CCA 200029034: Export receipts depend on when assigned contracts were shipped

Plain-English summary

A company acquired export sales contracts from an unrelated manufacturer and later received deferred contract payments and warranty or repair income. Chief Counsel advised that receipts for products shipped by the seller before the assignment were not foreign trading gross receipts of the buyer under section 924. Receipts for products shipped by the buyer after acquiring the contracts, including related services, could qualify if the foreign sales corporation requirements were met. Use of section 925's administrative commission pricing also depended on performing and properly accounting for required sales activities. The memorandum called for additional factual work and did not resolve other export-property or government-sale issues.

Ruling snapshot

• Question: Which acquired-contract receipts qualify as foreign trading gross receipts and for administrative commission pricing?
• Outcome: Advice given: pre-assignment shipments fail; later shipments may qualify if the stated requirements are met.
• Key authorities: IRC §§ 924, 925, and 927; Temp. Treas. Reg. § 1.924(a)-1T(b).

Full text (IRS public release)

                              DEPARTMENT OF THE TREASURY
                                I N T E R N AL R E V E N U E S E R V I C E
                                     WASHINGTON, D.C. 20224




Number: 200029034
Release Date: 7/21/2000
CC:INTL:Br6
TL-N-6337-99

UILC: 924.01-00

 INTERNAL REVENUE SERVICE NATIONAL OFFICE FIELD SERVICE ADVICE

DATE:                April 19, 2000

MEMORANDUM FOR BETTIE N. RICCA
               ASSOCIATE DISTRICT COUNSEL
               DELAWARE-MARYLAND DISTRICT, WASHINGTON, D.C.
               CC:SER:DEM:WAS
               Attention: Karen Chandler, Special Litigation Assistant

FROM:                Jacob Feldman
                     Special Counsel, CC:INTL

SUBJECT:



       This Field Service Advice responds to your memorandum dated November 8,
1999. Field Service Advice is not binding on Examination or Appeals and is not a
final case determination. This document is not to be used or cited as precedent.

LEGEND

Corp A                    =


Corp A-FSC                =


Corp B                    =

Country A                 =

Date 1                    =

                                          2
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Date 2                    =

Predecessor               =

Product                   =

Purchaser                 =

Subsidiary 1              =

Tax Year 1                =
Tax Year 2                =
Tax Year 3                =

Year 1                    =
Year 2                    =
Year 3                    =
Year 4                    =

ISSUES

       1. Whether income (including warranty and repair income) received by Corp
A with respect to export sales of the Product to Purchaser under contracts acquired
from Corp B, an unrelated entity, constitutes foreign trading gross receipts of Corp
A within the meaning of I.R.C. § 924, where some sales of the Product had been
shipped to the Purchaser by Corp B prior to Corp A’s acquisition of the contracts.

      2. Whether Corp A may use the administrative pricing rules of I.R.C.
§ 925(a) in determining commissions payable by Corp A to Corp A-FSC with
respect to foreign trading gross receipts from export sales of the Product to the
Purchaser.

CONCLUSIONS

       1. Corp A’s receipts with respect to the Product under contracts acquired
from Corp B do not generate foreign trading gross receipts where Corp B shipped
the Product prior to assignment of such contracts to Corp A. Temp. Treas. Reg.
§ 924(a)-1T(b). However, receipts with respect to sales in which the Product was
shipped by Corp A after its acquisition of the contracts, including receipts from
“related and subsidiary” services, may constitute foreign trading gross receipts,
provided that Corp A is found to have met all other requirements of the FSC
provisions, including performance of the foreign economic processes required
under sections 924(d) and 924(e).

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       2. Corp A may use the administrative pricing rules of section 925(a) in
determining commissions payable to Corp A-FSC with respect to any foreign
trading gross receipts from sales of Product shipped to Purchaser by Corp A after
acquiring the contracts from Corp B, but only if Corp A is found to have performed
the activities required under section 925(c).

FACTS

        Corp A, the taxpayer, is a domestic corporation. Corp A-FSC is a wholly-
owned subsidiary of Corp A, incorporated in Country A on Date 1, and acts as a
commission agent for Corp A's export sales. Subsidiary 1 is a wholly-owned
domestic subsidiary of Corp A. For all tax years at issue, Corp A-FSC had in place
a valid election to be treated as a foreign sales corporation (FSC) pursuant to
sections 922(a)(2) and 927(f)(1) and in all other respects continuously maintained
its status as a FSC as defined in section 922(a). Pursuant to service and
commission agreements, Corp A and Subsidiary 1 undertake to perform on behalf
of Corp A-FSC, and bill Corp A-FSC for, the foreign economic processes and
activities required under sections 924(d) and 924(e) with respect to sales
generating foreign trading gross receipts within the meaning of section 924(a).
These agreements also obligate Corp A and Subsidiary 1, as related suppliers, to
pay to Corp A-FSC the largest commission permitted for Federal income tax
purposes.

      The Product was originally developed and manufactured by Corp B, an
unrelated domestic corporation. Between Years 1 and 3, Corp B entered into
several contracts of sale with respect to the Product with Purchaser, an
instrumentality of the United States government. Pursuant to these contracts, Corp
B shipped the Product to the Purchaser between Years 2 and 4. On Date 2 (before
the beginning of Year 4), Corp A 1 acquired from Corp B all contracts and other
assets and liabilities related to the production of the Product. Subsequently, during
Tax Years 1, 2 and 3, the Purchaser paid to Corp A portions of the contract price
whose calculation had been deferred under Corp B's accounting method and the
formulas set forth in the contracts. The Purchaser also paid Corp A for Product
warranty and repair services that Corp A had assumed in the acquisition.

       In its original income tax returns filed for Tax Years 1, 2 and 3, Corp A did
not claim deductions for commissions payable to Corp A-FSC with respect to sales


      1
          You have advised us that the taxpayer that made this acquisition and filed the
original returns under audit was Predecessor, and that Corp A has succeeded to all of
Predecessor’s Federal tax attributes as the surviving entity in a subsequent corporate
reorganization. All references to Corp A in this memorandum are to be understood as
including both Corp A and Predecessor.

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of the Product or related services. Subsequently, however, Corp A determined that
the Purchaser used the Product outside the United States for the period of time
required by Temp. Treas. Reg. § 1.927(a)-1T(d)(4)(iii). See Temp. Treas. Reg.
§ 1.924(a)-1T(g)(2). Pursuant to Temp. Treas. Reg. § 1.925(a)-1T(e)(4), Corp A
now claims refunds of income taxes based on a redetermination of its commissions
payable to Corp A-FSC for Tax Years 1, 2 and 3, based on adding the sales of the
Product to those reported as eligible for FSC benefits. This claim is grounded on
Corp A's position that the Product constitutes export property within the meaning of
section 927(a) and that receipts from sale of the Product and related services
constitute foreign trading gross receipts within the meaning of section 924(a). In
computing commissions on the additional claimed foreign trading gross receipts,
Corp A seeks to use the administrative pricing rules of section 925(a).

LAW AND ANALYSIS

I. Qualification as Foreign Trading Gross Receipts

       The FSC provisions provide a partial exemption of income attributable to
“foreign trading gross receipts.” I.R.C. §§ 921(a), 923(a)(1), 923(b). Subject to the
foreign economic processes requirements discussed below, foreign trading gross
receipts generally include gross receipts received by a principal for whom a FSC
acts as a commission agent from the sale, lease, exchange or other disposition of
export property and for services related and subsidiary to such sale. I.R.C.
§§ 924(a)(1), 924(a)(3)(A), 925(b)(1); Temp. Treas. Reg. § 1.924(a)-1T(a), (b).

       Section 927(a) generally defines export property as property manufactured,
produced, grown, or extracted in the United States; held primarily for sale or lease
in the ordinary course of business by or to a FSC for direct use, consumption or
disposition outside the United States; and not more than 50 percent of the fair
market value of which is attributable to articles imported into the United States.
Your submission is limited to certain issues regarding the definition of foreign
trading gross receipts and does not raise any issue that may exist regarding the
qualification of the Product as export property as defined in section 927(a). Solely
for purposes of this advice, we assume that the Product is export property.

       Under section 924(f)(1)(A)(ii), certain sales of export property to the United
States government are excluded from status as foreign trading gross receipts. We
understand that the applicability of this provision to Corp A's sales of the Product is
at issue in this examination of the taxpayer but is not the subject of this advice.
Solely for purposes of the discussion of the issues presented here, we assume that
this exclusion does not apply.

      A. Basic Definition -- Section 924(a)

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             1. Deferred Contract Income

      The Temporary Treasury Regulations specifically address the situation of a
contract of sale assigned to the taxpayer by a third party. Temp. Treas. Reg.
§ 1.924(a)-1T(b) provides, in pertinent part:

      Foreign trading gross receipts of a FSC include gross receipts from the
      sale of export property by the FSC, or by any principal for whom the
      FSC acts as a commission agent . . . pursuant to the terms of a
      contract entered into with a purchaser by the FSC or by the principal at
      any time or by any other person and assigned to the FSC or the
      principal at any time prior to the shipment of the property to the
      purchaser. . . . (Emphasis added)

This provision also appears, almost verbatim, in the Treasury Regulations under the
Domestic International Sales Corporation (DISC) regime that preceded the FSC
regime. See Treas. Reg. § 1.993-1(b). The Technical Memorandum released by
the Service in connection with issuance of the DISC regulations stated that this
shipment-date cut-off was carefully considered and adopted over commentator
objections “because, without it, a DISC might be allocated income only as an
afterthought after a transaction occurred.” 1977 TM LEXIS 65 (T.D. 7514) (June
10, 1977).

       Thus where, as here, a FSC or its principal receives income as an assignee
of a contract of sale, those receipts potentially constitute foreign trading gross
receipts only to the extent that the assignment occurs prior to shipment of the
export property. With respect to most of the sale transactions involving the
Product, Corp B’s assignment of the contracts to Corp A on Date 2 occurred
several years after shipment of the Product by Corp B to the Purchaser. Therefore,
receipts of Corp A on account of the purchase price in such sales fail to meet the
basic definition of foreign trading gross receipts as set forth in section 924(a). This
basic definition is met, however, with respect to those sales of the Product shipped
by Corp A to the Purchaser after Date 2. Receipts from the latter sales may
constitute foreign trading gross receipts to the extent they meet all other
requirements of the FSC provisions, including the foreign economic processes
requirements at issue here and discussed below.

       This conclusion is consistent with analysis of the nature of the property
interest that Corp A acquired from Corp B. In the case of Product shipped before
the assignment of the contracts on Date 2, the acquired property was, at most,
accounts receivable whose amount remained subject to final calculation under the
contract formula. Accounts receivable are not export property within the meaning
of section 927(a)(1)(A) because they are not “manufactured, produced, grown, or
extracted,” and Corp A’s later collection of such accounts receivable did not give

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rise to foreign trading gross receipts because it was not a sale, exchange or other
type of disposition of export property enumerated in section 924(a). The FSC
regulations contain numerous references to disposition of receivables but in no
context equate such disposition with sale of export property. See, e.g., Temp.
Treas. Reg. § 1.924(a)-1T(g)(7) (discount on factoring of receivables from sale of
export property reduces foreign trading gross receipts); Treas. Reg. § 1.924(e)-
1(d)(2)(i) (proceeds of factoring qualify as receipt of payment for purposes of
economic processes test); Treas. Reg. § 1.924(e)-1(e)(1)(iv) (factoring trade
receivables qualify as assumption of credit risk in economic processes test); Treas.
Reg. § 1.927(d)-1(a)(Q&A-4) (factoring payment treated as payment of sales
proceeds for purpose of determining carrying-charge element of sales price, which
is excluded from foreign trading gross receipts). See also Temp. Treas. Reg.
§ 1.927(b)-1T(b)(1) (loan proceeds excluded from definition of gross receipts).

       With respect to sales shipped prior to Date 1, the date of incorporation of
Corp A-FSC, an additional reason for failure of the income to qualify as foreign
trading gross receipts arises under section 1.924(a)-1T(b), which provides, in
pertinent part:

      Gross receipts from the sale of export property, whenever received, do
      not constitute foreign trading gross receipts unless the seller (or the
      corporation acting as commission agent for the seller) is a FSC at the
      time of the shipment of the property to the purchaser.

Since Corp A-FSC was not in existence at the time of shipments prior to Date 1,
receipts with respect to these shipments, even to the extent received after Date 1,
do not constitute foreign trading gross receipts.

             2. Warranty and Repair Services

       Gross receipts from services generally are not enumerated in section 924(a)
and thus do not constitute foreign trading gross receipts. With respect to services
relevant to this case, sections 924(a)(3) and 1.924(a)-1T(d)(2) provide that certain
“related and subsidiary” services give rise to foreign trading gross receipts. Such
services must be “furnished by the FSC”; “related” to a sale of export property
giving rise to foreign trading gross receipts; and “subsidiary” to such sale.

                   a. “Furnished by the FSC”

      Services are “furnished by the FSC” if they are provided by:

            (i) The person who sold . . . the export property to which the
      services are related and subsidiary, provided that the FSC acts as a
      commission agent with respect to the sale . . . of the property. . . ,

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            (ii) The FSC as principal, or any other person pursuant to a
      contract with the FSC, provided the FSC acted as principal or
      commission agent with respect to the sale . . . of the property, or

             (iii) A member of the same controlled group as the FSC if the
      sale or lease of the export property is made by another member of the
      controlled group provided, however, that the FSC acts as principal or
      commission agent with respect to the sale . . . and as commission
      agent with respect to the services.

Temp. Treas. Reg. § 1.924(a)-1T(d)(2).

       With respect to sales closed by shipment of the Product by Corp B to the
Purchaser prior to Corp A’s acquisition of the sale contracts, Corp A, the provider of
the services, does not fall into any of the enumerated classes, being neither the
seller of the export Product (to which the services are claimed to be related and
subsidiary), nor a member of the same controlled group as the seller, nor under
contract with Corp A-FSC to provide the services. Additionally, a condition stated in
all enumerated classes has not been met in such cases because Corp A-FSC did
not act as the principal or commission agent with respect to the sale of Product. If
any FSC so acted, it was that of Corp B.

       However, with respect to sales closed by shipment of the Product by Corp A
to the Purchaser after Corp A’s acquisition of the sale contracts, Corp A is
described by at least the first category in Temp. Treas. Reg. § 1.924(a)-1T(d)(2),
since Corp A was the seller of the Product and Corp A-FSC was the commission
agent on the sale.

       Accordingly, Corp A’s services with respect to Product shipped prior to
acquisition of the contracts were not “furnished by the FSC,” while services with
respect to post-acquisition shipments do pass this element. This result is
consistent with that under the general rule governing assignments of contracts
under section 1.924(a)-1T(b), discussed above. In both cases, shipment of the
export property is recognized to be the key event determining the tax consequences
of the transaction.

      Because receipts for services with respect to pre-acquisition shipments fail
an essential definitional element, they cannot constitute foreign trading gross
receipts. Accordingly, we consider the remaining two elements with respect to
post-acquisition shipments.

                   b. “Related”

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       Warranty and repair services are specifically listed as services potentially
related to a sale of export property. Temp. Treas. Reg. § 1.924(a)-1T(d)(3). They
are related if they are (1) customarily and usually furnished with the type of
transaction in the trade or business in which the sale arose, and (2) provided for in
the sale contract (expressly or by implied warranty) or in a separate arrangement
offered to the purchaser prior to the first shipment of the goods and contracted for
within two years after the sale contract. Id. Facts should be developed to
determine whether Corp A meets the “related” element.

                    c. “Subsidiary”

       Services related to a sale of export property are “subsidiary” to the sale if the
gross receipts from all related services to be furnished in the first ten-year period
following sale are reasonably expected at the time of sale not to exceed 50 percent
of the total of the gross receipts from the sale and related services. Temp. Treas.
Reg. § 1.924(a)-1T(d)(4). Facts should be developed to determine whether Corp A
meets this element. The requisite reasonable expectation may be established
through such evidence as estimates, budget proposals or cost projections made by
Corp A contemporaneously with the sale of the Product.

                    d. Parts

       If, as appears likely, parts are furnished in connection with the services at
issue, the parts are disregarded in determining whether the services are
“subsidiary.” Receipts attributable to sale of the parts may qualify as foreign trading
gross receipts independently of the rules governing services. Temp. Treas. Reg.
§ 1.924(a)-1T(d)(4)(v). Sales of parts should be analyzed under the rules
discussed in I.A.1 above, relating to receipts on the sales of the Product.
Specifically, the receipts from the sale of parts shipped prior to Date 2, the date of
assignment of the contracts to Corp A, fail to meet the basic definition of foreign
trading gross receipts under sections 924(a) and 1.924(a)-1T(b). By contrast,
receipts from parts shipped after Date 2 may constitute foreign trading gross
receipts to the extent they meet all other requirements of the FSC provisions,
including the foreign economic processes requirements at issue here and discussed
below.

       In summary, the receipts from Corp A’s warranty and repair services
(including the sale of parts) with respect to pre-acquisition sales (again determined
by date of shipment) fail to meet the basic definition of foreign trading gross
receipts under section 924(a). However, with respect to post-acquisition sales, if
the facts indicate that the services provided by Corp A are “related” and
“subsidiary,” receipts for such services may meet the basic definition and thus may
constitute foreign trading gross receipts to the extent the sales meet all other

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requirements of the FSC provisions, including the foreign economic processes
requirements at issue here and discussed below.

      B. Foreign Economic Processes -- Sections 924(b)(1)(B), 924(d) and 924(e)

       Section 924(b)(1)(B) provides that “a FSC has foreign trading gross receipts
from any transaction only if economic processes with respect to such transaction
take place outside the United States as required by subsection (d).” (Emphasis
added).

       Section 924(d)(1)(A) requires the FSC “or any person acting under a contract
with” the FSC to participate in the solicitation (other than advertising), negotiation or
making of the sale contract. Treas. Reg. § 1.924(d)-1(c)(4) defines “making of a
contract” as performance of any of the elements necessary to complete a sale,
such as offer or acceptance. Making of a sale contract includes written
confirmation by the FSC to the customer of an oral or written agreement which
confirms variable contract terms, such as price, credit terms, quantity, or time or
manner of delivery, or specifies (directly or by cross-reference) additional contract
terms. Id.

        Sections 924(d)(1)(B) and 924(d)(2) require the FSC to incur outside the
United States certain minimum percentages of the direct costs attributable to
activities enumerated in section 924(e). The activities set forth in section 924(e)
are advertising and sales promotion; order processing and arrangements for
delivery; transportation; determination and transmittal of final invoice or statement
of account and receipt of payment; and assumption of credit risk. The FSC meets
the percentage tests of sections 924(d)(1)(B) and 924(d)(2) if either its total foreign
direct costs equal or exceed 50 percent of the total direct costs attributable to these
activities with respect to the transaction, or if its foreign direct costs with respect to
each of at least two of the enumerated activities equal or exceed 85 percent of the
direct costs attributable to that activity. In meeting these percentage tests, the FSC
is considered to perform activities performed by “any person acting under a contract
with such FSC.” I.R.C. § 924(d)(3)(A).

       Under the authority of section 924(d)(4), the Treasury Regulations set forth
rules implementing the foreign economic processes requirements in the case of
commission FSCs. See, e.g., Treas. Reg. § 1.924(e)-1(c)(1) (transportation activity
under section 924(e)(3) may be established if related supplier, rather than
commission FSC, bears risk of loss during shipment); Treas. Reg. § 1.924(e)-
1(e)(1) (credit risk assumption activity under section 924(e)(5) may be established if
commission contract transfers costs of nonpayment from related supplier to
commission FSC).

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       Section 927(d)(2)(B) provides generally that FSCs and their related suppliers
may, to the extent provided in regulations, apply the FSC provisions on the basis of
groups of transactions rather than on a transaction-by-transaction basis. The
Treasury Regulations provide that in meeting the various foreign economic
processes requirements, FSCs may elect to group transactions by product or
product line (determined by either two-digit (or inferior) Standard Industrial
Classification (SIC) code or by trade or industry usage), by customer, by contract,
or by various combinations thereof. Treas. Reg. §§ 1.924(d)-1(c)(5), 1.924(d)-1(e).
Groupings used for purposes of section 924(d)(1)(A) may be different from those
used for the foreign direct cost tests under sections 924(d)(1)(B) and 924(d)(2), and
grouping elections may be made separately for each of the activities within each
test. Treas. Reg. §§ 1.924(d)-1(c)(5)(iii), 1.924(d)-1(e)(3). An activity performed
with respect to any transaction in any such grouping is generally deemed performed
with respect to all transactions in the grouping for the tax year. Treas. Reg.
§§ 1.924(d)-1(c)(5), 1.924(d)-1(e). One exception is that where a product or
product line grouping is used, required sales activities under section 924(d)(1)(A)
must be performed with respect to either 20 percent or more of the foreign trading
gross receipts in the group for the current tax year or 50 percent or more of the
foreign trading gross receipts in the group for the preceding tax year. Treas. Reg.
§ 1.924(d)-1(c)(5)(i)(A). Similar 20-percent thresholds apply for the foreign direct
cost tests under sections 924(d)(1)(B) and 924(d)(2) with respect to certain of the
credit risk assumption activities under section 924(e)(5). Treas. Reg. § 1.924(e)-
1(e)(4)(ii).

       Treas. Reg. § 1.924(d)-1(b) provides that any person, related or unrelated,
may perform any of the required activities, “provided that the activity is performed
pursuant to a contract for the performance of that activity on behalf of the FSC.”
(Emphasis added). This rule recognizes services agreements such as those
entered into among Corp A, Subsidiary 1, and Corp A-FSC. See also I.R.C.
§§ 924(d)(1)(A), 924(d)(3)(A). Thus the plain language of the Code and Treasury
Regulations contemplates that the foreign economic processes may be performed
by or on behalf of the FSC.

       With respect to sales of the Product shipped before Date 2, none of the
requisite economic processes were, or could have been, performed by or on behalf
of Corp A or Corp A-FSC. Neither Corp A nor Corp A-FSC had any interest in the
Product or the contracts at issue at the time those sales were completed by
shipment. The only taxpayer whose eligibility for FSC (or, for pre-FSC years, DISC)
benefits in general, and whose performance of foreign economic processes in
particular, could ever be at issue with respect to such sales is Corp B and its own
FSC or DISC (if any). Nothing in the FSC regime permits an assignee such as
Corp A to succeed to an assignor’s performance of foreign economic processes as
a tax attribute, to “tack” the assignor’s activities onto its own, or to adopt a fiction

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that the assignor’s activities were somehow conducted “on behalf of” the assignee.

      We note that this result is consistent with the rules governing services and
assignment of contracts, discussed respectively at I.A.2 and I.A.1. above. Again
the date of shipment determines whether alleged foreign trading gross receipts are
appropriately attributable to a FSC and its related supplier.

        With respect to sales of the Product shipped by Corp A after its acquisition of
the contracts, Corp A’s deferred contract income, as well as “related and
subsidiary” warranty and repair income, may constitute foreign trading gross
receipts provided that Corp A and Corp A-FSC met the requirements of section
924(d) with respect to the sale transactions or groups of transactions. Facts should
be developed showing whether Corp A and Corp A-FSC met the standards
prescribed under the Treasury Regulations for performance of these required
foreign economic processes. For example, although Corp B appears to have
solicited and negotiated the contracts, it is possible that Corp A participated in the
making of the contracts by confirming open orders. See Treas. Reg. § 1.924(d)-
1(c)(4). It also appears possible that Corp A and Corp A-FSC during the shipment
process may have incurred at least 85 percent of two of the administrative activities
enumerated in section 924(e) and thus may have met the test under section
924(d)(2). To the extent that the foreign economic processes cannot be
documented as to each transaction at issue, Corp A-FSC may be able to use the
broad grouping rules discussed above to have such processes deemed performed
for all transactions in a group based on actual performance in only one or a limited
number of transactions.

       We note that the foreign economic processes requirements apply despite the
procedural posture of this claim as a redetermination, by amended return, of
commissions based on additional sales not originally reported as foreign trading
gross receipts. These requirements would have applied had Corp A and Corp A-
FSC treated these receipts as foreign trading gross receipts in their original returns.
Even if the receipts at issue were not or could not have been identified at that time
as foreign trading gross receipts, the taxpayer must demonstrate that the requisite
foreign economic processes were performed by Corp A-FSC or its agent with
respect to the transaction. Otherwise, Corp A and other taxpayers filing
redetermination claims based on additional sales would be in a better position than
taxpayers reporting the transactions on their original returns, an inequitable result.
See Stokely-Van Camp, Inc. v. United States, 21 Cl. Ct. 731 (1990), aff’d on other
grounds, 974 F.2d 1319 (Fed. Cir. 1992) (rejecting taxpayer argument that
regulatory requirement to pay DISC commission contemporaneously with original
sale transaction does not apply to additional sales on later amended return).

       Similarly, we are aware that Treas. Reg. § 1.924(d)-1(f) exempts “foreign
military sales” from the requirements of section 924(d)(1)(A). However, we do not

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view sales to the United States government for use abroad as “foreign military
sales” for this purpose.2 We believe that the exemption merely recognizes that the
solicitation, negotiation and other contracting activities normally performed by a
seller are unnecessary where the United States government serves as an
intermediary between a manufacturer and a foreign purchaser.

       In summary, the foreign economic processes requirements are not met with
respect to sales shipped prior to Date 2, but may be met, depending on the facts,
with respect to sales shipped thereafter. To the extent such requirements as well
as all other FSC requirements are met, Corp A’s deferred contract income, as well
as “related and subsidiary” warranty and repair income, constitutes foreign trading
gross receipts.

II. Administrative Pricing Rules -- Section 925(c)

       To the extent that the sales of the Product and “related and subsidiary”
services generate additional foreign trading gross receipts to Corp A, Corp A claims
that the administrative pricing methods allowed under section 925(a) are available
to Corp A and Corp A-FSC.

       Section 925(c) and Treas. Reg. § 1.925(a)-1T(b)(2)(ii) provide that the
administrative pricing methods are available only if the sales activities listed in
sections 924(d)(1)(A) and the direct cost activities listed in section 924(e) are
performed by or on behalf of the FSC and the costs of such activities are reflected
both on the FSC’s books and in the computation of combined taxable income.
However, the requisite activities are those in fact performed by any person with
respect to the transaction; activities not applicable to the transaction are excluded
from the section 925(c) requirements. Temp. Treas. Reg. § 1.925(a)-1T(b)(2)(ii).
In cases where the related supplier is performing the required activities on behalf of
the FSC, the requirements of section 925(c) are satisfied if (1) the FSC pays the
related supplier an amount equal to the direct and indirect expenses with respect to
those activities enumerated under sections 924(d)(1)(A) and 924(e) and actually
performed, and (2) such costs are reflected on the FSC’s books and taken into
account in computing combined taxable income. Id. In lieu of the enumerated
costs, the FSC may reflect all direct and indirect costs attributable to the
transaction, other than cost of goods sold, as described in Temp. Treas. Reg.
§ 1.925(a)-1T(c)(6)(iii)(D). Id. If some of these costs are not paid or reflected on
the FSC’s books or in computing combined taxable income, the FSC may still use
administrative pricing, with appropriate adjustments. Id.



      2
         This would not, however, affect any characterization of the Product as “military
property” within the meaning of section 923(a)(5).

                                         13
TL-N-6337-99

       The activities referenced under section 925(c) are the economic processes
discussed earlier as being required under sections 924(d) and 924(e) for gross
receipts to be treated as foreign trading gross receipts. With respect to sales of the
Product shipped before Date 2, we noted earlier that none of these activities were
or could have been performed by Corp A or Corp A-FSC. Accordingly, the
requirements of section 925(c) cannot be met with respect to such sales.

       With respect to sales of the Product that were shipped by Corp A after its
acquisition of the contracts and are determined under section I above to qualify as
additional sales giving rise to foreign trading gross receipts, Examination should
ascertain whether the expenses incurred by the taxpayer with respect to the sale
and shipment were properly reflected on the FSC’s books and were taken into
account in computing combined taxable income.

       In summary, Corp A and Corp A-FSC do not meet the requirements of
section 925(c) with respect to sales shipped prior to Date 2, but may meet such
requirements, depending on the facts, with respect to sales shipped thereafter. To
the extent these requirements are met, commissions on foreign trading gross
receipts arising from deferred contract income and “related and subsidiary”
warranty and repair services may be computed using the administrative pricing
rules of section 925(a).

      If you have any further questions, please call either Jacob Feldman (202-
622-3810) or Douglas Giblen (202-874-1490).




                                       _______________________________
                                       JACOB FELDMAN
                                       Field Service Special Counsel
                                       Associate Chief Counsel (International)