Semiconductor Supplier Seeks Clarification Under FDII, GILTI Regs

Comments of ON Semiconductor Corporation

On the
Deduction for Foreign-Derived Intangible Income
and Global Intangible Low-Taxed Income

84 Fed. Reg. 8188 (March 6, 2019)
[REG-104464-18]
RIN 1545–B055

ON Semiconductor Corporation appreciates the opportunity to comment to the Treasury Department and the Internal Revenue Service on the proposed regulations on the deductions for foreign-derived intangible income ("FDII") and global intangible low-taxed income ("GILTI") pursuant to section 250 (the "Proposed Regs"). 84 Fed. Reg. 8,188 (March 6, 2019).

ON Semiconductor, headquartered in Phoenix, Arizona, is a leading supplier of semiconductor-based solutions, offering a comprehensive portfolio of energy efficient connectivity, sensing, power management, analog, logic, timing, discrete, and custom devices for use in automotive, communications, computing, consumer, industrial, medical and aerospace/defense applications. More information about ON Semiconductor is available at www.onsemi.com.

ON Semiconductor conducts operations globally. Generally, ON Semiconductor engages in R&D and design activities in the U.S., along with a significant amount of wafer fabrication (also referred to as "front-end" manufacturing¹). These wafers are then sold to a wholly owned foreign subsidiary, which engages with related and unrelated foreign manufacturers to perform "back-end" manufacturing² and which then sells to foreign customers who incorporate the finished semiconductor product in their manufacturing processes.

The company's front end operations include factories in Idaho, Maine, New York, Oregon, and Pennsylvania, which is more states than any other U.S. semiconductor company.³ The company also recently announced a significant expansion of its U.S. manufacturing base with its acquisition of a front end facility in East Fishkill, New York that will process 12 inch diameter wafers, each of which can produce over double the number of chips compared to the 8 inch wafers used at the company's current factories.⁴

The intention of Congress, through the enactment of H.R. 1 (f/k/a the Tax Cuts and Jobs Act), was to encourage U.S. companies to bring back ("repatriate") intangible property ("IP") and manufacturing to the U.S. The newly created deduction for FDII was one incentive intended to encourage such repatriation. ON Semiconductor is actively evaluating the economic ownership of its IP rights, in primary part due to the potential benefits provided by FDII. However, the Proposed Regs. introduce significant administrative burdens as well as several areas of uncertainty. The Proposed Regs., as drafted, would have a significant impact on any decision by ON Semiconductor to restructure IP ownership and a potentially adverse impact on any decision to repatriate IP ownership to the U.S.

As a result of the administrative burden from, and uncertainty of, the Proposed Regs., ON Semiconductor respectfully requests that Treasury:

• Align the definition of foreign use for income from intangible property under §1.250(b)-4(e) with the definition of foreign use for general property under §1.250(b)-4(d)(2);

• Amend the "end user" language in §1.250(b)-4(e)(2) to define the term "end user" to be either (a) customers who further manufacture the product or (b) the ultimate end consumer (e.g. the customer's customer);

• Provide additional language to further define "physical and material change" in §1.250(b)-4(d)(2);

• Clarify the language of and provide examples in §1.250(b)-6(b)(5)(ii) to make clear that, for instance, a product sold from a US company to its foreign subsidiary and used by the foreign subsidiary to manufacture finished products meets the definition of "component" without regard to the definition of "component" in §1.250(b)-4(d)(2)(iii)(C);

• Include an election to permit the sale of product to an unrelated person that occurs after the FDII filing date pursuant to §1.250(b)-6(c)(1)(i) to be claimed as a carryforward and deducted on a future return rather than requiring the filing of an amended return; and,

• Amend the documentation requirements for determining the status of a customer as a "foreign person" under §1.250(b)-4(c)(2) to include documents more readily obtainable in the ordinary course of business such as commercial invoices, packaging slips, purchase orders, or bills of lading.

DEFINITION OF "FOREIGN USE" FOR INTANGIBLE INCOME

The preamble to the Proposed Regs. cites footnote 1522 of the Conference Report that accompanied H.R. 1 to conclude that because intangible property is not subject to manufacture, assembly, or processing and because no other discussion appears in the Conference Report with respect to intangible property, income from intangible property should not be eligible for "foreign use" based on further foreign manufacturing. However, Section 250(b)(5)(E) defines "sale", "sell", and "sold" to include any lease, license, exchange, or other disposition. ON Semiconductor believes that Footnote 1522 was intended to clarify that all income from a sale of property (including income from royalties or licensing fees) would be eligible for FDII if the property sold was subject to further manufacturing outside the United States. A royalty paid by a foreign related party to a US company for the right to make, use, and/or sell property should be eligible for FDII if such property ultimately sold by the foreign related party to a foreign customer is subject to further manufacturing outside the United States. ON Semiconductor respectfully requests that Treasury align the definition of foreign use for income from intangible property under §1.250(b)-4(e) with the definition of foreign use for general property under §1.250(b)-4(d)(2).

DEFINITION OF "END USER" FOR PURPOSES OF INCOME FROM INTANGIBLE PROPERTY

Proposed Reg. §1.250(b)-(4)(e)(2) states that "a sale of intangible property is for a foreign use only to the extent that the intangible property generates revenue from exploitation outside the United States". The Proposed Regs. further specify that "the intangible property is exploited at the location of the end user when the product is sold to the end user" (emphasis added). However, the Proposed Regs. do not define "end use and do not appear to contemplate business models where a taxpayer sells exclusively to original equipment manufacturers ("OEMs") and/or other customers who use the purchased product to engage in further manufacturing for subsequent sale of end products to consumers.

The "end user" of ON Semiconductor's product is a customer who engages in further manufacturing. ON Semiconductor does not generally have access to data from its OEM customers that would document the location of the consumer upon final sale by the OEM (or the customer of the OEM)⁵. Treasury should amend the language in the Proposed Regs. under §1.250(b)-4(e)(2) to define "end user" to include a customer who engages in further manufacturing. Alternatively, Treasury should consider eliminating the term "end user" and instead find an appropriate alternative such as "the location of the first unrelated customer who consumes the product or uses the product in further manufacturing processes when the product is sold to such customer."

DEFINITION OF "PHYSICAL AND MATERIAL CHANGE" FOR FOREIGN USE

Pursuant to §1.250(b)-4(d)(2), the sale of general property is for a foreign use if the property is subject to manufacture, assembly, or other processing outside the United States such that the property either (1) is physically and materially changed or (2) is incorporated as a component into a second product. ON Semiconductor recommends that Treasury provide additional language to further define "physical and material" change. The additional language should set out that the "physical and material" change test is met where general property is subject to processing or manufacturing activities that are substantial in nature and that are generally considered to constitute the manufacturing or production of property that is substantially different than the property which was sold to the customer⁶. This language is consistent with language used in the regulations under §954⁷. This language could be illustrated by the following example.

DEFINITION OF "COMPONENT" FOR RELATED PARTY SALES

ON Semiconductor respectfully requests Treasury to clarify the language of and provide additional examples in §1.250(b)-6, as the guidance contained in §1.250(b)-6(b)(5) is not clear. In particular, the distinction between §1.250(b)-6(b)(5)(ii) and §1.250(b)-6(b)(5)(iii) should be clarified. For example, is the sale of a wafer manufactured in the U.S. and sold to a CFC who engages in further manufacturing and then sells to unrelated customers for use outside the U.S. controlled by §1.250(b)-6(b)(5)(ii) or by §1.250(b)-6(b)(5)(iii)? Is the wafer "property sold [as] a component of property", or, rather, is the wafer "property used in connection with the property sold"? The better interpretation of the Proposed Regs. would appear to support the conclusion that this example would be governed by §1.250(b)-6(b)(5)(ii).

Further, ON Semiconductor recommends including the following language from the preamble to the Proposed Regs. in the Final Regulations themselves:

"For purposes of this rule, whether property is a component of another property that is subsequently sold in an unrelated party transaction is determined without regard to the rule defining a "component" for purposes of determining whether general property is subject to manufacturing, assembly, or other processing, as described in [part III(C)(3)(a) of this Explanation of Provisions section]."⁸

Because of the emphasis on the distinction between "physically and materially changed" and "incorporated as a component" contained in §1.250(b)-4(d)(2) (discussed above), it is critical that the final §250 regulations in §1.250(b)-6(b)(5) specifically stipulate that the classification under §1.250(b)-6(b)(5) has no bearing on the classification under §1.250(b)-4(d)(2).

ELECTION TO TREAT FDII SALES AS A CARRYFORWARD

ON Semiconductor respectfully requests Treasury include an election in §1.250(b)-6(c)(i) pursuant to which companies can claim FDDEI related party sales that are sold to a third party after the FDII filing date on future tax returns (in the respective taxable year in with the sale to the third party occurs) in lieu of filing an amended return. An amended return filing could create significant administrative burdens and undue hardships for some taxpayers. In addition to the complexities and costs of filing of an amended federal U.S. tax return, a taxpayer would be required to file amended state income tax returns in some or all of the states in which the taxpayer generally files. Allowing an election to claim the FDDEI sales in a subsequent year in which the third party sale occurs is analogous to the recurring item exception under §461⁹, which denies a current deduction for expenses paid out more than 9 months after the taxable year end (akin to the FDII filing date) but permits this deduction to be claimed in a subsequent taxable period when paid.

DOCUMENTATION REQUIREMENTS FOR "FOREIGN PERSON"

ON Semiconductor believes that the documentation requirements under §1.250(b)-4(c)(2) to establish the status of a customer as a foreign person result in a significant administrative burden on the taxpayer. The documentation requirements to establish foreign status for all foreign customers in a manner that meets one of the prescribed forms could be especially challenging, given that a large volume of sales are concluded through a purchase order rather than an individual, specific contract.

Further, the transition period only covers the period of time up to when the Proposed Regs. are published in final form, after which companies are required to provide the additional documentation. Unfortunately, several of the items listed in §1.250(b)-4(c)(2) are not easily or quickly obtainable by ON Semiconductor in the ordinary course of business (nor would it be offered or possibly provided by the recipient). For instance, ON Semiconductor would have significant difficulty obtaining a signed letter from a customer certifying foreign status.

As proposed, absent an ability to obtain the types of documents listed, ON Semiconductor will default to "other forms of documentation as prescribed by the Secretary." In lieu of providing a restricted list which may not be flexible enough to address many different business models, ON Semiconductor recommends that Treasury amend the list of qualifying documentation to include language such as "additional documents which are utilized in the ordinary course of business, such as, but not limited to, commercial invoices, packaging slips, purchase orders, or bills of lading."

* * * * *

Thank you in advance for your consideration of these requests. ON Semiconductor supports Congress efforts to encourage IP ownership and investment in the U.S. and believes that the changes outlined above will better align the Section 250 regulations with Congressional intent. I am available to talk through any of the concerns identified above with you and your staff.

Sincerely,

Matthew E. Beckler
Vice President, Global Tax
ON Semiconductor
Phoenix, AZ