[Federal Register Volume 59, Number 8 (Wednesday, January 12, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-668]


[[Page Unknown]]

[Federal Register: January 12, 1994]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[INTL-0068-92]
RIN 1545-AR18

 

Computation of Combined Taxable Income Under the Profit Split 
Method When the Possession Product Is a Component Product or an End-
Product Form

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed Income Tax Regulations 
relating to the determination of combined taxable income under the 
profit split method. These regulations would amend the current 
regulations and provide revised rules in order for taxpayers to compute 
the combined taxable income under profit split when the possession 
product chosen for purposes of section 936(h)(5) of the Internal 
Revenue Code is a component product or an end-product form. These 
regulations are necessary to provide guidance to taxpayers electing the 
profit split method of computing taxable income under section 
936(h)(5).

DATES: Written comments and requests for a public hearing must be 
received by March 14, 1994.

ADDRESSES: Send submissions to: Internal Revenue Service, P.O. Box 
7604, Ben Franklin Station, Attention: CC:CORP:T:R (INTL-0068-92), room 
5228, Washington, DC 20044. In the alternative, submissions may be hand 
delivered to: CC:DOM:CORP:T:R (INTL-0068-92), Internal Revenue Service, 
room 5228, 1111 Constitution Avenue, NW., Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Jacob Feldman or Mary Gillmarten of 
the Office of Associate Chief Counsel (International), Internal Revenue 
Service, at 202-622-3870 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under section 936 of the Internal Revenue 
Code of 1986. These amendments to the regulations are proposed to 
provide simplified rules for computing combined taxable income under 
the profit split method for a taxpayer that has chosen a component 
product or an end-product form as its possession product.

Explanation of Provisions

    The proposed regulations would amend Sec. 1.936-6(b)(1), Q & A. 12, 
with conforming changes made to Q & A. 10, A. 11, and A. 13. Under the 
proposed revision, where the possession product is a component product 
or an end-product form, the combined taxable income attributable to the 
possession product will be determined by multiplying the combined 
taxable income of the possession corporation and affiliated groups 
derived from covered sales of integrated products (which includes the 
possession product) by a production cost ratio. In the case of a 
component product, the combined taxable income of the integrated 
product would be multiplied by a ratio, the numerator of which equals 
the production costs of the component product and the denominator of 
which equals the production costs of the integrated product. The 
combined taxable income of an end-product form is determined in a 
similar manner using the production costs of the end-product form.
    The proposed change is intended to simplify the computation of 
combined taxable income under Q & A. 12 and to eliminate the need to 
apply section 482 in cases in which a possession product is a component 
product or an end-product form. No inference is intended as to the 
interpretation or scope of current regulations by the revisions 
proposed herein.
    The example under Sec. 1.936-6(b)(1), Q & A. 12 is modified to 
reflect the revised rule.

Proposed Effective Date

    The changes made in this document are proposed to be effective for 
taxable years beginning after December 31, 1993.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations 
and, therefore, a Regulatory Flexibility Analysis is not required. 
Pursuant to section 7805(f) of the Internal Revenue Code, a copy of 
this notice of proposed rulemaking will be submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Comments and Request for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments that are submitted 
timely (preferably a signed original and eight copies) to the IRS. All 
comments will be available for public inspection and copying. A public 
hearing may be scheduled if requested in writing by a person that 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place for the hearing will be published 
in the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Mary 
Gillmarten of the Office of Associate Chief Counsel (International), 
Internal Revenue Service. Other personnel from the Internal Revenue 
Service and Treasury Department participated in developing the 
regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

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

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


    Par. 2. The heading of Sec. 1.936-6 is amended by removing the 
colon after the word ``make'' and by adding in its place a semicolon.
    Par. 3. Section 1.936-6, paragraph (b)(1) is amended by:
    1. Revising Q & A. 10.
    2. Designating the first sentence of A. 11 as paragraph (i) and 
revising it.
    3. Designating the flush text and example following newly 
designated A. 11 (i) as paragraph (ii).
    4. Revising Q & A. 12.
    5. Revising A. 13.
    6. The revisions read as follows:


Sec. 1.936-6  Intangible property income when an election out is made; 
cost sharing and profit split options; covered intangibles.

* * * * *
    (b) * * * (1) * * *
    Q. 10: If the possessions corporation is entitled to use the profit 
split method in the situation described in Q. 9 (leasing units of the 
possession product or use of such units in the taxpayer's own trade or 
business), how should it compute combined taxable income with respect 
to such units?
    A. 10: In the case of an integrated product, combined taxable 
income shall be computed as if the U.S. affiliate had sold the units to 
an unrelated person (or to a foreign affiliate) at the time the units 
were first leased or otherwise placed in service by the U.S. affiliate. 
The sales price shall be equal to the sales price from comparable 
uncontrolled transactions determined in accordance with Sec. 1.482-
2(e)(2). If a sales price from comparable uncontrolled transactions 
cannot be determined in accordance with Sec. 1.482-2(e)(2), then the 
taxpayer shall not be treated as having possession sales with respect 
to such leasing transaction. If the possession product is a component 
product or an end-product form, and there is a comparable uncontrolled 
price for the integrated product which includes the possession product, 
the combined taxable income with respect to the possession product 
shall be determined under Q & A. 12 of this paragraph (b)(1). For 
purposes of determining the basis of a component product or an end-
product form, the deemed sales price of such product must be 
determined. The deemed sales price of the component product shall be 
determined by multiplying the deemed sales price of the integrated 
product by a ratio, the numerator of which is the production costs of 
the component product and the denominator of which is the production 
costs of the integrated product. The deemed sales price of an end-
product form shall be determined by multiplying the deemed sales price 
of the integrated product by a ratio, the numerator of which is the 
production costs of the end-product form and the denominator of which 
is the production costs of the integrated product. The definition of 
production costs with respect to the component product or end-product 
form shall be determined under the rules of Q & A. 12 of this paragraph 
(b)(1). The full amount of income received under the lease shall be 
treated as income of (and taxed to) the U.S. affiliate and not the 
possessions corporation.
* * * * *
    A. 11: (i) The U.S. affiliate shall be treated, for purposes of 
computing its basis in such units, as if it had repurchased such units 
immediately following the deemed sale and at the deemed sales price as 
provided in Q & A. 10 of this paragraph (b)(1).
    (ii) * * *
    Q. 12: If the possession product is a component product or an end-
product form, how is the combined taxable income for such product to be 
determined?
    A. 12: (i) Combined taxable income for a component product or an 
end-product form is computed under the production cost ratio (PCR) 
method.
    (ii) Under the PCR method, the combined taxable income for a 
component product will be the same proportion of the combined taxable 
income for the integrated product which the production costs 
attributable to the component product bear to the total production 
costs for the integrated product. Production costs will be the sum of 
the direct and indirect production costs as defined for inventory 
accounting purposes under Sec. 1.471-11 (b), (c) or (d), except that 
the costs will not include the costs of materials.
    (iii) Under the PCR method the combined taxable income for an end-
product form will be the same proportion of the combined taxable income 
for the integrated product which the production costs attributable to 
the end-product form bear to the total production costs for the 
integrated product. Production costs will be the sum of the direct and 
indirect production costs as defined for inventory accounting purposes 
under Sec. 1.471-11 (b), (c) or (d), except that the costs will not 
include the costs of materials.

    (iv) Example. The following example illustrates a possessions 
corporation, S, engaged in the manufacture of microprocessors. S 
obtains a component from a U.S. affiliate, O. S sells its production 
to another U.S. affiliate, P, which incorporates the microprocessors 
into central processing units (CPUs). P transfers the CPUs to a U.S. 
affiliate, Q, which incorporates the CPUs into computers for sale to 
unrelated persons. S chooses to define the possession product as the 
CPUs. The combined taxable income for the sale of the possession 
product on the basis of the given production, sales, and cost data 
is computed below: 

Production costs (excluding costs of materials):                        
  1. O's costs for the component..............................       100
  2. S's costs for the microprocessors........................       500
  3. P's costs for the CPU's (the possession product).........       200
  4. Q's costs for the computers..............................       400
  5. Total production costs for the computer (Add lines 1               
   through 4).................................................     1,200
  6. Combined production costs for the CPU (the possession              
   product) (Add lines 1 through 3)...........................       800
  7. Ratio of production costs for the CPUs (the possession             
   product) to the production costs for the computer (the               
   integrated product)........................................     0.667
Determination of combined taxable income for computers--Sales:          
                                                                        
  8. Total possession sales of computers to unrelated                   
   customers and foreign affiliates...........................     7,500
Total costs of O, S, P, and Q incurred in production of a               
 computer:                                                              
  9. Production costs (enter from line 5).....................     1,200
  10. Material costs..........................................       100
  11. Total costs (line 9 plus line 10).......................     1,300
  12. Combined gross income from sale of computers (line 8              
   minus line 11).............................................     6,200
Expenses of the affiliated group (other than foreign                    
 affiliates) allocable and apportionable to the computers or            
 any component thereof under the rules of Secs. 1.861-8                 
 through 1.861-14T and 1.936-6(b)(1), Question and Answer 1:            
  13. Expenses (other than research expenses).................       980
Research expenses of the affiliated group allocable and                 
 apportionable to the computers:                                        
  14. Total sales in the 3-digit SIC Code.....................    12,500
  15. Possession sales (enter from line 8)....................     7,500
  16. Cost sharing fraction (divide line 15 by line 14).......       0.6
  17. Research expenses incurred by the affiliated group in 3-          
   digit SIC Code multiplied by 120 percent...................       700
  18. Cost sharing amount (multiply line 16 by line 17).......       420
  19. Research of the affiliated group (other than foreign              
   affiliates) allocable and apportionable under Secs. 1.861-           
   8(e)(3) and 1.861-14T(e)(2) to the computers (the                    
   integrated product)........................................       300
  20. Enter the greater of line 18 or line 19.................       420
Computation of combined taxable income of the computer and the          
 CPU:                                                                   
  21. Combined taxable income attributable to the computer              
   (line 12 minus line 13 and line 20)........................     4,800
  22. Combined taxable income attributable to CPUs (multiply            
   line 21 by line 7) (production cost ratio).................     3,200
  23. Share of combined taxable income apportioned to S (50             
   percent of line 22)........................................     1,600
Share of combined taxable income apportioned to U.S.                    
 affiliate(s) of S:                                                     
  24. Adjustments for research expenses (line 18 minus line 19          
   multiplied by line 7)......................................        80
  25. Adjusted combined taxable income (line 22 plus line 24).     3,280
  26. Share of combined taxable income apportioned to                   
   affiliates of S (line 25 minus line 23)....................    1,680 
                                                                        

* * * * *
    A. 13: (i) The income shall be allocated to U.S. affiliates as 
follows--
    (A) First, to U.S. affiliates (other than tax-exempt affiliates) 
within the group (as determined under section 482) which derive income 
with respect to the product produced in whole or in part in the 
possession;
    (B) Second, to U.S. affiliates (other than tax-exempt affiliates) 
which derive income from the active conduct of a trade or business in 
the same product area as the possession product;
    (C) Third, to other U.S. affiliates (other than tax-exempt 
affiliates);
    (D) Fourth, to foreign affiliates which derive income from the 
active conduct of a U.S. trade or business in the same product area as 
the possession product (or, if the foreign members are resident in a 
country with which the U.S. has an income tax convention, then to those 
foreign members that have a permanent establishment in the United 
States which derives income in the same product area as the possession 
product); and
    (E) Fifth, to all other affiliates.
    (ii) The allocations made under paragraph (i)(A) of this A. 13 
shall be made on the basis of the relative gross income derived by each 
such affiliate with respect to the product produced in whole or in part 
in the possession. Where the product is a component product, the 
relative gross income with respect to the component product shall be 
determined by multiplying the relative gross income of the integrated 
product by a ratio, the numerator of which is the production costs of 
the component product and the denominator of which is the production 
costs of the integrated product. Where the product is an end-product 
form, the relative gross income of an end-product form shall be 
determined by multiplying the gross income of the integrated product by 
a ratio, the numerator of which is the production costs of the end-
product form and the denominator of which is the production costs of 
the integrated product.
    (iii) The allocations made under paragraphs (i)(B) and (i)(D) of 
this A. 13 shall be made on the basis of the relative gross income 
derived by each such affiliate from the active conduct of the trade or 
business in the same product area.
    (iv) The allocations made under paragraphs (i)(C) and (i)(E) of 
this A. 13 shall be made on the basis of the relative total gross 
income of each such affiliate before allocating income under this 
section.
    (v) Income allocated to affiliates shall be treated as U.S. source 
and section 863(b) does not apply for this purpose. For purposes of 
determining an affiliate's estimated tax liability with respect to 
income thus allocated, the income shall be deemed to be received on the 
last day of the taxable year of each such affiliate in which or with 
which the taxable year of the possessions corporation ends.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 94-668 Filed 1-11-94; 8:45 am]
BILLING CODE 4830-01-U