Subpart F Income: Latest Developments Impacting Tax...

Subpart F Income: Latest Developments

Impacting Tax Compliance Mastering Income Calculation, Tax Rates, Audit Preparation and Other Complexities

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Please refer to the instructions emailed to the registrant for the dial-in information.

Attendees can still view the presentation slides online. If you have any questions, please

contact Customer Service at 1-800-926-7926 ext. 10.

WEDNEDAY, FEBRUARY 6, 2013

Presenting a live 120-minute teleconference with interactive Q&A

Frederick Chilton, Partner, McDermott Will & Emery, Silicon Valley

Christopher Trump, Principal, International Tax Services, Deloitte Tax, Washington, D.C.

For this program, attendees must listen to the audio over the telephone.

Tips for Optimal Quality

Sound Quality

Call in on the telephone by dialing 1-866-570-7602 and enter your PIN when

prompted.

If you have any difficulties during the call, press *0 for assistance. You may also

send us a chat or e-mail [email protected] immediately so we can address

the problem.

Viewing Quality

To maximize your screen, press the F11 key on your keyboard. To exit full screen,

press the F11 key again.

Continuing Education Credits

Attendees must stay on the line throughout the program, including the Q & A

session, in order to qualify for full continuing education credits. Strafford is

required to monitor attendance.

Record verification codes presented throughout the seminar. If you have not

printed out the “Official Record of Attendance,” please print it now (see

“Handouts” tab in “Conference Materials” box on left-hand side of your computer

screen). To earn Continuing Education credits, you must write down the

verification codes in the corresponding spaces found on the Official Record of

Attendance form.

Please refer to the instructions emailed to the registrant for additional

information. If you have any questions, please contact Customer Service

at 1-800-926-7926 ext. 10.

FOR LIVE EVENT ONLY

Program Materials

If you have not printed the conference materials for this program, please

complete the following steps:

• Click on the + sign next to “Conference Materials” in the middle of the left-

hand column on your screen.

• Click on the tab labeled “Handouts” that appears, and there you will see a

PDF of the slides and the Official Record of Attendance for today's program.

• Double-click on the PDF and a separate page will open.

• Print the slides by clicking on the printer icon.

Subpart F Income: Latest Developments Impacting Tax Compliance Seminar

Frederick Chilton, McDermott Will & Emery

[email protected]

Feb. 6, 2013

Christopher Trump, Deloitte Tax

[email protected]

Today’s Program

Determination And Tax Treatment Of A CFC

[Christopher Trump]

Selected Types Of Subpart F Income

[Frederick Chilton]

Slide 33 – Slide 76

Slide 8 – Slide 32

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

DETERMINATION AND TAX TREATMENT OF A CFC

Christopher Trump, Deloitte Tax

Subpart F In General

I.

951-965 are found in “Subpart F” under Subchapter N of Chapter 1

of the Code.

A. Subpart F = anti-deferral regime = special rules for accelerating

U.S. tax on the undistributed earnings of CFCs

B. Enacted in 1962 to reduce perceived tax incentives on foreign

investment over domestic investment

II. Must have:

A. A controlled foreign corporation (CFC)

B. A U.S. shareholder

C. Tainted income

9

Controlled Foreign Corporation (CFC)

I. More than 50% voting power or value owned by U.S. shareholders

A. Attribution rules may be utilized to obtain CFC status

1. Family members

2. Corporations and shareholders

3. Partners and partnerships

4. Estates, trusts and beneficiaries

5. Option

B. Uninterrupted period of 30 days or more during any taxable year

II. U.S. shareholder

A. U.S. citizen or resident, partnership, trust, estate or corporation owning

directly or indirectly at least 10% of the voting power of the CFC

10

Categories Of Subpart F Income

I. Foreign base company income (Sect. 954)

II. Insurance income (Sect. 953)

III. International boycott income (Sect. 952(a)(3))

IV. Illegal payments (Sect. 952(a)(4))

V. Income from Sect. 901(j) countries (Sect. 952(a)(5))

VI. Investment of earnings in U.S. property (Sect. 956)

11

CFC Examples Of Direct, Indirect And Constructive

Ownership

Example Of Direct Ownership

15,000 voting

common shares at

$1 each – 75%

5,000 voting

common shares at

$1 each – 25%

Foreign Parent U.S. Parent

Foreign

Subsidiary A

(CFC)

75% 25%

13

CFC Direct Ownership: Scenario #1

Query: Is Foreign Subsidiary A a CFC?

Answer: No. Because U.S. Parent only owns an exact 50% interest,

the “more than 50%” requirement is not met. If U.S. Parent holds the

“tiebreaker vote”, then Foreign Subsidiary A would be a CFC.

5,000 voting

common shares at

$1 each

5,000 voting

common shares at

$1 each


Foreign

Subsidiary A

14



Answer: Yes, because U.S. Parent and U.S. 3rd Party are both 10% or

more U.S. shareholders, and collectively they own a more than 50%

interest (in this case, a 662/3% interest).

Each shareholder has:

5,000 voting common

shares at $1 each

Foreign Parent U.S. 3rd Party

Foreign

Subsidiary A

U.S. Parent

15



Answer: No, because U.S. Parent does not hold a “more than 50%”

voting or value interest. The voting interest is exactly 50%, and U.S.

Parent owns only a 331/3% value interest when the “C” class preferred

shares are taken into account. If U.S. Parent held the “C” class

preferred shares, then Foreign Subsidiary A would be a CFC using the

“more than 50% value” test.

5,000 voting common “A”

shares at $1 each

5,000 voting common “B”

shares at $1 each

5,000 preferred “C”

shares at $1 each


Foreign

Subsidiary A

16



Answer: No, because U.S. 3rd Party is not a “10% or more U.S.

Shareholder”; only U.S. Parent is. U.S. Parent owns 5/11ths (45.45%),

and thus the “more than 50% vote or value test is not met. If U.S. 3rd

Party is somehow “related” to U.S. Parent such that the

318(a)

constructive attribution rules apply, then Foreign Subsidiary A is a CFC.

Foreign Parent:

5,000 voting common “B”

shares at $1 each

U.S. 3rd Party:


shares at $1 each

U.S. Parent:


shares at $1 each

Foreign Parent U.S. 3rd Party

Foreign

Subsidiary A

U.S. Parent

17

Slide Intentionally Left Blank

Example Of Indirect Ownership

Foreign

Subsidiary A

(CFC)

Foreign

Subsidiary B

(CFC)

Foreign

Subsidiary C

(CFC)

U.S. Parent

100% 60%

60% 40%

US Parent indirectly owns 84% of

Foreign Subsidiary C

60% thru Fgn Sub A

24% thru Fgn Sub B (60% X 40%)

19

Example: Determining U.S. Shareholders

Cayman

LP

(Cayman Islands)

Foreign

Subsidiary

U.S.

Partner 1

Foreign

Partner 5

U.S.

Partner 3

U.S. shareholder

100%

10% 10% 50% 25% 5%

U.S. Corporate

Partner 2

U.S. shareholder

Foreign Corporate

Partner 4

U.S. Partner 1 is not a U.S.

shareholder of Foreign

Subsidiary (CFC), since only 5%

is constructively owned through

the Cayman partnership (10%

ownership of voting stock is

required to be U.S. shareholder).

U.S. Corporate Partner 2 and

U.S. Partner 3 are each U.S.

shareholders (owning 25% and

50% respectively).

1,000 shares of voting

common stock issued

and outstanding

20

Example: Determining CFC Status

Cayman

LP

(Cayman Islands)

Foreign

Subsidiary

(CFC)

U.S.

Partner 1

Foreign

Partner 5

U.S.

Partner 3

((U.S. shareholder

100%

10% 10% 50% 25% 5%

U.S. Corporate

Partner 2

U.S. shareholder

Foreign Corporate

Partner 4

Foreign Subsidiary is a CFC.

because U.S. shareholders (U.S.

Corporate Partner 2 and U.S.

Partner 3) own more than 50% of

Foreign Subsidiary through

Cayman LP (total owned by U.S.

shareholders is 75%)

21

Basic

318 Attributions Rules

What do the

318 attribution rules mean?

• Corporation attribution –

318(a)(2)(C): If 50% or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned, directly or indirectly, by or for such corporation, in that proportion which the value of the stock such person owns bears to the value of all stock in such corporation.

Corporation Attribution

23

Example Of Corporation Attribution (Looking Up The Chain To Determine CFC Status)

Foreign

Subsidiary A

(CFC)

Foreign

Subsidiary C

(CFC)

Foreign

Subsidiary B

(CFC)

U.S. Parent 3

(U.S. shareholder)

100% 60%

60% 40%

U.S. Parent 1

(U.S. shareholder)

Foreign

Subsidiary D

(10/50)

US Parent 1 owns 60% of

Foreign Subsidiary B

(60% X 100%).


Foreign Subsidiary D

(40% X 20%) through

Foreign Sub C.


Foreign Subsidiary D

(40% X 60%) through

Foreign Sub C.

Total owned (8+24) 32%

U.S. Parent 2

20%

24

• Operating rules –

318(a)(5):

– General: Stock constructively owned by a person shall be considered as actually owned by such person.

– Corporations and partnerships: Stock constructively owned under the “To Attribution” rules of

318(a)(3) are not applied again for purposes of

applying

318(a)(2), i.e., no double-counting between partners/partnerships or shareholders/corporations.

– Option rules –

318(a)(4): If any person has an option to acquire stock, then such stock shall be considered as owned by such person.

§318 Operating Rules

25

How does

958(b) modify the

318 attribution rules, for purposes of determining whether a corporation is a CFC?

• Partnership or corporation attribution –

958(b)(2): If a partnership, estate, trust or corporation owns, directly or indirectly, more than 50% of the total combined voting power of all classes of stock entitled to vote of a corporation, it shall be considered as owning ALL of the stock entitled to vote.

―Corporate attribution –

958(b)(3): The phrase “10%” shall be substituted for the phrase “50%,” for purposes of applying the proportionate ownership rule with respect to shareholders.

§958(b) Modification Rules To

318

26

§958(b) Modification Rules To

318 For Attribution To A Corporation: Example

NOTE: U.S Parent only

has an indirect 40.3%

ownership interest in

Foreign Subsidiary C

though both A and B.

All ownership %

interests are voting

interests.

Foreign

Subsidiary A

Foreign

Subsidiary B

Foreign

Subsidiary C

U.S. Parent

100% 30%

25% 51%

(Ownership of FS C becomes 100%

under modification rules of

958(b);

thus, U.S. Parent owns 30% of FS C

via FS B).

1. Since Foreign

Subsidiary B owns

more than 50% of

Foreign Subsidiary C,

it is deemed to own

100% of the stock of

Foreign Subsidiary C.

2. For purposes of

determining CFC

status: U.S. Parent

owns a 25% voting

interest via

Foreign Subsidiary

A and a 30% voting

interest via

Foreign Subsidiary

B, collectively a

55% voting

interest, resulting

in CFC status for

Foreign Subsidiary

C.

27

CFC Indirect Ownership Scenario #1

Query: Is Foreign Subsidiary C a CFC?

Foreign

Subsidiary A

Foreign

Subsidiary B

Foreign

Subsidiary C

U.S. Parent

100% 49%

30% 49%

28

CFC Indirect Ownership Scenario #1 (Cont.)


Answer: Yes, because Foreign Subsidiary A owns 30% and Foreign Subsidiary B owns 24.01% of Foreign Subsidiary C. Thus, collectively, U.S. Parent indirectly owns 54.01%.

Foreign

Subsidiary A

Foreign

Subsidiary B

Foreign

Subsidiary C

U.S. Parent

100% 49%

30% 49%

29

Attribution To A Corporation Scenario


All ownership %

interests are

voting interests.

Foreign

Subsidiary A

Foreign

Subsidiary B

Foreign

Subsidiary C

U.S. Parent

100% 30%

25% 51%

30

Check Your Knowledge: Attribution To A Corporation Scenario


Answer: Yes. Since Foreign Subsidiary B owns more than 50% of Foreign Subsidiary C, it is

deemed to own 100% of the stock of Foreign Subsidiary C. Thus, for purposes of determining

CFC status, U.S. Parent owns a 25% voting interest via Foreign Subsidiary A and a 30%

voting interest via Foreign Subsidiary B, collectively a 55% voting interest, resulting in CFC

status for Foreign Subsidiary C. U.S Parent only has an indirect 40.3% ownership interest in

Foreign Subsidiary C though both A and B.

All ownership %

interests are

voting interests.

Foreign

Subsidiary A

Foreign

Subsidiary B

Foreign

Subsidiary C

U.S. Parent

100% 30%

25% 51%

31

SELECTED TYPES OF SUBPART F INCOME

Frederick Chilton, McDermott Will & Emery

www.mwe.com 34

Foreign Base Company Sales

Income: Sect. 954(d)(1)

a. The statute

b. Manufacturing under Treas. Reg. §1.954-3(a)(4)

(i) Overview

(ii) Substantial transformation

(iii) Manufacture of a product when purchased components

constitute part of the property sold

(iv) Substantial contribution to manufacturing

www.mwe.com 35


Income: Sect. 954(d)(1), Cont.

a. The statute: Foreign base company sales income derived by a

controlled foreign corporation (CFC) from the purchase and sale of

personal property, when either the party purchasing the property from

the CFC or the party selling the personal property to the CFC is a

related party, and the transactions don’t have the requisite contacts

with the CFC’s country of incorporation

www.mwe.com 36


Income: Sect. 954(d)(1), Cont.

Example demonstrating application of the statute

CFC Related

CFC Unrelated Customer

3. CFC purchases goods

manufactured by a related CFC.

1. Related CFC

manufactures in

Country A.

2. CFC incorporated

in country B

4. CFC sells goods to unrelated

customer for use outside Country B.

a. The statute

www.mwe.com 37

Sect. 954(d)(1): Same

Country Manufacturing

The Statute: Exceptions.

PLR 201206003 (Nov. 9, 2011) dealt with the same country manufacturing

exception.

Y Foreign Corporation CFC

Related to CFC

4. Y incorporated in Country 1

(CFC’s country of incorporation).

2. Incorporated in Country 1

1. Sale of product

3. Sale of product

5. Product manufactured in Country 1

and further manufactured outside of

Country 1. Product labeled “Manufactured

In Country __” (a country other than 1).

Ruling held that income from sale of product by CFC did not constitute foreign base company sales

Income, because the same country manufacturing exception applied.

www.mwe.com 38

Manufacturing Under

Treas. Reg. §1.954-3(a)(4)


There are two aspects to this test.

(1) If an item of personal property would be considered

manufactured prior to sale by the CFC had all the manufacturing

undertaken with respect to that property prior to sale been undertaken by

the CFC through the activities of its employees, then the substantial

contribution rule will potentially apply.

(2) Whether the substantial contribution rules cause the CFC to be treated

as a manufacturer depends upon whether the CFC makes a substantial

contribution to manufacturing through its employees.

www.mwe.com 39

Manufacturing Under

Treas. Reg. §1.954-3(a)(4), Cont.


CFC activities

The determination of whether a CFC makes a substantial

contribution through the activities of its employees to the

manufacture of the personal property sold involves, but will not

necessarily be limited to, seven activities.

www.mwe.com 40

Manufacturing Under

Treas. Reg. §1.954-3(a)(4), Cont.


CFC activities (Cont.)

The seven activities are as follows:

(1) Oversight and direction of manufacturing

(2) Substantial transformation and manufacture of a product comprised of

components

(3) Material selection, vendor selection or control of raw materials, work-in-process or

finished goods

(4) Management of manufacturing costs or capacities

(5) Control of manufacturing related logistics

(6) Quality control

(7) Developing, or directing use or development of product design and design

specifications, as well as trade secrets, technology or other intellectual property for the

purpose of manufacturing

www.mwe.com 41

Manufacturing Under

Treas. Reg. §1.954-3(a)(4), Cont.


Application of substantial contribution test

When considering whether a CFC makes a substantial

contribution to the manufacture of personal property, the

performance of any activity will be taken into account. The

weight accorded to the performance of any quantum of any

activity will vary with the facts and circumstances of the

particular business.

www.mwe.com 42

Manufacturing Under

Treas. Reg. §1.954-3(a)(4), Cont.


Application of substantial contribution test (Cont.)

In determining whether the activities of the CFC constitute a

substantial contribution, there is no minimum performance

threshold before an activity can be considered. The fact that

other persons make a substantial contribution to the

manufacture of the personal property prior to sale does not

preclude the CFC from making a substantial contribution to the

manufacture of that property through the activities of its

employees.

www.mwe.com 43

Manufacturing Under

Treas. Reg. §1.954-3(a)(4), Cont.


Example illustrating substantial contribution to manufacturing

In the following example taken from the regulations, a CFC enters into a

contract manufacturing arrangement with an unrelated party. If the CFC is

not considered to have manufactured the property that it sells, it will have

foreign base company sales income. The example illustrates when the

CFC will be considered to be the manufacturer.

www.mwe.com 44

Manufacturing Under

Treas. Reg. §1.954-3(a)(4), Cont.

(iv) Substantial contribution to manufacturing (Cont.)

Example 3: CFC does not own raw materials but does carry out

three categories of substantial activities.

The CFC, through its employees, does:

(1) Select the materials that will be used in manufacturing by CM

(2) Exercise oversight and direction of the manufacturing process and

provide quality control

(3) Manage manufacturing costs and capacities by managing the risk of

loss and engaging in demand planning and production scheduling

www.mwe.com 45

Manufacturing Under

Treas. Reg. §1.954-3(a)(4), Cont.

(iv) Substantial contribution to manufacturing (Cont.)

Example 3: CFC does not own raw materials but does carry

out substantial activities

Result: Because the manufacturing activities undertaken by

CFC, through its employees, represent a substantial

contribution to manufacturing, paragraph (iv) applies. Treas.

Reg. §1.954-3(a)(4)(iv) ex. 3. While the example does not

specifically say so, it implies that the CFC is the only party

carrying out these three activities. Manufacturing could

not occur without selection of raw materials, oversight of

manufacturing and quality control, and demand planning

and production scheduling.

www.mwe.com 47

The Branch Rule: Sect. 954(d)(2)

1. The statute

2. Sales or purchase branch

a. Substantially the same tax effect as if it were a wholly owned subsidiary

corporation

i. Tax rate disparity test

ii. Application of special rules

b. Use of more than one sales branch

3. Manufacturing branch

a. Substantially the same tax effect as if it were a wholly owned subsidiary

corporation

i. Tax rate disparity test

ii. Application of special rules

b. Use of more than one manufacturing branch

www.mwe.com 48

1. The Statute

Code Sect. 954(d)(2) provides:

Certain branch income. For purposes of determining foreign base

company sales income in situations in which the carrying on of

activities by a controlled foreign corporation through a branch or

similar establishment outside the country of incorporation of the controlled

foreign corporation has substantially the same effect as if such branch or

similar establishment were a wholly owned subsidiary corporation

deriving such income, under regulations prescribed by the Secretary the

income attributable to the carrying on of such activities of such branch or

similar establishment shall be treated as income derived by a wholly

owned subsidiary of the controlled foreign corporation and shall

constitute foreign base company sales income of the controlled foreign

corporation.

www.mwe.com 49

2. Treas. Reg. §1.954-3(b)

The branch rule regulations address two different types of CFC branches:

(1) Sales/purchase branches, and (2) manufacturing branches.

www.mwe.com 50

If a CFC carries on purchasing or selling activities through a branch -

“sales branch” requires “sales activities”

TAM 8509004 (Nov. 23, 1984):

In the TAM, manufacturing and sales activities were carried out by

branches of the CFC. The CFC remainder performed the following:

Supervised sales subsidiaries and independent commission agents

Analyzed methods of financing export sales

Forecasted demand of new markets

Performed other market research activities

The TAM held: That even in the aggregate, these supportive activities

do not constitute “selling activities,” for purposes of the sales branch

rule.

2. Sales Or Purchase Branch

www.mwe.com 51

2. Sales Or Purchase Branch:

i. Tax Rate Disparity Test

Regulations – tax rate disparity test

The use of the branch for purchasing or sales activities will be considered

to have substantially the same tax effect as if it were a wholly owned

subsidiary corporation of the CFC, if the income allocated to the sales

branch … is …taxed in the year when earned at an effective rate of tax

that is less than 90 percent of, and at least 5 percentage points less

than the effective rate of tax which would apply to such income under the

laws of the country in which the CFC is created or organized. Treas. Reg.

§1.954-3(b)(1)(i)(b)

www.mwe.com 52

2. Sales Or Purchase Branch:

ii. Application Of Special Rules

The “special rules” must be considered to determine whether

the use of the sales branch, which is treated as a separate

corporation, will be considered to have substantially the same

tax effect as if it were a wholly owned subsidiary corporation of

the CFC. Treas. Reg. §1.954-3(b)(2)(i). In some instances, a

branch will not have foreign base company sales income even

though it is treated as a wholly owned CFC.

www.mwe.com 53

The treatment, under the special rules, of a branch as if it were

incorporated in the country in which it is located is relevant for application of the

same country exception.

2. Sales Or Purchase Branch

ii. Application Of

Special Rules (Cont.)

CFC

Sales branch

in country X

1. Assume tax rate disparity test is met, so sales

branch is treated as a separate CFC.

2. Sales branch sells in Country X a product

purchased from CFC.

3. Result: Sales branch is treated as separate

corporation, but the sales branch doesn’t have

foreign base company sales income because it

sells in its deemed country of incorporation.

www.mwe.com 54

3. Manufacturing Branch:

When To Apply Separate

Treatment To Branch And CFC

(ii) Manufacturing branch

Prerequisites: (1) If a CFC carries on manufacturing, producing, constructing, growing, or extracting activities by a branch (located outside the country under the laws of which such corporation is organized) and (2) the use of the branch for such activities with respect to personal property purchased or sold by or through the remainder of the CFC has substantially the same tax effect as if the branch or similar establishment were a wholly owned subsidiary corporation of such CFC. Effect: The branch or similar establishment and the remainder of the CFC will be treated as separate corporations, for purposes of determining foreign base company sales income of such corporations. Treas. Reg. §1.954-3(b)(1)(ii)(a)

www.mwe.com 55

Regulations – tax rate disparity test

The use of the branch for manufacturing activities will be considered to

have substantially the same tax effect as if it were a wholly owned

subsidiary corporation of the CFC in the year when earned at an

effective rate of tax that is less than 90% of, and at least 5

percentage points less than, the effective rate of tax which would

apply

to such income under the laws of the country in which the

manufacturing branch or similar establishment is organized. Treas. Reg.

§1.954-(b)(1)(ii)(b)

3.Manufacturing Branch:

When To Apply Separate Treatment

To Branch And CFC (Cont.)

www.mwe.com 56

(c) Activities treated as performed on behalf of branch.

With respect to manufacturing activities performed by or through the

branch, purchasing or selling activities performed by or through the

remainder of the CFC with respect to the personal property

manufactured by or through the branch shall be treated as

performed on behalf of the branch. Treas. Reg. §1.954-3(b)(2)(i)

3.Manufacturing Branch:

Special Rules

www.mwe.com 57


When To Apply Separate

Treatment To Branch And CFC

Manufacturing branch example: Unrelated-to-unrelated CFC sales

Unrelated Supplier CFC Unrelated

Customer

X

Employees carry out activities in Branch

X that constitute substantial contribution

to manufacturing, so CFC is treated as

Manufacturer. Tax rate in X is 17%.

Tax rate: 0%

Analysis: X and CFC are treated as separate CFCs as a result of the application of the

manufacturing branch tax rate disparity test. CFC is now treated as carrying out selling

activities on behalf of a related manufacturing entity (Branch X) and selling to an unrelated

party. CFC has foreign base company sales income. Branch X sells property that it

manufactures and has no foreign base company sales income.

www.mwe.com 58


b. CFC Has Manufacturing Branch

And Other Branches

For purposes of the “tax rate disparity test, the [actual] effective tax rate

[for the sales branch] is compared to the hypothetical effective tax rate [in

the manufacturing country] by comparing the…amount of tax that would

be paid on the FBCSI in each jurisdiction. Therefore, it is necessary to

determine the amount of taxable FBCSI under the principles of local law

in each jurisdiction in order to compare the tax rates on that income.”

PLR 200945036. However, that tax rate determined under local law is

presumably tested against income of the CFC determined under U.S. tax

principles.

www.mwe.com 59

3. Manufacturing Branch

b. CFC Has Manufacturing Branch

And Other Branches (Cont.)

Sales branch and manufacturing branch - APA

CFC

Sales Branch Manufacturing

Branch

Actual effective tax rate Hypothetical tax rate on income if earned in B

on income earned: 10% statutory tax rate: 20%

CFC has ruling in B that all of its income B is subject to tax at rate of 10%.

A B

www.mwe.com 60

IHCo

U.K. mfg. activities

Barbados Local sales

subsidiaries

Remainder

Effect of sales

branch rule if

Barbados treated

as separate CFC

3. Manufacturing Branch And Sales

Branch Treated As Separate CFCs;

Income Of Branch Determined Under

Arm’s Length Standard

www.mwe.com 61

A. Foreign Personal Holding Company Inclusions

1. Categories of foreign personal holding company income

2. Dividends, interest, royalties, rents etc.

3. Gain from sales of certain types of property

4. Character of income

5. Changes in the use of property

B. Exceptions to foreign personal holding company income

1. Exceptions for active business income

a. Exceptions to gain from sale of certain types of property

i. Gain from the sale of inventory, dealer property and property

that gives rise to active business rents and royalties

ii. Exception for property that does not give rise to income for gain from

the sale of property used in the CFC’s trade or business.

Foreign Personal Holding

Company Income:

www.mwe.com 62


Company Income (Cont.) B. Exceptions to foreign personal holding company income (Cont.)


a. Exceptions to gain from sale of certain types of property

iii. Comparing the exception for property that gives rise to dividends,

interest, rents and royalties and the exception for property that does

not give rise to income

iv. General exception for active business income

v. Change in property from property that gives rise to dividend income to

property used in the active conduct of a CFC’s business

b. Exceptions to dividend, interest, rent and royalty income

i. Active business rents and royalties

I. Rents

II. Royalties

www.mwe.com 63

B. Exceptions to foreign personal holding company income (Cont.)

2. Payments from related CFCs

a. Same country exception

b. Temporary look-through: Payments from related CFCs

C. Allocation of expenses against foreign personal holding company

income

1. §954(b)(5)

2. Situations in which §954(b)(5) comes into play


Company Income (Cont.)

www.mwe.com 64


b. Active business rents and royalties

FPHCI “shall not include rents and royalties which are derived

in the active conduct of a trade or business and which

are received from a person other than a related person …”

§954(c)(2)(A) of the Code

Exceptions To FPHCI

www.mwe.com 65

1. Exceptions for active business income (Cont.)


i. Royalties

Royalties are considered derived in the active conduct of a business if they

are derived by the CFC from either licensing property: (1) that the CFC has

developed, created or added substantial value to; or (2) as a result of the

performance of marketing functions by the CFC, through its officers and

staff, that are substantial relative to the royalty income. Treas. Reg. §1.954-

2(d)(1)

Exceptions To FPHCI (Cont.)

www.mwe.com 66



i. Royalties

Developed property of such kind

U.S. Parent

CFC Customer

Cost-sharing

arrangement

Royalties

Is CFC treated as developing

intangible property as a result

of participating in co-development

activities under a cost sharing

agreement?

CFC has no researchers.


www.mwe.com 67



i. Royalties

Royalties from property developed by the CFC - Treas. Reg. §1.954-

2(d)(3) ex. 5

CFC

Unrelated Corporation

Facts: CFC “finances” the

unrelated corporation to

develop patented items and

in return gets an

“ownership interest” in the

patents. The example focuses

on whether the CFC performs

marketing.

Conclusion in the

example: The CFC does

qualify for the active

royalty exception.

Assumption in the

example: The CFC has

not developed the IP.

Financing


www.mwe.com 68



II. Royalties


In situations involving the substantial assistance test, Exam and the

National Office have refused to recognize the distinction between

intercompany services and cost sharing. They cite a Construction/Real

Estate Issue Paper, “which dealt with Application of Section 482 and

Subpart F to Services Rendered to CFCs”, dated May 9, 1995, 95 TNI

9011. It addressed the proposition that product development services

rendered by a U.S. parent under a cost sharing arrangement should be

considered services rendered by the U.S. parent directly for the CFC cost

sharing participant.


www.mwe.com 69



i. Royalties


What constitutes development of marketing intangibles? What if the

CFC that licenses trademarks also carries out an active manufacturing

operation? Will the manufacturing operation, which creates personal

property to which the trademark is affixed, be considered to have

helped to develop the trademarks?


www.mwe.com 71

Foreign Base Company

Services Income A. The statute

1. Income included

2. Income not included as FBC services income

B. The regulations

1. Services performed for a related person

a. CFC paid by a related person

b. CFC performs services a related person

is obligated to perform.

c. CFC performs services with respect to

property sold by a related person.

www.mwe.com 72


Services Income (Cont.)

B. The regulations (Cont.)

1. Services performed for a related person

d. Substantial assistance provided to a

CFC so that it can perform services

1. Direction, supervision, services or

know-how

2. Financial assistance, equipment

3. Combination of tests

www.mwe.com 73



C. Notice 2007-13

1. Change in substantial assistance rule warranted by

change in global economy

2. Overview of changes in the substantial assistance

rule

a. Substantial assistance rules will not apply to

CFC-to-CFC services.

b. Certain U.S.-performed services will continue to

be subject to substantial assistance rules.

3. Amendment of substantial assistance regulations

4. Examples of new substantial assistance rules

D. The same country exception

www.mwe.com 74

A. The Statute

1. Income included as FBC services income:

§954(e) provides that foreign base company services

income means income derived in connection with the

performance of services that are performed: (1) for, or on

behalf of any related person; and (2) are performed

outside the country where the controlled foreign

corporation is incorporated.



www.mwe.com 75



The same country exception

Treas. Reg. Sect. 1.954-4(c) states:

In allocating time spent within and without the foreign country under

the laws of which the controlled foreign corporation is created or

organized, relative weight must also be given to the value of the various

functions performed by persons in fulfillment of the service contract or

arrangement. For example, clerical work will ordinarily be assigned little

value, while services performed by technical, highly skilled and

managerial personnel will be assigned greater values in relation to the

type of function performed by each individual.

www.mwe.com 76



D. The same country exception - allocation based on value

CFC

Incorporated in A

1. 100 employees perform services for related parties.

The services performed are maintenance of

supercomputers. Employees use valuable IP to

perform services.

20 employees in Branch B also perform services for

related parties. Branch B employees service laptop

Computers; such work doesn’t require IP.

Branch B

Subpart F Income: Latest Developments Impacting Tax...

Documents

Transcript of Subpart F Income: Latest Developments Impacting Tax...