Daily Tax Update - February 27, 2008

TREASURY AND THE IRS ISSUE PROPOSED REGULATIONS ON THE TREATMENT OF CONTRACT MANUFACTURING ARRANGEMENTS:  Today, Treasury and the IRS issued proposed regulations that would provide guidance on the treatment of foreign based company sales income (“FBCSI”) where personal property sold by a CFC is manufactured, produced, or constructed pursuant to a contract manufacturing arrangement or by one or more branches of the CFC. According to the preamble to the proposed regulations, the proposed regulations are intended to “modernize the FBCSI regulations in light of current business structures and practices that are inadequately addressed by the current regulations.”

  • The proposed regulations implement a facts and circumstances test (the “substantial contribution” test) to determine whether a CFC satisfies the manufacturing exception to FBCSI when the CFC engages in a contract manufacturing arrangement. The proposed regulations list nine activities to be considered in determining whether the CFC meets the “substantial contribution” test. For example, a CFC that engages in oversight, direction, and control of the contract manufacturer may have made a “substantial contribution.”
  • The proposed regulations clarify that, for purposes of determining FBCSI, personal property sold by a CFC will be considered to be the property purchased by the CFC irrespective of whether it is sold in a different form from which it was purchased. Accordingly, the proposed regulations explicitly reject the “its” argument made by certain taxpayers to avoid FBCSI treatment. The preamble to the proposed regulations confirms that Treasury and the IRS view the “its” argument to be contrary to existing law in effect until the proposed regulations are finalized. 
  • The proposed regulations continue to link the contract manufacturing exception to the branch rule through a rebuttable presumption. The proposed regulations create a rebuttable presumption for CFCs that claim to satisfy the substantial contribution test. The presumption is that, if a branch of the CFC satisfies the physical manufacturing test with respect to personal property sold by the remainder of the CFC, then the remainder of the CFC will be presumed not to make a substantial contribution to the manufacture of that personal property, unless the CFC can rebut the presumption to the satisfaction of the Commissioner.
  • Treasury and the IRS request comments on all aspects of the proposed regulations, including comments regarding the substantial contribution test, through May 28, 2008.
  • The proposed regulations will apply to taxable years of the CFCs beginning on or after the date they are published as final regulations in the Federal Register, and for taxable years of US shareholders in which or with which such taxable years of the CFCs end.
  • For additional information, contact Philip R. West - pwest@steptoe.com, Stanley Smilack - ssmilack@steptoe.com
  • The regulations can be accessed via: http://www.steptoe.com/attachment.html/3307.pdf

H.R.5497: To amend the Internal Revenue Code of 1986 to provide for tax preferred savings accounts for individuals under age 26, and for other purposes.
Sponsor: Rep Murtha, John P. [PA-12] (introduced 2/26/2008)      Cosponsors (None)

S.2668: A bill to amend the Internal Revenue Code of 1986 to remove cell phones from listed property under section 280F.
Sponsor: Sen Kerry, John F. [MA] (introduced 2/26/2008)      Cosponsors (1)

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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