IRS Proposes New Regulations on Contract Manufacturing and Subpart F Income

Excerpt from Practical US/International Tax Strategies by Peter J. Connors, Stephen Lessard and Matthew A. Clausen (Orrick, Herrington & Sutcliffe LLP)

In response to the growing importance of contract manufacturing and other manufacturing arrangements, on February 28, 2008, the Treasury Department and the Internal Revenue Service (IRS) have proposed to modernize the foreign base company sales income (FBCSI) regulations. Under section 951(a)(1)(A)(i), a U.S. shareholder of a controlled foreign company (CFC) includes in gross income its pro rata share of the CFC’s subpart F income for the CFC’s taxable year that ends with or within the taxable year of the shareholder. Section 952(a)(2) defines subpart F income to include “foreign base company income.” Section 954(a)(2) defines foreign base company income to include FBCSI for the taxable year. While the proposed regulations are prospective in application, taxpayers may choose to apply these regulations “in their entirety to all open tax years” as if they were final regulations. This flexibility will be an important consideration in resolving disputes with the IRS.

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