New Regulations on Contract Manufacturing and Cost Sharing

What they mean for your company

At the end of 2008, the U.S. Treasury issued two eagerly anticipated sets of regulations addressing contract manufacturing arrangements under the foreign base company sales income rules and cost-sharing arrangements under section 482. These new regulations will require many multinationals to take action within the next several months in order to maintain the benefits of their current structures.

Cost Sharing Regulations

The temporary regulations continue the reliance on the controversial investor model for determining buy-ins and on the upfront allocation and documentation of risk introduced in the proposed cost sharing regulations in 2005. The mostly technical changes in the regulations are generally favorable to taxpayers, with the exception of the tightening of the commensurate with income trigger. The temporary regulations, effective on January 5, 2009, clarify some of the Internal Revenue Service (IRS) positions that will likely have a significant impact on current IRS audits of existing cost sharing and other intangible arrangements.

Transition rules permit companies to apply the 1995 cost-sharing regulations to buy-in transactions prior to the effective date, including payments made after the effective date, as long as new documentation rules are satisfied, the cost-sharing arrangement is amended, and the participants substantially comply with the new rules. Taxpayers have only until July 6, 2009, to satisfy these new requirements.

Contract Manufacturing Regulations

The new contract manufacturing regulations primarily address the treatment of contract manufacturing operations conducted by controlled foreign corporations (CFCs) under the foreign base company sales income rules.

Deloitte's U.S. Tax Alert, released in late December, summarizes the new final and temporary regulations and offers a variety of insights, including:

Why the regulations are helpful by providing guidelines for the use of contract manufacturers.
Qualifying for the substantial contribution test will require analysis of the specific facts surrounding the manufacturing process and comparison with the examples contained in the regulations.
The flexible effective date provisions should give taxpayers an opportunity to assess their current supply chain and determine the activities needed to meet the manufacturing exception under the substantial contribution test.
For CFCs operating through branches outside their country of incorporation, the temporary regulations provide further guidance concerning the application of the §954(d)(2) branch rule that must be taken into account in evaluating the application of the FBCSI (Foreign Base Company Sales Income) provisions to these structures.

To learn more about these two new sets of regulations, download the report attached below, "The New U.S. Cost Sharing Regulations: Past, Present, and Future" and view the complete Contract Manufacturing Tax Alert. To gain additional insights, register to view our Dbriefs Webcasts on these topics.

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