Final CFC Manufacturing Branch Regulations Released by IRS on Foreign Base Company Sales Income
On December 19, 2011, the Service issued final regulations (T.D. 9563) with respect to foreign base company sales income under §954(d) for situations involving the sale of personal property by a corporation foreign corporation (CFC) which is purchased, sold, manufactured, produced, grown, extracted, or constructed by one or more branches of the CFC. The final regulations adopt, for the most part, the set of proposed regulations that were issued on the same subject in 2008 and that were followed up with temporary regulations which were to expire on December 23. The final regulations apply to tax years of CFCs commencing after June 30, 2009 and for tax years of U.S. shareholders in which the tax years of the CFCs end. The good news is that the final regulations only make minor modifications to the expiring temporary regulations in this area.
Under §954(d)(1), foreign based company sales income (FBCSI), which goes into the calculation of Subpart F income, means income (whether in the form of profits, commissions, fees, or otherwise) derived in connection with the purchase of personal property from a related person and its sale to any person, the sale of personal property to any person on behalf of a related person, the purchase of personal property from any person and its sale to a related person, or the purchase of personal property from any person on behalf of a related person where— (A) the property which is purchased (or in the case of property sold on behalf of a related person, the property which is sold) is manufactured, produced, grown, or extracted outside the country under the laws of which the controlled foreign corporation is created or organized, and (B) the property is sold for use, consumption, or disposition outside such foreign country, or, in the case of property purchased on behalf of a related person, is purchased for use, consumption, or disposition outside such foreign country. For purposes of this subsection, personal property does not include agricultural commodities which are not grown in the United States in commercially marketable quantities.
A special branch rule is contained in §954(d)(2) for CFCs which have a branch located outside of their country of incorporation. It applies where the CFC is engaged in purchasing, selling, manufacturing, producing, constructing, growing or extracting activities by or through the branch, and the carrying on of such activities has substantially the same effect were the branch a wholly subsidiary of the CFC. As a result, the branch and the CFC will be treated as separate corporations for purposes of determining the FBCSI of the CFC.
The "substantially same tax effect" determination is made pursuant to a tax rate disparity test set forth in Treas. Reg. § 1.954-3(b)(1)(i)(b) and Treas. Reg. § 1.954-3(b)(1)(ii)(b). With respect to a sales or purchase branch, the tax rate disparity test requires comparing the rate of tax imposed on the income derived from the purchasing or selling activities of the branch with the rate of tax that would apply if the income were earned by the remainder of the CFC. With respect to a manufacturing branch, the tax rate disparity test is applied by comparing the rate of tax imposed on the income derived from the purchasing and selling activities of the CFC with the rate of tax that would apply to such income under the laws of the country in which the manufacturing branch is located.
These final regulations provide guidance on the application of the branch rule, in particular with respect to a CFC that has multiple branches. For example, the regulations set forth rules on how to determine whether a CFC earns FBCSI if purchase and sales activities are conducted by multiple branches and if multiple branches are involved in the manufacture of either a single or multiple items of personal property that is sold by the CFC. The final regulations, in changing the temporary regulations, omit the word “demonstrably” in determining whether the tested manufacturing location or tested sales located provided a greater contribution instead of a “demonstrably greater contribution”.
1. Demonstrably greater contribution . Treas. Reg. § .954-3T(b)(1)(ii)(c)(3)(iii) provides that if none of the branches or the remainder of a CFC independently satisfies the substantial contribution test, but the CFC as a whole made a substantial contribution, then for purposes of applying the tax rate disparity test, the location of manufacture, production or construction is the "tested manufacturing location" unless the "tested sales location" provided a "demonstrably greater" contribution. uncertainty, the word "demonstrably" has been deleted from § 1.954-3(b)(1)(ii)(c)(3)(iii).
2. Grouping of branches . Treas. Reg. § 1.954-3T(b)(2)(ii)(a) provides, in general, that for the grouping of branches which do not have tax rate disparity with a purchasing or selling branch, or with the remainder of the CFC treated as purchasing or selling on behalf of a manufacturing branch. This grouping rule applies for purposes of Treas. Reg. § 1.954-3T(b)(2)(ii), which sets forth the rules that apply after it has been determined that a branch and the remainder of a CFC will be treated as separate corporations. The rules in Treas. Reg. § 1.954-3T(b)(2)(ii) allow a CFC to aggregate the activities of branches that do not have tax rate disparity with a sales or purchasing branch (or remainder) when applying the separate corporation analysis to determine whether the sales income of the sales or purchase branch (or remainder) is FBCSI. § 1.954-3(b)(1)(ii)(c)(3)(v), Example 1. This change to add the phrase “the activities of” to Treas. Reg. §1.954-3(b)(2)(ii)(a) was made to clarify that the grouping rule for branches that don’t have tax rate disparities between manufacturing and sales locations applies only to the activities and not the income of the branches.
C. Deletion of Treas. Reg. § 1.954-3(b)(2)(ii)(d) The final regulations delete paragraph (d) of Treas. Reg. § 1.954-3(b)(2)(ii), which provided that income that is FBCSI as a result of the application of Treas. Reg. § 1.954-3(b)(1)(i) (purchasing or selling branch rules) is not again classified as FBCSI as a result of the application of Treas. Reg. § 1.954-3(b)(1)(ii) (manufacturing branch rules). This change was made because it was redundant.
D. Future Guidance .The IRS and the Treasury Department announced it would continue to study additional FBCSI issues, and are considering whether to issue additional guidance, including guidance regarding when a branch should be treated as a separate corporation under §954(d)(2), and the scope of, and relationship between, FBCSI and foreign base company services income. Perhaps some may think that the guidance would extend to Treasury’s adding a definition of a “branch” for this purpose.
The final regulations for §954(d), contract manufacturing, for controlled foreign base company sales income included in Subpart F under the so-called branch rules, made relatively minor changes to previously issued temporary regulations that were to expire on December 23. Thus, some relief is in order that the final regulations did not take on new broad paths. Commentary on the final regulations welcomed however the change of the phrase “demonstrably greater” with using simply “greater” for purposes of Treas. Reg. §1.954-3(b)(1)(ii)(c)(3)(iii). There was concern that the additional word could be viewed by the courts as increasing the taxpayer’s burden of proof.
