[Code of Federal Regulations]
[Title 26, Volume 10]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.936-4]

[Page 139-140]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.936-4  Intangible property income in the absence of an election out.

    The rules in this section apply for purposes of section 936(h) and 
also for purposes of section 934(e), where applicable.
    Q. 1: If a possessions corporation and its affiliates do not make an 
election under either the cost sharing or 50/50

[[Page 140]]

profit split option, what rules will govern the treatment of income 
attributable to intangible property owned or leased by the possessions 
corporation?
    A. 1: Intangible property income will be allocated to the 
possessions corporation's U.S. shareholders with the proration of income 
based on shareholdings. If a shareholder of the possessions corporation 
is a foreign person or a tax-exempt person, the possessions corporation 
will be taxable on that shareholder's pro rata amount of the intangible 
property income. If any class of the stock of a possessions corporation 
is regularly traded on an established securities market, then the 
intangible property income will be taxable to the possessions 
corporation rather than the corporation's U.S. shareholders. For these 
purposes, a United States shareholder includes any shareholder who is a 
United States person as described under section 7701(a)(30). The term 
``intangible property income'' means the gross income of a possessions 
corporation attributable to any intangible property other than 
intangible property which has been licensed to such corporation since 
prior to 1948 and which was in use by such corporation on September 3, 
1982.
    Q. 2: What is the source of the intangible property income described 
in question 1?
    A. 2: The intangible property income is U.S. source, whether taxed 
to U.S. shareholders or taxed to the possessions corporation. Such 
intangible property income, if treated as income of the possessions 
corporation, does not enter into the calculation of the 80-percent 
possessions source test or the 65-percent active trade or business test 
of section 936(a)(2)(A) and (B).
    Q. 3: How will the amount of income attributable to intangible 
property be measured?
    A. 3: Income attributable to intangible property includes the amount 
received by a possessions corporation from the sale, exchange, or other 
disposition of any product or from the rendering of a service which is 
in excess of the reasonable costs it incurs in manufacturing the product 
or rendering the service (other than costs incurred in connection with 
intangibles) plus a reasonable profit margin. A reasonable profit margin 
shall be computed with respect to direct and indirect costs other than 
(i) costs incurred in connection with intangibles, (ii) interest 
expense, and (iii) the cost of materials which are subject to processing 
or which are components in a product manufactured by the possessions 
corporation. Notwithstanding the above, certain taxpayers who have been 
permitted by the Internal Revenue Service in taxable years beginning 
before January 1, 1983, to use the cost-plus method of pricing without 
reflecting a return from intangibles, but including the cost of 
materials in the cost base, will not be precluded from doing so. (Sec. 
3.02(3), Rev. Proc. 63-10, 1963-1 C.B. 490.) Thus, the Internal Revenue 
Service may continue in appropriate cases to permit such taxpayers to 
continue to report their income as they have been under existing 
procedures described in the previous sentence if it is appropriate under 
all the facts and circumstances and does not distort the income of the 
taxpayer.
    Q. 4: If there is no intangible property related to a product 
produced in whole or in part by a possessions corporation, what method 
may the possessions corporation use to compute its income?
    A. 4: The taxpayer may compute its income using the appropriate 
method as provided under section 482 and the regulations thereunder. The 
taxpayer may also elect the cost sharing or profit split method.

[T.D. 8090, 51 FR 21524, June 13, 1986]