The transfer pricing provisions under Section 482 of the Code have evolved to provide a similar result from

transfer pricing methodology standpoints, in the sense that the critical element of most transfer pricing determinations is an evaluation of the economic activity, or function, performed by a controlled entity followed by a determination of the arm's-length consideration that would be received by the controlled entity if the activity or function had been performed with respect to uncontrolled parties. Resolution of transfer pricing issues under Section 482 does not, of course, necessarily govern the resolution of substantive issues under the Code. But where the pricing and substantive issues largely require analysis of the same economic elements, it would certainly facilitate resolution of the U.S. tax consequences of international arrangements if both the pricing and substantive issues could be resolved at the same time.

IV. THE IC-DISC: THE LAST REMAINING U.S. EXPORT SUBSIDY

Qualification requirements. In order to qualify as a DISC, a corporation must satisfy the following conditions: (1) It must be incorporated in the U.S. (2) At least 95% of the corporation's gross receipts must be qualified export receipts. (3) At least 95% of the adjusted basis of the assets of the corporation at the end of each tax year must be qualified export assets. (4) The corporation must have only one class of stock with a par or stated value of at least $2,500 on each day of the corporation's tax ye a r. (5) The corporation has made an election, which is in effect for the tax year, to be treated as a DISC. (6) The corporation is not a member of a controlled group whose members include a foreign sales corporation (FSC).

If these conditions are met, the corporation, now a DISC, will not be subject to taxes under subtitle A of the Code, except for the excise taxes imposed by Sections 1491 through 1494. Taxes to which a DISC is not subject include the regular corporate income tax, the alternative minimum tax, and the accumulated earnings tax. Practical DISC Considerations The DISC provisions encompass panoply of activities, necessitating that the DISC, its owners, and its suppliers undertake the following on behalf of the DISC: (1) Set up an entity that meets the initial DISC formative requirements. (2) Structure DISC relationships with shareholders, suppliers, and customers. (3) Prepare the DISC election and secure shareholder consent. (4) Prepare DISC agreements. (5) Meet DISC gross receipts eligibility requirements. (6) Meet DISC assets eligibility requirements. (7) Determine DISC pricing and income and make payments. (8) Distribute DISC distributions to its shareholders. (9) Prepare documentation and retain substantiation. In order to qualify as a DISC, a corporation must be incorporated in the U.S, which includes any state or the District of Columbia. Entities incorporated in other jurisdictions, including Puerto Rico or the U.S. Virgin Islands, cannot be DISCs. At least 95% of the corporation's gross receipts must be qualified export receipts. Gross receipts are defined to include all amounts received or accrued from the sale or lease of property held for sale or lease in the ordinary course of the taxpayer's business and gross income from all other sources. Those sources include: The provision of services.

Dividends and interest. The sale at a gain of property other than property held for sale or lease in the ordinary course of business. Commissions from either the sale or lease of property or the provision of services. Qualified export receipts include: Receipts from the sale or lease of export property. Receipts from services related to the sale or lease. Gains from the sale of certain property. Dividends from a related foreign export corporation. Receipts from the provision of certain engineering and architectural services. Receipts from the provision of certain managerial services. Certain receipts are excluded from the definition of qualified export receipts, even though they may technically fit within one of the categories enumerated above. These are: Receipts from the sale or lease of property that will ultimately be used in the U.S. Receipts from the subsidized sale of export property. Services related to sales or leases in the first two categories. Receipts from the sale or lease of property within a controlled group. Export property is property that satisfies these four requirements: (1) It is manufactured, produced, grown, or extracted in the U.S. by someone other than a DISC. (2) It is to be sold or leased for use outside of the U.S. (3) It contains articles imported into the U.S. that make up not more than 50% of the fair market value of the property.

(4) It is not sold or leased by a DISC to another DISC that is a member of the same controlled group as the selling DISC. As in the case of qualified export receipts, certain property is excluded from the definition of qualified export property even though it may otherwise meet the definition of export property. The excluded property includes: Certain property leased by one member of a controlled group to another member of the same controlled group. Certain intangible property. Certain depletable property. Certain products the export of which is controlled by the government. The adjusted basis of a corporation's qualified export assets must be equal to at least 95% of the adjusted basis of all of its assets at the close of its tax year. Qualified export assets include nine categories of assets: (1) Export property. (2) Certain business assets. (3) Certain trade receivables. (4) Certain temporary investments. (5) Producer's loans. (6) Stock or securities of related foreign export corporations. (7) Certain obligations, including obligations of the Export-Import Bank that are used to finance exports. (8) Certain financing obligations. (9) Funds awaiting investment. Assets that fall into more than one category are counted only once. Producer's loans are particularly important because they are a way for the DISC's owners to use DISC profits and not yet not pay tax on those profits. A producer's loan must be made out of accumulated DISC income to a

borrower who produces export property in the U.S. The proceeds must be used to acquire export-related assets or to engage in research and development. The interest paid on producer's loans (which must be charged) is included in the taxable income of the DISC's shareholders. Capitalization. If a corporation wants to qualify as a DISC for a tax year, on each day of that tax year, the DISC must have only one class of stock. That stock's par value or stated value if there is no par value, on each day of the tax year must be at least $2,500. If, for some reason, the value of the corporation's stock is impaired after it makes the election to be a DISC that impairment will generally not result in the loss of DISC status. The one time in which it will is if the corporation takes steps to reduce the par value or stated value of its stock below the $2,500 minimum. Debt payable to shareholders may create problems. Therefore, the regulations provide that debt to shareholders, or members of the controlled group to which the DISC belongs, is treated as debt if one of these three tests are met: (1) The debt would qualify as debt under the Code even if the debtor was not a DISC. (2) The debt qualifies under a five-part test set out below. (3) The debt is accounts payable, as described below. The five-part test is as follows: (1) There must be a written obligation to pay a sum certain on or before a set date. (2) Interest must be charged that meets the requirements of Section 482 and the regulations thereunder (dealing with related-party transactions) and that is of a fixed amount or percentage of principal. (3) The debt is not convertible into stock or other debt, unless that debt meets one of the three criteria set forth above. (4) The debt does not give the lender voting rights, except if the debt is in default.

(5) Interest and principal are paid according to the terms of the obligation, or of the obligation as modified in conformity with the first four parts of the test. The tests in the preceding paragraph apply regardless of the proportion of debt held by shareholders, the debt-to-equity ratio, or the amount of debt. The terms of the debt may be modified, as long as the modification is consistent with the first four parts of the test, and principal and interest are paid according to the modified terms. Accounts payable can qualify as debt, provided the payables arose in the normal course of the DISC's trade or business, if the debt is paid within 15 months after it was incurred. Neither of the other two tests above has to be satisfied. However, if the payables are not paid with 15 months, the payables are not debt of the DISC unless they meet one of the other two tests. The rules outlined above with regard to debt are a relaxation of the normal rules regarding debt. They apply only to corporations during tax years for which they are treated as DISCs. Otherwise, the rules do not apply. Election. A corporation makes a valid election to be a DISC by filing Form 4876A with the service center that would process the corporation's income tax return, if it filed one. The form must be signed by an officer of the corporation with the authority to sign the corporation's income tax return. Generally, the election must also be consented to by each person who is a shareholder of the corporation on the first day of the tax year for which the election is effective. Consent must be made by each joint owner or tenant when the stock is owned as community property, tenants in common, joint tenants, or tenants by the entirety. The legal guardian (or natural guardian if there is no legal guardian) of a minor must consent for him or her. The administrator or executor of an estate consents for the estate. A trustee consents for a trust. Only one executor, administrator, or trustee needs to consent if there is

more than one. An officer of a corporation consents for a corporation. A general partner consents for a partnership. Anyone authorized to sign a foreign person's return, as if that individual was a U.S. person, can consent for the foreign person. If the corporation is electing to be treated as a DISC for its first tax year, the election must be made within 90 days of the beginning of that year. For any other corporation, the election must be made within the 90-day period preceding the start of the corporation's first tax year as a DISC. Generally, each person who is a shareholder of the DISC at the start of the DISC's first tax year must consent to the election. This is done by the shareholder either signing the consent section of Form 4876A or by attaching a statement of consent to the form. Once a shareholder's consent is given and the corporation makes a valid election, the shareholder cannot withdraw his or her consent. Further, that consent is also binding on all transferees of that shareholder's shares. Transfer pricing. The intercompany pricing rules of Section 482 do not apply to purchases by a DISC from a related company. Rather, the Section 994 r u le s a p p ly . Three methods. Under Section 994, a DISC is allowed to earn the largest amount of income computed under one of three methods. (1) 4% of the DISC's qualified export receipts on the sale of property purchased from a related company, plus 10% of the DISC's export promotion expenses associated with the sale of such property. (2) 50% of the taxable income of the DISC and its related supplier from qualified export receipts on the sale of property purchased from the related supplier, plus 10% of the DISC's export promotion expenses related to such sales. (3) The taxable income computed under Section 482.

When either of the first two methods is used, the IRS may not adjust the allocations under Section 482. These rules apply to any purchases for export, by either sale or lease, by a DISC from an entity owned or controlled by the same interest as the DISC, a related supplier. A DISC may have more than one related supplier. Only the company from which the DISC directly obtains a product is a related supplier for that product. The rules apply in the following specific cases only: The sale of export property by the supplier to the DISC for resale or earning of commissions by the DISC on sales of export property by the related supplier to third parties, including other related entities. The lease of export property by a related supplier to a DISC for sublease under comparable terms or earning of commissions by the DISC on lease of export property by the related supplier to third parties, including related entities. The sale of services that are related and subsidiary to a sale or lease by a related supplier described above. The sale of engineering or architectural services by a related supplier for construction projects to be located, or proposed to be located, outside the U.S. when the DISC is a principal or commission agent for the furnishing of such services to third parties, including related entities. The sale of managerial services by a related supplier to an unrelated DISC when the related DISC is a principal or commission agent for the furnishing of such services. Calculating taxable income. Combined taxable income is the DISC's gross income from the sale of export property less the costs of the DISC and its related supplier relating to the sale. Interest on unpaid receivables is not included in gross receipts. The taxpayer's method of accounting must be

used to determine when income is recognized and expenses deducted. Cost of goods sold is to be determined according to the provisions of Reg. 1.61-3 and inventories determined according to Sections 471 and 472. Costs, except for cost of goods sold, related to gross receipts from export property consist of two components: (1) Costs definitely related to such gross receipts, which are allocated or apportioned as appropriate. (2) Costs not related to any category of gross receipts, which are ratably assigned to gross receipts from the sale of export property. Related-party suppliers. The use of Section 994 to determine the transfer price for a transaction between a DISC and a related supplier does not preclude the use of Section 482 for transactions between the related supplier and parties other than the related DISC. In those cases, the related supplier and the DISC are treated as one entity. The transfer price charged by a related supplier to a DISC or the commission charged by a DISC to a related supplier (or a reasonable estimate of either) must be paid no later than 60 days after the end of the DISC's tax year in which the transaction took place. Payment may be made in any of the following forms: Money. Property, including accounts receivable. An obligation that satisfies the requirements of Reg. 1.992-1(d)(2)(ii). An accounting entry decreasing a debt owed by the current debtor to the current lender. Shareholder tax issues-Although a DISC is not subject to the corporate income tax, its shareholders are subject to tax, as follows: First, there are deemed distributions. Deemed distributions include, for each tax year, the lesser of the shareholder's pro rata amounts of income from the

following categories or the shareholder's pro rata share of the DISC's earnings and profits for the tax year. The categories are: Gross interest income from producer's loans. Gain recognized by the DISC on the sale of assets, other than export property, which were transferred to the DISC in a non-recognition transaction, but only to the extent of the gain not recognized on the transfer to the DISC. Gain (other than gain covered by the category above) recognized by the DISC on the sale of property (which the DISC does not consider inventory or other Section 1221(a)(1) property) transferred to the DISC in a nonrecognition transaction, but only to the extent of the transferor's gain that would have been ordinary income in a recognition transaction. 50% of the DISC's taxable income that is attributable to the sale of military property. That part of the DISC's taxable income attributable to qualified export receipts in excess of $10 million for that tax year. The sum of: (1) 1/17 of the amount by which the DISC's taxable income for the year exceeds the sum of the items above, but only for C corporation shareholders; (2) 16/17 of the amount in (1) multiplied by Section 999's international boycott factor; and (3) any Section 162(c) payment, such as an illegal bribe or kickback, paid by or on behalf of a DISC to a government official, employee, or agent. Foreign investment attributable to a DISC's producer's loans for the tax year. 65 DISC REQUIREMENTS AND ADVANTAGES Requirements. To qualify as a DISC, a corporation must satisfy the following conditions:

(1) The corporation must be incorporated in the U.S., which includes any state and the District of Columbia, but not other jurisdictions, such as Puerto Rico and the Virgin Islands. (2) At least 95% of the corporation's gross receipts must be qualified export receipts. Gross receipts included all amounts received or accrued from the sale or lease of property held for sale or lease in the ordinary course of the taxpayer's business, and gross income from all other sources. Qualified export receipts include (a) receipts from the sale or lease of export property, (b) receipts from services related to the sale or lease, (c) gains from the sale of certain property, (d) dividends from a related foreign export corporation, (e) receipts from the provision of certain engineering and architectural services, and (f) receipts from the provision of certain services. (3) At least 95% of the adjusted basis of the corporation's assets at the end of the year must be qualified export assets, which include: (a) export property, (b) certain business assets, (c) certain trade receivable, (d) certain temporary investments, (e) producer's loans, (f) stock or securities of related foreign export corporations, (g) certain obligations used to finance exports, (h) certain financing obligations, and (i) funds awaiting investment. (4) The corporation must have only one class of stock with a par or stated value of at least $2,500 on each day of the corporation's tax year. The stated value of shares is consideration paid for the shares that is not assigned to a surplus account. (5) The corporation makes a valid election to be treated as a DISC by filing Form 4876A. Generally, the election must be consented to by each shareholder on the first day of the tax year for which the election is effective. (6) The corporation is not a member of a controlled group whose members include a foreign sales corporation (FSC). Because FSCs were terminated in 2000, this requirement has limited applicability.

Advantages. Electing to be treated as a DISC confers these benefits on a corporation: (1) The intercompany pricing rules of Section 482 do not apply to purchases from a DISC from a related company. Instead, the more advantageous rules of Section 994 apply. Under Section 994, a DISC is allowed to earn the largest amount of income computed under one of three methods: (a) 4% of the DISC's qualified export receipts on the sale of property purchased from a related company plus 10% of the DISC's export promotion expenses associated with the sale of such property; (b) 50% of the taxable income of the DISC and its related supplier from qualified export receipts on the sale of property purchased from the related supplier plus 10% of the DISC's export promotion expenses related to such sales; and (c) the taxable income computed under Section 482. (2) The DISC is not subject to federal corporate income tax. The shareholders generally are not taxed on the DISC's earnings until actually distributed, a shareholder disposes of DISC stock in a taxable transaction, or the corporation ceases to qualify as a DISC. At that time, deferred earnings are includable, at the shareholder level, as a dividend.