Source: http://www.bna.com/presidents-budget-apply-n17179893436/
Timestamp: 2016-12-03 00:23:55
Document Index: 95641150

Matched Legal Cases: ['§954', '§954', '§1', '§954', '§1', '§1', '§1', '§1', '§1', '§1']

President's Budget Would Apply Subpart F to Toll Manufacturing Arrangements | Bloomberg BNA
President's Budget Would Apply Subpart F to Toll Manufacturing Arrangements
The Obama Administration's FY 2015 budget proposes to expand thedefinition of "foreign base company sales income" (FBCSI). The newrule would apply to income earned by a controlled foreigncorporation (CFC) from selling products that a related personmanufactures on its behalf.
The proposal targets the following structure. A CFCoperates as a principal. It purchases raw materials and componentsfrom unrelated suppliers and consigns them to a related "toll"manufacturer to produce finished products. The CFC then sells thefinished products to unrelated persons. The CFC principal pays therelated toll manufacturer a fee for its services. The CFC principalmay also pay service fees to related persons to assist with othersupply chain functions, and typically would own or license therelevant intangible property.
Section 954(d)(1) provides, in relevant part, that income fromthe purchase and sale of property is FBCSI only if it is derived bya CFC in connection with either: (1) the purchase of personalproperty from a related person1 and its sale toany person; or (2) the purchase of personal property from anyperson and its sale to a related person.2 Therefore, FBCSIgenerally does not include income derived by a CFC from sellingproducts where the CFC does not purchase the products from arelated person nor sell the products to a related person.3)
In the above example, the CFC principal purchases the rawmaterials and components from unrelated suppliers and owns theproperty throughout the manufacturing process, and then sells thefinished products to unrelated persons. Therefore, since the CFCneither purchases property from a related person, nor sells thefinished products to a related person, its sales income is notFBCSI.4
The Tax Court has analyzed the above structure and held in favorof the taxpayer. In Vetco, Inc. v. Commissioner,5 a Swiss CFC soldproducts manufactured on its behalf by a related U.K. CFC. TheSwiss CFC purchased raw materials from unrelated suppliers,consigned them to the U.K. CFC which manufactured finishedproducts, and then the Swiss CFC sold the products to unrelatedcustomers. The Swiss CFC paid the U.K. CFC for procurement andmanufacturing services. The Tax Court held that the sales incomewas not FBCSI.
The IRS asserted that the U.K. CFC should be treated as amanufacturing branch of the Swiss CFC for purposes of the branchrule of §954(d)(2) to create a related person transaction causingthe Swiss CFC's income to become FBCSI. The Tax Court rejected theIRS's argument, holding that a separate corporation is not abranch.6
In its description of the Administration's proposal, theTreasury acknowledges in the Green Book7 that "[i]n orderfor the foreign base company sales income rules of subpart F toapply, a CFC generally must engage in both a purchase andsubsequent sale of personal property where such property is eitherpurchased from, or sold to, a related person." The Treasury furthernotes that "[u]nder current law, taxpayers take the position that aCFC can avoid foreign base company sales income by structuring therelated party transaction by which the CFC obtains the propertythat the CFC sells to customers as the provision of a manufacturingservice to the CFC rather than as a purchase of the property by theCFC."8
The Administration expresses concern with a related manufacturerbeing based in the United States. The Green Book observes that"[i]n some cases, taxpayers take this position with respect toproperty produced in the United States on behalf of a related CFC."The Treasury states that the "policy concerns that underlie theforeign base company sales income rules" include "U.S. baseerosion," and that such concerns "apply with respect to incomeearned by a CFC from the sale of property produced by a relatedparty, regardless of whether the CFC is characterized as obtainingthe property through a purchase transaction or through amanufacturing service."9
The Administration's proposal would expand the category of FBCSIto include income of a CFC from the sale of property manufacturedon behalf of the CFC by a related person. Apparently, the CFC wouldbe treated as purchasing the products it sells from a relatedperson, i.e., the toll manufacturer. Under this construct, thetransaction would effectively be recast from a services arrangementwith the related manufacturer to a buy-sell arrangement.10
The exceptions to FBCSI would continue to apply. Accordingly, income otherwise subject to the new rule would not beFBCSI if the products are manufactured in a CFC's country oforganization, or sold for use in a CFC's country oforganization.11 Inaddition, if a CFC manufactures the property it sells, then theproposal would not cause its income to be FBCSI.12 For example, ifa CFC principal substantially contributes to the manufacture of theproperty by a related toll manufacturer, then the CFC's income fromselling the finished products would not be FBCSI.13
The proposal would not apply to other structures where the CFCdoes not purchase property from, nor sell property to, a relatedperson. For example, it would not apply where a CFC purchasesproducts from an unrelated contract manufacturer, and then sellsthe products to unrelated customers.14 Such salesincome would not be FBCSI under the proposal even if the CFC paidservice fees to a related person to assist with supply chainfunctions (provided those functions did not rise to the level of"substantial contribution" manufacturing).15
The Administration's proposal to apply Subpart F to "toll"manufacturing structures is short-sighted. Causing incomederived by foreign subsidiaries from the manufacture and sale ofproducts to be subject to taxation in the United States-which hasthe highest tax rate of any industrialized country-puts U.S.-basedcompanies at a competitive disadvantage. Similar operations ofnon-U.S.-based companies generally are not subject to home countrytaxation. In addition, targeting U.S. manufacturing iscounterproductive, as the high U.S. tax costs may incentivizeU.S.-based multinationals to look for manufacturing opportunitiesoutside the United States. The better answer is to repeal theFBCSI rules to level the playing field.
This commentary also will appear in the August 2014 issue ofthe Tax Management International Journal. Formore information, in the Tax Management Portfolios, see Yoder, 928T.M., CFCs - Foreign Bae Company Income (other than FPHCI), and in Tax Practice Series, see ¶7150, U.S. Persons -Worldwide Taxation.
1 A person is related to a CFC if such person iscontrolled by the CFC or is controlled by the same persons thatcontrol the CFC. For this purpose, "control" means, with respect toa corporation, the direct or indirect ownership of more than 50%(by vote or value) of the stock of such corporation.§954(d)(3).
2 Reg. §1.954-3(a)(1)(i). Section 954(d)(1)can also apply to commissions and fee income derived by a CFC frompurchasing or selling products on behalf of a related person. Theparadigm addressed herein involves a CFC that derives sales incomefrom actually selling products.
3 Under certain circumstances a branch rule canapply to treat a portion of the CFC's income as FBCSI. §954(d)(2);Reg. §1.954-3(b).
4 See Reg. §1.954-3(b)(4),Ex. 3 (since "[Corporation] D [is] unrelated to [CFC] E,none of the income would be foreign base company sales incomebecause [CFC] E [is] purchasing from and selling to unrelatedpersons…."). See NPRM, REG-124590-07, 73 Fed.Reg. 10716, 10722 (Feb. 28, 2008) ("NPRM") ("In addition, theresult in [Reg.] §1.954-3(b)(4), Example 3 is furtherrevised to add two alternative factual scenarios ([including a]purchase from an unrelated party…) to illustrate the point that, ingeneral, a branch will not have FBCSI if a separate CFC would nothave FBCSI under like circumstances.").
5 95 T.C. 579 (1990).
6 See also Ashland Oil Inc. v.Commissioner, 95 T.C. 348 (1990) (Tax Court rejected IRS'sargument that an unrelated contract manufacturer is a branch of aCFC that purchases products from the manufacturer). The IRSwill follow Ashland Oil and Vetco. Rev. Rul. 97-48, 1997-2 C.B. 89. See also NPRM, 73 Fed.Reg. at 10718 (noting that Rev. Rul. 97-48 states that the IRS willfollow Ashland Oil and Vetco and "thereforeconfirms that the IRS will not treat a separate contractmanufacturer as a branch for purposes of section 954(d)(2)").
7 Department of the Treasury, GeneralExplanations of the Administration's Fiscal Year 2015 RevenueProposals (2014).
8 Green Book, at p. 60.
10 The new rule would apply prospectively to yearsbeginning after December 31, 2014.
11 Reg. §1.954-3(a)(2) and Reg. §1.954-3(a)(3).See Yoder, "Same-Country-of-Manufacturing ExceptionApplied to Subpart F Sales Income," 38 Tax Mgmt. Int'l J.240 (Apr. 10, 2009).
12 Reg. §1.954-3(a)(4).
13 See Yoder, "Subpart F: Indicia ofManufacturing," 38 Tax Mgmt. Int'l J. 642 (Oct. 9, 2009);Yoder, "Supply Chain Distribution Structures Outside the Scope ofSubpart F," 42 Tax Mgmt. Int'l J. 367 (June 14,2013).
14 See Ashland, above, n. 6.
15 See Yoder, "The Application ofSubpart F to a Distributor Principal," 40 Tax Mgmt. Int'lJ. 241 (Apr. 18, 2011); Yoder, "No Subpart F Income if noRelated Party Purchase or Sale of Products," 40 Int'l TaxJ. 3 (July-August 2014).