General Instructions

Purpose of Form

Use this form to figure the amount of extraterritorial income (defined below) excluded from gross income for the tax year. Attach the form to your income tax return.

Note.

The amount figured on the form is net of the disallowed deductions.

ETI Repeal

The American Jobs Creation Act of 2004 repealed the ETI exclusion provisions generally for transactions after 2004, subject to transition rules.

Transition Rule

Taxpayers may claim the ETI exclusion for (a) transactions under a binding contract that meets the requirements described in Binding Contract Exception below or (b) transactions before 2005. Also see Pre-Repeal ETI Exclusion Rules below.

Binding Contract Exception

The Tax Increase Prevention and Reconciliation Act of 2005 repealed the ETI binding contract exception for tax years beginning after May 17, 2006. For tax years beginning before May 18, 2006, the following rules apply: The taxpayer may claim an ETI exclusion with respect to transactions in the ordinary course of a trade or business under a binding contract if such contract is between the taxpayer and an unrelated person (defined below) and such contract was in effect on September 17, 2003, and at all times thereafter.

For these purposes, a binding contract includes a purchase option, renewal option, or replacement option that is included in such contract and that is enforceable against the seller or lessor. For this purpose, a replacement option will be considered enforceable against a lessor notwithstanding the fact that a lessor retained approval of the replacement lessee.

Unrelated person.    An unrelated person is a person that is not a related person as defined in Qualifying Foreign Trade Property on page 2.

Pre-Repeal ETI Exclusion Rules

Who Qualifies for the Exclusion

Eligible Taxpayers

Individuals, corporations (including S corporations), partnerships, and other pass-through entities are entitled to the exclusion if they have extraterritorial income.

Special rule for DISCs.   The extraterritorial income exclusion does not apply to any taxpayer for any tax year if, at any time during the tax year, the taxpayer is a member of a controlled group of corporations (as defined in section 927(d)(4), as in effect before its repeal) of which a DISC (Domestic International Sales Corporation) is a member.

Eligible Transactions

Generally, the extraterritorial income exclusion applies to taxpayers with respect to transactions after September 30, 2000. However, the exclusion does not apply to any transaction in the ordinary course of a trade or business involving a FSC (Foreign Sales Corporation) that is under a binding contract that is in effect on September 30, 2000, and at all times thereafter, and that is between the FSC (or a person related to the FSC) and a person other than a related person.

Line 2 election.   The taxpayer may elect to apply the exclusion rules for the transactions described above involving a FSC. To make the election, check the box on line 2. See the instructions for line 2 for more details.

Extraterritorial Income

Extraterritorial income is the gross income of the taxpayer attributable to foreign trading gross receipts (defined below). The taxpayer reports all of its extraterritorial income on its tax return. It then uses Form 8873 to calculate its exclusion from income for extraterritorial income that is qualifying foreign trade income.

Qualifying Foreign Trade Income

Generally, qualifying foreign trade income is the amount of gross income that, if excluded, would result in a reduction of taxable income by the greatest of:

  • 15% of foreign trade income,

  • 1.2% of foreign trading gross receipts, or

  • 30% of foreign sale and leasing income.

See definitions below and on page 2.

Foreign TradingGross Receipts

A taxpayer is treated as having foreign trading gross receipts (FTGR) derived from certain activities in connection with qualifying foreign trade property (defined on page 2) only if it meets the foreign economic process requirements (described below). Foreign trading gross receipts are the taxpayer's gross receipts that are:

  1. From the sale, exchange, or other disposition of qualifying foreign trade property;

  2. From the lease or rental of qualifying foreign trade property for use by the lessee outside the United States;

  3. For services that are related and subsidiary to (a) any sale, exchange, or other disposition of qualifying foreign trade property by such taxpayer or (b) any lease or rental of qualifying foreign trade property for use by the lessee outside the United States;

  4. For engineering or architectural services for construction projects located (or proposed for location) outside the United States; or

  5. For the performance of managerial services for a person other than a related person connected with the production of foreign trading gross receipts described in items 1, 2, or 3 above. Item 5 does not apply to a taxpayer for any tax year unless at least 50% of its foreign trading gross receipts (determined without regard to this sentence) for such tax year are derived from the activities described in items 1, 2, or 3 above.

Excluded receipts.   Foreign trading gross receipts do not include the receipts of a taxpayer from a transaction if:
  • The qualifying foreign trade property or services are for ultimate use in the United States;

  • The qualifying foreign trade property or services are for use by the United States or any instrumentality of the United States and such use is required by law or regulation;

  • Such transaction is accomplished by a subsidy granted by the government (or any instrumentality) of the country or possession in which the property is manufactured, produced, grown, or extracted; or

  • The taxpayer has elected to exclude the receipts under section 942(a)(3). See the instructions for line 1 for more details.

Foreign Economic Process Requirements

You are generally treated as having foreign trading gross receipts from a transaction only if certain economic processes take place outside the United States with respect to that transaction. However, see $5 million gross receipts exception on page 2.

Generally, a transaction will qualify if two requirements are met:

  • Participation outside the United States in the sales portion of the transaction and

  • Satisfaction of either the 50% or the 85% foreign direct cost test.

For purposes of determining whether your gross receipts qualify as foreign trading gross receipts, the foreign economic process requirements are treated as satisfied if any related person has met the economic process requirements with respect to the same qualifying foreign trade property.

Participation outside the United States in the sales portion of the transaction.   Generally, the foreign economic process requirements are met for your gross receipts derived from any transaction if you have (or any person acting under a contract with you has) participated outside the United States in the solicitation (other than advertising), negotiation, or the making of the contract relating to the transaction.

50% foreign direct cost test.   You meet this test if the foreign direct costs you incurred that are attributable to the transaction equal or exceed 50% of the total direct costs you incurred attributable to the transaction.

   Total direct costs are those costs for any transaction that are attributable to the following activities you (or any person acting under a contract with you) performed at any location with respect to qualifying foreign trade property:
  • Advertising and sales promotion,

  • Processing of customer orders and arranging for delivery,

  • Transportation outside the United States in connection with delivery to the customer,

  • Determination and transmittal of a final invoice or statement of account or the receipt of payment, and

  • Assumption of credit risk.

   Foreign direct costs are the portion of the total direct costs of any transaction attributable to activities performed outside the United States.

Alternative 85% foreign direct cost test.   You meet this test if, for any two of the activities listed above, the foreign direct costs equal or exceed 85% of the total direct costs attributable to that activity.

   If you incur no direct costs with respect to any activity listed above, that activity is not taken into account for purposes of determining whether you have met either the 50% or 85% foreign direct cost test.

$5 million gross receipts exception.   The foreign economic process requirements do not apply to taxpayers whose foreign trading gross receipts for the tax year are $5 million or less. For tax years of less than 12 months, the test is determined on an annualized basis. For purposes of the exception, all related persons are treated as one taxpayer and, therefore, only one $5 million limit applies.

  In the case of a partnership, S corporation, or other pass-through entity, the limit applies to both the pass-through entity and its partners, shareholders, or other owners. The pass-through entity must advise its partners, shareholders, or other owners if and how the entity met the foreign economic process requirements.

Qualifying ForeignTrade Property

Generally, qualifying foreign trade property is property that meets all three of the following conditions.

  • The property must be held primarily for sale, lease, or rental, in the ordinary course of a trade or business, for direct use, consumption, or disposition outside the United States and Puerto Rico.

  • Not more than 50% of the fair market value of the property can be attributable to (a) articles manufactured, produced, grown, or extracted outside the United States and Puerto Rico and (b) direct costs of labor performed outside the United States and Puerto Rico.

  • The property generally must be manufactured, produced, grown, or extracted within the United States and Puerto Rico. However, property manufactured, produced, grown, or extracted outside the United States and Puerto Rico is qualifying foreign trade property if the property was manufactured, produced, grown, or extracted by:

  1. A domestic corporation,

  2. An individual who is a citizen or resident of the United States,

  3. A foreign corporation that elects to be treated as a domestic corporation under section 943(e), or

  4. A partnership or other pass-through entity all of the partners or owners of which are described in items 1, 2, or 3 above.

Excluded property.   The following property is excluded from the definition of qualifying foreign trade property:
  • Property with respect to which a related person (defined below) has calculated its exclusion using the 1.2% of foreign trading gross receipts method,

  • Property you lease or rent for use by any related person,

  • Certain intangibles described in section 943(a)(3)(B),

  • Oil or gas (or any primary product of oil or gas),

  • Any log, cant, or similar form of unprocessed softwood timber,

  • Products the transfer of which is prohibited or curtailed to carry out the policy stated in paragraph (2)(C) of section 3 of Public Law 96-72, The Export Administration Act of 1979, and

  • Property designated by an Executive order of the President as in short supply because the property is insufficient to meet the requirements of the domestic economy (beginning with the date specified in the Executive order).

Related person.   Generally, a person is considered related to another person, for purposes of the extraterritorial income exclusion, if the persons are treated as a single employer under section 52(a) or (b) or section 414(m) or (o). For this purpose, determinations under section 52(a) and (b) are made without regard to section 1563(b).

Foreign Trade Income

Foreign trade income (FTI) is your taxable income (determined without regard to the extraterritorial income exclusion) attributable to foreign trading gross receipts. See section 941(b)(2) for special rules for cooperatives.

Foreign Sale and Leasing Income

Foreign sale and leasing income (FSLI) is generally the amount of your foreign trade income for a transaction that is:

  • Properly allocable to activities that constitute foreign economic processes (described above),

  • Derived by you from the lease or rental of qualifying foreign trade property for use by the lessee outside the United States, or

  • Derived by you from the sale of qualifying foreign trade property formerly leased or rented for use by the lessee outside the United States.

Only directly allocable expenses are taken into account in figuring your foreign sale and leasing income. Income properly allocable to certain intangibles is excluded from foreign sale and leasing income. See sections 941(c)(2)(B) and 941(c)(3) for special rules related to foreign sale and leasing income.

Reporting of Transactions

Generally, you may report transactions (including sale transactions and leasing transactions) either on a transaction-by- 
transaction basis or on the basis of groups of transactions based on product lines or recognized industry or trade usage. See the instructions for line 5c for rules concerning grouping elections that may be made with respect to transactions. However, you may not group sales and leases together, and you may not report foreign sale and leasing income in column (b) of Part II of the form on the basis of groups.


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