Just as with respect to Foreign Base Company Service Income (The Foreign Service Corporation in Transnational Corporate Structures, October 21, 2013/Corporate/Federal/International/Tax Blogosphere/TaxConnections/United States) the Foreign Base Company Sales Company is subject to the Subpart F Income provisions. But there are safe harbors where a controlled foreign corporation can avert the controlled legislation by structuring its activities. This enables one to establish cost saving efficiency and avail itself of a low tax jurisdiction in achieving that result.
This writing is organized to set forth these governing provisions and bring them together to provide a practical application to the Foreign Sales Company Income and its utility in the corporate structure in international enterprise. This basic introduction to offshore financial corporate structuring should assist in a logical approach in applying these overall concepts. The operational phase incorporates planning options in relation to the obstacles brought to bear by Subpart F Income treatment.
Foreign Base Company Sales Income and Manufacturing and Production
One of the more conventional corporate structures and use of Offshore Financial Centers is the establishment of a sales company. The main purpose is to attribute part of the sales functions to a separate enterprise to avail itself of low tax jurisdiction and improved proximity in foreign markets.
Sales companies are specifically the type of Foreign Base Company Sales Income and activity that Subpart F Income seeks to govern. The essential objective is to establish a foreign corporation to participate in the functions of manufacturing, production, growing, extraction, use, consumption, and disposition of a personal property product. The manner in which the activities are segregated can result in the avoidance of Subpart F Income characterization to a foreign controlled corporation.
Generally, a sales company located in a Financial Haven is prevented from buying personal property as a sales enterprise from a related person and then selling the same property to any person, related or unrelated. It cannot, without being characterized as Foreign Base Company Sales Income, purchase personal property from any person and subsequently sell it to a related party. It cannot buy personal property from a person on behalf of a related person. All of these scenarios reflect the general thread of Foreign Based Company Sales Income.
Foreign Based Company Sales Income does not include income of a sales company derived in connection with the purchase and sale of personal property, provided the property is manufactured, produced, constructed, grown, or extracted in the country whose laws incorporated the controlled foreign corporation that purchases or sells.
If the controlled foreign corporation manufactures, produces, grows, or extracts the property that it sells in the country in which it is organized, the income from the sale of that property is not Foreign Base Company Sales Income regardless where the property is used or consumed.. [Dave Fischbeing Manufacturing Co. v. Commissioner, 59 T. C. 338 (1972)].
In their technical explanations of the bill enacting Subpart F treatment both the Senate Finance committee and the House Ways and Means Committee further explained that the definition of Foreign Base Company Sales Income did not apply to income of a controlled foreign corporation from the sale of a product that it manufactures. In a case in which a controlled foreign corporation purchases parts or materials which it then transforms or incorporates into a final product, income from the sale of the final product would not be foreign base company sales income. The condition is that the corporation substantially transforms the parts of materials with the result that the final product is not the property purchased. Manufacturing and construction activities (and production, processing, or assembling activities which are substantial in nature) would generally involve substantial transformation of purchased parts or materials. [See, S. Rept. 1881, 1962-3, C.B. at 949; H. Rept. 1447, 87th Cong., 2d Sess. (1962-3 C.B. at 592-593].
A controlled foreign corporation is considered to have manufactured personal property that it sells if the property sold is, in effect, not the property which it purchased. Personal property sold is not considered purchased property if it is substantially transformed prior to sale, and it is purchased property used as a component part of personal property sold. The utility of these planning structures would be subject to analysis of source of income, transfer pricing, and ownership percentages principles.
To understand the principles of utilizing this used, consumed, disposition exception, assume a controlled foreign corporation is established pursuant to the laws of the financial center Nevis, West Indies. It is a wholly owned subsidiary of a United States parent corporation. The Nevis controlled foreign corporation, a sales company, purchases from its United States domestic parent sewing machines manufactured in the United States by the parent corporation. The offshore Nevis sales company then sells the sewing machines to retail department stores in Nevis that are unrelated persons.
The entire activities of the department stores to which the sewing machines are sold consist of selling the goods from inventory to retail customers at its local retain outlets in Nevis. The Nevis sales company may assume the sewing machines will be used, consumed, or disposed of in Nevis. It will not be required that the Nevis sales company make a determination of where the sewing machines will ultimately be used by the customers of the retail department stores.
The income derived by the Nevis sales company is considered not to be Foreign Base Company Sales Income because the sale by a controlled foreign corporation of personal property to an unrelated person is presumed to have been sold for use, consumption, or disposition in the country of destination where the property was sold.
Sales Companies and Extraction
As previously stated Foreign Based Company Sales Income does not include income of a sales company derived in connection with the purchase and sale of personal property, provided the property is grown or extracted in the country whose laws incorporated the controlled foreign corporation that purchases or sells. With respect to extraction and by way of illustration, a United States parent corporation can establish a wholly owned subsidiary in the offshore situs of Andorra as a sales company. As such, it would be regarded as a controlled foreign corporation.
Its purpose could be to serve a selling function for related operational activities also located in Andorra. Where an operational subsidiary extracts sulfate in Andorra and then sells the sulfate to a newly established Andorra sales company, the sales company can sell the sulfate to its United States parent for use in the United States without being subject to Subpart F Income treatment.
Income received by a controlled foreign corporation from the purchase and sale is not Foreign Base Company Sales Income because the sulfate was extracted in Andorra. Foreign Base Company Sales Income does not include income derived in connection with the purchase and sale of personal property if the property is extracted in the country whose laws organized the controlled foreign corporation selling the property.
In working through the various structures to be utilized in offshore corporate structures, one will find it beneficial to establish a system of analysis that determines the source of income principles, transfer pricing standards, and ownership structuring applicable to each specific corporate structuring. With respect to the previous Andorra sales company scenario, the income would be deemed sourced in Andorra. Income derived from the purchase and sale of personal property is to be treated as derived entirely from the country in which the property is sold. Gross income from sources within the United States includes income derived from the purchase of personal property without the United States and its sale within the United States.
A sale of personal property is deemed to have been consummated at the time when, and the place where, the right, title, and interest of the seller of the property are transferred to the buyer. Where bare legal title is retained by the seller, the sale shall be deemed to have occurred at the time and place of the passage to the buyer of beneficial ownership and the risk of loss. Where a sales transaction seems to be arranged in a certain manner for the primary purpose of tax avoidance, the general rule as stated may not necessarily apply. The sale may be treated as having been consummated at the place where the substance of the sale occurred. The income of the Andorra based sales company would be deemed sourced in Andorra because right and title upon the sale is transferred to the buyer in Andorra.
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