rived by the Panamanian corporation are foreign base company sales income. How-
ever, if the Panamanian corporation were to sell the property in Panama for use in
Panama, then foreign base company sales income would not be generated. In addi-
tion, if the Panamanian corporation were to manufacture the property in Panama and
then sell it to related parties, foreign base company sales income would not be gen-
erated, because the property would have been produced in the CFC’s country of in-
corporation. Substantial transformation is required before property is treated as hav-
ing been produced by the selling corporation. Regulations provide a safe harbor rule
that, if the conversion cost, consisting of direct labor and factory burden, equals 20%
or more of the total cost of sales, then the property is considered to be manufactured
within the CFC’s country of incorporation. Mere packaging, labeling, or minor as-
sembling operations do not constitute production. There is an exception for sale of
certain agricultural commodities that are not grown in the United States in commer-
cially marketable quantities. Such agricultural commodities are excluded from the
foreign base company sales income provisions. Accordingly, a CFC can purchase or
sell cocoa from or to a related person without generating foreign base company sales
income. This is so, regardless of where the cocoa is used or grown, as cocoa is not
grown in the United States in commercially marketable quantities.
Under certain branch rules, if sales or purchasing activities are conducted by a
branch outside the CFC’s country of incorporation and the tax effect is substantially
the same as if the branch were a wholly owned subsidiary, the income attributable to
the branch activities is treated as income derived by a wholly owned subsidiary of the
CFC. Consequently, it could be considered foreign base company sales income.
Foreign base company services income is income derived from services per-
formed for, or on behalf of, a related party when the services are performed outside
the CFC’s country of incorporation. Services directly related to the sale by the CFC
of property manufactured by it and performed prior to the time of sale, or services re-
lated to an offer to sell such property, are subject to the foreign base company sales
rules rather than the services income rules. Foreign base company services income is
described by the following example.
CFC A enters into a contract with an unrelated person to drill an oil well in a for-
eign country. Domestic Corporation P owns all the outstanding stock of A, which em-
ploys a relatively small clerical and administrative staff and owns the necessary well-
drilling equipment. Most of the technical and supervisory personnel who will oversee
the drilling of the oil wells of A are regular employees of P, perhaps temporarily em-
ployed by A. In addition, A hires on the open market unskilled and semiskilled la-
borers to work on the drilling project. The services performed by A under the well-
drilling contract are performed for, or on behalf of, a related person, because the
services of technical and supervisory personnel that are provided by P are a substan-
tial assistance in the performance of the contract. They assist A directly in the exe-
cution of the contract and provide A with skills that are a principal element in pro-
ducing the income in the performance of such contracts.
Foreign base company shipping income is income derived from, or in connection
with, the use of any aircraft or vessel in foreign commerce. This includes charter in-
come, hiring (or leasing for use) of an aircraft or vessels, as well as performance of
services related to the use of such aircraft or vessels. Where the CFC has an in-
vestment in a lower-tier shipping company, foreign base company shipping income
includes dividends and interest (as well as gains from sales of stock) of lower-tier
corporations.
30 • 6 INTERNATIONAL TAXATION