tax notes international - Tuck School of Business - Dartmouth College

SPECIAL REPORTS
manufacturing is the tested manufacturing location
unless the tested sales location provides a
demonstrably greater contribution to the manufacture
of the property.
3. The tested manufacturing location is the location
of any branch or remainder that contributes
to the manufacture of the property and that
would be treated as a separate corporation under
the tax rate disparity test and that would have the
lowest effective rate of tax under the tax rate disparity
test.
4. The tested sales location is where the CFC
purchases or sells the personal property. The
tested sales location includes the activities of any
branch or remainder that would not be treated as
a separate corporation under the tax rate disparity
test.
5. The tested manufacturing location will be
deemed to include the activities of any branch or
remainder that would be treated as a separate
corporation from the tested sales location under
the tax rate disparity test.
6. If the tested sales location provides a demonstrably
greater contribution to the manufacturing,
or if there is no tested manufacturing location,
then the tested sales location is the location of
manufacturing.
Coordination of Branch Rules
The current manufacturing branch rule contemplates
the existence of a sales or purchase branch and a
manufacturing branch. The rules provide that in some
instances, the sales or purchase branch is treated as the
remainder of the CFC for purposes of applying the tax
rate disparity test. However, the sales or purchase
branch rules of the existing regulations do not indicate
that those rules do not apply in cases in which the
manufacturing branch rules are applied. Treasury and
the IRS believe that if one or more sales or purchase
branches are used in addition to a manufacturing
branch, and the manufacturing branch rule’s multiple
branch rule test is applied for income from the sale of
an item of personal property, then the sales or purchasing
branch rules should not apply to determine
whether that income is foreign base company sales income
(FBCSI). The temporary regulations reflect this
new clarifying coordination rule.
Unrelated to Unrelated Transactions
Commentators suggested that there was uncertainty
as to whether a substantial contribution to the manufacture,
production, or construction of personal property
by a CFC could cause the CFC to earn FBCSI in
cases when, in the absence of the substantial contribution
test, some taxpayers had taken the position that
they were outside the scope of the FBCSI rules. For
example, the CFC might purchase property from unrelated
persons and sell that property to unrelated per-
sons. Some commentators expressed concern that
transactions that are not currently subject to the existing
regulations may become subject to the regulations
as a result of the interaction of the substantial contribution
test and the manufacturing branch rule. Other
commentators suggested more generally that it was unclear
if the substantial contribution test might create a
branch through which a CFC carries on activities in a
contract manufacturer’s jurisdiction.
The IRS and Treasury agree that taxpayers may be
subject to the FBCSI rules as a result of CFC employees
performing indicia of manufacturing activities
through a branch outside the country of organization
of the CFC. The IRS and Treasury believe this result is
clear in the proposed regulations, and therefore no
modifications are made to the text of the temporary
regulations to further clarify this result.
The IRS and Treasury note in the preamble that in
response to comments, physical manufacturing and
activities satisfying the substantial contribution test are
treated with equal importance. Thus, the IRS and Treasury
did not incorporate in the temporary regulations
an exception for activities performed through a branch
located outside the country of organization of a CFC
for cases in which, in the absence of the substantial
contribution test, some taxpayers have taken the position
that they were outside the scope of the FBCSI
rules.
One commenter recommended that the IRS and
Treasury consider a special delayed effective date to
allow taxpayers with unrelated to unrelated transactions
that may now become subject to the FBCSI rules
time to restructure their operations in light of the regulations.
The commenter argued that these taxpayers
were outside the scope of the FBCSI rules before adoption
of these regulations and should be provided
enough time to restructure. A special effective date was
not provided, but the temporary regulations generally
have a delayed effective date.
Examples
I will describe the regulation’s examples in the order
in which they appear in the temporary regulation, and
I will not renumber them. This hopefully will help
readers match up the examples with the text in the
regulation. Unless stated otherwise, FS is a CFC organized
under the laws of Country M.
1. Example — Figure 1
FS operates three branches. Branch A in Country A
manufactures Product X. Branch B located in Country
B sells Product X manufactured by Branch A to customers
for use outside Country B. Branch C located in
Country C sells Product X manufactured by Branch A
to customers for use outside Country C. FS conducts
no manufacturing or selling activities of its own. Country
M imposes an effective tax rate on sales income of
0 percent. Country A imposes an effective tax rate on
454 • FEBRUARY 2, 2009 TAX NOTES INTERNATIONAL
(C) Tax Analysts 2009. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.