing foreign facilities they or their agents operate. This will most likely lead to various operating scenarios, all of which will include incorporation or residence of a foreign corporation in the Virgin Islands, a permanent Virgin Islands office, and in most cases, a resident Virgin Islands director. All other matters may or may not take place there.

Small FSCs have very little to do outside the U.S. Customs Zone. The large FSC must manage and administer the FSC from outside the U.S. Customs Zone, but the economic substance activities can take place in a variety of locations, depending on how a company decides to meet the requirements. The economic substance work is accomplished through related foreign companies or contracted out by the FSC. The Logistics work may be performed at an office in the Virgin Islands or in some other place outside the U.S. Customs Zone. Where a company carries out its activities will depend on its own needs and capabilities and the abilities of agents in the various financial centers. It makes special sense for Virgin island FSCs to do Their chores in the Virgin Islands or one of the other Caribbean business processing centers such as Barbados, Netherland Antilles, Panama, Cayman Islands and the Bahamas. However, large FSCs may locate their activities anywhere in the world outside the U.S. Customs Zone.

Costs for Managing an FSC

The cost of forming an FSC in the Virgin Islands will vary, but we except the average cost to be approximately $800. Annual fees for corporate services firms to supply a resident director, registered agent, permanent office, and minimum administration time will probably total $1,000. The Virgin Islands Legislature is considering proposals for annual Virgin Islands franchise fees ranging upwards from $500.

The total cost of an FSC can only be determined when the additional logistics cost is known. In some cases, this could be zero since the economic substance transactions are already being done or can easily be transferred outside the U.S. Customs Zone at no additional cost. There is no doubt that a medium or large FSC will save many thousands and, in some cases, millions of dollars. The small exporter must evaluate whether the estimated first-year cost of $2,300 and subsequent cost of $1,500 each year will be worth the trouble when compared to the tax savings. One advantage to the small exporter of forming an FSC may be a developed awareness of international financial planning, which could lead the exporter to expand his or her business interests even more internationally.

COPYRIGHT 1984 U.S. Government Printing Office
COPYRIGHT 2004 Gale Group