4.61.9  Possession Corporations

4.61.9.1  (05-01-2006)
Overview

  1. The 1996 Small Business Job Protection Act terminated the Puerto Rico and possession Tax Credit for tax years beginning after December 31, 1995 [section 936(j)], but grandfathers "existing credit claimants" [see IRC 936(j)(9)] over a ten-year phaseout period. The credit terminates for tax years beginning in 2006 and thereafter.

  2. By the time this IRM is issued, credits will be available only to existing credit claimants or a corporation that acquires all of the assets of a trade or business of an existing credit claimant. It is important to understand the phase out rules for these taxpayers.

4.61.9.2  (05-01-2006)
IRC 936 Credit for Possession Corporations

  1. Electing taxpayers receive a possession tax credit in lieu of any foreign tax credit that might otherwise be available. Taxpayers cannot receive both a possession tax credit and a foreign tax credit with respect to the same income.

  2. An election on Form 5712 (Election To Be Treated as a Possessions Corporation Under Section 936) is a prerequisite to the possession credit. Taxpayers must file the Form 5712 at the Philadelphia Service Center (PSC). The actual credit computation is on Form 5735 (Possessions Corporation Tax Credit (Under Sections 936 and 30(A) an attachment to Form 1120. Taxpayers electing the cost sharing or profit split methods must file Form 5712-A.

  3. A possession corporation is not eligible to join in the filing of a consolidated return for tax years in which an election of possession corporation status is in effect.

  4. There are two prerequisites to the possession credit:

    1. 80 percent or more of gross income for the 3-year period immediately preceding the close of the taxable year must be from sources within a possession (or possessions), and

    2. 75 percent or more of gross income must be derived from the active conduct of a trade or business within a possession.

  5. For purposes of determining the FTC limitation under IRC 904, taxable incomes does not include any income taken into account for purposes of the possession credit under IRC 936. Both the numerator and the denominator of the IRC 904 FTC limitation formula exclude income taken into account for purposes of the possession credit under IRC 936.

  6. The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) provided rules dealing with the intangible property income of the section 936 corporation. Under the general rule, intangible property income associated with possession source products or services is taxed to the U.S. shareholder(s) under section 936(h)(1) - (4). However, under the cost sharing election, eligible taxpayers can make a cost sharing payment and then be treated as the owner of all manufacturing intangibles related to the possessions product. Under the cost sharing method, possessions corporations generally receive no benefit from marketing intangibles. Under the profit split election, taxpayers determine "combined taxable income" and split that income by allocating 50 percent of the combined taxable income to the section 936 corporation and 50 percent to the appropriate U.S. affiliate(s). In order to elect either cost sharing or profit split, taxpayers are required to first satisfy the significant business presence test with respect to each possession product or group of possession products or type of service. This test is satisfied if at least 65 percent of the labor costs associated with the possessions product were incurred in the possession. A possession corporation may also satisfy the significant business presence test by meeting the 25% value-added test or the construction test. The profit split election also required that the product be manufactured or produced in the possession by the electing corporation within the meaning of section 954(d)(1)(A).

  7. The Tax Reform Act of 1986 imposed a requirement that the cost sharing payment determined under the cost sharing method formula could not be less than the commensurate with income royalty which would be required under section 367(d)(2) or section 482. In addition, the Act extended the definition of qualified possession source investment income to include investment income related to certain activities in certain Caribbean basin countries.

  8. The Revenue Reconciliation Act of 1993 (RRA) imposed limitations on the benefits available under section 936 by creating two alternative limitations on the amount of the credit in section 936(a)(4) The first limitation, the economic activity limitation, is based on wages and investment in plant and equipment. Alternatively, under the percentage limitations, the taxpayer may elect to have its section credit determined using the percentages set forth in section 936(a)(4)(B)(ii) (which reduced the section 936 benefit to 60 percent of the credit that would otherwise have been determined under section 936(a)(1)(A) in 1994 with further annual reductions to 40 percent for 1998 and tax years thereafter).

4.61.9.3  (05-01-2006)
General Phase Out Rules for Possession Corporations

  1. The 1996 Small Business Job Protection Act limited the section 936 (and section 30A) credits to existing credit claimants. It also reduced the section 936 benefit by repealing the passive income (QPSII) provisions and by imposing a cap on benefits. The cap is applied to taxpayers that elected the section 936(a)(4) economic activity limitation for taxable years beginning after December 31, 2001, and for taxpayers that elected the section 936(a)(4) percentage limitation for taxable years beginning after December 31, 1997. The cap does not apply to possession corporations in Guam, America Samoa, or the Commonwealth of the Northern Mariana Islands.

  2. A corporation can also qualify as an existing credit claimant if it acquires all of the trade or business of an existing credit claimant. An existing credit claimant that adds a substantial new line of business after October 13, 1995, will cease to be eligible for the section 936 credit in the tax year in which the new line of business is added. The phase out rules vary depending on the location of the possession, as shown below.

4.61.9.4  (05-01-2006)
Phase Out Rules for Possession Corporations in Possessions other than Puerto Rico

  1. IRC section 936(j) provides that existing credit claimants with respect to a possession other than Puerto Rico that have not elected the section 936(a)(4)(B) percentage limitation will be allowed the section 936 credit for taxable years beginning after December 31, 1995, and before January 1, 2002.

  2. For taxable years beginning after December 31, 2001, existing credit claimants with respect to a possession other than Puerto Rico that have not elected the section 936(a)(4)(B) percentage limitation will be allowed the section 936 credit, subject to a cap. The cap does not apply, however, to possession corporations in Guam, American Samoa, or the Commonwealth of the Northern Mariana Islands.

  3. Existing credit claimants with respect to a possession other than Puerto Rico that have elected the section 936(a)(4)(B) percentage limitation will be allowed the section 936 credit for taxable years beginning after December 31, 1995, and before January 1, 1998.

  4. For taxable years beginning after December 31, 1997, existing credit claimants with respect to a possession other than Puerto Rico that have elected the section 936(a)(4)(B) percentage limitation will be allowed the section 936 credit, subject to a cap. The cap does not apply, however, to possession corporations in Guam, American Samoa, or the Commonwealth of the Northern Mariana Islands.

  5. The section 936 credit will in all cases end with the last taxable year beginning before January 1, 2006.

4.61.9.5  (05-01-2006)
Phase Out Rules for Puerto Rico

  1. IRC section 30A provides that existing credit claimants with respect to Puerto Rico that have not elected the section 936(a)(4)(B) percentage limitation will be allowed a possession tax credit for taxable years beginning after December 31, 1995, and before January 2, 2002. IRC section 30A generally contains the same rules found in IRC section 936, including the economic activity limitation.

  2. For taxable years beginning after December 31, 2001, existing credit claimants with respect to Puerto Rico that have not elected the section 936(a)(4)(B) percentage limitation will be allowed a possession tax credit, subject to a cap.

  3. IRC section 936(j) provides that existing credit claimants with respect to Puerto Rico that have elected the section 936(a)(4)(B) percentage limitation will be allowed the section 936 credit for taxable years beginning after December 31, 1995, and before January 1, 1998.

  4. For taxable years beginning after December 31, 1997, existing credit claimants with respect to Puerto Rico that have elected the section 936(a)(4)(B) percentage limitation will be allowed the section 936 credit, subject to a cap.

  5. The possession tax credit under section 30A and section 936 will be all cases ending with the last taxable year beginning before January 1, 2006.

4.61.9.6  (05-01-2006)
Phase Out Rules for Guam, American Samoa, and the Commonwealth of the Northern Mariana Islands

  1. In the case of existing claimants with respect to Guam, American Samoa, and the commonwealth of the Northern Mariana Islands, the possession tax credit continues to apply without change for tax years beginning after December 31, 1995, and before January 1, 2006, when the credit is set to expire.


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