2008-03-23
We recently uploaded a chart of the Electronic Arts case that partially deals with the manufacturing exception for foreign base company sales income. The chart can be found at Electronic Arts. The Tax Court in Electronic Arts did not analyze in detail Treas. Reg. §1.954-3(a)(4). The case was a motion for summary judgment that dealt with both Code §§954 and 936. The rules under these two sections may not have been perfectly in accord with each other. In the opinion, the Tax Court stated:
petitioner's focus on certain language in section 1.954-3(a)(4), Income Tax Regs., overlooks the regulation's requirement that various actions have been done `by' the corporation being evaluated.
By "various actions," the Tax Court seems to mean "manufacturing." Thus, "manufactruing" must be done by the corporation. In the Electronic Arts case, it appeared that Electronic Arts Puerto Rico ("EAPR") legally and beneficially owned the raw materials, the work in process, and the finished products all throughout the manufacturing process. It also appeared that that product purchased was substantially transformed prior to its sale. A literal reading of Treas. Reg. §1.954-3(a)(4) would lead one to believe that EAPR "manufactured" and that the product should have been treated as manufactured "by" EAPR.