The Honorable Douglas H. Shulman The Honorable Donald L. Korb
Commissioner Chief Counsel
Internal Revenue Service Internal Revenue Service
1111 Constitution Ave., N.W. 1111 Constitution Ave., N.W.
Washington, D.C. 20224 Washington, D.C. 20224
Mr. Steven Musher Mr. Eric Solomon
Associate Chief Counsel (International) Assistant Secretary (Tax Policy)
Internal Revenue Service Department of the Treasury
1111 Constitution Avenue, N.W. 1500 Pennsylvania Avenue, NW
Washington, D.C. 20224 Room 3104 MT
Washington, DC 20220
HAND DELIVERED: Courier’s Desk, CC:PA:LPD:PR (REG-124590-07), Room 5205, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC
RE: Proposed Regulations (REG-124590-07) Regarding Foreign Base Company Sales Income Regulations Pertaining to Contract Manufacturing Arrangements
Dear Messrs. Shulman, Korb, Musher, and Solomon:
The American Institute of Certified Public Accountants (AICPA) is submitting comments on proposed regulations (REG-124590-07, 73 FR 10716, published in the Federal Register on February 28, 2008 and subject to technical corrections issued on April 15, 2008 and May 2, 2008) that provide guidance relating to foreign base company sales income, as defined in section 954(d), in cases in which personal property sold by a controlled foreign corporation (CFC) is manufactured, produced, or constructed pursuant to a contract manufacturing arrangement or by one or more branches of the CFC.
The AICPA is the national professional organization of certified public accountants comprised of approximately 350,000 members. Our members’ advise clients of federal, state and international tax matters, and prepare income and other tax returns for millions of Americans. Our members provide services to individuals, not-for-profit organizations, small and medium-sized business, as well as America’s largest businesses.
EXECUTIVE SUMMARY
Our comments make the following recommendations:
1. The regulations should provide further guidance regarding the non-exclusive factors under the Substantial Contribution test, including what it means to manage the risk of manufacturing profits and to control raw materials, workforce in place, and finished products.
2. The regulations should be explicit in noting that the application of the factors can vary by industry and that no one factor is per se more important than the others. The examples should be expanded to demonstrate how industry and product specific factors are taken into account.
3. We support the use of safe harbors on an industry specific basis. It would appear most efficient to develop the safe harbors outside of the regulations (e.g., through revenue rulings or revenue procedures) and upon consultation with taxpayers and industry groups.
4. The regulations should expand the “employees-only” rule to contemplate the use of non-employee labor (perhaps through a concept of “controlled labor” discussed in the comment letter). More specific guidance with respect to the use of non-employees could be done on an industry-specific basis through the revenue ruling or revenue procedure process suggested above.
5. We do not believe an anti-abuse rule with respect to excess U.S. contributions is necessary. If U.S. persons make excessive contributions, the CFC is unlikely to satisfy the Substantial Contribution test in any event.
6. There should be affirmative guidance that more than one CFC can satisfy the Substantial Contribution standard with respect to the same item of property.
7. The regulations should provide further guidance on whether and to what extent a CFC’s Substantial Contribution may create a branch.
8. With respect to the negative presumption regarding the Substantial Contribution activity of the remainder vis-à-vis a physical manufacturing branch, we recommend doing away with the presumption. There does not appear to be any strong policy reason for imposing a higher standard and such standard would, in effect, penalize CFCs that have certain types of business and operational models.
9. Regarding the default rule if there is no predominant contribution among non-physical manufacturing branches, we recommend that the determination of whether the branches in the aggregate have the effect of being a subsidiary corporation (under the manufacturing branch rule of section 954(d)(2) and Treas. Reg. sec. 1.954-3(b)(ii)) be conducted by reference to the weighted average tax rate of all such branches.
10. We request a clarification of the language in prop. reg. section 1.954-3(a)(4)(iv)(a).
11. We provide suggested additional examples in three areas:
a. Applying the Substantial Contribution test to “buy/sell” arrangements;
b. Defining what constitutes an employee who may perform activities considered to be a Substantial Contribution to the manufacturing process; and
c. Clarifying that the Substantial Contribution test can be met by a branch of a CFC.
The rationale for these recommendations are set forth in the enclosed comments.
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The attached comments were developed by the International Taxation Technical Resource Panel’s Proposed Contract Manufacturing Regulations Task Force and approved by the International Taxation Technical Resource Panel and Tax Executive Committee.
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We welcome the opportunity to discuss our comments further with you or others at the IRS. Please contact me at jeffrey.hoops@ey.com; Paul Schmidt, Chair of the International Tax Technical Resource Panel at pschmidt@bakerlaw.com; Ron Dabrowski, Chair of the AICPA Proposed Contract Manufacturing Regulations Task Force at rdabrowski@kpmg.com; or Eileen Sherr, AICPA Technical Manager at esherr@aicpa.org.