Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 79-75

1979-1 C.B. 261

Section 992
Section 993
Section 994

IRS Headnote

DISC; export property and receipts; inventory of parent. Undivided interests in export inventory, both goods in process and finished goods in inventory, that were purchased at a discount by a DISC from its parent-supplier that were neither specifically identified nor actually transferred, and that were later resold to the parent do not constitute qualified export assets of the DISC. Interest payments received by the DISC, in the form of the discount, do not constitute qualified export receipts.

Full Text

Rev. Rul. 79-75

ISSUE

Do undivided interests in export inventory purchased by a DISC from its parent and related supplier constitute qualified export assets of the DISC?

FACTS

P, a United States manufacturing corporation, is the sole shareholder of S, a corporation that has qualified as a Domestic International Sales Corporation (DISC). P pays S a commission determined under section 994 of the Internal Revenue Code of 1954 on sales of export property owned by P.

On September 30, 1976, the last day of S's taxable year, P and S entered into an agreement whereby S purchased an interest in inventory held for export sale by P for 100x dollars. This included goods in process and finished goods inventory. The agreement also provided that the purchase of inventory by S was subject to a discount at the rate of 5 percent.

The interest in inventory acquired did not consist of goods that were specifically identified and no actual transfers were made from P to S. As specific items were removed from P's inventory and replaced by other items, S's interest in P's inventory remained constant.

On September 30, 1977, the sale was reversed by a repurchase of the inventory by P for 100x dollars, and P and S entered into a similar agreement whereby S purchased an interest in P's export property for 120x dollars less the 5 percent discount. On September 30, 1978, this second agreement was cancelled, P repurchased the inventory for 120x dollars, and P and S entered into another similar agreement.

At all times during which these agreements were in effect, the total amount of outstanding loans by S to P classified as producer's loans within the meaning of section 993(d)(1) of the Code had reached the limitation provided by section 993(d)(2).

LAW AND ANALYSIS

The applicable sections of the Code are 992 and 993.

In order to qualify as a DISC for any taxable year, pursuant to section 992(a)(1)(B) of the Code, a corporation's adjusted basis in qualified export assets must equal or exceed 95 percent of the sum of the adjusted basis of all the corporation's assets at the end of the taxable year.

Under section 993(b) of the Code, qualified export assets are export property, assets used in connection with export property, and accounts receivable and evidences of indebtedness that arise by reason of transactions of the DISC.

"Export property" is defined by section 993(c)(1) of the Code as property held primarily for sale, lease, or rental in the ordinary course of trade or business by, or to, a DISC, for direct use, consumption, or disposition outside the United States. Such property must be manufactured in the United States by a person other than a DISC.

However, in the present situation, the "purchase" by S of an interest in P's export inventory is not a substantive purchase of export property for federal income tax purposes. S did not acquire ownership and control over the goods. S is not the party that benefits, or stands to lose, if the market value of the goods fluctuates or they are destroyed prior to sale.

Rather, the transaction constitutes a financing arrangement whereby S can continue to make funds available to P even though S cannot make additional producer's loans to P. P has the use of S's funds for one year and pays interest to S for the use of these funds in the form of a 5-percent discount. The loan is then repaid at the end of S's taxable year and another loan is made under the same terms. See, for example, Union Planters National Bank of Memphis v. U.S., 426 F.2d 115 (6th Cir. 1970), which provides that in cases where the legal characterization of economic facts is decisive, the principle is well established that the tax consequences should be determined by the economic substance of the transaction, not the labels put on it for other purposes.

HOLDING

Undivided interests in export inventory purchased by a DISC--whether operated as a commission or buy-sell DISC--from its parent-related supplier, under the circumstances set forth above, do not constitute qualified export assets of the DISC. In addition, the interest payments received by S from P in the form of a 5-percent discount do not constitute qualified export receipts to S. Only interest paid to a DISC on an obligation that is a qualified export asset is a qualified export receipt of the DISC. Section 993(a)(1)(F) of the Code.