Content area
Full text
PWC ITS U.S. INBOUND UPDATE
Treasury and the IRS issued Proposed Regulations (REG-124590-07, February 27,2008) relating to foreign base company sales income (FBCSI), as defined in Section 954(d), a form of Subpart F income earned by a controlled foreign corporation (CFC) and taxed currently to the CFC's U.S. shareholders. Specifically, the Proposed Regulations address the manufacturing exception to FBCSI treatment under Section 954(d)(1) where the CFC sells property that is manufactured pursuant to a contract manufacturing arrangement or by one or more branches of the CFC. In addition, the Proposed Regulations deal with miscellaneous branch rule issues under Section 954(d)(2) that have created uncertainty for taxpayers over the years.
The topics in the Proposed Regulations have caused controversy for many years. As discussed below, the new rules create certainty with respect to the treatment of some contract manufacturing arrangements that will clearly be considered acceptable or unacceptable to the government. For many taxpayers, however, the proposals may create greater uncertainty as to how their arrangements may be treated in practice. Some of the issues that have created uncertainty over the years are not addressed at all by the Proposed Regulations. Moreover, because guidance in this area has been lacking for so long, IRS agents may also look to the new Proposed Regulations as a reference point in interpreting the current final Regulations.
Key positions in new Regulations. See the sidebar. Although the Proposed Regulations provide clarity that will help many taxpayers in structuring contract manufacturing arrangements, as a practical matter, the Regulations when effective may increase the risk of IRS scrutiny of such arrangements by eliminating technical impediments that the Service faces under the current rules. The hazards of litigation in challenging the "its" argument (discussed below), on which some taxpayers rely, may have discouraged the IRS from vigorously pursuing contract manufacturing arrangements (at least in the toll manufacturing context). Enumerating facts to be taken into account in determining whether a CFC principal satisfies the substantial contribution standard provides IRS agents with a clearer frame of reference for analyzing contract manufacturing arrangements.
Under the current rules, some taxpayers may rely on the possession, but not necessarily the exercise, of oversight rights as the basis for qualifying as the manufacturer. Taxpayers may be required to...