Rev. Rul. 74-193

Advice has been requested whether, in the situation described below, a refined and converted mineral substance constitutes property manufactured in the United States for purposes of section 4914(c)(1)(B)(i) of the Internal Revenue Code of 1954.

In its operations, the taxpayer, a domestic corporation, purchases a natural mineral product which is mined in foreign countries and refines and converts such mineral product in the United States into a substance which is commercially usable. It sells the final product to unrelated foreign companies which, in payment therefor, issue debt obligations to the taxpayer that have periods remaining to maturity of one year or more.

Section 4911 of the Code, in part, imposes an interest equalization tax (IET) on each acquisition by a United States person (as defined in section 4920(a)(4)) of a debt obligation of a foreign obligor (if such obligation has a period remaining to maturity of 1 year or more).

Section 4914(c) of the Code provides an exemption from the IET for certain credit export transactions. Among the specific requirements for this exemption is the provision of section 4914(c)(1)(B)(i) that not less than 85 percent of the amount of the loan or the amount paid or other consideration given to acquire such debt obligation is attributable to the sale of personal property manufactured, produced, grown, or extracted in the United States.

Although there are no regulations under section 4914(c)(1)(B)(i) of the Code, there are regulations under section 954(d)(1)(A) which contain specific tests for determining what constitutes manufacture, production, or construction of property. The effect of both cited sections is to provide that a particular incidence of Federal taxation depends in part upon where property which is purchased and thereafter sold is manufactured, produced, grown, or extracted. Both sections employ similar language in accomplishing their purposes. It is, therefore, appropriate to refer to the regulations under section 954(d)(1)(A) to determine whether property is manufactured, produced, grown, or extracted in the United States for purposes of section 4914(c)(1)(B)(i).

Section 1.954-3(a)(4) of the Income Tax Regulations provides two alternative tests for determining whether a foreign corporation will be considered to have manufactured, produced, or constructed personal property which it purchases and thereafter sells. The two tests are (1) the "substantial transformation of property" test and (2) the "purchased components" test. The foreign corporation must satisfy one of these two tests to establish that the property which it sells is in effect not the property which it purchased. The "substantial transformation of property" test provides, in part, that if purchased personal property is substantially transformed prior to sale, the property sold will be treated as having been manufactured, produced, or constructed by the selling corporation. The examples of transformed property given in the subparagraph are: a change in wood pulp to paper; steel to screws and bolts; and tuna fish to canned tuna fish.

In the instant case, the refining and converting process which changes the natural mineral substance into a commercially usable substance would satisfy the "substantial transformation of property" test prescribed in section 1.954-3(a)(4) of the regulations. Accordingly, the refined and converted mineral substance constitutes property manufactured or produced within the United States for purposes of section 4914(c)(1)(B)(i) of the Code.

It should be noted that the rate of IET specified in section 4911(b) of the Code has been reduced to zero by Executive Order 11766, dated January 29, 1974, effective for acquisition of foreign stock and debt obligations made after January 29, 1974.