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Federal Register / Vol. 71, No. 248 / Wednesday, December 27, 2006 / Rules and Regulations

Regulatory Policies and Procedures (44
FR 11034; February 26, 1979); and (3)
does not warrant preparation of a
regulatory evaluation as the anticipated
impact is so minimal. For the same
reason, the FAA certifies that this
amendment will not have a significant
economic impact on a substantial
number of small entities under the
criteria of the Regulatory Flexibility Act.
List of Subjects in 14 CFR Part 97
Air Traffic Control, Airports,
Incorporation by reference, and
Navigation (Air).
Issued in Washington, DC, on December
15, 2006.
James J. Ballough,
Director, Flight Standards Service.

Adoption of the Amendment
Accordingly, pursuant to the authority
delegated to me, under title 14, Code of
Federal Regulations, part 97 (14 CFR
part 97) is amended by establishing,
amending, suspending, or revoking
Standard Instrument Approach
Procedures and Weather Takeoff
Minimums effective at 0901 UTC on the
dates specified, as follows:

■

PART 97—STANDARD INSTRUMENT
APPROACH PROCEDURES
1. The authority citation for part 97
continues to read as follows:

■

Authority: 49 U.S.C. 106(g), 40103, 40106,
40113, 40114, 40120, 44502, 44514, 44701,
44719, 44721–44722.

2. Part 97 is amended to read as
follows:

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■

Effective 18 January 2007
Eagle, CO, Eagle County Regional, LDA/DME
RWY 25, Orig–B
Wauchula, FL, Wauchula Muni, RNAV (GPS)
RWY 18, Orig
Wauchula, FL, Wauchula Muni, RNAV (GPS)
RWY 36, Orig
Wauchula, FL, Wauchula Muni, Takeoff
Minimums and Textual DP, Amdt 1
Atlanta, GA, Hartsfield-Jackson Atlanta Intl,
ILS PRM RWY 8L(Simultaneous Close
Parallel) Orig
Atlanta, GA, Hartsfield-Jackson Atlanta Intl,
ILS PRM RWY 8R (Simultaneous Close
Parallel) Orig
Atlanta, GA, Hartsfield-Jackson Atlanta Intl,
ILS PRM RWY 9L (Simultaneous Close
Parallel) Orig
Atlanta, GA, Hartsfield-Jackson Atlanta Intl,
ILS PRM RWY 9R (Simultaneous Close
Parallel) Orig
Atlanta, GA, Hartsfield-Jackson Atlanta Intl,
ILS PRM RWY 10 (Simultaneous Close
Parallel) Orig
Atlanta, GA, Hartsfield-Jackson Atlanta Intl,
ILS PRM RWY 26L (Simultaneous Close
Parallel) Orig
Atlanta, GA, Hartsfield-Jackson Atlanta Intl,
ILS PRM RWY 26R (Simultaneous Close
Parallel) Orig

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Jkt 211001

Atlanta, GA, Hartsfield-Jackson Atlanta Intl,
ILS PRM RWY 27L (Simultaneous Close
Parallel) Orig
Atlanta, GA, Hartsfield-Jackson Atlanta Intl,
ILS PRM RWY 27R (Simultaneous Close
Parallel) Orig
Atlanta, GA, Hartsfield-Jackson Atlanta Intl,
ILS PRM RWY 28 (Simultaneous Close
Parallel) Orig
Indianapolis, IN, Indianapolis Intl, RNAV
(GPS) RWY 14, Amdt 1
Indianapolis, IN, Indianapolis Intl, RNAV
(GPS) RWY 32, Amdt 1
Indianapolis, IN, Indianapolis Intl, ILS OR
LOC RWY 14, Amdt 5A
Indianapolis, IN, Indianapolis Intl, ILS OR
LOC RWY 32, Amdt 18
Indianapolis, IN, Indianapolis Intl, Takeoff
Minimums & Textual DP’s, Orig
Leonardtown, MD, St. Mary’s County
Regional, Takeoff Minimums and Textual
DP, Orig
Monett, MO, Monett Muni, RNAV (GPS)
RWY 18, Orig
Monett, MO, Monett Muni, RNAV (GPS)
RWY 36, Orig
Monett, MO, Monett Muni, GPS RWY 18,
Orig, CANCELLED
Monett, MO, Monett Muni, GPS RWY 36,
Amdt 1, CANCELLED
Monett, MO, Monett Muni, Takeoff
Minimums and Textual DP, Orig
Ripley, MS, Ripley, VOR/DME–A, Amdt 2
Ripley, MS, Ripley, RNAV (GPS) RWY 3,
Amdt 1
Ripley, MS, Ripley, RNAV (GPS) RWY 21,
Amdt 1
Ripley, MS, Ripley, Takeoff Minimums and
Textual DP, Orig
Elizabeth City, NC, Elizabeth City CG Air
Station/Regional, ILS OR LOC RWY 10,
Orig
Alliance, NE Alliance Muni, RNAV (GPS)
RWY 12, Orig
Alliance, NE Alliance Muni, RNAV (GPS)
RWY 30, Orig
Alliance, NE Alliance Muni, GPS RWY 30,
Orig–A, CANCELLED
Kimball, NE, Kimball Muni/Robert E. Arraj
Field, RNAV (GPS) RWY 10, Orig
Kimball, NE, Kimball Muni/Robert E. Arraj
Field, RNAV (GPS) RWY 28, Orig
Kimball, NE, Kimball Muni/Robert E. Arraj
Field, NDB RWY 28, Amdt 2
Kimball, NE, Kimball Muni/Robert E. Arraj
Field, GPS RWY 28, Orig–A, CANCELLED
Kimball, NE, Kimball Muni/Robert E. Arraj
Field, Takeoff Minimums and Textual DP,
Orig
Wellsville, NY, Wellsville Muni Arpt,
Tarantine Fld, VOR–A, Amdt 6
Wellsville, NY, Wellsville Muni Arpt,
Tarantine Fld, LOC/DME RWY 28, Amdt 4
Wellsville, NY, Wellsville Muni Arpt,
Tarantine Fld, RNAV (GPS) RWY 10, Orig
Wellsville, NY, Wellsville Muni Arpt,
Tarantine Fld, RNAV (GPS) RWY 28, Orig
Myerstown, PA, Deck, Takeoff Minimums
and Textual DP, Orig
Philadelphia, PA, Philadelphia Intl, ILS PRM
RWY 26 (Simultaneous Close Parallel),
Amdt 3
Philadelphia, PA, Philadelphia Intl, ILS PRM
RWY 27L (Simultaneous Close Parallel),
Amdt 3
The FAA published an Amendment in
Docket No. 30525 Amdt No. 3196 to Part 97

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of the Federal Aviation Regulations (Vol 71,
FR No. 239, page 74764, dated December 13,
2006) Under Section 97.29 effective 18
January 2007, which is hereby rescinded:
Homer, AK, Homer, RNAV (GPS) Y RWY 21,
Orig
Homer, AK, Homer, RNAV (GPS) Y RWY 3,
Orig
Homer, AK, Homer, GPS RWY 21, Orig–B,
CANCELLED
Homer, AK, Homer, GPS RWY 3, Orig–B,
CANCELLED
[FR Doc. E6–21956 Filed 12–26–06; 8:45 am]
BILLING CODE 4910–13–P

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 9305]
RIN 1545–AW50

Source of Income From Certain Space
and Ocean Activities; Source of
Communications Income
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:

SUMMARY: This document contains final
regulations under section 863(d)
governing the source of income from
certain space and ocean activities. It
also contains final regulations under
section 863(a), (d), and (e) governing the
source of income from certain
communications activities. In addition,
this document contains final regulations
under section 863(a) and (b), amending
the regulations in § 1.863–3 to conform
those regulations to these final
regulations. The final regulations
primarily affect persons who derive
income from activities conducted in
space, or on or under water not within
the jurisdiction of a foreign country,
possession of the United States, or the
United States (in international water).
The final regulations also affect persons
who derive income from transmission of
communications.
DATES: Effective Date: These regulations
are effective December 27, 2006.
Applicability Date: For dates of
applicability, see § 1.863–8(h) and
§ 1.863–9(l).
FOR FURTHER INFORMATION CONTACT: H.
Michael Huynh, (202) 435–5161 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act
The collections of information
contained in these final regulations have
been reviewed and approved by the

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Office of Management and Budget
(OMB) in accordance with the
Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)) under control number
1545–1718.
The collections of information in
these final regulations are in §§ 1.863–
8(g) and 1.863–9(k). This information is
required by the IRS to monitor
compliance with the Federal tax rules
for determining the source of income
from space or ocean activities, or from
transmission of communications.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information
displays a valid control number
assigned by the Office of Management
and Budget.
The estimated annual burden per
respondent is 5 hours.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to
the Internal Revenue Service, Attn: IRS
Reports Clearance Officer,
SE:W:CAR:MP:T:T:SP, Washington, DC
20224, and to the Office of Management
and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of
Information and Regulatory Affairs,
Washington, DC 20503.
Books or records relating to a
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background
Congress enacted section 863(d) and
(e) as part of the Tax Reform Act of
1986, Pub. L. No. 99–514, 100 Stat.
2085. Section 863(d) governs the source
of income derived from space or ocean
activities. Section 863(e) governs the
source of income derived from
international communications activities.
The Treasury Department and the IRS
published a notice of proposed
rulemaking (REG–106030–98) in the
Federal Register on January 17, 2001
(66 FR 3903), which provided proposed
regulations under section 863(a), (b), (d),
and (e) (the 2001 proposed regulations).
The Treasury Department and the IRS
received numerous written comments
on the 2001 proposed regulations and
held a public hearing on May 23, 2001.
Since that time, the aerospace,
telecommunications, and related
industries have experienced substantial
technological evolution and significant
business change and consolidation. In
addition, the American Jobs Creation
Act of 2004 (AJCA), Pub. L. No. 108–

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357, 118 Stat. 1418, enacted a number
of materially relevant statutory changes
that affect the treatment of space and
ocean income for purposes of the
foreign tax credit and subpart F rules.
In light of the extensive written
comments, industry evolution, and
AJCA changes, the Treasury Department
and the IRS felt that it was appropriate
to repropose these regulations to reflect
these changes and to provide another
opportunity for comment.
Consequently, the Treasury Department
and the IRS published another notice of
proposed rulemaking in the Federal
Register on September 19, 2005 (70 FR
54859), which withdrew the 2001
proposed regulations and provided new
proposed regulations under section
863(a), (b), (d), and (e) (the proposed
regulations). The proposed regulations
provided two sets of rules: one in
§ 1.863–8 for determining the source of
income from space or ocean activities,
the other in § 1.863–9 for determining
the source of income from
communications activities.
A public hearing on the proposed
regulations was scheduled for December
15, 2005, but was ultimately cancelled
because no one requested to speak. A
few written comments, however, were
received. These comments uniformly
praised the proposed regulations as an
improvement over the 2001 proposed
regulations and generally were
supportive of much of the proposed
regulations. However, commentators
suggested a few additional changes.
After consideration of these comments,
the proposed regulations are adopted as
final regulations, as amended by this
Treasury decision. The revisions to
regulations governing the source of
income from space or ocean activities
and the source of income from
communications activities are discussed
in section A and section B, respectively,
of this preamble.
Summary of Comments and
Explanation of Revisions
A. Space or Ocean Activity Under
Section 863(d)
Section 863(d) governs the source of
income from certain space or ocean
activities. In general, section 863(d)(1)
provides that, except as provided in
regulations, any income derived from a
space or ocean activity (space and ocean
income) is income from sources within
the United States (U.S. source income)
if derived by a United States person and
is income from sources without the
United States (foreign source income) if
derived by a foreign person. Section
863(d)(2)(A)(i) defines space activity to
include any activity conducted in space.

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77595

Section 863(d)(2)(A)(ii) defines ocean
activity to include any activity
conducted on or under water not within
the jurisdiction (as recognized by the
United States) of a foreign country,
possession of the United States, or the
United States. Section 863(d)(2)(B)
excludes three types of activities from
the definition of space or ocean activity.
Space or ocean activity does not include
any activity giving rise to transportation
income governed by section 863(c),
international communications income
governed by section 863(e), or income
with respect to mines, oil and gas wells,
or other natural deposits to the extent
within the United States or any foreign
country or possession of the United
States (as defined in section 638). See
Section 863(d)(2)(B).
Section 1.863–8 of the proposed
regulations generally provided rules for
determining the source of income
derived from space or ocean activity
under section 863(d). Section 1.863–
8(b)(1) of the proposed regulations
reflected the general source rule under
section 863(d)(1) that a United States
person’s space and ocean income is U.S.
source income. Pursuant to the grant of
regulatory authority under section
863(d)(1), however, the proposed
regulations provided an exception to
this general rule. Under that exception,
a United States person’s space and
ocean income is foreign source income
(and therefore not sourced on the basis
of citizenship or residency) to the extent
the income, based on all the facts and
circumstances, is attributable to
functions performed, resources
employed, or risks assumed in a foreign
country or countries.
For a foreign person, proposed
§ 1.863–8(b)(2) reflected the general
source rule under section 863(d)(1) that
a foreign person’s space and ocean
income is foreign source income.
Pursuant to regulatory authority under
section 863(d)(1), however, the
proposed regulations contained two
exceptions to this general rule, one for
controlled foreign corporations (CFCs),
the other for foreign persons engaged in
a U.S. trade or business. The proposed
regulations generally sourced space and
ocean income derived by a CFC, like
that of a United States person, as U.S.
source income. However, also like the
rule for a United States person, a CFC’s
space and ocean income is foreign
source income to the extent the income,
based on all the facts and
circumstances, is attributable to
functions performed, resources
employed, or risks assumed in a foreign
country or countries. For a foreign
person, other than a CFC, engaged in a
trade or business within the United

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States, space and ocean income is U.S.
source income to the extent it is
attributable to functions performed,
resources employed, or risks assumed
within the United States.
In addition to the general source rules
for United States and foreign persons,
the proposed regulations provided
special rules, applicable to both United
States and foreign persons, for income
from services, certain sales of property,
and communications activities (other
than international communications
activities). These special rules, as well
as modifications to the proposed
regulations, are discussed below.
1. Activities performed outside space
and international water
Section 1.863–8 of the proposed
regulations provided source rules only
for income from space or ocean activity.
Thus, in some cases, income derived
from a transaction must be allocated
between space and ocean income and
other income.
For example, § 1.863–8(b)(3)(ii)(C) of
the proposed regulations provided that
when property is produced both in
space or international water and outside
space and international water, gross
income allocable to production activity
is allocated to production occurring in
space or international water and
production occurring outside space and
international water based on where
functions are performed, resources are
employed, or risks are assumed. The
proposed regulations also provided a
similar analysis of functions performed,
resources employed, or risks assumed to
allocate income in the case of
performance of services. See Prop.
Treas. Reg. § 1.863–8(d)(2). Under the
proposed regulations, only the amount
allocated to production or performance
of a service occurring in space or
international water is treated as space
and ocean income (character rule). The
source of gross income allocated to
production or performance of a service
occurring in space or international
water is then determined under the
rules of proposed § 1.863–8(b)(1) or (2),
as applicable (source rule).
Section 1.863–8(b)(1) of the proposed
regulations reflected the general source
rule that a United States person’s space
and ocean income is U.S. source
income. Proposed § 1.863–8(b)(2)
reflected the general source rule that a
foreign person’s space and ocean
income is foreign source income. Both
proposed § 1.863–8(b)(1) and (2),
however, provided exceptions to their
respective general source rules. As
discussed above, under the exceptions,
a United States person’s space and
ocean income may be foreign source

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income and a foreign person’s space and
ocean income may be U.S. source
income based on where functions are
performed, resources are employed, or
risks are assumed.
One commentator noted that in some
situations, the allocation of income
derived from a transaction to determine
space and ocean income based on
functions performed, resources
employed, or risks assumed presumably
would remove the subsequent need to
further analyze functions performed,
resources employed, or risks assumed
within a country to determine the
source of the space and ocean income.
In other words, the very act of
determining the character of income
seems to also determine the source of
such income.
The Treasury Department and the IRS
agree with the commentator that use of
the same standard to classify the
transaction as space or ocean activity
and to source the space and ocean
income may be duplicative in some
cases. However, there are other cases
where a transaction with some landbased activity may be classified in its
entirety as a space or ocean activity (for
example, a lease of a satellite), but the
income may be partially U.S. source and
partially foreign source under the source
rules of proposed § 1.863–8(b)(1) and (2)
based on functions performed, resources
employed, or risks assumed within the
United States or a foreign country.
Consequently, the character and source
rules are not always duplicative.
Thus, the extent to which the
character rules overlap with the source
rules is particular to the type of
transaction involved. The Treasury
Department and the IRS recognize that
the overlap in the character and source
rules may produce equivalent results.
But, the overlap is necessary to provide
taxpayers and the IRS with workable
rules. As a result, the final regulations
do not follow this comment as a general
matter.
Nonetheless, a conforming
amendment has been made to the lease
transaction in Example 1 in § 1.863–8(f)
of the final regulations to more clearly
illustrate how the rules work. That
example illustrates that the transaction
involved is first classified in its entirety
as a space or ocean activity, and then
the resulting space and ocean income is
subjected to the source rules. The space
and ocean income is sourced as foreign
source income to the extent the income,
based on all the facts and
circumstances, is attributable to
functions performed, resources
employed, or risks assumed in a foreign
country or countries.

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2. Activities performed by another
person
Section 1.863–8(a) of the proposed
regulations provided that a taxpayer
will not be considered to derive income
from space or ocean activity if such
activity is performed by another person.
The approach under § 1.863–8(a) of the
proposed regulations, providing that a
taxpayer derives income from a space or
ocean activity only if it conducts such
activity directly, is consistent with the
approach adopted in the § 1.863–3
regulations governing the source of
income from certain sales of inventory.
See, e.g., Treas. Reg. § 1.863–3(c) (‘‘[T]he
only production activities that are taken
into account for purposes of §§ 1.863–1,
1.863–2, and this section are those
conducted directly by the taxpayer.’’).
Accordingly, commentators believed
that this provision assured that a
content provider that retains a satellite
operator to transmit programming
abroad would not derive space and
ocean income based on attribution of
the satellite operator’s activity. The
Treasury Department and the IRS agree.
One commentator noted, however,
that Examples 2 and 4 in § 1.863–8(f) of
the proposed regulations seem to
indicate that this is not what was
intended. In Example 2, the taxpayer, an
Internet service provider, transmits
information requested by its customer,
in part using satellite capacity leased
from a third party. Example 2 concludes
that the service performed by the
taxpayer is considered space activity to
the extent the value of the service is
attributable to functions performed,
resources employed, and risks assumed
in space. In Example 4, the taxpayer
uses satellite capacity acquired from a
third party to deliver programming
services directly to its customers’
televisions sets. Example 4 concludes
that the taxpayer’s delivery of
programming and other services is
considered space activity to the extent
the value of the delivery transaction is
attributable to performance in space. In
the commentator’s view, the results
reached in the examples conflict with
the provision stating that activities
performed by another person are not
attributable to the taxpayer.
The Treasury Department and the IRS
do not believe that Examples 2 and 4 of
§ 1.863–8(f) of the proposed regulations
produce the result that the commentator
raised. In Examples 2 and 4, the
taxpayer performed the transmission or
delivery activities using satellite
capacity leased or acquired from a third
party. Both Examples 2 and 4 correctly
conclude that the taxpayers derived
space and ocean income from their own

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Federal Register / Vol. 71, No. 248 / Wednesday, December 27, 2006 / Rules and Regulations
activities rather than from activities of
another person. Thus, the examples do
not, in fact, conflict with the text of the
proposed regulations. Nevertheless, the
Treasury Department and the IRS are
concerned that Examples 2 and 4 have
been misinterpreted as suggesting that
activities performed by another person
may be attributable to the taxpayer in
certain situations. This was not the
intent of these examples. Consequently,
Examples 2 and 4 in § 1.863–8(f) of the
final regulations have been modified to
make clear that the taxpayers in the
examples directly engage in a space
activity by performing the uplink
(transmitting to the satellite) and
downlink functions.
These examples differ from cases in
which the taxpayer is a mere content
provider that derives income either from
the creation of content or from the
creation and delivery of content, but in
either case contracts with another
person to deliver the content via
satellite. Pursuant to § 1.863–8(a) of the
final regulations, content providers of
this type would not derive space and
ocean income because the delivery of
the content via satellite is performed by
another person. This would be the result
even though the value of the customer
contract includes a payment to the
content provider for space or ocean
activity. To clarify the distinction
between these situations and Examples
2 and 4, a new Example 5 has been
added to the final regulations. That
example involves a content provider
that does not derive space and ocean
income because the taxpayer does not
directly perform any space or ocean
activity.

another, as neither Example 3 in
§ 1.863–8(f) of the proposed regulations
nor the text of the proposed regulations
provides any guidance as to when
activities performed in space or
international water would be de
minimis under a facts and
circumstances approach.
The Treasury Department and the IRS
recognize that issues of interpretation
may arise in any facts and
circumstances approach. Nevertheless,
the Treasury Department and the IRS
generally have refrained from adopting
the alternative approach, to wit,
adopting precise definitions and
quantitative measures for a de minimis
standard. Moreover, the inclusion of a
precise definition and quantitative
measures for determining de minimis
value could raise equal, if not greater,
concerns in terms of the quantitative
threshold and other issues. Thus, the
final regulations retain the de minimis
standard for determining whether a
taxpayer has space and ocean income. If
the value of the service attributable to
space or ocean activity is de minimis
based on the facts and circumstances,
the taxpayer will not derive space and
ocean income. Nevertheless, the
Treasury Department and the IRS agree
that more guidance could be provided
as to the application of the retained de
minimis rule. Accordingly, Examples 3
and 8 in § 1.863–8(f) of the final
regulations (Example 7 in the proposed
regulations) provide clearer illustrations
of when activities performed in space or
international water would be considered
de minimis for this purpose and when
those types of activities would not be
considered de minimis.

3. Income Characterization Rules for
Income from Services and the De
Minimis Exception
Under § 1.863–8(b)(4) of the proposed
regulations, to the extent a service is
characterized as space or ocean activity,
the source of gross income derived from
such transaction is determined under
proposed § 1.863–8(b)(1) or (2), as
applicable. Section 1.863–8(d)(2)(ii)(B)
of the proposed regulations provided,
however, that if the taxpayer can
demonstrate, based on all the facts and
circumstances, that the value of the
service attributable to performance in
space or international water is de
minimis, such service will not be
treated as space or ocean activity. The
de minimis rule was adopted to address
taxpayers’ concerns about potential
confusion in qualifying for the
‘‘facilitation exception’’ under the 2001
proposed regulations. One commentator
stated that the de minimis rule simply
replaced one vague standard with

4. Source Rules for Income From Certain
Sales of Property
The proposed regulations provided
special rules for income from certain
sales of property, either when any
production occurs in space or
international water, or when the sale
occurs in space or international water.
In either case, section 863(d) and the
proposed regulations applied to
determine the source of income from the
sales of property, and the rules of
sections 861(a)(6), 862(a)(6), 863(a),
863(b), and 865 apply only to the extent
provided in the proposed regulations.

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a. Sales of Property Produced in the
United States and Sold in Space or
International Water
Section 1.863–8(b)(3)(ii) of the
proposed regulations provided that
when the taxpayer both produces
property and sells such property, onehalf of the taxpayer’s gross income will
be considered income allocable to

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77597

production activity and one-half of such
gross income will be considered income
allocable to sales activity. Taxpayers
generally must then apply the rules of
section 863(d) and the proposed
regulations to determine the source of
income allocable to production activity
and sales activity.
For production activity, the source of
gross income allocable to production
occurring in space or international
water is generally based on the
citizenship or residence of the taxpayer,
applying the rules of proposed § 1.863–
8(b)(1) or (2), as applicable. The source
of gross income allocable to production
occurring outside space and
international water is determined under
section 863(b) rather than section
863(d). See Prop. Treas. Reg. § 1.863–
8(b)(3)(ii)(B) (referencing Treas. Reg.
§ 1.863–3(c)(1)).
As for sales activity, when property is
sold in space or international water, the
source of gross income allocable to sales
activity is generally based on the
citizenship or residence of the taxpayer,
applying the rules of proposed § 1.863–
8(b)(1) or (2), as applicable. An
exception to this general rule applied in
cases when the property sold is
inventory, within the meaning of
section 1221(a)(1), and is sold in space
or international water for use,
consumption, or disposition outside
space, international water, and the
United States. In that case, the source of
gross income allocable to sales activity
is determined under Treas. Reg. § 1.861–
7(c) and § 1.863–3(c)(2). Treas. Reg.
§ 1.861–7(c) and § 1.863–3(c)(2)
generally provide for foreign source
income where the seller’s rights, title,
and interest in the property are
transferred to the buyer (the title
passage rule) outside the United States
and the property is not sold for use,
consumption, or disposition in the
United States. Treas. Reg. § 1.861–7(c)
and § 1.863–3(c)(2) also applied to
property sold outside space and
international water. See Prop. Treas.
Reg. § 1.863–8(b)(3)(ii)(D).
One commentator believed that
because certain U.S. manufacturers,
such as U.S. satellite manufacturers,
produce property that is sold in space
or international water for use,
consumption, or disposition in space or
international water, they are at a
disadvantage relative to U.S.
manufacturers of other export property
because the former may have U.S.
source income with respect to income
allocable to sales activity, while the
latter may have foreign source income
from sales activity.
In response to comments on the 2001
proposed regulations, proposed § 1.863–

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8(b)(1) was revised to provide that space
and ocean income will be foreign source
income to the extent the space and
ocean income is attributable to
functions performed, resources
employed, or risks assumed in a foreign
country or countries. The Treasury
Department and the IRS believe that this
change may in many cases mitigate
concerns about U.S. manufacturers
potentially deriving 100 percent U.S.
source income in these cases. Moreover,
the Treasury Department and the IRS
believe that the rules under the
proposed regulations for determining
the source of income allocable to sales
activity are consistent with legislative
intent to assert primary tax jurisdiction
over income earned by United States
persons that is not subject to foreign tax.
See S. REP. NO. 99–313, 1986–3 C.B.
357–358 (‘‘[T]he committee believes the
United States should assert primary tax
jurisdiction over income earned by its
residents that is not within any foreign
country’s taxing jurisdiction* * *.
Moreover, when a U.S. taxpayer
conducts activities in space or
international waters, foreign countries
generally do not tax the income. Thus,
the foreign tax credit limitation is
inflated by income that is not within
any foreign country’s tax jurisdiction.’’).
Based on the legislative history, the
Treasury Department and the IRS
believe that sales of property in space or
international water—with the exception
of sales of inventory property in space
or international water for use,
consumption, or disposition outside
space, international water, and the
United States—should be considered
space or ocean activity and that the
source of income from such sales
activity should be determined under
section 863(d). As a result, no changes
were made in response to this comment.
b. Purchased Versus Produced Property
Sold for Use, Consumption, or
Disposition in the United States
One commentator questioned the
appropriateness of differences in
determining the source of sales income
depending on whether the taxpayer
produced or purchased the property
sold. Under the proposed regulations,
when property produced by the
taxpayer is sold in space or
international water, the source of gross
income allocable to sales activity is
generally based on the citizenship or
residence of the taxpayer, applying the
rules of proposed § 1.863–8(b)(1) or (2),
as applicable (and not the title passage
rule)—subject to the foregoing inventory
exception for property that will be used,
consumed, or disposed of outside space,
international water, and the United

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States. A slightly different rule applied
to sales of property that had been
purchased by the taxpayer. While the
proposed regulations also provided that,
for purchased property, the source of
gross income allocable to sales activity
is generally based on the citizenship or
residence of the taxpayer, the inventory
exception for purchased property only
required that the property be used,
consumed, or disposed of outside space
and international water.
The inventory exceptions for
produced and purchased property were
intended to produce different results
when inventory property is used,
consumed, or disposed of in the United
States. In such case, the source of
produced inventory property sales
income is generally based on the
citizenship or residence of the taxpayer,
applying the rules of proposed § 1.863–
8(b)(1) or (2), because the inventory
exception did not extend to produced
property sold for use, consumption, or
disposition in the United States. In
contrast, the source of purchased
inventory property sales income is
generally based on title passage under
Treas. Reg. § 1.861–7(c) because the
inventory exception did extend to
purchased property even if it was sold
for use, consumption, or disposition in
the United States. The Treasury
Department and the IRS believe that this
difference between the produced and
purchased property rules in the space
and ocean context is consistent with the
difference in the rules for sales of
produced and purchased property
outside the space and ocean context. In
particular, under section 863(a) and (b)
and the regulations thereunder, if
property is produced in the United
States and sold for use, consumption, or
disposition in the United States, the
place of sale will be presumed to be the
United States, and income attributable
to the sales activity will be U.S. source
income. See § 1.863–3(c)(2). There is,
however, no comparable rule for
purchased property under section
862(a)(6) or the regulations thereunder.
Thus, the final regulations simply
continue in the space and ocean context
the varying treatment elsewhere for
sales of purchased property and sales of
produced property.
In response to comments, however,
the produced and purchased property
rules have been modified to be similar
in structure and style, to better reflect
and highlight the differences between
these two rules.
5. Allocations
Taxpayers must allocate gross income
under paragraphs (b)(1) and (b)(2) of
proposed § 1.863–8 among U.S., foreign,

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and space or ocean activities. Under
proposed § 1.863–8(b)(3)(ii)(C),
allocations are also made between
production activity occurring in space
or international water and that
occurring outside space and
international water. Finally, allocations
are also made under proposed § 1.863–
8(b)(4) between services performed in
space or international water and
services performed outside space and
international water. In performing these
allocations, the proposed regulations
generally provided that taxpayers
should consider the relative value of
functions performed, resources
employed, or risks assumed in different
locations. Moreover, the preamble to the
proposed regulations provided that
allocations should be based generally on
section 482 principles. Commentators
noted that little guidance is given as to
the mechanics of allocation other than
the statement that the principles of
section 482 should be used.
Commentators stated that allocation of
gross income based on section 482
principles will result in added expense,
uncertainty, and extra burden on
multinational taxpayers who are already
required to undertake and update
functional analyses and satisfy
substantial documentation
requirements.
While the final regulations were not
changed in response to these comments,
the Treasury Department and the IRS
believe that some clarification is
warranted. In suggesting the use of
section 482 principles as a guide, the
Treasury Department and the IRS intend
for taxpayers to adopt a reasonable
approach to the allocations required in
this area. Taxpayers know their
businesses and will generally be in the
best position to fashion a reasonable
method that most reliably reflects the
relative value of functions performed,
resources employed, and risks assumed
in different locations. In the preamble to
the proposed regulations, the Treasury
Department and the IRS solicited
comments on alternative methods of
allocation for particular industries and
criteria that could be used to evaluate
the reasonableness of such methods. No
such comments were received. One
commentator noted, however, that the
proposed regulations perhaps reflected
what taxpayers in these industries have
already been doing in order to
determine the character and source of
their space and ocean income.
Consequently, the Treasury Department
and the IRS believe that allocations of
gross income based on functions
performed, resources employed, and

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risks assumed are appropriate in these
circumstances.

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6. Separation of a Single Transaction
and Aggregation of Multiple
Transactions
Paragraphs (d)(1)(i) and (d)(1)(ii) of
§ 1.863–8 of the proposed regulations
provided that for purposes of
determining space or ocean activity, the
Commissioner may separate parts of a
single transaction or combine separate
transactions into a single transaction.
One commentator stated that this is a
‘‘one-way’’ street, as only the
Commissioner has the authority to
separate or combine transactions for
purposes of the proposed regulations.
The final regulations do not change
this rule. The Treasury Department and
the IRS believe taxpayers are not
inappropriately disadvantaged by this
rule because taxpayers generally have
the ability to structure their transactions
in line with the economic prospects of
their businesses. In addition, the
Commissioner’s ability to separate or
combine transactions is not unfettered.
Rather, the Commissioner may only
separate or combine transactions to
better reflect the value of functions
performed, resources employed, or risks
assumed. A taxpayer can always protect
itself against recharacterization by
adopting an arrangement that
appropriately reflects the economic
realities of a transaction or series of
transactions. The taxpayer is clearly in
the best position at the outset to
structure its arrangements in this
manner. In addition, taxpayers
traditionally are not permitted to
restructure retroactively the form of
their completed transactions. Thus, the
Treasury Department and the IRS
believe that the limited ‘‘one-way’’ rule
is appropriate in this case.
7. Income Derived From the Leasing of
Shipping Cargo Containers
One commentator requested that the
Treasury Department and the IRS make
clear that the final regulations under
section 863(d) do not apply to income
derived from the leasing of shipping
cargo containers and that such income
should be treated as rental income,
sourced under sections 861 and 862.
This commentator noted that valid
arguments also exist for treating income
derived from the leasing of shipping
cargo containers as transportation
income; however, in the commentator’s
view, the most appropriate treatment is
rental income treatment, sourced under
sections 861 and 862.
The treatment of income derived from
the leasing of shipping cargo containers
is not covered by these final regulations.

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Instead, the Treasury Department and
the IRS intend to address the treatment
of such income explicitly in separate
guidance. That guidance may apply
section 863(c), section 863(d), or other
provisions to source income derived
from the leasing of shipping cargo
containers. Any such guidance will be
prospective in nature. Until such time,
the treatment of such income will be
determined under existing law.
B. Communications Activity Under
Section 863(a), (d), and (e)
Section 863(e) governs the source of
income from international
communications activities (international
communications income). International
communications income is defined in
section 863(e)(2) as income derived
from the transmission of
communications or data between the
United States and a foreign country (or
possession of the United States). Section
863(e)(1)(A) provides that any
international communications income
of a United States person is sourced 50
percent in the United States and 50
percent outside the United States (50/50
source rule). Section 863(e)(1)(A) does
not provide for any statutory or
regulatory exceptions to this 50/50
source rule. In contrast, section
863(e)(1)(B)(i) provides that any
international communications income
of a foreign person is sourced outside
the United States, except as provided in
regulations or in section 863(e)(1)(B)(ii).
The exception under section
863(e)(1)(B)(ii) provides that if a foreign
person maintains an office or other fixed
place of business in the United States,
any international communications
income attributable to such office or
other fixed place of business is U.S.
source income.
Section 1.863–9 of the proposed
regulations generally provided rules for
determining the source of international
communications income under section
863(e) and other communications
income under section 863(a) and (d).
Proposed § 1.863–9(b)(1) reflected the
rule under section 863(e)(1)(A) that a
United States person’s international
communications income is 50 percent
U.S. source income and 50 percent
foreign source income. Proposed
§ 1.863–9(b)(2) reflected the general rule
under section 863(e)(1)(B) that a foreign
person’s international communications
income is foreign source income.
Consistent with the statutory
exception under section 863(e)(1)(B)(ii),
proposed § 1.863–9(b)(2)(iii) provided
that any international communications
income derived by a foreign person,
other than a CFC, that is attributable to
an office or other fixed place of business

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of the foreign person in the United
States is U.S. source income.
International communications income is
attributable to an office or other fixed
place of business to the extent of
functions performed, resources
employed, or risks assumed by the
office or other fixed place of business.
In addition to the statutory exception
under section 863(e)(1)(B)(ii), section
863(e)(1)(B) provides general regulatory
authority to depart from the general 100
percent foreign source rule for foreign
persons. Thus, pursuant to this
regulatory authority, the proposed
regulations contained additional
exceptions to the general rule applicable
to foreign persons. In particular, the
proposed regulations provided that
international communications income
derived by a CFC is 50 percent U.S.
source income and 50 percent foreign
source income (the same as for United
States persons). The proposed
regulations also provided that
international communications income
derived by a foreign person, other than
a CFC, engaged in a trade or business
within the United States is income from
sources within the United States to the
extent the income, based on all the facts
and circumstances, is attributable to
functions performed, resources
employed, or risks assumed within the
United States.
In addition to the general source rules
for international communications
income of United States and foreign
persons, the proposed regulations also
provided rules, applicable to both
United States and foreign persons, for
income from U.S. communications,
foreign communications, space/ocean
communications, and communications
where endpoints are indeterminate.
These rules, as well as modifications to
the proposed regulations, are discussed
below.
1. Income Characterization Rules for
Communications Income
Section 1.863–9(h)(3) of the proposed
regulations provided that the type of
communications activity (and thus the
applicable source rule) is determined by
identifying the two points between
which the taxpayer is paid to transmit
the communication. For United States
and foreign persons, U.S.
communications income is entirely U.S.
source income. A taxpayer derives U.S.
communications income when the
taxpayer is paid to transmit between
two points in the United States or
between the United States and a point
in space or international water. In
contrast, foreign communications
income is entirely foreign source
income for United States and foreign

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persons. A taxpayer derives foreign
communications income when the
taxpayer is paid to transmit between
two points in a foreign country or
countries (or a possession or
possessions of the United States),
between a foreign country and a
possession of the United States, or
between a foreign country (or a
possession of the United States) and a
point in space or international water.
Finally, the proposed regulations
provided different source rules for
international communications income
of United States and foreign persons.
See section B.3 of this preamble for
further discussion. A taxpayer derives
international communications income
when the taxpayer is paid to transmit
between a point in the United States
and a point in a foreign country (or a
possession of the United States). When
a taxpayer cannot establish the two
points between which the taxpayer is
paid to transmit the communication,
§ 1.863–9(f) of the proposed regulation
provided a default source rule under
which all the income derived by the
taxpayer from such communications
activity is U.S. source income.
Commentators stated that the
treatment of communications income as
U.S. source income when the endpoints
are indeterminate is overbroad and
harsh, particularly as it relates to foreign
taxpayers. Commentators also stated
that taxpayers would have to commit
significant resources to develop the
technology necessary to identify the
endpoints of communications. One
commentator stated that it is unclear
that a reliable system can be created at
any expense to establish the endpoints
of the transmission under all
circumstances. Commentators suggested
instead the use of any reasonable
method to establish the endpoints
between which a taxpayer is paid to
transmit the communications. One
commentator suggested that the
Treasury Department and the IRS
consider employing the Industry Issue
Resolution Program or Prefiling
Agreement Program as aids in the
administration of a reasonable method
rule.
The Treasury Department and the IRS
solicited comments on the challenges to
identifying the endpoints of
communications in specific industries
or situations, as well as suggestions for
rules that are responsive to these
particular challenges. The Treasury
Department and the IRS also solicited
comments on methods to establish the
endpoints of a communication that may
be reasonable for particular industries,
as well as criteria that may be
appropriate to evaluate the

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reasonableness of such methods. In
response, one commentator submitted
examples of reasonable methods to
establish the endpoints between which
a taxpayer is paid to transmit the
communications. The examples relied
on statistical reports of data such as
minutes used, areas of transmission,
port locations, and transport charges.
This commentator noted that current
federal regulations already require
telecommunications companies to
submit some of these reports to certain
governmental agencies, for example, the
Federal Communications Commission.
In light of the potential complexity in
identifying the type of communications
activity and in response to comments,
the final regulations provide that a
taxpayer may satisfy the requirement
that the taxpayer establish the two
points between which the taxpayer is
paid to transmit, and bears the risk of
transmitting, the communication by
using any consistently applied
reasonable method to establish one or
both endpoints. In doing so, the
taxpayer carries the burden of proof and
must establish that the method used is
reasonable (taking into account all of the
facts and circumstances) and is
consistently applied. In satisfying its
burden of proof, a taxpayer will need to
maintain reasonable records of
communications activities. Depending
on the facts and circumstances, methods
based on, for example, records of port or
transport charges, customer billing
records, a satellite footprint, or records
of termination fees made pursuant to an
international settlement agreement may
be reasonable. In addition, practices
used by taxpayers to classify or
categorize certain communications
activity in connection with preparation
of statements and analyses for the use of
management, creditors, minority
shareholders, joint ventures, or other
parties or governmental agencies in
interest may be reliable indicators of the
reasonableness of the method chosen,
but need not be accorded conclusive
weight by the Commissioner.
Furthermore, in evaluating the
reasonableness of the method chosen,
consideration will be given to all the
facts and circumstances, including
whether the endpoints would otherwise
be identifiable absent this reasonable
method provision.
Along with resultant changes made to
the text of the final regulations, several
examples have been added to § 1.863–
9(j) of the final regulations that illustrate
instances where the taxpayer may be
able to use reasonable methods to
determine the endpoints between which
the taxpayer is paid to transmit the
communications.

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2. The Paid-to-do Rule With Respect to
Foreign-Originating Communications
Under the proposed regulations, a
taxpayer derives income from a certain
type of communications activity (for
example, foreign communications or
international communications) only if
the taxpayer is paid to transmit, and
bears the risk of transmitting (the paidto-do rule), the communications of such
type. See Prop. Treas. Reg. § 1.863–
9(h)(2) and (3). This is the case even if
the taxpayer contracts out the
transmission function.
Commentators stated that application
of the paid-to-do rule in all instances
would give rise to results that are
inconsistent with Congressional intent
and may result in excessive amounts of
U.S. source income. One commentator
noted that in some cases, while it is
clear that a communication originated
in a foreign country and that a U.S.
telecommunications company is paid to
terminate the foreign-originating traffic
in the United States, it is unclear exactly
where the U.S. telecommunications
company picked up the communication.
This lack of clarity often may be due to
legal restrictions in certain foreign
countries on ownership of capacity and
carriage of transmissions by nonnationals. It can also be due to the fact
that the international settlement
agreements under which major
international telecommunications
carriers operate often do not specify
where the traffic is picked up or handed
off, and in some cases the hand-off point
is specified by reference to a mid-point
convention, even though the
transmission signal, from a technical
standpoint, travels from end-to-end with
no real points in-between. The
commentator further stated that at the
time section 863(e) was enacted, U.S.
carriers were generally not allowed to
own and operate facilities in foreign
countries; specifically, no U.S. carrier
could carry a foreign-to-U.S. or U.S.-toforeign transmission end-to-end. Thus,
concluded the commentator, Congress
focused on the endpoints of the
communications rather than where the
activities constituting the transmission
of communications take place. The
commentator suggested a rule that
would provide that when a taxpayer is
paid to transmit foreign-originating
communications from a point outside
the United States to a point in the
United States, the taxpayer should be
deemed to have been paid to transmit
the communications from a point in the
foreign country in which the
communication originated.
Upon further consideration, the
Treasury Department and the IRS

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believe that the paid-to-do rule may be
over-inclusive in certain cases.
Accordingly, the final regulations
provide that international
communications income also includes
income derived from communications
activity when the taxpayer is paid to
transmit foreign-originating
communications (communications with
a beginning point in a foreign country
or a possession of the United States)
from a point in space or international
water to a point in the United States.
Also, a new example has been added to
§ 1.863–9(j) of the final regulations to
illustrate the changes made in the final
regulations with respect to foreignoriginating communications.
The changes made in the final
regulations only affect communications
that originate in a foreign country (or a
possession of the United States) and
does not affect communications that
originate in space, international water,
or the United States. The Treasury
Department and the IRS continue to
believe that communications activity is
most appropriately characterized based
on the two points between which the
taxpayer is paid to transmit, and bears
the risk of transmitting, the
communication.
3. Determining the Source of
Communications Income Based on
Functions Performed, Resources
Employed, or Risks Assumed in a
Foreign Country or Countries
As discussed above, the proposed
regulations provided that the source of
communications income is largely
dependant on the type of
communications activity and the
citizenship or residence of the taxpayer.
However, the proposed regulations
provided for two instances where (in
addition to the type of communications
activity and the citizenship or residence
of the taxpayer) the source of
communications income may depend
on functions performed, resources
employed, or risks assumed. First, the
proposed regulations provided that
international communications income
derived by a foreign person, other than
a CFC, that is attributable to an office or
other fixed place of business of the
foreign person in the United States is
U.S. source income. The proposed
regulations provided that international
communications income is attributable
to an office or other fixed place of
business to the extent of functions
performed, resources employed, or risks
assumed by the office or other fixed
place of business. Second, the proposed
regulations provided that international
communications income derived by a
foreign person, other than a CFC,

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engaged in a trade or business within
the United States is income from
sources within the United States to the
extent the income, based on all the facts
and circumstances, is attributable to
functions performed, resources
employed, or risks assumed within the
United States.
Commentators suggested that the final
regulations also provide for similar rules
that would source communications
income as foreign source income based
on functions performed, resources
employed, or risks assumed in a foreign
country or countries. For example, one
commentator suggested that the source
of international and U.S.
communications income derived by any
United States or foreign person
(including branches, partnerships, and
disregarded entities) engaged in a trade
or business in a foreign country or
countries is income from sources
without the United States to the extent
the income, based on all the facts and
circumstances, is attributable to
functions performed, resources
employed, or risks assumed in such
foreign country or countries.
While the Treasury Department and
the IRS recognize that commentators’
suggestion to provide for a source rule
based on functions performed, resources
employed, or risks assumed in a foreign
country or countries is reasonable, as
explained below, the Treasury
Department and the IRS believe that the
statute and legislative history preclude
such an option.
a. International Communications
Income
Consistent with section 863(e)(1)(A),
proposed § 1.863–9(b)(1) provided that
international communications income
of a United States person is 50 percent
U.S. source income and 50 percent
foreign source income. One
commentator suggested that it may be
appropriate, in certain situations, to
depart from the 50/50 source rule to
provide special rules for foreign
activities. According to the
commentator, as a result of local
regulatory requirements, U.S.-based
international telecommunications
providers often need to conduct
portions of their international business
through locally formed entities, and
such entities are fully subject to foreign
tax on their income. The commentator
therefore concluded that a source rule
for international communications
income based on functions performed,
resources employed, or risks assumed in
a foreign country or countries is not
only equitable but also consistent with
treatment accorded to foreign persons

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77601

having a U.S. fixed placed of business
or engaged in a U.S. trade or business.
The Treasury Department and the IRS
recognize that a source rule based on
functions performed, resources
employed, or risks assumed may be a
reasonable alternative to the 50/50
source rule. Nonetheless, they continue
to believe that the 50/50 source rule is
the method that must be used to
determine the source of a United States
person’s international communications
income. This is because section
863(e)(1)(A) provides for an explicit
50/50 source rule for those persons
without exception. In contrast, section
863(e)(1)(B) provides that a foreign
person’s international communications
income is generally sourced outside the
United States, except as provided in
regulations. The Treasury Department
and the IRS believe that the express
grant of regulatory authority in the case
of foreign persons and the omission of
any such authority in the case of United
States persons indicate that Congress
intended the 50/50 sourcing rule be
applied to United States persons
without regulatory modification. There
is nothing in the statute or legislative
history that clearly demonstrates a
different intention. In contrast, section
863(e)(1)(B)(ii) provides for a special
source rule with respect to foreign
persons with an office or other fixed
place of business in the United States.
A similar rule is not provided with
respect to a United States person’s
foreign activities. Thus, Congress chose
a rule that sourced international
communications income of foreign
persons in certain instances based on
the place of their activities, but
expressly chose the 50/50 method to
source international communications
income of United States persons,
regardless of the place of their activities.
The Treasury Department and the IRS
recognize that the statute does not
require strict application of the 50/50
source rule for CFCs. Section
863(e)(1)(B) only provides that the
international communications income
of a foreign person is foreign source
income, except as provided in
regulations. Consistent with and in light
of this regulatory authority, however,
the Treasury Department and the IRS
believe that the 50/50 source rule is the
most appropriate method to determine
the source of a CFC’s international
communications income. This approach
addresses the concern of the Treasury
Department and the IRS that United
States persons may use CFCs to obtain
benefits that are inconsistent with the
purposes of section 863(e).
Consequently, the rules for determining
the source of international

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communications income derived by a
CFC should be the same as the rules for
determining the source of such income
if it is derived by a United States
person. In addition, the Treasury
Department and the IRS believe that the
50/50 source rule for CFCs, as opposed
to the 100 percent U.S. source rule that
was originally proposed as part of the
2001 proposed regulations, should limit
the potential for multiple levels of
taxation that commentators raised with
respect to those prior proposed
regulations.

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b. U.S. Communications Income
Section 1.863–9(c) of the proposed
regulations provided that income
derived by a United States or foreign
person from U.S. communications
activity is entirely from sources within
the United States. One commentator
noted that a foreign person deriving
income from the transmission of
communications between a point in the
United States and another point in the
United States or between a point in the
United States and a point in space or
international water has 100 percent U.S.
source income, even if much or all of
the activity involved is outside the
United States. In contrast, under the
space and ocean rules, a foreign person
has U.S. source income only to the
extent the income is attributable to
functions performed, resources
employed, or risks assumed within the
United States. Commentators therefore
suggested modification of the 100
percent U.S. source rule for U.S.
communications income derived by
United States and foreign persons to
take into account foreign activities.
The Treasury Department and the IRS
recognize that a source rule based on
functions performed, resources
employed, or risks assumed may be a
reasonable alternative to the 100 percent
U.S. source rule for U.S.
communications. Nonetheless, the
Treasury Department and the IRS
believe that Congress did not intend
such an option. The legislative history
indicates that if a communication is
between two points within the United
States, the ‘‘income attributable thereto
is to be sourced entirely as U.S. source
income.’’ S. Rep. No. 99–313, 1986–3
C.B. 359 (emphasis added). Congress
intended such a result ‘‘even if the
communication is routed through a
satellite located in space, regardless of
the satellite’s location.’’ Id. Thus, the
legislative history clearly provides that
Congress intended that U.S.
communications income be sourced
entirely as U.S. source income.

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4. International Communications
Income Derived by a Foreign Person
(Other Than a CFC)
Proposed § 1.863–9(b)(2) reflected the
general rule under section 863(e)(1)(B)
that a foreign person’s international
communications income is foreign
source income. Consistent with the
statutory exception under section
863(e)(1)(B)(ii), proposed § 1.863–
9(b)(2)(iii) provided that any
international communications income
derived by a foreign person, other than
a CFC, that is attributable to an office or
other fixed place of business of the
foreign person in the United States is
U.S. source income. International
communications income is attributable
to an office or other fixed place of
business to the extent of functions
performed, resources employed, or risks
assumed by the office or other fixed
place of business. Pursuant to the grant
of regulatory authority under section
863(e)(1)(B), the proposed regulations
provided other exceptions to the general
rule for foreign persons. The first
exception is the 50/50 source rule for
CFCs under § 1.863–9(b)(2)(ii) of the
proposed regulations, as discussed
above. The second exception was
provided in § 1.863–9(b)(2)(iv) of the
proposed regulations and applied to
foreign persons other than CFCs.
Section 1.863–9(b)(2)(iv) of the
proposed regulations provided that
international communications income
derived by a foreign person, other than
a CFC, engaged in a trade or business
within the United States, that is
attributable to functions performed,
resources employed, or risks assumed
within the United States is U.S. source
income. One commentator noted that it
is unclear why a separate rule is needed
for a fixed place of business in the
United States and a U.S. trade or
business because international
communications income attributable to
a fixed place of business in the United
States should also be attributable to
functions performed, resources
employed and risks assumed within the
United States.
As indicated, the office or other fixed
place of business rule under § 1.863–
9(b)(2)(iii) of the proposed regulations
was derived from the statutory language
of section 863(e), while the trade or
business rule under § 1.863–9(b)(2)(iv)
of the proposed regulations was derived
from the express grant of regulatory
authority to source international
communications income of foreign
persons as other than foreign source.
The Treasury Department and the IRS
recognize that in most situations, the
latter trade or business rule would

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indeed subsume the former fixed place
of business rule, but still believe that the
later rule serves an important function.
The trade or business rule addresses the
concern of the Treasury Department and
the IRS that a foreign person could
avoid a U.S. fixed place of business
under section 863(e)(1)(B)(ii), yet engage
in significant communications activity
in the United States. The Treasury
Department and the IRS believe that
Congress intended that a foreign person
engaged in substantial business in the
United States be subject to U.S. tax on
that communications activity.
5. Allocations
Section 1.863–9(h)(1)(ii) of the
proposed regulations provided that to
the extent that a taxpayer’s transaction
consists in part of non-de minimis
communications activity and in part of
non-de minimis non-communications
activity, each part of the transaction
must be treated as a separate
transaction. Gross income is then
allocated to each communications
activity transaction and each noncommunications activity transaction to
the extent the income, based on all the
facts and circumstances, is attributable
to functions performed, resources
employed, or risks assumed in each
such activity. Moreover, the Treasury
Department and the IRS suggested in the
preamble to the proposed regulations
that allocations of gross income should
be based generally on section 482
principles. One commentator stated that
the complexities inherent in allocating
income, based on section 482
principles, between the separated
transactions are significant.
While the final regulations were not
changed in response to this comment, as
in the case of allocations for space and
ocean income, the Treasury Department
and the IRS believe that some
clarification is warranted. In suggesting
the use of section 482 principles as a
guide, the Treasury Department and the
IRS intend for taxpayers to adopt a
reasonable approach to the allocations
required in this area. Taxpayers know
their businesses and will generally be in
the best position to fashion a reasonable
method that most reliably reflects the
relative value of functions performed,
resources employed, and risks assumed
in different locations. In the preamble to
the proposed regulations, the Treasury
Department and the IRS solicited
comments on alternative methods of
allocation for particular industries and
criteria that could be used to evaluate
the reasonableness of such methods. No
such comments were received. One
commentator noted, however, that the
proposed regulations perhaps reflected

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what taxpayers in these industries have
already been doing in order to
determine the character and source of
their communications income.
Consequently, as in the case of space
and ocean income, the Treasury
Department and the IRS believe that
allocations of gross income based on
functions performed, resources
employed, and risks assumed are
appropriate in these circumstances.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment pursuant to that
Order is not required. It has also been
determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these
regulations. Pursuant to the Regulatory
Flexibility Act (5 U.S.C. chapter 6), it is
hereby certified that the collection of
information in these regulations will not
have a significant economic impact on
a substantial number of small entities.
This certification is based on the fact
that the rules provided in these
regulations principally affect large
multinational corporations that pay
foreign taxes on income derived from
substantial foreign operations and that
use these and any other applicable
source rules in determining their foreign
tax credit. Accordingly, a Regulatory
Flexibility Act assessment is not
required. Pursuant to section 7805(f) of
the Internal Revenue Code, the NPRM
preceding these regulations were
submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on their
impact on small business.
Drafting Information
The principal author of these
regulations is H. Michael Huynh of the
Office of the Associate Chief Counsel
(International). However, other
personnel from the Treasury
Department and the IRS participated in
their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
26 CFR Part 602

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Reporting and recordkeeping
requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:

■

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PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding entries
in numerical order to read, in part, as
follows:

■

Authority: 26 U.S.C. 7805 * * *.
Section 1.863–8 also issued under 26
U.S.C. 863(a), (b) and (d). * * *
Section 1.863–9 also issued under 26
U.S.C. 863(a), (d) and (e). * * *
■ Par. 2. Section 1.863–3 is amended
by:
■ 1. Adding a sentence after the first
sentence in paragraph (a)(1).
■ 2. Adding a sentence at the end of
paragraph (c)(1)(i)(A).
■ 3. Adding a sentence after the first
sentence in paragraph (c)(2).
The additions read as follows:

§ 1.863–3 Allocation and apportionment of
income from certain sales of inventory.

(a) * * *
(1) * * * To determine the source of
income from sales of property produced
by the taxpayer, when the property is
either produced in whole or in part in
space or on or under water not within
the jurisdiction (as recognized by the
United States) of a foreign country,
possession of the United States, or the
United States (in international water), or
is sold in space or international water,
the rules of § 1.863–8 apply, and the
rules of this section do not apply except
to the extent provided in § 1.863–8.
* * *
(c) * * *
(1) * * *
(i) * * *
(A) * * * For rules regarding the
source of income when production takes
place, in whole or in part, in space or
international water, the rules of § 1.863–
8 apply, and the rules of this section do
not apply except to the extent provided
in § 1.863–8.
*
*
*
*
*
(2) * * * Notwithstanding any other
provision, for rules regarding the source
of income when a sale takes place in
space or international water, the rules of
§ 1.863–8 apply, and the rules of this
section do not apply except to the extent
provided in § 1.863–8. * * *
*
*
*
*
*
■ Par. 3. Sections 1.863–8 and 1.863–9
are added to read as follows:
§ 1.863–8 Source of income derived from
space and ocean activity under section
863(d).

(a) In general. Income of a United
States or a foreign person derived from
space and ocean activity (space and
ocean income) is sourced under the
rules of this section, notwithstanding
any other provision, including sections

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861, 862, 863, and 865. A taxpayer will
not be considered to derive income from
space or ocean activity, as defined in
paragraph (d) of this section, if such
activity is performed by another person,
subject to the rules for the treatment of
consolidated groups in § 1.1502–13.
(b) Source of gross income from space
and ocean activity—(1) Space and
ocean income derived by a United
States person. Space and ocean income
derived by a United States person is
income from sources within the United
States. However, space and ocean
income derived by a United States
person is income from sources without
the United States to the extent the
income, based on all the facts and
circumstances, is attributable to
functions performed, resources
employed, or risks assumed in a foreign
country or countries.
(2) Space and ocean income derived
by a foreign person—(i) In general.
Space and ocean income derived by a
person other than a United States
person is income from sources without
the United States, except as otherwise
provided in this paragraph (b)(2).
(ii) Space and ocean income derived
by a controlled foreign corporation.
Space and ocean income derived by a
controlled foreign corporation within
the meaning of section 957 (CFC) is
income from sources within the United
States. However, space and ocean
income derived by a CFC is income
from sources without the United States
to the extent the income, based on all
the facts and circumstances, is
attributable to functions performed,
resources employed, or risks assumed in
a foreign country or countries.
(iii) Space and ocean income derived
by foreign persons engaged in a trade or
business within the United States. Space
and ocean income derived by a foreign
person (other than a CFC) engaged in a
trade or business within the United
States is income from sources within the
United States to the extent the income,
based on all the facts and
circumstances, is attributable to
functions performed, resources
employed, or risks assumed within the
United States.
(3) Source rules for income from
certain sales of property—(i) Sales of
purchased property. When a taxpayer
sells purchased property in space or
international water, the source of gross
income from the sale generally will be
determined under paragraph (b)(1) or (2)
of this section, as applicable. However,
if such property is inventory property
within the meaning of section 1221(a)(1)
(inventory property) and is sold for use,
consumption, or disposition outside
space and international water, the

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source of income from the sale will be
determined under § 1.861–7(c).
(ii) Sales of property produced by the
taxpayer—(A) General. If the taxpayer
both produces property and sells such
property, the taxpayer must allocate
gross income from such sales between
production activity and sales activity
under the 50/50 method. Under the 50/
50 method, one-half of the taxpayer’s
gross income will be considered income
allocable to production activity, and the
source of that income will be
determined under paragraph (b)(3)(ii)(B)
or (C) of this section. The remaining
one-half of such gross income will be
considered income allocable to sales
activity, and the source of that income
will be determined under paragraph
(b)(3)(ii)(D) of this section.
(B) Production only in space or
international water, or only outside
space and international water. When
production occurs only in space or
international water, income allocable to
production activity is sourced under
paragraph (b)(1) or (2) of this section, as
applicable. When production occurs
only outside space and international
water, income allocable to production
activity is sourced under § 1.863–3(c)(1).
(C) Production both in space or
international water and outside space
and international water. When property
is produced both in space or
international water and outside space
and international water, gross income
allocable to production activity must be
allocated to production occurring in
space or international water and
production occurring outside space and
international water. Such gross income
is allocated to production activity
occurring in space or international
water to the extent the income, based on
all the facts and circumstances, is
attributable to functions performed,
resources employed, or risks assumed in
space or international water. The
balance of such gross income is
allocated to production activity
occurring outside space and
international water. The source of gross
income allocable to production activity
in space or international water is
determined under paragraph (b)(1) or (2)
of this section, as applicable. The source
of gross income allocated to production
activity occurring outside space and
international water is determined under
§ 1.863–3(c)(1).
(D) Source of income allocable to
sales activity. When property produced
by the taxpayer is sold outside space
and international water, the source of
gross income allocable to sales activity
will be determined under §§ 1.861–7(c)
and 1.863–3(c)(2). When property
produced by the taxpayer is sold in

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space or international water, the source
of gross income allocable to sales
activity generally will be determined
under paragraph (b)(1) or (2) of this
section, as applicable. However, if such
property is inventory property within
the meaning of section 1221(a)(1) and is
sold in space or international water for
use, consumption, or disposition
outside space, international water, and
the United States, the source of gross
income allocable to sales activity will be
determined under §§ 1.861–7(c) and
1.863–3(c)(2).
(4) Special rule for determining the
source of gross income from services. To
the extent a transaction characterized as
the performance of a service constitutes
a space or ocean activity, as determined
under paragraph (d)(2)(ii) of this
section, the source of gross income
derived from such transaction is
determined under paragraph (b)(1) or (2)
of this section.
(5) Special rule for determining source
of income from communications activity
(other than income from international
communications activity). Space and
ocean activity, as defined in paragraph
(d) of this section, includes activity that
occurs in space or international water
that is characterized as a
communications activity as defined in
§ 1.863–9(h)(1) (other than international
communications activity). The source of
space and ocean income that is also
communications income as defined in
§ 1.863–9(h)(2) (but not space/ocean
communications income as defined in
§ 1.863–9(h)(3)(v)) is determined under
the rules of § 1.863–9(c), (d), and (f), as
applicable, rather than under paragraph
(b) of this section. The source of space
and ocean income that is also space/
ocean communications income as
defined in § 1.863–9(h)(3)(v) is
determined under the rules of paragraph
(b) of this section. See § 1.863–9(e).
(c) Taxable income. When a taxpayer
allocates gross income under paragraph
(b)(1), (b)(2), (b)(3)(ii)(C), or (b)(4) of this
section, the taxpayer must allocate
expenses, losses, and other deductions
as prescribed in §§ 1.861–8 through
1.861–14T to the class or classes of gross
income that include the income so
allocated in each case. A taxpayer must
then apply the rules of §§ 1.861–8
through 1.861–14T to apportion
properly amounts of expenses, losses,
and other deductions so allocated to
such gross income between gross
income from sources within the United
States and gross income from sources
without the United States.
(d) Space and ocean activity—(1)
Definition—(i) Space activity. In
general, space activity is any activity
conducted in space. For purposes of this

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section, space means any area not
within the jurisdiction (as recognized by
the United States) of a foreign country,
possession of the United States, or the
United States, and not in international
water. For purposes of determining
space activity, the Commissioner may
separate parts of a single transaction
into separate transactions or combine
separate transactions as part of a single
transaction. Paragraph (d)(3) of this
section lists specific exceptions to the
general definition of space activity.
Activities that constitute space activity
include but are not limited to—
(A) Performance and provision of
services in space, as defined in
paragraph (d)(2)(ii) of this section;
(B) Leasing of equipment located in
space, including spacecraft (for
example, satellites) or transponders
located in space;
(C) Licensing of technology or other
intangibles for use in space;
(D) Production, processing, or
creation of property in space, as defined
in paragraph (d)(2)(i) of this section;
(E) Activity occurring in space that is
characterized as communications
activity (other than international
communications activity) under
§ 1.863–9(h)(1);
(F) Underwriting income from the
insurance of risks on activities that
produce space income; and
(G) Sales of property in space (see
§ 1.861–7(c)).
(ii) Ocean activity. In general, ocean
activity is any activity conducted on or
under water not within the jurisdiction
(as recognized by the United States) of
a foreign country, possession of the
United States, or the United States
(collectively, in international water). For
purposes of determining ocean activity,
the Commissioner may separate parts of
a single transaction into separate
transactions or combine separate
transactions as part of a single
transaction. Paragraph (d)(3) of this
section lists specific exceptions to the
general definition of ocean activity.
Activities that constitute ocean activity
include but are not limited to—
(A) Performance and provision of
services in international water, as
defined in paragraph (d)(2)(ii) of this
section;
(B) Leasing of equipment located in
international water, including
underwater cables;
(C) Licensing of technology or other
intangibles for use in international
water;
(D) Production, processing, or
creation of property in international
water, as defined in paragraph (d)(2)(i)
of this section;

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(E) Activity occurring in international
water that is characterized as
communications activity (other than
international communications activity)
under § 1.863–9(h)(1);
(F) Underwriting income from the
insurance of risks on activities that
produce ocean income;
(G) Sales of property in international
water (see § 1.861–7(c));
(H) Any activity performed in
Antarctica;
(I) The leasing of a vessel that does
not transport cargo or persons for hire
between ports-of-call (for example, the
leasing of a vessel to engage in research
activities in international water); and
(J) The leasing of drilling rigs,
extraction of minerals, and performance
and provision of services related
thereto, except as provided in paragraph
(d)(3)(ii) of this section.
(2) Determining a space or ocean
activity—(i) Production of property in
space or international water. For
purposes of this section, production
activity means an activity that creates,
fabricates, manufactures, extracts,
processes, cures, or ages property within
the meaning of section 864(a) and
§ 1.864–1.
(ii) Special rule for performance of
services—(A) General. Except as
provided in paragraph (d)(2)(ii)(B) of
this section, if a transaction is
characterized as the performance of a
service, then such service will be treated
as a space or ocean activity in its
entirety when any part of the service is
performed in space or international
water. Services are performed in space
or international water if functions are
performed, resources are employed, or
risks are assumed in space or
international water, regardless of
whether performed by personnel,
equipment, or otherwise.
(B) Exception to the general rule. If
the taxpayer can demonstrate the value
of the service attributable to
performance occurring in space or
international water, and the value of the
service attributable to performance
occurring outside space and
international water, then such service
will be treated as space or ocean activity
only to the extent of the activity
performed in space or international
water. The value of the service is
attributable to performance occurring in
space or international water to the
extent the performance of the service,
based on all the facts and
circumstances, is attributable to
functions performed, resources
employed, or risks assumed in space or
international water. In addition, if the

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taxpayer can demonstrate, based on all
the facts and circumstances, that the
value of the service attributable to
performance in space and international
water is de minimis, such service will
not be treated as space or ocean activity.
(3) Exceptions to space or ocean
activity. Space or ocean activity does
not include the following types of
activities:
(i) Any activity giving rise to
transportation income as defined in
section 863(c).
(ii) Any activity with respect to
mines, oil and gas wells, or other
natural deposits, to the extent the
mines, wells, or natural deposits are
located within the jurisdiction (as
recognized by the United States) of any
country, including the United States
and its possessions.
(iii) Any activity giving rise to
international communications income
as defined in § 1.863–9(h)(3)(ii).
(e) Treatment of partnerships. This
section is applied at the partner level.
(f) Examples. The following examples
illustrate the rules of this section:
Example 1. Space activity—activity
occurring on land and in space—(i) Facts. S,
a United States person, owns satellites in
orbit. S leases one of its satellites to A. S, as
lessor, will not operate the satellite. Part of
S’s performance as lessor in this transaction
occurs on land. Assume that the combination
of S’s activities is characterized as the lease
of equipment.
(ii) Analysis. Because the leased equipment
is located in space, the transaction is defined
in its entirety as space activity under
paragraph (d)(1)(i) of this section. Income
derived from the lease will be sourced under
paragraph (b)(1) of this section. Under
paragraph (b)(1) of this section, S’s space
income is sourced outside the United States
to the extent the income, based on all the
facts and circumstances, is attributable to
functions performed, resources employed, or
risks assumed in a foreign country or
countries.
Example 2. Space activity—(i) Facts. X is
an Internet service provider. X offers a
service that permits a customer (C) to connect
to the Internet via a telephone call, initiated
by the modem of C’s personal computer, to
a control center. X transmits information
requested by C to C’s personal computer, in
part using satellite capacity leased by X from
S. X performs the uplink and downlink
functions. X charges its customers a flat
monthly fee. Assume that neither X nor S
derive international communications income
within the meaning of § 1.863–9(h)(3)(ii). In
addition, assume that X is able to
demonstrate, pursuant to paragraph
(d)(2)(ii)(B) of this section, the extent to
which the value of the service is attributable
to functions performed, resources employed,
and risks assumed in space.
(ii) Analysis. Under paragraph (d)(2)(ii) of
this section, the service performed by X

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constitutes space activity to the extent the
value of the service is attributable to
functions performed, resources employed,
and risks assumed in space. To the extent the
service performed by X constitutes space
activity, the source of X’s income from the
service transaction is determined under
paragraph (b) of this section. To the extent
the service performed by X does not
constitute space or ocean activity, the source
of X’s income from the service is determined
under sections 861, 862, and 863, as
applicable. To the extent that X derives space
and ocean income that is also
communications income within the meaning
of § 1.863–9(h)(2), the source of X’s income
is determined under paragraph (b) of this
section and § 1.863–9(c), (d), and (f), as
applicable, as provided in paragraph (b)(5) of
this section. S derives space and ocean
income that is also communications income
within the meaning of § 1.863–9(h)(2), and
the source of S’s income is therefore
determined under paragraph (b) of this
section and § 1.863–9(c), (d), and (f), as
applicable, as provided in paragraph (b)(5) of
this section.
Example 3. Services as space activity—de
minimis value attributable to performance
occurring in space—(i) Facts. R owns a retail
outlet in the United States. R engages S to
provide a security system for R’s premises. S
operates its security system by transmitting
images from R’s premises directly to a
satellite, and from the satellite to a group of
S employees located in Country B, who
monitor the premises by viewing the
transmitted images. The satellite is used as a
medium of delivery and not as a method of
surveillance. O provides S with transponder
capacity on O’s satellite, which S uses to
transmit those images. Assume that S’s
transaction with R is characterized as the
performance of a service. Assume that O’s
provision of transponder capacity is also
viewed as the provision of a service. Assume
also that S is able to demonstrate, pursuant
to § 1.863–9(h)(1), that the value of the
transaction with R attributable to
communications activities is de minimis.
(ii) Analysis. S derives income from
providing monitoring services. S can
demonstrate, pursuant to paragraph (d)(2)(ii)
of this section, that based on all the facts and
circumstances, the value of S’s service
transaction attributable to performance in
space is de minimis. Thus, S is not treated
as engaged in a space activity, and none of
S’s income from the service transaction is
space income. In addition, because S
demonstrates that the value of the transaction
with R attributable to communications
activities is de minimis, S is not required
under § 1.863–9(h)(1)(ii) to treat the
transaction as separate communications and
non-communications transactions, and none
of S’s gross income from the transaction is
treated as communications income within
the meaning of § 1.863–9(h)(2). O’s provision
of transponder capacity is viewed as the
provision of a service. Based on all the facts
and circumstances, the value of O’s service
transaction attributable to performance

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in space is not de minimis. Thus, O’s activity
will be considered space activity, pursuant to
paragraph (d)(2)(ii) of this section, to the
extent the value of the services transaction is
attributable to performance in space (unless
O’s activity in space is international
communications activity). To the extent that
O derives communications income, the
source of such income is determined under
paragraph (b) of this section and § 1.863–9(b),
(c), (d), and (f), as applicable, as provided in
paragraph (b)(5) of this section. R does not
derive any income from space activity.
Example 4. Space activity—(i) Facts. L, a
domestic corporation, offers programming
and certain other services to customers
located both in the United States and in
foreign countries. Assume that L’s provision
of programming and other services in this
Example 4 is characterized as the provision
of a service, and that no part of the service
transaction occurs in space or international
water. Assume that the delivery of the
programming constitutes a separate
transaction also characterized as the
performance of a service. L uses satellite
capacity acquired from S to deliver the
programming service directly to customers’
television sets. L performs the uplink and
downlink functions, so that part of the value
of the delivery transaction derives from
functions performed and resources employed
in space. Assume that these contributions to
the value of the delivery transaction
occurring in space are not considered de
minimis under paragraph (d)(2)(ii)(B) of this
section. Customer C pays L to provide and
deliver programming to C’s residence in the
United States. Assume S’s provision of
satellite capacity in this Example 4 is viewed
as the provision of a service, and also that S
does not derive international
communications income within the meaning
of § 1.863–9(h)(3)(ii).
(ii) Analysis. S’s activity will be considered
space activity. To the extent that S derives
space and ocean income that is also
communications income under § 1.863–
9(h)(2), the source of S’s income is
determined under paragraph (b) of this
section and § 1.863–9(c), (d), and (f), as
applicable, as provided in paragraph (b)(5) of
this section. On these facts, L’s activities are
treated as two separate service transactions:
the provision of programming (and other
services), and the delivery of programming.
L’s income derived from provision of
programming and other services is not
income derived from space activity. L’s
delivery of programming and other services
is considered space activity, pursuant to
paragraph (d)(2)(ii) of this section, to the
extent the value of the delivery transaction is
attributable to performance in space. To the
extent that the delivery of programming is
treated as a space activity, the source of L’s
income derived from the delivery transaction
is determined under paragraph (b)(1) of this
section, as provided in paragraph (b)(4) of
this section. To the extent that L derives
space and ocean income that is also
communications income within the meaning
of § 1.863–9(h)(2), the source of such income
is determined under paragraph (b) of this
section and § 1.863–9(b), (c), (d), (e), and (f),
as applicable, as provided in paragraph (b)(5)
of this section.

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Example 5. Space activity—(i) Facts. The
facts are the same as in Example 4, except
that L does not deliver the programming
service directly but instead engages R, a
domestic corporation specializing in content
delivery, to deliver by transmission its
programming. For all portions of a
transmission which require satellite capacity,
R, in turn, contracts out such functions to S.
S performs the uplink and downlink
functions, so that part of the value of the
delivery transaction derives from functions
performed and resources employed in space.
(ii) Analysis. L’s activity will not be
considered space activity because none of L’s
activity occurs in space. Thus, L does not
derive any space and ocean income. L does,
however, derive communications income
within the meaning of § 1.863–9(h)(2). This is
the case even though L does not perform the
transmission function because L is paid by
Customer C to transmit, and bears the risk of
transmitting, the communications or data. To
the extent that L’s activity consists in part of
non-de minimis communications and non-de
minimis non-communications activity, each
part of the transaction must be treated as a
separate transaction and gross income is
allocated accordingly under § 1.863–
9(h)(1)(ii). In addition, L must also allocate
expenses, losses, and other deductions, for
example, payments to R, to the class or
classes of gross income that include the
income so allocated. R’s activity will not be
considered space activity. Since R contracts
out all of the functions involving satellite
capacity to S, no part of R’s activity occurs
in space. Thus, R does not derive any space
and ocean income. R does, however, derive
communications income within the meaning
of § 1.863–9(h)(2). This is the case even
though R does not perform the transmission
function because R is paid by L to transmit,
and bears the risk of transmitting, the
communications or data. S’s activity will be
considered space activity. To the extent that
S derives space and ocean income that is also
communications income within the meaning
of § 1.863–9(h)(2), the source of such income
is determined under paragraph (b) of this
section and § 1.863–9(b), (c), (d), (e), and (f),
as applicable, as provided in paragraph (b)(5)
of this section.
Example 6. Space activity—treatment of
land activity—(i) Facts. S, a United States
person, offers remote imaging products and
services to its customers. In year 1, S uses its
satellite’s remote sensors to gather data on
certain geographical terrain. In year 3, C, a
construction development company,
contracts with S to obtain a satellite image of
an area for site development work. S pulls
data from its archives and transfers to C the
images gathered in year 1, in a transaction
that is characterized as a sale of the data. S’s
rights, title, and interest in the data pass to
C in the United States. Before transferring the
images to C, S uses computer software in its
land-based office to enhance the images so
that the images can be used.
(ii) Analysis. The collection of data and
creation of images in space is characterized
as the creation of property in space. Because
S both produces and sells the data, S must
allocate gross income from the sale of the
data between production activity and sales

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activity under the 50/50 method of paragraph
(b)(3)(ii)(A). The source of S’s income
allocable to production activity is determined
under paragraph (b)(3)(ii)(C) of this section
because production activities occur both in
space and on land. The source of S’s income
attributable to sales activity is determined
under paragraph (b)(3)(ii)(D) of this section
(by reference to § 1.863–3(c)(2)) as U.S.
source income because S’s rights, title, and
interest in the data pass to C in the United
States.
Example 7. Use of intangible property in
space—(i) Facts. X acquires a license to use
a particular satellite slot or orbit, which X
sublicenses to C. C pays X a royalty.
(ii) Analysis. Because the royalty is paid for
the right to use intangible property in space,
the source of the royalty paid by C to X is
determined under paragraph (b) of this
section.
Example 8. Performance of services—(i)
Facts. E, a domestic corporation, operates
satellites with sensing equipment that can
determine how much heat and light
particular plants emit and reflect. Based on
the data, E will provide F, a U.S. farmer, a
report analyzing the data, which F will use
in growing crops. E analyzes the data from
offices located in the United States. Assume
that E’s combined activities are characterized
as the performance of services.
(ii) Analysis. Based on all the facts and
circumstances, the value of E’s service
transaction attributable to performance in
space is not de minimis. Thus, E’s activities
will be considered space activities, pursuant
to paragraph (d)(2)(ii) of this section, to the
extent the value of E’s service transaction is
attributable to performance in space. To the
extent E’s service transaction constitutes a
space activity, the source of E’s income
derived from the service transaction will be
determined under paragraph (b)(4) of this
section, by reference to paragraph (b)(1) of
this section. To the extent that E’s service
transaction does not constitute a space or
ocean activity, the source of E’s income
derived from the service transaction is
determined under sections 861, 862, and 863,
as applicable.
Example 9. Separate transactions—(i)
Facts. The same facts as Example 8, except
that E provides the raw data to F in a
transaction characterized as a sale of a
copyrighted article. In addition, E provides
an analysis in the form of a report to F. The
price F pays E for the raw data is separately
stated.
(ii) Analysis. To the extent that the
provision of raw data and the analysis of the
data are each treated as separate transactions,
the source of income from the production
and sale of data is determined under
paragraph (b)(3)(ii) of this section. The
provision of services would be analyzed in
the same manner as in Example 8.
Example 10. Sale of property in
international water—(i) Facts. T purchased
and owns transatlantic cable that lies in
international water. T sells the cable to B,
with T’s rights, title, and interest in the cable

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passing to B in international water. Assume
that the transatlantic cable is not inventory
property within the meaning of section
1221(a)(1).
(ii) Analysis. Because T’s rights, title, and
interest in the property pass to B in
international water, the sale takes place in
international water under § 1.861–7(c), and
the sale transaction is ocean activity under
paragraph (d)(1)(ii) of this section. The
source of T’s sales income is determined
under paragraph (b)(3)(i) of this section, by
reference to paragraph (b)(1) or (2) of this
section.
Example 11. Sale of property in space—(i)
Facts. S, a United States person,
manufactures a satellite in the United States
and sells it to a customer who is not a United
States person. S’s rights, title, and interest in
the satellite pass to the customer in space.
(ii) Analysis. Because S’s rights, title, and
interest in the satellite pass to the customer
in space, the sale takes place in space under
§ 1.861–7(c), and the sale transaction is space
activity under paragraph (d)(1)(i) of this
section. The source of income derived from
the sale of the satellite in space is determined
under paragraph (b)(3)(ii) of this section,
with the source of income allocable to
production activity determined under
paragraphs (b)(3)(ii)(A) and (B) of this
section, and the source of income allocable
to sales activity determined under paragraphs
(b)(3)(ii)(A) and (D) of this section. Under
paragraph (b)(1) of this section, S’s space
income is sourced outside the United States
to the extent the income, based on all the
facts and circumstances, is attributable to
functions performed, resources employed, or
risks assumed in a foreign country or
countries.
Example 12. Sale of property in space—(i)
Facts. S has a right to operate from a
particular position (satellite slot or orbit) in
space. S sells the right to operate from that
position to P. Assume that the sale of the
satellite slot is characterized as a sale of
property and that S’s rights, title, and interest
in the satellite slot pass to P in space.
(ii) Analysis. The sale of the satellite slot
takes place in space under § 1.861–7(c)
because S’s rights, title, and interest in the
satellite slot pass to P in space. The sale of
the satellite slot is space activity under
paragraph (d)(1)(i) of this section, and
income or gain from the sale is sourced under
paragraph (b)(3)(i) of this section, by
reference to paragraph (b)(1) or (2) of this
section.
Example 13. Source of income of a foreign
person—(i) Facts. FP, a foreign corporation
that is not a CFC, derives income from the
operation of satellites. FP operates ground
stations in the United States and in foreign
Country FC. Assume that FP is considered
engaged in a trade or business within the
United States based on FP’s operation of the
ground station in the United States.
(ii) Analysis. Under paragraph (b)(2)(iii) of
this section, FP’s space income is sourced in
the United States to the extent the income,
based on all the facts and circumstances, is
attributable to functions performed, resources
employed, or risks assumed within the
United States.
Example 14. Source of income of a foreign
person—(i) Facts. FP, a foreign corporation

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that is not a CFC, operates remote sensing
satellites in space to collect data and images
for its customers. FP uses an independent
agent, A, in the United States who provides
marketing, order-taking, and other customer
service functions. Assume that FP is
considered engaged in a trade or business
within the United States based on A’s
activities on FP’s behalf in the United States.
(ii) Analysis. Under paragraph (b)(2)(iii) of
this section, FP’s space income is sourced in
the United States to the extent the income,
based on all the facts and circumstances, is
attributable to functions performed, resources
employed, or risks assumed within the
United States.

77607

does so by making the allocation on a
timely filed original return (including
extensions). However, a taxpayer will be
permitted to make changes to such
allocations made on its original return
with respect to any taxable year for
which the statute of limitations has not
closed as follows:
(i) In the case of a taxpayer that has
made a change to such allocations prior
to the opening conference for the audit
of the taxable year to which the
allocation relates or who makes such a
change within 90 days of such opening
conference, if the IRS issues a written
(g) Reporting and documentation
information document request asking
requirements—(1) In general. A taxpayer the taxpayer to provide the documents
making an allocation of gross income
and such other information described in
under paragraph (b)(1), (b)(2),
paragraphs (g)(2) and (3) of this section
(b)(3)(ii)(C), or (b)(4) of this section must with respect to the changed allocations
satisfy the requirements in paragraphs
and the taxpayer complies with such
(g)(2), (3), and (4) of this section.
request within 30 days of the request,
(2) Required documentation. In all
then the IRS will complete its
cases, a taxpayer must prepare and
examination, if any, with respect to the
maintain documentation in existence
allocations for that year as part of the
when its return is filed regarding the
current examination cycle. If the
allocation of gross income and
taxpayer does not provide the
allocation and apportionment of
documents and information described
expenses, losses, and other deductions,
in paragraphs (g)(2) and (3) of this
the methodologies used, and the
section within 30 days of the request,
circumstances justifying use of those
then the procedures described in
methodologies. The taxpayer must make paragraph (g)(4)(ii) of this section shall
available such documentation within 30 apply.
days upon request.
(ii) If the taxpayer changes such
(3) Access to software. If the taxpayer
allocations more than 90 days after the
or any third party used any computer
opening conference for the audit of the
software, within the meaning of section
taxable year to which the allocations
7612(d), to allocate gross income, or to
relate or the taxpayer does not provide
allocate or apportion expenses, losses,
the documents and information with
and other deductions, the taxpayer must respect to the changed allocations as
make available upon request—
requested in accordance with
(i) Any computer software executable paragraphs (g)(2) and (3) of this section,
code, within the meaning of section
then the IRS will, in a separate cycle,
7612(d), used for such purposes,
determine whether an examination of
including an executable copy of the
the taxpayer’s allocations is warranted
version of the software used in the
and complete any such examination.
preparation of the taxpayer’s return
The separate cycle will be worked as
(including any plug-ins, supplements,
resources are available and may not
etc.) and a copy of all related electronic
have the same estimated completion
data files. Thus, if software
date as the other issues under
subsequently is upgraded or
examination for the taxable year. The
supplemented, a separate executable
IRS may ask the taxpayer to extend the
copy of the version used in preparing
statute of limitations on assessment and
the taxpayer’s return must be retained;
collection for the taxable year to permit
(ii) Any related computer software
examination of the taxpayer’s method of
source code, within the meaning of
allocation, including an extension
section 7612(d), acquired or developed
limited, where appropriate, to the
by the taxpayer or a related person, or
taxpayer’s method of allocation.
primarily for internal use by the
(h) Effective date. This section applies
taxpayer or such person rather than for
to taxable years beginning on or after
commercial distribution; and
December 27, 2006.
(iii) In the case of any spreadsheet
software or similar software, any
§ 1.863–9 Source of income derived from
communications activity under section
formulae or links to supporting
863(a), (d), and (e).
worksheets.
(4) Use of allocation methodology. In
(a) In general. Income of a United
general, when a taxpayer allocates gross States or a foreign person derived from
income under paragraph (b)(1), (b)(2),
each type of communications activity,
(b)(3)(ii)(C), or (b)(4) of this section, it
as defined in paragraph (h)(3) of this

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section, is sourced under the rules of
this section, notwithstanding any other
provision including sections 861, 862,
863, and 865. Notwithstanding that a
communications activity would qualify
as space or ocean activity under section
863(d) and the regulations thereunder,
the source of income derived from such
communications activity is determined
under this section, and not under
section 863(d) and the regulations
thereunder, except to the extent
provided in § 1.863–8(b)(5).
(b) Source of international
communications income—(1)
International communications income
derived by a United States person.
Income derived from international
communications activity (international
communications income) by a United
States person is one-half from sources
within the United States and one-half
from sources without the United States.
(2) International communications
income derived by foreign persons—(i)
In general. International
communications income derived by a
person other than a United States
person is, except as otherwise provided
in this paragraph (b)(2), wholly from
sources without the United States.
(ii) International communications
income derived by a controlled foreign
corporation. International
communications income derived by a
controlled foreign corporation within
the meaning of section 957 (CFC) is onehalf from sources within the United
States and one-half from sources
without the United States.
(iii) International communications
income derived by foreign persons with
a fixed place of business in the United
States. International communications
income derived by a foreign person,
other than a CFC, that is attributable to
an office or other fixed place of business
of the foreign person in the United
States is from sources within the United
States. The principles of section
864(c)(5) apply in determining whether
a foreign person has an office or fixed
place of business in the United States.
See § 1.864–7. International
communications income is attributable
to an office or other fixed place of
business to the extent of functions
performed, resources employed, or risks
assumed by the office or other fixed
place of business.
(iv) International communications
income derived by foreign persons
engaged in a trade or business within
the United States. International
communications income derived by a
foreign person (other than a CFC)
engaged in a trade or business within
the United States is income from
sources within the United States to the

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extent the income, based on all the facts
and circumstances, is attributable to
functions performed, resources
employed, or risks assumed within the
United States.
(c) Source of U.S. communications
income. Income derived by a United
States or foreign person from U.S.
communications activity is from sources
within the United States.
(d) Source of foreign communications
income. Income derived by a United
States or foreign person from foreign
communications activity is from sources
without the United States.
(e) Source of space/ocean
communications income. The source of
income derived by a United States or
foreign person from space/ocean
communications activity is determined
under section 863(d) and the regulations
thereunder.
(f) Source of communications income
when taxpayer cannot establish the two
points between which the taxpayer is
paid to transmit the communication.
Income derived by a United States or
foreign person from communications
activity, when the taxpayer cannot
establish the two points between which
the taxpayer is paid to transmit the
communication as required in
paragraph (h)(3)(i) of this section, is
from sources within the United States.
(g) Taxable income. When a taxpayer
allocates gross income under paragraph
(b)(2)(iii), (b)(2)(iv), or (h)(1)(ii) of this
section, the taxpayer must allocate
expenses, losses, and other deductions
as prescribed in §§ 1.861–8 through
1.861–14T to the class or classes of gross
income that include the income so
allocated in each case. A taxpayer must
then apply the rules of §§ 1.861–8
through 1.861–14T properly to
apportion amounts of expenses, losses,
and other deductions so allocated to
such gross income between gross
income from sources within the United
States and gross income from sources
without the United States. For amounts
of expenses, losses, and other
deductions allocated to gross income
derived from international
communications activity, when the
source of income is determined under
the 50/50 method of paragraph (b)(1) or
(b)(2)(ii) of this section, taxpayers
generally must apportion expenses,
losses, and other deductions between
sources within the United States and
sources without the United States pro
rata based on the relative amounts of
gross income from sources within the
United States and gross income from
sources without the United States.
However, the preceding sentence shall
not apply to research and experimental
expenditures qualifying under § 1.861–

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17, which are to be allocated and
apportioned under the rules of that
section.
(h) Communications activity and
income derived from communications
activity—(1) Communications activity—
(i) General rule. For purposes of this
part, communications activity consists
solely of the delivery by transmission of
communications or data
(communications). Delivery of
communications other than by
transmission (for example, by delivery
of physical packages and letters) is not
communications activity within the
meaning of this section.
Communications activity also includes
the provision of capacity to transmit
communications. Provision of content
or any other additional service provided
along with, or in connection with, a
non-de minimis communications
activity must be treated as a separate
non-communications activity unless de
minimis. Communications activity or
non-communications activity will be
treated as de minimis to the extent,
based on the facts and circumstances,
the value attributable to such activity is
de minimis.
(ii) Separate transaction. To the
extent that a taxpayer’s transaction
consists in part of non-de minimis
communications activity and in part of
non-de minimis non-communications
activity, each such part of the
transaction must be treated as a separate
transaction. Gross income is allocated to
each such communications activity
transaction and non-communications
activity transaction to the extent the
income, based on all the facts and
circumstances, is attributable to
functions performed, resources
employed, or risks assumed in each
such activity.
(2) Income derived from
communications activity. Income
derived from communications activity
(communications income) is income
derived from the delivery by
transmission of communications,
including income derived from the
provision of capacity to transmit
communications. Income may be
considered derived from a
communications activity even if the
taxpayer itself does not perform the
transmission function, but in all cases,
the taxpayer derives communications
income only if the taxpayer is paid to
transmit, and bears the risk of
transmitting, the communications.
(3) Determining the type of
communications activity—(i) In general.
Whether income is derived from
international communications activity,
U.S. communications activity, foreign
communications activity, or space/

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ocean communications activity is
determined by identifying the two
points between which the taxpayer is
paid to transmit the communication.
The taxpayer must establish the two
points between which the taxpayer is
paid to transmit, and bears the risk of
transmitting, the communication.
Whether the taxpayer contracts out part
or all of the transmission function is not
relevant. A taxpayer may satisfy the
requirement that the taxpayer establish
the two points between which the
taxpayer is paid to transmit, and bears
the risk of transmitting, the
communication by using any
consistently applied reasonable method
to establish one or both endpoints. In
evaluating the reasonableness of such
method, consideration will be given to
all the facts and circumstances,
including whether the endpoints would
otherwise be identifiable absent this
reasonable method provision and the
reliability of the data. Depending on the
facts and circumstances, methods based
on, for example, records of port or
transport charges, customer billing
records, a satellite footprint, or records
of termination fees made pursuant to an
international settlement agreement may
be reasonable. In addition, practices
used by taxpayers to classify or
categorize certain communications
activity in connection with preparation
of statements and analyses for the use of
management, creditors, minority
shareholders, joint ventures, or other
parties or governmental agencies in
interest may be reliable indicators of the
reasonableness of the method chosen,
but need not be accorded conclusive
weight by the Commissioner. In all
cases, the method chosen to establish
the two points between which the
taxpayer is paid to transmit, and bears
the risk of transmitting, the
communication must be supported by
sufficient documentation to permit
verification by the Commissioner.
(ii) Income derived from international
communications activity. Income
derived by a taxpayer from international
communications activity (international
communications income) is income
derived from communications activity,
as defined in paragraph (h)(2) of this
section, when the taxpayer is paid to
transmit—
(A) Between a point in the United
States and a point in a foreign country
(or a possession of the United States); or
(B) Foreign-originating
communications (communications with
a beginning point in a foreign country
or a possession of the United States)

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from a point in space or international
water to a point in the United States.
(iii) Income derived from U.S.
communications activity. Income
derived by a taxpayer from U.S.
communications activity (U.S.
communications income) is income
derived from communications activity,
as defined in paragraph (h)(2) of this
section, when the taxpayer is paid to
transmit—
(A) Between two points in the United
States; or
(B) Between the United States and a
point in space or international water,
except as provided in paragraph
(h)(3)(ii)(B) of this section.
(iv) Income derived from foreign
communications activity. Income
derived by a taxpayer from foreign
communications activity (foreign
communications income) is income
derived from communications activity,
as defined in paragraph (h)(2) of this
section, when the taxpayer is paid to
transmit—
(A) Between two points in a foreign
country or countries (or a possession or
possessions of the United States);
(B) Between a foreign country and a
possession of the United States; or
(C) Between a foreign country (or a
possession of the United States) and a
point in space or international water.
(v) Income derived from space/ocean
communications activity. Income
derived by a taxpayer from space/ocean
communications activity (space/ocean
communications income) is income
derived from communications activity,
as defined in paragraph (h)(2) of this
section, when the taxpayer is paid to
transmit between a point in space or
international water and another point in
space or international water.
(i) Treatment of partnerships. This
section is applied at the partner level.
(j) Examples. The following examples
illustrate the rules of this section:
Example 1. Income derived from noncommunications activity—remote data base
access—(i) Facts. D provides its customers in
various foreign countries with access to its
data base, which contains information on
certain individuals’ health care insurance
coverage. Customer C obtains access to D’s
data base by placing a call to D’s telephone
number. Assume that C’s telephone service,
used to access D’s data base, is provided by
a third party, and that D assumes no
responsibility for the transmission of the
information via telephone.
(ii) Analysis. D is not paid to transmit
communications and does not derive income
from communications activity within the
meaning of paragraph (h)(2) of this section.
Rather, D derives income from provision of
content or provision of services to its

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77609

customers. Therefore, the rules of this section
do not apply to determine the source of D’s
income.
Example 2. Income derived from U.S.
communications activity—U.S. portion of
international communication—(i) Facts. TC,
a local telephone company, receives an
access fee from an international carrier for
picking up a call from a local telephone
customer and delivering the call to a U.S.
point of presence (POP) of the international
carrier. The international carrier picks up the
call from its U.S. POP and delivers the call
to a foreign country.
(ii) Analysis. TC is not paid to carry the
transmission between the United States and
a foreign country. TC is paid to transmit a
communication between two points in the
United States. TC derives U.S.
communications income as defined in
paragraph (h)(3)(iii) of this section, which is
sourced under paragraph (c) of this section as
U.S. source income.
Example 3. Income derived from
international communications activity—
underwater cable—(i) Facts. TC, a domestic
corporation, owns an underwater fiber optic
cable. Pursuant to contracts, TC makes
available to its customers capacity to transmit
communications via the cable. TC’s
customers then solicit telephone customers
and arrange to transmit the telephone
customers’ calls. The cable runs in part
through U.S. waters, in part through
international waters, and in part through
foreign country waters.
(ii) Analysis. TC derives international
communications income as defined in
paragraph (h)(3)(ii) of this section because TC
is paid to make available capacity to transmit
communications between the United States
and a foreign country. Because TC is a United
States person, TC’s international
communications income is sourced under
paragraph (b)(1) of this section as one-half
from sources within the United States and
one-half from sources without the United
States.
Example 4. Income derived from
international communications activity—
satellite—(i) Facts. S, a United States person,
owns satellites in orbit and uplink facilities
in Country X, a foreign country. B, a resident
of Country X, pays S to deliver B’s
programming from S’s uplink facility, located
in Country X, to a downlink facility in the
United States owned by C, a customer of B.
(ii) Analysis. S derives international
communications income under paragraph
(h)(3)(ii) of this section because S is paid to
transmit the communications between a
beginning point in a foreign country and an
endpoint in the United States. Because S is
a United States person, the source of S’s
international communications income is
determined under paragraph (b)(1) of this
section as one-half from sources within the
United States and one-half from sources
without the United States.
Example 5. The paid-to-do rule—foreign
communications via domestic route—(i)

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Facts. TC is paid to transmit communications
from Toronto, Canada, to Paris, France. TC
transmits the communications from Toronto
to New York. TC pays another
communications company, IC, to transmit the
communications from New York to Paris.
(ii) Analysis. Under the paid-to-do rule of
paragraph (h)(3)(i) of this section, TC derives
foreign communications income under
paragraph (h)(3)(iv) of this section because
TC is paid to transmit communications
between two points in foreign countries,
Toronto and Paris. Under paragraph (h)(3)(i)
of this section, the character of TC’s
communications activity is determined
without regard to the fact that TC pays IC to
transmit the communications for some
portion of the delivery path. IC has
international communications income under
paragraph (h)(3)(ii) of this section because IC
is paid to transmit the communications
between a point in the United States and a
point in a foreign country.
Example 6. The paid-to-do rule—domestic
communication via foreign route—(i) Facts.
TC is paid to transmit a call between two
points in the United States, but routes the
call through Canada.
(ii) Analysis. Under paragraph (h)(3)(i) of
this section, the character of income derived
from communications activity is determined
by the two points between which the
taxpayer is paid to transmit, and bears the
risk of transmitting, the communications,
without regard to the path of the
transmission between those two points.
Thus, under paragraph (h)(3)(iii) of this
section, TC derives income from U.S.
communications activity because it is paid to
transmit the communications between two
U.S. points.
Example 7. The paid-to-do rule—foreignoriginating communications—(i) Facts.
Under an international settlement agreement,
G, a Country X international carrier, pays T
to receive all calls originating in Country X
that are bound for the United States and to
terminate such calls in the United States. Due
to Country X legal restrictions, the
international settlement agreement specifies
that G carries the transmission to a point
outside the territory of Country X and that T
carries the foreign-originating transmission
from such point to the destined point in the
United States. T, in turn, contracts out with
another communications company, S, to
transmit the U.S. portion of the
communications. Tracing and identifying the
endpoints of each transmission is not
possible or practical. T does, however, keep
records of termination fees received from G
for terminating the foreign-originating calls.
(ii) Analysis. T derives communications
income as defined in paragraph (h)(2) of this
section. Based on all the facts and
circumstances, T can establish that T is paid
to transmit, and bears the risk of transmitting,
foreign-originating calls from a point in space
or international water to a point in the
United States using a reasonable method to
establish the endpoints, assuming that this
method is consistently applied. In this case,
T can reasonably establish that T is paid to
receive foreign-originating calls and
terminate such calls in the United States
based on the records of termination fees

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17:56 Dec 26, 2006

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pursuant to an international settlement
agreement. Under paragraph (h)(3)(ii)(B) of
this section, a taxpayer derives income from
international communications activity when
the taxpayer is paid to transmit foreignoriginating communications from space or
international water to the United States.
Thus, under paragraph (h)(3)(ii)(B) of this
section, T derives income from international
communications. If, based on all the facts
and circumstances, T could reasonably trace
and identify the endpoints, then T would
have to directly establish that each call
originated in a foreign country. Assuming T
is able to do so, the rest of the analysis in
this Example 7 remains the same. Under
paragraph (h)(3)(iii) of this section, S derives
income from U.S. communications activity
because S is paid to transmit the
communications between two U.S. points.
Example 8. Indeterminate endpoints—
prepaid telephone calling cards—(i) Facts. S
purchases capacity from TC to transmit
telephone calls. S sells prepaid telephone
calling cards that give customers access to
TC’s telephone lines for a certain number of
minutes. Assume that S cannot establish the
endpoints of its customers’ telephone calls,
even under the reasonable method rule of
paragraph (h)(3) of this section.
(ii) Analysis. S derives communications
income as defined in paragraph (h)(2) of this
section because S makes capacity to transmit
communications available to its customers.
In this case, S cannot establish the two points
between which the communications are
transmitted. Therefore, S’s communications
income is U.S. source income, as provided by
paragraph (f) of this section.
Example 9. Reasonable methods—minutes
of use data on long distance calling plans—
(i)Facts. B provides both domestic and
international long distance services in a
calling plan for a limited number of minutes
for a set amount each month. Tracing and
identifying the endpoints of each
transmission is not possible or practical. B is,
however, able to establish that the calling
plan generated $10,000 of revenue for 25,000
minutes based on reports derived from
customer billing records. Based on minutes
of use data in these reports, B is able to
establish that of the total 25,000 minutes, 60
percent or 15,000 minutes were for U.S. long
distance calls and 40 percent or 10,000
minutes were for international calls.
(ii) Analysis. B derives communications
income as defined in paragraph (h)(2) of this
section. Based on all the facts and
circumstances, B can establish the two points
between which B is paid to transmit, and
bears the risk of transmitting, the
communications using a reasonable method
to establish the endpoints, assuming that this
method is consistently applied. In this case,
B can reasonably establish that 60 percent of
the income derived from the long distance
calling plan is U.S. communications income
and 40 percent is international
communications income based on the
minutes of use data derived from customer
billing records to establish the endpoints of
the communications. If, based on all the facts
and circumstances, B could reasonably trace
and identify the endpoints, then B would
have to directly identify the endpoints

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between which B is paid to transmit the
communications.
Example 10. Reasonable methods—system
design—(i) Facts. D operates satellites which
are designed to transmit signals through two
separate ranges of signal frequencies (bands).
Due to technological limitations,
requirements, and practicalities, one band is
designed to only transmit signals within the
United States. The other band is designed to
transmit signals between foreign countries
and the United States. D cannot trace and
identify the endpoints of each individual
transmission. D does, however, track the total
transmission through each band and the total
income derived from transmitting signals
through each band.
(ii) Analysis. D derives communications
income as defined in paragraph (h)(2) of this
section. Based on all the facts and
circumstances, D can establish the two points
between which D is paid to transmit, and
bears the risk of transmitting, the
communications using a reasonable method
to establish endpoints, assuming that this
method is consistently applied. In this case,
D can reasonably establish that income
derived from transmissions through the first
band is U.S. communications income and
income derived from transmissions through
the second band is international
communications income based on the design
of the bands to establish the endpoints of the
communications.
Example 11. Reasonable methods—port
locations—(i) Facts. X provides its customer,
C, with a virtual private network (VPN) so
that C’s U.S. headquarter office canconnect
and communicate with offices in the United
States, Country X, Country Y, and Country Z.
Assume that the VPN is only for
communications with the U.S. headquarter
office. X cannot trace and identify the
endpoints of each transmission. C pays X a
set amount each month for the entire service,
regardless of the magnitude of the usage or
the geographic points between which C uses
the service.
(ii) Analysis. X derives communications
income as defined in paragraph (h)(2) of this
section. Based on the facts and
circumstances, X can establish the two points
between which X is paid to transmit, and
bears the risk of transmitting, the
communications using a reasonable method
to establish endpoints, assuming that this
method is consistently applied. In this case,
X can reasonably establish that one-fourth of
the income derived from the VPN service is
U.S. communications income and threefourths is international communications
income based on the location of the VPN
ports to establish the endpoints of the
communications.
Example 12. Indeterminate endpoints—
Internet access—(i) Facts. B, a domestic
corporation, is an Internet service provider.
B charges its customer, C, a monthly lump
sum for Internet access. C accesses the
Internet via a telephone call, initiated by the
modem of C’s personal computer, to one of
B’s control centers, which serves as C’s portal
to the Internet. B transmits data sent by C
from B’s control center in France to a
recipient in England, over the Internet. B
does not maintain records as to the beginning
and endpoints of the transmission.

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Federal Register / Vol. 71, No. 248 / Wednesday, December 27, 2006 / Rules and Regulations
(ii) Analysis. B derives communications
income as defined in paragraph (h)(2) of this
section. The source of B’s communications
income is determined under paragraph (f) of
this section as income from sources within
the United States because B cannot establish
the two points between which it is paid to
transmit the communications.
Example 13. De minimis noncommunications activity—(i) Facts. The
same facts as in Example 12. Assume in
addition that B replicates frequently
requested sites on B’s own servers, solely to
speed up response time. Assume that B’s
replication of frequently requested sites
would be considered a de minimis noncommunications activity under this section.
(ii) Analysis. On these facts, because B’s
replication of frequently requested sites
would be considered a de minimis noncommunications activity, B is not required to
treat the replication activity as a separate
non-communications activity transaction
under paragraph (h)(1) of this section. B
derives communications income under
paragraph (h)(2) of this section. The character
and source of B’s communications income
are determined by demonstrating the points
between which B is paid to transmit the
communications, under paragraph (h)(3)(i) of
this section.
Example 14. Income derived from
communications and non-communications
activity—bundled services—(i) Facts. A, a
domestic corporation, offers customers local
and long distance phone service, video, and
Internet services. Customers pay a flat
monthly fee plus 10 cents a minute for all
long-distance calls, including international
calls.
(ii) Analysis. Under paragraph (h)(1)(ii) of
this section, to the extent that A’s transaction
with its customer consists in part of non-de
minimis communications activity and in part
of non-de minimis non-communications
activity, each such part of the transaction
must be treated as a separate transaction. A’s
gross income from the transaction is
allocated to each such communications
activity transaction and non-communications
activity transaction in accordance with
paragraph (h)(1)(ii) of this section. To the
extent A can establish that it derives
international communications income as
defined in paragraph (h)(3)(ii) of this section,
A would determine the source of such
income under paragraph (b)(1) of this section.
If A cannot establish the points between
which it is paid to transmit communications,
as required by paragraph (h)(3)(i) of this
section, A’s communications income is from
sources within the United States, as provided
by paragraph (f) of this section.
Example 15. Income derived from
communications and non-communications
activity—(i) Facts. B, a domestic corporation,
is paid by D, a cable system operator in
Foreign Country, to provide television
programs and to transmit the television
programs to Foreign Country. Using its own
satellite transponder, B transmits the
television programs from the United States to
downlink facilities owned by D in Foreign
Country. D receives the transmission,
unscrambles the signals, and distributes the
broadcast to D’s customers in Foreign

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Country. Assume that B’s provision of
television programs is a non-de minimis noncommunications activity, and that B’s
transmission of television programs is a nonde minimis communications activity.
(ii) Analysis. Under paragraph (h)(1)(ii) of
this section, B must treat its communications
and non-communications activities as
separate transactions. B’s gross income is
allocated to each such separate
communications and non-communications
activity transaction in accordance with
paragraph (h)(1)(ii) of this section. Income
derived by B from the transmission of
television programs to D’s Foreign Country
downlink facility is international
communications income as defined in
paragraph (h)(3)(ii) of this section because B
is paid to transmit communications from the
United States to a foreign country.
Example 16. Income derived from foreign
communications activity—(i) Facts. STS
provides satellite capacity to B, a broadcaster
located in Australia. B beams programming
from Australia to the satellite. S’s satellite
picks the communications up in space and
beams the programming over a footprint
covering Southeast Asia.
(ii) Analysis. S derives communications
income as defined in paragraph (h)(2) of this
section. S’s income is characterized as
foreign communications income under
paragraph (h)(3)(iv) of this section because S
picks up the communication in space, and
beams it to a footprint entirely covering a
foreign area. Under paragraph (d) of this
section, S’s foreign communications income
is from sources without the United States. If
S were beaming the programming over a
satellite footprint that covered area both in
the United States and outside the United
States, S would be required to allocate the
income derived from the different types of
communications activity.

77611

including an executable copy of the
version of the software used in the
preparation of the taxpayer’s return
(including any plug-ins, supplements,
etc.) and a copy of all related electronic
data files. Thus, if software
subsequently is upgraded or
supplemented, a separate executable
copy of the version used in preparing
the taxpayer’s return must be retained;
(ii) Any related computer software
source code, within the meaning of
section 7612(d), acquired or developed
by the taxpayer or a related person, or
primarily for internal use by the
taxpayer or such person rather than for
commercial distribution; and
(iii) In the case of any spreadsheet
software or similar software, any
formulae or links to supporting
worksheets.
(4) Use of allocation methodology. In
general, when a taxpayer allocates gross
income under paragraph (b)(2)(iii),
(b)(2)(iv), or (h)(1)(ii) of this section, it
does so by making the allocation on a
timely filed original return (including
extensions). However, a taxpayer will be
permitted to make changes to such
allocations made on its original return
with respect to any taxable year for
which the statute of limitations has not
closed as follows:
(i) In the case of a taxpayer that has
made a change to such allocations prior
to the opening conference for the audit
of the taxable year to which the
allocation relates or who makes such a
change within 90 days of such opening
conference, if the IRS issues a written
information document request asking
(k) Reporting and documentation
requirements—(1) In general. A taxpayer the taxpayer to provide the documents
and such other information described in
making an allocation of gross income
paragraphs (k)(2) and (3) of this section
under paragraph (b)(2)(iii), (b)(2)(iv), or
with respect to the changed allocations
(h)(1)(ii) of this section must satisfy the
and the taxpayer complies with such
requirements in paragraphs (k)(2), (3),
request within 30 days of the request,
and (4) of this section.
then the IRS will complete its
(2) Required documentation. In all
examination, if any, with respect to the
cases, a taxpayer must prepare and
allocations for that year as part of the
maintain documentation in existence
current examination cycle. If the
when its return is filed regarding the
taxpayer does not provide the
allocation of gross income, and
documents and information described
allocation and apportionment of
in paragraphs (k)(2) and (3) of this
expenses, losses, and other deductions,
section within 30 days of the request,
the methodologies used, and the
then the procedures described in
circumstances justifying use of those
methodologies. The taxpayer must make paragraph (k)(4)(ii) of this section shall
available such documentation within 30 apply.
(ii) If the taxpayer changes such
days upon request.
allocations more than 90 days after the
(3) Access to software. If the taxpayer
opening conference for the audit of the
or any third party used any computer
taxable year to which the allocations
software, within the meaning of section
relate or the taxpayer does not provide
7612(d), to allocate gross income, or to
the documents and information with
allocate or apportion expenses, losses,
and other deductions, the taxpayer must respect to the changed allocations as
requested in accordance with
make available upon request—
(i) Any computer software executable paragraphs (k)(2) and (3) of this section,
then the IRS will, in a separate cycle,
code, within the meaning of section
determine whether an examination of
7612(d), used for such purposes,

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Federal Register / Vol. 71, No. 248 / Wednesday, December 27, 2006 / Rules and Regulations

the taxpayer’s allocations is warranted
and complete any such examination.
The separate cycle will be worked as
resources are available and may not
have the same estimated completion
date as the other issues under
examination for the taxable year. The
IRS may ask the taxpayer to extend the
statute of limitations on assessment and
collection for the taxable year to permit
examination of the taxpayer’s method of
allocation, including an extension
limited, where appropriate, to the
taxpayer’s method of allocation.
(l) Effective date. This section applies
to taxable years beginning on or after
December 27, 2006.
PART 602—OMB CONTROL NUMBERS
UNDER THE PAPERWORK
REDUCTION ACT
■ Par. 4. The authority citation for part
602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 5. In § 602.101 paragraph (b) is
amended by adding an entry to the table
in numerical order, §§ 1.863–8 and
1.863–9, to read as follows:

■

§ 602.101

*

OMB Control numbers.

*
*
(b) * * *

*

CFR part or section
where identified and
described

*

Current OMB control
No.

9276) that were published in the
Federal Register on Tuesday, July 25,
2006 (71 FR 42049), amending the
regulations that provide for determining
the amount of income tax withholding
on supplemental wages. These
regulations apply to all employers and
others making supplemental wage
payments to employees.
DATES: The correction will be effective
January 1, 2007.
FOR FURTHER INFORMATION CONTACT: A.G.
Kelley, (202) 622–6040 (not a toll-free
number).
SUPPLEMENTARY INFORMATION:
Background
The final regulations that are the
subject of these corrections are under
sections 3401 and 3402 of the Internal
Revenue Code.
Need for Corrections
As published, final regulations (TD
9276) contain errors that may prove to
be misleading and are in need of
clarification.
List of Subjects in 26 CFR Part 31
Employment taxes, Income taxes,
Penalties, Pensions, Railroad retirement,
Reporting and recordkeeping
requirements, Social security,
Unemployment compensation.
Accordingly, 26 CFR part 31 is
corrected by making the following
correcting amendments:

1545–1718.
1545–1718.

Kevin M. Brown,
Acting Deputy Commissioner for Services and
Enforcement.
Approved: December 21, 2006.
Eric Solomon,
Assistant Secretary of the Treasury (Tax
Policy).
[FR Doc. E6–22174 Filed 12–26–06; 8:45 am]
BILLING CODE 4830–01–P

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 31
[TD 9276]

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Internal Revenue Service (IRS),
Treasury.
ACTION: Correcting amendment.
AGENCY:

SUMMARY: This document contains
corrections to final regulations (TD

17:07 Dec 26, 2006

Paragraph 1. The authority citation
for part 31 continues to read, in part, as
follows:

■

Authority: 26 U.S.C. 7805 * * *
■ Par. 2. Section 31.3402(g)-1(a)(8) is
amended by revising the fifth sentence
of Example 1 paragraph (iii), the fifth
sentence of Example 3 paragraph (i), the
last sentence of Example 3 paragraph
(iv) and the third sentence of Example
3 paragraph (vi).
The revisions read as follows:

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Supplemental wage

(a) * * *
(8) * * *

Flat Rate Supplemental Wage
Withholding; Correction

VerDate Aug<31>2005

PART 31—EMPLOYMENT TAXES AND
COLLECTION OF INCOME TAX AT
SOURCE

§ 31.3402(g)–1
payments.

RIN 1545–BD96

Example 1. * * *
(iii) * * * If Y elected to withhold income
tax using paragraph (a)(7) of this section, Y
would withhold on the $400,000 component
at 25 percent (pursuant to paragraph
(a)(7)(iii)(F) of this section), which would
result in $100,000 tax withheld. * * *

*

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*

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*

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*

*

*

*

*

(iv) * * * If R elects to use optional flat
rate withholding provided under paragraph
(a)(7)(iii)(f) of this section, withholding
would be calculated at 25 percent of the
$1,000,000 portion of the payment and
would be $250,000.

*

*

*

*

*

(vi) * * * If U elects to withhold income
tax at the flat rate provided under paragraph
(a)(7)(iii)(F) of this section, withholding on
the $50,000 of sick pay would be calculated
at 25 percent of the $50,000 payment and
would be $12,500. * * *

*

*

*

*

*

LaNita Van Dyke,
Chief, Publications and Regulations Branch,
Legal Processing Division, Associate Chief
Counsel (Procedure and Administration).
[FR Doc. E6–22022 Filed 12–26–06; 8:45 am]
BILLING CODE 4830–01–P

DEPARTMENT OF HOMELAND
SECURITY
Coast Guard
33 CFR Part 117
[CGD05–06–119]

Correction of Publication
■

1.863–8 .....................
1.863–9 .....................

Example 3. (i) * * * Unrelated company U
pays D sick pay as an agent of the employer
R and such sick pay is supplemental wages
pursuant to § 31.3401(a)-1(b)(8)(i)(b)(2).
* * *

RIN 1625–AA–09

Drawbridge Operation Regulations;
Potomac River, Alexandria, VA and
Oxon Hill, MD
Coast Guard, DHS.
Notice of temporary deviation
from regulations.

AGENCY:
ACTION:

SUMMARY: The Commander, Fifth Coast
Guard District, has issued a temporary
deviation from the regulation governing
the operation of the new Woodrow
Wilson Memorial (I–95) Bridge, mile
103.8, across Potomac River between
Alexandria, Virginia and Oxon Hill,
Maryland. This deviation allows the
new drawbridge to remain closed to
navigation each day from 10 a.m. to 2
p.m. beginning on December 25, 2006
until and including February 22, 2007,
to facilitate completion of the Outer
Loop portion for the new Woodrow
Wilson Bridge construction project.
DATES: This deviation is effective from
10 a.m. on December 25, 2006, until 2
p.m. on February 22, 2007.
ADDRESSES: Materials referred to in this
document are available for inspection or
copying at Commander (dpb), Fifth
Coast Guard District, Federal Building,
1st Floor, 431 Crawford Street,

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