United States

California: FTB Addresses Treatment of IC DISCs and their Owners

Jul 13, 2015
From KPMG TaxWatch

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In recent Legal Ruling 2015-02, the Franchise Tax Board (FTB) discusses the treatment of transactions between Interest Charged Domestic International Sales Corporations (IC DISCs) and their owners when the owner of the IC DISC is not included in the California combined report.

Congress created IC DISCs with the goal of spurring American exports. For federal income tax purposes, owners of IC DISCs may attribute their foreign sales to the IC DISC (an entity not subject to federal income tax) and may take deductions for commissions paid to the IC DISC, regardless of whether cash is actually transferred between the parties, i.e., even if the transactions between the IC DISC and the owners is reflected only in accounting transactions in the books and records of the parties, as is often the case. Because an IC DISC generally has no employees or operations, the FTB observed that there is no economic substance to the transactions attributed to the IC DISCs by their owners.

California does not conform to the federal income tax treatment of IC DISCs. Moreover, as outlined in Legal Ruling 2015-02, the FTB reserves the right to re-allocate gross income and deductions among IC DISCs and their owners to properly reflect the economic substance of the transactions. If the IC DISC’s owner is another C corporation and the two entities are included on the same California combined return, there is no re-allocation needed because the income attributable to the IC DISC will offset the expense attributable to its owner.  However, if the IC DISC’s owner is an individual, an entity other than a C corporation (e.g., a partnership), or a C corporation that is not included on the same California combined report as the IC DISC, then (i) any sales attributed to the IC DISC will be attributed back to the owner and (ii) any commissions “paid” to the IC DISC by the owner will be ignored (i.e., the owner does not receive a deduction). Note that IC DISCs registered in California will still be subject to the California minimum franchise tax. For more information on FTB Legal Ruling 2015-02, please contact Doug Bramhall at (480) 459-3491 or Scott Salmon at (202) 533-4202.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.