Rev. Proc. 68-22

SECTION 1. SCOPE.

This Revenue Procedure relates to the application of section 1.482-2(b) of the Income Tax Regulations in examining income tax returns, making allocations, and disposing of cases for taxable year beginning prior to May 1, 1968. It also provides for the continued application of the guidelines set forth in Revenue Procedure 63-10, C.B. 1963-1, 490, in examining income 7(3) provides that, except in and disposing of cases involving the allocation of income and deductions between United States corporations and their manufacturing affiliates in Puerto Rico.

SEC. 2. BACKGROUND.

.01 Section 482 of the Internal Revenue Code of 1954 gives the Commissioner of Internal Revenue authority to distribute, apportion, or allocate gross income, deductions, and credits among related organizations, trades, or business if it is necessary in order to clearly reflect the income of such entities or to prevent avoidance of taxes. Section 1.482-2(b) of the regulations, Treasury Decision 6952, published in the Federal Register of April 16, 1968 (33 F.R. 5848), page 218, this Bulletin provides specific guidelines for the allocation of income and deductions with respect to the performance of services. Subparagraph (1) of section 1.482-2(b) of the regulations states the general rule that the equivalent of an arm's length charge must be made for the performance of services. Subparagraph (3) provides that, except in certain cases, an arm's length charge for the performance of services shall be deemed equal to costs or deductions unless the taxpayer establishes a more appropriate rate based on arm's length standards.

.02 Paragraph (b) of section 1.482-2 of the regulations was first published as part of a notice of proposed rule making on April 1, 1965 (30 F.R. 4256). On August 2, 1966, the notice of April 1, 1965, was withdrawn and a new notice of proposed rule making was published (31 F.R. 10394). Subparagraphs (3) and (7) appeared in that notice as follows:

(3) Arm's length charge .-For the purpose of this paragraph an arm's length charge for services rendered shall be the amount which was charged or would have been charged for the same or similar services in independent transactions with unrelated parties under similar circumstances considering all relevant facts. However, if the services rendered are not services which are part of a trade or business (as described in subparagraph (7) of this paragraph), the arm's length charge shall be deemed to be equal to costs or deductions incurred with respect to such services by the member or members rendering such services unless the taxpayer establishes a more appropriate rate under the standards set forth in the first sentence of this subparagraph.

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(7) Services which are part of a trade or business .-Services rendered by one member of a group of controlled entities for the benefit, or on behalf, of another member of the group shall be considered to be services which are part of a trade or business in the following cases:

(i) If the member rendering such services is engaged in the trade or business of rendering such services to unrelated parties,

(ii) If the services are rendered to or on behalf of another member of the group which is engaged in the trade or business of rendering services to unrelated parties and the sevices rendered to or on behalf of the other member constitute a significant portion of the total services rendered to such unrelated parties,

(iii) If the services are rendered to or on behalf of another member of the group in direct connection with the sale to an unrelated party of a unique product constructed or fabricated by the other member in accordance with the specifications provided by, or accepted by, the unrelated party,

(iv) If a significant portion of the total services rendered by one member of the group to or for the benefit of another member of the group is or should be reflected as a direct cost in the cost of goods sold of the member receiving the benefit of such services, or

(v) If one member of a group which has a permanent establishment in a particular country renders selling or other related services in connection with sales made in such country by another member of the group which has no permanent establishment in such country.

.03 On April 16, 1968, section 1.482-2(b) of the regulations was published in final form with the exception of subparagraph (7) which was reserved. On the same date a new notice of proposed rule making with respect to subparagraph (7) was published in the Federal Register (33 F.R. 5858).

.04 Both as proposed in the notice of August 2, 1966, and as proposed in the notice of April 16, 1968, subparagraph (7) of section 1.482-2(b) of the proposed regulations describes services which are intended to be excepted from the rule that an arm's length charge for the performance of services is deemed equal to costs or deductions. In the notice of August 2, 1966, those services were described as transactions in which the services rendered were part of a trade or business. The April 16, 1968, notice describes the proposed exceptions to the `cost' rule as transactions in which the services rendered are an integral part of the business activity of either party to the transaction.

.05 In Revenue Procedure 63-10 the Internal Revenue Service announced guidelines with respect to the allocation of income and deductions under section 482 of the Code in cases involving Puerto Rican affiliates.

SEC. 3. APPLICATION OF SECTION 1.482-2(b)(3) AND (7) OF THE PROPOSED REGULATIONS.

In examining income tax returns, making allocations, and disposing of cases for taxable years beginning prior to May 1, 1968, the Service will, when requested to do so by the taxpayer, apply the provisions of subparagraphs (3) and (7) of section 1.482-2(b) of the proposed regulations as published in the Federal Register on August 2, 1966, and as quoted in section 2.02 of this Revenue Procedure.

SEC. 4. PUERTO RICAN AFFILIATES.

In recognition that Puerto Rican allocation problems arise in a unique factual context in that the economic relationship between Puerto Rico and the United States has special characteristics, guidelines for the proper application of section 482 directed specifically and solely to cases involving U.S. companies and their manufacturing affiliates in Puerto Rico were published in Revenue Procedure 63-10. The Service will continue to close cases on the basis of the guidelines published in Revenue Procedure 68-10 in cases involving the allocation of income and deductions between U.S. companies and their manufacturing affiliates in Puerto Rico if the result is more favorable to the taxpayer than the result under the regulations prescribed by Treasury Decision 6952.

¹ Also released as Technical Information Release 975, dated April 16, 1968.