8-21-90 7943
[~ 7527]
By using marginal costing, a transfer pricing method, Foreign Sales Corporations (FSCs) can often increase their income from export sales.' Marginal costing uses certair, costs when determining the combined taxable income (CTI) of a FSC and its related supplier. If the FSC meets various quantitative tests, it automati- cally establishes or maintains a market for marginal costing.
Marginal costing enables a FSC and its related supplier to eliminate fixed costs and a significant portion of their other costs and expenses. This strategy increases Cfl, which then can often increase FSC income.
These FSC benefits are often substantial, but require careful structuring of intercompany pricing. The marginal costing rules for increasing allowable FSC profits are described below under the following topics:
1.Background 7527,1
2. Costs and Expenses 7527.2
3, Overall Profit Percentage Limitation .7527.3
4. No Loss Rule 7527,4
5. Grouping 7527.5
[~ 7527.1]
BACKGROUND
The prerequisite for marginal costing is that the FSC must be
seeking to establish or maintain a market for export property.3
However, neither the Code nor the regulations interposes any requirements
that pertain to either establishing or maintaining a
market,4 This test emanates from requirements imposed by the General
Agreement on Tariffs and Trade (GA TT) that predates the FSC enactment.
Under the regulations, the overall profit percentage limitation (OPPL) was designed to employ the "establish or maintain" test,S but this calculation applies imperfectly in many situations. FSC sales provide marginal costing benefits only when export sales are less profitable than domestic sales.
FSC pricing emanates from the Domestic International Sales Corporation (DISC) program, but some significant changes in marginal costing rules have taken place since the DISC program was proposed more than 20 years ago. First, the definition of "costs" to be included in the marginal costing computation has been modified,6 Second, the focus has shifted away from "export promotion expenses."7 Third, a new limitation, called the 100% limitation, or full cost method, restricts FSC marginal costing benefits.8 Eligibility for marginal costing is based on "an item, product, or product line," so that grouping rules apply.9 Selection of marginal cost grouping can be made each tax year.IO
Any change in gross receipts, whether by increasing or decreasing these amounts, changes CTI. The gross receipts method, which generally provides the FSC with income equal to 1.83% of foreign trading gross receipts, has no direct impact on marginal costing, but the gross receipts formula affects various aspects of marginal costing.
[~ 7527 ,2]
COSTS AND EXPENSES
Under marginal costing rules, only direct production costs
are used in computing Cfl, and other costs are excluded.11
Direct production costs are direct 6
«:J 1990
Macmillan. Inc.-U.S. Taxation of International Operations: Tax
Ideas ~ 7527.2
