 |
 |
 |
 |
 |
DISCLAIMER: These materials do not, and are not intended to, constitute legal or tax advice. You should consult an attorney or tax advisor for individual advice regarding your own situation.Although we have made considerable efforts to be thorough in the construction of these pages, we offer no assurance that the information posted here is timely, accurate, complete or applicable to any particular set of facts. To the contrary, be aware that some of the material on these pages is out of date, incomplete and/or altered in relation to the official version. These documents are not posted here for commercial use and should not be relied upon for any purpose whatsoever.
|
954 Branch Rule Regulations |
The subpart F income “branch” rules are very complex. However, the drafters of the section 954 regulations could have dramatically simplified the regulations by creating a few definitions. The 1.954-3(b) regulations are reproduced below with the newly defined terms in capitals. The terms are defined at the bottom. We have included some commentary on the regulations prior to their reproduction.
Tax Rates
A tax rate differential exists if the "actual" tax rate is less than 90% of, and at least 5 percentage points less than, the "hypothetical" tax rate. The hypothetical tax rate is determined as if the income were earned and taxed through a permanent establishment. Because the hypothetical tax rate is exactly that - hypothetical, it is unclear what assumptions should be made in determining the tax rate. What if most taxpayers operating through PEs in that jurisdiction obtain rulings that substantially reduce the tax rate from what would otherwise be the statutory rate? Is it acceptable to assume that a ruling "would have" been obtained?
Purchasing or Selling Activities
Another interesting question is what constitutes "purchasing or selling activities"? If a branch or a remainder does not "carry on" or "perform" "purchasing or selling activities", then the branch rules are either not applicable (sales branch) or there is no subpart F income (manufacturing branch -- see Reg. 1.954-3(b)(2)(ii) below).
The regulations provide no definition of purchasing or selling activities. Further, the regulations almost seem to contemplate that a CFC could only have income from two types of activities - "manufacturing activities" and "purchasing or selling activities". The regulations were published in January of 1964 when life was much more simple - but was it really that simple? Do headquarter-type activities, such as accounting finance, legal, and intangibles holding generate any income or are they simply cost centers? Is the holding of a marketing intangible a sales activity? What if marketing personnel are located in the same jurisdiction and they oversee global advertising?
Comparison With Ordinary Treatment
Reg. 1.954-3(b)(2)(ii) provides that there is no subpart F income under the branch rules if there would have been no subpart F income "under like circumstances" if the branch was in fact a CFC. On its face, this rule appears intended to capture circumstances where the purchasing or selling activities occur in the jurisdiction where the manufacturing took place or where the consumption took place. See Reg. 1.954-3(a)(2) and (3).
However, what if the relationship between the manufacturing activities and the purchasing or selling activities has been arranged so that the "ordinary treatment" would result in a contract manufacturing arrangement? With the IRS's publication of Rev. Rul. 97-48, taking such a position would clearly carry risk. However, it would seem appropriate for "ordinary treatment" take into consideration all factors, including whether a contract manufacturing arrangement exists.
Click here for a chart relating specifically to Electronic Arts Foreign Base Company Sales Income.
For blog postings related to Electronic Arts and Foreign Base Company Sales Income go to our blog at www.intltax.typepad.com.
For selected charts dealing with subpart F income see: Subpart F Income Charts.
Reg. 1.954-3(b) Branches of CFC treated as separate corporations--
(1) General rules for determining when to apply separate treatment --
(i) Sales or purchase branch --
(a) In general. If a CFC carries on purchasing or selling activities THRU a BRANCH located outside the COUNTRY OF INCORPORATION and A TAX RATE DIFFERENTIAL EXISTS, the BRANCH and the REMAINDER will be treated as separate corporations for purposes of determining FBCSI of such corporation. See section 954(d)(2).
(b) Allocation of income and comparison of effective rates of tax. The determination as to whether A TAX RATE DIFFERENTIAL EXISTS shall be made by allocating to such BRANCH only that income derived by the branch or establishment which, when the special rules of subparagraph (2)(i) of this paragraph are applied, is described in paragraph (a) of this section (but determined without applying subparagraphs (2), (3), and (4) of such paragraph). A TAX RATE DIFFERENTIAL EXISTS if the income allocated to the BRANCH under the immediately preceding sentence is, by statute, treaty obligation, or otherwise, 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 OF INCORPORATION, if, under the laws of such country, the entire income of the CFC were considered derived by the corporation from sources within such country from doing business through a permanent establishment therein, received in such country, and allocable to such permanent establishment, and the corporation were managed and controlled in such country.
(c) Use of more than one branch. If a CFC carries on purchasing or selling activities THRU more than one BRANCH located outside the COUNTRY OF INCORPORATION, or THRU one or more such BRANCH’s in a case where subdivision (ii) of this subparagraph also applies, then (b) of this subdivision shall be applied separately to the income derived by each such BRANCH (by treating such purchasing or selling BRANCH as if it were the only BRANCH of the CFC and as if any such other BRANCH’s were separate corporations) in determining whether A TAX RATE DIFFERENTIAL EXISTS.
(ii) Manufacturing branch --
(a) In general. If a CFC carries on MANUFACTURING activities THRU a BRANCH located outside the COUNTRY OF INCORPORATION and A TAX RATE DIFFERENTIAL EXISTS, the BRANCH and the REMAINDER will be treated as separate corporations for purposes of determining FBCSI of such corporation. See section 954(d)(2).
(b) Allocation of income and comparison of effective rates of tax. The determination as to whether A TAX RATE DIFFERENTIAL EXISTS shall be made by allocating to the REMAINDER only that income derived by the REMAINDER, which, when the special rules of subparagraph (2)(i) of this paragraph are applied, is described in paragraph (a) of this section (but determined without applying subparagraphs (2), (3), and (4) of such paragraph). A TAX RATE DIFFERENTIAL EXISTS if income allocated to the REMAINDER under the immediately preceding sentence is, by statute, treaty obligation, or otherwise, 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 BRANCH is located, if, under the laws of such country, the entire income of the CFC were considered derived by such corporation from sources within such country from doing business through a permanent establishment therein, received in such country, and allocable to such permanent establishment, and the corporation were created or organized under the laws of, and managed and controlled in, such country.
(c) Use of one or more sales or purchase branches in addition to a manufacturing branch. If, with respect to personal property MANUFACTURED THRU a BRANCH located outside the COUNTRY OF INCORPORATION, purchasing or selling activities are carried on THRU more than one BRANCH, or THRU one or more BRANCH’s located outside such country, of such corporation, then (b) of this subdivision shall be applied separately to the income derived by each such purchasing or selling BRANCH (by treating such purchasing or selling BRANCH as though it alone were the REMAINDER) for purposes of determining whether A TAX RATE DIFFERENTIAL EXISTS.
(2) Special rules--
(i) Determination of treatment as a SUBSIDIARY. For purposes of determining under this paragraph whether A TAX RATE DIFFERENTIAL EXISTS --
(a) Treatment as separate corporations. The BRANCH will be treated as a SUBSIDIARY of the CFC, and such BRANCH will be deemed to be incorporated in the country in which it is located.
(b) Activities treated as performed on behalf of remainder of corporation. With respect to purchasing or selling activities performed THRU the BRANCH, such purchasing or selling activities shall--
(1) With respect to personal property MANUFACTURED by the CFC, or
(2) With respect to personal property (other than property described in (1) of this subdivision (b)) purchased or sold, or purchased and sold, by the CFC. be treated as performed on behalf of the CFC.
(c) Activities treated as performed on behalf of branch. With respect to MANUFACTURING activities performed THRU the BRANCH, purchasing or selling activities performed THRU the REMAINDER with respect to the personal property MANUFACTURED THRU the BRANCH shall be treated as performed on behalf of the BRANCH.
(d) Determination of hypothetical tax. To the extent applicable, the principles of paragraph (b)(4)(ii) of §1.954-1 shall be used in determining, under subdivision (i) of subparagraph (1) of this paragraph, the effective rate of tax which would apply to the income of the BRANCH under the laws of the COUNTRY OF INCORPORATION, or in determining, under subdivision (ii) of such subparagraph, the effective rate of tax which would apply to the income of the BRANCH under the laws of the country in which the MANUFACTURING BRANCH is located.
(e) Tax laws to be taken into account. Tax determinations shall be made by taking into account only the income, war profits, excess profits, or similar tax laws (or the absence of such laws) of the countries involved.
(ii) Determination of FBCSI. Once it has been determined under subparagraph (1) of this paragraph that a BRANCH and the REMAINDER are to be treated as separate corporations, the determination of whether such BRANCH, or the REMAINDER, as the case may be, has FBCSI shall be made by applying the following rules:
(a) Treatment as separate corporations. The BRANCH will be treated as a SUBSIDIARY of the CFC, and such BRANCH will be deemed to be incorporated in the country in which it is located.
(b) Activities treated as performed on behalf of remainder of corporation. With respect to purchasing or selling activities performed THRU the BRANCH, such purchasing or selling activities shall--
(1) With respect to personal property MANUFACTURED by the CFC, or
(2) With respect to personal property (other than property described in (1) of this subdivision (b)) purchased or sold, or purchased and sold, by the CFC, be treated as performed on behalf of the CFC.
(c) Activities treated as performed on behalf of branch. With respect to MANUFACTURING activities performed THRU the BRANCH, purchasing or selling activities performed THRU the REMAINDER with respect to the personal property MANUFACTURED THRU the BRANCH shall be treated as performed on behalf of the BRANCH.
(d) Items not to be twice included in income. Income which is classified as FBCSI as a result of the application of subdivision (i) of subparagraph (1) of this paragraph shall not be again classified as FBCSI as a result of the application of subdivision (ii) of such subparagraph.
(e) Comparison with ordinary treatment. Income derived by the BRANCH, or by the REMAINDER, shall not be considered FBCSI if the income would not be so considered if it were derived by a separate CFC under like circumstances.
(f) Priority of application. If income derived by the BRANCH, or by the REMAINDER, from a transaction would be classified as FBCSI of such CFC under section 954(d)(1) and paragraph (a) of this section, the income shall, notwithstanding this paragraph, be treated as FBCSI under paragraph (a) of this section and the BRANCH shall not be treated as a separate corporation with respect to such income.
(3) Inclusion of amounts in gross income of United States shareholders. A BRANCH of a CFC and the REMAINDER shall be treated as separate corporations under this paragraph solely for purposes of determining the FBCSI of each such corporation and for purposes of including an amount in subpart F income of the CFC under section 952(a). See section 954(b)(3) and paragraph (d)(4) of §1.954-1 for rules relating to the treatment of a BRANCH of a CFC and the REMAINDER as separate corporations for purposes of independently determining if the foreign base company income of each such corporation is less than 10 percent, or more than 70 percent, of its gross income. For all other purposes, however, a BRANCH of a CFC and the REMAINDER shall not be treated as separate corporations. For example, if the CFC has a deficit in earnings and profits to which section 952(c) applies, the limitation of such section on the amount includible in the subpart F income of such corporation will apply. Moreover, income, war profits, or excess profits taxes paid by a BRANCH to a foreign country will be treated as having been paid by the CFC for purposes of section 960 (relating to special rules for foreign tax credit) and the regulations thereunder. Also, income of a BRANCH, treated as a separate corporation under this paragraph, will not be treated as dividend income of the CFC of which it is a BRANCH.
Defined Terms
BRANCH = branch or similar establishment
BRANCH’s = branches or similar establishments
CFC = controlled foreign corporation
FBCSI = foreign base company sales income
THRU = by or through
REMAINDER
= remainder of such corporation, or
= remainder of the CFC, or
= remainder of such CFC
SUBSIDIARY = wholly owned subsidiary corporation
MANUFACTURED = manufactured, produced, constructed, grown, or extracted
MANUFACTURING = manufacturing, producing, constructing, growing, or extracting
COUNTRY OF INCORPORATION
= country under the laws of which such corporation is created or organized, or
= country in which the CFC is created or organized, or
= country under the laws of which the CFC is created or organized
A TAX RATE DIFFERENTIAL EXISTS
= the use of the BRANCH for such activities has substantially the same tax effect
as if the BRANCH were a SUBSIDIARY of such CFC, or
= such use of the BRANCH has the same tax effect as if it were a SUBSIDIARY of the
CFC, or
= The use of the BRANCH for such activities will be considered to have substantially
the same tax effect as if it were a SUBSIDIARY of the CFC, or
= the use of such BRANCH has substantially the same tax effect as if such BRANCH
were a SUBSIDIARY of the CFC, or
= the use of the BRANCH for such activities with respect to personal property
purchased or sold THRU the REMAINDER has substantially the same tax effect
as if the BRANCH were a SUBSIDIARY of such CFC, or
= such use of the BRANCH has substantially the same tax effect as if the BRANCH
were a SUBSIDIARY of the CFC, or
= The use of the BRANCH for such activities will be considered to have substantially
the same tax effect as if it were a SUBSIDIARY of the CFC, or
= the use of such MANUFACTURING BRANCH has substantially the same tax
effect as if such BRANCH were a SUBSIDIARY of the CFC, or
= the use of a BRANCH which is treated as a separate corporation has substantially
the same tax effect Cas if the BRANCH were a SUBSIDIARY of a CFC
