Treasury bolsters its position on contract manufacturing.

• Author: Cohen, Harrison J.
• Position: U.S. Treasury Dept.

Buried in the proposed Brown Group regulations (REG. 104537-97) relating to partnerships and subpart F are two significant amendments to the subpart F regulations, attacking the use of contract manufacturing arrangements to claim the "manufacturing exception" from foreign base company sales income (FBCSI). These proposed amendments have nothing to do with the treatment of partnerships, but would bolster the Treasury's recent revocation of Rev. Rul. 75-7 in Rev. Rul. 97-48. The Treasury proposes that these amendments be effective for tax years of controlled foreign corporations (CFCs) beginning on or after the date the final regulations are published.

In Rev. Rul. 97-48, the IRS stated that the manufacturing activities of a contract manufacturer cannot be attributed to a CFC in determining whether the CFC income is exempt from FBCSI under the manufacturing exception of Regs. Sec. 1.954-3(a)(4).

Existing final regulations might be read to suggest otherwise. The second sentence of Regs. Sec. 1.954-3(a)(4)(i) provides that "A foreign corporation will be considered, for purposes of this subparagraph, to have manufactured, produced, or constructed personal property which it sells if the property sold is in effect not the property which it purchased" (emphasis added). In, addition, the first sentence of Regs. Sec. 1.954-3(a) (4) (ii) provides that, "If purchased personal property is substantially transformed prior to sale, the property sold will be treated as having been manufactured, produced, or constructed by the selling corporation" (emphasis added). Neither of these sentences identifies the person who would have transformed the property purchased by the CFC prior to its sale, implying that the manufacturing exception may apply to a CFC...