EXPORT ECONOMIC ACTIVITY TESTS
As a guideline, the export economic activities
include, but are not limited to, activities that satisfy one or more
activities of the sales activity test and two or more activities
of the foreign direct cost tests. These tests were originally used
to define foreign economic processing (FEP) and then after its repeal,
were applied to the Extraterritorial Income Exclusion (ETI). In keeping
with the definition already approved by the IRS, we are using these
tests to define export economic activities.
There are special requirements regarding the export economic activities
pertaining to military sales, so please contact Export Assist or
your tax advisor for more information.
Solicitation | Negotiation | Making
Any communication, by any method, at any time during a 12-month period
immediately preceding the execution of a contract or purchase order
that is made to a specific, targeted customer or potential customer
that brings attention to the product or service covered by the
transaction. However, a sale need not occur to satisfy the test.
Situs: Outside the U.S. customs zone from where the sales material
Example: Mailing a brochure or a new price list to customers who
represent 50% of last year's FTGR every 12 months is a popular way
to meet this test. If an exporter uses wholesalers or a distributor
and, hence, has very few customers in number, it may send to all
of them. This is the test usually chosen to meet the sales activities
Caution: You cannot send
the same material for both solicitation and advertising (see direct
If your company produces many products and you group by product,
this test must be done for each product line.
Any communication by the exporter
to a customer or potential customer concerning the terms of the
transaction. Those terms could be both
terms of payment regarding method (i.e., Letters of Credit, cash
in advance, open account credit terms) and terms of sale (i.e.,
price, quantity, delivery method, and incoterms). [Reg. 1.924(d)-1(c)(3)]
Situs: Outside the U.S. customs zone.
Example: This could be the actual negotiation of the terms of a contract
by a sales representative calling on clients
it could be a letter sent from outside the U.S. to a client
regarding the terms of a contract.
Making of Contract
Any activity that completes the sale or order, including making
and/or accepting an order, written confirmation of the order
by the exporter
or an acceptance of an unsolicited bid or order, and written
confirmation of contract term (i.e., terms of sale, terms of
Situs: Outside the U.S. customs zone.
Example: Written acceptance of an unsolicited bid or order will
be considered "making the contract". Written confirmation
by the exporter or its agent (i.e., Export Assist, Inc.) that confirms
variable contract terms also constitutes "making the contract".
An example of how this test might be met is by having copies of renewal
contracts sent to the exporter’s office outside the U.S. from
where the contracts are mailed to the customers for signature, returned
to the foreign office where they are signed by a representative of
the exporter and then copies are sent to the customer, the parent
company, and a copy is kept in the exporter’s office.
and Sales Promotion | Processing
Orders and Arranging Delivery | Transportation | Determination
and Transmittal and Receipt of Payment | Assumption
of Credit Risk
and Sales Promotion
The announcement or description of the export property or services
in some medium of mass communication in order to induce multiple
customers or potential
customers to buy or rent the property or services from the exporter or
its related supplier. The communication piece must describe one
or more specific
products and/or services. Image building communications such as “have
a nice day” are to be excluded, as are U.S. targets. [Reg. 1.924(e)-1(a)(1)]
Situs: To where the material is sent.
Placing an advertisement in a trade journal or newspaper that
has at least 85% non-U.S. readership.
Sending brochures or other materials to customers outside the
U.S. (Although the Regulations state that the situs is "to" where
the material is sent, some tax advisors are more comfortable having
the material mailed from outside the U.S.)
Caution: You cannot
send the same material for both solicitation and advertising.
The material must be generically different.
Costs: The costs of advertising are the costs
of running the advertisement in a newspaper, magazine, or trade
journal. If sales material is
transmitted to customers or potential customers directly, the
cost is the cost of displaying, distributing, printing and sending
materials. Any costs relating to the preparation of the ad or
the sales material (i.e., artist, advertising agency) are not
In instances where goods are sold through a distributor, if the
exporter pays at least 20% of the distributor's advertising costs
or indirectly), the costs count as direct costs of advertising.
The costs are considered foreign direct costs as long as the
activity is directed to customers outside the U.S.
An appeal made in person to an export customer or to a potential
export customer for the sale or rental of qualifying export property
or services made in the context of a trade show or customer meeting.
Customer meeting is defined as a periodic meeting at which ten
or more customers (from different companies) or potential customers
are reasonably expected to attend. [Reg. 1.924(e)-1(a)(2)]
Situs: Where the trade show or customer meeting is held.
a booth at a trade show outside the U.S. for the purpose of promoting
export sales of your product.
Caution: If you have costs that would fall into the sales promotion
category, they must be included under the costs recorded for
this entire test, as it is a dual category test. Be aware that
shows held in the U.S. for foreign customers will count as
a domestic direct
Costs: The direct costs of sales promotion would be the
rent for space and other specific charges at the trade show and
of travel and lodging for those directly involved in the
at the show, but not salaries or other compensation. If printed
materials are distributed that are used for other promotional
cost of these materials is not included.
If a customer meeting
is held, the costs can include travel and lodging for both company
sales people and the customers
Also, if material has been especially produced for such
a meeting, the cost of printing can be included in the direct
Customer Orders and Arranging for Delivery
Notifying the related supplier of the order and of the requirements
for delivery. [Reg. 1.924(c)-1(b)(1)] This activity,
along with arranging for delivery, must be performed with respect
20% or more of the FTGR of all transactions within
the grouping. [Reg. 1.924(e)-1(b)]
Arranging for Delivery
Situs: From where the communication
is initiated outside the U.S
Costs: The costs include payment
to personnel located outside the U.S. who perform the work and
telegraph, overnight service, telephone, e-mail,
facsimile or in person.
Taking the necessary steps to have the export property delivered
to the customer in accordance with the requirements of the
order. This could include communication with the carrier or freight
forwarder who will provide the transportation of the goods.
can also include
notifying the customer of the time and place of delivery. [Reg.
Situs: From where the arranging takes place
outside the U.S
Example: Since this category (which includes both
parts) involves both acknowledging the order and taking the necessary
to have the order delivered from outside the U.S., it is
the direct cost tests. The information about the order and
delivery would have to be transmitted outside the U.S. and
back to the related supplier, the carrier, and the customer.
Costs: The costs include payment made to personnel outside the U.S. who
perform the work and the cost of communication:
overnight service, telephone, e-mail, facsimile or in person.
Moving or shipping the export property during the period
when the exporter owns or is responsible for the property.
a commission, it is when the related supplier owns or
is responsible for the property, but after the commission
for purposes of transportation. [Reg. 1.924(e)-1(c)(1)]
The wording in the sales/commission agreement between the exporter
and the parent/related supplier should define
agreement with the exporter begins such as "…U.S.
customs zone" or "…hands of an international
Situs: Transportation of goods from the point where they
leave the U.S. customs zone until they are delivered
to customers in a foreign
Example: This might be met by one shipment
a year if during the normal course of business all other shipments
This one shipment would have to be sent: FOB. destination,
CIF. or CPT. It cannot be sent FOB. shipping point
or CFR to meet
Caution: Please note that shipping
FOB destination may create foreign source income on that shipment
which may not be desirable. In making shipments that go partially
by land across the U.S., the U.S. part may be counted as a domestic
cost. This can be avoided
by handing the shipment over to an international freight forwarder
at the shipping point. In this way, the entire cost can be counted
as a foreign cost.
Costs: The costs for transportation are those costs incurred when
shipping goods. This might include freight charges, fees charged
by a freight forwarder, freight insurance premiums, or the cost of
preparing documents. All of these costs must be for transportation
outside the U.S.
Determination and Transmittal of
Invoice or Statement of Account and/or Receipt of Payment
Determination and Transmittal of Invoice
or Statement of Account
The assembly of the final invoice or statement
of account and the forwarding of that document to the customer.
Note: If the exporter elects to group by product
in this category, a special rule applies. If the test is performed
with respect to
customers representing 50% of the FTGR for either the current
or previous year, all domestic costs are disregarded and the exporter
is considered to have no domestic costs in this category.
Situs: Location is outside the U.S. where the invoice or statement of
account is both assembled and forwarded.
Example: Statements are sent
to the management firm to fold, place in envelopes, address envelopes,
and mail from outside
Costs: The costs here can include the costs of office
supplies and equipment, payment made to personnel, and the mailing
and delivery charges, if it can be established that these
related to the assembly and transmittal of the invoice
Receipt of Payment
The crediting to the exporter’s bank account of an amount
that is not less than 1.83% of the gross receipts associated with
transaction within 35 calendar days from the receipt
of good funds.
Situs: At the exporter’s bank account maintained in an approved
jurisdiction outside the U.S.
Example: The parent company receives
payment in its regular U.S. bank account. Within 35 days of receipt,
percentages (at least
1.83%) of these payments are wired to the exporter’s bank
account in a qualifying jurisdiction. The funds are then wired
back to the
U.S. bank account.
Costs: The costs include the expenses of maintaining
the foreign bank account where payment is sent, the cost of converting
into U.S. currency, and the bank charges for the transfer of
funds in and out of this bank account. The location of the costs
be the foreign bank in which the activity occurs.
of Credit Risk
Assuming the economic risk of non-payment with respect to an
export transaction. This risk can also be included in a commission
This economic risk is defined by the terms of payment and credit
enhancement negotiated and/or selected by the exporter on each
export transaction. [Reg. 1.924(e)-1(c)(1)]
Assumption Loss Method: This method requires that the exporter
specifically assume the risk of loss due to a bad
debt and that there is a loss during a three-year period. If there
is no loss during the three years, this test can be used for the
first two years of the three-year period, but not for the third year.
(This assumption of loss by the exporter should be specifically mentioned
in the agreement between the parent/related supplier and the exporter.)
Note: A bad debt is an amount that is not collectible or an
amount taken into consideration in the determination of additions
debt reserves. [Reg. 1.924(e) 1(e)(2)]
"Active" or Insurance Expense Method:
includes the following activities: selling by Letters of Credit,
insuring against loss, and investigating the credit of customers
or potential customers. One must obtain Letters of Credit
for customers that represent at least 20% of the FTGR from sales run
the export company; 20% of the face amount of the receivables
factored; 20% of the face amount of the receivables must
insured; or 20% (in dollar volume) of new or potential customers
Situs: The location is where the customer, whose
payment is at risk, is located. However, the investigation of credit
taken place outside the U.S. to qualify.
Costs: For the four
tests in the insurance-expense category, the direct costs are the
fees for the Letters of Credit; the
factoring trade receivables; the cost of obtaining the insurance
(all of which might be incurred in the U.S.); and the cost
of the credit investigation.
Although the Foreign Economic Processes tests, both sales
activities and direct cost, are to be done on a transaction-by-transaction
the grouping of transactions is allowed. There are four ways
transactions can be grouped to accomplish these tests. They are:
- Product: The product (or product
line) is usually based on a two digit SIC (Standard Industry Classification)
code or could
be a product line that is recognized in a particular industry.
use the SIC code. It is possible for a company to group by
product for some sales and to use the transaction-by-transaction
When the company uses the product grouping for any
of the sales activities tests, they must perform activities outside
with respect to current
or potential customers which represent 20% of the foreign trading gross
receipts (FTGR) for the current year or 50% of the FTGR for the
previous year (even
if there are no sales in the current year to last year's customers.)
The product grouping is easily done
by companies who have very few and/or related products. In most
can meet the economic process test
for one transaction
or the minimum set out in the federal regulations and thereby
meet this requirement for all of the transactions within the
- Customer: The customer grouping would include all of the transactions
with one particular customer during a tax year. If your
or three major distributors but has a very large selection
of different products, this might be a good grouping for you. In
case, the FEP tests would have
to be done for each customer, but not for each product.
- Contract: The
contract grouping would include all of the transactions
that took place under a single contract during the tax year. One
might be to supply certain equipment and some ancillary
services. All of these
could be grouped by contract for the year, so one shipment
contract could be used to meet the transportation requirement.
There is a special rule for grouping by contract which
allows all the transactions for the first and the last
year to be
with the year
following and the year preceding. This would allow, for
instance, the cost of transportation in the first year
to also be used
in the second
of the contract in which there were no costs in transportation.
In addition, the sales
activities test needs to be satisfied only in the first
year of the contract if the contract is between unrelated
activities test must be satisfied each year.
- Product or Product Line
within a Customer or Contract Group: This is self
explanatory by the title. It is rarely seen, but is an option.
It is important to note that a different grouping can
be used for different tests. For example, the solicitation
test (sales activity test) might
be grouped by customer and advertising (direct cost test) might be by product. The choice of grouping can also be changed and an amended return filed before the statute of limitations runs out.