Form 5735, Possessions Corporation Tax Credit (Under Sections 936 and 30A), and Schedule P, Allocation of Income and Expenses Under Section 936(h)(5).

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Instructions for Form 5735

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Instructions for Form 5735

Department of the Treasury
Internal Revenue Service

(Rev. April 2003)
Possessions Corporation Tax Credit
(Under Sections 936 and 30A)
Section references are to the Internal Revenue Code, unless otherwise noted.

A Change To Note
The “Caution” on line 11 has been updated to reflect the
transition rules of sections 936(j)(2) and (3).

General Instructions

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

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:
1. Was engaged in the active conduct of a trade or
business within the possession on October 13, 1995 and
2. 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

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:
1. 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).
2. 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.
3. 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:
1. Tax on accumulated earnings (section 531).
2. Personal holding company tax (section 541).

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3. Additional tax for recovery of foreign expropriation
losses (section 1351).
4. Recapture of investment credit (section 50).
5. Recapture of low-income housing credit (section
42(j)(4)(D)).
6. Recapture of Indian employment credit (section
45A).

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.

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)).

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

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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.

Part II—Taxable Income From
Possession Sources

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.

In column B, Part II, enter only QPSII received or
accrued by a corporation that is an existing credit
CAUTION 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

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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)).

Specific Instructions
Part I—Gross Income in Applicable
Period
Applicable period. The “applicable period” is generally
the shorter of 36 months or the period when the
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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.

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.

Part III—Possessions Credit Using
the Percentage Limitation Method

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.

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).

Note: 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.

Note: 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 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).

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

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

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.

Note: 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.
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Part VI—Summary From Schedule P
(Form 5735)

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).
Note: 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).

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.
Paperwork Reduction Act Notice. We ask for the
information on this form to carry out the Internal Revenue
laws of the United States. You are required to give us the
information. We need it to ensure that you are complying
with these laws and to allow us to figure and collect the
right amount of tax.
You are not required to provide the information
requested on a form that is subject to the Paperwork
Reduction Act unless the form displays a valid OMB
control number. Books or records relating to a form or its
instructions must be retained as long as their contents
may become material in the administration of any Internal
Revenue law. Generally, tax returns are confidential, as
required by section 6103.
The time needed to complete and file this form will
vary depending on individual circumstances. The
estimated average time is:

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).
Note: 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).
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).

Recordkeeping . . . . . . . . . . . . . . . . . . . . . .
Learning about the law or the form . . . . . . .
Preparing the form . . . . . . . . . . . . . . . . . . .
Copying, assembling, and sending the form
to the IRS . . . . . . . . . . . . . . . . . . . . . . . . . .

20 hr., 5 min.
4 hr., 48 min.
7 hr., 12 min.
32 min.

If you have comments concerning the accuracy of
these time estimates or suggestions for making this form
simpler, we would be happy to hear from you. See the
instructions for the tax return with which this form is filed.

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