Export Tax Incentives for Establishing Foreign Markets: An Analysis of Marginal Costing Techniques

Abstract

The tax law provides two administrative pricing methods for allocating profit between a foreign sales corporation (FSC) and its related supplier. Each of the methods can be applied using either full costing or marginal costing. However, the extant literature provides little guidance about which approach might yield optimal tax benefits in given situations. Though marginal costing provides substantial tax savings in may cases, the technique appears to have been under-utilized. This study conducts sensitivity analyses to determine the impact and interaction effects of four study variables: (1) export profit rate, (2) domestic profit rate, (3) relative size of the export market and (4) the impact of overhead costs. Simulation results suggest that marginal costing is most beneficial when export profit rates are low (and low relative to domestic profit rates) and the export market is small relative to the exporter?s total market. Thus, small businesses and new-to-export firms attempting to establish or maintain a foreign market are particularly good candidates for marginal costing. Further, the tax benefit is generally greater for companies in which overhead is a t least 30 percent of product cost. Manufacturers with low overhead can increase their FSC benefit through restructuring.

JEL Classification: M40, M46, K34