Instructions for Form 5735 (4/2003)

Specific Instructions

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Table of Contents

Part I—Gross Income in Applicable Period

Applicable period. The “applicable period” is generally the shorter of 36 months or the period when the corporation actively conducted a trade or business in a U.S. possession.

Column (f). Include amount(s) reported on line 6, Part II, Schedule(s) P.

Column (i). Gross qualified possession source investment income (QPSII) is gross income that is:

From sources within a possession of the United States in which a trade or business is actively conducted and
Attributable to the investment in that possession (for use therein) of funds derived from the active conduct of a trade or business in that possession or from that investment.

Do not enter an amount in column (i) unless the corporation is an existing credit claimant with respect to Guam, American Samoa, or the Commonwealth of the Northern Mariana Islands.

Part II—Taxable Income From Possession Sources

In column B, Part II, enter only QPSII received or accrued by a corporation that is an existing credit claimant with respect to Guam, American Samoa, or the Commonwealth of the Northern Mariana Islands.

Line 6a. Include amount(s) reported on line 6, Part II, Schedule(s) P.

Line 7a. With respect to amounts received in the United States:

Enter U.S. source income from the active conduct of a trade or business within a U.S. possession that is received from a person who is not a related person.
Do not include foreign source income from the active conduct of a trade or business within a U.S. possession that is received from a person who is not a related person. Instead, include these amounts on line 6a, 6b, or 6d, whichever applies.

Line 7c. Enter the amount of marketing intangible property income which is associated with any product(s) subject to the cost sharing method and which is not included in the gross income of a shareholder because such a shareholder is a foreign person or a tax-exempt U.S. person. See Regulations section 1.936-6(a)(5).

Line 8a. If the cost sharing method applies, enter the sum of all cost sharing amounts entered on line 7, Part I, Schedule(s) P.

Line 8b. Include all amounts entered on line 7, Part II, Schedule(s) P. Also include the corporation's other definitely allocable deductions.

Line 8c. Enter the ratable part of deductions that cannot be definitely allocated to qualified income. To obtain this amount, reduce the deductions by the amount entered on line 8b. Multiply this result by the amount obtained when you divide the amount entered on line 7e by the gross income on the corporation's income tax return.

Line 10a. If the corporation sustained a loss for the current year on any category of income for which a separate foreign tax credit limit applies, allocate the loss to the possessions income that qualifies for the credit in proportion to the ratio of that income to total taxable income, excluding the loss.

Line 10b. If the corporation sustained an overall foreign loss in any year, the loss is recaptured in later tax years by treating part of the corporation's taxable income from sources outside the U.S. as income from sources in the U.S. (section 904(f)).

Line 11. Do not enter more than the corporation's adjusted base period income in column A.

Adjusted base period income is the average of the inflation-adjusted possession incomes of the corporation for each base period year.

Inflation-adjusted possession income is the possession income (as defined in section 936(j)(6)) of the corporation for the base period year, increased by the inflation adjustment percentage (defined in section 936(j)(4)(C)) for the base period year multiplied by the possession income.

Base period year generally means each of three of the corporation's five most recent tax years ending before October 14, 1995, without regard to the tax years with the highest and lowest inflation-adjusted possession incomes. Generally, for purposes of this computation, only years in which the corporation had significant possession income (as defined in section 936(j)(5)(B)(iii)) are taken into account.

Line 12. Corporations that are taking a deduction for possession income taxes (i.e., corporations that have elected the percentage limitation or that use the economic activity limitation and the profit split method), enter taxable income without regard to any deduction for possession income taxes.

Part III—Possessions Credit Using the Percentage Limitation Method

If a corporation is claiming the reduced credit (percentage limitation), the economic-activity limitation (figured in Part IV) does not apply.

If the corporation made the election to use the percentage limitation in an earlier tax year, it remains in effect for all tax years unless it was revoked before the first tax year beginning in 1997. If the election was revoked, the revocation applies to all subsequent tax years.

The percentage limitation applies only if all possession corporations that are members of an affiliated group make the election. If an election is not in effect for a possession corporation that is a member of an affiliated group, the election for any other group member is revoked for the tax year and subsequent tax years.

For more information, see sections 936(a)(4)(B) and 936(j).

Part IV—Possessions Credit Using the Economic-Activity Limitation Method

Any wages or other expenses taken into account in determining the possessions credit using the economic-activity limitation of section 30A may not be taken into account in determining the research credit under section 41.

Line 18. Enter 60% of the sum of:

The aggregate amount of the possession corporation's qualified possession wages for the tax year and
The allocable employee fringe benefit expenses of the possession corporation for the tax year.

Qualified possession wages. Qualified possession wages are wages paid or incurred by the possession corporation during the tax year in connection with the active conduct of a trade or business in a U.S. possession to an employee for services performed in that possession, but only if the services are performed while the employee's principal place of employment is in that possession.

The term “wages” generally means wages as defined in section 3306(b), but without regard to any dollar limitation contained in that section. For this purpose, section 3306(b) is applied as if the term “United States” includes all possessions of the United States. See section 936(i)(1)(D)(ii) for a special rule for agricultural labor and railway labor.

The wages that are taken into account for the tax year for any employee are limited to 85% of the old-age, survivors, and disability insurance (OASDI) contribution and benefit base for the calendar year in which that tax year begins. The OASDI contribution and benefit base for 2003 is $87,000. The amount for future tax years may be found at www.ssa.gov.

Special rules apply to part-time employees and employees whose principal place of employment with the possession corporation is not within the possession at all times during the tax year.

For more information, see section 936(i)(1).

Allocable employee fringe benefit expenses. The total amount of employee fringe benefit expenses taken into account in figuring the economic-activity limitation is the amount deductible by the possession corporation in the tax year for:

Employer contributions to stock bonus, pensions, profit-sharing, or annuity plans,
Employer-provided health or accident plan coverage for the employees, and
The cost of life or disability insurance provided to employees.

Any amount treated as wages (above) may not be treated as an employee fringe benefit expense.

The amount of allocable employee fringe benefit expenses for a tax year is equal to the total amount of employee fringe benefit expenses (defined above) multiplied by a fraction. The fraction consists of the possession corporation's qualified possession wages (defined above) for the tax year, divided by the aggregate amount of wages paid or incurred by the possession corporation during the tax year.

The allocable employee fringe benefit expenses cannot exceed 15% of the possession corporation's qualified possession wages for the tax year.

For more information, see section 936(i)(2).

Line 19. Enter the total of the following amounts:

15% of the depreciation deduction for short-life qualified tangible property (defined below),
40% of the depreciation deduction for medium-life qualified tangible property, and
65% of the depreciation deduction for long-life qualified tangible property.

Qualified tangible property means any tangible property used by the possession corporation in a possession of the United States in the active conduct of a trade or business within such possession.

Short-life qualified tangible property is qualified tangible property that is 3-year or 5-year property under section 168.

Medium-life qualified tangible property is qualified tangible property that is 7-year or 10-year property under section 168.

Long-life qualified tangible property is qualified tangible property that is not short-life or medium-life qualified tangible property.

For more information, see section 936(i)(4).

In the case of any qualified tangible property to which section 168 (as in effect before the date of enactment of the Tax Reform Act of 1986) applies, any references above to section 168 are to that Code section as then in effect.

For more information on classifying property and figuring the depreciation deduction, see section 168 and the Instructions for Form 4562, Depreciation and Amortization.

Line 23. Enter possession income taxes on line 23 only to the extent that they do not exceed 9% of taxable income for the tax year.

For this purpose, possession income taxes are any income, war profits, or excess profits taxes of a possession of the United States that are not taken into account in computing the foreign tax credit. See section 936(i)(3)(C).

Line 24. For more information on figuring possession income taxes allocable to nonsheltered income, see section 936(i)(3).

Part V—Deduction For Possession Income Taxes

Complete Part V to figure the corporation's deduction for possession income taxes. A corporation may take a deduction for a portion of its possession income taxes if it is either:

A corporation that uses the economic-activity limitation and the profit split method to allocate income from intangible property or
A corporation that claims the percentage limitation (reduced credit).

In determining the credit or the deduction, taxable income is determined without regard to any deduction for possession income taxes. See section 936(i)(3)(B).

Part VI—Summary From Schedule P (Form 5735)

The corporation is not required to complete Part VI if it has attached less than 10 Schedules P. Although Part VI information will not affect the corporation's tax liability, failure to complete this part, if required, will delay the processing of Form 5735.

Line 34. Enter on line 34a the sum of sales of possession products (as reported on line 2, Part I, Schedule(s) P) subject to the cost sharing method. Enter on line 34b the sum of sales of possession products (as reported on line 2, Part I, Schedule(s) P) subject to the profit split method.

Line 35. Enter on lines 35a through 35e the sum of sales of possession products (as reported on line 2, Part I, Schedule(s) P) which have met the listed business presence test. Total sales included on lines 35a through 35e should equal the total of lines 34a and 34b.

Specific Instructions

Part I—Gross Income in Applicable Period

Part II—Taxable Income From Possession Sources

Part III—Possessions Credit Using the Percentage Limitation Method

Note:

Part IV—Possessions Credit Using the Economic-Activity Limitation Method

Note:

Note:

Note:

Part V—Deduction For Possession Income Taxes

Note:

Part VI—Summary From Schedule P (Form 5735)