tax notes international - Tuck School of Business - Dartmouth College

U.S. Tax Review
by James P. Fuller
James P. Fuller is an attorney and a partner at Fenwick & West in Mountain View, Calif.
Contract Manufacturing: Final Regulations
The IRS and Treasury issued final contract manufacturing
regulations that will apply to tax years of
controlled foreign corporations beginning after June 30,
2009. (For the final regulations, see Doc 2008-27115 or
2008 WTD 249-34.) New branch rule regulations were
also issued, albeit in temporary form. Those are discussed
separately below. A taxpayer may choose to apply
the new contract manufacturing regulations and the
temporary branch rule regulations retroactively for its
open tax years. A taxpayer may so choose only if the
taxpayer and all members of its affiliated group apply
both the contract manufacturing regulations and the
temporary branch rule regulations in their entirety to
the earliest tax year of each CFC that ends with or
within an open tax year of the taxpayer and to all subsequent
tax years of the taxpayer.
Substantial Contribution Test: Employees
The proposed regulations provided that a CFC will
satisfy the substantial important contribution test regarding
personal property only if all the facts and circumstances
show that the CFC made a substantial contribution
through the activities of its employees to the
manufacture of the property. The proposed regulations
provided a nonexclusive list of activities to be considered
in determining whether the CFC satisfies the substantial
contribution test.
The final regulation defines employees by reference
to Treas. reg. section 31.3121(d)-1(c). That provision,
entitled ‘‘Common-Law Employees,’’ states that every
individual is an employee if, under the usual commonlaw
rules, the relationship between him and the person
for whom he performs services is the legal relationship
of employer and employee. It continues by stating that
generally, such a relationship exists when the person
for whom services are performed has the right to con-
trol and direct the individual who performs the services,
not only as to the result to be accomplished by
the work but also as to the details and means by which
that result is accomplished. That is, the regulation
states, an employee is subject to the will and control of
the employer and not only as to what will be done but
how it will be done.
It is not necessary under that provision that the employer
direct or control the manner in which the services
are performed; it is sufficient if he has the right to
do so.
The right to discharge is also an important factor
indicating that the person possessing that right is an
employer. Other factors characteristic of an employer,
but not necessarily present in every case, are the furnishing
of tools, and the furnishing of a place to work,
to the individual who performs the services.
If an individual is subject to the control and direction
of another merely as to the result to be accomplished
by the work and not as to the means and
methods for accomplishing the result, he generally is
an independent contractor. An individual performing
services as an independent contractor is not as to those
services an employee under the usual common-law
rules. Whether the relationship of an employer and
employee exists will be determined upon an examination
of the facts of each case.
The IRS and Treasury state that this clarification of
the term ‘‘employee’’ will promote more effective application
of the contract manufacturing regulations. The
IRS and Treasury believe that the activities performed
by certain nonpayroll workers should be considered in
determining whether a CFC provides a substantial contribution
through its employees. The IRS and Treasury
concluded that it would be inappropriate to broaden
the definition of employee to include anyone in an
agency relationship with the CFC, because it could
TAX NOTES INTERNATIONAL FEBRUARY 2, 2009 • 447
(C) Tax Analysts 2009. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.