Instructions For Form 1120-Fsc - 2006 (Page 3 of 13) in pdf

trade income. The $5 million limit is reduced

meetings of the shareholders of the FSC

Instead of satisfying the 50% foreign

if the small FSC has a short tax year. It may

that take place during the tax year must take

direct cost test, the FSC may incur foreign

also be reduced if the small FSC is a

place outside the United States.

direct costs attributable to activities

member of a controlled group that contains

described in each of two of the section

In addition, all such meetings must

other small FSCs. See Regulations section

924(e) categories. The costs must equal or

comply with the local laws of the foreign

1.921-2(b) for more information.

exceed 85% of the total direct costs incurred

country or U.S. possession in which the

by the FSC attributable to the activity

FSC was created or organized. The local

Tax Treatment of a FSC

described in each of the two categories. If

laws determine whether a meeting must be

no direct costs are incurred by the FSC in a

A FSC is not taxed on its exempt foreign

held, when and where it must be held (if it is

trade income. Section 923 defines foreign

particular category, that category is not

held at all), who must be present, quorum

trade income as the gross income of a FSC

taken into account for purposes of

requirements, use of proxies, etc.

determining whether the FSC has met either

attributable to foreign trading gross receipts

Principal bank accounts. See Regulations

the 50% or 85% foreign direct cost test.

(defined below).

section 1.924(c)-1(c) for information

The percentage of foreign trade income

Direct costs are costs that:

regarding principal bank accounts.

•

exempt from tax is figured differently for

Are incident to and necessary for the

Foreign Economic Process Rules

income determined under the administrative

performance of any activity described in

pricing rules (for details, see the instructions

A FSC (other than a small FSC) has foreign

section 924(e);

•

for Schedule P (Form 1120-FSC)) and

trading gross receipts from any transaction

Include the cost of materials consumed in

income determined without regard to the

only if certain economic processes for the

the performance of the activity and the cost

administrative pricing rules. These

transaction take place outside the United

of labor that can be identified or associated

percentages are computed on Schedule E,

States. Section 924(d) and Regulations

directly with the performance of the activity

page 4, Form 1120-FSC, and carried over to

section 1.924(d)-1 set forth the rules for

(but only to the extent of wages, salaries,

lines 9a and 9b of Schedule B, page 3,

determining whether a sufficient amount of

fees for professional services, and other

Form 1120-FSC, to figure taxable income or

the economic processes of a transaction

amounts paid for personal services actually

(loss).

takes place outside the United States.

rendered, such as bonuses or compensation

paid for services on the basis of a

See section 923(a)(4) for a special rule

Generally, a transaction will qualify if the

percentage of profits); and

for foreign trade income allocable to a

FSC satisfies two requirements:

•

Include the allowable depreciation

cooperative. See section 923(a)(5) for a

Participation outside the United States in

deduction for equipment or facilities (or the

special rule for military property.

the sales portion of the transaction and

•

rental cost for its use) that can be

Satisfaction of either the 50% or the 85%

Tax treaty benefits. A FSC may not claim

specifically identified or associated with the

foreign direct cost test.

any benefits under any income tax treaty

activity, as well as the contract price of an

between the United States and any foreign

The activities comprising these economic

activity performed on behalf of the FSC by a

country.

processes may be performed by the FSC or

contractor.

by any other person acting under contract

Foreign Trading Gross Receipts

Total direct costs means all of the direct

with the FSC.

costs of any transaction attributable to

A FSC is treated as having foreign trading

Participation outside the United States in

activities described in any paragraph of

gross receipts (defined in section 924) only

the sales portion of the transaction.

section 924(e). For purposes of the 50% test

if it has met certain foreign management

Generally, the requirement of section

of section 924(d)(1)(B), total direct costs are

and foreign economic process requirements.

924(d)(1)(A) is met for the gross receipts of

based on the direct costs of all activities

Foreign trading gross receipts do not

a FSC derived from any transaction if the

described in all paragraphs of section

include:

FSC has participated outside the United

•

924(e). For purposes of the 85% test of

Certain excluded receipts (defined in

States in the following sales activities

section 924(d)(2), however, the total direct

section 924(f)).

relating to the transaction: (1) solicitation

•

costs are determined separately for each

Receipts attributable to property excluded

(other than advertising), (2) negotiation, and

paragraph of section 924(e).

from export property under section

(3) making a contract.

927(a)(2).

Foreign direct costs means the portion

1. Solicitation (other than advertising) is

•

Investment income (defined in section

of the total direct costs of any transaction

any communication (including, but not

927(c)).

attributable to activities performed outside

limited to, telephone, telegraph, mail, or in

•

Carrying charges (defined in section

the United States. For purposes of the 50%

person) by the FSC, to a specific, targeted

927(d)(1)).

test, foreign direct costs are based on the

customer or potential customer.

direct costs of all activities described in all

Note. Computer software licensed for

2. Negotiation is any communication by

paragraphs of section 924(e). For purposes

reproduction abroad is not excluded from

the FSC to a customer or potential customer

of the 85% test, however, foreign direct

export property under section 927(a)(2).

aimed at an agreement on one or more of

costs are determined separately for each

Therefore, receipts attributable to the sale,

the terms of a transaction, including, but not

paragraph of section 924(e).

lease, or rental of computer software and

limited to, price, credit terms, quantity, or

services related and subsidiary to such

time or manner of delivery.

For more details, see Regulations

transactions qualify as foreign trading gross

3. Making a contract refers to

section 1.924(d)-1(d).

receipts.

performance by the FSC of any of the

Check the applicable box(es) on line 10b,

elements necessary to complete a sale,

Additional Information, on page 2 of the

such as making or accepting an offer.

form, to indicate how the FSC met the

Foreign Management Rules

foreign direct costs requirement.

Grouping transactions. Generally, the

A FSC (other than a small FSC) is treated

Grouping transactions. Generally, the

sales activities described above are to be

as having foreign trading gross receipts for

foreign direct cost tests under Regulations

the tax year only if the management of the

applied on a transaction-by-transaction

section 1.924(d)-1(d) are applied on a

FSC during the year takes place outside the

basis. However, a FSC may make an

transaction-by-transaction basis. However,

United States. These management activities

annual election to apply any of the sales

the FSC may make an annual election (on

include:

activities on the basis of a group. To make

•

line 10d, Additional Information, on page 2

the election, check the applicable box on

Meetings of the board of directors and

of the form) to apply the foreign direct cost

line 10a, Additional Information, on page 2

meetings of the shareholders.

•

tests on a customer, contract, or product or

Disbursing cash, dividends, legal and

of Form 1120-FSC. See Regulations section

product line grouping basis. Any grouping

accounting fees, salaries of officers, and

1.924(d)-1(c)(5) for details.

used must be supported by adequate

salaries or fees of directors from the

Satisfaction of either the 50% or 85%

documentation of performance of activities

principal bank account (see below).

foreign direct cost test. To qualify as

•

and costs of activities relating to the

Maintaining the principal bank account at

foreign trading gross receipts, the foreign

grouping used. See Regulations section

all times during the tax year.

direct costs incurred by the FSC attributable

1.924(d)-1(e) for details.

Meetings of directors and meetings of

to the transaction must equal or exceed

the shareholders. All meetings of the

50% of the total direct costs incurred by the

Exception for foreign military property.

board of directors of the FSC and all

FSC attributable to the transaction.

The economic process rules do not apply to

-3-

Instructions For Form 1120-Fsc - 2006 Page 3

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