Comments on proposed contract manufacturing regulations.

• Author: Ugai, Brian C.

March 27, 2009

On March 27, 2009, Tax Executives Institute submitted the following comments to the U.S. Department of the Treasury and the Internal Revenue Service relating to proposed regulations regarding the treatment of foreign base company sales income from property produced under contract manufacturing arrangements and sold by controlled foreign corporations under section 954(d) of the Internal Revenue Code. The comments were prepared under the aegis of TEI's International Tax Committee whose chair is Brian C. Ugai of Starbucks Coffee Company. Other members of the Institute who contributed to the project are Anthony J. Blackburn and Terri Yuhaniak of Goodyear Tire & Rubber Company, Dorothy C. Chao of Baxter International, Inc., Lester D. Ezrati of Hewlett-Packard Company, Daniel R. Goff of Xilinx, Inc., Peter Hiltz of Cisco Systems, Inc., Howard Schneck of Atheros Communications, Inc., and Daniel J. Wenzel of S.C. Johnson & Son. TEl General Counsel Mary L. Fahey served as staff liaison on this project.

On December 24, 2008, the U.S. Department of Treasury and the Internal Revenue Service issued final, temporary and proposed regulations to provide guidance regarding the treatment of foreign base company sales income from property produced under contract manufacturing arrangements and sold by controlled foreign corporations under section 954(d) of the Internal Revenue Code (hereinafter the "December 2008 regulations"). The regulations replace proposed regulations issued on February 28, 2008 (hereinafter the "February 2008 regulations").

The December 2008 regulations were published in the January 31, 2009, issue of the Internal Revenue Bulletin (2009-5 I.R.B. 387), and the December 29, 2008, issue of the Federal Register (73 Fed. Reg. 79421). A hearing is scheduled for April 20, 2009.

Background

Tax Executives Institute is the preeminent association of business tax executives in North America. Our 7,000 members represent 3,200 of the leading corporations in the United States, Canada, Europe, and Asia. TEl represents a cross-section of the business community, and is dedicated to developing and effectively implementing sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and the government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply in a cost-efficient manner.

Members of TEl are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to business enterprises. We believe that the diversity and professional training of our members enable us to bring a balanced and practical perspective to the proposed regulations regarding the treatment of foreign base company sales income from property produced under contract manufacturing arrangements and sold by controlled foreign corporations under section 954(d).

Overview

Under section 954(d) of the Code, "foreign base company sales income" (FBCSI) generally encompasses income derived by a controlled foreign corporation (CFC) from selling personal property that the CFC purchased from a related person (e.g., a domestic parent) or from buying personal property such as raw materials for sale to a related person if the property is both produced and sold for use outside the country in which the CFC is incorporated. Treas. Reg. [section] 1.954-3(a)(4)(i) provides that FBCSI excludes income of a CFC from the sale of property that was "manufactured, produced, or constructed by such corporation, in whole or in part, from personal property which it has purchased" (the "manufacturing exception"). The regulations set forth two separate tests--the substantial transformation and substantive tests--to determine whether a CFC is considered to manufacture, produce, or construct personal property that it sells. Under these tests, the personal property sold will not be considered the property purchased if the property is either:

(1) substantially transformed prior to sale, or

(2) used as a component part of personal property that is sold, if the operations conducted by the selling corporation in connection with the property purchased and sold are substantial in nature and are generally considered to constitute the manufacture, production, or construction of property.

The December 2008 regulations expand this exception by adding the substantial...