Rev. Rul. 71-358

Advice has been requested whether, under the circumstances described below, the unitary treatment is appropriate in applying section 4914(c)(2) of the Internal Revenue Code of 1954, thereby excluding the acquisition of certain foreign debt obligations from the application of the interest equalization tax.

X, a domestic corporation, is engaged in the production in the United States of heavy electrical equipment. Y, a domestic corporation, is a wholly owned subsidiary of X and is engaged in installing and servicing equipment produced by X. Both corporations are includible in an affiliated group as defined in section 1504 of the Code.

X has entered into a project contract with R, an unrelated foreign corporation incorporated in country T, for the design, engineering, delivery, construction, and start-up of a thermo-electric power plant to be erected in country T. To simplify the compliance with the exposure of foreign tax and the "doing business" requirements of country T, X and Y included in the contract with R as an additional contracting party and as the recipient of all payments pertaining to the performance of work and services required in country T. The contract provided that X perform in the United States the production portion of the contract including the design, engineering, manufacturing, and attendant services, and that Y perform in country T the construction and installation portion of the contract including the start-up and attendant services. X had a portion of the materials manufactured in its own plants and had other equipment supplied by United States suppliers. Y conducted supervisory work through its employees in country T and utilized the engineering and construction services of S, an unrelated foreign corporation. The total base price of the project was 32,000x dollars. Under the production portion of the project, X was to receive 25,000x dollars of which 12,000x dollars was attributable to X's production and services and 13,000x dollars was attributable to production and services of X's suppliers in the United States. Under the construction and installation portion of the project, Y was to receive 7,000x dollars of which 1,000x dollars was attributable to Y's services and 6,000x dollars was attributable to services performed by S.

The contract provided that with respect to X's production portion of the contract and the services performed specifically by Y in the total amount of 26,000x dollars, such full amount would be paid by the time of the completion of the project. With respect to 6,000x dollars paid to Y for services performed by S for Y, 10 percent was to be paid to Y within 60 days from date contract was signed and 90 percent was payable in 14 consecutive equal semi-annual installments beginning three years after the date the contract was signed. The debt obligation amounted to 5,400x dollars (6,000x dollars X 90 percent).

Section 4911 of the Code provides, in relevant part, that the interest equalization tax is imposed on each acquisition by a United States person of a debt obligation of a foreign obligor if such debt obligation has a period remaining to maturity of one year or more.

Section 4914(c)(2) of the Code (relating to an alternate rule for producing exporters) provides, in pertinent part, that the tax imposed by section 4911 of the Code shall not apply to the acquisition by a United States person of a debt obligation of a foreign obligor arising out of the sale of tangible personal property or services (or both) to such obligor if (A) at least 30 percent of the purchase price (or 60 percent of the actual value of the debt obligation acquired) is attributable to either or both the sale of property manufactured or produced in the United States by such United States person or the performance of services by such United States person, or by one or more such corporations includible in an affiliated group, as defined in section 1504 of the Code, and (B) at least 50 percent of the purchase price (or 100 percent of the actual value of the debt obligation acquired) is attributable to either or both the sale of property manufactured or produced in the United States or to the performance of services by United States persons (affiliated or nonaffiliated).

The question is whether the unitary treatment is appropriate in applying sections 4914(c)(2) (A) and (B) of the Code to the above facts, that is, whether the equipment and services furnished by the domestic parent, X, and its domestic subsidiary, Y, should be aggregated in determining whether the percentage tests of section 4914(c)(2) of the Code are satisfied, or whether X and Y must be viewed separately in determining whether such tests are satisfied. In the latter event the percentage tests of section 4914(c)(2)(B) of the Code would not be satisfied by Y.

Although only one contract existed between R and X and Y, the contract had been divided into two parts, one to be performed by X and the other to be performed by Y. In essence the two parts reflect a two-step interdependent contract effectuating an integrated project controlled by X. The segregation of the contract was dictated by the "doing business" requirements of the foreign country T and by the desire to simplify compliance with the exposure to foreign tax.

Accordingly, the unitary treatment is appropriate in applying sections 4914(c)(2)(A) and (B) of the Code and since the aggregate of equipment sold and services performed by X and Y exceed the 30 percent requirement of section 4914(c)(2)(A) of the Code and the 50 percent requirement of section 4914(c)(2)(B) of the Code, the acquisition by Y of the debt obligations of R is excluded from the application of the interest equalization tax.

Where an acquisition of a debt obligation by a United States person has been excluded from tax under section 4914(c)(2) of the Code and such obligation is subsequently transferred by such person to another United States person, the transfer may be subject to the interest equalization tax under section 4914(j)(1)(A) of the Code, as amended.