Rev. Rul. 88-74

1988-2 C.B. 300, 1988-38 I.R.B. 1.

                       Internal Revenue Service

                                 Revenue Ruling

                      DISC; 60-DAY COMMISSION PAYMENT RULE

                           Published: August 31, 1988

Section 994. - Inter-company Pricing Rules, 26 CFR 1.994-1: Inter-company pricing rules for DISC's.

  DISC; 60-day commission payment rule. Additional commissions payable to a DISC by a related supplier under a change in the Service's published position of what constitutes qualified export receipts and paid more than 60 days after the close of the DISC's taxable year will be disregarded for purposes of the reasonable estimate test under the 60-day commission payment rule of section 1.994-1(e)(3) of the regulations.

  Will additional commissions payable to a DISC by a related supplier under a change in the Internal Revenue Service's published position of what constitutes qualified export receipts and paid more than 60 days after the close of the DISC's taxable year be disregarded for purposes of determining whether the reasonable estimate test of section 1.994-1(e)(3) of the Income Tax Regulations has been met?

                                     FACTS

  X, a domestic corporation that uses the calendar year as its taxable year, manufactures personal care products. During 1984, X sold part of those products to a company located in Country A for retail sale in that country. With regard to those sales, on February 1, 1985, X paid Y, a domestic corporation owned by X that qualified as a DISC for 1984 under section 992(a) of the Internal Revenue Code of 1954, the maximum commission allowable under section 994. The products were 'export products' within the meaning of section 993(c) and the gross receipts from those sales were 'qualified export receipts' under section 993(a). X and Y were parties to a commission agreement that provided that X would pay Y a commission equal to the maximum amount allowable under section 994 on all sales of export property that resulted in qualified export receipts.

  Also, during 1984, X sold a portion of those products to the Department of Defense for resale at post and base exchanges and commissary stores located on United States military installations in foreign countries. X paid Y on February 1, 1985, the maximum commission allowable with regard to the sales made to post and base exchanges. Because of the holding in Rev. Rul. 73-71, 1973-1 C.B. 361, X did not pay a commission to Y with regard to the sales made to commissary stores. That ruling held that receipts from the sale of export property to the Department of Defense for resale in overseas commissary stores did not constitute qualified export receipts.

  Rev. Rul. 88-11, 1988-6 I.R.B. 10 (February 8, 1988) modified Rev. Rul. 73-71 by holding that those receipts were in fact qualified export receipts. X thereafter recomputed the commission due Y under the commission agreement by including the sales to commissary stores. The additional commission due Y exceeds 50 percent of Y's taxable income for 1984 from the total sales of the products. X and Y filed amended income tax returns on this basis.

                                LAW AND ANALYSIS

  In order to qualify as a DISC, a corporation must meet the asset test of section 992(a)(1)(B) of the Code, which requires that the adjusted basis of the corporation's 'qualified export assets' at the close of its taxable year equal at least 95 percent of the adjusted basis of all its assets at the close of the taxable year.

  Sections 1.993-2(d)(2), 1.994-1(e)(3), and 1.994-1(e)(5) of the regulations describe the circumstances under which commissions owed to a DISC by a related supplier constitute qualified export assets. Section 1.993-2(d)(2) provides that an account receivable or evidence of indebtedness held by a DISC and representing commissions payable to a DISC by a related supplier will not be treated as a trade receivable (and thus a qualified export asset) unless it is payable and paid in a time and manner that satisfy the requirements of section 1.994-1(e)(3) or (5). Section 1.994-1(e)(3)(i) provides, in part, that the amount of a sales commission (or reasonable estimate thereof) actually charged by a DISC to a related supplier must be paid no later than 60 days following the close of the taxable year of the DISC during which the transaction occurred. Section 1.994- 1(e)(3)(iii) provides that if the district director can demonstrate, based upon the data available as of the 60th day after the close of such taxable year, that the amount actually paid did not represent a reasonable estimate of the commission to be determined under section 994 of the Code and the regulations thereunder, an indebtedness will be deemed to arise in an amount equal to the difference between the amount of the commission so determined and the amount actually paid and received. This indebtedness will not constitute a qualified export asset. As a result, the corporation may fail the section 992(a)(1)(B) assets test.

  The purpose of the 60-day rule is to require timely payment of the commissions owed to the DISC in order to prevent a disguised loan to the DISC's related supplier that does not meet the producer's loan requirements of section 993(d) of the Code. Here X paid additional commissions to Y and filed amended returns to reflect these additional commissions only after a change in the Service's interpretation of the applicable law occurring after the close of the 60-day period. Accordingly, disregarding those commissions in determining a reasonable estimate under section 1.994-1(e)(3) would not frustrate the purpose of the 60-day rule.

                                    HOLDING

  Additional commissions payable to a DISC by a related supplier under a change in the Internal Revenue Service's published position of what constitutes qualified export receipts and payment of those commissions more than 60 days after the close of the DISC's taxable year will be disregarded for purposes of determining whether the reasonable estimate test of section 1.994-1(e)(3) of the regulations has been met.

                              DRAFTING INFORMATION

  The principal author of this revenue ruling is Richard Chewning of the Office of Associate Chief Counsel (International). For further information regarding this revenue ruling contact Mr. Chewning on (202) 566-6384 (not a toll-free call).

Rev. Rul. 88-74, 1988-2 C.B. 300, 1988-38 I.R.B. 1.