Silicon Valley Chapter

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1 Silicon Valley Chapter Subpart F: Sales Income Review and Planning Strategies March 23, 2017 Biltmore Hotel & Suites, Santa Clara Lowell D. Yoder

2 Subpart F Sales Income CFC purchases property from or sells property to a related person (>50% ownership); and Property is both manufactured and sold for use outside CFC s country of organization. 954(d); Regs

3 CFC Distributor: USP Purchasing Services Not 954(d) Related Person Transaction Suppliers 1 US Parent Swiss Distributor (8%) Fee for Purchasing Services 2 Customers IP 2

4 Sale of Software Developed by USP Develops Software US Parent No Purchase Cost Sharing/ Royalty 1 Singapore CFC* (5%) Software 2 Customers *Hires toll manufacturer to replicate software or sells software online. IP 3

5 Commissionaire Sales Arrangement Suppliers US Parent 1 PE under BEPS? Swiss Principal (8%) Sales Commission French Commissionaire (33%) IP Title to 2 Invoice Sales to French Customers 4

6 Local Country Disregarded Limited Risk Distributor IP Suppliers High Taxed Sales Income (branch rule does not apply) 1 2 Swiss Principal (8%) French LRD (33%) 3 Branch rule does not apply French Customers Same Country of use Exception (branch rule does not apply) 5

7 Toll Manufacturing US Parent Components/ Raw Materials 1 Suppliers German Manufacturer (30%) 3 Manufacturing Services 2 Consign Components/ Raw Materials Swiss Principal (8%) Note: Swiss Principal can engage in transactions with related suppliers or customers if it satisfies the manufacturing exception. Finished 4 IP Foreign Customers 6

8 Same Country Manufacturing US Parent BVI BVI 2 China Business Trust 1 Chinese Mfg 7

9 Same Country Manufacturing: Manufacturing in Two Countries Luxembourg HoldCo PLR Irish Distributor Finished 3 Related/ Customers IrishCo (Mfg Components in Ireland) Components 1 Finished 2 GermanCo (mfg. components & assemble finished products) 8

10 Manufacturing Exception CFC physically transforms, converts or assembles the products ( physical manufacturing ) CFC hires a contract manufacturer to physically manufacture the products on its behalf and the CFC substantially contributes to the physical manufacture of the products ( SC manufacturing ) Only activities of the CFC s own employees are taken into account 9

11 Physical Manufacturing Transformation of raw materials or components into products (e.g., steel rods into screws) Assembly of components into products where activities are considered as manufacturing in the industry (not minor assembly) Safe Harbor: Labor and factory burden is 20% or more of cost-of-goods sold 10

12 Cases & IRS Guidance Dave Fischbein Mfg. Co. Assembly of bag closing machine Bausch & Lomb Assembly of sunglasses IRS LMSB Each independently is mfg Fabrication of semiconductor chips Assembly and test activities Software (Microsoft 936 case) 11

13 CFC Manufactures US Parent Related & Suppliers Components 1 Irish Mfg (12.5%) Finished 2 Related & Customers IP 12

14 Non-Resident CFC with Same Country Manufacturing Branch IP Irish NR* Distributor (0%) 3 Related/ Customers Related/ Suppliers Raw Materials 1 Irish Mfg (12.5%) 2 No Foreign Branch (same country) *Irish NR rule repealed with grandfather until

15 Cooper Case US Parent Barbados Branch (5%) Clerical Employees Mfg Service Fee (cost +) UK Principal (0%) UK Mfg (24%) IRS: Barbados is a purchasing/selling branch and is attributed most of the profits. Selling DEs 14

16 Substantial Contribution Manufacturing Activities Oversight & direction of manufacturing activities and process Material or vendor selection, or control of raw materials, work-in-process or finished goods Management of manufacturing costs & capacities Control of manufacturing related logistics Quality control Developing, or directing the use or development of, product design and other IP for the purpose of manufacturing property 15

17 Substantial Contribution: Operating Rules Activity connected to manufacturing (e.g., not distribution logistics or managing marketing intangibles) Consider all manufacturing related activities in the aggregate, factors not listed may be relevant (e.g., hiring the CM), and not all activities are required Contributions by other parties not directly relevant, more than one party can satisfy the SC definition, and principal may perform a portion of same activity as an affiliate Rights to control CM activities, IP ownership, bearing risk of loss are not relevant (only activities) Weight given depends on facts and circumstances (economic significance to manufacturing operations); no super-factor 16

18 SC Manufacturing Issues Level of activity necessary to satisfy test (functional analysis?) Decision making employees with important valueadd functions (economic drivers) Industry reference How to apply to hundreds of products and multiple contract manufacturers? Necessary documentation? 17

19 Contract Manufacturing: SC Manufacturing Exception Related/ Suppliers U.S. Parent Sell Components/ Raw Materials 1 German Manufacturer (30%) 2 Swiss Principal (8%) 3 Related/ Customers SC Mfg Activities IP 18

20 Purchase or Sell on Behalf of a Related Party Section 954(d) contains a unique rule that treats a CFC as earning sales income when it receives fees or commissions for Purchasing products on behalf of a related person, or Selling products on behalf of a related person The IRS has broadly interpreted this to apply to most services with a connection to the purchase or sale of products by a related person Commission income reclassified as sales income should not be also tested as foreign base company services income 19

21 Procurement Commission: SC Manufacturing Exception Procurement Commission U.S. Parent Hong Kong ServiceCo Chinese Contract Mfg SC Mfg Activities PLR ; see also PLR (sales commission). 20

22 When is Services Income Characterized As Sales Income? Must a CFC negotiate material contract terms with unrelated suppliers or customers? Enter contracts on behalf of a related person? Identify suppliers? Oversight of suppliers and manufacturers? Logistics? Quality control? Can income of a CFC be bifurcated between services and sales income? 21

23 Same Country Services Fees For Purchasing Support Services US Parent Hong Kong ServiceCo Chinese Contract Mfg Logistics, shipping, quality control, communications (no negotiations or entering contracts) 22

24 FAA F: Services Income Treated as Sales Income CFC1 (Country A) Performs services in Country A US Parent Sales Support Services Suppliers 1 CFC2 (Country B) 2 Country B Customers IRS: CFC1 s fee income is analyzed as sales income because CFC2 is selling on behalf of CFC1 (confusing?) Unclear if CFC1 negotiates terms or enters contracts Taxpayer: Bifurcate presale (sales) vs. post-sale functions (services)? 23

Silicon Valley Chapter

Silicon Valley Chapter Subpart F: Section 956 Review and Planning Strategies March 23, 2017 Biltmore Hotel & Suites, Santa Clara Lowell D. Yoder lyoder@mwe.com Basic Rule A CFC s investment of its earnings