Not surprisingly, most taxpayers prefer to pay as little tax as possible. In the context of the international sales of goods, prior to the creation of the Transfer Pricing and Subpart F rules, a taxpayer could create a subsidiary corporation in a foreign low-tax jurisdiction and then sell goods to that foreign subsidiary at a price equal to or slightly above cost, triggering a small amount of U.S. taxable gain. The foreign subsidiary could then sell those goods in foreign jurisdictions at a marked-up price, triggering only the low-tax jurisdiction's tax rate on the gain. One of the reasons Congress imposed the foreign base company sales income (FBCSI) rules of Subpart F was to currently tax U.S. taxpayers on the gain realized by the foreign subsidiary on sales income generated in such low-tax jurisdictions.1 Congress was concerned with income of a selling subsidiary that had been separated from manufacturing activities of a related corporation merely to obtain a lower rate of tax for the sales income. However, Congress only intended the FBCSI rules to apply where the foreign subsidiary did not add any appreciable value to the product, such as manufacturing, major assembling, or construction activity. Therefore, the FBCSI rules contain an exemption for manufacturing activities conducted by the foreign subsidiary. Since the current regulations were promulgated in 1964, manufacturing has increasingly been outsourced to third-party manufacturers in so-called contract manufacturing arrangements. Under a typical contract manufacturing arrangement, a party contracts with the contract manufacturer to convert raw materials into finished goods or to assemble component parts into a finished product, in accordance with the party's specifications. Title to the property changes hands depending on the type of arrangement entered between the parties. In turnkey arrangements, the contract manufacturer retains title to the raw materials or component parts during the manufacturing process and title is transferred to the party at the time the finished product is delivered.
