AUGUST 1984 - VOLUME 5 - NUMBER 8
"FISC Fever" in the Virgin Islands
by William Steif
The U.S. Virgin Islands, 132 square miles of beaches and green hills more than 1,200 miles southeast of Miami, have suddenly become feverish with the possibility of luring subsidiaries of huge mainland multinational corporations to their shores.
Lawyers and accountants are forming new companies. The 15-member legislature is passing new legislation. Real estate people, hoteliers and restaurateurs are slavering at the prospects opened by a little-known section of the tax bill President Reagan signed in mid-July.
The islands-the two chief islands are St. Thomas and St. Croix because the bulk of the third island, St. John, is a national park-are infected with what in calypsonian parlance might be known as "FISC Fever."
FISC is the spoken version of FSC, the abbreviation for Foreign Sales Corporation. Hardly anyone in the Virgin Islands knew what a FSC was in mid-July. Today -there are dozens of experts, or quasiexperts.
The multinationals knew, of course. The tax bill Reagan signed gave them a $12 billion windfall, representing forgiveness of deferred taxes on foreign profits from 1971 until the end of this year. Few in Congress, apparently, objected to this forgiveness, probably because the U.S. balance of payments, on the current account, is so deeply in the red. In the first six months of 1984 the red ink on the U.S. balance of payments was almost $70 billion, a function of a too-strong dollar which destroyed the competitiveness of U.S. products overseas.
So the Reagan Administration, and Congress, thought it would do all it could to keep U.S. multinationals competitive. The $12 billion was a gift.
The thread of the FSC goes back to the Nixon Administration which, in 1971, got Congress to enact a law permitting multinationals to set up Domestic International Sales Corporations (DISCs) so that the U.S. multinationals could compete more readily with foreign firms. The DISCs could be established anywhere in the U.S. The advantage they gave American multinationals was that taxes on foreign profits could be deferred-not exempted, deferred.
A number of foreign nations, especially in Western Europe, began complaining that the DISCs violated the General Agreement on Tariffs and Trade (GATT), the treaty that regulates the non-Communist world's trade.
The U.S. government never has conceded that DISCs violated GATT, but they probably did. Why, for example, should a DISC in Richmond, Virginia, be able to defer taxes just because it's shipping tobacco overseas?
There are now 9,000 active DISCs in the U.S. Of the American export trade total of $233.7 billion in 1981, two thirds was handled by DISCs.
To satisfy the rising chorus of complaints among GATT partners, the Reagan Administration's Treasury decided to get the DISC law changed so that companies handling American exports would truly be offshore. It's okay under GATT to give tax breaks to offshore trading firms; the firms just can't be in Richmond, Va., New York City, Chicago, San Francisco or elsewhere within the U.S.
The proposed change was placed into the big tax bill Congress cranked out at the start of the summer and Reagan signed in mid-July. The bill contained the $,12 billion forgiveness of deferred taxes as a kind of sop to the multinationals for having to uproot their DISCs.
To replace the DISCs, the Treasury proposed and Congress affirmed setting up FSCs outside the U.S. Customs Zone in jurisdictions sharing full tax information with the U.S. Internal Revenue Service. For purposes of this law, the U.S. Virgin Islands, Guam, American Samoa and the Northern Marianas Commonwealth were declared outside the customs zone.
The Treasury lawyers drafting the legislation, aided by Guam's Congressional delegate, Antonio Won Pat, and the Virgin Islands' Congressional delegate, Ron de Lugo, wanted to cool off the protests within GATT and at the same time keep the multinationals' funds within the dollar zone as much as possible. So the small, offshore U.S. possessions were given a break-a head start.
The multinationals have until the end of 1984 to phase out their DISCs. Small exporters have the option of retaining a modified DISC (and the option of continuing to pay interest on their deferred taxes) or of setting up another, "small FSC" version.
Around November 1 the Treasury is scheduled to publish a list of jurisdictions -probably countries like the United Kingdom, possible offshore territories like the Netherlands Antilles-where FSCs can be established. Some multinationals certainly will prefer to relocate in First World nations-London, for example, has excellent communications, skilled clerical workers, and no language problem.
The new Federal law exempts the new FSCs from all taxes for calendar years 1985 and 1986 and provides that each FSC must have on its board of directors at least one resident of the place where it's established.
What will the FSCs do?
They'll process figures -recording sales, inventory, income, outgo, all on computers. 'The idea is to stimulate U.S. exports because of the giant U.S. balance-of-trade deficit. Once a FSC is set up, there are three different formulas a multinational can use to save taxes on export profits. The savings can run from 16 to 32 percent. and sometimes more, depending on the formula used.
The U.S. Virgin Islands is in the best position of the four U .S. offshore jurisdictions to take advantage of the FSCs because it is in virtually the same time zone as the U.S. East Coast (during daylight savings time, the islands are in the same time zone; when the U.S. East Coast falls back to standard time, the islands are an hour ahead of the east coast). The Virgin Islands have direct air service to New York, Miami and San Juan, and better telecommunications systems than the Pacific possessions. Among the 100,000 Virgin Islanders (50,000 on St. Croix, 46,500 on St. Thomas, 3,500 on St. John) there are probably enough people with sophisticated skills needed to do the FSC processing.
Enormous multinationals are likely to set up their own FSCs. Eastman Kodak, for example, began sniffing around St. Croix last spring when that company became aware of the FSC possibilities. It took an option on a twostory building in the center of Frederiksted, on St. Croix's west coast, and quietly waited for the tax legislation to be signed. Only a few days after the bill was signed Kodak exercised its option and plans to pay around $250,000 for the building in this historic and depressed town and to spend around $250,000 more to upgrade the building for its FSC. Kodak plans to employ 15 to 25 Virgin Islanders. It is the 24th largest multinational, according to a Forbes magazine summary published in July, netting $59 million on foreign revenue of $3.27 billion last year.
Dow Chemical, the 14th largest multinational, also has been prowling the U.S. Virgin Islands. It had a team looking into the islands' possibilities for an FSC in early August. The team was headed by Alan Winston Granwell, of the Wall Street law firm of Cadwalader, Wickersham and Taft. Granwell worked for the U.S. Treasury until late spring, drafted the new FSC law and then left for Wall Street. He testified to a Virgin Islands legislative committee that the new law was "compatible with GATT." Dow last year had a foreign operating profit of $382 million on foreign revenues of $5.726 billion.
Monsanto Chemical ($206 million net on foreign revenues of $1.703 billion last year) also has been looking over the Virgin Islands scene. It is the 56th biggest multinational. Many other multinationals have expressed interest. Over all, the 100 largest multinationals, headed by Exxon, Mobil and Texaco, grossed $422 billion last year, according to Forbes.
Many of the smaller multinationals, however, will not go to the lengths of Kodak to set up shop in the Virgin Islands. Many-perhaps most-of the FSCs will be simple depositories for invoices, quarterly income statements, and annual balance sheets stored in the islands but prepared at mainland headquarters. Local lawyers, accountants and management firms will handle these operations, with anywhere from a dozen to 100 FSCs housed in the same office -and computer.
For a U.S. territory that is at the edge of the Third World -per capita income in the islands is just over $7,000 yearly, the highest in the Caribbean but only two thirds of that in the U.S. - the FSC spinoff benefits could be great. Bank deposits could take a big jump, making more money available for loans. Non-resident directors could hold board meetings in the islands-these are the chaps who carry gold American Express cards and tend to take wives on "business trips." Hotels, restaurants, taxis, gift shops would receive a major fillip. So would real estate dealers. And there would be some new jobs, possibly 300 to 400, estimates the territorial commerce department's chief economist, Richard Moore. He says movement of 500 FSCs to the Virgin Islands could mean a $20 million to $22 million addition to the islands' economy.
All this has left Territorial Governor Juan Luis and his administration in a quandary. Luis and the legislature, wrestling with trying to balance a territorial budget of around $235 million, would like to grab some new taxes from the FSCs. At the same time they have been warned repeatedly not to "scare away" FSCs - a Kodak or a Dow can walk out as easily as it walks in.
The legislature's solution in September was to pass a .85 percent income tax-with tax credits for hiring Virgin Islanders which in effect reduce tax liability to zero. And so far Guam has responded by passing legislation in essence charging a foreign sales corporation $1000 to establish in that island country.
Everyone concerned knows that the territories' haste has been necessary since no multinational will commit itself to a substantial investment until it knows what the tax situation in the local jurisdiction will be (Kodak doesn't need to worry about its Frederiksted property anyway because the entire town is a historic zone and restoring a building there brings hefty tax credits).
In addition, the multinationals want to see the list of possible jurisdictions the Treasury is bringing out late this year to see if they can get a better deal elsewhere.
Adrienne Palmer, a St. Thomas tax lawyer who has formed First Guardian Trust Co. with former stock broker Ed Hanley to act as an FSC depository, is fearful of overtaxing the multinationals. She says the trick is "to keep the territory competitive and not to stick it to 'em."
Tom Bennett, executive director of the St. 'Thomas-St. John Chamber of Commerce, echoes those sentiments, saying "our legislators ... can impose unrealistic fees and taxes on the FSCs or burden them with red tape or hiring requirements that no other local firm must face."
There's a near-calypso beat among the business community in the islands that could be expressed in a song entitled "FISC Fever." Its refrain would be:
"V.I. People Shouldn't
Almost no one talks about the $12 billion in forgiven federal taxes.
William Steif is a freelance writer currently based in the Virgin Islands.