To entice a firm to export, get the products to foreign destinations and collect the international receivables, a number of additional intermediaries or resources other than lenders are needed. These intermediaries or resources include U.S. government agencies, foreign sales corporations, and U.S. freight forwarders.

Several U.S. government agencies provide assistance to level the playing field for exporters, and in many cases, counter export credit subsidies of foreign governments. For example, the U.S. Trade and Development Agency provides grant financing for projects and activities conducted by U.S. firms. The Overseas Private Investment Corporation provides specialized assistance to U.S. firms. The United States Small Business Administration (SBA) and the United States Export-Import Bank (Ex-Im Bank) offer programs that, among other things, address the financial needs of smaller exporters. And the Agency for International Development provides grants to developing nations that can be used to purchase U.S. goods and services.

Foreign Sales Corporations (FSCs), defined as foreign subsidiaries formed outside U.S. customs territory to transact export sales for their parent companies in the United States, offer generous tax advantages that can enhance export business. Freight forwarders tackle many of the logistics involved in getting the goods to their destinations.

In this section, the roles of some of these resources are reviewed in order to improve understanding of the export process so that the lender may better serve the exporter’s diverse needs. More information about specific organizations can be obtained from their internet websites.

United States Small Business Administration, Office of International Trade

The U.S. Small Business Administration (SBA) provides financial and business development assistance to encourage and help small businesses develop export markets. By participating in the SBA’s Export Working Capital Program (EWCP), lenders can help small businesses, yet minimize their own lending risks (See Appendix A).

Many small businesses invest the time and resources necessary to develop export leads, only to find that they can’t secure the credit to close the sales. The SBA’s EWCP gives lenders the comfort they need so that small businesses can get the financing they need. Under the program, the SBA backs up each loan request with a repayment guaranty of up to $750,000 or 90 percent of the loan amount, whichever is less. The exporter can finance a single export order or multiple sales under a revolving line of credit. For a single deal, the term is set to fit the transaction. The term for a revolving line is usually one year. The EWCP can help a small firm with its pre- and post-export financing needs. Under the program, the exporter can use the loan to:

  • Acquire inventory;
  • Pay manufacturing costs of goods for export;
  • Purchase goods or services for export;
  • Support standby letters of credit;
  • Finance foreign accounts receivable; and
  • Use standby language.

When exporters are competing for export orders, they need financing fast. The SBA understands this. As a result, the SBA provides simplified procedures with a quick turnaround. More than 200 experienced export lenders participate in the EWCP, some of whom have special approval authority under the EWCP — which means an even faster turnaround.

Small banks often view export sales as riskier than domestic ones and won’t provide the credit. Further, larger banks with international trade departments won’t make the smaller loans small firms routinely need. To help alleviate this problem, the SBA has developed the SBA Export Express. It takes the guesswork out of export transactions by providing lenders with the tools they need to assess the international risk involved in the exporter’s loan application.

The Export-Import Bank of the United States

The Export-Import Bank of the United States (Ex-Im Bank) guarantees the repayment of loans, makes loans to foreign purchasers of U.S. goods and services, and provides guarantees of working capital loans for U.S. exporters. As the Export Credit Agency (ECA) of the United States, it also provides credit insurance. Ex-Im Bank does not compete with commercial lenders, but assumes the risks they cannot accept (See details in Appendix B).

An exporter may reduce foreign risks by purchasing Ex-Im Bank export credit insurance through an insurance broker or directly from Ex-Im Bank. A wide range of policies is available to accommodate many different export credit insurance needs. Insurance coverage:

  • Protects the exporter against the failure of foreign buyers to pay their credit obligations for commercial or political reasons;
  • Encourages exporters to offer foreign buyers competitive terms of payment;
  • Supports an exporter’s prudent penetration of higher risk foreign markets; and
  • Because the proceeds of the policies are assignable from the insured exporter to a financial institution, it gives exporters and their banks greater financial flexibility in handling overseas accounts receivable.

Ex-Im Bank offers a short-term (up to 180 days) insurance policy geared to meet the particular credit requirements of smaller, less experienced exporters. Products typically supported under short-term policies are spare parts, raw materials and consumer goods. In addition, the government agency’s Umbrella Policy allows state agencies, export trading and management companies, insurance brokers, and similar agencies to act as intermediaries between Ex-Im Bank and their clients by assisting their clients in obtaining export credit insurance.

For those exporters who do not want to insure all their short-term export credit sales under a multi-buyer type of policy, the Short-Term Single Buyer Policy is available to cover single or repetitive sales. The policy offers 90 to 100 percent coverage for both political and commercial risks of default (depending on the type of buyer, terms of sale and product) and has no deductible. A special reduced minimum premium is available to small businesses.

Medium-term insurance is available for exporters of capital goods or services in amounts less than $10 million and terms up to five years. Ex-Im Bank offers 100 percent commercial and political risk protection. Although similar to the guarantee program, medium-term insurance applications will usually be decided in a more timely fashion because of their conditional nature. Ex-Im Bank also provides direct loans and guarantees of commercial financing to foreign buyers of U.S. capital goods and related services. Both programs cover up to 85 percent of the U.S. export value, with repayment terms of one year or more.

Ex-Im Bank’s Working Capital Guarantee Program assists small businesses in obtaining crucial working capital by guaranteeing loans in amounts greater than $750,000 to fund their export activities. (Note: The SBA guarantees the working capital needs of businesses for amounts under $750,000.) The program guarantees 90 percent of the principal and interest on working capital loans extended by commercial lenders to eligible U.S. exporters. The loan may be used for pre-export activities such as the purchase of inventory, raw materials or the manufacture of a product.

Ex-Im Bank will support the export of environmental goods and services through a short-term environmental insurance policy with coverage of 95 percent of the commercial and 100 percent of the political risks of default, without a deductible. Medium-term environmental exports will have enhanced guarantee coverage with local cost coverage equal to 15 percent of the U.S. contract price, and capitalization of interest during construction.

The organization has a special U.S. toll-free number, (800) 565-EXIM, to provide information on the availability and use of working capital guarantees, export credit insurance, guarantees, and loans extended to finance the sale of U.S. goods and services abroad. The toll number is (202) 565-EXIM.

State and Local Agencies

Numerous state and local governments offer export related services and financial support to small businesses. In fact, to better serve the needs of local firms, many states have established offices in foreign countries. Services range from education and counseling, to providing trade leads, to facilitating federal agency funding, loan guarantees and insurance.

The Case of the Erie County Industrial Development Agency

New York State’s Erie County Industrial Development Agency (ECIDA), through its Trade Assistance Program, provides export assistance designed to promote and enhance the exporting activities of Erie County businesses. To encourage exports, the ECIDA offers the exporter access to sources of financial support, market research, the facilities of trade missions to foreign markets and general export counseling. The organization seeks to play a facultative, awareness-raising role, resolving gaps in Western New York’s export infrastructure.

In attempting to achieve its goals, the ECIDA, a designated intermediary for SBA’s EWCP program, provides local exporters with an understanding of SBA and Ex-Im Bank programs, and helps facilitate the financing process, making it easy to obtain the necessary guarantees, insurance and loan solutions. In 1997, working closely with local banks, the ECIDA assisted local companies in obtaining 10 working capital loans totaling $6,943,000, of which 90 percent were guaranteed by either the SBA or Ex-Im Bank under the Export Working Capital Program. In addition, the organization helped facilitate several export credit insurance policies, and an Ex-Im Bank medium-term loan of $3,500,000.

Freight Forwarders

It is highly recommended that small business exporters work with freight forwarders. They act as the exporter’s agent or representative by advising on, and/or coordinating, a number of export related activities. These include:

  • Recommending the best type of packaging in order to protect the merchandise in transit;
  • Arranging for the goods to be packed at the port or containerized if necessary;
  • Coordinating and managing inland transportation from the exporter’s location to the ocean port, ocean transportation, foreign inland transportation, and warehousing along the way, if necessary;
  • Explaining and completing export and foreign customs documentation requirements;
  • Providing quotes for shipping, port charges, consular fees, costs of special documentation, insurance and handling fees; and
  • Reviewing financial documents, commercial invoices and other documentation.

Documents required in an export transaction differ depending on the destination and product category. Nevertheless, in addition to the required shipping and customs documents, it is wise to provide as much quality information as possible to help foreign customs agents and other foreign officials through the clearing process. According to several freight forwarders, this strategy can be very worthwhile.

Mexico is the United States’ second largest and growing export market. When dealing with Mexico, for example, the U.S. exporter usually will ship the merchandise to a U.S. freight forwarder located along the Mexican border. The Mexican importer generally then will handle all other transportation and customs requirements. Prior to this, however, U.S. exporters are advised to do the following:

  1. Send a proforma invoice in advance of the shipment to the U.S. forwarder to allow for any corrections;
  2. Provide catalogs or complete descriptions of the products to assist the appraiser in determining the accurate tariff product classification;
  3. Properly package the merchandise to allow for easy and secure loading and unloading;
  4. Speak with the U.S. freight forwarder to ensure all product restrictions, documentation requirements and fees are understood;
  5. Specifically determine well in advance whether or not an export permit is required; and
  6. Never ship products to the forwarder without prior notice.

The Mexican importer will usually be responsible for all broker and transportation fees south of the border, plus fees incurred by the U.S.-based forwarder. The following is an example of a routine shipment to Mexico City from Laredo, Texas with customs clearance in Nuevo Laredo, Mexico.

  • Day 1: The Laredo, Texas forwarder receives the merchandise and reviews the documentation.
  • Day 2: The merchandise appraiser determines the Mexican import duties, then reports this amount to the Mexican broker, who collects the funds from the Mexican importer.
  • Day 3: The funds are received or credit is arranged, and the freight forwarder is instructed to reload the merchandise (if previously unloaded). The freight forwarder then arranges to ship the merchandise across the border the following morning.
  • Day 4: The merchandise is received in Nuevo Laredo for inspection by Mexican customs officials. Delivery instructions are given to the Mexican carrier.
  • Day 5: The carrier picks up the merchandise and begins its two-day journey to Mexico City.

Prior to exporting, it is highly recommended that the exporter work closely with his/her freight forwarder to ensure all documents are in order and accurate. But that’s not all. According to Thomas Cook, Managing Director, American River International (FSI), Melville, New York, there are many issues related to trade where one often needs professional assistance to successfully steer the goods through the maze of legalities, customs documentation requirements, shipping considerations, political concerns, financial disputes, and language barriers, etc. These professionals (i.e., custom officials, freight forwarders, etc.) often rely on each other to manage the intricacies of an international transaction.

Cook says, “Documentation is always an issue because each country has different requirements that are not always in black and white, and change on a frequent basis.” As a result, the U.S.-based freight forwarder must have a strong presence or agency network in the exporter’s destination country, and have local knowledge and the necessary expertise to mitigate common problems. The key to successful exporting is understanding that logistics play a significant role in the exporter’s ability to deliver the goods and get paid.

Foreign Sales Corporations and Lenders

As a result of stiff competition among financial institutions, it is important for lenders to provide their customers with as much value as possible. Additionally, as a member of their customers’ financial advisory team, lenders need to be aware of special tax planning tools that can help exporters profit, and in turn, export more goods and services. Foreign sales corporations can accomplish this, while helping exporters save income tax on up to 30 percent on gross income from exporting.

Foreign Sales Corporations (FSCs), created under the 1984 Tax Reform Act, are foreign subsidiaries formed outside U.S. customs territory to transact export sales for their parent companies in the United States. Under the FSC program, when an export sale is made by the parent company, a commission is recorded to the FSC using an IRS-authorized formula. The commission expense can be deducted from the income of the parent company, while a portion of the commission is exempt from the federal tax of the FSC.

Although exotic locales are involved in forming FSCs, and certain tax compliance and management regulations exist and must be closely adhered to, FSCs were never meant to be complicated. In fact, according to James A. Sachs of the Buffalo, New York-based accounting firm of Freed Maxick Sachs & Murphy, P.C., the FSC program was designed as an incentive program to increase export trade by reducing the tax bill on foreign profits.

Sachs said, “FSCs were established by Congress to help balance U.S. trade deficits and increase the competitiveness of manufacturing companies throughout the world.” They can be formed by manufacturers, export intermediaries, or groups of exporters, such as export trading companies. An FSC can buy and sell for its own account, or serve as a commissioned agent. Its parent can be a manufacturer or an independent merchant or broker. Sales to an intermediary must be shipped outside the United States by the middleperson within 12 months of the original sale to qualify under the FSC rules. Shipments to Canada and Mexico qualify as foreign sales.

There are three primary types of foreign FSCs: small, large and shared. Although all are similar in terms of their fundamental operating procedures and tax benefits, they differ in some important ways.

Small FSCs really are not much more than a company through which bookkeeping entries are created to generate tax savings for both the parent company and the FSC. Annual maintenance costs for ensuring that an FSC meets tax code and local jurisdiction requirements can be in the $2,500-$3,000 range. Companies electing small FSC status can benefit only on export sales of up to $5 million annually. The basic procedures for setting up a small FSC are as follows:

  1. Establish a corporation in a qualifying U.S. territory or foreign jurisdiction. Countries qualified to maintain an FSC business office must have a reciprocity agreement with the U.S. Treasury. Although there are more than 35 qualified countries, the most popular FSC locations are the U.S. Virgin Islands (holding with 50 percent of the existing FSCs), Barbados, Bermuda, and Guam. FSCs incorporated under the laws of a qualified foreign country are also subject to the applicable tax laws and regulations of that particular country. Because an FSC cannot receive a foreign tax credit for foreign taxes imposed on its qualified income, it is most beneficial to have an FSC in a country where local income taxes and withholding taxes are minimized.
  2. File an election with the IRS within 90 days after the beginning of the FSC’s taxable year. The FSC, generally a wholly-owned subsidiary of the parent company, must have the same taxable year as the parent. Status cannot be changed during the tax year; therefore, some tax planning is important to ensure the most advantageous FSC arrangement.
  3. Maintain an office outside the U.S. and keep a duplicate set of tax records and books at that overseas office. The office does not have to be in the jurisdiction in which the FSC was incorporated; however, it must be within a qualified foreign county as governed by the 1984 Tax Reform Act. The FSC must also keep certain tax records, statements and tax returns at a location within the United States.
  4. Hire a non-U.S. resident to serve on the board of directors.
  5. Although a bank account is not necessary in most cases, it is required for an IRA-owned FSC (see below).

Small FSCs may not issue preferred stock or have more than 25 shareholders at any one time. The status of a small FSC must be elected, and can be as simple as writing a check. First, the exporter needs to decide if the tax savings from an FSC exceed the cost. If so, he/she needs to write the check to his/her professional advisor and the advisor will worry about the rest. The exporter’s bookkeeper will make journal entries and the advisor will prepare the return.

Companies wishing to benefit from export sales of more than $5 million annually must elect large FSC status. Although the operating procedures are basically the same as those required by small FSCs, a large FSC must fulfill some additional requirements. These include:

  1. Holding all meetings of the board of directors and shareholders outside the United States.
  2. Maintaining the principal FSC bank account in a qualifying country.
  3. Conducting the following disbursements through the principal bank: dividends, legal fees, accounting fees, officers’ salaries, and board of directors’ fees.

In addition to meeting the foreign management requirements, the large FSC must meet the “foreign economic processes” test. This test determines which of the foreign transactions will generate foreign trading gross receipts that will qualify for a tax benefit to the FSC. The foreign economic processes test is fulfilled if two requirements are met concerning (1) foreign direct costs and (2) foreign sales activities.

“The foreign economic processes test was designed to ensure that an FSC has a substantial role in export transactions,” Sachs remarked. “In essence, the large FSC must meet a certain burden of proof in order to take advantage of the tax break.” To fulfill the foreign direct costs requirement, the FSC or its agent must incur a certain percentage of transaction costs outside the U.S. For the purpose of this test, “direct costs” include: material consumed in the activity; labor costs directly associated with the activity; and incremental costs of facilities or services incidentally related to the FSC’s activities.

The activities tested are grouped in the following five categories: (1) advertising and promotion; (2) processing of customers’ orders and arranging for delivery of export property outside the U.S.; (3) transporting the export property to the customer; (4) determining and transmitting the final invoice or statement of account and receiving payment from the customer; and (5) assuming the credit risk.

An FSC meets this portion of the test if its foreign direct costs are either 50 percent or more of the total direct costs for these five activities, or 85 percent or more of direct costs incurred in each of any two of the five activities listed above. With respect to the portion of the test concerning foreign sales activities, the FSC or its agent must participate outside of the United States in any one of the following export transactions:

  1. Solicitation (other than advertising);
  2. Negotiation; or
  3. Contracting.

A shared FSC is one that is “shared” by 25 or fewer unrelated exporters who incorporate to receive the tax benefits and lower the managerial costs involved in establishing an FSC. States, regional authorities, trade associations, foreign trade zones, or private businesses can sponsor an FSC. The only element shared by companies engaging in this type of FSC is the cost; company benefits and proprietary information are not intermingled.

When determining an FSC’s profit, only a few basic decisions need to be made with respect to the profit allocation method. One method is a fixed 23 percent of the parent corporation’s combined taxable income relating to the foreign sales. Another method uses a fixed 1.83 percent of foreign gross sales to maximize savings when net profit is between 4 and 8 percent. Should the net profit drop below 4 percent, 46 percent of combined income can be allocated to the FSC.

Once the FSC profit number is determined, the exporter will need to compute the nontaxable amount of the FSC income. If a “C” corporation owns the FSC stock, the exclusion rate is 15/23rds of FSC income. If the shareholder is not a “C” corporation, 16/23rds of the FSC income will not be taxed. In both instances, the FSC is taxed on about one-third of its income at regular corporate tax rates.

As of 1997, changes in U.S. corporate tax regulations enable “S” corporations to take advantage of FSCs. Prior to that time, “S” corporations could not own subsidiaries, but could create an FSC and direct the tax exempt refunds to a corporate individual retirement account (IRA). An IRA investing in an FSC can produce non-taxable gains that may earn more than IRAs invested in publicly-traded securities. In addition, closely-held “C” corporations will find IRA-owned FSCs to be an appealing alternative for enhancing deferred income plans, since these profits post no immediate tax expense to shareholders.

It should be noted that a tax saving incurred as result of an FSC is permanent — it is not just a deferral. Therefore, a benefit to the financial statement is provided in addition to offering current tax savings.

An example of the FSC tax savings:

  • Profit from Export Sales: 300,000
  • Allocated to the FSC: 23% (69,000)
  • Exempt From Taxes: 15/23
  • Will Not Be Taxes: 45,000
  • Assumed Tax Rate: 34%
  • Tax Savings and Increased Cash Flow: 15,300

Role of the Lender

To date, approximately 6,500 companies have established an FSC, but there is room for more. According to U.S. Commerce Department statistics, less than one-half of eligible companies are realizing the tax benefits of FSCs. For the lenders, the opportunities for assisting customers within the FSC realm are immeasurable. In addition to obtaining a reduced rate of tax, a lender’s customers will benefit from an increase in cash flow, and may be encouraged to more fully participate in the financial benefits of international trade.

On a more practical level, lenders can assist their customers by alerting them to the existence of this tax incentive and guiding them to other members of their financial team, who can prepare a cost-tax benefit analysis to ensure that an FSC is the most beneficial option. “Watching a customer reap the dollar benefits from one of your suggestions is always a lift,” Sachs noted, “And it helps increase referral business. It is the essence of what financial advisors do and do well.”

This appeared as Chapter Four in the book Trade and Finance For Lenders, 1999.
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John Manzella
About The Author John Manzella [Full Bio]
John Manzella is a world-recognized author and speaker on global business, competitive strategies and the latest economic trends. He also is CEO of World Trade Center BN, chair of the Upstate New York District Export Council, and founder of The Manzella Report and Manzella Trade Communications Inc. His latest book is Global America: Understanding Global and Economic Trends and How To Ensure Competitiveness.




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