New and emerging markets offer incredible opportunities for investors and corporations – however, not without risk. Political and economic instability in these markets can pose a significant threat to businesses and can lead to catastrophic losses for investors and lenders.

What Is Political Risk?

Political Risk, also known as “geopolitical risk,” is the risk of loss of assets, income, or property suffered by corporations, lenders, or investors as a result of political changes or instability in a country.  Political risk is present with physical assets located in a host country and when trading with a foreign buyer or a sovereign owned enterprise. 

Political risks can drastically impact a company’s investment in a host country.  Foreign government intervention or political violence can render a company unable to operate or withdraw their capital from a host country.

What are the Common Types of Political Risk?

The most common types of political risk are government confiscation, expropriation, nationalization (CEN); currency inconvertibility (CI) and political violence (PV). 

1. Government Confiscation, Expropriation or Nationalization (CEN): Foreign government action involving seizure or confiscation of assets, forced divestiture or forced transfer of ownership of assets, or policies (such as regulatory requirements or tax laws) enacted to hinder a firm’s business operations in such a way as to have the effect of expropriation, all fall under this heading. Often done by governments to shore up domestic political popularity, increase government revenue, or exert control over a critical economic sector, expropriation usually contravenes international agreements and causes a firm to lose its ability to operate its overseas investments or assets.

2. Currency Inconvertibility: This includes the imposition of restrictions on conversion of local currency revenues to major currencies (such as US Dollars or Euros), or capital controls, which prevent remission of earnings from an affected country. Currency controls are enacted by foreign governments or their central banks often in response to a rapidly accelerating currency crisis or a sudden change in government or economic policy and have the effect of forcing a firm to limit or end its overseas operations.

3. Political Violence: Civil strife such as rioting, violent protests, terrorism, and war are all forms of politically-motivated violence that can either cause the physical destruction of a firm’s assets or the creation of a situation in which business operations are curtailed or impossible.

How to Protect Against Political Risk

Staying engaged and aware of political events and trends in a country or region is important when doing business internationally.  Working with trusted sources of information both domestically and internationally is important to assessing risk and developing strong procedures well before a crisis develops.  Professional risk analysts as well as local sources of information such as business partners can be valuable sources of information. 

Other suggestions to prepare for political risk include:

1. Understand Your Supply Chain: Supply chains are complex and a firm’s international operations and those of business suppliers can be impacted by political crises in nearby countries or even locations far beyond a specific place of business. Think about possible bottlenecks.  Having backup or contingency plans in the case of supply chain disruptions can help mitigate losses or disruptions due to unforeseen events.

2. Know the Decision-Makers: Having partners with a strong economic profile in host country of foreign operations and hiring local employees may reduce your exposure to political risk.  A relationship with local bank or an international or regional bank with local operations may help to hedge against political risk.  Local banking may facilitate foreign exchange conversions and transfers.  Additionally, local banks may be familiar with options to shield some of your assets in the case of a crisis or alert you to political trends in the financial sector that could impact your investment and business operations.

3. Understand Your Credit Risk: An important consideration is that a country’s political and economic difficulties may have implications on credit.  Often political crisis can cause spark a series of events leading to a steep and protracted currency devaluation which leads to buyer payment default. Having a credit risk contingency plan, including a trade credit insurance policy, is another aspect of overall political risk planning to consider.

4. Consider Political Risk Insurance: Political risk insurance is an important part of any risk protection strategy.  Protection against risks noted above such as expropriation, violent conflict, political unrest, and currency controls protects your business, investors, and other stakeholders and allows your company to more confidently conduct international business.  With a strong political risk policy in place, companies can be more focused on their growth strategies in specific countries and in the short-to-long term, particularly in emerging markets or developing economies. 

Photo by Oscar Chan from Pexels

What Does Political Risk Insurance Cover?

There are many political factors that are outside the control for a foreign investor which could cause a loss.  A political risk policy typically includes but is not limited to:

1. War and Political Violence or (“PV”)

2. Confiscation, Expropriation and Nationalization or (CEN)

3. Deprivation of Capital

4. Embargo

5. License Cancellations

6. Currency inconvertibility / Non-Transfer

7. Forced Divestiture

8. Contract Frustration / Non-Honoring

9. Unfair and Fair Calling of Bonds

Who Uses Political Risk Insurance?

Corporations, lenders, and investors with physical (fixed/mobile) assets, contracts, investments and international operations in emerging markets. Some typical clients include:

1. Corporations and corporate investors with ownership of overseas financial assets, or international business operations such as joint ventures or subsidiaries that are exposed to financial risk from government policies.

2. Corporations or investors that own overseas physical assets that are exposed to property damage from political violence.

3. Financial Institutions that finance trade transactions, international projects, or other international exposure that is potentially threatened by political risks.

4. Importers and Exporters that have agreements with either private companies, foreign governments, or state-owned enterprises and are exposed to risks to trade flows from political factors.

5. Contractors, developers, and other service providers that do business with foreign governments or state-owned enterprises.

6. Companies in sectors such as mining, engineering, construction, and other services, where both contractual obligations may be threatened by political risks or actual physical assets are at risk of being damaged, expropriated, or become inaccessible due to political factors

How Do I Get Political Risk Insurance?

A political risk insurance broker can assist in developing a policy that meets the specific needs of your business and addresses a country’s political risk in a comprehensive way.  A broker can assist in explaining many of the definitions and details of a political risk insurance policy and help you to identify areas of risk you may not have previously considered.

Why Use Securitas Global Risk Solutions?

Since 2004, Securitas Global Risk Solutions (“Securitas”) has helped clients across the United States develop credit and political risk transfer solutions that provides value on several levels.  As a specialty independent trade credit and political risk insurance broker, Securitas is focused on developing comprehensive solutions that meet the needs of their clients, ensures complete understanding of policy wording and delivers responsive excellent customer service.

Utilizing An IC-DISC to Unlock Greater Export Revenue

Firms exporting overseas may be unaware of an incentive in the U.S. tax code that can noticeably reduce tax liability and free up more revenue.  An Interest Charge-Domestic International Sales Corporation (IC-DISC) is a provision that allows some or all of taxable income relative to export sales to be taxed at a lower rate.  Since the early 1970s, U.S. tax law has allowed DISCs to exist in some form as an incentive for U.S. companies export products overseas or expand their export operations. 

Our Guide to IC-DISC is a free resource that explains everything you need to know about using an IC-DISC to improve your cash flow.

How Does an IC-DISC Work?

An IC-DISC works by reducing an exporters tax liability by allowing some or all taxable export income to be taxed at a lower rate as a qualified dividend, rather than as ordinary income. 

While a company carries out all of its export operations as usual, an IC-DISC is an intermediary company    that serves as a sales commission agent for the exporter.  An IC-DISC is a separate legal entity, and firms seeking to create an IC-DISC must obtain approval from the IRS and must also maintain separate financial operations for the IC-DISC such as bank accounts, accounting structures, and tax reporting.

An IC-DISC is particularly attractive for small-to-medium sized U.S. based exporters, who struggle with tight margins and a highly competitive overseas environment.  The extra cash flow generated by an IC-DISC can be a valuable tool to increase profits and improve overall business operations.

Source: Withum.com

Case Study: COMPANY X Easily Creates an IC-DISC to Improve Business

Company X, a small professional services firm delivering services both domestically and overseas, set up and IC-DISC in 2014.  Working with a certified public accountant, Company X determined which of its 2013 export revenues would qualify as export gross receipts under Internal Revenue Code 199.  

Structured with an S Corporation shareholder, Company X and its CPA confirmed its qualifications and its tax benefit calculations – which rest on the difference between the qualified dividend tax rate on the annual dividend versus the ordinary tax rate of the shareholder on the annual commission payment.       

Company X formed the new corporate entity in Delaware to act as its registered agent and the new company elected to be treated as an IC-DISC under IRS 4876-A (Election To Be Treated as an Interest Charge DISC.)  The new IC-DISC opened a bank account with $2,500 and established a legal Commissions Agreement between it and Company X.  Set-up costs incurred were under $1,500.

Annually, Company X determines which sales qualify as export sales and uses a simplified 4% method to calculate income.  The IC-DISC exists using journal entries with its own set of accounting records and files an annual federal tax return and a Delaware franchise tax return.  Annual costs incurred are under $1000.  Company X finds that the process to set up and maintain an IC-DISC are not complicated or burdensome for a small business.

What Are the Benefits of an IC-DISC?

For example, if an S corporation company similar to Company X above earns $2 million in net taxable international income and pays a commission of 50% or $1 million of that amount to an IC-DISC, it reduces its reported taxable income by that amount. 

The company’s shareholders report this income (now reduced to $1 million from $2 million) on their individual tax returns.  Assuming the shareholders are in the top tax bracket – and taxed at 29.6% (the top rate of 37% multiplied by 80%*) – the commission to the IC-DISC resulted in a total federal tax reduction of $296,000 for the shareholders.

The $1 million commission paid to the IC-DISC is taxed to the IC-DISC’s owners – when paid or deemed paid – as a qualified dividend at the 23.8% rate, resulting in a tax of $238,000.  The difference between paying ordinary income tax rate (29.6% noted above) on $1 million and the qualified dividend rate for the IC-DISC results in a tax savings of $58,000.

*This 80% assumes the full benefit for pass-through entities of the newly enacted 20% Qualified Business Income Tax deduction (see Internal Revenue Code Section 199A)

How to Start Using an IC-DISC

Nearly any firm that exports overseas may qualify for an IC-DISC.  Manufactured products as well as agricultural and horticultural products qualify.  Software and professional services such as engineering and architectural designs are also covered.  A firm that manufactures a good that is included in a product that is subsequently exported can also qualify.

As with any tax incentive, a number of legal details have to be considered.  Eligibility requirements mainly include (but are not limited to): companies must be privately owned; exported products must contain at least 50 percent U.S. content (based on total market value); and a company must directly or indirectly export more than $3 million annually. 

To determine if your company is eligible and for more details on utilizing an IC-DISC, a number of sources exist.  The EXIM Bank has resources such as briefing pages and Webinars, and can provide lists of experts than can help a company get the ball rolling on an IC-DISC strategy.  

Tax regulations and registration requirements are subject to change, so a consultation with a CPA or tax attorney with experience in IC-DISCs is strongly suggested.  Securitas works with business advisors such as the teams at Kreischer Miller and Baker Tilly, who can provide clients with more detailed information on IC-DISCs and their benefits.

In addition to offering comprehensive export credit insurance solutions, the team at Securitas can also put new clients in touch with current and former clients who have utilized an IC-DISC to their advantage. 

Get Your Money-Saving Guide to the IC-Disc

Why Securitas?

As an insurance broker rather than an insurance agent, Securitas Global Risk Solutions is able to apply to multiple carriers to find the best contract, with the most coverage, for the least cost. A carrier’s agent can only advise you as to that carrier’s specific contract. We have a team of experts who are available to you 24/7 to answer any questions or concerns. Additionally, our service comes at no charge to you.