Instructions for Form 5735 (4/2003)

General Instructions

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Table of Contents

Purpose of Form

Form 5735 is used to figure the possessions corporation tax credit under section 936 (or section 30A, if applicable). The credit is generally allowed against income tax imposed by Chapter 1 (see page 2 for exceptions) and is figured separately for each possession. For purposes of the credit, U.S. possessions include Puerto Rico, Guam, American Samoa, the Commonwealth of the Northern Mariana Islands, and the U.S. Virgin Islands. Special rules apply to existing credit claimants (defined below) from Puerto Rico, Guam, American Samoa, and the Commonwealth of the Northern Mariana Islands (see below).

Who Must File

A domestic corporation (other than an S corporation) that is an existing credit claimant (defined below) must complete Form 5735 for each year the possessions credit election is in effect.

Where To File

Attach Form 5735 to the corporation's income tax return and file the return with the Internal Revenue Service Center, Philadelphia, PA 19255.

Existing Credit Claimant

A corporation is an existing credit claimant with respect to a possession if the corporation:

Was engaged in the active conduct of a trade or business within the possession on October 13, 1995 and
Elected the benefits of the possessions credit, effective for its taxable year that includes October 13, 1995.

The determination of whether a taxpayer is an existing credit claimant is made separately for each possession. A corporation that acquires all of the assets of a trade or business of an existing credit claimant will qualify as an existing credit claimant.

Binding contract exception. For purposes of these rules, a corporation is treated as engaged in the active conduct of a trade or business within a possession on October 13, 1995, if the corporation had in effect on that date, and at all times thereafter, a binding contract for the acquisition of assets to be used in, or the sale of property to be produced from, that trade or business.

Substantial new line of business. A corporation that adds a substantial new line of business or that has a new line of business that becomes substantial, ceases to be an existing credit claimant at the beginning of the tax year in which (a) it added the new line of business or (b) the new line of business becomes substantial. For details, see Regulations section 1.936-11.

Special Rules for Certain Possessions

Puerto Rico

An existing credit claimant with respect to Puerto Rico that is using the economic activity limitation figures its credit for income from Puerto Rico separately under section 30A. Generally, the provisions of section 936 apply for purposes of figuring the credit under section 30A. See section 30A(e) for more information.

Guam, American Samoa, and the Commonwealth of the Northern Mariana Islands

For tax years beginning before January 1, 2006, the amendments made by the Small Business Job Protection Act of 1996 do not apply to existing credit claimants with respect to Guam, American Samoa, and the Commonwealth of the Northern Mariana Islands. Existing credit claimants may figure the credit with respect to those possessions (including the credit for qualified possession source investment income (QPSII)), using section 936 (as in effect before the 1996 Act). See section 936(j)(8).

Qualifying for the Credit

To qualify for the possessions corporation tax credit, a corporation must meet all three of the following requirements:

The corporation must have filed a valid Form 5712, Election to Be Treated as a Possessions Corporation Under Section 936, by the due date (including extensions) of the first return to which the election applies. In addition, the corporation must qualify as an existing credit claimant (see definition above).
The corporation must have derived 80% or more of its gross income from sources in a U.S. possession during the applicable period (defined in the instructions for Part I) immediately before the tax year ended.
The corporation must have derived 75% or more of its gross income from the active conduct of a trade or business in a U.S. possession during the applicable period immediately before the tax year ended.

Restrictions

The credit is not allowed against the following taxes:

Tax on accumulated earnings (section 531).
Personal holding company tax (section 541).
Additional tax for recovery of foreign expropriation losses (section 1351).
Recapture of investment credit (section 50).
Recapture of low-income housing credit (section 42(j)(4)(D)).
Recapture of Indian employment credit (section 45A).

IC-DISC or FSC

A corporation cannot take the possessions corporation tax credit for any tax year it is an IC-DISC or former IC-DISC, or for any tax year in which it owns stock in an IC-DISC or FSC, or former IC-DISC or former FSC (section 936(f)).

Alternative Minimum Tax

Income eligible for the possessions corporation tax credit is not taxed under the alternative minimum tax rules. See Form 4626, Alternative Minimum Tax—Corporations.

Foreign Tax Credit/Deduction

Generally, the corporation cannot take a deduction (however, see the instructions for Part V) or foreign tax credit for taxes it paid or accrued to a foreign country or U.S. possession if any of the income on which those taxes were paid or accrued is used in computing the possessions corporation tax credit.

Other Forms and Schedules That May Be Required

Form 5712-A. Use Form 5712-A, Election and Verification of the Cost Sharing or Profit Split Method Under Section 936(h)(5), to show that the corporation has a significant business presence in the U.S. possession for the tax year, and to elect either the cost sharing or profit split method of computing taxable income from certain possession products. Attach Form 5712-A to Form 5735.

Schedule P (Form 5735). If the corporation elects to use either the cost sharing or profit split method, it must complete and attach Schedule P (Form 5735), Allocation of Income and Expenses Under Section 936(h)(5), to Form 5735. Attach a separate Schedule P for each product to which the cost sharing or profit split method applies.

Source of Gross Income, etc.

See sections 638, 861-864, and 936 to determine if the source of gross income, deductions, and taxable income is in or outside the United States or in a U.S. possession. Amounts received in the United States may be considered sourced outside the United States if they are from sources outside the United States and received from an unrelated person in the active conduct of a trade or business (section 936(b)).