SEC. 2. BACKGROUND

.01 Section 936(a)(1)(A) provides that a qualified possessions corporation electing the application of § 936 is allowed a credit against its U.S. tax liability equal to the portion of such tax attributable to taxable income from the active conduct of a trade or business within a U.S. possession or the sale or exchange of substantially all of the assets used by the taxpayer in the active conduct of such trade or business.

.02 OBRA amended § 936 by adding §§ 936(a)(4) and 936(i). Section 936(a)(4) imposes one of two alternative limitations on the § 936 credit with respect to § 936(a)(1)(A) active business income in post-1993 tax years: the § 936(a)(4)(A) economic activity limitation and the § 936(a)(4)(B) percentage limitation. The economic activity limitation applies unless the taxpayer elects the percentage limitation. The amount of the post-1993 § 936 credit is limited to the lesser of the § 936(a)(4) credit limitation amount or the amount of the § 936 credit as computed without regard to the limitation under § 936(a)(4). These limitations apply to possessions corporations which are defined in § 936(i)(6) as domestic corporations for which the election provided in § 936(a) is in effect.

.03 The economic activity limitation of § 936(a)(4)(A) provides that the credit determined with respect to income referred to in § 936(a)(1)(A) shall not exceed the sum of the following amounts: (1) sixty percent of the aggregate amount of a possessions corporation’s qualified possession wages and allocable fringe benefit expenses for the taxable year; (2) fifteen percent of the corporation’s annual depreciation allowance with respect to short-life qualified tangible property; (3) forty percent of the annual depreciation allowance with respect to medium-life qualified tangible property; (4) sixty-five percent of the annual depreciation allowance with respect to long-life qualified tangible property; and (5) in the case of a possessions corporation that does not elect the profit split method of allocating intangible property income under § 936(h)(5)(C)(ii), § 936(a)(4)(A)(iii)

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provides that the economic activity limitation base also includes certain possession income taxes allocable to nonsheltered income.

.04 A possessions corporation which elects the profit split method of allocating intangible property income is not permitted to include possession income taxes in the economic activity limitation base. However, under § 936(i)(3)(B), such a corporation is allowed a deduction for certain possession taxes.

.05 Sections 936(i)(5)(A) and (B) provide that an affiliated group may elect to treat all possessions corporations which would be members of such group but for §§ 1504(b)(3) or (4) as one corporation. Thus, the economic activity limitation may be determined on a consolidated basis and allocated among such possessions corporations in such manner as the Secretary may prescribe. An election to compute the economic activity limitation on a consolidated basis shall apply to the taxable year for which made and all succeeding taxable years unless revoked with the consent of the Secretary.

.06 The percentage limitation of § 936(a)(4)(B) provides that the credit determined with respect to income referred to in § 936(a)(1)(A) shall be the applicable percentage of the credit which would otherwise have been determined under § 936(a)(1) with respect to such income.

.07 Section 936(a)(4)(B) further provides that a possessions corporation electing the percentage limitation method is entitled to a deduction, as determined under § 936(i)(3)(B), for taxes allocable (on a pro rata basis) to taxable income the tax on which is not offset by reason of the percentage limitation.

.08 Sections 936(a)(4)(B)(iii)(I) and (II) require that an election to use the percentage limitation be made by a possessions corporation for its first taxable year beginning after December 31, 1993 for which it is a possessions corporation. The election applies to the taxable year for which made and all subsequent years unless revoked.

.09 Section 936(a)(4)(B)(iii)(III) provides that if, for any taxable year, an election is not in effect for any possessions corporation which is a member of an affiliated group, any § 936(a)(4)(B)(iii) election for any other member of such group is revoked for that taxable year and all subsequent

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taxable years. For this purpose, members of an affiliated group shall be determined without regard to the exceptions contained in § 1504(b) and as if the constructive ownership rules of § 1563(e) applied for purposes of § 1504(a).

.10 Section 936(e)(2) provides that an election under § 936(a) may be revoked for any taxable year beginning before the expiration of the ninth taxable year following the year for which such election first applies only with the consent of the Secretary. Section 936(h) provides that intangible property income may be accounted for under the general rules of §§ 936(h)(1) to (h)(3), or, if properly elected, under the cost sharing or profit split methods specified in § 936(h)(5)(C). The Secretary is directed to take into account the significant nature of the modifications made by OBRA to the operation of § 936 in cases where a possessions corporation seeks to revoke its election to use the § 936 credit or change its method of allocating income from intangible property under § 936(h). H.R. Conf. Rep. No. 213, 103rd Cong., 1st Sess. 622 (1993), 1993–3 C.B. 393, 509 (Conference Report). .11 Section 1504(a) defines an affiliated group as one or more chains of includible corporations connected with a common parent corporation which is an includible corporation if: (1) the common parent owns directly at least 80 percent of the total voting power of the stock and 80 percent of the total value of the stock of at least one other includible corporation; and (2) at least 80 percent of the total voting power of the stock and 80 percent of the total value of the stock of each includible corporation (except the common parent) is owned directly by one or more of the other includible corporations.

.12 Section 1504(b) provides that the term includible corporation means any corporation except: (1) corporations exempt from taxation under § 501; (2) insurance companies subject to taxation under § 801; (3) foreign corporations; (4) corporations with respect to which an election under § 936 (relating to possession tax credit) is in effect for the taxable year; (5) regulated investment companies and real estate investment trusts subject to tax under subchapter M of chapter 1; and (6) a DISC (as defined in § 992(a)(1)).

.13 Section 1563(e) attributes ownership of stock to an option holder; proportionate ownership of stock held

by or for a partnership to a partner having a capital or profits interest in the partnership of 5 percent or more; certain ownership of stock held by a trust or estate to a beneficiary having an actuarial interest in such stock of 5 percent or more; ownership of stock held by or for a grantor trust to the grantor or other substantial owner; proportionate ownership of stock held by or for a corporation to a shareholder owning 5 percent or more of the stock value; and certain ownership of stock held by an individual’s spouse, children, grandchildren, parents, and grandparents.