tax notes international - Tuck School of Business - Dartmouth College

oversight to FS in connection with the functions performed
by FS through its employees. FS satisfies the
substantial contribution test. Selection of the contract
manufacturer, even though not specifically identified on
the nonexclusive factors list, is considered in determining
whether FS makes a substantial contribution to the
manufacture of Product X through its employees.
Example 7
Assume the same facts as in Example 6, except that
the software and network systems, and the upgrades to
those systems, were purchased by FS rather than developed
by employees of FS. FS satisfies the substantial
contribution test. The lack of performance of software
and network system development activities is not determinative
under the facts and circumstances of the business.
Further, this determination does not require a
comparison between the activities of FS and the activities
of the domestic parent.
Example 8
FS has raw materials manufactured into Product X
by an unrelated contract manufacturer. FS controls the
raw materials, work-in-process, and finished goods. FS
controls the manufacturing-related logistics, manages
the manufacturing costs and capabilities, and provides
quality control for the contract manufacturer’s manufacturing
process and product. No intellectual property
of significant value is required to manufacture the
product. FS does not own any intellectual property or
hold an exclusive or nonexclusive right to manufacture
Product X. FS satisfies the substantial contribution test.
Example 9
FS1 and FS2, unrelated CFCs, contract with an unrelated
contract manufacturer to manufacture Product
X. Neither FS1 nor FS2 owns the materials or work-inprocess
during the manufacturing. FS1, through its employees,
designs Product X. FS1 directs the use of the
product design and design specifications and other intellectual
property for the purpose of manufacturing
Product X. Employees of FS1 also select the materials
that will be used in the manufacture of the product
and the vendors to provide those materials. FS2,
through its employees, designs the process for manufacturing
Product X. FS2, through its employees, manages
the manufacturing costs and capabilities for Product X.
FS1 and FS2 each provide quality control and oversight
and direction of the contract manufacturer’s
manufacturing activities for different aspects of the
manufacture of Product X. Both FS1 and FS2 satisfy
the substantial contribution test. Each independently
makes a substantial contribution through the activities
of its employees for the manufacture of the product.
Example 10
FS purchases raw materials and has them manufactured
into Product X by an unrelated contract manufacturer.
Products in the X industry are distinguished
(and vary widely in value) based on the raw materials
used to make the product and the product design. FS
SPECIAL REPORTS
designs the product and selects the materials that the
contract manufacturer will use to manufacture the
product. FS also manages the manufacturing costs and
capabilities. Product X can be manufactured from the
raw materials to FS’s design and specifications without
significant oversight and direction, quality control, or
control of manufacturing-related logistics. The activities
most relevant to the substantial contribution analysis
under these facts are material selection, product design,
and management of the manufacturing costs and capabilities.
FS makes a substantial contribution through
the activities of its employees to the manufacture of
the product.
Example 11
FS purchases raw materials and has them manufactured
into Product X by an unrelated contract manufacturer.
FS controls the raw material, work-in-process,
and finished goods; manages the manufacturing costs
and capabilities; and provides oversight and direction
of the manufacture of Product X. Employees of FS
visit the manufacturer’s facility for one week each
quarter and perform quality control tests on a random
sample of the units of Product X produced during the
week. In the industry, quarterly visits to a manufacturing
facility by qualified persons are sufficient to control
the quality of manufacturing. FS satisfies the substantial
contribution test.
Manufacturing Branch Rules
The manufacturing branch rule regulations that were
proposed with the contract manufacturing regulations
were adopted as temporary regulations. (For the proposed
regulations, see Doc 2008-27116 or 2008 WTD 249-
35.) Treasury and the IRS presumably concluded that
there were sufficient changes in these regulations such
that they should be issued in temporary form and also
reproposed. A public hearing has been scheduled for
the proposed version of these regulations on April 20,
2009. The temporary regulations apply to tax years of
CFCs beginning after June 30, 2009, and for tax years
of U.S. shareholders in which these tax years of CFCs
end. As discussed above, the temporary regulations
under some conditions may be applied retroactively by
a taxpayer for its open tax years.
Branch Definition: Important Issues
The proposed regulations did not define the term
‘‘branch.’’ Some commentators suggested that the regulations
define the term. These commentators suggested
various definitions for the IRS and Treasury to consider.
Some commentators suggested, for example, that
a branch be defined as a permanent establishment, as a
business activity in a jurisdiction outside a CFC’s
country of organization that has separate books and
records, or as a trade or business outside a CFC’s
country of organization. Commentators pointed to precedents
in the section 367 and section 987 regulations.
Alternatively, some commentators requested that the
TAX NOTES INTERNATIONAL FEBRUARY 2, 2009 • 451
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