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property income as United States source income unless an election
out is made by the possessions corporation. Sec. 936(h)(1)(A).
However, the general rule of possessions corporations is
inapplicable if an eligible possessions corporation elects out of
its provisions by electing to use either the cost sharing method
or the profit split method for computing its taxable income.
This election may be made under section 936(h)(5). For purposes
of subparagraph (B) of section 936(h)(5), costs incurred by the
electing corporation or a member of its affiliated group in
connection with contract manufacturing by a person other than a
member of the affiliated group are not treated as production
costs of the electing corporation in the possession or as direct
material costs or as compensation for services performed in the
possession. Sec. 936(h)(5)(B)(iii)(II). Rather, they are
treated as the direct labor costs of the affiliated group. Id.
The effect of the term “contract manufacturing” in section
936(h)(5)(B)(iii)(II) is to make it more difficult to establish a
substantial business presence in a possession--within the meaning
of section 936(h)(5)(B)(i)--when the possessions corporation uses
contract manufacturing for its manufacturing activities. The
term appears in a rule which is statutorily directed to apply
“For purposes of this subparagraph,” that is, subparagraph (B) of
section 936(h)(5). Thus, when examined in context, the
“expressio unius” canon of construction suggests that contract
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