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How Can an IC-DISC Save on Taxes When Doing Business Abroad?

One way to tap into foreign markets without going overseas could be through the use of an interest charge domestic international sales company (IC-DISC).

Before you start doing business in a foreign country, it pays to understand that nation’s tax laws. American executives tend to think that foreign countries have assumed our tax laws. Some business leaders presume that what’s taxable in the U.S. would be taxable abroad and that what’s not taxable here would not be taxable in other countries. That’s not necessarily true.

It’s essential to get professional assistance as soon as you think you’re going to start doing business in a foreign jurisdiction. If you set up your operations in a way that is not tax-advantageous, it can be next to impossible to backpedal and make the necessary changes later.

IC-DISCs offer advantages for U.S. companies

An IC-DISC is a vastly underused opportunity to defer or avoid federal income taxes. It is an IRS-sanctioned tool that allows you considerable benefits if you are selling domestically produced goods for foreign consumption. You don’t even have to sell the goods to another country—you just have to make sure that that’s where they end up. You can transfer title in Los Angeles and have your buyer put them on a boat, as long as you know they’re going to be used overseas.

How does a IC-DISC work?

With an IC-DISC, the profit on a transaction is split between the manufacturer/distributor and the IC-DISC. So if the profit on a unit is $10, some of that profit belongs to the IC-DISC and some belongs to the manufacturer. There are all sorts of pricing rules that tell you how to split it. The portion attributable to the IC-DISC is like a commission.

So, if the IC-DISC is going to earn $4 of the $10, then the manufacturer pays tax on only $6 and the IC-DISC has $4 of income. And the IC-DISC doesn’t have to pay income tax in most circumstances; it only has to pay the interest on what the taxes would be. So if the IC-DISC has $4 of income and the tax on that is 35% or $1.40, rather than paying $1.40 to the government, the IC-DISC pays interest at a government rate, which is probably 4% or 5%. As long as you leave the money inside the IC-DISC, you don’t pay tax—you only pay interest on the tax.

An executive might say, "If this $4 is sitting in the IC-DISC, what good does it do me?" With that $4, you can go back to your supplier and say, "I know that ABC Company in China owes you $4.25. I’ll buy that receivable from you for $4." Then the supplier will have $4 cash now, and the executive would collect the $4.25 from the Chinese company, making more money that’s tax-deferred.

IC-DISCs offer up to a 20% tax break—for now

What is becoming a very hot topic is that when the government dropped the dividend tax rate to 15% for individuals and trusts a few years ago, it inadvertently dropped the rate on an IC-DISC dividend to 15%, too. So, people have been saying, "Forget the deferral, I’m going to pay that $4 to the IC-DISC, so my company gets a $4 deduction at 35%. Then, I’ll have the IC-DISC pay a dividend back to its owner, and the owner will pay tax at 15%, so I get a 35% deduction and 15% income for doing virtually nothing but having a paper company set up. The IRS recognizes that an IC-DISC is a paper company; they’re not looking for employees.

Once this loophole came to the attention of Congress, they said, "This is not at all what we intended, and we’re going to change it." There has been some proposed legislation that has gone nowhere. Washington pundits predict that nothing will happen in 2008. It’s not advisable to set up a IC-DISC thinking that the 20% tax break is going to last a long time, but the deferral properties will continue. So, short-term, big benefit; long-term, the deferral works.  

Questions about setting up an IC-DISC? 
Contact Mike Calahan at 312-980-2996.

Our thanks to Alan Alport for his assistance in writing this article. 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.