Pietra G. Lettieri, Esq. Public Finance / Economic Development and Tax Law Practice Groups Harris Beach PLLC 726 Exchange Street, Suite 1000 Buffalo, New

Pietra G. Lettieri, Esq.Public Finance / Economic Development and Tax Law Practice Groups

Harris Beach PLLC726 Exchange Street, Suite 1000

Buffalo, New York 14210

[email protected](800) 685-1429

(716) 200-5112 (Direct)(716) 200-5215 (Fax)

MAXIMIZING NEW YORK STATE AND LOCAL FINANCIAL INCENTIVES FOR

CROSS-BORDER TRANSACTIONSMarch 29, 2012

Financial Incentives Planning

Structured Correctly – Obtain tax exempt bond financing Significantly reduce or eliminate NYS Income Tax

Liability Eliminate NYS Sales Tax liability for project related

costs Significantly reduce or eliminate NYS Real Property

Taxes for a fixed amount of time Obtain NYS refundable credits of 10% to 50% of

certain remedial costs and capital investments on “contaminated” property

Obtain grants and low-cost financing through NYS programs

2Pietra G. Lettieri, Esq.(716) 200-5112© Harris Beach PLLC, 2012

Pietra G. Lettieri, Esq.(716) 200-5112© Harris Beach PLLC, 2012

Financial Incentives – The Usual Suspects Federal and New York State Incentives Industrial Development Agency Incentives New York State Excelsior Program Incentives NYS Brownfield Cleanup Program Incentives Historic Tax Credits – Federal and State NYS ESD Capital Grant New York Power Authority and NYSERDA Incentives Enterprise Communities Empowerment Zone/Renewal Community Program New Markets Tax Credit Program

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Financial Incentive Planning Tip

Plan early – Get a team in place ASAP and Establish Timelines- Attorney- Accountant- Architect/Engineer- Lobbyist- Project Manager/Owner’s Representative - Community Relations Consultant

Identify All Incentives Up-Front – Best to identify/analyze all benefits together

Overlap: Overlap financial incentive planning with site acquisition, permitting, lending considerations and timing

- Project description for permits and incentives need to match- Need to tell a good story and get Community and NYS buy-in

* Job Creation* Investment* New Real Property Taxes* Wealth Creation

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Note: Empire Zone program sunset in June of 2010 and has

been replaced by Excelsior Jobs Program Industrial Development Agencies no longer have the

ability to undertake civic facility projects All existing Business Tax Credits are deferred for

taxpayers with greater than $2 million in credits

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Local Incentives: Industrial Development Agency

Straight Lease or Bond Financing (Federal Tax Exempt Bonds) - Use of Local Development Corporations for Not-for-Profits

Sales Tax Exemption (local and state) on Build-Out Only

Mortgage Recording Tax Exemption

Tax Abatement – Payment in Lieu of Taxes (“PILOT”)/tax stability

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New York State Incentives – ESD

Empire State Development ("ESD") is the trade name under which New York State offers benefits that have been statutorily authorized under the Office of Economic Development, Job Development and Urban Development Corporation (d/b/a Empire State Development Corporation).

Through ESD, the State can provide direct loans, capital grants, or interest rate subsidy grants that result in low-cost financing for the acquisition, construction, renovation, or improvement of real estate, including both land and buildings, as well as the acquisition of machinery and equipment and related soft costs. Direct loans are provided at below-market rates to provide a lower overall blended rate with conventional sources. Interest rate subsidy grants that reduce the costs of borrowing from a conventional lender are also available.

Eligible recipients of these loans and grants include industrial companies such as manufacturers, service providers, assemblers, and distributors, and local development entities on their behalf, as well as headquarter facilities for a broader spectrum of businesses.

ESD has implemented the New York State Consolidated Funding Application (CFA), a single application for multiple sources of state funding. New York State is soliciting grant applications for funding to advance the priorities of the Regional Economic Development Councils (REDC). The CFA can be found at https://apps.cio.ny.gov/apps/cfa/index.cfm . Note that at press time, the CFA was being revised.

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New York State Incentives – Excelsior Program Incentives

Replaces the Empire Zone Program (Expired June, 2010) Purpose – to encourage the expansion in, and relocation to New York, of

businesses in certain growth industries Credits against personal, corporate, bank and insurance franchise tax 10 year benefit period

JOB GROWTH TRACK

To Be Eligible – a business must predominately operate in one ofthe following Strategic Industries and meet job creation thresholds:

1. Financial Services center/back office [100 Net New Jobs (“NNJ”)]2. Manufacturing (25 NNJ)3. Software development (10 NNJ)4. Scientific R&D (10 NNJ)5. Agriculture (10 NNJ)6. Back office expansion (150 NNJ)7. Distribution center (150 NNJ)8. Significant growth industry (to be designated by the Commissioner)9. Regionally Significant Project - a business making significant capital investment

in the state creating 20-500 net new jobs (not limited to any particular industry)

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INVESTMENT TRACK

If a business operating in an industry above cannot meet the job creation requirements, it can still qualify if:

1. It has, and will retain, at least 50 FTEs, 2. Makes a significant capital investment and,3. Passes a cost-benefit ratio of 10:1 (ratio of total investment,

wages and benefits/tax credits)

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Excelsior Jobs Tax Credit- Based on salary paid for each net new job- 6.85% of wages per NNJ- New to the state- Refundable

Excelsior Investment Tax Credit- Equals 2% of cost basis of a qualified investment - Refundable

Excelsior Research and Development Tax Credit- Equals 50% of Federal R&D tax credit- Refundable

Excelsior Real Property Tax Credit- Must be located in an Investment Zone or be an RSP- Credit equals 50% of RPT paid in year prior to year accepted into Excelsior

Program- Credit is 40% in year 2, 30% in year 3, 20% in year 4, and 10% in year 5- Refundable

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BCP Tax Benefits

Three Refundable New York State Tax Credits:

1. Brownfield Redevelopment Tax Credit (BRTC)− Refundable investment credit based on cleanup and build out

and equipment costs (site prep, groundwater treatment, tangible property)

2. Tax Credit for Remediated Brownfields (TCRB)− Refundable Real Property Tax Benefit

3. Environmental Remediation Insurance Credit (ERIC)− Refundable insurance premium credit

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BCP: BRTC is the most Significant Refundable NYS Tax Credit

2008 BCP Brownfield Redevelopment Tax Credit Amendments

- Recall BRTC consists of (1) Site Preparation, (2) Tangible Property, and (3) Groundwater Remediation Component

For Projects Accepted After June 23, 2008:

1) Amendments to calculation of BRTC Site Preparation/GW Component

2) Amendments to calculation of BRTC Tangible Property Component

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BCP Amendments to BRTC Tax CreditsChanges to BCP Site Prep/Ground Water Tax Credit

Site Preparation and Groundwater Remediation Component increased from 10% to 22% of such costs to 22% to 50%

Cleanup to Soil Cleanup Objectives as follows:

Use Unrestricted Residential Commercial Industrial

Track 1 50% N/A N/A N/A

Tracks 2 and 3 N/A 40% 33% 27%

Track 4 N/A 28% 25% 22%

RESULT – More tax credit available/generated for cleaner cleanups

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Message – Under the new BCP, the key is Understanding and Maximizing Site Preparation Costs

Note: Site Preparation Costs Definition Remains Unchanged:

The term "site preparation costs" shall mean all amounts properly chargeable to a capital account, (i) which are paid or incurred in connection with a site's qualification for a certificate of completion, and (ii) all other site preparation costs paid or incurred in connection with preparing a site for the erection of a building or a component of a building, or otherwise to establish a site as usable for its industrial, commercial (including the commercial development of residential housing), recreational or conservation purposes.

Site preparation costs shall include, but not be limited to, the costs of excavation, temporary electric wiring, scaffolding, demolition costs, and the costs of fencing and security facilities. Site preparation costs shall not include the cost of acquiring the site and shall not include amounts included in the cost or other basis for federal income tax purposes of qualified tangible property, as described in paragraph three of this subdivision.

NY Tax Law Section 21(b)(2).

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BCP: Site Preparation (level of cleanup) Component is KEY: List of Activities Potentially Qualifying as Site Preparation Activities

Barricades/Fencing Erosion Control Post work/signs Protection of existing utilities Demolition or removal of utilities Removal of debris Demolition of structure Demolition of Foundation Remove and relocate rail lines Dust Control Demolition of roadways All soft and hard costs (engineering, architectural, consulting, legal, accounting) related to BCP New Roadway construction/access Roads Brush removal and disposal Topsoil fill, stripping, and stockpiling Handling processes related to earth materials Rough site grading Disposal of regulated waste Interim remedial measures Final remediation measures On-site management of solid non-hazardous wastes Community are monitoring during earthwork phases Stormwater management during construction

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BCP Amendments to BRTC Tax Credits Changes to BCP Tangible Property Credit Component

1) BRTC for Tangible Property Credit Component increased by additional 2% to maximum 24% of eligible costs if project is within a BOA (Range 10 to 24%)

2) BRTC Tangible Property Credit Component calculated in same manner

3) BRTC Cap – BRTC that is claimed cannot exceed lesser of :

i) For non-manufacturing project: $35mm or Product of (Site Prep and groundwater remediation costs) x (3)

ii) For manufacturing project: $45mm or Product of (Site Prep and groundwater remediation costs) x (6)

SUMMARY - 22% to 50% refund of site prep/cleanup- $3 or $6 refund for every $1 spent on site pre/cleanup

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New York Historic Rehabilitation Tax Credit

Used with Federal Historic Tax Credit

Equals 20% of Qualified Rehabilitation Expenditures (20% for Federal purposes and 20% for State purposes)

Capped at $5,000,000

Building must be listed on State or National Register of Historic Places or listed as a building contributing to the character of the historic district in which it resides

Must be located in a Distressed Federal Census Tract

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Thank You

Pietra G. Lettieri

Public Finance Practice Group

For more information, visit www.harrisbeach.com and download our Economic Development Handbook:

http://www.harrisbeach.com/sites/default/files/brochures/HBPubFinHandbook2010.pdf

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New York State Ontario Bar SummitPresenting Attorney:

Anthony P. MarshallHarris Beach PLLC333 West Washington StreetSyracuse, NY 13202315-423-7100 Phone315-422-9331 [email protected]

Anthony P. Marshall(315) 423-7100© Harris Beach PLLC, 2012

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New Markets Tax Credit


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NEW MARKETS TAX CREDIT (NMTC)(IRC Section 45D and Regulations Section 1.45D)

NMTC in a nutshell:

CDEs must use substantially all of the proceeds from QEIs to make QLICIs in QALICBs located in LICs.


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1. NMTC: The NMTC is equal to 39% of the qualified equity investment (QEI) made by a taxpayer/investor to a CDE, to be taken over a 7 year period, beginning in the year the QEI is first made. The NMTC is taken 5% in the first 3 years and 6% in the last 4 years.

2. CDE: A Community Development Entity (CDE) is any treated as a domestic corporation or partnership for federal income tax purposes which is certified as a CDE following application for certification, which satisfies the following two tests and becomes certified as a CDE following application for certification:i. Primary Mission Test: The primary mission of the CDE must be to serve, or

provide investment capital for, low-income communities (LICs) or low income persons (LIPs).

ii. Accountability Test: The CDE must maintain accountability to residents of LICs through their representation on CDE governing or advisory boards (at least 20% of the members of its board of directors or advisory boards by representative of the LIC).



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3. QEI: A qualified equity investment (QEI) is an investment by a taxpayer for an equity interest in an entity that is certified as a CDE, acquired at its original issue solely for cash and substantially all of the QEI is used to make qualified low income community investments (QLICIs). The tax basis of a QEI is reduced by the amount of the new markets tax credit taken with respect to the investment.

4. QLICI: A QLICI is generally any capital or equity investment in, or loan to, any qualified active low-income community business (“QALICB”). The QLICI must be made within 12 months of the date the QEI is made. Certain CDE-to-CDE transactions can constitute QLICIs. No investment or loan can be a QLICI if the project is entitled to low income housing tax credits under §42.



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5. QALICB: A QALICB is any corporation (including a nonprofit corporation) or partnership engaged in the active conduct of a qualified business which, for the tax year, satisfies the following: i. Property Test: at least 40% of the use of the QALICB’s property is within a

LIC.

ii. Services Test: at least 40% of the services performed for QALICB by its employees are performed in a LIC. Where an entity has no employees, this 40% test will be deemed satisfied if the Property Test is met 85% or more.

iii. Gross Income Test: at least 50% of QALICB’s total gross income is derived from the active conduct of a qualified business (“QB”) within a LIC. This test is met if either of the Property Test or Services Test is met after substituting 50% for the 40%.



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6. Qualified Business: A qualified business (QB) is any trade or business, except for the following (note that there is no requirement that employees of the qualified business be residents of a LIC): i. buildings that derive 80% or more of its income from residential dwelling units

(IE, mixed use projects are qualified if residential rents are less than 80% of total rents);

ii. the rental of unimproved real property;

iii. farming businesses whose aggregate assets owned and leased, valued at the higher of fair market value or unadjusted basis, exceeds $500,000;

iv. any trade or business consisting predominantly of the development or holding of intangibles for sale or license; or

v. any “sin business” (private or public golf course, racetrack or other facility used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises).



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7. Other QALICB Rules: i. An entity will be treated as engaged in the active conduct of trade or business if, at

the time the CDE makes a QLICI, the CDE reasonably expects that the entity will generate revenues (or, in the case of a non-profit, engage in an activity that furthers its non-profit purpose) within 3 years after the date the QLICI is made.

ii. A CDE may treat a portion of any trade or business (“POB”), as a QALICB if (i) the POB satisfies the tests of QALICB status if it were separately incorporated, and (ii) it maintains complete and separate books and records are maintained for the trade or business.

iii. For a business to be a QALICB, its nonqualified financial property (“NQFP”) must be less than 5% of the average of the aggregate unadjusted basis of all of its property, where NQFP essentially means cash, cash equivalents, debt, stock, partnership interests, or other similar property, EXCEPT, the term does not include reasonable amounts of working capital held in cash, cash equivalents or debt instruments with a term of 18 months or less. In applying this rule, (as a default rule) the proceeds of a QLICI that will be expended for construction of real property within 12 months after the date of the QLICI is treated as a reasonable amount of working capital.



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8. LIC: A low-income community (“LIC”) means any population census tract that:i. has a poverty rate of at least 20%; or

ii. if the tract is located outside of a metropolitan area, the median family income does not exceed 80% of statewide median family income; or

iii. if the tract is located within a metropolitan area, the median family income does not exceed 80% of the greater of (i) statewide median family income or (ii) the metropolitan median family income; or

iv. is in a “high migration county”, which are census tracts which, during the 20-year period ending in 2000, has a net out-migration of population of at least 10% of the population of the county at the beginning of such period, if the MFI for the tract does not exceed 85% of SMI; or

v. is in a low population tract (less than 2,000) which is also in a federally designated empowerment zone and contiguous to a LIC as defined in (i)-(iii) above; or

vi. that serves targeted populations (at least 40% of its employees are low income persons (LIPs), determined at the time of hire; or at least 50% of income is derived from sales to LIPs; or at least 50% of the entity is owned by LIPs. For non-metro targeted population areas, a LIP is an individual with family income (adjusted for size) of not more than 80% of the greater of (i) area MFI or (ii) SMFI.



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9. Reinvestmentsi. The QLICI must be maintained as such over the entire seven year credit

period. Any return OF capital during the seven year credit period in an amount that would fail the substantially all test must be redeployed within 12 months of receipt, or a recapture event will occur. (Returns ON capital (interest or dividends) is allowed during the 7 year credit period).

ii. Amounts received by a CDE in re-payment of capital, equity or principal with respect to a QLICI must be reinvested by the CDE in another QLICI no later than 12 months from the date of receipt to continue to be treated as continuously invested in a QLICI for the balance of the 7-year compliance period.

iii. Reserves not in excess of 5% of the QEI maintained by the CDE for loan losses or for additional investments in existing QLICIs are treated as invested in a QLICI.



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10. Recapturei. If, during the 7 years from the original issue date of the QEI in a CDE, a

recapture event occurs, then the tax credit is recaptured. A recapture event occurs when (i) the entity ceases to be a CDE; (ii) the proceeds of the QEI cease to be used in a manner which satisfies the substantially-all test; or (iii) there is redemption or other cash-out of the QEI.

ii. Typically, the CDE is a partnership for federal tax purposes. A pro-rata distribution by the CDE to its partners each tax year will not be treated as redemption if the distribution does not exceed the CDE's operating income for that tax year. In addition, a non-pro rata de minimis distribution by a CDE to a partner or partners during a tax year will not be treated as a redemption; where a non-pro rata de minimis distribution may not exceed the lesser of (i) 5% of the CDE's operating income for that tax year, or (ii) 10% of the partner's capital interest in the CDE. For this rule, operating income is the sum of the CDE's taxable income determined under §703, with certain adjustments.



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iii. The bankruptcy of a CDE is not a recapture event.

iv. The Service may waive a requirement or extend a deadline relating to recapture events and its effect on CDE investor and the availability of NMTCs, provided such waiver or extension does not materially frustrate the purposes of §45D and Regs. §1.45D-1(e) (relating to recapture). Request for waiver or extension is made only by the CDE in the form of ruling request consistent with Rev. Proc. 2005-1.

v. The recaptured credit will increase the tax for the year the recapture event occurs in an amount equal to the amount of the credits claimed, plus interest on the resulting underpayment from the due date of the return for the year in which the credit was initially taken. The interest is non-deductible, and the resulting tax cannot be reduced by any other available credits in that year.



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11. Other Federal Tax Benefits

Federal tax benefits that do not limit the availability of the NMTCs include:

i. The rehabilitation credit under §47 (IE, the HTC may be coupled with NMTCs in the same transaction to further leverage NMTC equity);

ii. All deductions under §167 and 168, including the first year depreciation under §168(k) and the expense deduction for certain depreciable property under §179;

iii. All tax benefits relating to certain designated areas, such as empowerment zones, enterprise communities, renewal communities and the New York Liberty Zone under §1400L.



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12. Obtaining/Accessing an NMTC Allocation

i. CDE must file an Allocation Application each year upon the Fund’s issuance of a Notice of Allocation Availability (NOAA) each year. A very competitive application process.

ii. To gain access to NMTC allocations, proposed QALICBs must shown that its project:

§ Complies with the CDE’s Allocation Agreement and its business strategy;

§ Meets the “but for” test (the project capital gap requires the NMTC equity);

§ Is essentially ready to close at the time request for allocation is made (has other needed debt, a credit investor, site control, approvals, etc.); and

§ Exhibits strong community impact (jobs, spurs other development, environmental sustainability; etc.).



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13. Leverage Loan Transactional Structure (see charts on following slides)

i. Equity (or Leveraged) Model. The IRS has ruled (Revenue Ruling 2003-20) that a QEI can include the proceeds of a loan in leverage of equity which acquires the NMTCs. This is referred to a "leveraged" transaction.

ii. Interest Subsidy Model. Where the CDE, lender and credit investor are within an affiliated group.



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Leverage Loan Model


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Interest Subsidy Model


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Interest Charge-Domestic International

Sales Corporation (IC-DISC)


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Interest Charge-Domestic InternationalSales Corporation (IC-DISC)

1. BASIC TAXATION AND GENERAL RULES:a. IC-DISC is not subject to US corporate income tax in that it does not pay US

tax on its commission income from a manufacturer. [IRC 991]

b. DISC shareholders are taxed on deemed dividend distributions equal to the taxable income of the DISC in excess of $10 million. [IRC 995(b)]

c. The manufacturer deducts the commission.

d. DISC pays a dividend to its shareholders, taxed at the applicable dividend rate (currently 15% US).

e. If the manufacturer is a pass through entity (LLC or S-corporation), the tax savings is 20% (assume 35% tax bracket of pass through taxpayers, less the 15% DISC dividend rate).

f. If the manufacturer is a C-corporation, the tax savings is 29.75% (assume C-corporation rate of 35%, and the net C-corporation dividend is taxed at 15%).


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g. The interest charge aspect of an IC-DISC is essentially a low interest loan from the US Treasury. The charge is on the shareholder’s deferred tax liability, which equals the difference between the shareholder’s tax computed with the accumulated (non-distributed) IC-DISC income and then without. The interest rate is the 52-week T-Bill rate. [IRC 995(f)(2)]

h. Given that the rate of tax on dividends is only 15% (and Congress could always change that), shareholders of an IC-DISC should always distribute the dividend each year. If distributed, no interest charge is due and no deemed dividend distribution tax is due.

i. While most IC-DISCs are commission DISCs, it can be a so-called “buy-sell” IC-DISC. Here, the DISC will actually take title to the export property from a US manufacturer before the export sale takes place and sell the export property. All export sale contracts must move to the DISC. Given these logistical complications, this form of DISC may occur where a seller of a branded, upscale product line desires to sell an inferior, unbranded line and wishes to avoid confusion or impact on its upscale line. There is no difference in the determination or calculation of the DISC benefit in either form.



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2. ORGANIZATION FORMALITIES:

a. Analyze export sale history and determine likely IC-DISC tax benefits. These benefits should exceed the cost of formation and operating the DISC.

b. Incorporate under the laws of any State prior to applicable export sales. Taxpayer cannot obtain the DISC benefit for sales occurring prior to formation.

c. Can have only class of stock with a minimum par value of $2,500 [IRC 992(a)(1)(c)]. It is advisable to capitalize at $3,000 to avoid any circumstance where par value could drop below $2,500. Each DISC shareholder would contribute their respective pro-rata share of the total capitalization.

d. File Form 4876-A with IRS within 90 days after beginning of 1st tax year.



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e. Execute a Commission Agreement between the IC-DISC and exporter, drafted with maximum flexibility, allowing the exporter to chose which foreign sales can run through the DISC. Agreement should be dated upon formation; but if not, can be executed after formation with an effective date back to formation.

f. Shareholders of IC-DISC may require commonality of ownership with the manufacturer entity under gift tax rules, in that value is being transferred by the DISC commission payment.

g. Note that the DISC is not required to be affiliated with a manufacturer. An exporter/distributor can establish a DISC and receive the same tax benefits.

h. The IC-DISC is not required to have any operations, nor have any employees.



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3. IC-DISC QUALIFICATION REQUIREMENTS:

To qualify as an IC-DISC, the domestic corporation must satisfy 2 tests:

a. Qualified Exports Receipts (QER) test

At least 95% of the DISC’s gross receipts must be qualified export receipts. [IRC 992(a)(1) and 993(d),(f)]. For purposes of this test:

§ “Gross receipts” means gross income from all sources; and

§ “Qualified export receipts” includes gross receipts from:

§ Sales of export property; § Lease of export property outside the US; § Services related to export sales;§ Engineering or architectural services for construction projects located outside the US.



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b. Qualified Exports Assets (QEA) test:

At least 95% of the DISC’s assets must be qualified export assets. [IRC 992(a)(1) and 993(d),(f)]. For purposes of this test, “qualified export

assets” include:

§ Any asset used primarily in connection with the sale or lease of export property, or performance of engineering or architectural services for construction projects located outside the US.

§ Accounts receivable of the DISC

§ Temporary investments of the DISC

Note: If the IC-DISC were to distribute all of its commission income each year, its only asset will be its par value (IE, the $3,000 initially capitalized upon formation). Under the diminis rules under the regulations [(1.993-2(c)(3)(iii)], this par value is considered a temporary investment. As 100% of the IC-DISC’s assets are QEA, it satisfies the QEA test.

4. Producer loans are loans made to a person engaged in the manufacturing, production, growing or extraction of export property in the US.



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4. SALES OF EXPORT PROPERTY

a. There are 3 requirements for an IC-DISC to receive commission income from the sale of export property: [IRC993(c)]

a. Manufacturing: property must be manufactured, produced, grown or extracted in the US by other than the DISC;

b. Destination: export property held primarily for sale or lease for direct use, consumption or disposition outside the US; AND

c. US Content: export property must have at least 50% US content.

Note: While export property is typically thought of as newly manufactured property, the property can be used equipment or even scrap.



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b. Manufacturing Requirement:1. The export property must be manufactured in the US, and not by the IC-DISC (the

manufacturer will form the IC-DIDSC to capture the export sales).

2. Property is manufactured in the US if:A. 20% of its conversion costs are incurred in the US;

B. There is a substantial transformation in the US; OR

C. The operations in the US are generally considered to constitute manufacturing. [IRC 1.993-3(c)]

3. Substantial transformation: Examples include converting tuna to canned tuna; pulp to paper; and curiously assembly of components of eyeglasses (lenses, wings, screws, etc.) is a substantial transformation. Curiously still is a case involving GE: assembly of a manufacturer product (IE, jet engines) into another manufacturer product (jet airplanes) is generally not considered manufacturing. Stated another way, affixing a completed product to another completed product may not constitute manufacturing. [General Electric v. Commissioner, 245 F3d (2d Cir. 2001)]



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c. Destination Requirement:

1. Export property must be held for sale or lease in the ordinary course of business for direct use, disposition or consumption outside the US. [IRC 993(c)(1)(B)]

2. Delivery of property directly to a foreign purchaser satisfies this test. Delivery of property to a freight forwarder for ultimate shipment abroad satisfies this test. [IRC 1.993-3(d)(2)(i)(a)]

3. Sales of property to a US distributor satisfy this test if:

A. The property does not undergo further manufacturing by the purchaser prior to its export; and

B. The property is shipped abroad within 1 year of purchase. [IRC 1.993-3(d)(2)(i)(b)]

Note: In the referenced GE v Commissioner case, GE sold jet engines to Boeing (a US seller), who sold to foreign purchasers. Since Boeing’s affixing of the jet engines sold by GE was determined not to be further manufacturing, GE received the DISC benefit. That was the crux of that case.

Proofs: Require as part of the sale that the US distributors provide information that the product was exported (such as export bill of lading or a shipper’s export declaration).



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4. Example: Company manufactures windshield wipers with US materials. Company’s IC-DISC sells the wipers to a US car manufacturer, which affixes them to its cars that are exported to Canada. Affixing the wipers is not further manufacturing, so the property retains its export property character. As the final destination of the cars is outside the US, the sale of the wipers to the US manufacturer is an export property sale. Require documentation from the manufacturer of the export.

5. Sales of property to a foreign purchaser in Toronto, who then sells the property in Buffalo, are not entitled to the DISC benefit.

6. Note that an exporter can receive IC-DISC benefits on sales to a foreign subsidiary, but only on the sale by the exporter to its foreign subsidiary (and not on subsequent sales by its foreign subsidiary).


d. US Content:

1. All export property may have no more than 50% of the value of the final costs attributable to foreign components, where value is determined based on the dutiable value of the foreign components. [IRC 1.993-3(e)(4)(i)]

2. Final cost includes both labor and material.


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5. DETERMINING THE IC-DISC BENEFIT

The amount of the commission payable to either a commission or buy-sell an IC-DISC from sales of export property is calculated based on either:

a. Qualified exports receipts method [IRC 994(a)(1)]: This method allocates 4% of the qualified exports receipts from the export sales to the IC-DISC.

Rule of thumb: The qualified exports receipts method provides the larger commission income when net pre-tax margin is less than 8% (IE, low margin), producing a benefit of approximately $8,000 per $1 million of qualified exports receipts. (Note in the above example that $48,000 was the savings on $6 million of qualifying export sales).

b. Combined Taxable Income Method [IRC 994(a)(2)]: This method allocates 50% of the taxable income from export sales to the IC-DISC.

Rule of thumb: The combined taxable income method provides the larger commission income when exports have a net pre-tax margin of 8% or greater (IE, high margin), producing a benefit of approximately $100,000 per $1 million of combined taxable income. (Note in the above example that $100,000 was the savings on $1 million of qualifying export sales).



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6. MAXIMIZING THE IC-DISC BENEFIT

In the context of calculating the commission using the combined taxable income method, there are 3 techniques for increasing the IC-DISC’s taxable income: grouping, marginal costing and expense allocations.

a. General concepts:

1. An IC-DISC is permitted to apply the qualified exports receipts or combined taxable income method on a product line-to- product line basis, transaction-by-transaction, and can change methods year-to-year or transaction-by-transaction. [IRC 1.994-1(c)(7)]

2. Product line groupings are accepted if the groupings conform to recognized trade or industry usage or the 2-digit major groups of standard industrial classification (SIC) codes. [IRC 1.994-1(c)(7)(ii)]

3. An exporter can maximize IC-DISC commission income by ignoring loss sales. [IRC 1.994-1(e)(1)]



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b. Grouping: Grouping allows an exporter to maximize the IC-DISC’s commission by segregating high margin sales from low margin sales.

c.Marginal Costing [IRC 994(b)(2) and 1.994-2(c)]:

1. Full costing combined taxable income (FCCTI) equals qualified export receipts, less total direct and indirect costs attributable to exports sales. [IRC 1.994-1(c)(3)]

2. Under marginal costing, only marginal costs (IE, direct material and direct labor costs) are taken into account in computing combined taxable income. All other indirect costs (selling, general administrative, interest expense, etc.) are ignored in computing marginal costing combined taxable income (MCCTI). [IRC 1.994-2(b)(2)]

3. Marginal costing allows a taxpayer to increase combined taxable income by excluding the indirect costs related to export sales.

4. Use of marginal costing requires only that MCCTI exceed FCCTI. [IRC 1.994-2(b)(1)]

5. Limitation: An “overall profit percentage” (OPP) limitation restricts the combined taxable income of an exporter to an amount equal to:

1. FCCTI from all sales (domestic and foreign), times

2. The ratio of qualified export receipts to total receipts (domestic and foreign). [IRC 1.994-2(b)(3)]



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d. Expense Allocations: A taxpayer can increase combined taxable income (which increases the IC-DISC commission) by allocating fewer indirect costs against qualified export receipts, with the intent being to allocate as much indirect costs to domestic sales. Allocations can be based on relative (domestic vs. foreign) sales, gross profit, units produced, units sold.



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Examples of Calculation of DISC Commission


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Qualified exports receipts method [IRC 994(a)(1)]: This method allocates 4% of the qualified exports receipts from the export sales to the IC-DISC.

Example: Manufacturer is a disregarded LLC which has $6 million of qualifying export sales through its IC-DISC. Manufacturer will deduct a commission of $240,000 (4% of $6 million), reducing its tax by $84,000 (assume personal tax rate of 35%, times $240,000). Assuming the IC-DISC distributes the commission to its shareholder, a tax of $36,000 is due (15% times $240,000). Total tax savings is $48,000 ($84,000 saved, less $36,000 due).

Combined Taxable Income Method [IRC 994(a)(2)]: This method allocates 50% of the taxable income from export sales to the IC-DISC.

Example: Manufacturer is a disregarded LLC which has $1 million of combined taxable income from export sales. Manufacturer will deduct a commission of $500,000 (50% of $1 million of combined taxable income), reducing its tax by $175,000 (assume personal tax rate of 35%, times $500,000). Assuming the IC-DISC distributes the commission to its shareholder, a tax of $75,000 is due (15% times $500,000). Total tax savings is $100,000 ($175,000 saved, less $75,000 due).



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Ways to maximize Combined Taxable Income

Grouping: segregate high margin sales from low margin sales.

Example: Exporter exports domestically produced beer and wine. The annual gross qualified export receipts and combined taxable income from these export sales are as follows:


Receipts Combined T.I. Net pre-tax margin Beer $5,000,000 $1,000,000 20% Wine $5,000,000 $ 200,000 4% Total $10,000,000 $1,200,000 12%

Calculation of IC-DISC commission:

Combined taxable income method:

50% of $1,200,000 = IC-DISC commission of $600,000

Qualified export receipts method:

4% of $5,000,000 = IC-DISC commission of $200,000

Result of Grouping:

Beer (high margin): use 50% of combined taxable income method 50% of $1,000,000 = $500,000 commission to the IC-DISC

Wine (low margin): use qualified export receipts method

4% of $5,000,000 = $200,000 commission to the IC-DISC.

Total commission income = $700,000


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Marginal Costing: increase combined taxable income by excluding the indirect costs related to export sales.

Example: Exporter exports widgets through its IC-DISC. The widgets constitute qualified export property. Results from operations for its year just ended are as follows:


Export sales US sales Total Sales Sales $10,000,000 $15,000,000 $25,000,000 Direct material and labor costs

$ 5,000,000 $ 8,000,000 $13,000,000

MCCTI $ 5,000,000 $ 7,000,000 $12,000,000 Indirect costs $ 3,000,000 $ 3,000,000 $ 6,000,000 FCCTI $ 2,000,000 $ 4,000,000 $ 6,000,000

OPP Limitation:

$6,000,000 (FCCTI from all sales, times)

40% (qualified export receipts ($10MM) ÷ total receipts ($25MM)

$2,400,000 = OPP limited combined taxable income

50%

$1,200,000 = IC-DISC commission

$2,000,000 = FCCTI

50%

$1,000,000 = IC-DISC commission

Marginal costing results in an additional IC-DISC commission of $200,000

Qualified export receipts method: 4% of $10,000,000=$400,000


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Expense Allocations: increase combined taxable income by allocating fewer indirect costs against qualified export receipts. based on relative (domestic vs. foreign) sales, gross profit, units produced, units sold.

Example: Assume the following results of operations, which include $10 million of indirect costs on all sales, which (based on known data) can be allocated to export sales based on sales or gross profits:

Allocation of indirect costs based on Sales:


Sales Direct Costs Gross Profit Indirect Cost as allocated based on relative sales

Combined Taxable Income

Domestic $24,000,000 $ 9,000,000 $15,000,000 $ 6,700,000 $ 8,300,000 Foreign $12,000,000 $ 7,000,000 $ 5,000,000 $ 3,300,000 $ 1,700,000 Total $36,000,000 $16,000,000 $20,000,000 $10,000,000 $10,000,000

Allocation of indirect costs based on Gross Profit:

Sales Direct Costs Gross Profit Indirect Cost as allocated based on relative gross profit

Combined Taxable Income

Domestic $24,000,000 $ 9,000,000 $15,000,000 $ 7,500,000 $ 7,500,000 Foreign $12,000,000 $ 7,000,000 $ 5,000,000 $ 2,500,000 $ 2,500,000 Total $36,000,000 $16,000,000 $20,000,000 $10,000,000 $10,000,000


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a. Combined taxable income method (based on sales):

50% of $1,700,000 = $850,000 commission

b. Combined taxable income method (based on gross profit):

50% of $2,500,000 = $1,250,000 commission

c. Qualified export receipts method:

4% of $12,000,000 =$480,000 commission


Documents

Pietra G. Lettieri, Esq. Public Finance / Economic Development and Tax Law Practice Groups Harris Beach PLLC 726 Exchange Street, Suite 1000 Buffalo, New