tax notes international - Tuck School of Business - Dartmouth College

such as optimization of plan capacity and reduction of
waste (for example, waste of raw materials). However,
not all corporate managerial decisions are intended to
be considered in the substantial contribution test, because
they may not be directly related to the manufacture
of the personal property. For example, the IRS
and Treasury do not intend that corporate finance decisions
be considered in the substantial contribution test.
Similarly, the IRS and Treasury do not intend that the
general management of enterprise risk be considered in
the substantial contribution test.
In considering logistics, the activity is intended to
include, for example, arranging for delivery of raw materials
to a contract manufacturer, but to exclude delivery
of finished goods to a customer. Thus, the final
regulations revised the activities’ description to read
‘‘control of manufacturing related logistics.’’
Changes were made in the ‘‘use of trade secrets’’
provision (number 7 above) to clarify that developing,
or directing the use or development of, trade secrets,
technology, or other intellectual property are considered
under the substantial contribution test, but only
when activities of this nature are undertaken for the
purpose of the manufacture of the personal property.
The term ‘‘protection’’ regarding trade secrets was
deleted. The IRS and Treasury were concerned that
absent this clarification, the final regulations could read
to provide that legal work performed by a CFC’s inhouse
legal staff was considered under the substantial
contribution test, including in cases in which, for example,
litigation success could be heavily correlated to
profitability or business failure regarding a product.
The activity as described in both the proposed and
final regulations concerns intellectual property used in
the manufacture of the personal property. Thus, developing,
or directing the use or development of, marketing
intangibles is not intended to be considered in the
substantial contribution test.
Other Matters
The IRS and Treasury had requested comments on
whether the substantial contribution test should include
an antiabuse rule and safe harbor. In particular, comments
were requested as to whether it would be appropriate
to add an antiabuse rule to prevent a CFC from
satisfying the substantial contribution test when a significant
part of the direct or indirect contributions to
the manufacture of personal property provided collectively
by the CFC and any related U.S. persons are provided
by one or more related U.S. persons. Commentators
recommended that in determining whether a CFC
makes a substantial contribution, it should not be relevant
whether other persons (whether U.S. or foreign,
related or unrelated) contribute to the manufacturing
process. The IRS and Treasury agreed with those commentators.
Thus, the final regulations do not adopt an
antiabuse rule.
SPECIAL REPORTS
The IRS and Treasury also concluded that no safe
harbor could fairly apply across the range of industries
potentially subject to these contract manufacturing
rules, and therefore no safe harbor was provided in the
final regulations.
A CFC may provide a
substantial contribution to
a largely automated
manufacturing process
through its employees.
Commentators requested that the regulations adopt
principles to determine when the employees of a partnership
should be treated as employees of the CFC for
purposes of determining whether the CFC’s relative
economic interest in the partnership should be relevant
to determining whether the CFC satisfies the substantial
contribution test. The IRS and Treasury concluded
that this issue was beyond the scope of the regulatory
project, but they continue to study the issue and welcome
comments. Thus, the final regulation provides
only that a CFC’s distributive share of income of a
partnership will be considered earned from products
manufactured, produced, or constructed by the CFC
only if the manufacturing exception would have applied
to exclude the income from subpart F income if
the CFC had earned the income directly, determined
by taking into account only the activities of the employees
of, and the property owned by, the partnership.
The proposed regulations contained a rebuttable presumption
that a CFC does not satisfy the substantial
contribution test when the activities of a branch of the
CFC satisfy the physical manufacturing test. In response
to comments, the IRS and Treasury concluded
that the substantial contribution test can be administered
without the benefit of a rebuttable presumption,
and the final regulations do not contain this rebuttable
presumption.
Automated manufacturing (Example 4 in the proposed
regulations) was the subject of significant comment.
A number of examples were added to clarify
that a CFC may provide a substantial contribution to a
largely automated manufacturing process through its
employees. The examples are discussed below.
The IRS and Treasury generally agreed with commentators
that if the substantial contribution test is
sufficient to constitute the manufacture of the personal
property where a CFC substantially contributes to the
manufacture, production, or construction of that property,
then it should be equally sufficient if those activities
are performed by a related person in the CFC’s
TAX NOTES INTERNATIONAL FEBRUARY 2, 2009 • 449
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