Q:  How can I claim U.S. tax benefits for income from qualified foreign manufacturing activities?

A:  Income earned by a qualified foreign corporation is eligible for the ETI exclusion.  In order to qualify, the foreign corporation must satisfy three eligibility requirements under Sec. 943(e).  These requirements include:

1)          The foreign corporation must be involved in the manufacture, production or assembly of property in the ordinary course of its trade or business;

2)          Substantially all of the foreign corporation’s receipts must be FTGR; and

3)          The foreign corporation must file an election and waive any U.S. income tax treaty benefits.

An electing foreign corporation may have its election revoked or terminated in the event it fails to satisfy the three requirements, listed above.   The statute does not contain any attribution rules, so presumably, this election can only be applied to first, and not lower-tier foreign affiliates.  Presumably, if an intermediary or holding company makes a check-the-box election, an election filed by a second-tier manufacturing corporation or corporate joint venture would be effective.

Under Sec. 367, a foreign corporation making this election is treated as having transferred its assets tax-free to a domestic corporation under Sec. 354.  Thus, this election constitutes a deemed liquidation, like the check-the-box election under Sec. 7701.  The electing foreign corporation rules, however, are more favorable for U.S. taxpayers, since the earnings and profits accumulated prior to October 1, 2000, are not included in the U.S. shareholder’s income.

Once the election is made, the foreign corporation is treated like a U.S. corporation for all purposes of the Code.  Thus, the foreign corporation would be a member of an affiliated group in filing a consolidated return, be subject to estimated and final tax liability filings, be eligible to claim foreign tax credits, avoid the application of Subpart F and be subject to IRS audit for transfer pricing and other U.S. tax purposes.  Prior to making this election, tax practitioners are urged to consult with a professional tax advisor.