Microsoft Corporation - Page 4

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            an amount equal to that portion of its U.S. tax that is                                     
            attributable to certain of its possession-source taxable income.                            
            Sec. 936(a)(1).3  To qualify for the section 936 credit, the                                
            possessions corporation (here, MS-Puerto Rico) must show that: (1)                          
            80 percent or more of its gross income for the 3-year period                                
            immediately preceding the taxable year for which the credit is                              
            elected was derived from sources within a possession of the United                          
            States (here, Puerto Rico); and (2) 75 percent or more of its gross                         
            income for that period was derived from the active conduct of a                             
            trade or business within the U.S. possession.  Sec. 936(a)(2).                              
                  If the possessions corporation qualifies for the section 936                          
            credit, it may further elect to compute its taxable income under                            
            the profit-split method (described in section 936(h)(5)(C)(ii))                             
            provided it satisfies the "significant business presence" test with                         
            respect to its product (here, the diskettes). Sec. 936(h)(5)(B)(i).                         
            This test requires that, among other things, the electing                                   
            possessions corporation manufacture or produce the product in the                           
            U.S. possession  within  the  meaning  of  section  954.  Sec.                              
            936(h)(5)(B)(ii).                                                                           



                  3     For a discussion of the historical development of sec.                          
            936, see Coca-Cola Co. & Subs. v. Commissioner, 106 T.C. 1                                  
            (1996).  The sec. 936 credit was terminated, effective for all                              
            tax years after Dec. 31, 1995, with a limited phaseout until Dec.                           
            31, 2005.  Small Business Job Protection Act of 1996, Pub. L.                               
            104-188, sec. 1601(a), 110 Stat. 1827.                                                      




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