Rev. Rul. 57-542

Advice has been requested whether intercompany transactions will adversely affect the qualifications of a Western Hemisphere trade corporation under the circumstances set forth below.

A United States company has a domestic affiliate, the principal business of which is production of minerals in Venezuela. A substantial portion of the sales of this mineral by the affiliate for the years in question was made to the United States company for processing in the United States. The agreement under which these sales were made provided that all purchases would be f.o.b. Venezuela and that title to the mineral would pass at the Venezuela shipping points. During 2 years, the affiliate claimed the deduction in computing taxable income allowed to a Western Hemisphere trade corporation. In the second year, it jointed in the consolidated return of the United States corporation and affiliated companies.

In order to qualify as a Western Hemisphere trade corporation, a taxpayer must meet all the tests prescribed by section 921 of the Internal Revenue Code of 1954, namely, that (a) it must be a domestic corporation whose entire business (other than incidental purchases) is done within the geographical limits of North, Central, or South America, or in the West Indies; (b) ninety-five percent or more of its gross income for the 3-year period immediately preceding the close of the taxable year, or for such part of such period during which it was in existence, must be derived from sources without the United States; and (c) ninety percent or more of its gross income for such period, or such part thereof, must be derived from the active conduct of a trade or business.

It is clear that the fact that taxpayer has made sales to the United States company cannot affect a determination whether it has met the first and third tests above. It is the position of the Internal Revenue Service that income of a corporation, whether or not received from another domestic corporation or a corporation doing business in the United States, is income from sources without the United States for purposes of section 921 of the Code if it constitutes such income under the applicable provisions of sections 861, 862 and 863 of the 1954 Code, relating to the determination of whether income is from sources within or without the United States.

Accordingly, it is held that intercompany transactions between a domestic corporation and its domestic affiliate doing business in Venezuela will not adversely affect the qualifications of the affiliate as a Western Hemisphere trade corporation. However, transactions between two closely related corporations, such as in the instant case, will be carefully examined to ascertain whether they are on an `arm's length' basis, and section 482 of the Code will be applied to reallocate income and deductions between them where necessary to prevent evasion of taxes or clearly to reflect income of either company. See Rev. Rul. 15, C.B. 1953-1, 141.