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ITAR provisions related to remote work.
The notice and comment process will
require additional time, including to
allow DDTC to address any potential
revisions through the interagency
process.
Pursuant to ITAR §§ 126.2 and 126.3,
in the interest of the security and
foreign policy of the United States and
as warranted by the exceptional and
undue hardships and risks to safety
caused by the public health emergency
related to the SARS–COV2 pandemic,
notice is provided that the following
temporary suspensions, modifications,
and exceptions are being extended as
follows:
1. As of March 13, 2020, a temporary
suspension, modification, and exception to
the requirement that a regular employee, for
purposes of ITAR § 120.39(a)(2), work at the
company’s facilities, to allow the individual
to work at a remote work location, so long
as the individual is not located in Russia or
a country listed in ITAR § 126.1. This
suspension, modification, and exception
shall terminate on June 30, 2021, unless
otherwise extended in writing.
2. As of March 13, 2020, a temporary
suspension, modification, and exception to
authorize regular employees of licensed
entities who are working remotely in a
country not currently authorized by a
technical assistance agreement,
manufacturing license agreement, or
exemption to send, receive, or access any
technical data authorized for export,
reexport, or retransfer to their employer via
a technical assistance agreement,
manufacturing license agreement, or
exemption so long as the regular employee is
not located in Russia or a country listed in
ITAR § 126.1. This suspension, modification,
and exception shall terminate on June 30,
2021, unless otherwise extended in writing.

This notification makes no other
revision to the document published at
85 FR 25287, nor does it make any other
temporary suspension, modification, or
exception to the requirements of the
ITAR.
Authority: 22 CFR 126.2 and 126.3)
Michael F. Miller,
Deputy Assistant Secretary for Defense Trade
Controls, U.S. Department of State.
[FR Doc. 2020–27024 Filed 12–10–20; 8:45 am]

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BILLING CODE 4710–25–P

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DEPARTMENT OF THE TREASURY
Internal Revenue Service

79837

of this Summary of Comments and
Explanation of Revisions.’’
Crystal Pemberton,
Senior Federal Register Liaison, Publications
and Regulations Branch, Legal Processing
Division, Associate Chief Counsel, (Procedure
and Administration).

26 CFR Part 1
[TD 9902]

[FR Doc. 2020–25374 Filed 12–10–20; 8:45 am]

RIN 1545–BP15

BILLING CODE 4830–01–P

Guidance Under Sections 951A and
954 Regarding Income Subject to a
High Rate of Foreign Tax; Correction

DEPARTMENT OF THE TREASURY

Internal Revenue Service (IRS),
Treasury.

26 CFR Part 1

AGENCY:
ACTION:

Final regulations; correction.

Internal Revenue Service

[TD 9921]
RIN 1545–BP16

This document contains
corrections to Treasury Decision 9902,
which was published in the Federal
Register on Thursday, July 23, 2020.
Treasury Decision 9902 contained final
regulations under the global intangible
low-taxed income and subpart F income
provisions of the Internal Revenue Code
regarding the treatment of income that
is subject to a high rate of foreign tax.

SUMMARY:

This correction is effective on
December 11, 2020.

DATES:

FOR FURTHER INFORMATION CONTACT:

Jorge M. Oben or Larry R. Pounders at
(202) 317–6934 (not a toll-free number).
SUPPLEMENTARY INFORMATION:

Background
The final regulations that are the
subject of this correction are issued
under section 951A of the Code.
Need for Correction
As published, the final regulations
contain errors that need to be corrected.
Correction of Publication
Accordingly, the final regulations (TD
9902) that are the subject of FR Doc.
2020–15351, beginning on page 44620
in the issue of July 23, 2020, are
corrected as follows:
On page 44629, in the first column,
the text of footnote 6 is corrected to
read:
‘‘Under currently applicable
§ 1.951A–1(e)(2), a domestic partnership
can be a controlling domestic
shareholder—for example, for purposes
of determining which party elects the
GILTI high-tax exclusion under
§ 1.951A–2(c)(7)(viii)(A), including
potentially for taxable years beginning
after December 31, 2017, under
§ 1.951A–7(b), as discussed in part VIII

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Source of Income From Certain Sales
of Personal Property
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:

This document contains final
regulations modifying the rules for
determining the source of income from
sales of inventory produced within the
United States and sold without the
United States or vice versa. These final
regulations also contain new rules for
determining the source of income from
sales of personal property (including
inventory) by nonresidents that are
attributable to an office or other fixed
place of business that the nonresident
maintains in the United States. Finally,
these final regulations modify certain
rules for determining whether foreign
source income is effectively connected
with the conduct of a trade or business
within the United States.
DATES:
Effective Date: These final regulations
are effective on December 11, 2020.
Applicability Dates: For dates of
applicability, see §§ 1.863–1(f), 1.863–
2(c), 1.863–3(g), 1.863–8(h), 1.864–5(e),
1.864–6(c)(4), and 1.865–3(g).
FOR FURTHER INFORMATION CONTACT: Brad
McCormack at (202) 317–6911 (not a toll
free number).
SUPPLEMENTARY INFORMATION:
SUMMARY:

Background
The Tax Cuts and Jobs Act, Public
Law 115–97, 131 Stat. 2054, 2208 (2017)
(the ‘‘Act’’), enacted on December 22,
2017, amended section 863(b) of the
Internal Revenue Code (‘‘Code’’). On
December 30, 2019, the Department of
the Treasury (‘‘Treasury Department’’)
and the IRS published proposed
regulations (REG–100956–19) under
sections 863, 864, 865, 937, and 1502 in
the Federal Register (84 FR 71836) (the

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‘‘proposed regulations’’). A public
hearing on the proposed regulations was
held on June 3, 2020. All written
comments received in response to the
proposed regulations are available at
https://www.regulations.gov or upon
request. Terms used but not defined in
this preamble have the meaning
provided in these final regulations.
Summary of Comments and
Explanation of Revisions
I. Overview
The final regulations retain the overall
approach of the proposed regulations,
with certain revisions. This Summary of
Comments and Explanation of Revisions
section discusses those revisions as well
as comments received in response to the
solicitation of comments in the notice of
proposed rulemaking. Comments
outside the scope of this rulemaking are
generally not addressed but may be
considered in connection with future
guidance projects.

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II. Comments on and Revisions to
Proposed § 1.863–1—Allocation of Gross
Income Under Section 863(a) and
Proposed § 1.863–3—Allocation and
Apportionment of Income From Certain
Sales of Inventory
The Act amended section 863 of the
Code, which provides special sourcing
rules for determining the source of
income, including income partly from
within and partly from without the
United States. Specifically, the Act
amended section 863(b) to allocate or
apportion income from the sale or
exchange of inventory property
produced (in whole or in part) by a
taxpayer within the United States and
sold or exchanged without the United
States or produced (in whole or in part)
by the taxpayer without the United
States and sold or exchanged within the
United States (collectively, ‘‘Section
863(b)(2) Sales’’) solely on the basis of
production activities with respect to
that inventory. Before the Act, section
863(b) provided that income from
Section 863(b)(2) Sales would be treated
as derived partly from sources within
and partly from sources without the
United States without providing the
basis for such allocation or
apportionment. Consistent with the
Act’s changes to section 863(b), the
proposed regulations amended § 1.863–
3 in order to properly allocate or
apportion gross income from Section
863(b)(2) Sales based solely on
production activity.
Under § 1.863–3(c)(1)(ii)(A) (which
has been redesignated in the final
regulations as § 1.863–3(c)(2)(i)), where
the taxpayer’s production assets are

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located both within and without the
United States, the amount of income
from sources without the United States
is determined by multiplying all the
income attributable to the taxpayer’s
production activities by a fraction, the
numerator of which is the average
adjusted basis of production assets that
are located without the United States
and the denominator of which is the
average adjusted basis of all the
production assets located within and
without the United States.
For purposes of applying this formula,
the adjusted basis of production assets
is determined under section 1011,
which is adjusted under section 1016
for depreciation deductions allowed.
The Act also amended section 168(k) to
allow an additional first-year
depreciation deduction of 100 percent
of the basis of certain property placed in
service after September 27, 2017, and
before January 1, 2023. Therefore,
certain new and used production assets
placed in service and used
predominantly within the United States
during this period may have an adjusted
basis of zero. However, production
assets either placed in service or used
predominantly without the United
States, or both, do not qualify for this
accelerated depreciation and must be
depreciated using the straight-line
method under the alternative
depreciation system (‘‘ADS’’) of section
168(g)(2). In light of the Act’s change to
section 168(k) to allow accelerated
depreciation in some circumstances, the
proposed regulations provided a new
rule for computing the adjusted basis of
production assets for purposes of
applying the allocation formula in
§ 1.863–3.
A. Income Attributable to Sales Activity
Section 1.863–3, as in effect before
this Treasury Decision, provided rules
and corresponding methods for
allocating or apportioning gross income
from Section 863(b)(2) Sales between
production activity and sales activity.
To implement the changes to section
863(b) under the Act, the proposed
regulations proposed removing § 1.863–
3(c)(2) which allocates and apportions
income attributable to sales activity.
One comment argued that removing
§ 1.863–3(c)(2) could lead to double
taxation when a foreign jurisdiction
imposes taxation on the sales activity.
The Act amended section 863(b) to
source income from the sale by a
taxpayer of inventory produced by that
taxpayer based only on production
activity. Under the Code, sales activity
is no longer a relevant factor for
allocating and apportioning such
income. Therefore, the final regulations

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remove § 1.863–3(c)(2). But see part V of
this Summary of Comments and
Explanation of Revisions section for a
discussion of the interaction with
income tax treaties.
Another comment suggested that two
aspects of § 1.863–3(c)(2) have
continued relevance even after the Act’s
changes to section 863(b)(2). First,
§ 1.863–3(c)(2) has a special rule
modifying the rule in § 1.861–7(c) that
generally sources income from the sale
of personal property based on the place
of sale. Under § 1.861–7(c), a sale is
generally treated as consummated in the
place where the rights, title, and interest
of the seller in the property are
transferred to the buyer. However, if a
taxpayer wholly produces inventory in
the United States and sells it for use,
consumption, or disposition in the
United States, § 1.863–3(c)(2) presumes
that the place of sale is in the United
States, even if title passes outside the
United States. The comment
recommended the final regulations
include a similar rule and expand it to
inventory wholly or partly produced in
the United States that is acquired by a
related party and resold for use,
consumption, or disposition in the
United States with title passing outside
the United States. The comment
observed that in the absence of such a
rule, the sale by the related party would
generate foreign source income,
notwithstanding the fact that the
inventory was produced wholly or
partly in the United States and
ultimately sold for use, consumption, or
disposition in the United States.
The final regulations do not adopt this
comment. The place of sale rule of
§ 1.861–7(c) already contains a broad
anti-abuse rule that would apply to any
sales transactions ‘‘arranged in a
particular manner for the primary
purpose of tax avoidance,’’ which may
cover certain related party arrangements
about which the comment is concerned.
Section 482 also applies to require that
compensation paid between related
parties is consistent with the arm’s
length standard and will take into
account the business functions and
assets of, and risks assumed by, the
related party intermediary. The
Treasury Department and the IRS
continue to study issues related to the
distribution among related entities of
the business functions, assets, and risks
that generate business income,
including sales income, and may
address these issues in future guidance,
particularly with respect to the sourcing
of income from certain digital
transactions.
Second, the comment observed that
§ 1.863–3(c)(2) treats inventory as

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wholly produced in the United States
for purposes of determining whether the
place of sale is presumed to be in the
United States if only minor assembly,
packaging, repackaging, or labeling
occurs outside the United States. The
comment recommended including this
rule as part of proposed § 1.863–
3(c)(1)(i). The final regulations adopt
this comment in § 1.863–3(c)(1)(i) by
incorporating the ‘‘principles of § 1.954–
3(a)(4)’’ (other than § 1.954–3(a)(4)(iv)).
Section 1.954–3(a)(4) provides rules for
determining when a corporation has
manufactured, produced, or constructed
personal property. Under § 1.954–
3(a)(4)(iii), packaging, repackaging,
labeling, or minor assembly operations
do not constitute the manufacture,
production, or construction of property.
Accordingly, under the final
regulations, these principles apply for
purposes of determining whether a
taxpayer’s activities constitute
production activity under § 1.863–
3(c)(1)(i) as well. See part II.B. of this
Summary of Comments and Explanation
of Revisions section.
B. Definition of Production Activities
Proposed § 1.863–1(b)(2) provided the
rule for sourcing gross receipts from the
sale of natural resources where the
taxpayer performs production activities
in addition to its ownership of a farm,
mine, oil or gas well, other natural
deposit, or uncut timber. Section 1.863–
1(b)(3)(ii) defines such ‘‘additional
production activities’’ by reference to
the ‘‘principles of § 1.954–3(a)(4).’’
Under section 951(a)(1)(A), a United
States shareholder of a controlled
foreign corporation (‘‘CFC’’) includes in
gross income its pro rata share of the
CFC’s subpart F income for the CFC’s
taxable year which ends with or within
the taxable year of the shareholder.
Section 952(a)(2) defines the term
subpart F income to include foreign
base company income. Section 954(a)(2)
defines foreign base company income to
include foreign base company sales
income (‘‘FBCSI’’) for the taxable year.
Section 954(d)(1) defines FBCSI to mean
income derived by a CFC in connection
with certain related party transactions.
Section 1.954–3(a)(4) provides an
exception to FBCSI when a CFC
manufactures property that it sells. One
comment supported defining
‘‘additional production activities’’ by
reference to ‘‘the principles of § 1.954–
3(a)(4),’’ as described in § 1.863–
1(b)(3)(ii), and requested that §§ 1.863–
3 and 1.865–3 include a similar cross
reference.
The final regulations adopt this
recommendation, in part. Specifically,
under the final regulations, §§ 1.863–3

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and 1.865–3 incorporate the principles
of § 1.954–3(a)(4), with the exception of
the rules regarding a ‘‘substantial
contribution to the manufacturing of
personal property’’ under § 1.954–
3(a)(4)(iv). See §§ 1.863–3(c)(1)(i) and
1.865–3(d)(2). The final regulations also
modify § 1.863–1(b)(3)(ii) to incorporate
the principles of § 1.954–3(a)(4), other
than the ‘‘substantial contribution to the
manufacturing of personal property’’
under § 1.954–3(a)(4)(iv). The
substantial contribution rules were
added to § 1.954–3(a)(4) in T.D. 9438
(December 29, 2008) after the adoption
of § 1.863–1(b)(3)(ii) in T.D. 8687
(November 27, 1996). While the
Treasury Department and the IRS agree
with the comment that the principles of
§ 1.954–3(a)(4) may generally be helpful
in determining the location of
production activity for sourcing
purposes, the substantial contribution
rules of § 1.954–3(a)(4)(iv) are
concerned with whether there is
production activity and do not address
the geographic location of that
production activity, which is relevant
for sourcing under sections 861, 863,
and 865. Additionally, the substantial
contribution rules are premised on
treating a corporation as engaged in
production activities even if it is not
engaged in the direct use of production
assets (other than oversight assets),
while § 1.863–3 focuses on sourcing
income based on the location of a
corporation’s production assets that are
used for production activities. See
§ 1.863–3(c)(1)(ii) (which has been
redesignated in the final regulations as
§ 1.863–3(c)(2)). In this regard, there is
not a clear metric for quantifying
production arising from substantial
contribution activities, even if such
activities are properly identified, in
order to assign production activities to
a particular geographic location for
purposes of determining the place of
production under sections 861, 863, and
865. Therefore, the final regulations
provide that the principles of § 1.954–
3(a)(4), other than the substantial
contribution rules in § 1.954–3(a)(4)(iv),
apply in determining whether
production activities exist.
C. Measuring Adjusted Basis of
Production Assets
For inventory produced both within
and without the United States, the
proposed regulations continued to
allocate or apportion the gross income
between U.S. and foreign sources based
on the formula in § 1.863–3(c)(1)(ii)(A)
(redesignated as proposed § 1.863–
3(c)(2)(i)). This formula determined the
amount of foreign source income by
multiplying the total gross income by a

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fraction, the numerator of which is the
average adjusted basis of production
assets located outside the United States
and the denominator of which is the
average adjusted basis of all production
assets within and without the United
States. The remaining gross income is
from U.S. sources.
In light of the Act’s changes to section
168(k), proposed § 1.863–3(c)(2)(ii)
measured the adjusted basis of the U.S.
production assets for purposes of this
formula based on the alternative
depreciation system (‘‘ADS’’) of section
168(g)(2). The preamble to the proposed
regulations observed that such rule
allows the basis of both U.S. and nonU.S. production assets to be measured
consistently on a straight-line method
over the same recovery period, and
requested comments on using ADS for
this purpose or alternatives for
measuring relative U.S. and non-U.S.
production assets.
One comment suggested that some
taxpayers such as partnerships and S
corporations would face administrative
burdens if they had to maintain separate
ADS books that they may not otherwise
maintain if section 951A(d)(3) or
250(b)(2)(B) do not apply to them. The
comment observed that the Act, in
contrast to those other sections, does not
mandate the use of ADS in the section
863(b) context. The comment requested
that the final regulations maintain the
existing rule of § 1.863–3(c)(1)(ii)(B)
measuring the basis under section 1011
(as adjusted by section 1016), either as
the principal rule or, alternatively, at
the election of the taxpayer.
The final regulations do not adopt this
comment. The Treasury Department and
the IRS have determined that the use of
ADS for this purpose will prevent the
Act’s modifications to section 168(k)
(resulting in accelerated depreciation)
from inappropriately skewing the
apportionment formula under § 1.863–
3(c)(2)(i) in favor of foreign source
income. While the Act does not
mandate the use of ADS for this
purpose, the Treasury Department and
the IRS have authority to mandate the
use of ADS under sections 863(a) and
7805 and have determined that the use
of ADS is necessary to accurately
measure the place of production using
adjusted basis, as other basis
measurements might inappropriately
inflate foreign production activities.

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III. Comments on and Revisions to
Proposed § 1.865–3—Source of Gross
Income From Sales of Personal Property
(Including Inventory Property) by a
Nonresident Attributable to an Office or
Other Fixed Place of Business in the
United States
Section 865 provides rules for
sourcing income from sales of personal
property. Section 865(e)(2) applies with
respect to all sales of personal property
(including inventory) by a nonresident,
as that term is defined in section
865(g)(1)(B), attributable to an office or
other fixed place of business in the
United States. Section 865(e)(2)(A)
generally provides that income from any
sale of personal property attributable to
such an office or other fixed place of
business is sourced in the United States.
An exception is provided in section
865(e)(2)(B) for a sale of inventory for
use, disposition, or consumption
outside the United States if a foreign
office of the nonresident ‘‘materially
participated’’ in the sale. Section
865(e)(3) provides that the ‘‘principles
of section 864(c)(5) shall apply’’ to
determine whether a nonresident has an
office or other fixed place of business
and whether a sale is attributable to
such office or other fixed place of
business. Where applicable, section
865(e)(2) applies ‘‘[n]otwithstanding any
other provisions’’ of subchapter N, part
I, including sections 863(b), 861(a)(6),
and 862(a)(6). The proposed regulations
under § 1.865–3 clarified the application
of the principles of section 864(c)(5) in
the context of section 865(e)(2) and
provided that sales of inventory
property produced outside the United
States and sold through an office
maintained by the nonresident in the
United States must be sourced in the
United States in part.
Proposed § 1.865–3(e) also included a
cross-reference to the rules for allocating
and apportioning expenses to gross
income effectively connected with the
conduct of a trade or business in the
United States in §§ 1.882–4 and 1.882–
5. Since those regulations apply only to
foreign corporations, one comment
requested that the final regulations also
refer to § 1.873–1 to cover nonresident
alien taxpayers subject to proposed
§ 1.865–3. In response to this comment,
the final regulations broaden the crossreferences to include sections 882(c)(1)
and 873(a) for purposes of allocating
and apportioning expenses. See § 1.865–
3(e).
The final regulations also reorder and
revise parts of § 1.865–3 in a nonsubstantive manner solely for purposes
of improving clarity and ease of
application. The revision also helps to

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clarify that § 1.865–3 applies only if a
nonresident maintains an office or other
fixed place of business in the United
States to which a sale of personal
property is attributable. Otherwise, the
source of the income, gain, or loss from
the sale will be determined under other
applicable provisions of section 865,
such as section 865(b) through (d).
The final regulations also retain, with
certain modifications, the rules for
determining the portion of gross income
from sales and production activities
under § 1.865–3(d). Under the proposed
regulations, the ‘‘50/50 method,’’
described in § 1.865–3(d)(2)(i), was the
default method because it was ‘‘an
appropriate and administrable way’’ to
apply section 865(e)(2), but the
proposed regulations also allowed
nonresidents to elect a books and
records method that would ‘‘more
precisely’’ reflect their gross income
from both sales and production
activities, if any, in the United States,
provided the nonresidents met certain
requirements for maintaining their
books of account under proposed
§ 1.865–3(d)(2)(ii)(B)(1) through (3). See
84 FR 71836, 71843. Under the final
regulations, the 50/50 method continues
to be the default method and taxpayers
continue to be permitted to elect the
books and records method. However,
the Treasury Department and the IRS
have determined that, where taxpayers
have demonstrated the ability to use
their books of account to determine
their U.S. source gross income under the
books and records method, a limitation
is appropriate to prevent a nonresident
from returning to the less precise 50/50
method solely to obtain a better tax
result. In addition, the Treasury
Department and the IRS have
determined that revising the election to
provide that it remains in effect until
revoked would reduce the risk to
taxpayers of inadvertently failing to
include the election with their Federal
income tax return. Accordingly, under
the final regulations, an election to
apply the books and records method
continues until revoked and may not be
revoked, without the consent of the
Commissioner, for any taxable year
beginning within 48 months of the end
of the taxable year in which the election
was made.
The final regulations also revise
§ 1.864–5 to clarify the interaction with
section 865(e)(2) and (3) and the
promulgation of § 1.865–3. Gross
income, gain, or loss from the sale of
personal property treated as from
sources within the United States under
§ 1.865–3 will generally be effectively
connected with the conduct of a trade
or business in the United States to the

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extent provided in section 864(c), other
than section 864(c)(4) or (5). Gross
income, gain, or loss from the sale of
personal property treated as from
sources without the United States under
§ 1.865–3 is not described in § 1.864–
5(b) and thus will generally not be
effectively connected with the conduct
of a trade or business in the United
States.
The rules of §§ 1.864–5, 1.864–6, and
1.864–7 continue to apply, however, in
determining whether foreign source
income of nonresident aliens and
foreign corporations that does not arise
from the sale of personal property
described in § 1.865–3(c) is effectively
connected with the conduct of a trade
or business in the United States. The
rules of §§ 1.864–5, 1.864–6, and 1.864–
7 also continue to apply in determining
whether foreign source income from the
sale of inventory by nonresident aliens,
who would be residents under section
865(g)(1)(A), is effectively connected
with the conduct of a trade or business
in the United States.
IV. Comments on the Rules for
Determining the Location or Existence
of Production Activity
The proposed regulations did not
modify the rules in § 1.863–3 for
determining the location or existence of
production activity for purposes of
determining the sourcing of income
derived from the sale of inventory.
Section 1.863–3(c)(1)(i)(A) (which has
been redesignated in the final
regulations as § 1.863–3(c)(1)(i))
provides the rule for sourcing of income
where production occurs only within
the United States or only within foreign
countries. That paragraph generally
limits the scope of ‘‘production
activities’’ to only ‘‘those conducted
directly by the taxpayer.’’ Similarly,
§ 1.863–3(c)(1)(i)(B) (which has been
redesignated in the final regulations as
§ 1.863–3(c)(1)(ii)) provides that
production assets are those ‘‘owned
directly by the taxpayer that are directly
used by the taxpayer to produce
inventory.’’ Section 1.863–3(c)(1)(ii)
(which has been redesignated in the
final regulations as § 1.863–3(c)(2))
provides the rule for the sourcing of
income where production occurs both
within and without the United States,
and, as discussed in part II.C of this
Summary of Comments and Explanation
of Revisions section, allocates gross
income based on the relative adjusted
basis of production assets located
within and without the United States,
respectively.
The final regulations clarify the
determination of the adjusted basis of
production assets under § 1.863–

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3(c)(1)(ii)(B) (which has been
redesignated in the final regulations as
§ 1.863–3(c)(2)(ii)(A)). Under the final
regulations, the adjusted basis of
production assets for a taxable year is
determined by averaging the basis of the
assets at the beginning and end of the
year, except in the event that a change
during the year would cause the average
to ‘‘materially distort’’ the calculation
for sourcing of income attributable to
production activity under § 1.863–
3(c)(1)(ii)(A) (which has been
redesignated in the final regulations as
§ 1.863–3(c)(2)(i)). This clarification
uses certain concepts from § 1.861–
9(g)(2)(i)(A) to further explain when a
change might ‘‘materially distort’’ the
calculation. For example, the rule
applies when an event such as a lateyear disposition of substantially all the
U.S. production assets of a corporation
would cause a material distortion in the
corporation’s calculation of the split
between U.S. and foreign production
activities.
One comment provided a range of
suggestions to modify the rules of
proposed §§ 1.863–3(c) and 1.865–3(d).
This comment suggested that the rules
of proposed §§ 1.863–3(c) and 1.865–
3(d) were adequate, in general, where a
taxpayer independently manufactured
its own inventory, but inadequate with
respect to other business models that
rely on limited risk contract
manufacturers or where multiple
members of a group each perform only
limited manufacturing functions in
various jurisdictions. The comment
observed that apportionment of gross
income using the relative adjusted basis
of production assets may not reflect
high value-adding core production and
risk management functions and
ownership of production assets by
unrelated contract manufacturers.
The comment suggested expanding
the scope of covered production
activities and ownership of production
assets to include activities conducted
and assets owned by related parties and
unrelated agents of the taxpayer. The
comment also recommended that these
rules include any activities that
constitute a ‘‘substantial contribution’’
within the meaning of § 1.954–
3(a)(4)(iv) to better conform to the rules
under subpart F. See part II.B of this
Summary of Comments and Explanation
of Revisions section. In addition, the
comment suggested that § 1.863–3
should not allocate and apportion gross
income using only the relative adjusted
basis of production assets located
within and without the United States,
and recommended allocation and
apportionment based on other metrics,
such as the location of personnel

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involved in the production activities or
personnel costs. The comment
suggested that these modifications
could, alternatively, be rebuttable
presumptions that a taxpayer could
overcome by showing that allocating
and apportioning gross income based on
adjusted basis or some other approach
provides a more appropriate result
under the taxpayer’s facts.
Another comment suggested that the
existing allocation and apportionment
rules that rely on the relative adjusted
basis of production assets encourage
businesses to move (or locate
additional) production assets outside
the United States. Specifically, the
comment expressed concern that
treating income from the sale of
inventory produced, in whole or in part,
in the United States as U.S. source
income might result in double taxation
if the income is also subject to tax in a
foreign jurisdiction, since the U.S.
source income would be excluded from
the numerator of the section 904
limitation, reducing the section 904
limitation, and potentially limiting the
U.S. taxpayer’s ability to use its foreign
tax credits. The comment requested
replacing these rules with a more
comprehensive formula, preferably one
that minimizes the risk of double
taxation. The comment did not suggest
an alternative formula and observed that
further legislation may be necessary in
this regard.
The Treasury Department and the IRS
appreciate the various concerns
presented by these comments and
suggested revisions. The final
regulations do not adopt these
comments, but the Treasury Department
and the IRS may consider these
recommendations as part of a more
comprehensive review of the sourcing
rules for production activity (for
purposes of both § 1.863–3 and § 1.865–
3) in a future notice of proposed
rulemaking. Additionally, the anti-abuse
rule in § 1.863–3(c)(1)(iii) (which has
been redesignated in the final
regulations as § 1.863–3(c)(3)) already
applies to make appropriate adjustments
where taxpayers enter into or structure
certain transactions with a principal
purpose of reducing U.S. tax liability
under § 1.863–3, including by using
production assets owned by a related
party. To clarify the application of this
rule, the final regulations provide that
the anti-abuse rule applies to
transactions inconsistent with the
purpose of § 1.863–3(b) or (c), and adds
as an example that the anti-abuse rule
may cover acquisitions of domestic
production assets by related
partnerships (or subsidiaries thereof)
with a principal purpose of reducing the

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transferor’s U.S. tax liability by treating
income from the sale of inventory
property as subject to section 862(a)(6)
rather than section 863(b). The Treasury
Department and the IRS continue to
request comments regarding potential
approaches to determine the location or
existence of production activity or other
modifications to § 1.863–3 that may be
appropriate.
V. Comments on Income Tax Treaties
The preamble to the proposed
regulations included a statement about
how proposed § 1.865–3 interacted with
U.S. income tax treaties under which
the business profits of foreign treaty
residents may be taxable in the United
States only if the profits are attributable
to a permanent establishment in the
United States. The preamble to the
proposed regulations stated, ‘‘[w]ith
respect to taxpayers entitled to the
benefits of an income tax treaty, the
amount of profits attributable to a U.S.
permanent establishment will not be
affected by these regulations.’’ See 84
FR 71836, 71844.
One comment supported the
preamble’s statement and requested
that, consistent with the statement in
the preamble, the final regulations not
apply to Section 863(b)(2) Sales in a
manner that results in double taxation
to U.S. taxpayers engaged in business
operations through a permanent
establishment in a treaty jurisdiction,
notwithstanding the Act’s change to
section 863(b). The comment also
requested that competent authority
relief be provided in this regard. These
regulations do not affect the ability of a
taxpayer to rely on treaty provisions to
mitigate or relieve double taxation,
including treaty provisions that permit
a taxpayer to make a request to the
competent authority for assistance
pursuant to a mutual agreement
procedure article of an applicable
income tax treaty.
VI. Comment on Proposed Applicability
Date
The proposed regulations were
proposed to apply to taxable years
ending on or after December 23, 2019,
although taxpayers and their related
parties could generally apply the rules
in their entirety for taxable years
beginning after December 31, 2017, and
ending before December 23, 2019. One
comment requested that the final
regulations apply to taxable years
ending after December 31, 2019, because
some taxpayers have consistently relied
on the existing methods of § 1.863–3(b)
for many years. The final regulations do
not adopt this comment. Under section
7805(b)(1)(B), a final regulation can

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apply to any taxable period ending on
or after the date on which the proposed
regulation to which such final
regulation relates was filed with the
Federal Register, which for these final
regulations was December 23, 2019. The
final regulations implement the Act’s
statutory change to section 863(b),
which was effective for taxable years
beginning after December 31, 2017. To
provide certainty to taxpayers and avoid
a multiplicity of different
interpretations of the statute, the
Treasury Department and the IRS have
determined that it is appropriate for the
final regulations to apply as closely as
possible to the effective date of the
statutory change.
Applicability Date
The final regulations generally apply
to taxable years ending on or after
December 23, 2019. Taxpayers may
choose to apply the final regulations for
any taxable year beginning after
December 31, 2017, and ending before
December 23, 2019, provided that the
taxpayer and all persons that are related
to the taxpayer (within the meaning of
section 267 or 707) apply the final
regulations in their entirety and, once
applied, the taxpayer and all persons
related to the taxpayer (within the
meaning of section 267 or 707) continue
to apply the final regulations in their
entirety for all subsequent taxable years.
See section 7805(b)(7). Alternatively,
taxpayers may rely on the proposed
regulations for any taxable year
beginning after December 31, 2017, and
ending on or before September 29, 2020,
provided that the taxpayer and all
persons that are related to the taxpayer
(within the meaning of section 267 or
707) rely on the proposed regulations in
their entirety and provided that the
taxpayer and all persons that are related
to the taxpayer (within the meaning of
section 267 or 707) have not applied the
final regulations to any preceding year.
Special Analyses
These regulations are not subject to
review under section 6(b) of Executive
Order 12866 pursuant to the
Memorandum of Agreement (April 11,
2018) between the Treasury Department
and the Office of Management and
Budget regarding review of tax
regulations.
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I. Paperwork Reduction Act
The Paperwork Reduction Act of 1995
(44 U.S.C. 3501–3520) (‘‘PRA’’)
generally requires that a federal agency
obtain the approval of OMB before
collecting information from the public,
whether such collection of information

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is mandatory, voluntary, or required to
obtain or retain a benefit.
The final regulations include a
collection of information in § 1.865–
3(d)(2)(ii)(B). Section 1.865–
3(d)(2)(ii)(B) allows a nonresident, as
defined in section 865(g)(1)(B), whose
inventory sales are described in § 1.865–
3(d)(2) (relating to inventory produced
by the nonresident) to elect to allocate
the profit from such sales to its U.S.
office using a books and records method
under § 1.865–3(d)(2)(ii), rather than
using a default ‘‘50/50 method’’ under
§ 1.865–3(d)(2)(i). If the collection of
information in § 1.865–3(d)(2)(ii)(B)
applies to a nonresident, the
nonresident must maintain detailed
records of its receipts and expenditures
attributable to its sales and production
activities to support the allocation of its
income, gain, or loss to its sales
activities in the United States under the
principles of section 482. See § 1.865–
3(d)(2)(ii)(B)(2). The nonresident must
also prepare an explanation of how the
allocation was determined. See § 1.865–
3(d)(2)(ii)(B)(3). The nonresident must
make an election to apply the books and
records method under § 1.865–3(d)(2)(ii)
by attaching a statement to its original
timely filed Federal income tax return
(including extensions) that it elects to
apply the books and records method
under § 1.865–3(d)(2)(ii)(A) and has
prepared the records described in
§ 1.865–3(d)(2)(ii)(B)(2) and (3). The
nonresident must make available the
explanation and records upon request of
the Commissioner, within 30 days or
some other time period as agreed
between the Commissioner and the
nonresident. See § 1.865–
3(d)(2)(ii)(B)(3).
The reporting burdens associated with
the collection of information in § 1.865–
3(d)(2)(ii)(B) will be reflected in the
Form 14029, Paperwork Reduction Act
Submission, that the Treasury
Department and the IRS will submit to
OMB for tax returns in the Forms 1120–
F, U.S. Income Tax Return of a Foreign
Corporation, and Forms 1040–NR, U.S.
Nonresident Alien Income Tax Return.
In particular, the reporting burden
associated with the information
collection in § 1.865–3(d)(2)(ii)(B) will
be included in the burden estimate for
OMB control numbers 1545–0123 and
1545–0074. OMB control number 1545–
0123 represents a total estimated burden
time for all forms and schedules for
corporations of 3.344 billion hours and
total estimated monetized costs of
$61.558 billion ($2019). OMB control
number 1545–0074 represents a total
estimated burden time, including all
other related forms and schedules for
individuals, of 1.717 billion hours and

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total estimated monetized costs of
$33.267 billion ($2019). Table 1
summarizes the status of the PRA
submissions of the Treasury Department
and the IRS related to Forms 1120–F
and 1040–NR.
The overall burden estimate provided
by the Treasury Department and the IRS
to OMB in the PRA submissions for
OMB control numbers 1545–0123 and
1545–0074 are aggregate amounts
related to the U.S. Business Income Tax
Return and the U.S. Individual Income
Tax Return, along with any associated
forms. The burden estimates in these
PRA submissions, however, do not
account for any burden imposed by
§ 1.865–3(d)(2)(ii)(B). The Treasury
Department and the IRS have not
identified the estimated burden for the
collections of information in § 1.865–
3(d)(2)(ii)(B) because there are no
burden estimates specific to § 1.865–
3(d)(2)(ii)(B) currently available. The
burden estimates in the PRA
submissions that the Treasury
Department and the IRS will submit to
OMB will in the future include, but not
isolate, the estimated burden related to
the collection of information in § 1.865–
3(d)(2)(ii)(B).
The Treasury Department and the IRS
have included the burdens related to the
PRA submissions for OMB control
numbers 1545–0123 and 1545–0074 in
the PRA analysis for other regulations
issued by the Treasury Department and
the IRS related to the taxation of crossborder income. The Treasury
Department and the IRS encourage users
of this information to take measures to
avoid overestimating the burden that the
collection of information in § 1.865–
3(d)(2)(ii)(B), together with other
international tax provisions, imposes.
Moreover, the Treasury Department and
the IRS also note that the Treasury
Department and the IRS estimate PRA
burdens on a taxpayer-type basis rather
than a provision-specific basis because
an estimate based on the taxpayer-type
most accurately reflects taxpayers’
interactions with the forms.
The Treasury Department and the IRS
request comments on the forms that
reflect the information collection
burdens related to the final regulations,
including estimates for how much time
it would take to comply with the
paperwork burden described above for
each relevant form and ways for the IRS
to minimize the paperwork burden.
Proposed revisions (if any) to these
forms that reflect the information
collection contained in § 1.865–
3(d)(2)(ii)(B) will be made available for
public comment at https://apps.irs.gov/
app/picklist/list/draftTaxForms.html
and will not be finalized until after

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these forms have been approved by
OMB under the PRA.

TABLE 1—SUMMARY OF INFORMATION COLLECTION REQUEST SUBMISSIONS RELATED TO FORMS 1120–F AND FORMS
1040–NR
Form

Type of filer

OMB Nos.

Form 1040–NR ......

Individual (NEW Model) ................

Status

1545–0074

Approved by OIRA 1/30/2020 until 1/31/2021.

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201909-1545-021.
Form 1120–F .........

Business (NEW Model) ................

1545–0123

Approved by OIRA 1/30/2020 until 1/31/2021.

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201907-1545-001.

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II. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibility
Act (5 U.S.C. chapter 6), it is hereby
certified that these final regulations will
not have a significant economic impact
on a substantial number of small
entities. Although data are not readily
available to assess the number of small
entities potentially affected, any
economic impact of these regulations is
unlikely to be significant. Specifically,
the regulations in §§ 1.863–1 and 1.863–
3 (with conforming changes in crossreferencing regulations) implement the
statutory change made to section 863(b)
by the Act. This change affects sales of
inventory property by any taxpayer
where the taxpayer produces the
inventory (in whole or in part) within
the United States and sells that
inventory without the United States, or
vice versa. The change in sourcing for
those entities is attributable to the
change in section 863(b) made by the
Act. Sections 1.863–1 and 1.863–3
merely implement the statutory change
with limited additional guidance. The
Treasury Department and the IRS do not
anticipate that any differences between
the changes in section 863(b) made by
the Act and the changes in §§ 1.863–1
and 1.863–3 made by these regulations
will have a significant economic impact
on a substantial number of small
entities.
The other regulations in this
publication (other than changes to
ensure consistency with section 863(b))
are the final regulations in §§ 1.864–5,
1.864–6, and 1.865–3. These regulations
solely affect non-U.S. taxpayers, which
are not subject to the Regulatory
Flexibility Act.
Pursuant to section 7805(f) of the
Code, the proposed regulations
preceding these final regulations were
submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on their
impact on small businesses. No
comments were received.

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III. Unfunded Mandates Reform Act
Section 202 of the Unfunded
Mandates Reform Act of 1995 requires
that agencies assess anticipated costs
and benefits and take certain other
actions before issuing a final rule that
includes any Federal mandate that may
result in expenditures in any one year
by a state, local, or tribal government, in
the aggregate, or by the private sector, of
$100 million in 1995 dollars, updated
annually for inflation. These regulations
do not include any Federal mandate that
may result in expenditures by state,
local, or tribal governments, or by the
private sector in excess of that
threshold.
IV. Executive Order 13132: Federalism
Executive Order 13132 (entitled
‘‘Federalism’’) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state
law, unless the agency meets the
consultation and funding requirements
of section 6 of the Executive Order.
These regulations do not have
federalism implications and do not
impose substantial direct compliance
costs on state and local governments or
preempt state law within the meaning of
the Executive Order.
Drafting Information
The principal author of the
regulations is Brad McCormack of the
Office of Associate Chief Counsel
(International). However, other
personnel from the Treasury
Department and the IRS participated in
the development of the regulations.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
amended as follows:

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PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding an entry
for § 1.865–3 in numerical order.
The addition reads in part as follows:

■

Authority: 26 U.S.C. 7805 * * *

*

*

*

*

*

Section 1.865–3 also issued under 26
U.S.C. 865(j).

*

*
*
*
*
Par. 2. Section 1.863–0 is revised to
read as follows:

■

§ 1.863–0

Table of contents.

This section lists captions contained
in §§ 1.863–1 through 1.863–10.
§ 1.863–1 Allocation of gross income under
section 863(a).
(a) In general.
(b) Natural resources.
(1) In general.
(2) Additional production activities.
(3) Definitions.
(i) Production activity.
(ii) Additional production activities.
(4) Determination of fair market value.
(5) Determination of gross income.
(6) Tax return disclosure.
(7) Examples.
(i) Example 1. No additional production,
foreign source gross receipts.
(ii) Example 2. No additional production,
U.S. source gross receipts.
(iii) Example 3. Production in United
States, foreign sales.
(iv) Example 4. Production and sales in
United States.
(v) Example 5. Additional production.
(c) Determination of taxable income.
(d) Scholarships, fellowship grants, grants,
prizes, and awards.
(1) In general.
(2) Source of income.
(i) United States source income.
(ii) Foreign source income.
(iii) Certain activities conducted outside
the United States.
(3) Definitions.
(4) Effective dates.
(i) Scholarships and fellowship grants.
(ii) Grants, prizes and awards.
(e) Residual interest in a REMIC.
(1) REMIC inducement fees.
(2) Excess inclusion income and net losses.

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(f) Applicability date.
§ 1.863–2 Allocation and apportionment of
taxable income.
(a) Determination of taxable income.
(b) Determination of source of taxable
income.
(c) Applicability date.
§ 1.863–3 Allocation and apportionment of
income from certain sales of inventory.
(a) In general.
(1) Scope.
(2) Cross references.
(b) Sourcing based solely on production
activities.
(c) Determination of the source of gross
income from production activity.
(1) Production only within the United
States or only within foreign countries.
(i) Source of income.
(ii) Definition of production assets.
(iii) Location of production assets.
(2) Production both within and without the
United States.
(i) Source of income.
(ii) Adjusted basis of production assets.
(A) In general.
(B) Production assets used to produce other
property.
(3) Anti-abuse rule.
(4) Examples.
(i) Example1. Source of gross income.
(ii) Example 2. Location of intangible
property.
(iii) Example 3. Anti-abuse rule.
(d) Determination of source of taxable
income.
(e) Income partly from sources within a
possession of the United States.
(1) In general.
(2) Allocation or apportionment for
Possession Production Sales.
(3) Allocation or apportionment for
Possession Purchase Sales.
(i) Determination of source of gross income
from Possession Purchase Sales.
(ii) Determination of source of gross
income from business activity.
(A) Source of gross income.
(B) Business activity.
(C) Location of business activity.
(1) Sales activity.
(2) Cost of goods sold.
(3) Expenses.
(4) Examples.
(i) Example 1: Purchase of goods
manufactured in possession.
(ii) Example 2: Purchase of goods
manufactured outside possession.
(5) Special rules for partnerships.
(f) Special rules for partnerships.
(1) General rule.
(2) Exceptions.
(i) In general.
(ii) Attribution of production assets to or
from a partnership.
(iii) Basis.
(3) Examples.
(i) Example 1. Distributive share of
partnership income.
(ii) Example 2. Distribution in kind.
(g) Applicability dates.
§ 1.863–4 Certain transportation services.
(a) General.
(b) Gross income.
(c) Allocation of costs or expenses.

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(d) Items not included as costs or expenses.
(1) Taxes and interest.
(2) Other business activity and general
expenses.
(3) Personal exemptions and special
deductions.
(e) Property used while within the United
States.
(1) General.
(2) Average property.
(3) Current assets.
(f) Taxable income.
(1) General.
(2) Interest and taxes.
(3) General expenses.
(4) Personal exemptions.
(5) Special deductions.
(g) Allocation based on books of account.
§ 1.863–6 Income from sources within a
foreign country.
§ 1.863–7 Allocation of income attributable
to certain notional principal contracts
under section 863(a).
(a) Scope.
(1) Introduction.
(2) Effective/applicability date.
(b) Source of notional principal contract
income.
(1) General rule.
(2) Qualified business unit exception.
(3) Effectively connected notional principal
contract income.
(c) Election.
(1) Eligibility and effect.
(2) Time for making election.
(3) Manner of making election.
(d) Example.
(e) Cross references.
§ 1.863–8 Source of income derived from
space and ocean activity under section
863(d).
(a) In general.
(b) Source of gross income from space and
ocean activity.
(1) Space and ocean income derived by a
United States person.
(2) Space and ocean income derived by a
foreign person.
(i) In general.
(ii) Space and ocean income derived by a
controlled foreign corporation.
(iii) Space and ocean income derived by
foreign persons engaged in a trade or
business within the United States.
(3) Source rules for income from certain
sales of property.
(i) Sales of purchased property.
(ii) Sales of property produced by the
taxpayer.
(A) General.
(B) Production only in space or
international water, or only outside space
and international water.
(C) Production both in space or
international water and outside space and
international water.
(4) Special rule for determining the source
of gross income from services.
(5) Special rule for determining source of
income from communications activity (other
than income from international
communications activity).
(c) Taxable income.
(d) Space and ocean activity.
(1) Definition.

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(i) Space activity.
(ii) Ocean activity.
(2) Determining a space or ocean activity.
(i) Production of property in space or
international water.
(ii) Special rule for performance of
services.
(A) General.
(B) Exception to the general rule.
(3) Exceptions to space or ocean activity.
(e) Treatment of partnerships.
(f) Examples.
(1) Example 1. Space activity—activity
occurring on land and in space.
(2) Example 2. Space activity.
(3) Example 3. Services as space activity—
de minimis value attributable to performance
occurring in space.
(4) Example 4. Space activity.
(5) Example 5. Space activity.
(6) Example 6. Space activity—treatment of
land activity.
(7) Example 7. Use of intangible property
in space.
(8) Example 8. Performance of services.
(9) Example 9. Separate transactions.
(10) Example 10. Sale of property in
international water.
(11) Example 11. Sale of property in space.
(12) Example 12. Sale of property in space.
(13) Example 13. Source of income of a
foreign person.
(14) Example 14. Source of income of a
foreign person.
(g) Reporting and documentation
requirements.
(1) In general.
(2) Required documentation.
(3) Access to software.
(4) Use of allocation methodology.
(h) Applicability date.
§ 1.863–9 Source of income derived from
communications activity under section
863(a), (d), and (e).
(a) In general.
(b) Source of international communications
income.
(1) International communications income
derived by a United States person.
(2) International communications income
derived by foreign persons.
(i) In general.
(ii) International communications income
derived by a controlled foreign corporation.
(iii) International communications income
derived by foreign persons with a fixed place
of business in the United States.
(iv) International communications income
derived by foreign persons engaged in a trade
or business within the United States.
(c) Source of U.S. communications income.
(d) Source of foreign communications
income.
(e) Source of space/ocean communications
income.
(f) Source of communications income
when taxpayer cannot establish the two
points between which the taxpayer is paid to
transmit the communication.
(g) Taxable income.
(h) Communications activity and income
derived from communications activity.
(1) Communications activity.
(i) General rule.
(ii) Separate transaction.
(2) Income derived from communications
activity.

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Federal Register / Vol. 85, No. 239 / Friday, December 11, 2020 / Rules and Regulations
(3) Determining the type of
communications activity.
(i) In general.
(ii) Income derived from international
communications activity.
(iii) Income derived from U.S.
communications activity.
(iv) Income derived from foreign
communications activity.
(v) Income derived from space/ocean
communications activity.
(i) Treatment of partnerships.
(j) Examples.
(k) Reporting and documentation
requirements.
(1) In general.
(2) Required documentation.
(3) Access to software.
(4) Use of allocation methodology.
(l) Effective date.
§ 1.863–10 Source of income from a
qualified fails charge.
(a) In general.
(b) Qualified business unit exception.
(c) Effectively connected income
exception.
(d) Qualified fails charge.
(e) Designated security.
(g) Effective/applicability date.

Par. 3. Section 1.863–0A is added to
read as follows:

■

§ 1.863–0A

Table of contents.

This section lists captions contained
in §§ 1.863–3A and 1.863–3AT.
§ 1.863–3A Income from the sale of
personal property derived partly from
within and partly from without the
United States.
(a) General.
(1) Classes of income.
(2) Definition.
(b) Income partly from sources within a
foreign country.
(1) General.
(2) Allocation or apportionment.
(c) Income partly from sources within a
possession of the United States.
(1) General.
(2) Allocation or apportionment.
(3) Personal property produced and sold.
(4) Personal property purchased and sold.
§ 1.863–3AT Income from the sale of
personal property derived partly from
within and partly from without the
United States (temporary).
(a) [Reserved].
(b) Income partly from sources within a
foreign country.
(1) [Reserved].
(2) Allocation or apportionment.
(c)(1) through (4) [Reserved].

Par. 4. Section 1.863–1 is amended as
follows:
■ a. In paragraph (a):
■ i. Revising the third sentence.
■ ii. Removing ‘‘§ 1.863–3(g)’’ and
adding in its place ‘‘§ 1.863–3(f).’’
■ b. Revising paragraph (b)(1).
■ c. In paragraph (b)(2):
■ i. Removing ‘‘prior to export terminal’’
from the heading and adding in its place
‘‘activities.’’

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ii. Removing ‘‘before the relevant
product is shipped from the export
terminal’’ from the first sentence.
■ iii. Adding ‘‘oil or gas’’ before ‘‘well’’
and ‘‘other natural’’ before ‘‘deposit’’ in
the second sentence.
■ d. Removing ‘‘§§ 1.1502–13 or 1.863–
3(g)(2)’’ from paragraph (b)(3)(i) and
adding in its place ‘‘§ 1.1502–13 or
1.863–3(f)(2).’’
■ e. In paragraph (b)(3)(ii):
■ i. Adding ‘‘uncut’’ before ‘‘timber’’ in
the first sentence.
■ ii. Adding ‘‘(except for § 1.954–
3(a)(4)(iv))’’ at the end of the second
sentence.
■ iii. Removing ‘‘to or from the export
terminal’’ from the third sentence.
■ f. Removing paragraph (b)(3)(iii).
■ g. In paragraph (b)(6), removing ‘‘this
paragraph (b)’’ from the first sentence
and adding in its place ‘‘paragraph (b)(2)
of this section.’’
■ h. Designating Examples 1, 2, 3, 4, and
5 of paragraph (b)(7) as paragraphs
(b)(7)(i) through (v).
■ i. Revising newly designated
paragraphs (b)(7)(i) through (v).
■ j. In paragraph (f):
■ i. Revising the heading.
■ ii. Adding three sentences at the start
of the paragraph.
The revisions and additions read as
follows:
■

§ 1.863–1 Allocation of gross income
under section 863(a).

(a) * * * See also section 865(b) for
rules for sourcing income from the sale
of inventory property, within the
meaning of section 865(i)(1) (inventory),
generally, and section 865(e)(2) and
§ 1.865–3 for sourcing income from the
sale of personal property (including
inventory) by a nonresident that is
attributable to the nonresident’s office
or other fixed place of business in the
United States. * * *
(b) Natural resources—(1) In general.
Notwithstanding any other provision of
this part, except to the extent provided
in paragraph (b)(2) of this section or
§ 1.865–3, gross receipts from the sale
outside the United States of products
derived from the ownership or
operation of any farm, mine, oil or gas
well, other natural deposit, or uncut
timber within the United States shall be
treated as from sources within the
United States, and gross receipts from
the sale within the United States of
products derived from the ownership or
operation of any farm, mine, oil or gas
well, other natural deposit, or uncut
timber outside the United States shall be
treated as from sources without the
United States.
*
*
*
*
*
(7) * * *

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(i) Example 1. No additional
production, foreign source gross
receipts. U.S. Mines, a domestic
corporation, operates a copper mine and
mill in Country X. U.S. Mines extracts
copper-bearing rocks from the ground
and transports the rocks to the mill
where the rocks are ground and
processed to produce copper-bearing
concentrate. The concentrate is
transported to a port where it is dried
in preparation for export, stored, and
then shipped to purchasers in the
United States. Because, under the facts
and circumstances, none of U.S. Mines’
activities constitute additional
production activities, within the
meaning of paragraph (b)(3)(ii) of this
section, paragraph (b)(2) of this section
does not apply, and under paragraph
(b)(1) of this section, gross receipts from
the sale of the concentrate will be
treated as from sources without the
United States.
(ii) Example 2. No additional
production, U.S. source gross receipts.
U.S. Gas, a domestic corporation,
extracts natural gas within the United
States, and transports the natural gas to
a Country X port where it is liquefied in
preparation for shipment. The liquefied
natural gas is then transported via
freighter and sold without additional
production activities in a foreign
country. Under paragraph (b)(3)(ii) of
this section, liquefaction of natural gas
is not an additional production activity
because liquefaction prepares the
natural gas for transportation. Therefore,
under paragraph (b)(1) of this section,
gross receipts from the sale of the
liquefied natural gas will be treated as
from sources within the United States.
(iii) Example 3. Production in United
States, foreign sales. U.S. Gold, a
domestic corporation, mines gold in
Country X, produces gold jewelry using
production assets located in the United
States, and sells the jewelry in Country
Y. Assume that the fair market value of
the gold before the additional
production activities in the United
States is $40x and that U.S. Gold
ultimately sells the gold jewelry in
Country Y for $100x. Under paragraph
(b)(2) of this section, $40x of U.S. Gold’s
gross receipts will be treated as from
sources without the United States, and
the remaining $60x of gross receipts will
be treated as from sources within the
United States under § 1.863–3.
(iv) Example 4. Production and sales
in United States. U.S. Oil, a domestic
corporation, extracts oil in Country X,
transports the oil via a pipeline to the
United States, refines the oil using
production assets located in the United
States, and sells the refined product in
the United States to unrelated persons.

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Assume that the fair market value of the
oil before refinement in the United
States is $80x and U.S. Oil ultimately
sells the refined product for $100x.
Under paragraph (b)(2) of this section,
$80x of gross receipts will be treated as
from sources without the United States,
and the remaining $20x of gross receipts
will be treated as from sources within
the United States under § 1.863–3.
(v) Example 5. Additional production.
The facts are the same as in paragraph
(b)(7)(i) of this section (the facts in
Example 1), except that U.S. Mines also
operates a smelter in Country X. The
concentrate output from the mill is
transported to the smelter where it is
transformed into smelted copper. The
smelted copper is exported to
purchasers in the United States. Under
the facts and circumstances, all the
processes applied to make copper
concentrate are considered mining.
Therefore, under paragraph (b)(2) of this
section, gross receipts equal to the fair
market value of the concentrate at the
smelter will be treated as from sources
without the United States. Under the
facts and circumstances, the conversion
of the concentrate into smelted copper
is an additional production activity in a
foreign country within the meaning of
paragraph (b)(3)(ii) of this section.
Therefore, the source of U.S. Mines’s
excess gross receipts will be determined
under § 1.863–3, pursuant to paragraph
(b)(2) of this section.
*
*
*
*
*
(f) Applicability date. Paragraph (b) of
this section applies to taxable years
ending on or after December 23, 2019.
However, a taxpayer may apply
paragraph (b) of this section in its
entirety for taxable years beginning after
December 31, 2017, and ending before
December 23, 2019, provided that the
taxpayer and all persons related to the
taxpayer (within the meaning of section
267 or 707) apply paragraph (b) of this
section and §§ 1.863–2(b), 1.863–3,
1.863–8(b)(3)(ii), 1.864–5(a) and (b),
1.864–6(c)(2), and 1.865–3 in their
entirety for the taxable year, and once
applied, the taxpayer and all persons
related to the taxpayer (within the
meaning of section 267 or 707) continue
to apply these regulations in their
entirety for all subsequent taxable years.
For regulations generally applicable to
taxable years ending before December
23, 2019, see § 1.863–1 as contained in
26 CFR part 1 revised as of April 1,
2020. * * *
■ Par. 5. Section 1.863–2 is amended as
follows:
■ a. In paragraph (a) introductory text:
■ i. Removing ‘‘(and that is treated as
derived partly from sources within and

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partly from sources without the United
States)’’ from the third sentence.
■ ii. Adding a colon after the word
‘‘income’’ at the end of the paragraph.
■ b. Revising paragraph (b).
■ c. Revising paragraph (c).
The revisions read as follows:
§ 1.863–2 Allocation and apportionment of
taxable income.

*

*
*
*
*
(b) Determination of source of taxable
income. Income treated as derived from
sources partly within and partly without
the United States under paragraph (a) of
this section may be allocated or
apportioned to sources within and
without the United States pursuant to
§§ 1.863–1, 1.863–3, 1.863–4, 1.863–8,
and 1.863–9. To determine the source of
certain types of income described in
paragraph (a)(1) of this section, see
§ 1.863–4. To determine the source of
gross income described in paragraph
(a)(2) of this section, see § 1.863–1 for
natural resources, § 1.863–3 for other
sales of inventory property, and § 1.863–
8 for source of gross income from space
and ocean activity. Section 1.865–3 may
apply instead of the provisions in this
section to source gross income from
sales of personal property (including
inventory property) by nonresidents
attributable to an office or other fixed
place of business in the United States.
To determine the source of income
partly from sources within a possession
of the United States, including income
described in paragraph (a)(3) of this
section, see § 1.863–3(e).
(c) Applicability date. Except as
provided in this paragraph (c), this
section applies to taxable years
beginning after December 30, 1996.
Paragraph (b) of this section applies to
taxable years ending on or after
December 23, 2019. However, a taxpayer
may apply paragraph (b) of this section
in its entirety for taxable years
beginning after December 31, 2017, and
ending before December 23, 2019,
provided that the taxpayer and all
persons related to the taxpayer (within
the meaning of section 267 or 707)
apply paragraph (b) of this section and
§§ 1.863–1(b), 1.863–3, 1.863–8(b)(3)(ii),
1.864–5(a) and (b), 1.864–6(c)(2), and
1.865–3 in their entirety for the taxable
year, and once applied, the taxpayer and
all persons related to the taxpayer
(within the meaning of section 267 or
707) continue to apply these regulations
in their entirety for all subsequent
taxable years. For regulations generally
applicable to taxable years ending
before December 23, 2019, see § 1.863–
2 as contained in 26 CFR part 1 revised
as of April 1, 2020.

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Par. 6. Section 1.863–3 is revised as
follows:

■

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

(a) In general—(1) Scope. Subject to
the rules of § 1.865–3, paragraphs (a)
through (d) of this section apply to
determine the source of income derived
from the sale of inventory property
(inventory) that a taxpayer produces (in
whole or in part) within the United
States and sells without the United
States, or that a taxpayer produces (in
whole or in part) without the United
States and sells within the United States
(collectively, Section 863(b)(2) Sales).
See section 865(i)(1) for the definition of
inventory. Paragraph (b) of this section
provides that the source of gross income
from Section 863(b)(2) Sales is based
solely on the production activities with
respect to the inventory. Paragraph (c) of
this section describes how to determine
source based on production activity,
including when inventory is produced
partly within the United States and
partly without the United States.
Paragraph (d) of this section determines
taxable income from Section 863(b)(2)
Sales. Paragraph (e) of this section
applies to determine the source of
certain income derived from a
possession of the United States.
Paragraph (f) of this section provides
special rules for partnerships for all
sales subject to §§ 1.863–1 through
1.863–3. Paragraph (g) of this section
provides applicability dates for the rules
in this section.
(2) Cross references. To determine the
source of income derived from the sale
of personal property (including
inventory) by a nonresident that is
attributable to the nonresident’s office
or other fixed place of business in the
United States under section 865(e)(2)
and § 1.865–3(c), the rules of § 1.865–3
apply, and the rules of this section do
not apply except to the extent provided
in § 1.865–3. 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, as defined in § 1.863–8(d)(1)(i), or
international water, as defined in
§ 1.863–8(d)(1)(ii), 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.
(b) Sourcing based solely on
production activities. Subject to the
rules of § 1.865–3, all income, gain, or
loss derived from Section 863(b)(2)
Sales is allocated and apportioned
solely on the basis of the production
activities with respect to the inventory.

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(c) Determination of the source of
gross income from production activity—
(1) Production only within the United
States or only within foreign countries—
(i) Source of income. For purposes of
this section, production activity means
an activity that creates, fabricates,
manufactures, extracts, processes, cures,
or ages inventory. See § 1.864–1.
Whether a taxpayer’s activities
constitute production activity is
determined under the principles of
§ 1.954–3(a)(4) (except for § 1.954–
3(a)(4)(iv)). Subject to the provisions in
§ 1.1502–13 or paragraph (f)(2)(ii) of this
section, the 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. Where the taxpayer’s
production assets are located only
within the United States or only outside
the United States, gross income is
sourced where the taxpayer’s
production assets are located. For rules
regarding the source of income when
production assets are located both
within the United States and without
the United States, see paragraph (c)(2) of
this section. 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.
(ii) Definition of production assets.
Subject to the provisions of § 1.1502–13
and paragraph (f)(2)(ii) of this section,
production assets include only tangible
and intangible assets owned directly by
the taxpayer that are directly used by
the taxpayer to produce inventory
described in paragraph (a) of this
section. Production assets do not
include assets that are not directly used
to produce inventory described in
paragraph (a) of this section. Thus,
production assets do not include such
assets as accounts receivables,
intangibles not related to production of
inventory (e.g., marketing intangibles,
including trademarks and customer
lists), transportation assets, warehouses,
the inventory itself, raw materials, or
work-in-process. In addition,
production assets do not include cash or
other liquid assets (including working
capital), investment assets, prepaid
expenses, or stock of a subsidiary.
(iii) Location of production assets. For
purposes of this section, a tangible
production asset will be considered
located where the asset is physically
located. An intangible production asset
will be considered located where the
tangible production assets owned by the
taxpayer to which it relates are located.

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(2) Production both within and
without the United States—(i) Source of
income. Where the taxpayer’s
production assets are located both
within and without the United States,
income from sources without the United
States will be determined by
multiplying the gross income by a
fraction, the numerator of which is the
average adjusted basis of production
assets that are located outside the
United States and the denominator of
which is the average adjusted basis of
all production assets within and
without the United States. The
remaining income is treated as from
sources within the United States.
(ii) Adjusted basis of production
assets—(A) In general. For purposes of
paragraph (c)(2)(i) of this section, the
adjusted basis of an asset is determined
by using the alternative depreciation
system under section 168(g)(2). The
adjusted basis of all production assets
for purposes of paragraph (c)(2)(i) of this
section is determined as though the
production assets were subject to the
alternative depreciation system set forth
in section 168(g)(2) for the entire period
that such property has been in service.
The adjusted basis of the production
assets is determined without regard to
the election to expense certain
depreciable assets under section 179
and without regard to any additional
first-year depreciation provision (for
example, section 168(k), (l), and (m),
and former sections 1400L(b) and
1400N(d)). The average adjusted basis of
assets is computed by averaging the
adjusted basis at the beginning and end
of the taxable year, unless by reason of
changes during the taxable year, as
might be the case in the event of a major
acquisition or disposition of assets, the
average would materially distort the
calculation in paragraph (c)(2)(i) of this
section. In this event, the average
adjusted basis is determined upon a
more appropriate basis that is weighted
to reasonably reflect the period for
which the assets are held by the
taxpayer during the taxable year.
(B) Production assets used to produce
other property. If a production asset is
used to produce inventory sold in
Section 863(b)(2) Sales and also used to
produce other property during the
taxable year, the portion of its adjusted
basis that is included in the fraction
described in paragraph (c)(2)(i) of this
section will be determined under any
method that reasonably reflects the
portion of the asset that produces
inventory sold in Section 863(b)(2)
Sales. For example, the portion of such
an asset that is included in the formula
may be determined by multiplying the
asset’s average adjusted basis by a

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fraction, the numerator of which is the
gross receipts from sales of inventory
from Section 863(b)(2) Sales produced
by the asset, and the denominator of
which is the gross receipts from all
property produced by that asset.
(3) Anti-abuse rule. The purpose of
paragraph (b) of this section and this
paragraph (c) is to attribute the source
of the taxpayer’s gross income from
certain sales of inventory property to the
location of the taxpayer’s production
activity. Therefore, if the taxpayer has
entered into or structured one or more
transactions with a principal purpose of
reducing its U.S. tax liability in a
manner inconsistent with the purpose of
paragraph (b) of this section or this
paragraph (c), the Commissioner may
make appropriate adjustments so that
the source of the taxpayer’s gross
income more clearly reflects the
location of production activity. For
example, a taxpayer may be subject to
the rule in this paragraph (c)(3) if
domestic production assets are acquired
by a related partnership (or a subsidiary
of a related partnership) with a
principal purpose of reducing its U.S.
tax liability by claiming that the
taxpayer’s income from sales of
inventory is subject to section 862(a)(6)
rather than section 863(b).
(4) Examples. The following examples
illustrate the rules of this paragraph (c):
(i) Example 1. Source of gross
income—(A) Facts. A, a U.S.
corporation, produces widgets that are
sold both within the United States and
within a foreign country. The initial
manufacture of all widgets occurs in the
United States. The second stage of
production of widgets that are sold
within a foreign country is completed
within the country of sale. A’s U.S.
plant and machinery which is involved
in the initial manufacture of the widgets
has an average adjusted basis of $200, as
determined using the alternative
depreciation system under section
168(g)(2). A also owns warehouses used
to store work-in-process. A owns foreign
equipment with an average adjusted
basis of $25. A’s gross receipts from all
sales of widgets is $100, and its gross
receipts from export sales of widgets is
$25. Assume that apportioning average
adjusted basis using gross receipts is
reasonable. Assume A’s cost of goods
sold from the sale of widgets in the
foreign countries is $13 and thus, its
gross income from widgets sold in
foreign countries is $12.
(B) Analysis. A determines its gross
income from sources without the United
States by multiplying A’s $12 of gross
income from sales of widgets in foreign
countries by a fraction, the numerator of
which is all relevant foreign production

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assets, or $25, and the denominator of
which is all relevant production assets,
or $75 ($25 foreign assets + ($200 U.S.
assets × $25 gross receipts from export
sales/$100 gross receipts from all sales)).
Therefore, A’s gross income from
sources without the United States is $4
($12 × ($25/$75)).
(ii) Example 2. Location of intangible
property. Assume the same facts as in
paragraph (c)(4)(i)(A) of this section (the
facts in Example 1), except that A
employs a patented process that applies
only to the initial production of widgets.
In computing the formula used to
determine the source of gross income,
A’s patent, if it has an average adjusted
basis, would be located in the United
States.
(iii) Example 3. Anti-abuse rule—(A)
Facts. Assume the same facts as in
paragraph (c)(4)(i)(A) of this section (the
facts in Example 1). A sells its U.S.
assets to B, an unrelated U.S.
corporation, with a principal purpose of
reducing its U.S. tax liability by
manipulating the property fraction. A
then leases these assets from B. After
this transaction, under the general rule
of paragraph (c)(2) of this section, all of
A’s gross income would be considered
from sources without the United States,
because all of A’s relevant production
assets are located within a foreign
country. Since the leased property is not
owned by the taxpayer, it is not
included in the fraction.
(B) Analysis. Because A has entered
into a transaction with a principal
purpose of reducing its U.S. tax liability
by manipulating the formula described
in paragraph (c)(2)(i) of this section, A’s
income must be adjusted to more clearly
reflect the source of that income. In this
case, the Commissioner may
redetermine the source of A’s gross
income by ignoring the sale-leaseback
transactions.
(d) Determination of source of taxable
income. Once the source of gross
income has been determined under
paragraph (c) of this section, the
taxpayer must properly allocate and
apportion its expenses, losses, and other
deductions to its respective amounts of
gross income from sources within and
without the United States from its
Section 863(b)(2) Sales. See §§ 1.861–8
through 1.861–14T and 1.861–17.
(e) Income partly from sources within
a possession of the United States—(1) In
general. This paragraph (e) relates to
certain sales that give rise to income,
gain, or loss that is treated as derived
partly from sources within the United
States and partly from sources within a
possession of the United States (Section
863 Possession Sales). This paragraph
(e) applies to determine the source of

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income derived from the sale of
inventory produced (in whole or in part)
by a taxpayer within the United States
and sold within a possession of the
United States, or produced (in whole or
in part) by a taxpayer in a possession of
the United States and sold within the
United States (collectively, Possession
Production Sales). It also applies to
determine the source of income derived
from the purchase of personal property
within a possession of the United States
and its sale within the United States
(Possession Purchase Sales). A taxpayer
subject to this paragraph (e) must
apportion gross income from Section
863 Possession Sales under paragraph
(e)(2) of this section (in the case of
Possession Production Sales) or under
paragraph (e)(3) of this section (in the
case of Possession Purchase Sales). The
source of taxable income from Section
863 Possession Sales is determined
under paragraph (d) of this section.
(2) Allocation or apportionment for
Possession Production Sales. The source
of gross income from Possession
Production Sales is determined under
the rules of paragraph (c) of this section,
except that the term possession of the
United States is substituted for foreign
country wherever it appears.
(3) Allocation or apportionment for
Possession Purchase Sales—(i)
Determination of source of gross income
from Possession Purchase Sales. Gross
income from Possession Purchase Sales
is allocated in its entirety to the
taxpayer’s business activity, and is then
apportioned between sources within the
United States and sources within a
possession of the United States under
paragraph (e)(3)(ii) of this section.
(ii) Determination of source of gross
income from business activity—(A)
Source of gross income. Gross income
from the taxpayer’s business activity is
sourced in the possession in the same
proportion that the amount of the
taxpayer’s business activity for the
taxable year within the possession bears
to the amount of the taxpayer’s business
activity for the taxable year both within
the possession and outside the
possession, with respect to Possession
Purchase Sales. The remaining income
is sourced in the United States.
(B) Business activity. For purposes of
this paragraph (e)(3)(ii), the taxpayer’s
business activity is equal to the sum
of—
(1) The amounts for the taxable period
paid for wages, salaries, and other
compensation of employees, and other
expenses attributable to Possession
Purchase Sales (other than amounts that
are nondeductible under section 263A,
interest, and research and
development);

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(2) Cost of goods sold attributable to
Possession Purchase Sales during the
taxable period; and
(3) Possession Purchase Sales for the
taxable period.
(C) Location of business activity. For
purposes of determining the location of
the taxpayer’s business activity within a
possession, the following rules apply:
(1) Sales activity. Receipts from gross
sales will be attributed to a possession
in accordance with the principles of
§ 1.861–7(c).
(2) Cost of goods sold. Payments for
cost of goods sold will be properly
attributable to gross receipts from
sources within the possession only to
the extent that the property purchased
was manufactured, produced, grown, or
extracted in the possession (within the
meaning of section 954(d)(1)(A)).
(3) Expenses. Expenses will be
attributed to a possession under the
rules of §§ 1.861–8 through 1.861–14T.
(4) Examples. The following examples
illustrate the rules of paragraph (e)(3)(ii)
of this section relating to the
determination of source of gross income
from business activity:
(i) Example 1. Purchase of goods
manufactured in possession—(A) Facts.
U.S. Co. purchases in a possession
product X for $80 from A. A
manufactures X in the possession.
Without further production, U.S. Co.
sells X in the United States for $100.
Assume U.S. Co. has sales and
administrative expenses in the
possession of $10.
(B) Analysis. To determine the source
of U.S. Co.’s gross income, the $100
gross income from sales of X is allocated
entirely to U.S. Co.’s business activity.
Forty-seven dollars of U.S. Co.’s gross
income is sourced in the possession.
[Possession expenses ($10) plus
possession purchases (i.e., cost of goods
sold) ($80) plus possessions sales ($0),
divided by total expenses ($10) plus
total purchases ($80) plus total sales
($100).] The remaining $53 is sourced in
the United States.
(ii) Example 2. Purchase of goods
manufactured outside possession—(A)
Facts. Assume the same facts as in
paragraph (e)(4)(i)(A) of this section (the
facts in Example 1), except that A
manufactures X outside the possession.
(B) Analysis. To determine the source
of U.S. Co.’s gross income, the $100
gross income is allocated entirely to
U.S. Co.’s business activity. Five dollars
of U.S. Co.’s gross income is sourced in
the possession. [Possession expenses
($10) plus possession purchases ($0)
plus possession sales ($0), divided by
total expenses ($10) plus total purchases
($80) plus total sales ($100).] The $80
purchase is not included in the

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Federal Register / Vol. 85, No. 239 / Friday, December 11, 2020 / Rules and Regulations
numerator used to determine U.S. Co.’s
business activity in the possession,
since product X was not manufactured
in the possession. The remaining $95 is
sourced in the United States.
(5) Special rules for partnerships. In
applying the rules of this paragraph (e)
to transactions involving partners and
partnerships, the rules of paragraph (f)
of this section apply.
(f) Special rules for partnerships—(1)
General rule. For purposes of § 1.863–1
and this section, a taxpayer’s production
activity does not include production
activities conducted by a partnership of
which the taxpayer is a partner either
directly or through one or more
partnerships, except as otherwise
provided in paragraphs (c)(3) or (f)(2) of
this section.
(2) Exceptions—(i) In general. For
purposes of determining the source of
the partner’s distributive share of
partnership income or determining the
source of the partner’s income from the
sale of inventory property which the
partnership distributes to the partner in
kind, the partner’s production activity
includes an activity conducted by the
partnership. In addition, the production
activity of a partnership includes the
production activity of a taxpayer that is
a partner either directly or through one
or more partnerships, to the extent that
the partner’s production activity is
related to inventory that the partner
contributes to the partnership in a
transaction described under section 721.
(ii) Attribution of production assets to
or from a partnership. A partner will be
treated as owning its proportionate
share of the partnership’s production
assets only to the extent that, under
paragraph (f)(2)(i) of this section, the
partner’s activity includes production
activity conducted through a
partnership. A partner’s share of
partnership assets will be determined by
reference to the partner’s distributive
share of partnership income for the year
attributable to such production assets.
Similarly, to the extent a partnership’s
activities include the production
activities of a partner, the partnership
will be treated as owning the partner’s
production assets related to the
inventory that is contributed in kind to
the partnership. See paragraph (c)(2)(ii)
of this section for rules apportioning the
basis of assets to Section 863 Sales.
(iii) Basis. For purposes of this
section, in those cases where the partner
is treated as owning its proportionate
share of the partnership’s production
assets, the partner’s basis in production
assets held through a partnership shall
be determined by reference to the
partnership’s adjusted basis in its assets
(including a partner’s special basis

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adjustment, if any, under section 743).
Similarly, a partnership’s basis in a
partner’s production assets is
determined with reference to the
partner’s adjusted basis in its assets.
(3) Examples. The following examples
illustrate the rules of this paragraph (f):
(i) Example 1. Distributive share of
partnership income. A, a U.S.
corporation, forms a partnership in the
United States with B, a country X
corporation. A and B each have a 50
percent interest in the income, gains,
losses, deductions and credits of the
partnership. The partnership is engaged
in the manufacture and sale of widgets.
The widgets are manufactured in the
partnership’s plant located in the
United States and are sold by the
partnership outside the United States.
The partnership owns the
manufacturing facility and all other
production assets used to produce the
widgets. A’s distributive share of
partnership income includes 50 percent
of the sales income from these sales. In
applying the rules of section 863 to
determine the source of its distributive
share of partnership income from the
export sales of widgets, A is treated as
carrying on the activity of the
partnership related to production of
these widgets and as owning a
proportionate share of the partnership’s
assets related to production of the
widgets, based upon its distributive
share of partnership income.
(ii) Example 2. Distribution in kind.
Assume the same facts as in paragraph
(f)(3)(i) of this section (the facts in
Example 1) except that the partnership,
instead of selling the widgets,
distributes the widgets to A and B. A
then further processes the widgets and
then sells them outside the United
States. In determining the source of the
income earned by A on the sales outside
the United States, A is treated as
conducting the activities of the
partnership related to production of the
distributed widgets. Thus, the source of
gross income on the sale of the widgets
is determined under section 863 and
this section. In applying paragraph (c) of
this section, A is treated as owning its
proportionate share of the partnership’s
production assets based upon its
distributive share of partnership
income.
(g) Applicability dates. This section
applies to taxable years ending on or
after December 23, 2019. However, a
taxpayer may apply this section in its
entirety for taxable years beginning after
December 31, 2017, and ending before
December 23, 2019, provided that the
taxpayer and all persons related to the
taxpayer (within the meaning of section
267 or 707) apply this section and

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§§ 1.863–1(b), 1.863–2(b), 1.863–
8(b)(3)(ii), 1.864–5(a) and (b), 1.864–
6(c)(2), and 1.865–3 in their entirety for
the taxable year, and once applied, the
taxpayer and all persons related to the
taxpayer (within the meaning of section
267 or 707) continue to apply these
regulations in their entirety for all
subsequent taxable years. For
regulations generally applicable to
taxable years ending before December
23, 2019, see § 1.863–3 as contained in
26 CFR part 1 revised as of April 1,
2020.
■ Par. 7. Section 1.863–8 is amended as
follows:
■ a. Revising paragraph (b)(3)(ii)(A).
■ b. In paragraph (b)(3)(ii)(B):
■ i. Removing ‘‘income allocable to
production activity’’ wherever it
appears and adding in its place ‘‘gross
income’’.
■ ii. Removing ‘‘§ 1.863–3(c)(1)’’ from
the second sentence and adding in its
place ‘‘§ 1.863–3(c)’’.
■ c. In paragraph (b)(3)(ii)(C):
■ i. Removing ‘‘allocable to production
activity’’ wherever it appears.
■ ii. Removing ‘‘allocated to production
activity’’ from the fifth sentence.
■ iii. Removing ‘‘§ 1.863–3(c)(1)’’ from
the fifth sentence and adding in its
place ‘‘§ 1.863–3(c)’’.
■ d. Removing paragraph (b)(3)(ii)(D).
■ e. In paragraph (c), removing
‘‘(b)(3)(ii)(C)’’ from the first sentence
and adding in its place ‘‘(b)(3)(ii)’’.
■ f. Designating Examples 1 through 14
of paragraph (f) as paragraphs (f)(1)
through (14).
■ g. In newly designated paragraphs
(f)(1) through (14), removing the period
between the second and third level
paragraph headings and adding an emdash in its place.
■ h. Removing ‘‘this Example 4’’ from
newly designated paragraph (f)(4)(i)
wherever it appears and adding in its
place ‘‘paragraph (f)(4)(i) (Example 4)’’.
■ i. Removing ‘‘Example 4’’ from newly
designated paragraph (f)(5)(i) and
adding in its place ‘‘paragraph (f)(4)(i) of
this section (the facts in Example 4)’’.
■ j. Revising newly designated
paragraph (f)(6)(ii).
■ k. Removing ‘‘Example 8’’ from newly
designated paragraph (f)(9)(i) and
adding in its place ‘‘in paragraph (f)(8)(i)
of this section (the facts in Example 8)’’.
■ l. Removing ‘‘Example 8’’ from newly
designated paragraph (f)(9)(ii) and
adding in its place ‘‘paragraph (f)(8)(ii)
of this section (the analysis in Example
8)’’.
■ m. Revising newly designated
paragraph (f)(11)(ii).
■ n. In paragraph (g)(1), removing
‘‘(b)(3)(ii)(C)’’ from the first sentence
and adding in its place ‘‘(b)(3)(ii)’’.

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o. In paragraph (g)(4) introductory
text, removing ‘‘(b)(3)(ii)(C)’’ from the
first sentence and adding in its place
‘‘(b)(3)(ii)’’.
■ p. In paragraph (h), adding three
sentences at the end of the paragraph.
The revisions and additions read as
follows:
■

§ 1.863–8 Source of income derived from
space and ocean activity under section
863(d).

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*

*
*
*
*
(b) * * *
(3) * * *
(ii) Sales of property produced by the
taxpayer—(A) General. If the taxpayer
both produces property and sells such
property and either the production (in
whole or in part) or the sale takes place
in space or international water, the
taxpayer must allocate and apportion all
income, gain, or loss derived from sales
of such property solely on the basis of
the production activities with respect to
such property, and the source of that
income will be determined under
paragraph (b)(3)(ii)(B) or (C) of this
section. To determine the source of
income derived from the sale of
personal property (including inventory)
by a nonresident that is attributable to
the nonresident’s office or other fixed
place of business in the United States
under section 865(e)(2), the rules of
§ 1.865–3 apply, and the rules of this
section do not apply.
*
*
*
*
*
(f) * * *
(6) * * *
(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, the source of the gross
income from the sale of the data is
determined under paragraph (b)(3)(ii) of
this section solely on the basis of the
production activities. The source of S’s
gross income is determined under
paragraph (b)(3)(ii)(C) of this section
because production activities occur both
in space and on land.
*
*
*
*
*
(11) * * *
(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 manufactured in the
United States and sold in space is
determined under paragraph (b)(3)(ii) of
this section solely on the basis of the
production activities with respect to the
satellite.
*
*
*
*
*

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(h) * * * Paragraph (b)(3)(ii) of this
section applies to taxable years ending
on or after December 23, 2019. However,
a taxpayer may apply paragraph
(b)(3)(ii) of this section in its entirety for
taxable years beginning after December
31, 2017, and ending before December
23, 2019, provided that the taxpayer and
all persons related to the taxpayer
(within the meaning of section 267 or
707) apply paragraph (b)(3)(ii) of this
section and §§ 1.863–1(b), 1.863–2(b),
1.863–3, 1.864–5(a) and (b), 1.864–
6(c)(2), and 1.865–3 in their entirety for
the taxable year, and once applied, the
taxpayer and all persons related to the
taxpayer (within the meaning of section
267 or 707) continue to apply these
regulations in their entirety for all
subsequent taxable years. For
regulations generally applicable to
taxable years ending before December
23, 2019, see § 1.863–8 as contained in
26 CFR part 1 revised as of April 1,
2020.
■ Par. 8. Section 1.864–5 is amended as
follows:
■ a. Adding a sentence to the end of
paragraph (a);
■ b. Revising the first sentence of
paragraph (b) introductory text; and
■ c. Adding paragraph (e).
The additions read as follows:
§ 1.864–5 Foreign source income
effectively connected with U.S. business.

(a) * * * To determine the source of
income, gain or loss from the sale of
personal property (including inventory
property) attributable to an office or
other fixed place of business in the
United States by nonresidents, as
defined in section 865(g)(1)(B), see
§ 1.865–3.
(b) * * * Income, gain, or loss from
sources without the United States other
than income described in paragraph (c)
of this section or income from section
865(e)(2) sales, as defined in § 1.865–
3(c), shall be taken into account
pursuant to paragraph (a) of this section
in applying §§ 1.864–6 and 1.864–7 only
if it consists of—
*
*
*
*
*
(e) Applicability dates. Paragraphs (a)
and (b) of this section apply to taxable
years ending on or after December 23,
2019. However, a taxpayer may apply
paragraphs (a) and (b) of this section in
their entirety for taxable years beginning
after December 31, 2017, and ending
before December 23, 2019, provided that
the taxpayer and all persons related to
the taxpayer (within the meaning of
section 267 or 707) apply paragraphs (a)
and (b) of this section and §§ 1.863–1(b),
1.863–2(b), 1.863–3, 1.863–8(b)(3)(ii),
1.864–6(c)(2), and 1.865–3 in their
entirety for the taxable year, and once

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applied, the taxpayer and all persons
related to the taxpayer (within the
meaning of section 267 or 707) continue
to apply these regulations in their
entirety for all subsequent taxable years.
For regulations generally applicable to
taxable years ending before December
23, 2019, see § 1.864–5 as contained in
26 CFR part 1 revised as of April 1,
2020.
■ Par. 9. Section 1.864–6 is amended as
follows:
■ a. Revising paragraph (c)(2).
■ b. Revising paragraph (c)(3).
■ c. Adding paragraph (c)(4).
The revisions and additions read as
follows:
§ 1.864–6 Income, gain, or loss attributable
to an office or other fixed place of business
in the United States.

*

*
*
*
*
(c) * * *
(2) Special limitation in case of sales
of goods or merchandise through U.S.
office. Notwithstanding paragraph (c)(1)
of this section, the special rules
described in this paragraph (c)(2) apply
with respect to a sale of goods or
merchandise specified in § 1.864–
5(b)(3), to which paragraph (b)(3)(i) of
this section does not apply. In the case
of a nonresident alien with a tax home
within the United States, as defined in
section 911(d)(3), the amount of income
from the sale of goods or merchandise
that is properly allocable to the
individual’s U.S. office is determined
under § 1.865–3(d).
(3) Examples. The application of this
paragraph (c) may be illustrated by the
following examples—
(i) Example 1. Sales of produced
inventory through a U.S. sales office.
Individual A, who is a nonresident alien
within the meaning of section
7701(b)(1)(B) and has a tax home in the
United States, manufactures machinery
in a foreign country and sells the
machinery outside the United States
through A’s sales office in the United
States for use in foreign countries. A is
not a nonresident within the meaning of
section 865(g)(1)(B). Therefore, § 1.865–
3 does not apply to A’s sale of the
machinery, except to the extent
provided in paragraph (c)(2) of this
section. Title to the property sold is
transferred to the foreign purchaser
outside the United States, but no office
or other fixed place of business of A in
a foreign country materially participates
in the sale made through A’s U.S. office.
By reason of its sales activities in the
United States, A is engaged in business
in the United States during the taxable
year. During the taxable year, A derives
a total income of $250,000x from these
sales. Under paragraph (c)(2) of this

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Federal Register / Vol. 85, No. 239 / Friday, December 11, 2020 / Rules and Regulations
section, the amount of income that is
allocable to A’s U.S. office is
determined under § 1.865–3(d)(2). The
taxpayer does not allocate income from
the sale under the books and records
method described in § 1.865–3(d)(2)(ii).
Thus, 50 percent of A’s foreign source
income of $250,000x, plus any
additional income allocable based on
the location of production activities
under §§ 1.865–3(d)(2)(i) and 1.863–3
(in this case, $0x), is effectively
connected for the taxable year with the
conduct of A’s U.S. trade or business, or
$125,000x.
(ii) Example 2. Sales of inventory
purchased and resold through a U.S.
sales office by a nonresident alien with
a tax home in the United States.
Individual B, who is a nonresident alien
within the meaning of section
7701(b)(1)(B) and has a tax home in the
United States, has an office in a foreign
country that purchases merchandise and
sells it through B’s sales office in the
United States for use in various foreign
countries, with title to the property
passing outside the United States. B is
not a nonresident within the meaning of
section 865(g)(1)(B). Therefore, § 1.865–
3 does not apply to B’s sale of the
merchandise, except to the extent
provided in paragraph (c)(2) of this
section. No other office of B materially
participates in these sales made through
its U.S. office. By reason of its sales
activities in the United States, B is
engaged in business in the United States
during the taxable year. During the
taxable year, B derives income of
$300,000x from these sales made
through its U.S. sales office. All of B’s
income from these sales is foreign
source as B purchases the merchandise
outside the United States and title to the
merchandise also passes outside the
United States. The amount of income
properly allocable to B’s U.S. office
determined under § 1.865–3(d)(3) is
$300,000x, and thus $300,000x is
effectively connected for the taxable
year with the conduct of B’s U.S. trade
or business.
(iii) Example 3. Foreign sales office
also materially participates in sale. The
facts are the same as in paragraph
(c)(3)(ii) of this section (the facts in
Example 2), except that B also has an
office in a foreign country that is a
material factor in the realization of
income from the sales made through B’s
U.S. office. No income from the sale of
merchandise is allocable to B’s U.S.
sales office for the taxable year, by
reason of paragraph (b)(3)(i) of this
section, and thus none of the $300,000x
is effectively connected for the taxable
year with the conduct of B’s U.S. trade
or business.

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(iv) Example 4. Sales of inventory
purchased and resold through a U.S.
sales office by a foreign corporation.
The facts are the same as in paragraph
(c)(3)(ii) of this section (the facts in
Example 2), except that B is a foreign
corporation. B is a nonresident within
the meaning of section 865(g)(1)(B). The
income from such sales will be sourced
in accordance with § 1.865–3(a) and
(d)(3).
(4) Applicability date. Paragraph (c)(2)
of this section applies to taxable years
ending on or after December 23, 2019.
However, a taxpayer may apply
paragraph (c)(2) of this section in its
entirety for taxable years beginning after
December 31, 2017, and ending before
December 23, 2019, provided that the
taxpayer and all persons related to the
taxpayer (within the meaning of section
267 or 707) apply paragraph (c)(2) of
this section and §§ 1.863–1(b), 1.863–
2(b), 1.863–3, 1.863–8(b)(3)(ii), 1.864–
5(a) and (b), and 1.865–3 in their
entirety for the taxable year, and once
applied, the taxpayer and all persons
related to the taxpayer (within the
meaning of section 267 or 707) continue
to apply these regulations in their
entirety for all subsequent taxable years.
For regulations generally applicable to
taxable years ending before December
23, 2019, see § 1.864–6 as contained in
26 CFR part 1 revised as of April 1,
2020.
■ Par. 10. Section 1.865–3 is added to
read as follows:
§ 1.865–3 Source of gross income from
sales of personal property (including
inventory property) by a nonresident
attributable to an office or other fixed place
of business in the United States.

(a) In general. Notwithstanding any
provision of section 861 through 865 or
other regulations in this part, this
section provides the sole sourcing rules
for gross income, gain, or loss from
section 865(e)(2) sales. Gross income,
gain, or loss from a section 865(e)(2) sale
is U.S. source income to the extent that
the gross income, gain, or loss is
properly allocable to an office or other
fixed place of business in the United
States under paragraph (d) of this
section.
(b) Exception for certain inventory
sales for use, disposition or
consumption outside the United States.
A section 865(e)(2) sale does not include
any sale of inventory property that is
sold for use, disposition, or
consumption outside the United States
if an office or other fixed place of
business of the nonresident in a foreign
country materially participates in the
sale. See § 1.864–6(b)(3) to determine
whether a foreign office materially

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participates in the sale and whether the
property was destined for foreign use.
(c) Section 865(e)(2) sales. For
purposes of this section, a ‘‘section
865(e)(2) sale’’ is a sale of personal
property by a nonresident, including
inventory property, other than a sale
described in paragraph (b) of this
section, that is attributable to an office
or other fixed place of business in the
United States under the principles of
section 864(c)(5)(B) as prescribed in
§ 1.864–6(b)(1) and (2). In determining
whether a nonresident maintains an
office or other fixed place of business in
the United States, the principles of
section 864(c)(5)(A) as prescribed in
§ 1.864–7 apply, including the rules of
paragraph (d) of that section regarding
the office or other fixed place of
business of a dependent agent of the
nonresident. For purposes of this
section, ‘‘inventory property’’ has the
meaning provided in section 865(i)(1),
and ‘‘nonresident’’ has the meaning
provided in section 865(g)(1)(B).
(d) Amount of gross income, gain, or
loss on sale of personal property
properly allocable to a U.S. office—(1)
In general. Except as otherwise
provided in paragraphs (d)(2) through
(4) of this section, the amount of gross
income, gain, or loss from a section
865(e)(2) sale that is properly allocable
to an office or other fixed place of
business in the United States is
determined under the principles of
§ 1.864–6(c)(1).
(2) Produced inventory property.
Gross income, gain, or loss from a
section 865(e)(2) sale of inventory
property that is produced by the
nonresident seller is properly allocable
to an office or other fixed place of
business in the United States or to
production activities in accordance with
the ‘‘50/50 method’’ described in
paragraph (d)(2)(i) of this section.
However, in lieu of the 50/50 method,
the nonresident seller may elect to
allocate the gross income, gain, or loss
under the ‘‘books and records method’’
described in paragraph (d)(2)(ii)(A) of
this section, provided that the
nonresident satisfies all of the
requirements described in paragraph
(d)(2)(ii)(B) of this section to the
satisfaction of the Commissioner. Gross
income allocable to production
activities under this paragraph (d)(2) is
sourced in accordance with § 1.863–3.
For purposes of this paragraph (d)(2),
the term ‘‘produced’’ includes created,
fabricated, manufactured, extracted,
processed, cured, and aged, as
determined under the principles of
§ 1.954–3(a)(4) (except for § 1.954–
3(a)(4)(iv)). See section 864(a) and
§ 1.864–1.

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Federal Register / Vol. 85, No. 239 / Friday, December 11, 2020 / Rules and Regulations

(i) The 50/50 method. Fifty percent of
the gross income, gain, or loss from a
section 865(e)(2) sale of inventory
property that is produced by the
nonresident seller is properly allocable
to an office or other fixed place of
business in the United States, and the
remaining 50 percent of the gross
income, gain, or loss is properly
allocable to production activities (the
‘‘50/50 method’’).
(ii) Books and records method—(A)
Method. Subject to paragraph
(d)(2)(ii)(B) of this section, a
nonresident may elect to determine the
amount of its gross income, gain, or loss
from the sale of inventory property
produced by the nonresident seller that
is properly allocable to production
activities and sales activities for the
taxable year based upon its books of
account (the ‘‘books and records
method’’). The gross income, gain, or
loss allocable to sales activities under
this method is treated as properly
allocable to an office or other fixed
place of business in the United States
and the remaining gross income, gain, or
loss is treated as properly allocable to
production activities.
(B) Election and reporting rules—(1)
In general. A nonresident may not make
the election described in paragraph
(d)(2)(ii)(A) of this section unless the
requirements of paragraphs
(d)(2)(ii)(B)(2) through (4) of this section
are satisfied. Once the election is made,
the nonresident must continue to satisfy
the requirements of paragraphs
(d)(2)(ii)(B)(2) through (4) of this section
until the election is revoked. If the
nonresident fails to satisfy the
requirements in paragraphs
(d)(2)(ii)(B)(2) through (4) of this section
to the satisfaction of the Commissioner,
the Commissioner may, in its sole
discretion, apply the 50/50 method
described in paragraph (d)(2)(i) of this
section.
(2) Books of account. The nonresident
must establish that it, in good faith and
unaffected by considerations of tax
liability, regularly employs in its books
of account a detailed allocation of
receipts and expenditures that, under
the principles of section 482, clearly
reflects both the amount of the
nonresident’s gross income, gain, or loss
from its inventory sales that are
attributable to its sales activities, and
the amount of its gross income, gain, or
loss from its inventory sales that are
attributable to its production activities.
For purposes of this paragraph
(d)(2)(ii)(B)(2), section 482 principles
apply as if the office or other fixed place
of business in the United States were a
separate organization, trade, or business
(and, thus, a separate controlled

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taxpayer) from the nonresident (whether
or not payments are made between the
United States office or other fixed place
of business and the nonresident’s other
offices, and whether or not the
nonresident itself would otherwise
constitute an organization, trade, or
business).
(3) Required records. The nonresident
must prepare and maintain the records
described in paragraph (d)(2)(ii)(B)(2) of
this section, which must be in existence
when its return is filed. The nonresident
must also prepare an explanation of
how the allocation clearly reflects the
nonresident’s gross income, gain, or loss
from production and sales activities
under the principles of section 482. The
nonresident must make available the
explanation and records of the
nonresident (including for the office or
other fixed place of business in the
United States and the offices or
branches that perform the production
activities) upon request of the
Commissioner, within 30 days, unless
some other period is agreed upon
between the Commissioner and the
nonresident.
(4) Making and revoking the books
and records method election; disclosure
of election. Except as otherwise
provided in publications, forms,
instructions, or other guidance, a
nonresident makes or revokes the
election to apply the books and records
method by attaching a statement to its
original timely filed Federal income tax
return (including extensions) providing
that it elects, or revokes the election, to
apply the books and records method
described in paragraph (d)(2)(ii)(A) of
this section. For nonresidents making
the election, the statement must provide
that the nonresident has prepared the
records described in paragraph
(d)(2)(ii)(B)(2) and (3) of this section.
(5) Limitation on revoking the books
and records method election. Once
made, the books and records method
election continues until revoked. An
election cannot be revoked, without the
consent of the Commissioner, for any
taxable year beginning within 48
months of the last day of the taxable
year for which the election was made.
(3) Purchased inventory property. All
gross income, gain, or loss from a
section 865(e)(2) sale of inventory
property that is both purchased and sold
by a nonresident is properly allocable to
an office or other fixed place of business
in the United States.
(4) Depreciable personal property.
Gain from a section 865(e)(2) sale of
depreciable personal property (as
defined in section 865(c)(4)) is allocated
under paragraphs (d)(4)(i) and (ii) of this
section.

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(i) The gain not in excess of the
depreciation adjustments, if any, is
properly allocable to an office or other
fixed place of business in the United
States to the same extent that the gain
would be allocated to sources within the
United States under the rules of section
865(c)(1). The remaining gain not in
excess of the depreciation adjustments,
if any, is allocated to sources without
the United States in accordance with
section 865(c)(1). However,
notwithstanding the preceding
sentences, if the property was
predominantly used in the United
States, within the meaning of section
865(c)(3)(B)(i), for a particular taxable
year, all of the gain not in excess of
depreciation for that year is properly
allocable to the office or other fixed
place of business in the United States.
(ii) The gain in excess of the
depreciation adjustments, if any, is
treated as if such gain was from the sale
of inventory and the amount allocable to
an office or fixed place of business in
the United States is determined under
paragraph (d)(2) or (3) of this section, as
applicable.
(e) Determination of source of taxable
income. For rules allocating and
apportioning expenses to gross income
effectively connected with the conduct
of a trade or business of a foreign
corporation in the United States
(including gross income, gain, or loss
sourced under this section), see section
882(c)(1). For rules allocating and
apportioning expenses to gross income,
gain, or loss effectively connected with
the conduct of a trade or business of a
nonresident alien in the United States
(including gross income, gain, or loss
sourced under this section), see section
873(a).
(f) Export trade corporations. This
section does not apply for purposes of
defining an export trade corporation
under section 971(a).
(g) Applicability date. This section
applies to taxable years ending on or
after December 23, 2019. However, a
nonresident may apply this section in
its entirety for taxable years beginning
after December 31, 2017, and ending
before December 23, 2019, provided that
the nonresident and all persons related
to the nonresident (within the meaning
of section 267 or 707) apply this section
and §§ 1.863–1(b), 1.863–2(b), 1.863–3,
1.863–8(b)(3)(ii), 1.864–5(a) and (b), and
1.864–6(c)(2) in their entirety for the
taxable year, and once applied, the
nonresident and all persons related to
the nonresident (within the meaning of
section 267 or 707) continue to apply
these regulations in their entirety for all
subsequent taxable years.

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Federal Register / Vol. 85, No. 239 / Friday, December 11, 2020 / Rules and Regulations
§ 1.937–2

[Amended]

Par. 11. In § 1.937–2 amend paragraph
(d) by removing ‘‘§ 1.863–3(f)’’ and
adding in its place ‘‘§ 1.863–3(e)’’.

■

§ 1.937–3

[Amended]

Par. 12. In § 1.937–3 amend paragraph
(d) by removing ‘‘§ 1.863–3(f)’’ and
adding in its place ‘‘§ 1.863–3(e)’’.
■ Par. 13. Section 1.1502–13 is
amended by revising paragraph
(c)(7)(ii)(N) to read as follows:
■

§ 1.1502–13

Intercompany transactions.

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*

*
*
*
*
(c) * * *
(7) * * *
(ii) * * *
(N) Example (14): Source of income
under section 863—(1) Intercompany
sale—(i) Facts. S manufactures
inventory property solely in the United
States and recognizes $75x of income on
sales to B in Year 1. B conducts further
production activity on the inventory
property solely in Country Y and then
sells the inventory property to X in
Country Y and recognizes $25x of
income on the sale to X, also in Year 1.
Title passes from S to B, and from B to
X, in Country Y. Assume that applying
§ 1.863–3 on a single entity basis,
including the formula for
apportionment of multi-country
production activities by reference to the
basis of production assets, $10x would
be treated as foreign source income and
$90x would be treated as U.S. source
income (that is, 10 percent of the
production occurred outside the United
States and 90 percent occurred within
the United States, as measured by the
basis of assets used in production
activities with respect to the property).
Assume further that, on a separate entity
basis, S would have $0x of foreign
source income and $75x of U.S. source
income and all of B’s $25x of income
would be foreign source income.
(ii) Analysis. Under the matching rule,
both S’s $75x intercompany item and
B’s $25x corresponding item are taken
into account in Year 1. In determining
the source of S and B’s income from the
inventory property sales, the attributes
of S’s intercompany item and B’s
corresponding item are redetermined to
the extent necessary to produce the
same effect on consolidated taxable
income (and consolidated tax liability)
as if S and B were divisions of a single
corporation. See paragraph (c)(1)(i) of
this section. On a single entity basis, S
and B would have $10x that would be
treated as foreign source income and
$90x that would be treated as U.S.
source income, but without application
of this section (that is, on a separate

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entity basis), S would have $75x of U.S.
source income and B would have $25x
of foreign source income. Under
paragraph (c)(4)(ii) of this section, a
redetermined attribute must be allocated
between S and B using a reasonable
method. On a separate entity basis B
would have only foreign source income
and S would have only U.S. source
income. Accordingly, under paragraph
(c)(1)(i) of this section, $15x of B’s $25x
sales income that would be treated as
foreign source income on a separate
entity basis is redetermined to be U.S.
source income.
(2) Sale of property reflecting
intercompany services or intangibles—
(i) Facts. S earns $10x of income
performing services in the United States
for B. B capitalizes S’s fees into the basis
of inventory property that it
manufactures in the United States and
sells to an unrelated person in Year 1 at
a $90x profit, with title passing in
Country Y. Assume that on a single
entity basis, $100x is treated as U.S.
source income and $0x is treated as
foreign source income. Further assume
that on a separate entity basis, S would
have $10x of U.S. source income, and B
would have $90x of U.S. source income,
with neither having any foreign source
income.
(ii) Analysis. Under the matching rule,
S’s $10x income and B’s $90x income
are taken into account in Year 1. In
determining the source of S and B’s
income, the attributes of S’s
intercompany item and B’s
corresponding item are redetermined to
the extent necessary to produce the
same effect on consolidated taxable
income (and consolidated tax liability)
as if S and B were divisions of a single
corporation. Because the results are the
same on a single entity basis and a
separate entity basis ($100x of U.S.
source income and $0x of foreign source
income), the attributes are not
redetermined under paragraph (c)(1)(i)
of this section.
Sunita Lough,
Deputy Commissioner for Services and
Enforcement.
Approved: September 21, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax
Policy).
[FR Doc. 2020–21817 Filed 12–10–20; 8:45 am]
BILLING CODE 4830–01–P

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79853

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9902]
RIN 1545–BP15

Guidance Under Sections 951A and
954 Regarding Income Subject to a
High Rate of Foreign Tax; Correcting
Amendment
Internal Revenue Service (IRS),
Treasury.
ACTION: Correcting amendments.
AGENCY:

This document contains
corrections to Treasury Decision 9902,
which was published in the Federal
Register on Thursday, July 23, 2020.
Treasury Decision 9902 contained final
regulations under the global intangible
low-taxed income and subpart F income
provisions of the Internal Revenue Code
regarding the treatment of income that
is subject to a high rate of foreign tax.
DATES: This correction is effective on
December 11, 2020.
FOR FURTHER INFORMATION CONTACT:
Jorge M. Oben or Larry R. Pounders at
(202) 317–6934 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
SUMMARY:

Background
The final regulations (TD 9902) that
are the subject of this correction are
issued under section 951A of the Code.
Need for Correction
As published on July 23, 2020 (85 FR
44620) the final regulations (TD 9902)
contain errors that need to be corrected.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Correction of Publication
Accordingly, 26 CFR part 1 is
corrected by making the following
correcting amendments:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 continues to read in part as
follows:

■

Authority: 26 U.S.C. 7805.

*

*
*
*
*
Par. 2. Section 1.951A–2 is amended
by:
■ a. Revising the third sentence of
paragraph (c)(3)(ii)(B).
■ b. Revising paragraphs (c)(7)(iii)(B)(2)
and (c)(7)(viii)(A)(2)(ii).
■ c. Revising the first sentence of
paragraph (c)(7)(viii)(A)(4) introductory
text.
■

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