USco, a domestic corporation, produces industrial engines at its United States plant for sale in the United States and Canada. USco also has a plant in Canada that performs the final stages of production with respect to the engines sold in Canada. All of the output of the Canadian plant is sold in Canada, whereas only one-third of the output of the United States plant is shipped to Canada. The Canadian operation is classified as a branch for United States tax purposes. During the current year, USco’s total sales to Canadian customers were $10 million, and the related cost of goods sold is $7 million. The average value of property, plant, and equipment is $30 million at the U.S. plant, and $5 million at the Canadian plant. USco sells all goods with title passing at the Canadian plant in the case of Canadian sales and at the United States plant in the case of United States sales.
a) How much of USco’s export gross profit of $3 million is classified as foreign source for U.S. tax purposes?
b) Now assume that the facts are the same as in part (a), except that the Canadian factory is structured as a wholly-owned Canadian subsidiary, rather than a branch. USco’s sales of semi-finished engines to the Canadian subsidiary (which still represent one-third of its output) were $6 million during the year and the related cost of goods sold was $4 million. The Canadian subsidiary’s total sales of finished engines to Canadian customers (which represents all of its output) was $10 million and the related cost of goods sold is $7 million. The average value of property, plant and equipment is still $30 million at the U.S. plant, and $5 million at the Canadian plant, and USco sells all goods with title passing at its U.S. plant. How much of USco’s export gross profit of $2 million is classified as foreign source for U.S. tax purposes?
c) How would your answer (to part b) change if USco sold its goods with title passing at the customer’s location?