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GRASSLEY PROPOSES MANUFACTURING, AG SPECIAL DEDUCTION

September 24, 2003

Nine Percent Off!

That's the substance of a new tax break for manufacturers proposed last week by Senator Charles Grassley, Finance Committee Chairman, and Max Baucus, ranking Democrat on the committee. The plan would allow corporations a deduction of 9 percent of taxable income attributable to production activities.

The bill, known as the "JOBS" bill for reasons we will explain shortly, is the Finance Committee's response to threats of sanctions by the World Trade Organization. The WTO some time ago determined that the "Extraterritorial Income exclusion" and "Foreign Sales Corporation" rules for U.S. exporters are illegal export subsidies. The JOBS bill repeals the ETI exclusion and FSC rules while modifying several foreign tax rules. The nine-percent deduction is designed to make up for the loss of the ETI/FSC benefits.

NOT JUST FOR EXPORTERS - OR FOR FACTORIES

While the JOBS deduction is part of a bill designed to replace a manufacturing export subsidy, it has no requirement that production be exported. Nor does it require the use of a "factory" as normally understood; exports of software and agricultural products also qualify for the JOBS nine-percent deduction.

The bill appears designed to overcome the objections to the two contending ETI repeal bills that have been in play until now. The bill proposed by House Ways and Means Committee Chairman Thomas had been criticized for benefiting manufacturers only in a relatively narrow taxable income range, and for including a variety of seemingly unrelated tax breaks that made it a significant revenue loser. The "Crane-Rangel" ETI repeal bill had been criticized for failing to benefit S corporations and for not providing more tax relief.

The deduction would be based on taxable income from production, based on direct costs and "allocated" indirect costs.

WHAT WON'T QUALIFY?

The JOBS bill excludes a number of produced items from its benefits:

- "consumable property that is sold, leased, or licensed by the taxpayer as an integral part of the provision of services." That means we can't qualify as producers by sending tax returns overseas.

-oil and gas;

-electricity;

-water supplied by pipeline to the consumer;

-any unprocessed timber which is softwood;

-utility services,

- Any "tape, recording, book, magazine, newspaper, or similar property the market for which is primarily topical or otherwise essentially transitory in nature." Fortunately, the Tax Update is timeless. Unfortunately, we don't sell it.

WHEN WOULD THIS TAKE EFFECT?

The JOBS bill would phase in the nine-percent deduction starting in 2004, with a one percent deduction; the deduction would be 2% in 2005; 3% in 2006; 6% in 2007 and 2008; and 9% thereafter. It would phase out the ETI/FSC rules by 2007.

WHY NOT PARTNERSHIPS?

The bill excludes producers that operate as partnerships, such as limited liability companies. This creates an anomaly in the tax law; few provisions apply to S corporations and C corporations, but not partnerships. Individuals with LLC interests might be able to get around such problems by holding their manufacturing LLC interests in an S corporation. This is a common structure in Iowa, where S corporation shareholders get a break related to out-of-state sales that is unavailable to partners.

WHY "JOBS"?

The bill continues the questionable trend towards giving tax proposals catchy acronyms. JOBS is short for "Jumpstart Our Business Strength." The title may be a reaction to the unpronouncable and vaguely disreputable-sounding JGTRRA passed earlier this year.

UPDATE: Tax Analysts says insiders are sceptical that an ETI repeal will pass this year.

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