Sunday, December 30, 2018

restructuring tax memo

This is an example of a tax memo that I wrote many years ago. Not to be taken as tax or legal advice as it's now very stale, but there may be snippets in here of use to people.


AquaDuct Technology, Inc.
 
Global Restructuring - Analysis of U.S. Federal Income Tax Issues
 
 
 


- 2 -


Table of Contents
I.              Purpose              3
II.              Background              3
A.              Company Background              3
B.              Legal Structure              3
C.              Business Operations              3
1.              Sales              3
2.              Marketing              3
3.              Research & Development              3
4.              Manufacturing Operations              3
III.              Issues Presented & Conclusions              4
A.              Subpart F              4
B.              U.S. Trade or Business and Effectively Connected Income              5
IV.              Subpart F Review              5
A.              Summary of Relevant Law              5
1.              U.S. Check-the-Box Rules              5
2.              Controlled Foreign Corporation              6
3.              Subpart F              6
B.              Analysis of Operating Model              12
1.              Sale of Products by AquaDuct Cayman to Third-Party Customers              13
2.              Sale of Products by AquaDuct Cayman to AquaDuct U.S.              22
3.              Income Earned by AquaDuct Subsidiaries and Branches with Respect to Sales Support Activities              30
4.              Royalty Income Earned by AquaDuct Cayman from IP Licensed to AquaDuct Singapore              30
V.              Review of U.S. Trade or Business and Effectively Connected Income              31
A.              Summary of Relevant Law              31
1.              U.S. Office or Fixed Place of Business              32
2.              Foreign Material Participation              33
B.              Analysis of U.S. Trade or Business and Effectively Connected Income of AquaDuct Cayman              34
1.              Source of Income for Products Sales by AquaDuct Cayman              34
2.              Fixed Place of Business in the United States              35
3.              Management Support Activities by AquaDuct U.S.              36
4.              Other Support Activities by AquaDuct U.S.              37
5.              Cost Sharing Arrangement              38
6.              Combination of Services Provided by AquaDuct U.S.              38
7.              Foreign Material Participation              38
8.              Conclusion              41

I.   

Purpose
The AquaDuct group implemented a restructuring of its global business operations effective March 1, 2007 (referred to herein as the “Operating Model”).  This memorandum provides a detailed description of the facts and background of the Operating Model, as well as an analysis of the key U.S. federal income tax consequences arising as a result of the Operating Model.
In this memorandum, we have analyzed the potential application of provisions of the applicable Subpart F, U.S. trade or business, and effectively connected income rules of the U.S. federal income tax laws to AquaDuct's Operating Model. 
Our conclusions are based upon the accuracy and completeness of the facts and representations presented by AquaDuct and summarized below.  We have not independently verified these facts and representations.  Any inaccuracy or incompleteness in our understanding of the facts, or a substantial change in facts, could adversely affect the analyses and conclusions expressed in this memorandum and should be brought to our attention immediately.
This memorandum is not an opinion.  Indications of terms such as "will", "should", or "likely" are used in this memorandum in a generic sense, and should not be interpreted as our opinion.  The conclusions reached in this memorandum represent and are based upon our best judgment regarding the application of U.S. federal income tax laws arising under the Internal Revenue Code, existing judicial decisions, administrative regulations and published rulings and procedures.  Our conclusion is not binding upon the Internal Revenue Service or the courts.  Furthermore, no assurance can be given that future legislative or administrative changes, on either a prospective or retroactive basis, would not adversely affect the accuracy of the conclusions stated herein. 

II.           Background

A. Company Background

[redacted]

B. Legal Structure

[redacted]

C.  Business Operations

1.   Sales

[redacted]

2.   Marketing

[redacted]

3.   Research & Development

[redacted]

4.   Manufacturing Operations

[redacted]

III.        Issues Presented & Conclusions

A. Subpart F

Issue 1
Does the income earned by AquaDuct Cayman from sales to non-U.S. customers under the Operating Model generate Foreign Base Company Sales Income ("FBCSI") under § 954(d)?
Conclusion
Income earned by AquaDuct Cayman from non-U.S. sales should not give rise to FBCSI because AquaDuct Cayman buys from, and sells to, unrelated parties under the Operating Model.  Additionally, production and distribution of Products to non-U.S. customers by AquaDuct Singapore should not result in FBCSI under the sales branch or manufacturing branch rules under § 954(d)(2). 
Issue 2
Does the sale of Products by AquaDuct Cayman to AquaDuct U.S. give rise to FBCSI?
Conclusion
Procurement of finished Products by AquaDuct Cayman and the subsequent sale of such Products to AquaDuct U.S. will result in FBCSI to the extent of income earned by AquaDuct Cayman.  To the extent AquaDuct Singapore is considered a manufacturer of certain products where it owns the wafers through the manufacturing process and performs sufficient oversight of the third-party subcontractors, the Company may be able to establish a position that there is no FBCSI on the sale of such products to AquaDuct U.S.  We recommend more thoroughly reviewing this position as the sales operations and manufacturing functions of AquaDuct Singapore expand.
Issue 3
Does the income earned by the AquaDuct Subsidiaries and Branches with respect to their sales support activities give rise to FBCSI or Foreign Base Company Services Income ("FBCSvI") under § 954(e)(1).
Conclusion
Marketing and sales support fees earned by disregarded entities of AquaDuct Cayman should be disregarded for U.S. federal income tax purposes, and therefore not constitute FBCSI or FBCSvI.  Additionally, as discussed below, the sales branch rule should not apply to the AquaDuct Subsidiaries and Branches.
Issue 4
Does the royalty income earned by AquaDuct Cayman in exchange for the IP license to AquaDuct Singapore result in Foreign Personal Holding Company Income ("FPHCI") under § 954(c)?
Conclusion
The royalty payment from AquaDuct Singapore, a check-the-box subsidiary of AquaDuct Cayman, to AquaDuct Cayman should not give rise to FPHCI as AquaDuct Singapore is treated as a branch of AquaDuct Cayman and the transactions between a branch and its home office are disregarded for U.S. federal income tax purposes.

B. U.S. Trade or Business and Effectively Connected Income

Issue
Do the activities of AquaDuct Cayman (and/or AquaDuct Singapore) under the Operating Model create a U.S. trade or business with effectively connected income subject to U.S. federal income tax?
Conclusion
AquaDuct Cayman could be subject to U.S. federal income taxation if it has income effectively connected with a trade or business in the United States.  Based on the facts presented in this memo, the activities anticipated to be performed by AquaDuct Cayman are not likely to create income that is effectively connected to a U.S. trade or business.  However, this analysis is factual and hence the facts and analysis needs to be reviewed periodically to ensure that there is no U.S. federal income tax exposure.

IV.        Subpart F Review

A. Summary of Relevant Law

1.   U.S. Check-the-Box Rules

An eligible entity with a single owner may elect to be disregarded as an entity separate from its owner for U.S. federal income tax purposes.[1]  The ability to choose an eligible foreign entity's classification for U.S. federal income tax purposes is commonly referred to as a "check the box" election.  A check the box election is made by filing Form 8832 (Entity Classification Election).[2]  An entity may elect its classification for U.S. federal income tax purposes regardless of how the entity is classified in a foreign country.  A foreign entity that is treated as a corporation for local country purposes but is treated as a disregarded entity (or branch) for U.S. federal income tax purposes is commonly referred to as a "hybrid entity."[3]  As a result of owning a hybrid entity, for U.S. federal income tax purposes any activities attributable to the hybrid entity will flow through to the hybrid entity’s parent.[4]
Under the Operating Model, AquaDuct Cayman acts as the international principal for sale of Products through its wholly-owned subsidiary AquaDuct Singapore.  AquaDuct Singapore elected to be disregarded as separate from its owner, AquaDuct Cayman, by filing a check-the-box election effective January 1, 2007.  AquaDuct Germany and AquaDuct Japan elected to be disregarded as separate from their owner, AquaDuct Singapore, by filing check-the-box elections.  AquaDuct International, a U.S. California limited liability company, is a flow-through entity by default, as are the branches of AquaDuct International.[5]  As a result, all of the direct and indirect subsidiaries of AquaDuct Cayman are treated as branches of AquaDuct Cayman, and the activities performed by these entities are therefore attributable to AquaDuct Cayman for U.S. federal income tax purposes.[6]  Therefore, for the purposes of this memorandum, AquaDuct Cayman refers to all of these entities and the U.S. federal income tax issues discussed will be analyzed at the AquaDuct Cayman level.

2.   Controlled Foreign Corporation

Generally, income earned by a foreign corporation that conducts its business entirely outside of the United States is not currently subject to U.S. income taxation.[7]  However, certain income and investments of a "controlled foreign corporation" ("CFC") are taxable currently to its "U.S. shareholders" under Subpart F of the Internal Revenue Code and its accompanying regulations.  This income is commonly referred to as "Subpart F income."  A CFC is a foreign corporation of which more than 50 percent of the shares (either by vote or value) are owned directly or indirectly by "U.S. shareholders."[8]  In determining whether the ownership test is satisfied, stock held directly, indirectly and constructively is taken into account. As a result of the stock attribution rules, a foreign corporation can be a CFC even though none of its direct owners are U.S. shareholders.[9]  For example, a wholly-owned foreign subsidiary of a foreign corporation, which is itself wholly owned by a U.S. corporation, would be considered a CFC. 
The AquaDuct group has two CFC's:  AquaDuct Cayman and AquaDuct India.  As mentioned above, all of the other AquaDuct foreign entities are disregarded entities of AquaDuct Cayman.  AquaDuct India primarily performs research and development on behalf of the AquaDuct group, and its activities are outside the scope of this memorandum.  For purposes of analyzing the Subpart F treatment of AquaDuct's activities, unless otherwise noted, references to AquaDuct's CFC refers to AquaDuct Cayman. 

3.   Subpart F

a)  Overview of Subpart F Income

Subpart F of the Internal Revenue Code comprises §§ 951-965 and generally provides for the taxation of U.S. shareholders on their pro-rata share of a controlled foreign corporation's income.   The principal category of income currently taxable to U.S. shareholders of a CFC is foreign base company income ("FBCI"), which includes Foreign Base Company Sales Income, Foreign Base Company Services Income and Foreign Personal Holding Company Income (consisting of certain passive income such as dividends, interest and royalties).[10] 
There are two relevant exceptions from FBCI.  First, an exception is provided for income that would otherwise be Subpart F income if the income is subject to a foreign income tax rate that is greater than 90 percent of the highest U.S. corporate income tax rate (the "high tax exception").[11]   The second exception is for de minimis amounts of FBCI.  Under § 954(b)(3)(A), if the sum of the FBCI is less than the lower of 5 percent of gross income or $1,000,000, none of such income will be subject to inclusion in the U.S. shareholder’s taxable income as FBCI.

b) Foreign Base Company Sales Income

Foreign base company sales income is income resulting from a sale of personal property involving related parties.[12]  FBCSI consists of:
·                  Income from the CFC’s purchase of personal property from a related party and the subsequent sale of such personal property to any person,[13]
·                  Income from the CFC’s sale to a related person of personal property purchased from any person,[14]
·                  Income from the CFC’s sale of personal property to any person on behalf of a related person,[15] and
·                  Income from the CFC’s purchase of personal property from any person on behalf of a related party[16]
where such property is both manufactured outside the CFC’s country of incorporation and sold for use outside such country.[17]  FBCSI includes commission income, fees, gains, as well as the profits on the underlying sales.[18]
Thus, if a CFC sells property that was manufactured or constructed within its country of incorporation, the income would not be treated as FBCSI, regardless of whether it buys from or sells to a related party.[19] Similarly, if a CFC sells property for use in its country of incorporation, the resulting income would fall under the "same country exception" and would not be treated as FBCSI, regardless of whether the CFC buys from or sells to a related party. 
(1)         Sales Branch Rule
Absent the branch rule, a CFC’s transactions with its branches generally do not give rise to the FBCSI issues discussed above, because a transaction between a CFC and its branches (or between the branches of the same CFC) is generally disregarded for U.S. federal tax purposes as transactions between divisions of the same company and therefore not considered to be related-party transactions to which the FBCSI rules would apply.  However, under certain circumstances, a branch is treated as a separate, related, entity from its home office and transactions between that branch and its home office or other branches of that home office are regarded as transactions between separate entities. 
 
Such a circumstance arises when a CFC is subject to the branch rules under § 954(d)(2). Section 954(d)(2) states that a CFC and its offshore branch will be treated as separate CFCs, for purposes of determining whether the FBCSI rules apply, if the use of that offshore branch has substantially the same tax effect” as if it were a wholly-owned subsidiary corporation of the CFC. Having substantially the same tax effect” will cause certain income attributed to the branch to be treated as if it were income earned by a wholly-owned subsidiary of the CFC.[20]  Such income will be treated as FBCSI unless one of the exceptions discussed above applies (the same country or the manufacturing exceptions). 
Definition of "Branch or Other Similar Establishments” 
Neither the IRC nor the regulations define the term “branch or other similar establishments” for purposes of the branch rule, but in cases dealing with the branch rule, the Tax Court has held that the term "branch" should be given its ordinary meaning in a business or accounting sense. The Tax Court accepted the following definition of "branch" from a law dictionary: "A division, office, or other unit of business located at a different location from the main office or headquarters." The Tax Court read "similar establishment" to mean an establishment that bears the typical characteristics of a branch, but goes by another name for accounting, financial reporting, local law, or other purposes.[21]
The Mechanical “Same Tax Effect” Tests
Whether the “same tax effect” exists depends on a comparison of effective tax rates on income attributed to a branch and the rest of the CFC (the regulations call it the “remainder of the CFC”). If income earned by the branch and “remainder of the CFC” is subject to tax rates that differ by some minimum threshold, the branch rule will apply to treat the branch as a separate CFC for purposes of applying the FBCSI rules. This tax rate disparity test is applied differently depending on whether the branch in question is a sales branch or a manufacturing branch.
The mechanical “same tax effect” test for a sales branch involves a two-step process. First, a portion of the combined CFC and branch income is allocated to the sales branch. The allocated amount should reflect income that the branch earns from selling or purchasing products that are made by, purchased from, or sold through, the CFC home office.[22]  Then, the taxpayer quantifies the actual rate of tax associated with the allocated income.[23] Based on the examples, the tax rate should mirror the actual taxes levied by the country in which the branch is located.[24]  The regulations do not explain in detail how taxpayers should determine the tax rate, but only generally say that the taxpayer should consider the income tax law of the “countries involved.”[25]
Next, the taxpayer must compute a hypothetical effective tax rate assuming that the same income was (1) earned in the CFC home office’s country of incorporation, (2) sourced to that country, and (3) earned through a permanent establishment that was controlled and managed in that country.[26]  This series of assumptions is intended to establish the highest amount of tax that the CFC home office, or “remainder of” the CFC, would have paid on the sales income that it had diverted to the branch.
The use of a sales branch will have the “same tax effect” as if it were a separate corporation, if the tax rate on the allocated income of the branch is less than 90 percent of, and at least 5 percent lower than, the hypothetical tax rate applicable to the CFC's head office/remainder.  If a CFC has more than one sales branch, the test must be applied separately to each sales branch, by treating each as if it were the only branch.[27]
The regulations contain an example involving a CFC with multiple sales branches. In that example,[28] a CFC is incorporated in country X and manufactures through its home office and sells through branches B and C located in countries Y and Z, respectively. The home office and each branch earned income solely from sources within their countries of incorporation or operation, and those countries levy a tax only on domestically sourced income. The CFC and its branches’ income and income taxes are as follows:                        
     
Country X
Country Y
Country Z
Home office income
$200,000 
--
--
Branch B income
--
$100,000 
--
Branch C income
--
--
$100,000 
Income tax
$100,000 
$20,000 
$20,000 
Effective rate of tax
50%
20%
20%

 
By applying the sales branch test to Branch B’s activities, the 20 percent tax rate on its income is less than 90 percent of, and at least 5 percentage points lower than, the hypothetical 50 percent tax rate that would apply if all of the income earned by the CFC's home office as well as the income of the branch were from sources within country X. 
Similarly, by applying the sales branch test to Branch C’s activities, again the 20 percent tax rate on its income is less than 90 percent of, and at least 5 percentage points lower than, the hypothetical 50 percent tax rate that would apply to if all of the income earned by the CFC's home office as well as the income of the branch were from sources within country X. 
Since both Branch B and Branch C met the thresholds outlined under the mechanical test, the CFC’s use of the branches is considered to have the “same tax effect” as though the branches were separate corporations. As a result, both branches are treated as separate CFCs for purposes of determining if there is FBCSI, and each branch’s income from the sale of goods purchased from the home office is treated as income from the sale of personal property on behalf of a related party (i.e. CFC home office that is now treated as a separate corporation). Such income would be treated as Subpart F income unless an exception like the “same country exception” applies.
(2)         Manufacturing Branch Rule
The Code also provides for specialized treatment in certain circumstances when a CFC manufactures through a branch located outside the country of incorporation of the CFC.
The regulations define a “manufacturing branch” as a branch, located outside of the CFC’s country of incorporation, which conducts “manufacturing, producing, constructing, growing, or extracting activities.”[29]  There are no enumerated tests in the regulations for determining whether a branch is a “manufacturing branch.”  In the absence of specific regulatory authority, it is reasonable to conclude that, in order for a branch to be considered a manufacturing branch, the branch must conduct activities which in and of themselves would constitute “manufacturing” under the manufacturing exception to FBCSI.
The manufacturing branch rule of § 954(d)(2) applies in those situations where a CFC’s non-branch income is taxed at a lower rate than the country in which a manufacturing branch is located.  In such cases, the branch may be treated as a separate corporation for purposes of applying the FBCSI rules to the CFC.[30]  As a result, the CFC will be treated as though it performed purchasing or selling activities on behalf of a related party (i.e., the branch), which could then give rise to FBCSI upon the sale of such property by the "remainder" of the CFC (i.e., the non-branch portion) for use outside of the CFC’s country of incorporation.[31]  Income from products sold for use within the CFC’s country of incorporation, and manufacturing income earned by the branch, would not constitute FBCSI.[32]
In order for the manufacturing branch rule to apply, personal property manufactured or produced by the branch must be "purchased or sold by or through" the "remainder" of the CFC.  The "remainder" of the CFC is not defined in the relevant regulations.  Presumably, "remainder" of the CFC refers to the CFC home office.  Alternatively, "remainder" could also refer to the CFC home office and any branch or similar establishment (other than the manufacturing branch at issue) of the CFC outside the country of its incorporation.
The manufacturing branch rule only applies in the event that the use of a manufacturing branch has “substantially the same tax effect as if the branch … were a wholly owned subsidiary corporation” of the CFC.[33]  With respect to a manufacturing branch, the regulations indicate that it is necessary to look at a hypothetical tax based on the tax rate of the branch country.  Specifically, the manufacturing branch rule will apply if the effective rate at which the CFC is taxed on its non-branch income is less than 90 percent of, and at least five percentage points less than, the effective rate of tax which would apply to such income under the laws of the country in which the branch is located.[34]
If the manufacturing branch rule applies, the purchasing or selling activities performed by the remainder of the CFC will be deemed to be performed “on behalf of” the manufacturing branch.[35]  Accordingly, such activities (i.e., the sale of property to any person on behalf of a related person) may generate Subpart F income to the CFC under § 954(d).  However, it should be noted that, pursuant to the regulations, income should not be considered FBCSI under the branch rule if it would not have been considered FBCSI if derived by a separate CFC “under like circumstances.”[36] 
To the extent that a CFC has multiple sales branches that sell products manufactured by a manufacturing branch, each sales branch should be tested as if such sales branch alone were the remainder of the CFC for purposes of determining whether use of a manufacturing branch has the requisite tax effect.[37]  When the sales activities are conducted in the same country as the manufacturing activities, the branch rule should not apply.[38]

c)  Foreign Base Company Services Income

Foreign base company services income ("FBCSvI") is income derived by a CFC in connection with the performance of services for (or on behalf of) a related party and that are performed outside of the CFC’s country of organization.[39]  Thus, to have FBCSvI, all of the following elements must be present:
·                  The CFC must derive income in connection with the performance of services;
·                  Such services are performed outside of the country under the laws of which the CFC was organized; and
·                  Such services are performed by the CFC for (or on behalf of) a related party.[40]
Therefore, income from services performed by a CFC for an unrelated person with no related person involvement, or performed for a related person within the CFC’s country of organization, would not constitute FBCSvI.[41]

d) Foreign Personal Holding Company Income

Foreign Personal Holding Company Income (FPHCI) generally includes passive items, or items which reflect the time value of money, including dividends, interest and their equivalents.[42]  Royalties are specifically included within the definition of FPHCI.[43]  However, royalty (and other) payments between hybrid branches of CFCs are not currently subject to Subpart F.  Proposed regulations may make payments between hybrid branches of a CFC subject to Subpart F, however, the proposed regulations have not yet been finalized.[44]  Notice 98-35 indicates that once Treasury regulations are finalized on this point, structures which are in place should receive five years of transition relief. 

B. Analysis of Operating Model

As discussed above, AquaDuct Cayman (including the check-the-box subsidiaries) will be considered a CFC for purposes of applying the rules under Subpart F.[45]
Based on the Operating Model, the following four transactions merit review for purposes of determining if there is any Subpart F income applicable to the Operating Model:
1. Sales of products by AquaDuct Cayman to third-party customers.
2. Sale of products by AquaDuct Cayman to AquaDuct U.S.
3. Income earned by AquaDuct Subsidiaries and Branches with respect to sales support
    activities.
4. Royalty income earned by AquaDuct Cayman in exchange for the IP license to AquaDuct  
    Singapore.
Each of these transactions is evaluated in detail below.

1.   Sale of Products by AquaDuct Cayman to Third-Party Customers

Under § 954(d)(1), FBCSI arises when income is derived in connection with the purchase of personal property from a related person or the sale of personal property to a related person.
AquaDuct Singapore will manufacture AquaDuct Products and ship them directly to unrelated non-Americas customers.  The AquaDuct Subsidiaries and Branches will solicit customers and perform sales support services.  The check-the-box elections made with regard to the AquaDuct Subsidiaries and Branches will cause those entities to be disregarded from their ultimate owner, AquaDuct Cayman.  Therefore, under the Operating Model, the sales activities of the AquaDuct Subsidiaries and Branches will be attributable to AquaDuct Cayman.  For U.S. federal income tax purposes, there is a purchase by AquaDuct Cayman of finished products from unrelated parties (i.e., third-party subcontractors), followed by a sale of Products by AquaDuct Cayman to unrelated parties (i.e., non-Americas customers).  No related party is involved in either the purchase or sale, therefore no FBCSI should arise from these transactions, unless the sales or manufacturing branch rules are applicable.

a)  The Sales Branch Rule

As discussed above, a sales branch is a division, office or other unit of business located outside of the country of the CFC which conducts purchasing or sales activities on behalf of the CFC.  Under Treas. Reg. §1.954-3(b)(1)(i)(a), income derived from purchasing or selling activities which a CFC conducts through a branch outside of the country where it is organized may be recharacterized under the sales branch rules of § 954(d)(2) and Treas. Reg. §1.954-3(b).  If the sales branch rules of § 954(d)(2) and Treas. Reg. §1.954-3(b) are applicable, the activities of each foreign disregarded branch or check-the-box subsidiary would not be attributed to AquaDuct Cayman.  Rather, the entity would be treated as a separate CFC and the transactions between the CFC and the deemed CFC would need to be analyzed separately under the FBCSI rules. 
When a CFC utilizes multiple branches to conduct its sales activities, the branch rule is applied separately to the income of each branch.[46]  Therefore, the analysis below considers each of the check-the-box subsidiaries individually.  
The sales branch rule could apply to recharacterize a branch as a deemed CFC if the foreign branch's income is taxed at an effective rate of tax that is less than 90 percent of, and at least 5 percentage points less than, the effective tax rate that would have applied to such income if it were earned entirely by the entity in the Cayman Islands through a permanent establishment located therein.[47] 
The following discussion analyzes the applicability of sales branch rule to various branches of AquaDuct Cayman:
(1)         AquaDuct Singapore
In the present case, the sales branch rule should not be triggered with respect to the purchase and sale of Products by AquaDuct Singapore.  As previously discussed, the sales branch rule applies only in those situations where the use of a sales branch has “substantially the same tax effect as if the branch … were a wholly owned subsidiary corporation” of the CFC,[48] which is determined by looking at a hypothetical tax based on the tax rate of the CFC’s country of incorporation.  In the present case, the sales branch rule will apply if the effective rate at which AquaDuct Singapore's income is taxed falls below 90 percent of, and is at least five percentage points less than, the tax rate that would be applicable to its income if earned in the country of incorporation of AquaDuct Cayman (i.e., 0 percent in the Cayman Islands).[49] 
Singapore taxes corporate income at a statutory tax rate of 18 percent.[50]  However, AquaDuct Singapore has obtained an income tax ruling in Singapore that provides that its Singapore branch income will be taxed at an incentivized rate of 10 percent for a period of ten years.  The tax ruling has been obtained in Singapore on the basis of certain employee and activity commitments that AquaDuct Singapore has made in connection with its activities in Singapore.
Accordingly, based on the tax rates currently in effect in Singapore and the Cayman Islands and the likely future rates, the sales branch rule should not apply to income earned on sales of AquaDuct products by AquaDuct Singapore.
(2)         Check-the-box/disregarded sales support and marketing entities
AquaDuct Cayman owns various sales support and marketing subsidiaries that are treated as disregarded branches of AquaDuct Cayman for U.S. federal income tax purposes.  Arguably, the services performed by these subsidiaries may not fall under the foreign base company sales income rules.  In that case, the services will be disregarded as occurring within the AquaDuct Cayman CFC.  However, if the foreign base company sales income rules do apply, the disregarded sales support and marketing subsidiaries are subject to testing under the sales branch rule.
In connection with sales of Products, all sales support and marketing subsidiaries provide sales support and marketing services to AquaDuct Cayman in exchange for an arm's length cost-plus reimbursement.  These transactions are treated as if AquaDuct Cayman, a CFC, is conducting sales activities through branches located outside Cayman Islands (the country of incorporation of AquaDuct Cayman). 
Regulation §1.954-3(b)(1)(i)(b) indicates that for purposes of comparing effective tax rates, the rate to be used is the rate "which would apply" if the income of the branch were taxed in the country of organization of the CFC (in the case of AquaDuct Cayman, 0 percent). 
Comparison of Cayman Corporate Tax Rate and Local Effective/Statutory Tax Rates
Jurisdiction of Foreign Branch
Local Statutory Tax Rates
Cayman Effective Tax Rate
Sales Branch Rule Applicable
China 33%0%No
France 33%0%No
Taiwan 25%0%No
United Kingdom 30%0%No


Under the sales branch rule test, the check-the-box subsidiaries could be deemed CFCs if the effective tax rate of any of the check-the-box subsidiaries would be less than ninety percent of and more than five percentage points below the Cayman statutory tax rate of zero percent.
Using the zero percent rate, the sales branch rule test should not apply to any of the check-the-box subsidiaries.  For each of these entities the relevant statutory rate of their jurisdiction is not less than ninety percent of the Cayman statutory rate of zero percent and also is not more than five percentage points below the Cayman statutory rate.  This analysis assumes that the local statutory rate in such foreign locations is also the effective tax rate.  The above rate test will need to be reevaluated in the event that the effective tax rate applicable to AquaDuct Cayman changes from 0 percent.

b) Manufacturing Branch Rule

The manufacturing branch rule applies to the Operating Model if AquaDuct's CFC (i.e., AquaDuct Cayman) manufactures through a branch located outside the country of incorporation of the CFC. 
AquaDuct Singapore is treated as a branch of AquaDuct Cayman for U.S. federal income tax purposes.  If AquaDuct Singapore is determined to conduct manufacturing activities outside of Cayman, the manufacturing branch rule could apply to the Operating Model. 
(1)         Summary of branch activities
Under the Operating Model, the Operations Group in AquaDuct Singapore provides contract manufacturing oversight and logistics support services with respect to the third-party subcontractors used by AquaDuct to manufacture Products.  Accordingly, the manufacturing branch rule could apply with respect to AquaDuct Singapore if AquaDuct Singapore were to be considered as carrying on manufacturing, producing, or constructing activities.[51]
[redacted]
(2)         Definition of manufacturing activities
In order for the manufacturing branch rule to apply to the activities of AquaDuct employees outside of the Cayman Islands, the IRS must not only establish that AquaDuct conducts such activities through a branch or branches outside of the Cayman Islands, but also that such activities constitute “manufacturing activities.”[52]  A court addressing this question must resolve two issues in this regard.  First, it must define “manufacturing activities” within the meaning of Treas. Reg. § 1.954-3(b)(1)(ii)(a) and then determine whether the activities of AquaDuct's employees outside of the Cayman Islands meet that definition.  Second, even if AquaDuct's activities meet the definition of “manufacturing activities,” a court must determine whether the regulations also require that such activities be of a sufficient degree to trigger the application of the manufacturing branch rule.  As discussed below, a strong argument can be made that the activities of the AquaDuct Singapore employees do not constitute “manufacturing activities” within the meaning of the regulation and, even if they were found to constitute manufacturing activities, are not substantial enough, standing alone, to trigger the application of the manufacturing branch rule. 
Degree of “Manufacturing Activity”
Language in the manufacturing branch rule, quoted below, suggests that merely conducting manufacturing activities through a branch is not enough to give rise to a “manufacturing” branch.  Rather, the CFC’s branch manufacturing activity must rise to the level of causing the property sold to be treated as “manufactured” by or through the branch.  Furthermore, in light of the Tax Court’s decisions in Ashland and Vetco, and the other language in the manufacturing branch regulations, a strong argument can be made that the activities of a contract manufacturer will not be considered with the direct activities of the CFC’s employees in making this determination; that is, that the CFC’s direct activities through the branch, standing alone, must result in the relevant property being manufactured within the meaning of § 954(d).
“Manufactured”/ ”Manufacturing” Standard
Under general principles of statutory construction, a provision of the Code should be interpreted in light of every other material part of the statute.[53]  In this regard, Treas. Reg. § 1.954-3(b)(1)(ii)(c), which applies the branch rule to the use of multiple sales branches or the concurrent use of sales and manufacturing branches, arguably provides guidance for interpreting the degree of “manufacturing activity” required to give rise to a “manufacturing” branch under the general manufacturing branch rule.  Specifically, Treas. Reg. § 1.954-3(b)(1)(ii)(c) suggests that the drafters of the regulations contemplated that, in order for a CFC’s “manufacturing activities” conducted through a branch to trigger the application of the manufacturing branch rule, such activities must rise to such a level that the property sold by the CFC is considered to be “manufactured, produced, constructed, grown, or extracted” by or through the branch at issue.  Treas. Reg. § 1.954-3(b)(1)(ii)(c) states in relevant part:
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 [CFC] 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 (b) of this subdivision shall be applied separately to the income derived by each such purchasing or selling branch or similar establishment … 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. (Emphasis added)
One could reasonably interpret the above provision to mean that, in order for the sales and manufacturing branch rule to apply in conjunction, and by extension for the general manufacturing branch rule to apply, the property that is sold by the sales branch must have been “manufactured, produced, constructed, grown or extracted” by or through the CFC’s other offshore branch (i.e., the “manufacturing branch”).  Therefore, based on such an interpretation, a branch that does not “manufacture, produce, construct, grow, or extract” the property that is sold should not be considered a manufacturing branch for purposes of the branch rule.
Furthermore, based on the canon of statutory interpretation that words in a statute should be interpreted in the same way each time they appear in a related provision,[54] definitions of “manufactured, produced, constructed, grown or extracted” provided in other parts of § 954(d) and the regulations thereunder should be given weight as to the meaning of “manufactured, produced, constructed, grown or extracted” within the meaning of Treas. Reg. § 1.954-3(b)(1)(ii)(c).  Specifically, the phrase “manufactured, produced, constructed, grown or extracted” is used in the so-called “same country manufacturing exception” under § 954(d)(1).[55]  That exception applies to income derived by a CFC from the sale of property that is “manufactured, produced, constructed, grown, or extracted” within its country of incorporation.  For purposes of the same country manufacturing exception, the quoted phrase is defined by reference to “principles set forth” in Treas. Reg. § 1.954-3(a)(4), i.e., the “manufacturing exception.”  The regulations governing the manufacturing exception state in relevant part:
A foreign corporation will be considered, for purposes of this subparagraph, to have manufactured, produced, or constructed personal property which it sells if the property sold is in effect not the property which it purchased.  In the case of the manufacture, production, or construction of personal property, the property sold will be considered, for purposes of this subparagraph, as not being the property which is purchased if the provisions of subdivision (ii) or (iii) of this subparagraph are satisfied.[56]  (Emphasis added).
The foregoing exception can be met by a CFC that has “substantially transformed” the product that it sells.  Treas. Reg. § 1.954-3(a)(4)(ii) provides three examples of the application of the “substantial transformation” standard.  Under these examples, substantial transformation occurs when wood pulp is converted into paper, steel rods are transformed into screws and bolts, and fresh fish is processed into canned fish.[57]  These examples describe a permanent and irreversible physical transformation.  The manufacturing exception alternatively may be met by a CFC that conducts an operation that is, with respect to the property sold, “substantial in nature” and is “generally considered” to be manufacturing.[58]
Moreover, the IRS and Treasury issued both the manufacturing exception regulations and the branch regulations at the same time as parts of the same Treasury Decision.[59]  From this history it would be reasonable to believe that the similarity in the language between the two sets of rules did not arise by sheer coincidence; rather, it is likely that the drafters of the regulations thought of the term “manufacturing” in both sets of rules interchangeably, and intended for them to be interpreted consistently.  Support for this reasoning may be found in certain technical advice memoranda and private letter rulings issued by the IRS, which suggest that it has considered the “manufacturing exception” standard in determining whether the requisite “manufacturing activities” have occurred for purposes of the manufacturing branch rule.[60]  For these reasons, we believe the  definition of “manufacturing” for purposes of the manufacturing exception should be viewed as authoritative, or at least highly persuasive, in determining whether the requisite degree of “manufacturing activities” occurred for purposes of the branch rule under § 954(d)(2).
Finally, one could argue that the term “manufacturing, producing, constructing, growing or extracting activities” should be interpreted broadly to encompass any activity relevant to a manufacturing business, not just those that rise to the level of “manufacturing” for purposes of the manufacturing and same country manufacturing exceptions, as described above.  We do not believe such an interpretation to be the better view.  That interpretation arguably would give the manufacturing branch rule an unreasonably broad reach.  For example, it could mean that a CFC is subject to the manufacturing branch rule wherever it has a branch that conducts any level of activity relevant to its manufacturing business.  Alternatively, it could bring within the ambit of the manufacturing branch rule a CFC that buys property from unrelated parties, resells to unrelated parties in substantially the same form, but happens to use a branch that does some minor manufacturing-related activities, e.g., repackaging or labeling, with respect to the property sold.  We have not found support in statute or legislative history supporting such a broad application of the manufacturing branch rule.  
Only Direct Activities Taken Into Account
In Rev. Rul. 75-7, the IRS concluded that manufacturing services performed by a contract manufacturer could be attributed to an unrelated CFC principal for purposes of the FBCSI “manufacturing exception” under Treas. Reg. § 1.954-3(a)(4) and further that such an unrelated contract manufacturer could be considered a “branch or similar establishment” of the CFC for purposes of the branch rule.[61]  The IRS attributed the manufacturing activities of the contract manufacturer to the CFC and noted that “since [the CFC] is conducting a manufacturing operation outside [its home country] it will be considered to do so through a branch or similar establishment within the meaning of the branch rule.”[62]  In other words, the IRS has long taken the position that manufacturing activities attributed to a CFC for § 954(d)(1) purposes must also be so attributed for branch rule purposes.
In Ashland Oil and Vetco, however, the Tax Court held that the activities of an unrelated contract manufacturer and a separate related CFC, respectively, could not be attributed to the subject CFC principal for purposes of the branch rule.  In Ashland Oil, the Tax Court rejected the IRS’s contention that an unrelated contract manufacturer is an “agent” and therefore a branch or similar establishment of the CFC principal.  Because the unrelated contract manufacturer is not a branch of the CFC within the “customary business meaning” of the term, the court reasoned that “the degree of control exercised by [the CFC principal] over a part of [the contract manufacturer’s] operations, any disproportionate risk borne by [the CFC] relative to [the contract manufacturer] … are irrelevant considerations.”[63]  The court also stated that because the CFC does not have a claim against any manufacturing income of the unrelated contract manufacturer, its conclusion “does not seem to … be unjustifiably permissive to taxpayers.”[64]  Based on this holding and analysis, a strong argument could be made that an unrelated contract manufacturer’s activities (including “manufacturing” activities) may not be attributed to the CFC principal for purposes of the branch rules, including for purposes of determining whether the CFC’s manufacturing activities through a branch result in property being “manufactured” by or through the branch.[65] 
There is a reasonable position that the oversight activities, in and of themselves, performed by AquaDuct Singapore are not sufficient to be considered "manufacturing" under Treas. Reg. § 1.954-3(a)(4) for purposes of applying the manufacturing branch rule.  However, even if the IRS disagrees with this position, the manufacturing branch rule should not be applicable because there is no separation of manufacturing and sales activities, as discussed in more detail below.
(3)         Sales & manufacturing activities performed by the branch
The regulations do not contain examples for applying the tax rate test to offshore branches, like AquaDuct Singapore, that perform both manufacturing and sales activities with respect to the products that they sell. The IRS, however, has discussed this situation in Technical Advice Memorandum (“T.A.M.”) 8509004[66] and P.L.R. 8645062.[67]
In T.A.M. 8509004, the IRS field agent concluded that the branch qualifies for the manufacturing exception.[68]  The home office (or “remainder”) of the CFC performs no selling or purchasing activities on the products that the branch makes and the branch sold its products directly to related and unrelated parties.  
The IRS National Office said that since the CFC home office purchased or sold none of the products made by the branch, the manufacturing branch rule does not apply. The IRS cited the text of the manufacturing branch rules, in relevant part:
If a controlled foreign corporation carries on manufacturing ... activities ... through a branch ... and the use of the branch ... 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 foreign base company sales income of such corporation.[69] (Emphasis added.)
Based on the underlined language, the IRS concluded that the manufacturing branch rule applies only in situations where the CFC home office purchases or sells the products made by its offshore branch.
Note this T.A.M. does not address how the taxpayer should have applied the sales branch rule. According to a later ruling, P.L.R. 8645062, the IRS concluded that neither the manufacturing nor the sales branch rule applies “[i]n cases where the manufacturing and sales activities are carried on in the same country the branch rule will not apply because there is no separation of activities ...” However, the IRS also advised that its discussion about the branch rule is “general in nature and does not constitute a ruling.”[70]
Alternatively, in the absence of any other specific guidance, it would seem reasonable to separately analyze the branch’s sales activity under the sales branch rules.
Even if AquaDuct Singapore were considered to be a manufacturing branch, AquaDuct Cayman itself performs no sales and marketing functions.  All sales are concluded directly by AquaDuct Singapore, and all sales and marketing support services are provided by the AquaDuct Subsidiaries and Branches, all of which are treated as branches of AquaDuct Cayman. 
The legislative intent to the branch rule, the statutory and regulatory language implementing this intent, as illustrated in PLR 8509004, indicate that the branch rule should not apply at all with respect to the AquaDuct Cayman head office/remainder, because AquaDuct Cayman does not perform any selling activities within the meaning of the regulations. 
The manufacturing branch rule may apply to AquaDuct Singapore with respect to the check-the-box sales branches, since they do actually perform selling activities.  The manufacturing branch rule will apply if the effective rate at which the AquaDuct Subsidiaries and Branches are individually taxed on their income is less than 90 percent of, and at least five percentage points less than, the effective rate of tax which would apply to such income under the laws of Singapore.[71]
Comparison of AquaDuct Subsidiaries and Branches Tax Rates and
Singapore Tax Rate
Jurisdiction of CFC Remainder
CFC Remainder Statutory Tax Rates
Singapore Tax Rate
Manufacturing Branch Rule Applicable
China 33%18%No
France 33%18%No
Taiwan 25%18%No
United Kingdom 30%18%No

 
Using the rate test, the manufacturing branch rule should not apply to any of the AquaDuct Subsidiaries and Branches.  For each of these entities, the relevant statutory rate of their jurisdiction is not less than ninety percent of the Singapore statutory tax rate of 18 percent and also is not more than five percentage points below the Singapore statutory tax rate.  Although AquaDuct Singapore has received a tax holiday rate of 10 percent on business income, for purposes of this analysis we have used the Singapore statutory tax rate of 18 percent.  This conservative position reflects that the Singapore tax holiday is for a limited period of time, and may not apply to income earned by the branches of AquaDuct Singapore.
The above rate test will need to be conducted on an annual basis based on the income allocated to such branches using the effective tax rates applicable in the respective locations.

2.                         Sale of Products by AquaDuct Cayman to AquaDuct U.S.

Under the Operating Model, AquaDuct Cayman will also sell finished AquaDuct Products to AquaDuct U.S.  The Products will then be on-sold by AquaDuct U.S. to customers in the Americas territory.  AquaDuct U.S. will compensate AquaDuct Cayman for the manufacturing of these products at an arm's length transfer price.
This sale transaction will involve the sale of personal property to a related party (i.e., AquaDuct U.S.).  To the extent that AquaDuct Cayman earns income on the sale of the Products to AquaDuct U.S., such income should result in FBCSI, unless an exception applies.
AquaDuct Cayman may argue that there has been no “purchase of personal property” and “its sale” within the explicit language of the FBCSI rules under § 954(d)(1) (i.e., the property which is sold by AquaDuct Cayman is different from that which is purchased by AquaDuct Cayman).  However, this position is strongly disputed by the IRS.
 
As an alternative and stronger argument, AquaDuct may be able to argue that the activities performed by the third-party subcontractors at AquaDuct Cayman's direction are attributable to AquaDuct Cayman for purposes of the manufacturing exception.  If the activities performed by the third-party subcontractors are attributable to AquaDuct Cayman, such revenue should then be excluded from the definition of FBCSI as revenue attributable to property manufactured or produced by AquaDuct Cayman.[72]
There is no clear guidance in the statutory, regulatory or case law with regards to whether the activities of a third-party subcontractor can be attributed to a hiring CFC for purposes of applying the manufacturing exception under the FBCSI rules discussed above.  As analyzed below, despite the IRS's current opposition to attribution, attribution should be possible under the appropriate circumstances.

a)  No Statutory or Regulatory Requirement that CFC Itself Manufacture the Products

Contract manufacturing arrangements are not addressed in the context of FBCSI by the Code, relevant legislative history, or the regulations.[73]  However, there is no prohibition in the Code, relevant legislative history, or regulations against attribution for purposes of the manufacturing exception;[74] nor has any court decided on this issue.[75]
Additionally, there is no express requirement in the Code, relevant legislative history, or the regulations that a CFC itself manufactures the products for purposes of the manufacturing exception.[76]  In describing the manufacturing exception, Treas. Reg. § 1.954-3(a)(4)(i) provides that:
Foreign base company sales income does not include income of a [CFC] derived in connection with the sale of personal property manufactured, produced, or constructed by such corporation in whole or in part from personal property which it has purchased.  A foreign corporation will be considered, for purposes of this subparagraph, to have manufactured, produced, or constructed personal property which it sells if the property sold is in effect not the property which it purchased.  In the case of the manufacture, production, construction of personal property, the property sold will be considered, for purposes of this subparagraph, as not being the property which it purchased if the provisions of this subdivision (ii) or (iii) of this subparagraph are satisfied.
Although the first sentence of Treas. Reg. § 1.954-3(a)(4)(i) initially refers to “property manufactured …by such corporation” which may be interpreted as requiring the CFC itself to manufacture the products sold, the next sentence merely states that a foreign corporation “will be considered to manufacture, for purposes of this subparagraph, personal property which it sells if the property sold is in effect not the property which it purchased”.  The forgoing “property sold is in effect not property purchased” standard “will be considered met for purposes of this subparagraph” if the “substantial transformation” requirement under Treas. Reg. § 1.954-3(a)(4)(ii) is met.[77]  The “will be considered met for purposes of this subparagraph” language illustrates situations where the manufacturing exception contained in Treas. Reg. § 1.954-3(a)(4)(i) will be considered met (“for purposes of this subparagraph”) and contains no express requirement that the CFC itself manufacture the property through its own employees.  Similarly, the “substantial transformation” requirement does not require the CFC itself to manufacture the products sold either by providing that, “[i]f purchased personal property is substantially transformed prior to sale, the property sold will be treated as having been manufactured, produced, or constructed by the selling corporation”[78]  Thus, it appears reasonable that, if a CFC satisfies the “will be considered” language quoted above, even if the CFC does not manufacture the products by itself, the manufacturing exception will be considered met.
This “no prohibition” interpretation of the regulations is consistent with the Tax Court’s views as expressed in Electronic Arts, Inc. v. Comm’r.[79]  In Electronic Arts, when the IRS urged the Tax Court to deny the taxpayer’s summary judgment motion because, as a matter of law, the taxpayer cannot attribute activities of the third-party subcontractor to the CFC to satisfy the test under § 936(h)(5)(B)(ii) which incorporates by reference the “manufactured outside the CFC’s country of organization” language in § 954(d)(1)(A), the court denied the IRS’s request and stated, “our examination of … § 954(d)(1)(A) and the legislative history of that provision enacted in 1962, convinces us that there is no absolute requirement that only the activities actually performed by a corporation’s employees or officers are to be taken into account in determining whether the corporation manufactured or produced a product in a possession, within the meaning of §§ 936(h)(5)(B)(ii) (final flush)[80] and 954(d)(1)(A).”[81]

b) Prior IRS Support for Attribution

To date, no court has decided whether the manufacturing exception applies to sales income derived by a CFC pursuant to a contract manufacturing arrangement, or whether activities of the third-party subcontractor may be attributed to the CFC for such purpose.  As noted by the Tax Court in Electronic Arts, such issue has never been decided by a court.[82]  The only express authority supporting attribution came from the IRS.  For over 22 years, the IRS officially interpreted the manufacturing exception regulations by treating the hiring CFC as the manufacturer of products produced on its behalf by a third-party subcontractor pursuant to a manufacturing service arrangement,[83] until the IRS revoked Rev. Rul. 75-7[84] with the issuance of Rev. Rul. 97-48.[85] 
In Rev. Rul. 75-7, the CFC purchased metal ore concentrate from related persons and contracted with an unrelated person to convert the concentrate into ferroalloy for a fee pursuant to a contract.  The production was done outside the CFC’s country of incorporation.  The CFC sold the finished products to unrelated persons outside its country of incorporation.  The IRS ruled that the manufacturing activities of the third-party subcontractor should be attributed to the CFC so that the CFC would be considered a manufacturer of the ferroalloy for purposes of applying the manufacturing exception in Treas. Reg. § 1.954-3(a)(4).[86]  Summarized below are the key facts specific to this CFC that are cited by FSA 200220005[87] as thirteen key factors favoring attribution:
  1. the CFC entered into an arm’s length contract with an unrelated third-party subcontractor;
  2. the manufacturing process was intricate and involved highly skilled labor, working in accordance with scientific controls;
  3. the third-party subcontractor’s plant was one of the few in the world equipped to accomplish the task;
  4. the third-party subcontractor had no present or future plans to have an affiliation with the CFC other than through the contractual obligation arising under the arm’s length contract;
  5. the third-party subcontractor received a conversion fee rather than a share of the profits;
  6. the CFC owned the raw materials and the finished products;
  7. the CFC alone purchased the raw materials needed to manufacture the product;
  8. the CFC bore risk of loss at all times in connection with the operation;
  9. the CFC had complete control of the time and quantity of the production;
  10. the CFC had complete control of the quality of the product by requiring the third-party subcontractor to use such processes as directed by the CFC;
  11. the CFC could, when occasion warranted it, send engineers or technicians to the third-party subcontractor’s plant to inspect, correct or advise with respect to the manufacturing process;
  12. the negotiation and consummation of the sale of finished products were solely the responsibility of the CFC, which is entitled to all profits from such sales; and
  13. the finished products were sold to unrelated parties.
Following after the issuance of Rev. Rul. 75-7, the IRS has applied the same analysis to similar facts in a number of subsequent private letter rulings and technical advice memoranda to attribute to a hiring CFC the activities of a manufacturing service provider.  See, e.g., T.A.M.s 8333008,[88] 8509004;[89] P.L.R.s 8413062[90] and 8749060.[91]

c)  IRS Position Against Attribution             

In 1997, the IRS issued Rev. Rul. 97-48 revoking Rev. Rul. 75-7.  This reversal of position was in response to two tax court cases decided seven years earlier, Ashland Oil[92] and Vetco,[93] which held that the third-party subcontractor's activities do not become the hiring CFC's branches for applying the branch rule under § 954(d)(2) . 
In Ashland Oil,[94] the contract manufacturing arrangement was similar to the one in Rev. Rul. 75-7 except that the unrelated third-party subcontractor formally owned the raw materials, work-in-process, and finished products until they were purchased by the CFC.  The Tax Court held that the activities of the unrelated third-party subcontractor could not be imputed to the CFC for purposes of applying the Subpart F manufacturing branch rule,[95] irrespective of the amount of control exercised by the CFC and the relative risks borne by the contracting parties.[96]  The court did not discuss the issue of whether the manufacturing activities of the third-party subcontractor would be attributed to the CFC for purposes of applying the manufacturing exception.  Rather, the court limited its previous decision to the specific facts concerning an ore-processing corporation, hence it would not be construed as substantive authority to decide the issue of the branch rule in discussing Rev. Rul. 75-7.[97] 
Vetco[98] involved a similar contract manufacturing arrangement.  Unlike Ashland and Rev. Rul. 75-7, the third-party subcontractor in Vetco was a related party (a wholly owned subsidiary of the CFC).  The court nevertheless held that the branch rule should not apply because a subsidiary could not be a branch or similar establishment of its parent.[99]
At issue in Ashland Oil and Vetco were the manufacturing branch rule and the definition of “branch.”  Underlying the Tax Court’s decisions in both cases was the rationale that a third-party subcontractor does not constitute a “branch or similar establishment” as that term is used in § 954(d)(2) and the regulations promulgated thereunder.[100]  The manufacturing exception under Treas. Reg. § 1.954-3(a)(4) was never at issue in either case, let alone the attribution issue for that purpose.  The court did not address the attribution issue either.[101]  As such, though Ashland Oil and Vetco partially invalidated Rev. Rul. 75-7’s holding that a CFC has a branch for purposes of the Subpart F manufacturing branch rule by virtue of the third-party subcontractor’s activities, the court did not address the portion of Rev. Rul. 75-7 that treated a hiring CFC as the manufacturer by virtue of the third-party subcontractor’s manufacturing activities for purposes of the manufacturing exception rules.
Rev. Rul. 97-48 was issued in response to the IRS’s failed litigation in Ashland Oil and Vetco.  The IRS simply stated in Rev. Rul. 97-48 that, “[t]he Service will follow the Ashland Oil and Vetco opinions.  The activities of a contract manufacturer cannot be attributed to a [CFC] for purposes of either § 954(d)(1) or § 954(d)(2) …[a]ccordingly Rev. Rul. 75-7 is revoked.”  The IRS further stated that it had never been of the view that activities of a third-party subcontractor could be attributed to a CFC “without treating those activities as performed through a branch or similar establishment of [the CFC]”.  The above quoted language, considered in connection with the IRS’s prior position allowing attribution for purposes of both the manufacturing exception and the branch rules under § 954(d)(2), indicate that the IRS asserts as a condition to attribution for the manufacturing exception, the application of the branch rule.  However, the authorities cited by Rev. Rul. 97-48, Ashland Oil and Vetco, do not support the IRS’s position in Rev. Rul. 97-48.  Rather, Ashland Oil and Vetco disallowed the application of the branch rule based on the rationale that a third-party subcontractor was not a branch and did not address attribution for purposes of the manufacturing exception nor require the application of the branch rule as a condition of attribution for purposes of the manufacturing exception.  As such, we believe there is a position that taxpayers may continue relying on Rev. Rul. 75-7 as modified by Ashland Oil and Vetco.
Subsequent to the issuance of Rev. Rul. 97-48, proposed regulations[102] were issued on March 23, 1998, which would have amended the language of two sentences of the existing regulations, which provide for the manufacturing exception.  The proposed regulations would require that the selling corporation (i.e., the CFC) itself perform the manufacturing activities.  These proposed regulations were subsequently withdrawn on July 13, 1999.[103] 
In FSA 200220005,[104] the IRS restated its position adopted in Rev. Rul. 97-48 against attributing the activities of a third-party subcontractor to a hiring CFC for purposes of the manufacturing exception.  Although the IRS applied the same analysis as contained in Rev. Rul. 75-7 (because the years at issue were prior to Rev. Rul. 97-48), it did not attribute the activities of the third-party subcontractor to the CFC.  Adopting a narrow interpretation of Rev. Rul. 97-48, it found that only two out of thirteen factors favoring attribution were present in the instant situation.
In 2007, the IRS, through its International Tax Counsel, advised that it is developing guidance to address when the use of a contract manufacturer by a CFC would qualify for the manufacturing exception to Subpart F income under the principles of attribution.  It is expected that this guidance will include rules on the nature of activities performed by the contract manufacturer and the oversight activities performed by the CFC that may give rise to attribution.  It is not known when this guidance will be provided.

d) Summary of Above Legal Analysis

In summary, no statutory or regulatory authority governs and no case law has decided on the specific issue of whether the activities of a third-party subcontractor can be attributed to a hiring CFC so that the CFC can be treated as a manufacturer for purposes of Treas. Reg. § 1.954-3(a)(4).  At a minimum, no statutory, regulatory, or legal authority prohibits attribution.  Additionally, as analyzed above, if the “will be considered” language[105] and the tests thereunder[106]are satisfied, the manufacturing exception “will be considered met” irrespective of the first sentence of Treas. Reg. § 1.954-3(a)(4)(i) that seemingly requires the CFC itself manufacture the goods sold; the “will be considered” language[107] and the tests thereunder[108] do not require the CFC to manufacture the products through its own employees.
The only express Subpart F authorities addressing the attribution issue are the IRS rulings prior to the revocation of Rev. Rul. 75-7 in 1997.  For over 22 years, the IRS interpreted the Code and regulations as allowing for such attribution (Rev. Rul. 75-7 etc.); but pursuant to Rev. Rul. 97-48, the IRS no longer attributes a third-party subcontractor’s manufacturing activities to a hiring CFC (although there has been no statutory or regulatory changes, or cases supporting this reversal in position).  As previously discussed, the authorities cited by Rev. Rul. 97-48 did not support the IRS’s revocation of Rev. Rul. 75-7.  Furthermore, the absence of further guidance in any form for over eight years may suggest the IRS’s own uncertainty regarding their latest position as set forth in the revoked proposed regulations of 1998 requiring that the manufacturing operations be conducted by the CFC itself.  As such, we believe that the IRS's original guidance on attribution as articulated in Rev. Rul. 75-7 as modified by Ashland Oil and Vetco may support a position that the activities of a third-party subcontractor can be attributed to a hiring CFC so that the CFC can be treated as a manufacturer for purposes of Treas. Reg. § 1.954-3(a)(4).
AquaDuct is currently building its manufacturing oversight operations in AquaDuct Cayman.  Additionally, as discussed above, the rules regarding attribution of manufacturing activity for third-party subcontractors is also evolving and the IRS has expressed an intent to issue further guidance on this issue.  It is feasible that with additional oversight activities, AquaDuct Cayman may be able to take a reasonable position in the future that it is the manufacturer of products for purposes of applying the manufacturing exception under Treas. Reg. § 1.954-3(a)(4).  We suggest that this position be reevaluated over time to determine if reliance on the manufacturing exception can be taken.

3.   Income Earned by AquaDuct Subsidiaries and Branches with Respect to Sales Support Activities

Under the Operating Model, the check-the-box subsidiaries will provide sales support and marketing and technical support services (hereinafter "support services") in their respective local jurisdictions in exchange for an arm's length service fee under an intercompany services contract with AquaDuct Cayman.[109]  
The service fee earned by such disregarded branches of AquaDuct Cayman should be disregarded for U.S. federal income tax purposes and therefore not give rise to foreign base company services income.  However, if this service fee is considered sales income under the foreign base company sales income rules, the sales branch rule would apply, as discussed under the application of the sales branch rule.  As has been discussed in detail in that section, the application of the sales branch rule should not result in the inclusion of foreign base company sales income.  As also noted above, proposed regulations may make payments between hybrid branches of a CFC subject to Subpart F, however, the proposed regulations have not yet been finalized.[110]  Notice 98-35 indicates that once Treasury regulations are finalized on this point, structures which are in place should receive five years of transition relief. 

4.                         Royalty Income Earned by AquaDuct Cayman from IP Licensed to AquaDuct Singapore

As stated above, Foreign Personal Holding Company Income ("FPHCI") generally includes passive items, or items which reflect the time value of money, including dividends, interest and their equivalents.[111]
Royalties are specifically included within the definition of FPHCI.[112]  However, royalty payments between branches of CFCs are not currently subject to Subpart F.   As noted above, proposed regulations may make payments between hybrid branches of a CFC subject to Subpart F, however, the proposed regulations have not yet been finalized.[113]  Notice 98-35 indicates that once Treasury regulations are finalized on this point, structures which are in place should receive five years of transition relief. 
Under the Operating Model, AquaDuct Cayman has granted an operating license to AquaDuct Singapore to manufacture and sell AquaDuct Products outside of the Americas in exchange for a royalty payment. 
The payment between AquaDuct Singapore and AquaDuct Cayman should be disregarded because AquaDuct Singapore is disregarded for U.S. federal income tax purposes and thus should not result in Subpart F income under current tax laws.

V.           Review of U.S. Trade or Business and Effectively Connected Income

A. Summary of Relevant Law

A non-U.S. corporation generally will not be subject to U.S. federal income tax on its business income, unless it is engaged in a U.S. trade or business.  When a non-U.S. corporation is engaged in a U.S. trade or business, taxation will generally be limited to the income which is “effectively connected” with the U.S. trade or business.[114]  In general, only U.S. source income will be treated as “effectively connected income”.  Foreign source income is generally not effectively connected with a U.S. trade or business.[115]  
The source of income from the sale of inventory property is generally the location where title to the goods passes to the purchaser.[116]  Therefore, income from export sales will generally be foreign source income since the title to the goods passes to the purchaser outside of the United States. However, income from the sale of inventory for use, consumption, or disposition outside of the United States will be considered U.S. source, effectively connected income if the foreign seller has an “office or other fixed place of business within the United States to which such income . . . is attributable.”[117]  However, this rule will not apply if “an office or other fixed place of business of the taxpayer in a foreign country participated materially in such sale.”[118]
Therefore, a foreign corporation’s income from export sales cannot be subject to U.S. federal income taxation unless the foreign corporation has an office or other fixed place of business in the United States. 

1.   U.S. Office or Fixed Place of Business

 
An office or other fixed place of business can arise through either direct activities, an actual office of the foreign corporation in the United States, or through imputed activities, when activities of agents, partnerships and trusts can in certain circumstances be imputed to a foreign corporation. 
In order to constitute a U.S. trade or business, activities performed by a foreign corporation in the United States have to be active.  Case law has interpreted the "active" requirement to be more than a passive investment or ownership of property, and must be  “numerous” and “major”.[119]  Isolated transactions in the absence of “continuity” or “sustained activity” do not cause a foreign corporation to be engaged in a U.S. trade or business.[120]
The nature of the activities is also important.  In Spermacet Whaling and Shipping Co v. Comr., the Tax Court held that receiving monthly statements and correspondence and making certain payments was “ministerial and clerical in nature” and did not involve the exercise of business judgement “necessary to the production of the income in question.”[121] In that case, all major management decisions were made abroad.  In addition, a number of other categories of activity have been held not to be of a type to give rise to constitute a U.S. trade or business and they include investigatory activities[122], purchasing[123], promotional activities and representative offices.[124]
A foreign corporation may also be engaged in a U.S. trade or business through the activities of its agents in the United States under common law principles of agency.  Case law has established that when an agent is subject to a high degree of control by the principal, as employees or agents acting almost exclusively for a corporation, their activities are properly imputed to the corporation.[125]  However, the activities of the corporation are not imputed to its shareholders simply by virtue of shareholder’s ownership of stock.[126]
Subject to the “foreign material participation” exception discussed below, if a foreign company has a U.S. office, § 864(c)(5)(B) provides that income shall not be considered “attributable” to the U.S. office, unless the following two requirements both are satisfied:
(i) the U.S. office is a “material factor” in the production of such income, and
(ii) the U.S. office regularly carries on activities of the type from which such income is derived.
Treas. Reg. § 1.864-6(b)(1) provides that the activities of a U.S. office shall not be considered to be a “material factor” in the realization of the income “unless they provide a significant contribution to, by being an essential economic element in, the realization of the income.”  Since the United States generally only taxes U.S. source income of foreign persons, § 865(e)(2)(A) designates such income as being U.S. source even if it would be foreign source under the passage of title rule.
Treas. Reg. § 1.864-6(b)(2)(iii), which applies specifically to income from sales of inventory, provides that a U.S. office shall be considered to be a “material factor” in the realization of income from sales of goods if it “actively participates in soliciting the order, negotiating the contract of sale, or performing other significant services necessary for the consummation of the sale which are not the subject of a separate agreement between the seller and the buyer.”[127] 
The legislative history sheds further light on the underlying intent by using the language “actively participates in soliciting, negotiating or performing other activities required to arrange for such a sale.”[128]  Based upon this language, participating in negotiations in unusual cases and directly contacting existing customers, at sites within the U.S., in furtherance of marketing, engineering, consulting and business development efforts would seem to constitute “material factors” in the realization of income from sales of goods.  Conversely, the regulations specifically provide that making the sale subject to final approval by a U.S. office does not mean that the U.S. office materially participated in the sale.[129] 

2.   Foreign Material Participation

Even if a foreign corporation is considered to have a U.S. office, and export sales are treated as “attributable” to this U.S. office, income from the sale of inventory for use outside the United States should not be subject to U.S. federal income tax if a foreign office of the foreign corporation materially participates in the sale.[130]  In addition, § 865(e)(2)(B) provides that if inventory is sold for use, disposition or consumption outside the United States and an office or other fixed place of business outside of the United States materially participates in the sale, then the general  passage of title rule will apply to source the income arising from such sale.
“Foreign material participation” is defined under Treas. Reg. § 1.864-6(b)(3)(i) as:
(i) active participation in soliciting orders,
(ii) negotiating contracts of sale, or
(iii) performing other significant services necessary for the consummation of the sale that are not the subject of a separate agreement between the seller and the buyer. 
The regulations further provide that an office shall not be considered to have participated materially in a sale merely because of one or more of the following activities:
(a) the sale is made subject to the final approval of such office;
(b) the property sold is held in, and distributed from, such office;
(c) samples of the property sold are displayed (but not otherwise promoted or sold) in such office;
(d) such office is used for purposes of having title to the property pass outside the United States, or
(e) such office performs merely clerical functions incident to the sale.[131]
Additionally, the selling company need not directly employ the person or persons relied upon for foreign material participation.  Instead, the persons providing the material participation could be, for example, employees of a foreign entity that is a disregarded branch of the seller for U.S. federal income tax purposes.  Under the check-the-box rules, if the foreign entity is disregarded for U.S. federal income tax purposes, then the company that owns the disregarded entity will be treated as the employer for U.S. federal income tax purposes.[132]

B. Analysis of U.S. Trade or Business and Effectively Connected Income of AquaDuct Cayman

The United States does not have a double tax avoidance treaty with the Cayman Islands.  Therefore, any potential domestic activities of AquaDuct Cayman are evaluated under applicable U.S. federal income tax laws, without regard to the application of a tax treaty.
The determination of whether AquaDuct Cayman is engaged in a U.S. trade or business is a highly factual analysis.  This section analyzes various business activities involving AquaDuct Cayman under the Operating Model to assess the U.S. corporate tax exposure of AquaDuct Cayman.  Under the Operating Model, the activities of the disregarded entities of AquaDuct Cayman (i.e., AquaDuct Singapore and the AquaDuct Subsidiaries and Branches) are attributable for U.S. federal income tax purposes to AquaDuct Cayman.  Therefore, references in this section to AquaDuct Cayman refer to the activities of AquaDuct Cayman and its subsidiaries and branches.

1.   Source of Income for Products Sales by AquaDuct Cayman

[redacted]
The source of gross income attributable to sales activity is generally determined under the place of sale rules, subject to the "fixed place of business" exception described below.  A sale of personal property is consummated at the time when, and the place where, the rights, title, and interest of the seller in the property are transferred to the buyer.[133]  Where the seller retains bare legal title, the sale should be deemed to have occurred at the time and place of passage to the buyer of beneficial ownership and the risk of loss.  All factors of the transaction, such as negotiations, the execution of the agreement, the location of the property, and the place of payment will be considered, and the sale will be treated as taking place where the substance of the transaction occurred. [134]
For all Product sale transactions by AquaDuct Cayman, title passage and risk of loss will take place outside of the United States (i.e., at point of shipment in Singapore, when goods are delivered into the hands of third-party carriers located in Singapore).
Under the U.S. rules for source of income, in the case of income derived from the sale of inventory property that is not produced by the seller, the source of the income is generally the place where the property is sold, i.e., the place where title to the property passes.[135]  As a result, the sale outside of the United States of inventory property which is not produced by the taxpayer generally should not generate U.S. source income. 
In the case of income derived from the sale of inventory property that is produced by the seller, the income from such sale is sourced partly to the place of production and partly to the place of sale.[136]  A taxpayer that produces (in whole or in part) inventory property outside of the United States and sells within the United States must divide gross income from such sales between production activities and sales activities.[137] 
The source of gross income attributable to production activity is determined based on the location of production assets.[138] Based on our understanding, AquaDuct Cayman will not use any tangible assets in the production of Products, whether in the United States or otherwise.  All production assets of the third-party subcontractors are located outside the United States, but will be ignored for purposes of this determination under the regulations because the assets and activities of contract manufacturers are ignored for purposes of application of the sourcing rules.[139]  Any intangible assets of AquaDuct Cayman associated with manufacturing activities are attributed to the location where any tangible production assets are located.  Therefore, all of AquaDuct Cayman’s foreign sales income due to production activity should be sourced outside of the United States.

2.   Fixed Place of Business in the United States

Notwithstanding the determination of source of income under the title passage rules, above, income from AquaDuct Cayman's sale of inventory sourced outside the United States will be considered U.S. source, effectively connected income if AquaDuct Cayman is found to have an office or other fixed place of business within the United States to which the sales are attributable.[140]  However, this exception to the title passage rule will not apply if the inventory is sold for use, consumption, or disposition outside the United States, and an office or other fixed place of business of the taxpayer in a foreign country participated materially in such sale.[141]
As discussed above, an office or other fixed place of business can arise either directly, through an actual office of the foreign corporation in the United States, or through the activities of an agent or employee.  If a foreign company has a U.S. office, § 864(c)(5)(B) provides that income shall not be considered “attributable” to the U.S. office, unless the U.S. office is a “material factor” in the production of such income, and the U.S. office regularly carries on activities of the type from which such income is derived.  The Treasury Regulations and legislative history indicate that a U.S. office shall not be considered to be a “material factor” in the realization of the income unless they provide a significant contribution to the realization of income.  This may occur if the U.S. office actively participates in soliciting orders, negotiating the contracts of sale, or performing other significant services necessary for the sales to occur.
With regard to the sale of products by AquaDuct Cayman to non-U.S. customers, AquaDuct Cayman will not have an office, warehouse, or other leased or owned facility in the United States, nor will AquaDuct Cayman have any of its day to day operations conducted in the U.S. either directly or through a dependent agent acting on its behalf.  If AquaDuct Cayman makes use of the offices of AquaDuct U.S. in the United States, such offices may be considered a fixed place of business of AquaDuct Cayman if this use is more than relatively sporadic and infrequent.[142]  Under the Operating Model, it is not contemplated that AquaDuct Cayman will use the offices of AquaDuct U.S. for any business activity. 
Further, it is our understanding that even if AquaDuct Cayman uses the offices of AquaDuct U.S. for business activity, this activity will be sporadic and infrequent, and is not likely to be considered a "material factor" in the realization of income of AquaDuct Cayman.  As long as any activities of AquaDuct Cayman that would take place in the United States are insignificant and administrative in nature, these activities are not likely to provide a significant contribution to the realization of income. 

3.   Management Support Activities by AquaDuct U.S.

AquaDuct U.S. will provide general management oversight to its various foreign subsidiaries under the Operating Model, including AquaDuct Cayman.  The following analysis addresses whether the provision of such management oversight services by AquaDuct U.S. to AquaDuct Cayman may give rise to a U.S. trade or business for AquaDuct Cayman.
Under U.S. domestic tax law, a foreign corporation does not have an office or fixed place of business merely because a person controlling that corporation has an office or fixed place of business from which general stewardship, supervision and control over the policies of the foreign corporation are exercised.  Stewardship includes management functions of the foreign corporation, day-to-day trade or business planning and policy decisions.[143] 
Even if top management decisions affecting AquaDuct Cayman are made in the United States, this alone does not mean that the corporation has a U.S. office or fixed place of business.  For example, officers of AquaDuct Cayman having periodic discussions with officers of AquaDuct U.S. in the United States, occasionally visiting AquaDuct U.S.’s office, or temporarily conducting the business of AquaDuct Cayman out of AquaDuct U.S.’s offices during those visits are facts that do not necessarily indicate a U.S. trade or business.[144]  In contrast to stewardship activities, management of AquaDuct Cayman’s day-to-day operations within the United States would be evidence of a U.S. trade or business.
In summary, as long as AquaDuct U.S. in its capacity as corporate parent corporation, provides only general management support to AquaDuct Cayman it is not likely that AquaDuct Cayman is considered to have a U.S. trade or business.  Under the Operating Model, board meetings and day-to-day management of AquaDuct Cayman, AquaDuct Singapore, and the AquaDuct Subsidiaries and Branches should not be conducted from the United States.

4.   Other Support Activities by AquaDuct U.S.

Under the Operating Model, it is contemplated that AquaDuct U.S. will provide various support services to AquaDuct Cayman from time to time.  These support services are more fully described above, but broadly include operational support services, which include demand forecasting and quality assurance, strategic marketing planning and materials, assistance in accounting, human resources and legal matters and other general and administrative services.  AquaDuct U.S. is compensated by AquaDuct Cayman for providing these services on an arm's length basis.
Most of the above-mentioned services (such as assistance in accounting, human resources, legal matters and other general and administrative services) can arguably be viewed as ancillary business activities, which alone are not likely to create a U.S. trade or business as long as they do not encompass day-to-day management decision-making and as long as all services are properly compensated on an arm’s length basis, as planned under the Operating Model.  Furthermore, as discussed above, AquaDuct U.S., in its capacity as the ultimate parent of the AquaDuct group, can provide policy formulation, direction, and supervision of group activities without exposing AquaDuct Cayman to a risk of a U.S. trade or business.
In summary, the contemplated support services alone are not likely to cause AquaDuct Cayman to have a U.S. trade or business.  However, AquaDuct U.S. and AquaDuct Cayman should ensure that such services do not in fact involve day-to-day management of AquaDuct Cayman’s business and that AquaDuct U.S. is fully remunerated by AquaDuct Cayman on an arm’s length basis for these services, as planned under the Operating Model.

5.   Cost Sharing Arrangement

AquaDuct U.S. and AquaDuct Cayman, have entered into a Cost Sharing Agreement effective from March 1, 2007, under the terms of which AquaDuct U.S. and AquaDuct Cayman will share the research and development costs for developing any new IP.  Since some research and development activities will be physically conducted in the United States (in addition to the R&D activities to be performed in India by AquaDuct India and in Sweden by AquaDuct Sweden), an issue arises as to whether such research and development activities in the United States could expose AquaDuct Cayman to a risk of a U.S. trade or business.
Generally, such regular business activities in the United States may give rise to a U.S. trade or business exposure.  However, Treas. Reg. § 1.482-7(a)(1) specifically provides that “a participant (in a Cost Sharing Agreement) that is a foreign corporation or nonresident alien individual will not be treated as engaged in trade or business within the United States solely by reason of its participation in such a cost sharing arrangement.”[145]  Accordingly, the Cost Sharing Agreement per se will not give rise to a U.S. trade or business for AquaDuct Cayman.

6.   Combination of Services Provided by AquaDuct U.S.

Any of the individual activities of AquaDuct U.S. may not create a U.S. trade or business for AquaDuct Cayman.  However, based on the actual activities performed in the future under the Operating Model, there is at least some risk that the U.S. federal income tax authorities could argue that the combination of the activities described above, as well as other future activities, if any, may give rise to a U.S. trade or business based on an argument that such activities in totality may indicate that AquaDuct Cayman has a fixed place of business in the United States from which it partly carries on its business.  We have included guidelines in Appendix 2 that should be followed that may reduce the risk of creating a U.S. trade or business.

7.   U.S. Material Participation

With regard to the sale of products by AquaDuct Cayman to AquaDuct U.S. for onsale to customers in the United States, income from AquaDuct Cayman's sale of inventory sourced outside the United States will be considered U.S. source, effectively connected income if AquaDuct Cayman is found to have an office or other fixed place of business within the United States to which the sales are attributable.[146]  Because the products sold by AquaDuct Cayman to AquaDuct U.S. are sold for use inside the United States, the general title passage rule described above is superseded by the participation of a U.S. trade or business in the sale.[147]  The sales will be "attributable" to an office or other fixed place of business within the United States only if the office or fixed place of business is a material factor in the production of the income, and only if such office regularly carries on activities related to the production of that income.[148] 
Sale of products by AquaDuct Cayman to AquaDuct U.S. will be made pursuant to purchase orders issued by AquaDuct U.S. and accepted by AquaDuct Cayman.  Therefore, any negotiation of terms and conclusion of the sales contracts will be done outside the United States by AquaDuct Cayman.  It is anticipated that AquaDuct U.S. will assist AquaDuct Singapore with supply chain management and quality control functions related to the production of all of AquaDuct Cayman's products.
It is not likely that the supportive activities performed by AquaDuct U.S. on behalf of AquaDuct Cayman rise to the level of a "material factor" in the production of sales income of AquaDuct Cayman.  Therefore, it is not likely that the activities described above would create a U.S. office or other fixed place of business for AquaDuct Cayman. 
 

8.   Foreign Material Participation

Even if AquaDuct Cayman is found to have a U.S. Office or Fixed Place of Business, the office or other fixed place of business in the United States should not be considered to be a material factor in the realization of income from sales of goods for use outside the United States if an office or other fixed place of business which the foreign corporation has outside the United States participates materially in such sales. 
The Code and Treas. Regulations do not specifically define what activities would be deemed to result in “material” participation by a foreign office in a foreign sale.  However, the regulations do provide some guidance as to what the IRS considers material.  For example, if the activities of an office or any other fixed place of business provide for significant contributions, i.e. being an essential economic element, in the realization of any income, gain or loss, the activities would be considered material.[149]  In addition, the following activities alone do not necessarily result in “material” participation in a sale transaction:
a.    the sale is made subject to the final approval of such office or other fixed place of business;
b.    the property sold is held in, and distributed from, such office or other fixed place of business;
c.    samples of the property sold are displayed (but not otherwise promoted or sold) in such office or other fixed place of business;
d.    such office or other fixed place of business is used for purposes of having title to the property pass outside of the United States; or
e.    such office or other fixed place of business performs merely clerical functions incident to the sale.[150]
AquaDuct Cayman, through the activities of the AquaDuct Subsidiaries and Branches, will engage in the following foreign sales and marketing activities:
·       Interact directly with third-party distributors and customers in the non-Americas market.
·       Solicit sales and pursue business development opportunities with existing and potential customers.
·       Review, accept, and approve purchase orders from non-Americas customers.
·       Set terms and conditions for sale of Products to non-Americas customers.
·       Participate with AquaDuct U.S. in setting product pricing.
·       Perform all invoicing and collections functions for non-Americas customers.
·       Manage the non-Americas sales operations, including soliciting sales, directing business development, and negotiation of sales terms, with the assistance of the AquaDuct Subsidiaries and Branches.
·       Provide direct customer support to non-Americas customers through field application engineers (“FAEs”), who work directly with local customers.  The FAEs develop technology expertise in a market segment that is most prominent in their geographic areas.  The FAEs support the customers primarily during the design process.
·       Key management personnel within AquaDuct Cayman’s offices located in Singapore and Taiwan will have pan-regional responsibilities covering the non-Americas market.  This includes the Vice Presidents of Sales and other key management personnel who will be located within Singapore and Taiwan and directly maintain customer relationships.
·       AquaDuct Cayman bears all commercial risks relating to its business within its territory.
Based on the contemplated activities of AquaDuct Cayman to be performed by the AquaDuct Subsidiaries and Branches, as described above, it is likely that AquaDuct Cayman has foreign material participation in its sales to non-U.S. customers. 
In determining whether the goods are sold for use, consumption, or disposition outside of the United States, the Treasury Regulations provide that personal property sold to an unrelated person shall be presumed to have been sold for use, consumption or disposition in the country of destination.  If, however, the taxpayer knew or should have known that its products ultimately would not be used, consumed or disposed of in the country of shipping destination, the taxpayer must determine the country of ultimate use, consumption or deposition of the products or the property would be assumed to be used, consumed or disposed of in the United States and the associated income from these product sales would be subject to U.S. federal income tax, irrespective of whether its foreign offices materially participate in such sales.[151] 
All of AquaDuct's Products are integrated by AquaDuct's customers into significantly more complex products which are then sold to customers in various jurisdictions.  The integration of AquaDuct Products into more complex products manufactured by its customers is likely to be considered use and consumption of the Products in the location in which the manufacturing occurs. 

9.   Conclusion

AquaDuct Cayman will be subject to U.S. corporate taxation only if it has income effectively connected with a trade or business in the United States.  In the event that AquaDuct Cayman’s business operations rises to the level of a U.S. trade or business, AquaDuct Cayman’s non-U.S. sales could become subject to tax in the United States unless it can demonstrate that such sales are foreign destination sales and that a foreign sales office of AquaDuct Cayman materially participates in such sales.  Based on the above analysis, the activities of AquaDuct Cayman, AquaDuct Singapore, and the AquaDuct Subsidiaries and Branches are not likely to create income that is effectively connected with a U.S. trade or business.
As discussed above, the application of the U.S. trade or business rules is a highly factual analysis, and AquaDuct's operational facts must be continuously reviewed for application of these rules.  Additionally, the IRS has recently expressed intent to carefully scrutinize and audit corporate structures that defer income from current U.S. federal income taxation.  To protect against any IRS assertion that AquaDuct Cayman’s business operations create a U.S. trade or business and that AquaDuct Cayman has income effectively connected to such trade or business, AquaDuct Cayman should consider timely filing protective U.S. income tax returns.  This is a protective measure only and would allow AquaDuct Cayman to claim deductions and tax credits against any income that may be deemed to be effectively connected with a U.S. trade or business.
 

Appendix 1 - Legal Entity Organization Chart







Appendix 2 - Business Guidelines
The following are guidelines that would assist in minimizing AquaDuct Cayman's business activities in the United States.
1.    AquaDuct Cayman should not have any U.S.-based employees;
2.    AquaDuct U.S. and AquaDuct Cayman must each be free to make day-to-day business decisions on their own behalf;
3.    Any services performed in the United States for AquaDuct Cayman should be compensated at arm’s length;
4.    Board meetings of AquaDuct Cayman and its subsidiaries and branches should take place outside of the United States;
5.    Day-to-day management of employees of AquaDuct Cayman and the AquaDuct Subsidiaries and Branches must take place outside of the United States (custodial or stewardship functions may take place in the United States);
6.    All sales to non-Americas customers should be negotiated and concluded outside of the United States;
7.    All contracts signed by AquaDuct Cayman and its subsidiaries and branches should be signed outside of the United States;
8.    AquaDuct Cayman should continue to build its operational infrastructure outside of the United States with respect to administration, sales, R&D, and management;
9.    The Cost Sharing Agreement does not grant AquaDuct Cayman a right to sell to customers in the Americas market. However, if such right is granted by AquaDuct U.S. to AquaDuct Cayman in the future, we recommend review of the operations at such time to determine the tax ramifications. 


[1] Treas. Reg. § 301.7701-3(a).  Unless otherwise indicated, all "§" and "section" references are to the Internal Revenue Code of 1986, as amended (the "Code" or "IRC"), and all "Treas. Reg. §," "Temp. Treas. Reg. §, " and "Prop. Treas. Reg. §" references are to the final, temporary, and proposed regulations, respectively, promulgated thereunder (the "Regulations"). All "IRS" or "Service" references are to the Internal Revenue Service. 
[2] Treas. Reg. § 301.7701-3(c)(i).
[3] IRS Notice 98-35, 1998-27 I.R.B. 35, 1998-2 C.B. 32 (Jul. 6, 1998).
[4] Treas. Reg. § 301.7701-3(a).
[5] Treas. Reg. § 301.7701-3(b).
[6] Treas. Reg. § 301.7701-2(a).
[7] §§ 881, 882.
[8] § 957(a).  Under § 951(b), a "U.S. shareholder" is defined as a U.S. person, including a domestic corporation, that owns 10 percent or more of the CFC’s total combined voting power.
[9] §§ 957(a), 958(a) and (b).
[10] §§ 951(a)(1)(A)(i), 952(a)(2), and 954.
[11] § 954(b)(4).  The effective tax rate at the CFC level (not the statutory tax rate) is used for purposes of determining qualification for the high tax exception. The determination is made separately for each item of income. See Treas. Reg. § 1.954-1(d).  An election must be made to exclude an item under the high tax exception.  Treas. Reg. § 1.954-1(d)(1)(i).
[12] § 954(d).
[13]. § 954(d)(1); Treas. Reg. § 1.954-3(a)(1)(i).
[14] Id.
[15] Id.
[16] Id.
[17] Id.
[18] Id.
[19] Treas. Reg. § 1.954-3(a)(2).
[20] Treas. Reg. §§ 1.954-3(b)(1)(i)(b), 1.954-3(b)(1)(ii)(b).
[21] See Ashland Oil v. Commissioner, 95 TC 348, 357 (1990) (the Tax Court observed that “[i]n the absence of a specified technical definition, a statutory term should be given its normal and ordinary meaning” and referred to Black’s Law Dictionary for the definition of “branch”); Vetco, Inc. v. Commissioner, 95 TC 579, 591 (1990) (rejecting the IRS’s assertion that a wholly-owned subsidiary can be a “branch” of a CFC. The IRS claimed that if a subsidiary is economically captive to its CFC shareholder, then such subsidiary is “really no different than a branch within the meaning of section 954(d)(2)”).
[22] See Treas. Reg. § 1.954-3(b)(1)(i)(b) (the “special rules” under Treas. Reg. § 1.954-3(b)(2)(i) must be used to allocate income to a sales branch for purposes of testing the sales branch’s tax rate disparity); Treas. Reg. § 1.954-3(b)(2)(i)(b) (activities treated as performed on behalf of the remainder CFC includes a sales branch’s purchasing or selling of property manufactured by, or purchased and sold by, the CFC).
[23] Treas. Reg. § 1.954-3(b)(1)(i)(b).
[24] See various examples in Treas. Reg. 1.954-3(b)(4).
[25] Treas. Reg. § 1.954-3(b)(2)(i)(e).
[26] Treas. Reg. § 1.954-3(b)(1)(i)(b).
[27] Treas. Reg. § 1.954-3(b)(1)(i)(c).
[28] Treas. Reg. § 1.954-3(b)(4), Example 5.
[29] Treas. Reg. § 1.954-3(b)(1)(ii)(a).
[30] § 954(d)(2); Treas. Reg. § 1.954-3(b)(1)(ii).
[31] Treas. Reg. § 1.954-3(b)(2)(i)(c).
[32] See Treas. Reg. § 1.954-3(b)(4), Example (2).
[33] Treas. Reg. § 1.954-3(b)(1)(ii)(a).
[34] Treas. Reg. § 1.954-3(b)(1)(ii)(b).
[35] Treas. Reg. § 1.954-3(b)(2)(ii)(b).
[36] Treas. Reg. § 1.954-3(b)(2)(ii)(e).
[37] Treas. Reg. § 1.954-3(b)(1)(ii)(c).
[38] See T.A.M.8509004 (Nov. 23, 1984).
[39]  § 954(e); Treas. Reg. § 1.954-4(a).
[40] Id.
[41] Id. 
[42] § 954(c)(1)(A).
[43] § 954(c).
[44] Prop. Treas. Reg. § 1.954-9.  See also Notice 98-11, 1998-6 I.R.B. 18 (Issued January 16, 1998) and Brown Group Regulations (T.D. 9008, July 23, 2002).
[45] § 957(a); § 951(b).
[46] Treas. Reg. § 1.954-3(b)(1)(i)(c).
[47] Treas. Reg. § 1.954-3(b)(1)(i)(b). 
[48] Treas. Reg. § 1.954-3(b)(1)(i)(a).
[49] Treas. Reg. § 1.954-3(b)(1)(i)(b).
[50] The Singapore statutory corporate tax rate is 20 percent for 2007, and 18 percent for tax years beginning on or after January 1, 2008.  For purposes of the analysis in this memorandum, we have used 18 percent as the Singapore statutory tax rate.
[51] Treas. Reg. § 1.954-3(b)(1)(ii).
[52] Treas. Reg. § 1.954-3(b)(1)(ii)(a).
[53] White v. United States, 305 U.S. 281, 292 (1938). Compare Electronic Arts, Inc. v. Commissioner, 118 T.C. 226, 266 (2002).  This case involved the question of whether video games were manufactured by a Puerto Rican subsidiary in Puerto Rico within the meaning of § 954(d)(1)(A), for purposes of qualifying for the possessions tax credit under § 936.  The Tax Court stated “ordinarily, if we do not have a clear authoritative interpretation of this language in § 936(h)(5)(B)(ii) (final flush), then we would examine other Code provisions that use the same language and treat interpretations of any such Code provisions as authoritative, or at least highly persuasive, definitions of this language.”  Electronic Arts, Inc. v. Commissioner, 118 T.C. 226, 242-243 n.9 (2002). 
[54] See, e.g., Commissioner v. Lundy, 516 U.S. 235, 249-50 (1996).  Supreme Court held that “claim” means the same thing in § 6512 as it does in § 6511(a), stating that that “we have been given no reason that Congress meant the term “claim” to mean one thing in § 6511 but to mean something else altogether in the very next section of the statute.  The interrelationship and close proximity of these provisions of the statute presents a classic case for application of the ‘normal rule of statutory construction that identical words used in different parts of the same act are intended to have the same meaning.”  See also Brodzy v. Commissioner, 321 F2d 331, 335 (5th Cir. 1963) (“provisions of the Internal Revenue Code should be interpreted similarly where similar language is used in related code provisions...” and held “wholly worthless” in § 166 to mean the same thing as in § 165).
[55] Treas. Reg. § 1.954-3(a)(2).
[56] Subdivision (ii) refers to the substantial transformation of property rules and subdivision (iii) refers to the manufacture of a product when purchased components constitute part of the property (which provides for either a substantial operations” facts and circumstances test or a safe harbor test that is met where the conversion costs account for 20 percent or more of the total cost of goods sold).
[57] Treas. Reg. § 1.954-3(a)(4)(ii), Ex. 1-3.
[58] Treas. Reg. § 1.954-3(a)(4)(iii).
[59] T.D. 6734, 29 Fed. Reg. 6392 (May 15, 1964).
[60] See, e.g., T.A.M. 8739003 (June 17, 1987) (IRS concluded that the manufacturing branch rule should apply to a CFC principal because “the activities of [an unrelated contract manufacturer] should be considered the activities of [the CFC principal] and [the CFC] should be considered to have engaged in manufacturing outside of its country of incorporation through a branch or similar establishment within the meaning of § 1.954-3(a)(4)”) (Emphasis added).  T.A.M. 8333008 (July 13, 1982) (“the branch rule will apply if [the CFC at issue] is deemed to have substantially transformed personal property in Country Y and if the use of [its contract manufacturer] is considered to have substantially the same tax effect as if it were a wholly owned corporation”) (Emphasis added).  P.L.R. 7612101490A (December 10, 1976) (IRS concluded that if a CFC contract manufacturer’s activities fail to meet the manufacturing exception of Treas. Reg. § 1.954-3(a)(4), then the branch rules will not apply to its activities and the income related thereto; however, if it meets the manufacturing exception by meeting, for example, the “substantial transformation” standard, then  “it becomes of concern whether [the CFC’s] income would be treated as Subpart F income under the 'branch rule' of § 1.954-3(b).”)  Although helpful in showing IRS’s past ruling practices, technical advice memoranda and private letter rulings do not constitute valid precedents.   See § 6110(k)(3).
[61] Rev. Rul. 75-7, 1975-1 C.B. 244.  See also T.A.M. 8333008 (July 13, 1982) and P.L.R. 8739003 (June 17, 1987).
[62] Id.
[63]  97 T.C. at 360-361.
[64]  Id. at 361.
[65] See also Vetco, Inc. v. Commissioner, 95 T.C. 579 (1990) (rejecting a similar IRS contention that a wholly-owned subsidiary of a CFC is a branch or similar establishment thereof by reason of the subsidiary’s “functioning as a contractual manufacturer” and being “economically captive” to the CFC).
[66] November 23, 1984. See a similar discussion in a later IRS Field Service Advice (“F.S.A.”), 1996 WL 33321252, April 30, 1996. 
[67] August 12, 1986.
[68] Based on Rev. Rul. 75-7, 1975-1 C.B. 244, declared obsolete by Rev. Rul. 97-48, 1997-2 C.B. 89.
[69] Treas. Reg. § 1.954-3(b)(1)(ii)(a).
[70] P.L.R. 8645062 was issued mainly to address reorganization and associated IRC § 367 issues.
[71] Treas. Reg. §§ 1.954-3(b)(1)(ii)(b) and 1.954-3(b)(1)(ii)(c).
[72] Treas. Reg. § 1.954-3(a)(4). For this purpose, manufacturing activities of a contract manufacturer (related or unrelated) will be attributed to the CFC. See Rev. Rul. 75-7, 1975-1 C.B. 244; cf., Ashland Oil, Inc. at 348; Vetco, Inc. at 579.
[73] See, e.g., § 954(d); Treas. Reg. § 1.954-3(a).
[74] Electronic Arts v. Comm’r, 118 T.C. 226, 262 (2002).
[75] Id. at 267-68.
[76] Cf. Treas. Reg. § 1.954-2(c)(1)(iv) (exception to foreign base company personal holding company income for active rents applies to income from leasing property as a result of “the performance of marketing functions by such lessor if the lessor, through its own officers and staff of employees, located in a foreign country, maintains and operates an organization”); Treas. Reg. § 1.863-3(c)(1) (expressly does not permit taking into account activities of contract manufacturers for purposes of determining source of income from production and sales activities in the context of inventory sales income apportionment).
[77] Treas. Reg. § 1.954-3(a)(4)(i).
[78] Treas. Reg. § 1.954-3(a)(4)(ii).
[79] 118 T.C. 226.
[80] Id. “Final flush” refers to final flush language.
[81] Id. at 265.
[82] Id at 267-68.  Though having no precedential value, it is worth noting that during the litigation of Limited Inc. v. Comm’r, USTC Docket No. 26618-95, the Tax Court rejected the IRS’s request for summary judgment that, as a matter of law, a CFC was not engaged in manufacturing for purposes of applying the FBCSI rules, where the CFC was involved in some contract manufacturing arrangement and had an oversight role.  This case was eventually tried for § 956 issue, but not the attribution issue addressed in this memorandum. 
[83] See, e.g., Rev. Rul. 75-7.
[84] Id.
[85] 1997-2 C.B. 89.
[86] Id. The IRS also ruled that since the manufacturing did not occur in the country in which the CFC was organized, the CFC would be considered to be conducting manufacturing through a branch for purposes of the “branch rule” of § 954(d)(2).  Such conclusion relating to the “branch rule” was contrary to the Tax Court’s holdings in Ashland Oil v. Comm’r, 95 T.C. 348 (1990) and Vetco, Inc. v. Comm’r, 95 T.C. 579 (1990).  Rev. Rul. 75-7 was later revoked by Rev. Rul. 97-48.
[87] FSA 200220005 (February 5, 2002) (this is the first occasion the IRS stated that the factual background in Rev. Rul. 75-7 actually represented the conditions favorable for attribution, despite the fact that the IRS had already issued several rulings on this issue).
[88] T.A.M. 8333008 (July 13, 1982).
[89] T.A.M. 8509004 (November 23, 1984).
[90] P.L.R. 8413062 (December 29, 1983).
[91] P.L.R. 8749060 (September 8, 1987).
[92] Ashland Oil v. Comm’r, 95 T.C. 348 (1990).
[93] Vetco, Inc. v. Comm’r, 95 T.C. 579 (1990).
[94] 95 T.C. 348.
[95] Id., at 363.
[96] Id., at 360.
[97] Id.
[98] 95 T.C. 579.
[99] Id. at 591.
[100] See, Ashland Oil at 363 and Vetco at 594.
[101] Vetco, at 594 (“because we hold that VOL is not a branch …we do not address whether VOL was engaged in manufacturing).
[102] Prop. Reg. § 1.954-3(a)(4)(i), 63 F.R. 14669-01, 1998-1 C.B. 892, 1998-16 I.R.B. 21 (1998).
[103] See, T.D. 8827, 1999-30 I.R.B. 125.
[104] February 5, 2002.
[105] The second and third sentences of Treas. Reg. § 1.954-3(a)(4)(i).
[106] Treas. Reg. § 1.954-3(a)(4)(ii) and (iii).
[107] The second and third sentences of Treas. Reg. § 1.954-3(a)(4)(i).
[108] Treas. Reg. § 1.954-3(a)(4)(ii) and (iii).
[109] The intercompany service contracts will be between the subsidiaries and AquaDuct Singapore, but for U.S. tax purposes, the agreements will be treated as being with AquaDuct Cayman due to the check-the-box election made by AquaDuct Singapore.
[110] Prop. Treas. Reg. § 1.954-9.  See also Notice 98-11, 1998-6 I.R.B. 18 (Issued January 16, 1998) and Brown Group Regulations (T.D. 9008, July 23, 2002).
[111] § 954(c).
[112] § 954(c)(3)(A)(ii).
[113] Prop. Treas. Reg. § 1.954-9.  See also Notice 98-11, 1998-6 I.R.B. 18 (Issued January 16, 1998) and Brown Group Regulations (T.D. 9008, July 23, 2002).
[114] § 882(a)(1).
[115] See § 864(c)(2) and (3) (only treating U.S. source income as effectively connected and therefore subject to U.S. federal income tax at graduated rates); see also § 864(c)(4)(A) (providing that foreign source income will not be treated as effectively connected).
[116] See e.g., § 861(a)(6).
[117] § 864(c)(4)(B)(iii).
[118] Id.
[119] United States v. Balanovski 236 F.2d 298, 303, 304 (2d Cir. 1956), cert. denied, 352 U.S. 986 (1957).
[120] Lines Thread Co. v. Comr. 265 F.2d 40, 44–45 (9th Cir. 1959), cert. denied, 361 U.S. 827 (1959).
[121] 30 T.C. 618, 633–34 (1958), aff'd , 281 F.2d 646 (6th Cir. 1960).
[122] 50 T.C. 145, 153–54 (1968), acq. 1948–2 C.B. 1, aff'd, 429 F.2d 1209 (2d Cir. 1970), cert. denied, 400 U.S. 1008 (1971).
[123] United States v. Balanovski, 131 F. Supp. 898, 903 (S.D.N.Y. 1955)
[124] Isenbergh, “The ‘Trade or Business' of Foreign Taxpayers in the United States,” 61 TAXES 972, 979 (1983); Postlewaite & Frentzen, International Taxation: Corporate and Individual pp. 2–17–2–19 (2d ed. 1994).
[125] For example, see Lewenhaupt v. Comr., 20 T.C. 151 (1953); Adda v. Comr., 10 T.C. 273 (1948).
[126] De Vegvar v. Comr., 28 T.C. 1055 (1957).
[127] Treas. Reg. § 1.864-6(b)(2)(iii).
[128] Foreign Investors Tax Act of 1966, 89th Cong., 2d Sess., H.R. No. 1450, P.L. 89-809 (reprinted at 1966-2 C.B. 967, 1013).
[129] Treas. Reg. § 1.864-6(b)(2)(iii).
[130] § 864(c)(4)(B)(iii).
[131] Treas. Reg. 1.864-6(b)(3)(i).
[132] See Treas. Reg. § 301.7701-2 et seq.
[133] Treas. Reg. § 1.861-7(c).
[134] Id..
[135] §§ 865(b), 861(a)(6), 862(a)(6), and 863(b).  Treas. Reg. § 1.861-7(c). 
[136] § 863(b).
[137] Treas. Reg. § 1.863-3(a)(1).
[138] Treas. Reg. § 1.863-3(c)(1).
[139] T.D. 8687 (IRB 1996-52), Treas. Reg. §§ 1.863-3(c)(1)(i)(B) and 1.863-3(c)(1)(i)(C).
[140] § 864(c)(4)(B)(iii).
[141] Id.
[142] Treas. Reg. § 1.864-7(b)(2).
[143] Treas. Reg. § 1.864-7(c).
[144] Id.See Treas. Reg. § 1.864-3(b), Example 2 (A foreign corporation, R, did not engage in a trade or business even though R had an office in the U.S. where its chief executive officer spent a substantial portion of the taxable year supervising R’s investment in its U.S. operating subsidiaries); H.R. No. 1450, at 975.
[145] There is some uncertainty as to whether this sentence applies to all cost sharing arrangements or only to qualified cost sharing arrangements.  Logically, it should apply to all cost sharing agreements. In any regard, the Cost Sharing Agreement is intended to be a “qualified cost sharing agreement.”
[146] § 864(c)(4)(B)(iii).
[147] Id.
[148] § 864(c)(5)(B).
[149] Treas. Reg. § 1.864-6(b)(1).
[150] Treas. Reg. § 1.864-6(b)(3).
[151] Treas. Reg. § 1.864-6(b)(3)(ii).

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