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The IC-DISC and its related supplier use a franchise agreement to control Section 994 transfer pricing, the parties' relationship, and how the parties otherwise develop their business dealings.
The Interest Charge Domestic International Sales Corporation (IC-DISC) franchise agreement has been the keystone of DISC structure ever since the initiation of the DISC program in 1971.1 Professional advisors who work on IC-DISCs typically have three objectives: (1) enable the IC-DISC to comply with the IC-DISC qualification requirements; (2) substantiate the ICDISC's tax-favored pricing structure; and (3) preclude tax malpractice claims in the event of unfavorable tax audit results.2As an IC-DISC-related supplier franchise agreement becomes "old and cold" after many years of operation, it is appropriate to review the structure of the agreement.
Peculiar History of the Franchise Agreement Requirement
In defining "DISC," Section 992(a)(1), enacted as part of the Tax Reform Act of 1971, lists two ongoing operating requirements and two initial formative requirements. The ongoing operative requirements are the Sect ion 992 (a)(1)(A) gross receipts requirement and the Section 992(a)(1)(B) export assets test requirement. The two initial formative requirements pertain to Section 992(a)(1)(C), which addresses the "one class of stock" requirement and the $2,500 par or stated value requirement, and Section 992(a)(1)(D), which relates to the DISC election requirement.
After enactment, Treasury issued paid-in capital Regulations to elaborate on the initial DISC formative requirements. In fact, the Regulations expanded the statutory provisions. Reg. 1.992-1(d)(1) modified the scope of Section 992 (a)(1)(C) to preclude a putative DISC's reliance on notes or evidence of indebtedness as being paid-in capital. Reg. 1.992-1(a)(6) required the putative DISC to meet a bank account requirement, subject to inapplicable exceptions, on each day of the tax year.
After Treasury issued Regulations that expanded the initial DISC formative requirements, Robert Feinschreiber, in Domestic International Sales Corporations, sharply criticized the Regulation's minimum capital requirement,3 separate bank account requirement,4 and franchise agreement requirement5 as being beyond the statute. In Durbin Paper Stock Co. Inc., 80 TC 252 (1983), the Tax Court addressed the issue of whether Durbin International, Inc., a wholly owned subsidiary of the petitioner, qualified as a DISC pursuant to Section 992(a). Citing Feinschreiber, Judge Sterrett addressed the basic DISC formative requirements beyond those in Section 992(a)(1)(C), i.e., the $2,500 capitalization...