Electronic Arts: Taxpayers Appear to Win a Battle on the Subpart F Contract Manufacturing Front
U.S.-based multinational corporations with controlled-foreign-corporation ("CFC") subsidiaries have long used contract manufacturing arrangements to defer U.S. tax on their manufacturing income. This deferral was available because manufacturing income is not subject to current tax under Subpart F (the "Manufacturing Exception"), and for many years the Internal Revenue Service (the "IRS") agreed that the activities of the contract manufacturer may be attributed to the CFC for this purpose.(1) The IRS' much-criticized reversal of its long-held position in 1997,(2) however, cast doubt on the continued viability of contract manufacturing arrangements for Subpart F deferral purposes.(3)
In Electronic Arts v. Commissioner,(4) a case focusing on the possessions tax credit, the Tax Court implicitly held that, on appropriate facts, a contract manufacturing arrangements may be used to access the Manufacturing Exception. Thus, Electronic Arts would appear to represent a significant victory for U.S. multinationals who commission others to manufacture their goods.
Before describing the Tax Court's opinion in greater detail, some background on the possessions tax credit and certain Subpart F rules may be helpful.
Overview of the Possessions Tax Credit
Code Sec. 936 provides a tax credit to an electing domestic corporation that, among other requirements, earns 75% or more of its gross income from "the active conduct of a trade or business within a possession of the United States" ("possessions corporation").(5) Code Sec. 936 does not provide rules for determining whether this active-conduct-of-a-trade-or-business test is satisfied.
The possessions tax credit is based upon the amount of taxable income considered to have been earned by the possessions corporation,(6) it is desirable to maximize the possessions corporation's taxable income.
Code Sec. 936(h) generally requires "intangible property income" to be taxed directly to the shareholders of the possessions corporation, thereby reducing the taxable income of the possessions corporation. A qualifying possessions corporation may elect out of this general rule, however, by electing to compute its taxable income under either a cost-sharing method or a profit split method.(7)
In order to make this election, the possessions corporation must have a "significant business presence" in the possession.(8) A possessions corporation will have the requisite significant business presence if it satisfies a two-prong test. To satisfy the first prong, the possessions corporation must satisfy any of three statutory tests: (1) a 25%-value-added test, (2) a direct-labor-production test, or (3) a direct-labor test for purchases and resales.(9)
A possessions corporation electing to compute its taxable income under the profit-split method must also satisfy a second prong of the significant-business-presence test:
"Notwithstanding satisfaction of one of the foregoing tests, an electing corporation shall not be treated as having a significant business presence in a possession with respect to a product produced in whole or in part by the electing corporation in the possession, for purposes of an election to use the method specified in subparagraph (C)(ii) [the profit-split method], unless such product is manufactured or produced in the possession by the electing corporation within the meaning of subsection (d)(1)(A) of section 954."(10)
The significance of this second prong is discussed below.
Overview of the Subpart F Rules
As noted above, a U.S. shareholder(11) of a CFC(12) is subject to current U.S. tax on its pro rata share of the CFC's Subpart F income, which includes most passive income (e.g., interest, dividends and capital gains), as well as FBCSI.(13) Code Sec. 954(d)(1) generally defines FBCSI as follows.
"(1) In general. -- For purposes of subsection (a)(2), the term 'foreign base company sales income' means income (whether in the form of profits, commissions, fees, or otherwise) derived in connection with the purchase of personal property from a related person and its sale to any person, the sale of personal property to any person on behalf of a related person, the purchase of personal property from any person and its sale to a related person, or the purchase of personal property from any person on behalf of a related person where
(A) the property which is purchased (or in the case of property sold on behalf of a related person, the property which is sold) is manufactured, produced, grown, or extracted outside the country under the laws of which the controlled foreign corporation is created or organized, and
(B) the property is sold for use, consumption, or disposition outside such foreign country, or, in the case of property purchased on behalf of a related person, is purchased for use, consumption, or disposition outside such foreign country.
For purposes of this subsection, personal property does not include agricultural commodities which are not grown in the United States in commercially marketable quantities."
Thus, FBCSI includes, among other things, certain gains from purchases and sales of personal property where either the purchase or sale transaction is with a related person. Pursuant to Sec. 954(d)(1)(A), however, FBCSI does not include gain from the sale of property manufactured in the country in which the CFC is organized. This exception (the "Same Country Exception") applies regardless of whether the CFC or another entity performs the manufacturing activity.
Reg. Sec. 1.954-3(a)(4)(i) provides in part that FBCSI "does not include income of a controlled foreign corporation 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." This Manufacturing Exception is implicit in Code Sec. 954(d)(1), but is expressly set forth only in the regulations.
The Electronic Arts Decision
Background
Electronic Arts, Inc. and its subsidiaries (collectively, "EA") developed, marketed and distributed standardized video game cartridges (video games) for entertainment systems and personal computers. Prior to the years at issue (fiscal years ended March 31, 1993, 1994 and 1995), EA relied on unrelated manufacturers in Taiwan and Japan to manufacture its video games. In 1992, Electronic Arts Puerto Rico, Inc. ("EAPR") was formed as a subsidiary of EA to manufacture video games and other software entertainment products in Puerto Rico.
EAPR entered into a commercial lease with an unrelated company, Power Parts, Inc. ("PPI"), relating to a portion of PPI's facilities in Puerto Rico. EAPR and PPI also entered into a Manufacturing Services Agreement (the "Agreement") pursuant to which EAPR ordered and provided all materials, components and equipment required for the manufacture of the video games, and PPI provided leased employees to EAPR.
The Agreement provided, among other things, as follows:
"All employees leased by PPI hereunder shall be located in the Premises leased by EAPR from PPI and shall be under the general supervision of EAPR. EAPR shall also supervise and control all technical and product-related training required by such employees. EAPR shall have the right to locate its own employees in the building space leased by it from PPI for the purpose of overseeing and directing the work of the employees leased to it by PPI. . . ."(14)
EAPR employed a manager who at all times during the years at issue worked in the leased facility. During most of the period at issue, the manager was Orlando Alvarado. Mr. Alvarado supervised PPI employees who worked on inventory control and saw to it that they entered the correct data into the computer. He generally did not deal directly with the assembly line operation, but if he saw mistakes being made, he saw to it that they were corrected. Mr. Alvarado made a declaration stating as follows:
"In general I did not deal with the assembly line operation, since this was handled by PPI. However, if I saw a mistake being made, then I would see to it that it got corrected. My basic function in regard to the assembly work was to watch out for EA's interests. However, PPI handled the daily production requirements and PPI scheduled the employees, assigned positions to them, handled things on the assembly floor, took care of sick leave and other personnel problems. If things were going wrong, then PPI would call me in for assistance. Otherwise, PPI handled everything."(15)
At all times during the manufacturing process, EAPR owned all raw materials and components, work in progress, inventory, and finished products.
EAPR claimed the possessions tax credit for the years at issue and elected to compute its taxable income using the profit-split method referred to above. The IRS (1) disallowed the credit generally, on the ground that EAPR was not engaged in the conduct of an active trade or business in Puerto Rico, and (2) challenged EAPR's qualification for use of the profit-split method. The taxpayers filed a motion for partial summary judgment, contending that EAPR (1) was engaged in the active conduct of a trade or business in Puerto Rico, entitling it to the possessions tax credit under Sec. 936, and (2) had a significant business presence in Puerto Rico with respect to the manufacture of video games, entitling it to compute its taxable income under the profit-split method.
The Tax Court's Analysis
Active Conduct of a Trade or Business
The Tax Court held that EAPR was engaged in the active conduct of a trade or business in Puerto Rico,(16) relying heavily on its analysis in Medchem, Inc. v. Commissioner.(17)
In Medchem, a domestic corporation (MedChem) purchased a drug-manufacturing business from an unrelated company (Alcon) that had previously manufactured the drug in Puerto Rico. Following the purchase, MedChem and Alcon entered into a contract manufacturing arrangement pursuant to which MedChem supplied the raw materials and equipment, but took no managerial role in the manufacturing process (and was contractually prohibited from assuming any such role). At issue was whether MedChem was engaged in the active conduct of a trade or business in Puerto Rico for purposes of the possessions tax credit.
The Tax Court set forth the applicable standard as follows:
"In light of Congress' intent for section 936, the Secretary's interpretations of the subject phrase for purposes of other sections of the Code, and the Supreme Court's interpretation of the phrase 'trade or business' in section 162(a), we believe that, for purposes of section 936(a), a taxpayer actively conducts a trade or business in a U.S. possession only if it participates regularly, continually, extensively, and actively in the management and operation of its profit-motivated activity in that possession. We also believe that, for the purpose of this participation requirement, the services underlying a manufacturing contract may be imputed to a taxpayer only to the extent that the performance of those services is adequately supervised by the taxpayer's own employees."(18)
Emphasizing that MedChem "lacked any operational or directional control" over the manufacturing process, and that all of the business activities connected to Avitene were directed and controlled by Alcon and MedChem's parent corporation (from the U.S.), the Tax Court held that MedChem did not qualify as engaged in the active conduct of a trade or business in Puerto Rico; implicitly, the Tax Court held that Alcon's manufacturing activities could not be attributed to MedChem.(19)
In Electronic Arts, the Tax Court observed that, in contrast with MedChem's extremely limited role with respect to the manufacture of Avitene, "EAPR, through its manager, participated regularly, continually, extensively, and actively in the management and operation of the manufacturing of video games in Puerto Rico."(20) Accordingly, the Tax Court held that EAPR was engaged in the active conduct of a trade or business in Puerto Rico for purposes of Sec. 936.(21)
The Tax Court's opinion does not expressly state that EAPR satisfied this test through attribution of the activities of PPI, but this is implicit in the analysis, and the contentions of the parties were expressly framed in terms of whether or not attribution is permissible.
Significant Business Presence
The principal issue raised under the significant-business-presence test was whether EAPR satisfied the second prong's manufacturing requirement.(22) As noted above, the second prong precludes a possessions corporation from computing its income under the profit-split method, with respect to a product produced in whole or in part by the electing corporation in the possession, unless "such product is manufactured or produced in the possession by the electing corporation within the meaning of subsection (d)(1)(A) of section 954."(23)
Code Sec. 954(d)(1)(A), which sets forth the Same Country Exception described above, is concerned solely with the place of manufacture. Nevertheless, the Tax Court framed the critical issue as whether EAPR was the manufacturer within the meaning of Code Sec. 954(d)(1)(A).(24) Of course, EAPR can be considered the manufacturer of the video games at issue only if the activities of the leased employees are imputed to it.(25)
Preliminarily, the Tax Court declined to address authorities interpreting manufacturing and production requirements under other Code provisions, on the ground that short, common terms such as "manufactured" or "produced" have no uniform generalized meaning in the Code.(26) Instead, the Tax Court focussed on the legislative history underlying Code Secs. 936 and 954. On this basis, the Tax Court implicitly concluded that attribution is not per se prohibited.
"Our examination of (1) section 936(h)(5)(B)(ii) and the legislative history of that provision's enactment in 1982, and (2) section 954(d)(1)(A) and the legislative history of that provision's enactment in 1962, convinces us that there is not an 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 sections 936(h)(5)(B)(ii) (final flush) and 954(d)(1)(A)."(27)
Notably, the legislative history underlying Code Secs. 936 and 954 neither expressly, nor by clear implication, addresses contract manufacturing arrangements. Presumably, the Tax Court found the absence of any express prohibition on attribution to be significant.(28)
Having implicitly held that the activities of a contract manufacturer may be attributed to the taxpayer in appropriate circumstances, the Tax Court next considered whether, on the facts presented, the manufacturing activities of PPI should be attributed to EAPR. The Tax Court essentially "punted" on this issue; it invited the parties to propose a standard for determining when attribution should be permitted, and to develop any facts required to apply that standard.
"In light of our rejection of both sides' views of the law, we conclude that proper evaluation of the merits of the instant cases requires a fuller development of the facts and perhaps a fuller exposition of the law consistent with the views we have expressed in this opinion. Under these circumstances, we conclude that petitioners have failed to carry their burden of proving that they are entitled to summary judgment as to the second prong."(29)
Thus, the Tax Court denied the taxpayers' motion for summary judgment as to the significant-business-presence issue.
Comments on the Tax Court's Decision
Active Conduct of a Trade or Business
The Tax Court's attribution of the activities of leased employees to EAPR for purposes of the active-conduct-of-a-trade-or-business test in Electronic Arts breaks little new ground, since the Tax Court applied the same test it had announced in Medchem, namely, that "the services underlying a manufacturing contract may be imputed to a taxpayer only to the extent that the performance of those services is adequately supervised by the taxpayer's own employees."(30) The Tax Court's application of that test, however, is particularly interesting.
As noted above, the Agreement entered into between EAPR and PPI provided that all of the leased employees would be under the "general supervision" of EAPR, and that EAPR would "supervise and control" all technical and product-related training required by such employees. Nevertheless, EAPR's supervision of PPI's employees, through its manager, Mr. Alvarado, was principally with respect to the inventory control process. Mr. Alvarado generally did not deal with the assembly line operation.
Apparently, Mr. Alvarado's activities were sufficient for the Tax Court to conclude that "EAPR, through its manager, participated regularly, continually, extensively, and actively in the management and operation of the manufacturing of video games in Puerto Rico."(31)
It is not clear whether this conclusion was based solely on Mr. Alvarado's supervision of the inventory control process or whether his supervision of the manufacturing process, though minimal and sporadic, was also a factor. In addition, it is not clear whether the attribution to EAPR extends to all of the services performed by leased employees under the Agreement or only the inventory-control services regularly supervised by EAPR.
In any event, the Tax Court's decision to apply an attribution approach for purposes of the active-conduct-of-a-trade-or-business test may not have any direct impact on whether such approach applies for purposes of the Subpart F Manufacturing Exception.
Significant Business Presence
Under the second prong of the significant-business-presence test, a possessions corporation may compute its taxable income under the profit-split method, with respect to a product produced in whole or in part in the possession, only if the product is "manufactured or produced in the possession by the electing corporation within the meaning of subsection (d)(1)(A) of section 954."(32)
Code Sec. 954(d)(1)(A) provides that income from the sale of personal property will constitute FBCSI (Subpart F income taxable to a CFC's U.S. shareholder) only if:
"the property ... is manufactured, produced, grown, or extracted outside the country under the laws of which the controlled foreign corporation is created or organized[.]"
This provision, the Same Country Exception described above, is concerned solely with the place of manufacture; the identity of the manufacturer is wholly irrelevant. The Tax Court apparently overlooked this technicality, perhaps taking the view that the cross-reference to Code Sec. 954(d)(1)(A) should be interpreted as a broader reference to Code Sec. 954(d)(1) (and the regulations thereunder) with respect to the issue of whether the possessions corporation is the manufacturer.(33)
Such an approach is supported by the regulations promulgated under Code Sec. 936, which provide guidance as to whether a product "is considered to have been manufactured or produced within the meaning of section 954(d)(1)(A) and sec. 1.954-3(a)(4)."(34) In any event, the Tax Court proceeded to consider whether EAPR could be considered the manufacturer of the video games under the rules of the Subpart F Manufacturing Exception.
Like many a proud traveler, the Tax Court was reluctant to ask for directions. As noted above, the Tax Court declined to address various authorities interpreting manufacturing and production requirements under other Code provisions, on the ground that the terms "manufactured" and "produced" have no generalized meaning in the Code.(35) Thus, the Tax Court considered the significant body of case law addressing contract manufacturing arrangements in similar contexts to be irrelevant.
The Tax Court is correct that common terms such as "manufactured" and "produced" have such divergent meanings throughout the Code that it is difficult to reach general conclusions as to the quantum of activity required in order to constitute manufacturing or production.(36) Whether the activities of a contract manufacturer may be imputed to a taxpayer for purposes of determining if the taxpayer is a manufacturer, however, is an entirely separate question from the definition of manufacturing (or producing) in any given case. It is not at all clear from the Tax Court's opinion why there should not (or could not) be a generalized approach to attributing activities performed in connection with contract manufacturing, as opposed to determining whether certain activities are sufficient to constitute manufacturing (or production).(37)
In any event, Electronic Arts is an important decision because the Tax Court emphatically rejected the proposition that activities of a contract manufacturer cannot be attributed to a taxpayer for purposes of Code Secs. 954(d)(1) and 936(h)(5)(B)(i).(38) Implicitly, then, the Tax Court appears to have held that a properly structured contract manufacturing arrangement may be used to access the Manufacturing Exception, because the activities of the contract manufacturer will be attributed to a CFC on appropriate facts.
Curiously, Electronic Arts provides no guidance as to the specific type of fact pattern required in order for attribution to apply. Rather, the Tax Court essentially asked the parties to think about it and come up with some good ideas.
"In light of our rejection of both sides' views of the law, we conclude that proper evaluation of the merits of the instant cases requires a fuller development of the facts and perhaps a fuller exposition of the law consistent with the views we have expressed in this opinion."(39)
Apparently, the parties were so intent on establishing per se rules that neither addressed to the Tax Court's satisfaction the issue of when attribution should be permitted (or prohibited) under a facts-and-circumstances approach. The Tax Court's exercise of prudence is understandable, but the absence of even very general guidance is still somewhat disappointing.
Conclusion
In Electronic Arts, the Tax Court rejected the proposition that activities of a contract manufacturer cannot be attributed to a taxpayer for purposes of Code Secs. 954(d)(1) and 936(h)(5)(B)(i). Implicitly, then, the Tax Court reasoned that a properly structured contract manufacturing arrangement may be used to access the Manufacturing Exception. This result would represent a significant victory for U.S.-based multinationals seeking to access the Manufacturing Exception, and should not be overlooked merely because the issue ultimately decided was the availability of the possessions tax credit.
Unfortunately, no further guidance was provided by the Tax Court as to how a contract manufacturing arrangement must be structured to access the Manufacturing Exception. Stay tuned.
FOOTNOTES____________________
1. Rev. Rul. 75-7, 1975-1 CB 244. Pursuant to Subpart F of the Internal Revenue Code of 1986, as amended (the "Code"), a U.S. shareholder of a CFC is subject to current U.S. tax on its pro rata share of the "Subpart F income" earned by the CFC. Code Sec. 951(a). Subpart F income includes most passive income (e.g., interest, dividends and capital gains), as well as "foreign base company sales income" ("FBCSI"). Code Secs. 952(a)(2) & 954. As discussed in greater detail below, FBCSI includes certain income from purchases and sales of goods where either the original seller or the ultimate purchaser is related to the CFC. Pursuant to the Manufacturing Exception, FBCSI does not include income from sales of goods manufactured by the CFC. Reg. Sec. 1.954-3(a)(4)(i).
2. Rev. Rul. 97-48, 1997-2 CB 89.
3. For a recent review of various authorities supporting the continued viability of such arrangements, see Levine et al. "Accessing the Manufacturing Exception to Subpart F Through Contract Manufacturing Arrangements," 1 Journal of Taxation of Global Transactions 37 (2001).
4. Electronic Arts, Inc., 118 T.C. 226, Dec. 54,680 (2002).
5. For this purpose, Puerto Rico is considered a possession of the United States. Code Sec. 936(d)(1).
6. Code Sec. 936(a).
7. Code Sec. 936(h)(5)(A) & (C).
8. Code Sec. 936(h)(5)(B)(ii).
9. "For purposes of this subparagraph, an electing corporation has a 'significant business presence' in a possession for a taxable year with respect to a product or type of service if:
(I) the total production costs (other than direct material costs and other than interest excluded by regulations prescribed by the Secretary) incurred by the electing corporation in the possession in producing units of that product sold or otherwise disposed of during the taxable year by the affiliated group to persons who are not members of the affiliated group are not less than 25 percent of the difference between (a) the gross receipts from sales or other dispositions during the taxable year by the affiliated group to persons who are not members of the affiliated group of such units of the product produced, in whole or in part, by the electing corporation in the possession, and (b) the direct material costs of the purchase of materials for such units of that product by all members of the affiliated group from persons who are not members of the affiliated group; or
(II) no less than 65 percent of the direct labor costs of the affiliated group for units of the product produced during the taxable year in whole or in part by the electing corporation or for the type of service rendered by the electing corporation during the taxable year, is incurred by the electing corporation and is compensation for services performed in the possession; or
(III) with respect to purchases and sales by an electing corporation of all goods not produced in whole or in part by any member of the affiliated group and sold by the electing corporation to persons other than members of the affiliated group, no less than 65 percent of the total direct labor costs of the affiliated group in connection with all purchases and sales of such goods sold during the taxable year by such electing corporation is incurred by such electing corporation and is compensation for services performed in the possession." Code Sec. 936(h)(5)(B)(ii).
10. Code Sec. 936(h)(5)(B)(ii) (flush language; emphasis added).
11. For this purpose, a U.S. shareholder is a U.S. person that, directly, indirectly or by application of certain attribution rules, owns at least 10% of the voting stock of the foreign corporation. Code Sec. 951(b).
12. A CFC is a foreign corporation a majority of the shares of which (measured by either vote or value) are owned by U.S. shareholders. Code Sec. 957(a).
13. Code Secs. 951(a), 952(a)(2) & 954.
14. Electronic Arts, supra at note 4.
15. Electronic Arts, supra at note 4.
16. A threshold issue was presented as to where the video games were considered to be manufactured. The IRS had stipulated the place of manufacture to be Puerto Rico, but argued on brief that the video games were manufactured in the Dominican Republic. The Tax Court bound the IRS to its stipulation, finding there to be no genuine issue of fact as to the place of manufacture.
17. 116 T.C. 308 (2001) ("Medchem").
18. Medchem at 336-337 (emphasis added; citations omitted).
19. Medchem at 338-343.
20. The Tax Court also observed that the formation of EAPR and the contract manufacturing arrangement between EAPR and PPI transferred to Puerto Rico manufacturing operations that had previously been conducted in Asia, whereas MedChem's purchase of a Puerto-Rico-based drug-manufacturing business and entry into a contract manufacturing arrangement with the seller of that business did not affect what happened "on the ground" in Puerto Rico. Electronic Arts, supra at note 4.
21. The Tax Court also drew guidance from, and considered its holding consistent with, case law interpreting rules applicable to "Western Hemisphere Trading Corporations" ("WHTCs"). See Frank v. International Canadian Corp., 308 F.2d 520 (9th Cir. 1962); Babson Brothers Export Co. v. Commissioner, T.C. Memo. 1963-144. Under Sec. 109(b) of the 1939 Internal Revenue Code, a domestic corporation qualified for a corporate surtax exemption if, among other requirements, it was engaged in "the active conduct of a trade or business."
22. As noted above, the IRS initially stipulated that the video games at issue were manufactured in Puerto Rico, but later attempted to argue that the video games were manufactured at least partly in the Dominican Republic. Based upon this new perspective, the IRS argued that the first prong of the significant-business-presence test might not be satisfied because some of the direct labor costs claimed to have been incurred in Puerto Rico were in fact incurred in the Dominican Republic. The Tax Court dismissed this contention since, as noted above, it bound the IRS to its stipulation.
23. Code Sec. 936(h)(5)(B)(ii) (flush language; emphasis added).
24. "This leaves the second prong as the only bone of contention on this issue, whether EAPR satisfies the requirement that the video games were 'manufactured or produced' in Puerto Rico 'by' EAPR 'within the meaning of subsection (d)(1)(A) of section 954." Electronic Arts, supra at note 4.
25. Ironically, the IRS argued that the Tax Court should not take into account Rev. Rul. 75-7, 1975-1 CB 244 (which had not yet been revoked during the years at issue), on the ground that revenue rulings represent only the IRS's position on a specific set of facts, rather than substantive authority.
26. Electronic Arts, supra at note 4, citing Spalding v. Commissioner, 66 T.C. 1017, 1021 (1976) ("Spalding").
27. Electronic Arts, supra at note 4 (emphasis added). Viewed in a vacuum, the language above would appear to say nothing about the Manufacturing Exception, since that exception is derived from the language of Code Sec. 954(d)(1), but not Code Sec. 954(d)(1)(A). As noted above, however, the Tax Court apparently treated the reference to Code Sec. 954(d)(1)(A), set forth in Code Sec. 936(h)(5)(B)(ii), as a broader reference to Code Sec. 954(d)(1). If the language above were treated as limited solely to Code Sec. 954(d)(1)(A), such language -- and, indeed, the Tax Court's entire analysis of the significant-business-presence issue -- would be wholly meaningless. As noted above, the IRS stipulated that the video games at issue were manufactured in Puerto Rico, and the Tax Court held early on in its opinion that the IRS was bound by this stipulation. The only significant issue was whether EAPR could be considered the manufacturer, and of course this depended entirely on whether the activities of the leased employees could be attributed to EAPR.
28. With respect to the legislative history of Code Sec. 936, the Tax Court stated: "We are at a loss to understand how the foregoing advances the thesis of that part of respondent's brief, that 'Attribution is contrary to the legislative history and the purpose behind the enactment of section 936.'" Electronic Arts, supra at note 4.
29. Electronic Arts, supra at note 4.
30. Medchem at 337.
31. Electronic Arts, supra at note 4.
32. Code Sec. 936(h)(5)(B)(ii) (flush language; emphasis added).
33. Alternatively, one might conclude that the intention was to incorporate the rules of Code Sec. 954(d)(1) only for purposes of determining where the manufacturing activity takes place.
34. Reg. Sec. 1.936-5(b)(6), Q&A-1 (emphasis added).
35. See Electronic Arts, supra at note 4, citing Spalding at 1021.
36. However, we note, as other commentators have noted, that the language of Code Sec. 263A, which applies to tangible property produced "by the taxpayer", is similar to the language in Reg. Sec. 1.954-3(a)(4)(i), which requires that personal property be manufactured "by such corporation" in order for the Manufacturing Exception to apply. See James P. Fuller, "U.S. Tax Review," 26 Tax Notes International 489, 494 (Apr. 29, 2002).
37. A number of authorities that support attribution of contract-manufacturer activities are reviewed in Levine et al. "Accessing the Manufacturing Exception to Subpart F Through Contract Manufacturing Arrangements," 1 Journal of Taxation of Global Transactions 37 (2001). The Tax Court cited this article, but noted that it did not address (1) variations in statutory language or (2) the analysis in Spalding. The Tax Court's abbreviated critique appears to miss the mark, however, since the article does not purport to provide a uniform definition of manufacturing or production, but rather provides support for attributing the activities of a contract manufacturer. As noted above, the quantum of activity required to constitute manufacturing or production is a separate issue from whether the activities of a contract manufacturer should be imputed to the taxpayer.
38. As noted above, the Tax Court concluded that "there is not an 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 sections 936(h)(5)(B)(ii) (final flush) and 954(d)(1)(A)." Electronic Arts, supra at note 4. As also noted above, the Tax Court apparently took the view that the reference to Code Sec. 954(d)(1)(A) should be interpreted as a broader reference to Code Sec. 954(d)(1).
39. Electronic Arts, supra at note 4 (emphasis added).