Technical Explanation of the ETI Legislation

• Congress Repeals FSC Legislation

• Transition Rules for Existing FSCs Extend Benefits through 2001

• Understanding the New Extraterritorial Income (EI) Exclusion Rules

• Computing Qualifying Foreign Trade Income (QFTI)

• What Constitutes Foreign Trading Gross Receipts (FTGR) and Qualified Foreign Trading Property under the New EI Exclusion Regime?

• Election to Treat a Foreign Corporation as a Domestic Corporation

• Technical and Conforming Amendments for FSC Replacement Rules

Congress Repeals FSC Legislation

President Clinton approves new Extraterritorial Income (ETI) exclusion tax regime for U.S. and foreign manufacturing income

On November 15, 2000, President Clinton approved the FSC Repeal and Extraterritorial Income Exclusion Act of 2000 (the Act).  The Act (H.R. 4986) was drafted by members of the Treasury Department and the Joint Committee on Taxation.  The President remarked that passage of the FSC replacement legislation was the result of bipartisan support in Congress.  The Act is intended to assure the U.S. business community that comparable tax benefits are available under the ETI tax regime and that the record-keeping requirements will be simplified.  On the other side of the Atlantic, recent statements from Commissioner Lamy at the European Union indicate that the FSC replacement legislation is not WTO-compatible, so further negotiations are expected.

As a concession to its trading partners and the World Trade Organization (WTO), the Act repeals Secs. 921-927 of the Internal Revenue Code of 1986 (the Code), effective September 30, 2000.  These sections contain the operative statutory FSC provisions.  Presumably, conforming amendments will be made to other provisions in the Code under the foreign tax credit, Subpart F, expense apportionment and dividend received deduction rules to eliminate references to the FSC.

Tax Benefits of ETI Exclusion Legislation

As an alternative, the Act implements the extraterritorial income (ETI) exclusion.  The exclusion provides U.S. manufacturers with a 5.25% reduction in their U.S. tax rate on ETI.  The benefits of the ETI exclusion are expected to mirror the current benefits under the FSC provisions, only the ETI exclusion should apply to more U.S. taxpayers

The Act reflects the acceptance of the WTO decision against FSCs. Remarks by Treasury Secretary Eizenstat indicate that the U.S. has complied with the complaints raised by the European Union (EU) at the WTO hearings last year.  In addition, based on Eizenstat’s explanation, the Act is WTO-compliant.  The following points were cited:

·        the exclusion applies to all U.S. taxpayers, so there is no subsidy or revenue “foregone” that is otherwise due,

·        foreign and U.S. manufactured goods are eligible for the exclusion, so benefits are not contingent upon export,

·        no incentives are provided for the use of low or no-tax jurisdictions, and formulary pricing rules are eliminated