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Section 1.954-3(a)(4)(iii), Income Tax Regs., provides:
(iii) Manufacture of a product when purchased com-
ponents constitute part of the property sold. If pur-
chased property is used as a component part of personal
property which is sold, the sale of the property will
be treated as the sale of a manufactured product, rath-
er than the sale of component parts, if the operations
conducted by the selling corporation in connection with
the property purchased and sold are substantial in na-
ture and are generally considered to constitute the
manufacture, production, or construction of property.
Without limiting this substantive test, which is depen-
dent on the facts and circumstances of each case, the
operations of the selling corporation in connection
with the use of the purchased property as a component
part of the personal property which is sold will be
considered to constitute the manufacture of a product
if in connection with such property conversion costs
(direct labor and factory burden) of such corporation
account for 20 percent or more of the total cost of
goods sold. In no event, however, will packaging,
repackaging, labeling, or minor assembly operations
constitute the manufacture, production, or construction
of property for purposes of section 954(d)(1). The ap-
plication of this subdivision may be illustrated by the
following examples:
Example (1). Controlled foreign corporation A,
incorporated under the laws of foreign country X, sells
industrial engines for use, consumption, and disposi-
tion outside country X. Corporation A, in connection
with the assembly of such engines, performs machining
and assembly operations. In addition, A Corporation
purchases, from related and unrelated persons, com-
ponents manufactured in foreign country Y. On a per
unit basis, A Corporation's selling price and costs of
such engines are as follows:
Selling price.................................. $400
Cost of goods sold:
Material--
Acquired from related
persons........................ $100
Acquired from others............. 40
Total material.................... $140
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