Rev. Rul. 68-549

A United States controlling taxpayer manufactures a secret ingredient which it sells to its controlled foreign entity. The controlled foreign entity uses the ingredient in the manufacture of a product which it sells to unrelated foreign persons. The unrelated foreign persons use the purchased product as a necessary ingredient in the manufacture of another product which they sell. The agreement under which the ingredient is sold by the United States controlling taxpayer to its controlled foreign entity gives, without adequate consideration, the controlled foreign entity the right to allow the unrelated foreign persons to use trademarks and other intangibles, belonging to the United States controlling taxpayer, in connection with the sale of the product which the unrelated foreign persons manufacture. The price at which the controlled foreign entity sells the product manufactured by it to the unrelated foreign persons reflects a charge for the use by the unrelated foreign persons of the trade-marks and other intangibles belonging to the United States controlling taxpayer.

In such circumstances under section 482 of the Internal Revenue Code of 1954 a proper allocation in computing taxable income may be made to reflect the value of the use of such intangibles. However, for the years to which it is applicable, section 4.012 of Revenue Procedure 64-54, C.B. 1964-2, 1008, provides, in part, that allocations to reflect charges or royalties for the use of intangible assets belonging to a United States controlling taxpayer will not be made to the extent that the intangibles are used by a controlled foreign entity in the manufacture of products or the sale of products manufactured by the foreign entity or other foreign person.

Revenue Ruling 65-109, C.B. 1965-1, 222, holds that in applying section 4.012 of Revenue Procedure 64-54, an allocation under section 482 of the Code to reflect charges or royalties for the use of intangible assets belonging to the United States controlling taxpayer may be made in those situations where the right to use such intangibles has been relicensed by its controlled foreign entity for a consideration, whether or not the relicensing was to another controlled foreign entity which used the intangibles in the manufacture of products or the sale of products manufactured by the foreign entity or other foreign person.

Held, Revenue Ruling 65-109 does not apply where, as in the instant case, a controlled foreign entity manufactures a product and in connection with and incident to the sale thereof relicenses intangibles, belonging to the United States controlling taxpayer, to the purchaser of its product for a consideration and the purchaser uses the intangibles in the sale of a product the manufacture of which necessitates the use of the product manufactured by the controlled foreign entity. In such case, section 4.012 of Revenue Procedure 64-54 is applicable.

Revenue Ruling 65-109 and section 4.012 of Revenue Procedure 64-54 are clarified.