Guidance Regarding Foreign Base Company Sales Income, 78545-78553 [2011-32394]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 76, Number 243 (Monday, December 19, 2011)]
[Rules and Regulations]
[Pages 78545-78553]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-32394]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9563]
RIN 1545-BI45


Guidance Regarding Foreign Base Company Sales Income

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations that provide guidance 
relating to foreign base company sales income when personal property 
sold by a controlled foreign corporation (CFC) is purchased, sold, 
manufactured, produced, constructed, grown or extracted by one or more 
branches of the CFC. The regulations finalize proposed regulations and 
withdraw temporary regulations published on December 29, 2008. These 
regulations, in general, affect controlled foreign corporations and 
their United States shareholders.

DATES: Effective Date: These regulations are effective on December 19, 
2011.
    Applicability Date: These regulations apply to taxable years of 
CFCs beginning after June 30, 2009, and for taxable years of United 
States shareholders in which or with which such taxable years of the 
CFCs end.

FOR FURTHER INFORMATION CONTACT: Barbara E. Rasch, (202) 622-3840 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    On February 28, 2008, the IRS and the Treasury Department published 
a notice of proposed rulemaking in the Federal Register (REG-124590-07, 
2008-16 IRB 801, 73 FR 10716, as corrected at 73 FR 20201), which 
proposed amendments to Sec.  1.954-3, including rules that addressed 
the application of the section 954(d)(2) branch rules under the foreign 
base company sales income (FBCSI) rules. Written comments were received 
in response to the notice of proposed rulemaking, and a public hearing 
on the proposed regulations was held on July 29, 2008. On December 29, 
2008, the IRS and the Treasury Department published final and temporary 
regulations under section 954(d) (TD 9438, 73 FR 79334-01, as corrected 
at 74 FR 11843-01) in the Federal Register. On the same date, the IRS 
and the Treasury Department published a notice of proposed rulemaking 
(REG-150066-08, 2009-5 IRB 423, 73 FR 79421-01) in the Federal Register 
cross-referencing the temporary regulations. The temporary and proposed 
regulations address the treatment under the FBCSI rules of the sale by 
a CFC of personal property that is purchased, sold, manufactured, 
produced, constructed, grown or extracted by one or more branches of 
the CFC. Written comments were received, and are available at 
www.regulations.gov or upon request. A public hearing was not requested 
and none was held. This Treasury decision adopts the proposed 
regulation with the changes described below as a final regulation and 
removes the corresponding temporary regulations.

Explanation of Provisions

    These regulations amend the provisions of Sec.  1.954-3(b) that 
address the application of the FBCSI rules to CFCs with branches or 
similar establishments (branches), and, in particular manufacturing 
branches.

A. Branch Rule

    Section 954(d)(1) defines FBCSI to mean income derived by a CFC in 
connection with: (i) The purchase of personal property from a related 
person and its sale to any person; (ii) the sale of personal property 
to any person on behalf of a related person; (iii) the purchase of 
personal property from any person and its sale to a related person; or 
(iv) the purchase of personal property from any person on behalf of a 
related person, provided (in all of these cases) that the property is 
manufactured, produced, grown or extracted outside of the CFC's country 
of organization and is sold for use, consumption or disposition outside 
of such country. There are certain exceptions to the FBCSI rules, 
including an exception that applies if a CFC sells personal property 
that it manufactured, produced, constructed, grew or extracted. See 
section 954(d)(1)(A), Sec.  1.954-3(a)(4).
    Section 954(d)(2) applies the FBCSI rules to a CFC that has a 
branch outside the CFC's country of incorporation (branch rule). The 
branch rule applies if the CFC carries on purchasing, selling, 
manufacturing, producing, constructing, growing or extracting 
activities by or through the branch, and the carrying on of such 
activities has substantially the same tax effect as if the branch were 
a wholly-owned subsidiary of the CFC, as provided in regulations. If 
so, the branch and the remainder of the CFC will be treated as separate 
corporations for purposes of determining FBCSI of such CFC.
    The ``substantially same tax effect'' determination is made 
pursuant to a tax rate disparity test set forth in Sec.  1.954-
3(b)(1)(i)(b) and Sec.  1.954-3(b)(1)(ii)(b). With respect to a sales 
or purchase branch, the tax rate disparity test is applied by comparing 
the rate of tax imposed on the income derived from the purchasing or 
selling activities of the branch with the rate of tax that would apply 
if the income were earned by the remainder of the CFC. With respect to 
a manufacturing branch, the tax rate disparity test is applied by 
comparing the rate of tax imposed on the income derived from the 
purchasing and selling activities of the CFC with the rate of tax that 
would apply to such income under the laws of the country in which the 
manufacturing branch is located.
    These final regulations provide guidance on the application of the 
branch rule, in particular with respect to a CFC that has multiple 
branches. For example, the regulations set forth rules on how to 
determine whether a CFC earns FBCSI if purchase and sales activities 
are conducted by multiple branches and if multiple branches are 
involved in the manufacture of either a single or multiple items of 
personal property that is sold by the CFC.

B. Summary of Comments

1. Demonstrably Greater Contribution
    Section 1.954-3T(b)(1)(ii)(c)(3)(iii) provides that if none of the 
branches or the remainder of a CFC independently satisfies the 
substantial contribution test, but the CFC as a whole made a 
substantial contribution, then for purposes of applying the tax rate

[[Page 78546]]

disparity test, the location of manufacture, production or construction 
is the ``tested manufacturing location'' unless the ``tested sales 
location'' provided a ``demonstrably greater'' contribution. Comments 
were received seeking clarification on the meaning of the word 
``demonstrably'' and expressing concern that it could be interpreted to 
provide an evidentiary rule regarding the standard of proof required 
with respect to the determination of the location of manufacture of an 
item pursuant to Sec.  1.954-3T(b)(1)(ii)(c)(3)(iii). The IRS and the 
Treasury Department did not intend the word ``demonstrably'' to refer 
to an elevated standard of proof. In order to eliminate uncertainty, 
the word ``demonstrably'' has been deleted from Sec.  1.954-
3(b)(1)(ii)(c)(3)(iii).
2. Grouping of Branches
    Comments sought clarification of the rule in Sec.  1.954-
3T(b)(2)(ii)(a) that generally provides for the grouping of branches 
that do not have tax rate disparity with a purchasing or selling 
branch, or with the remainder of the CFC treated as purchasing or 
selling on behalf of a manufacturing branch. This grouping rule applies 
for purposes of Sec.  1.954-3T(b)(2)(ii), which sets forth the rules 
that apply after it has been determined that a branch and the remainder 
of a CFC will be treated as separate corporations. Comments suggested 
that this grouping rule could be interpreted to group not only the 
activities of the branches but also the income of those branches and 
recommended that the rule be clarified by specifically stating that the 
rule groups the ``activities'' of the relevant branches.
    The rules in Sec.  1.954-3T(b)(2)(ii) apply to determine whether 
the income of a branch or remainder of a CFC is FBCSI rather than to 
determine the amount of the income of the branch or remainder of the 
CFC. The purpose of this grouping rule is to allow a CFC to aggregate 
the activities of branches that do not have tax rate disparity with a 
sales or purchasing branch (or remainder) when applying the separate 
corporation analysis to determine whether the sales income of the sales 
or purchase branch (or remainder) is FBCSI. Sec.  1.954-
3(b)(1)(ii)(c)(3)(v), Example 1. The IRS and the Treasury Department 
believe that the grouping rule in Sec.  1.954-3T(b)(2)(ii)(a) properly 
aggregates the activities of the relevant branches (or remainder). 
However, for clarity, the phrase ``the activities of'' was added to 
Sec.  1.954-3(b)(2)(ii)(a).

C. Deletion of Sec.  1.954-3(b)(2)(ii)(d)

    The final regulations delete paragraph (d) of Sec.  1.954-
3(b)(2)(ii), which provided that income that is FBCSI as a result of 
the application of Sec.  1.954-3(b)(1)(i) (purchasing or selling branch 
rules) is not again classified as FBCSI as a result of the application 
of Sec.  1.954-3(b)(1)(ii) (manufacturing branch rules). This paragraph 
is no longer needed as a result of the addition of the rule in Sec.  
1.954-3(b)(1)(ii)(c)(1), which provides that if one or more sales or 
purchasing branches are used in addition to a manufacturing branch, 
then only the manufacturing branch rules apply.

D. Future Guidance

    The IRS and the Treasury Department continue to study additional 
FBCSI issues, and are considering whether to issue additional guidance, 
including guidance regarding when a branch should be treated as a 
separate corporation under section 954(d)(2), and the scope of, and 
relationship between, FBCSI and foreign base company services income. 
The IRS and the Treasury Department welcome comments on these issues.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866; 
therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. In addition, the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply because 
the regulations do not impose a collection of information on small 
entities. Pursuant to section 7805(f) of the Code, the notice of 
proposed rulemaking that preceded these final and temporary regulations 
was submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Barbara E. Rasch of 
the Office of Associate Chief Counsel (International). However, other 
personnel from the IRS and the Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for 26 CFR part 1 continues to read 
in part as follows:

    Authority:  26 U.S.C. 7805 * * *.


0
Par. 2. Section 1.954-3 is amended by:
0
1. Revising paragraphs (b)(1)(i)(c), (b)(1)(ii)(a), and (b)(1)(ii)(c).
0
2. Revising paragraphs (b)(2)(i)(b), (b)(2)(ii)(a), and (b)(2)(ii)(b).
0
3. Removing and reserving paragraph (b)(2)(ii)(d).
0
4. Revising paragraph (b)(2)(ii)(e).
0
5. Revising paragraph (b)(4) introductory text.
0
6. Revising Example 3 in paragraph (b)(4).
0
7. Adding Examples 8 and 9 in paragraph (b)(4).
0
8. Revising paragraphs (c) and (d).
    The revisions and additions read as follows:


Sec.  1.954-3  Foreign base company sales income.

* * * * *
    (b) * * *
    (1) * * *
    (i) * * *
    (c) Use of more than one branch. If a controlled foreign 
corporation carries on purchasing or selling activities by or through 
more than one branch or similar establishment located outside the 
country under the laws of which such corporation is created or 
organized, then paragraph (b)(1)(i)(b) of this section shall be applied 
separately to the income derived by each such branch or similar 
establishment (by treating such purchasing or selling branch or similar 
establishment as if it were the only branch or similar establishment of 
the controlled foreign corporation and as if any such other branches or 
similar establishments were separate corporations) in determining 
whether the use of such branch or similar establishment has 
substantially the same tax effect as if such branch or similar 
establishment were a wholly owned subsidiary corporation of the 
controlled foreign corporation. See paragraph (b)(1)(ii)(c)(1) of this 
section for rules applicable to a controlled foreign corporation that 
carries on purchase or sales activities by or through one or more 
branches or similar establishments in addition to carrying on 
manufacturing activities by or through one or more branches or similar 
establishments.

[[Page 78547]]

    (ii) Manufacturing branch--(a) In general. If a controlled foreign 
corporation carries on manufacturing, producing, constructing, growing, 
or extracting activities by or through a branch or similar 
establishment located outside the country under the laws of which such 
corporation is created or organized and the use of the branch or 
similar establishment for such activities with respect to personal 
property purchased or sold by or through the remainder of the 
controlled foreign corporation has substantially the same tax effect as 
if the branch or similar establishment were a wholly owned subsidiary 
corporation of such controlled foreign corporation, the branch or 
similar establishment and the remainder of the controlled foreign 
corporation will be treated as separate corporations for purposes of 
determining the foreign base company sales income of such corporation. 
See section 954(d)(2). The provisions of this paragraph (b)(1)(ii) will 
apply only if the controlled foreign corporation (including any 
branches or similar establishments of such controlled foreign 
corporation) manufactures, produces, or constructs such personal 
property within the meaning of paragraph (a)(4)(i) of this section, or 
carries on growing or extracting activities with respect to such 
personal property.
* * * * *
    (c) Use of more than one branch--(1) Use of one or more sales or 
purchase branches in addition to a manufacturing branch. If, with 
respect to personal property manufactured, produced, constructed, 
grown, or extracted by or through a branch or similar establishment 
located outside the country under the laws of which the controlled 
foreign corporation is created or organized, purchasing or selling 
activities are carried on by or through more than one branch or similar 
establishment, or by or through one or more branches or similar 
establishments located outside such country, of such corporation, then 
paragraph (b)(1)(ii)(b) of this section shall be applied separately to 
the income derived by each such purchasing or selling branch or similar 
establishment (by treating such purchasing or selling branch or similar 
establishment as though it alone were the remainder of the controlled 
foreign corporation) for purposes of determining whether the use of 
such manufacturing, producing, constructing, growing, or extracting 
branch or similar establishment has substantially the same tax effect 
as if such branch or similar establishment were a wholly owned 
subsidiary corporation of the controlled foreign corporation. If this 
rule applies, the sales or purchase branch rules contained in paragraph 
(b)(1)(i) of this section do not apply. The application of this 
paragraph (b)(1)(ii)(c)(1) is illustrated by the following example:

    Example. All activities of controlled foreign corporation 
conducted through sales branches and manufacturing branch. (i) 
Facts. FS, a controlled foreign corporation organized under the laws 
of country M, operates three branches. Branch A, located in country 
A, manufactures Product X under the principles of paragraph 
(a)(4)(i) of this section. Branch B, located in Country B, sells 
Product X manufactured by Branch A to customers for use outside of 
Country B. Branch C, located in Country C sells Product X 
manufactured by Branch A to customers for use outside of Country C. 
FS does not conduct any manufacturing or selling activities apart 
from the activities of Branches A, B and C. Country M imposes an 
effective rate of tax on sales income of 0%. Country A imposes an 
effective rate of tax on sales income of 20%. Country B imposes an 
effective rate of tax on sales income of 20%. Country C imposes an 
effective rate of tax on sales income of 18%.
    (ii) Result. Pursuant to this paragraph (b)(1)(ii)(c)(1), 
paragraph (b)(1)(ii)(b) of this section is applied to the sales 
income derived by Branch B by treating Branch B as though it alone 
were the remainder of the controlled foreign corporation. The use of 
Branch B does not have the same tax effect as if Branch B were a 
wholly owned subsidiary of FS because the tax rate applicable to the 
income allocated to Branch B under paragraph (b)(1)(ii)(b) of this 
section (20%) is not less than 90% of, and at least 5 percentage 
points less than, the effective rate of tax which would apply to 
such income under the laws of Country A (20%), the country in which 
Branch A is located. In addition, paragraph (b)(1)(ii)(b) of this 
section is applied separately to the sales income derived by Branch 
C by treating Branch C as though it alone were the remainder of the 
controlled foreign corporation. The use of Branch C does not have 
the same tax effect as if Branch C were a wholly owned subsidiary of 
FS because the tax rate applicable to the income allocated to Branch 
C under paragraph (b)(1)(ii)(b) of this section (18%) is not less 
than 90% of, and at least 5 percentage points less than, the 
effective rate of tax which would apply to such income under the 
laws of Country A (20%), the country in which Branch A is located. 
Pursuant to this paragraph (b)(1)(ii)(c)(1), the rules under 
paragraph (b)(1)(i) of this section for determining whether a sales 
or purchase branch is treated as a separate corporation from the 
remainder of the controlled foreign corporation do not apply.

    (2) Use of more than one branch to manufacture, produce, construct, 
grow, or extract separate items of personal property. If a controlled 
foreign corporation carries on manufacturing, producing, constructing, 
growing, or extracting activities with respect to separate items of 
personal property by or through more than one branch or similar 
establishment located outside the country under the laws of which such 
corporation is created or organized, then paragraphs (b)(1)(ii)(b) and 
(c) of this section will be applied separately to each such branch or 
similar establishment (by treating such manufacturing branch or similar 
establishment as if it were the only such branch or similar 
establishment of the controlled foreign corporation and as if any other 
such branches or similar establishments were separate corporations) for 
purposes of determining whether the use of such branch or similar 
establishment has substantially the same tax effect as if such branch 
or similar establishment were a wholly owned subsidiary corporation of 
the controlled foreign corporation. The application of this paragraph 
(b)(1)(ii)(c)(2) is illustrated by the following example:

    Example. Multiple branches that satisfy paragraph (a)(4)(i). (i) 
Facts. FS is a controlled foreign corporation organized in Country 
M. FS operates two branches, Branch A and Branch B located in 
Country A and Country B, respectively. Branch A and Branch B each 
manufacture separate items of personal property (Product X and 
Product Y, respectively) within the meaning of paragraph (a)(4)(ii) 
or (iii) of this section. Raw materials used in the manufacture of 
Product X and Product Y are purchased by FS from an unrelated 
person. FS engages in activities in Country M to sell Product X and 
Product Y to a related person for use, disposition or consumption 
outside of Country M. Employees of FS located in Country M perform 
only sales functions. The effective rate of tax imposed in Country M 
on the income from the sales of Product X and Product Y is 10%. 
Country A imposes an effective rate of tax on sales income of 20%. 
Country B imposes an effective rate of tax on sales income of 12%.
    (ii) Result. Pursuant to this paragraph (b)(1)(ii)(c)(2), 
paragraph (b)(1)(ii)(b) of this section is applied separately to 
Branch A and Branch B with respect to the sales income of FS 
attributable to Product X (manufactured by Branch A) and Product Y 
(manufactured by Branch B). Because the effective rate of tax on 
FS's sales income from the sale of Product X in Country M (10%) is 
less than 90% of, and at least 5 percentage points less than, the 
effective rate of tax that would apply to such income in the country 
in which Branch A is located (20%), the use of Branch A to 
manufacture Product X has substantially the same tax effect as if 
Branch A were a wholly owned subsidiary corporation of FS. Because 
the effective rate of tax on FS's sales income from the sale of 
Product Y in Country M (10%) is not less than 90% of, and at least 5 
percentage points less than, the effective rate of tax that would 
apply to such income in the country in which Branch B is located 
(12%), the use of Branch B to manufacture

[[Page 78548]]

Product Y does not have substantially the same tax effect as if 
Branch B were a wholly owned subsidiary corporation of FS. 
Consequently, only Branch A is treated as a separate corporation 
apart from the remainder of FS for purposes of determining foreign 
base company sales income from the sales of Product X.

    (3) Use of more than one manufacturing branch, or one or more 
manufacturing branches and the remainder of the controlled foreign 
corporation, to manufacture, produce, or construct the same item of 
personal property--(i) In general. This paragraph (b)(1)(ii)(c)(3) 
applies to determine the location of manufacture, production, or 
construction of personal property for purposes of applying paragraph 
(b)(1)(i)(b) or (b)(1)(ii)(b) of this section where more than one 
branch or similar establishment of a controlled foreign corporation, or 
one or more branches or similar establishments of a controlled foreign 
corporation and the remainder of the controlled foreign corporation, 
each engage in manufacturing, producing, or constructing activities 
with respect to the same item of personal property which is then sold 
by the controlled foreign corporation. This paragraph (b)(1)(ii)(c)(3) 
is applied separately with respect to the income derived by each 
purchasing or selling branch or similar establishment or purchasing or 
selling remainder of the controlled foreign corporation as provided 
under paragraphs (b)(1)(i) and (b)(1)(ii) of this section. The location 
of manufacture, production, or construction is determined under 
paragraph (b)(1)(ii)(c)(3)(ii) of this section if one or more branches 
or similar establishments or the remainder of the controlled foreign 
corporation independently satisfies paragraph (a)(4)(i) of this section 
with respect to an item of personal property. The location of 
manufacture, production, or construction is determined under paragraph 
(b)(1)(ii)(c)(3)(iii) of this section if none of the branches or 
similar establishments or the remainder of the controlled foreign 
corporation independently satisfies paragraph (a)(4)(i) of this section 
with respect to an item of personal property, but the controlled 
foreign corporation as a whole makes a substantial contribution to the 
manufacture, production or construction of that property within the 
meaning of paragraph (a)(4)(iv) of this section. For purposes of this 
paragraph (b)(1)(ii)(c)(3), the location of any activity with respect 
to the manufacture, production, or construction of an item of personal 
property is determined under paragraph (b)(1)(ii)(c)(3)(iv) of this 
section. For purposes of this paragraph (b)(1)(ii)(c)(3), if multiple 
branches or similar establishments are located in a single 
jurisdiction, then the activities of those branches will be aggregated 
for purposes of determining whether a branch or remainder of the 
controlled foreign corporation satisfies paragraph (a)(4)(i) of this 
section.
    (ii) Manufacture, production, or construction in one or more 
locations. If only one branch or similar establishment or only the 
remainder of a controlled foreign corporation independently satisfies 
paragraph (a)(4)(i) of this section with respect to an item of personal 
property, then that branch or similar establishment or the remainder of 
the controlled foreign corporation will be the location of manufacture, 
production, or construction of that property for purposes of applying 
paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section to the income 
from the sale of that property. See paragraph (b)(1)(ii)(c)(3)(v) 
Example 1 of this section. If more than one branch or similar 
establishment or one or more branches or similar establishments and the 
remainder of the controlled foreign corporation, each independently 
satisfy paragraph (a)(4)(i) of this section with respect to an item of 
personal property, then the location of manufacture, production, or 
construction of that property for purposes of applying paragraph 
(b)(1)(i)(b) or (b)(1)(ii)(b) of this section will be the location of 
that branch or similar establishment or the jurisdiction under the laws 
of which the remainder of the controlled foreign corporation is 
organized that satisfies paragraph (a)(4)(i) of this section and that 
would, after applying paragraph (b)(1)(ii)(b) of this section to such 
branch or similar establishment or paragraph (b)(1)(i)(b) of this 
section to the remainder of the controlled foreign corporation, impose 
the lowest effective rate of tax on the income allocated to such branch 
or the remainder of the controlled foreign corporation under such 
section (that is, either paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of 
this section). See paragraph (b)(1)(ii)(c)(3)(v) Example 2 of this 
section.
    (iii) No location independently satisfies manufacturing test. If no 
branch or similar establishment or the remainder of the controlled 
foreign corporation independently satisfies paragraph (a)(4)(i) of this 
section with respect to an item of personal property but the controlled 
foreign corporation as a whole makes a substantial contribution to the 
manufacture, production, or construction of that property within the 
meaning of paragraph (a)(4)(iv) of this section, then for purposes of 
applying paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section, the 
location of manufacture, production, or construction with respect to 
the income derived by a purchasing or selling branch or similar 
establishment or the purchasing or selling remainder of the controlled 
foreign corporation in connection with the purchase or sale of that 
property will be the ``tested manufacturing location'' unless the 
``tested sales location'' provides a greater contribution to the 
manufacture, production, or construction of the property. The tested 
manufacturing location is the location of any branch or similar 
establishment or remainder of the controlled foreign corporation that 
contributes to the manufacture, production, or construction of the 
personal property, if any, that would, after applying paragraph 
(b)(1)(ii)(b) of this section to such branch or similar establishment 
or paragraph (b)(1)(i)(b) of this section to the remainder of the 
controlled foreign corporation, be treated as a separate corporation 
and would impose the lowest effective rate of tax on the income 
allocated to such branch or similar establishment or to the remainder 
of the controlled foreign corporation under such section (that is, 
either paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section). The 
tested sales location is the location of the purchasing or selling 
branch or similar establishment or the remainder of the controlled 
foreign corporation by or through which the purchasing or selling 
activities are carried on with respect to the personal property. For 
purposes of this paragraph (b)(1)(ii)(c)(3)(iii), the contribution to 
the manufacture, production, or construction of the personal property 
by the tested sales location will be deemed to include the activities 
of any branch or similar establishment or remainder of the controlled 
foreign corporation that would not be treated as a corporation separate 
from the tested sales location after the application of paragraph 
(b)(1)(i)(b) or (b)(1)(ii)(b) of this section. For purposes of this 
paragraph (b)(1)(ii)(c)(3)(iii), the contribution of the tested 
manufacturing location to the manufacture, production, or construction 
of the personal property will be deemed to include any activities of 
any branch or similar establishment or remainder of the controlled 
foreign corporation that would be treated as a corporation separate 
from the tested sales location after the application of paragraph 
(b)(1)(i)(b) or (b)(1)(ii)(b) of this section. Whether the tested sales 
location provides a greater contribution to the manufacture, 
production, or

[[Page 78549]]

construction of the personal property is determined by weighing the 
relative contributions to the manufacture, production, or construction 
of that property by the tested sales location and the tested 
manufacturing location under the facts and circumstances test provided 
in paragraph (a)(4)(iv) of this section. See paragraph 
(b)(1)(ii)(c)(3)(v) Examples 3, 4, 5, and 6 of this section. If the 
tested sales location provides a greater contribution to the 
manufacture, production, or construction of the personal property than 
the tested manufacturing location or if there is no tested 
manufacturing location, then the tested sales location is the location 
of manufacture, production, or construction of that property and the 
rules of paragraphs (b)(1)(i)(a) and (b)(1)(ii)(a) of this section will 
not apply with respect to the income derived by the tested sales 
location in connection with the purchase or sale of that property and 
the use of that purchasing or selling branch or similar establishment 
or the purchasing or selling remainder will not result in a branch 
being treated as a separate corporation for purposes of paragraph 
(b)(2)(ii) of this section.
    (iv) Location of activity. For purposes of paragraph 
(b)(1)(ii)(c)(3) of this section, the location of any activity with 
respect to the manufacture, production, or construction of an item of 
personal property is the location where the employees of the controlled 
foreign corporation perform such activity. For example, the location of 
any activity concerning intellectual property is determined based on 
where employees of the controlled foreign corporation develop or direct 
the use or development of the intellectual property, not on the formal 
assignment of that intellectual property.
    (v) Examples. The following examples illustrate the application of 
this paragraph (b)(1)(ii)(c)(3):

    Example 1. Multiple branches contribute to the manufacture of a 
single product only one branch satisfies paragraph (a)(4)(i). (i) 
Facts. FS is a controlled foreign corporation organized in Country 
M. FS operates three branches, Branch A, Branch B, and Branch C, 
located respectively in Country A, Country B, and Country C. Branch 
A, Branch B, and Branch C each performs different manufacturing 
activities with respect to the manufacture of Product X. Branch A, 
through the activities of employees of FS located in Country A, 
designs Product X. Branch B, through the activities of employees of 
FS located in Country B, provides quality control and oversight and 
direction. Branch C, through the activities of employees of FS 
located in Country C, manufactures Product X (within the meaning of 
paragraph (a)(4)(ii) or (a)(4)(iii) of this section) using the 
designs developed by Branch A and under the oversight of the quality 
control personnel of Branch B. The activities of Branch A and Branch 
B do not independently satisfy paragraph (a)(4)(i) of this section. 
Employees of FS located in Country M purchase the raw materials used 
in the manufacture of Product X from a related person and control 
the work-in-process and finished goods throughout the manufacturing 
process. Employees of FS located in Country M also manage the 
manufacturing costs and capacities related to Product X. Further, 
employees of FS located in Country M oversee the coordination 
between the branches. The activities of the remainder of FS in 
Country M do not independently satisfy paragraph (a)(4)(i) of this 
section. Employees of FS located in Country M sell Product X to 
unrelated persons for use outside of Country M. The sales income 
from the sale of Product X is taxed in Country M at an effective 
rate of tax of 10%. Country C imposes an effective rate of tax of 
20% on sales income.
    (ii) Result. Country C is the location of manufacture for 
purposes of applying paragraph (b)(1)(ii)(b) of this section because 
only the activities of Branch C independently satisfy paragraph 
(a)(4)(i) of this section. The use of Branch C has substantially the 
same tax effect as if Branch C were a wholly owned subsidiary 
corporation of FS because the effective rate of tax on the sales 
income (10%) is less than 90% of, and at least 5 percentage points 
less than, the effective rate of tax that would apply to such income 
in the country in which Branch C is located (20%). Therefore, sales 
of Product X by the remainder of FS are treated as sales on behalf 
of Branch C. In determining whether the remainder of FS will qualify 
for the manufacturing exception under paragraph (a)(4)(iv) of this 
section, the activities of FS will include the activities of Branch 
A or Branch B, respectively, if each of those branches would not be 
treated as a separate corporation under paragraph (b)(1)(ii)(b) of 
this section, if that paragraph were applied independently to each 
of Branch A and Branch B. See paragraph (b)(2)(ii)(a) of this 
section.
    Example 2. Multiple branches satisfy paragraph (a)(4)(i) with 
respect to the same product sold by the controlled foreign 
corporation. (i) Facts. Assume the same facts as in Example 1, 
except for the following. In addition to the design of Product X, 
Branch A also performs in Country A other manufacturing activities, 
including those ascribed to FS in Example 1, that are sufficient to 
qualify as manufacturing under paragraph (a)(4)(iv) of this section 
with respect to Product X. Country A imposes an effective rate of 
tax of 12% on sales income.
    (ii) Result. Branch A and Branch C through their activities each 
independently satisfy the requirements of paragraph (a)(4)(i) of 
this section. Therefore, paragraph (b)(1)(ii)(b) of this section is 
applied by comparing the effective rate of tax imposed on the income 
from the sales of Product X against the lowest effective rate of tax 
that would apply to the sales income in either Country A or Country 
C if paragraph (b)(1)(ii)(b) of this section were applied separately 
to Branch A and Branch C. Country A imposes the lower effective rate 
of tax, and therefore, Branch A is treated as the location of 
manufacture for purposes of applying paragraph (b)(1)(ii)(b) of this 
section. The effective rate of tax in Country B is not considered 
because Branch B does not satisfy paragraph (a)(4)(i) of this 
section. Neither Branch A nor Branch C is treated as a separate 
corporation because the effective rate of tax on the sales income of 
FS from the sale of Product X (10%) is not less than 90% of, and at 
least 5 percentage points less than, the effective rate of tax that 
would apply to such income in the country in which Branch A is 
located (12%). Sales of Product X by the remainder of the controlled 
foreign corporation are not treated as made on behalf of any branch.
    Example 3. Determining the location of manufacture when 
manufacturing activities performed by multiple branches and no 
branch independently satisfies paragraph (a)(4)(i). (i) Facts. FS, a 
controlled foreign corporation organized in Country M, purchases raw 
materials from a related person. The raw materials are manufactured 
(under the principles of paragraph (a)(4)(ii) or (a)(4)(iii) of this 
section) into Product X by CM, an unrelated corporation, pursuant to 
a contract manufacturing arrangement. CM physically performs the 
substantial transformation, assembly, or conversion of the raw 
materials in Country C. FS has two branches, Branch A and Branch B, 
located in Country A and Country B respectively. Branch A, through 
the activities of employees of FS located in Country A, designs 
Product X. Branch B, through the activities of employees of FS 
located in Country B, controls manufacturing related logistics, 
provides oversight and direction during the manufacturing process, 
and controls the raw materials and work-in-process. FS manages the 
manufacturing costs and capacities related to the manufacture of 
Product X through employees located in Country M. Further, employees 
of FS located in Country M oversee the coordination between the 
branches. Employees of FS located in Country M also sell Product X 
to unrelated persons for use outside of Country M. Country M imposes 
an effective rate of tax on sales income of 10%. Country A imposes 
an effective rate of tax on sales income of 20%, and Country B 
imposes an effective rate of tax on sales income of 24%. Neither the 
remainder of FS, nor any branch of FS independently satisfies 
paragraph (a)(4)(i) of this section. However, under the facts and 
circumstances of the business, FS as a whole provides a substantial 
contribution to the manufacture of Product X within the meaning of 
paragraph (a)(4)(iv) of this section.
    (ii) Result. Based on the facts, neither the remainder of FS 
(through the activities of its employees in Country M) nor any 
branch of FS independently satisfies paragraph (a)(4)(i) of this 
section with respect to Product X, but FS, as a whole, provides a 
substantial contribution through the activities of its employees to 
the manufacture of Product X. The remainder of FS, Branch A, and 
Branch B each provides a contribution through the activities of 
employees to the manufacture of Product X. Therefore, FS must 
determine the location of manufacture under paragraph

[[Page 78550]]

(b)(1)(ii)(c)(3)(iii) of this section. The tested sales location is 
Country M because the selling activities with respect to Product X 
are carried on by the remainder of FS. The location of Branch A is 
the tested manufacturing location because the effective rate of tax 
imposed on FS's sales income by Country M (10%) is less than 90% of, 
and at least 5 percentage points less than, the effective rate of 
tax that would apply to such income in Country A (20%), and Country 
A has the lowest effective rate of tax among the manufacturing 
branches that would, after applying paragraph (b)(1)(ii)(b) of this 
section, be treated as a separate corporation. The activities of 
Branch B will be included in the contribution of Branch A for 
purposes of determining the location of manufacture of Product X 
because the effective rate of tax imposed on the sales income by 
Country M (10%) is less than 90% of, and at least 5 percentage 
points less than, the effective rate of tax that would apply to such 
income in Country B (24%). Under the facts and circumstances of the 
business, the activities of the remainder of FS would not provide a 
greater contribution to the manufacture of Product X than the 
activities of Branch A and Branch B, considered together. Therefore, 
the location of manufacture is Country A, the location of Branch A.
    Example 4. Manufacturing activities performed by multiple 
branches, no branch independently satisfies paragraph (a)(4)(i), 
selling activities carried on by remainder of the controlled foreign 
corporation, remainder contribution includes branch manufacturing 
activities. (i) Facts. The facts are the same as Example 3, except 
that the effective rate of tax on sales income in Country B is 12%. 
In addition, under the facts of the particular business, the 
activities of employees of FS located in Country B and Country M, if 
considered together, would provide a greater contribution to the 
manufacture of Product X than the activities of employees of FS 
located in Country A.
    (ii) Result. Based on the facts, neither the remainder of FS 
(through activities of its employees in Country M) nor any branch of 
FS independently satisfies paragraph (a)(4)(i) of this section with 
respect to Product X, but FS, as a whole, provides a substantial 
contribution through the activities of its employees to the 
manufacture of Product X. The remainder of FS, Branch A, and Branch 
B each provide a contribution through the activities of their 
employees to the manufacture of Product X. Therefore, FS must 
determine the location of manufacture under paragraph 
(b)(1)(ii)(c)(3)(iii) of this section. The tested sales location is 
Country M because the selling activities with respect to Product X 
are carried on by the remainder of FS. The location of Branch A is 
the tested manufacturing location because the effective rate of tax 
imposed on FS's sales income by Country M (10%) is less than 90% of, 
and at least 5 percentage points less than, the effective rate of 
tax that would apply to such income in Country A (20%), and Branch A 
is the only branch that would, after applying paragraph 
(b)(1)(ii)(b) of this section, be treated as a separate corporation. 
The activities of Branch B will be included in the contribution of 
the remainder of FS for purposes of determining the location of 
manufacture of Product X because the effective rate of tax imposed 
on the sales income by Country M (10%) is not less than 90% of, and 
at least 5 percentage points less than, the effective rate of tax 
that would apply to such income in Country B (12%). Under a facts 
and circumstances analysis, considered together, the activities of 
Branch B and the remainder of FS would provide a greater 
contribution to the manufacture of Product X than the activities of 
Branch A. Therefore, the rules of paragraph (b)(1)(ii)(a) of this 
section will not apply with respect to the income derived by the 
remainder of FS in connection with the sale of Product X, and 
neither Branch A nor Branch B will be treated as a separate 
corporation for purposes of paragraph (b)(2)(ii) of this section.
    Example 5. Manufacturing activities performed by multiple 
branches, no branch independently satisfies paragraph (a)(4)(i), 
sales carried on by remainder of the controlled foreign corporation 
and a sales branch. (i) Facts. The facts are the same as Example 3, 
except that sales of Product X are also carried on through Branch D 
in Country D, and Country D imposes a 16% effective rate of tax on 
sales income. In addition, under the facts and circumstances of the 
business, the activities of employees of FS located in Country A and 
Country M, considered together, would provide a greater contribution 
to the manufacture of Product X than the activities of employees of 
FS located in Country B.
    (ii) Result. Based on the facts, neither the remainder of FS nor 
any branch of FS independently satisfies paragraph (a)(4)(i) of this 
section with respect to Product X, but FS, as a whole, provides a 
substantial contribution through the activities of its employees to 
the manufacture of Product X. The remainder of FS, Branch A, and 
Branch B each provide a contribution through the activities of their 
employees to the manufacture of Product X. Therefore, FS must 
determine the location of manufacture under paragraph 
(b)(1)(ii)(c)(3)(iii) of this section. Further, pursuant to 
paragraph (b)(1)(ii)(c)(1) of this section, paragraph 
(b)(1)(ii)(c)(3)(iii) of this section must be applied separately to 
the sales income derived by the remainder of FS and Branch D 
respectively. The results with respect to the income derived by the 
remainder of FS in connection with the sale of Product X in this 
Example 5 are the same as in Example 3. However, paragraph 
(b)(1)(ii)(c)(3)(iii) of this section must also be applied with 
respect to Branch D because the sale of Product X is also carried on 
through Branch D. Thus, for purposes of that sales income, the 
location of Branch D is the tested sales location. The location of 
Branch B is the tested manufacturing location because the effective 
rate of tax imposed on Branch D's sales income by Country D (16%) is 
less than 90% of, and at least 5 percentage points less than, the 
effective rate of tax that would apply to such income in Country B 
(24%), and Branch B is the only branch that would, after applying 
paragraph (b)(1)(ii)(b) of this section, be treated as a separate 
corporation. The manufacturing activities performed in Country M by 
the remainder of FS and the manufacturing activities performed in 
Country A by Branch A will be included in Branch D's contribution to 
the manufacture of Product X for purposes of determining the 
location of manufacture of Product X with respect to Branch D's 
sales income because the effective rate of tax imposed on the sales 
income by Country D (16%) is not less than 90% of, and at least 5 
percentage points less than, the effective rate of tax that would 
apply to such income in Country M (10%) and Country A (20%). Under 
the facts and circumstances of the business, the activities of 
Branch D, Branch A, and the remainder of FS, considered together, 
would provide a greater contribution to the manufacture of Product X 
than the activities of Branch B. Therefore, the rules of paragraph 
(b)(1)(ii)(a) of this section will not apply with respect to the 
income derived by Branch D in connection with the sale of Product X 
and the use of Branch D to sell Product X will not result in a 
branch being treated as a separate corporation for purposes of 
paragraph (b)(2)(ii) of this section.
    Example 6. Determining the location of manufacture when 
employees of remainder of controlled foreign corporation travel to 
location of unrelated contract manufacturer to perform manufacturing 
activities. (i) Facts. FS, a controlled foreign corporation 
organized in Country M, purchases raw materials from a related 
person. The raw materials are manufactured (under the principles of 
paragraph (a)(4)(ii) or (a)(4)(iii) of this section) into Product X 
by CM, an unrelated corporation, pursuant to a contract 
manufacturing arrangement. CM physically performs the substantial 
transformation, assembly, or conversion of the raw materials in 
Country C. Employees of FS located in Country M sell Product X to 
unrelated persons for use outside of Country M. Employees of FS 
located in Country M engage in product design, manage the 
manufacturing costs and capacities with respect to Product X, and 
direct the use of intellectual property for the purpose of 
manufacturing Product X. Quality control and oversight and direction 
of the manufacturing process are conducted in Country C by employees 
of FS who are employed in Country M but who regularly travel to 
Country C. Branch A, located in Country A, is the only branch of FS. 
Product design with respect to Product X conducted by employees of 
FS located in Country A is supplemental to the bulk of the design 
work, which is done by employees of FS located in Country M. At all 
times, employees of Branch A control the raw materials, work-in-
process and finished goods. Employees of FS located in Country A 
also control manufacturing related logistics with respect to Product 
X. Country M imposes an effective rate of tax on sales income of 
10%. Country A imposes an effective rate of tax on sales income of 
20%. Neither the remainder of FS nor Branch A independently 
satisfies paragraph (a)(4)(i) of this section. However, under the 
facts and circumstance of the business, FS as a whole (including 
Branch A) provides a substantial contribution to the manufacture of 
Product X within the meaning of paragraph (a)(4)(iv) of this 
section.
    (ii) Result. Based on the facts, neither the remainder of FS nor 
Branch A independently

[[Page 78551]]

satisfies paragraph (a)(4)(i) of this section with respect to 
Product X, but FS, as a whole, provides a substantial contribution 
through the activities of its employees to the manufacture of 
Product X. The remainder of FS and Branch A each provide a 
contribution through the activities of employees to the manufacture 
of Product X. Therefore, FS must determine the location of 
manufacture under paragraph (b)(1)(ii)(c)(3)(iii) of this section. 
The tested sales location is Country M because the selling 
activities with respect to Product X are carried on by the remainder 
of FS. The tested manufacturing location is the location of Branch A 
because the effective rate of tax imposed on the remainder of FS's 
sales income by Country M (10%) is less than 90% of, and at least 5 
percentage points less than, the effective rate of tax that would 
apply to such income in Country A (20%), and Branch A is the only 
branch that would, after applying paragraph (b)(1)(ii)(b) of this 
section, be treated as a separate corporation. Although the 
activities of traveling employees are considered in determining 
whether FS, as a whole, makes a substantial contribution to the 
manufacture of Product X under paragraph (a)(4)(iv) of this section, 
the activities of the employees of FS that are performed in Country 
C are not taken into consideration in determining whether Country M, 
the jurisdiction under the laws of which FS is organized, is the 
location of manufacture under paragraph (b)(1)(ii)(c)(3)(iii) of 
this section. Activities of employees performed outside the 
jurisdiction in which the controlled foreign corporation is 
organized and outside a location in which the controlled foreign 
corporation maintains a branch or similar establishment, are not 
considered in determining the location of manufacture. Under the 
facts and circumstances of the business, the activities of employees 
of FS performed in Country M do not provide a greater contribution 
to the manufacture of Product X than the activities of employees of 
FS performed in Country A. Therefore, the location of manufacture is 
Country A, the location of Branch A.

    (4) Use of more than one branch to manufacture, produce, construct, 
grow, or extract separate items of personal property. For purposes of 
paragraphs (b)(1)(ii)(c)(2) and (b)(1)(ii)(c)(3) of this section, an 
item of personal property refers to an individual unit of personal 
property rather than a type or class of personal property.
    (2) * * *
    (i) * * *
    (b) Activities treated as performed on behalf of the remainder of 
corporation. (1) With respect to purchasing or selling activities 
performed by or through the branch or similar establishment, such 
purchasing or selling activities will, with respect to personal 
property manufactured, produced, constructed, grown, or extracted by 
the remainder of the controlled foreign corporation, be treated as 
performed on behalf of the remainder of the controlled foreign 
corporation.
    (2) With respect to purchasing or selling activities performed by 
or through the branch or similar establishment, such purchasing or 
selling activities will, with respect to personal property (other than 
property described in paragraph (b)(2)(i)(b)(1) of this section) 
purchased or sold, or purchased and sold, by the remainder of the 
controlled foreign corporation (or any branch treated as the remainder 
of the controlled foreign corporation), be treated as performed on 
behalf of the remainder of the controlled foreign corporation.
* * * * *
    (ii) * * *
    (a) Treatment as separate corporations. The branch or similar 
establishment will be treated as a wholly owned subsidiary corporation 
of the controlled foreign corporation, and such branch or similar 
establishment will be deemed to be incorporated in the country in which 
it is located. For purposes of applying the rules of this paragraph 
(b)(2)(ii), a branch or similar establishment of a controlled foreign 
corporation treated as a separate corporation purchasing or selling on 
behalf of the remainder of the controlled foreign corporation under 
paragraph (b)(2)(ii)(b) of this section, or the remainder of the 
controlled foreign corporation treated as a separate corporation 
purchasing or selling on behalf of a branch or similar establishment of 
the controlled foreign corporation under paragraph (b)(2)(ii)(c) of 
this section, will include the activities of any other branch or 
similar establishment or remainder of the controlled foreign 
corporation that would not be treated as a separate corporation (apart 
from the branch or similar establishment of a controlled foreign 
corporation that is treated as performing purchasing or selling 
activities on behalf of the remainder of the controlled foreign 
corporation under paragraph (b)(2)(ii)(b) of this section or the 
remainder of the controlled foreign corporation that is treated as 
performing purchasing or selling activities on behalf of the branch or 
similar establishment under paragraph (b)(2)(ii)(c) of this section) if 
the effective rate of tax imposed on the income of the purchasing or 
selling branch or similar establishment, or purchasing or selling 
remainder of the controlled foreign corporation, were tested under the 
principles of paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section 
against the effective rate of tax that would apply to such income if it 
were considered derived by such other branch or similar establishment 
or the remainder of the controlled foreign corporation.
    (b) Activities treated as performed on behalf of the remainder of 
corporation. (1) With respect to purchasing or selling activities 
performed by or through the branch or similar establishment, such 
purchasing or selling activities will, with respect to personal 
property manufactured, produced, constructed, grown, or extracted by 
the remainder of the controlled foreign corporation, be treated as 
performed on behalf of the remainder of the controlled foreign 
corporation.
    (2) With respect to purchasing or selling activities performed by 
or through the branch or similar establishment, such purchasing or 
selling activities will, with respect to personal property (other than 
property described in paragraph (b)(2)(ii)(b)(1) of this section) 
purchased or sold, or purchased and sold, by the remainder of the 
controlled foreign corporation (or any branch treated as the remainder 
of the controlled foreign corporation), be treated as performed on 
behalf of the remainder of the controlled foreign corporation.
* * * * *
    (d) [Reserved].
    (e) Comparison with ordinary treatment. Income derived by a branch 
or similar establishment, or by the remainder of the controlled foreign 
corporation, will not be foreign base company sales income under 
paragraph (b) of this section if the income would not be foreign base 
company sales income if it were derived by a separate controlled 
foreign corporation under like circumstances.
* * * * *
    (4) Illustrations. The application of this paragraph (b) may be 
illustrated by the following examples:
* * * * *
    Example 3. (i) Facts. Corporation E, a controlled foreign 
corporation incorporated under the laws of foreign Country X, is a 
wholly owned subsidiary of Corporation D, also a controlled foreign 
corporation incorporated under the laws of Country X. Corporation E 
maintains Branch B in foreign Country Y. Both corporations use the 
calendar year as the taxable year. In 1964, Corporation E's sole 
activity, carried on through Branch B, consists of the purchase of 
articles manufactured in Country X by Corporation D, a related 
person, and the sale of the articles through Branch B to unrelated 
persons. One hundred percent of the articles sold through Branch B 
are sold for use outside Country X and 90% are also sold for use 
outside of Country Y. The income of Corporation E derived by Branch 
B from such transactions is taxed to Corporation E by Country X only 
at the time Corporation E distributes such income to Corporation D 
and

[[Page 78552]]

is taxed on the basis of what the tax (a 40% effective rate) would 
have been if the income had been derived in 1964 by Corporation E 
from sources within Country X from doing business through a 
permanent establishment therein. Country Y levies an income tax at 
an effective rate of 50% on income derived from sources within such 
country, but the income of Branch B for 1964 is effectively taxed by 
Country Y at a 5% rate since under the laws of such country, only 
10% of Branch B's income is derived from sources within such 
country. Corporation E makes no distributions to Corporation D in 
1964.
    (ii) Result. In determining foreign base company sales income of 
Corporation E for 1964, Branch B is treated as a separate wholly 
owned subsidiary corporation of Corporation E, the 5% rate of tax 
being less than 90% of, and at least 5 percentage points less than 
the 40% rate. Income derived by Branch B, treated as a separate 
corporation, from the purchase from a related person (Corporation 
D), of personal property manufactured outside of Country Y and sold 
for use, disposition, or consumption outside of Country Y 
constitutes foreign base company sales income. If, instead, 
Corporation D were unrelated to Corporation E, none of the income 
would be foreign base company sales income because Corporation E 
would be purchasing from and selling to unrelated persons and if 
Branch B were treated as a separate corporation it would likewise be 
purchasing from and selling to unrelated persons. Alternatively, if 
Corporation D were related to Corporation E, but Branch B 
manufactured the articles prior to sale under the principles of 
paragraph (a)(4)(iv) of this section, the income would not be 
foreign base company sales income because Branch B, treated as a 
separate corporation, would qualify for the manufacturing exception 
under paragraph (a)(4) of this section.
* * * * *
    Example 8. Uniformly applicable incentive tax rate in one 
country. (i) Facts. FS is a controlled foreign corporation organized 
in Country M. FS operates one branch, Branch A, located in Country 
A. Branch A manufactures Product X within the meaning of paragraph 
(a)(4)(ii) or (a)(4)(iii) of this section. Raw materials used in the 
manufacture of Product X are purchased by FS from an unrelated 
person. FS engages in activities in Country M to sell Product X to a 
related person for use outside of Country M. Employees of FS located 
in Country M carry on only sales functions. The effective rate 
imposed in Country M on the income from the sale of Product X is 
10%. Country A generally imposes an effective rate of tax on income 
of 20%, but imposes a uniformly applicable incentive rate of tax of 
10% on manufacturing income and related sales income.
    (ii) Result. The use of Branch A to manufacture Product X does 
not have substantially the same tax effect as if Branch A were a 
wholly owned subsidiary corporation of FS because the effective rate 
of tax on FS's sales income from the sale of Product X in Country M 
(10%) is not less than 90% of, and at least 5 percentage points less 
than, the effective rate of tax that would apply to such income in 
the country in which Branch A is located (10%). Consequently, 
pursuant to paragraph (b)(1)(ii)(b) of this section, Branch A is not 
treated as a separate corporation apart from the remainder of FS for 
purposes of determining foreign base company sales income.
    Example 9. Manufacturing activities performed by multiple 
branches, no branch independently satisfies paragraph (a)(4)(i), 
selling activities carried on by remainder of the controlled foreign 
corporation, some branch manufacturing activities included in 
remainder contribution. (i) Facts. FS, a controlled foreign 
corporation organized in Country M, has three branches, Branch A, 
Branch B, and Branch C, located in Country A, Country B, and Country 
C respectively. FS purchases raw materials from a related person. 
The raw materials are manufactured (under the principles of 
paragraph (a)(4)(ii) or (a)(4)(iii) of this section) into Product X 
by CM, an unrelated corporation, pursuant to a contract 
manufacturing arrangement. CM physically performs the substantial 
transformation, assembly, or conversion required to manufacture 
Product X outside of FS's country of organization. FS manages the 
manufacturing costs and capacities with respect to the manufacture 
of Product X through employees located in Country M. Further, 
employees of FS located in Country M oversee the coordination 
between the branches. Branch A, through the activities of employees 
of FS located in Country A, designs Product X, controls 
manufacturing related logistics, and controls the raw materials and 
work-in-process during the manufacturing process. Branch B, through 
the activities of employees of FS located in Country B, provides 
quality control. Branch C, through the activities of employees of FS 
located in Country C, provides oversight and direction during the 
manufacturing process. Employees of FS located in Country M sell 
Product X to unrelated persons for use outside of Country M. Country 
M imposes an effective rate of tax on sales income of 10%. Country A 
imposes an effective rate of tax on sales income of 12%, Country B 
imposes an effective rate of tax on sales income of 24%, and Country 
C imposes an effective rate of tax on sales income of 25%. None of 
the remainder of FS, Branch A, Branch B, or Branch C independently 
satisfies paragraph (a)(4)(i) of this section. However, under the 
facts and circumstances of the business, FS, as a whole, provides a 
substantial contribution to the manufacture of Product X within the 
meaning of paragraph (a)(4)(iv) of this section. Under the facts and 
circumstances of the business, the activities of the remainder of FS 
and Branch A, if considered together, would not provide a greater 
contribution to the manufacture of Product X than the activities of 
Branch B and Branch C, if considered together. Under the facts and 
circumstances of the business, however, the activities of the 
employees of the remainder of FS and Branch A, if considered 
together, would constitute a substantial contribution to the 
manufacture of Product X.
    (ii) Result. Based on the facts, neither the remainder of FS 
(through activities of its employees in Country M) nor any branch of 
FS independently satisfies paragraph (a)(4)(i) of this section with 
respect to Product X, but FS, as a whole, provides a substantial 
contribution through the activities of its employees to the 
manufacture of Product X. The remainder of FS, Branch A, Branch B, 
and Branch C each provide a contribution through the activities of 
employees to the manufacture of Product X. Therefore, FS must 
determine the location of manufacture under paragraph 
(b)(1)(ii)(c)(3)(iii) of this section. The tested sales location is 
Country M because the selling activities with respect to Product X 
are carried on by the remainder of FS. The location of Branch B is 
the tested manufacturing location because the effective rate of tax 
imposed on FS's sales income by Country M (10%) is less than 90% of, 
and at least 5 percentage points less than, the effective rate of 
tax that would apply to such income in Country B (24%), and Country 
B has the lowest effective rate of tax among the manufacturing 
branches that would, after applying paragraph (b)(1)(ii)(b) of this 
section, be treated as a separate corporation. The manufacturing 
activities performed in Country A by Branch A will be included in 
the contribution of the remainder of FS for purposes of determining 
the location of manufacture of Product X because the effective rate 
of tax imposed on the sales income by Country M (10%) is not less 
than 90% of, and at least 5 percentage points less than, the 
effective rate of tax that would apply to such income in Country A 
(12%). The manufacturing activities performed in Country C by Branch 
C will be included in the contribution of Branch B for purposes of 
determining the location of manufacture of Product X because the 
effective rate of tax imposed on the s