If the Internal Revenue Service has its way, U.S. businesses with foreign subsidiaries may soon be affected by new tax rules in making overseas sales. Responding to the increasing globalization of the manufacturing operations of U.S. corporations, the IRS has proposed new regulations to update enforcement of the IRS Code provisions pertaining to sales of goods by foreign subsidiaries of U.S. corporations (CFCs).

The Code's so-called foreign base company sales income provisions, originally enacted in 1962 and now rather antiquated, are intended to prevent the use of related party sales to shift income to low-tax jurisdictions. At present, the provisions generally require the current inclusion of any sales income generated by a CFC in the taxable income of its U.S. parent corporation when the goods sold have been manufactured outside the foreign country in which the CFC has been organized. Federal income tax on this category of offshore income is not deferred until the earnings are repatriated to the U.S.

Changes in the nature of manufacturing have forced a redefinition of the provisions. The business realities of the global marketplace now require the use of contract manufacturing arrangements in producing many components that go into a final product, which makes the "physical manufacturing" test of the current regulations too restrictive a test for determining whether a CFC should be deemed a manufacturer, and not merely a seller. In its place, the proposed regulations would substitute a multifactored "substantial contribution" test of manufacturer status. The proposed regulations would also modify the current rules for determining whether manufacturing operations conducted by branches of CFCs located in other jurisdictions should affect the CFC’s status as a manufacturer of the goods that it sells.

Before adopting the proposed regulations, the IRS is soliciting comments between now and May 28, 2008, on the factors to be considered in determining whether the substantial contribution test is satisfied and on the development of appropriate administrative safe harbors. The IRS also has requested comments on the presumptions to be employed in determining whether a branch is the manufacturer of the goods sold by a CFC and on the need for an anti-abuse rule.

The Tax Group of Ballard Spahr Andrews & Ingersoll, LLP is able to assist U.S. manufacturers with foreign operations in the development and submission of written comments on the proposed regulations. We also will advise companies on the restructuring of global operations to minimize current U.S. taxation. Please contact Ballard Spahr partners Wayne Strasbaugh or Jeffrey Davine for additional information and assistance.

Copyright © 2008 by Ballard Spahr LLP.
(No claim to original U.S. government material.)

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the author and publisher.

This newsletter is a periodic publication of Ballard Spahr LLP and is intended to alert the recipients to new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your situation and specific legal questions you have.

Related Practice