[Federal Register Volume 63, Number 198 (Wednesday, October 14, 1998)]
[Rules and Regulations]
[Pages 55020-55025]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-27395]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8786]
RIN 1545-AU79
Source of Income From Sales of Inventory Partly From Sources
Within a Possession of the United States; Also, Source of Income
Derived From Certain Purchases From a Corporation Electing Section 936
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations under section 863
governing the source of income from sales of inventory produced in the
United States and sold in a possession of the United States or produced
in a possession of the United States and sold in the United States;
final regulations under section 863 governing the source of income from
sales of inventory purchased in a possession of the United States and
sold in the United States; and final regulations under section 936
governing the source of income of a taxpayer from the sale in the
United States of property purchased from a corporation that has an
election under section 936 in effect. This document affects persons who
produce (in whole or in part) inventory in the United States and sell
in a possession, or produce (in whole or in part) inventory in a
possession and sell in the United States, as well as persons who
purchase inventory in a possession and sell in the United States, and
also persons who sell in the United States property purchased from a
corporation that has a section 936 election in effect.
DATES: Effective Date: These regulations are effective November 13,
1998.
Applicability Date: These regulations apply to taxable years
beginning on or after November 13, 1998.
FOR FURTHER INFORMATION CONTACT: Anne Shelburne, (202) 874-1305 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this final regulation
has been reviewed and approved by the Office of Management and Budget
in accordance with the requirements of the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)) under control number 1545-1556. Responses to
this collection of information are mandatory.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.
The estimated average annual burden per respondent is approximately
2.5 hours.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224, and the Office of Management and Budget, Attn:
Desk Officer for the Department of Treasury, Office of Information and
Regulatory Affairs, Washington, DC 20503.
Books or records relating to a collection of information must be
[[Page 55021]]
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
This document contains final regulations under section 863 of the
Internal Revenue Code (Code), providing rules to source income from
cross-border sales of certain property, where the property is
manufactured in a possession of the United States and sold in the
United States, or vice versa, or purchased in a possession and sold in
the United States. These regulations also contain rules under section
936 to source income of a taxpayer from the sale in the United States
of property purchased from a corporation that has an election under
section 936 in effect.
On October 10, 1997, proposed regulations (REG-251985-96) were
published in the Federal Register (62 FR 52953). Having considered the
comments, the IRS and the Treasury Department adopt the proposed
regulations without significant change in this Treasury decision.
Explanation of Provisions
I. Income Partly From Sources Within a Possession
Section 863 authorizes the Secretary to promulgate regulations
allocating or apportioning, to sources within or without the United
States, all items of gross income, expenses, losses, and deductions
other than those items specified in sections 861(a) and 862(a).
Guidance in these regulations to determine the source of possession
income under section 863 concerns two types of transactions:
transactions described in section 863(b)(2) for property produced in
the United States and sold in a possession (or vice versa), and
transactions described in section 863(b)(3) for property purchased in a
possession and sold in the United States (collectively, Section 863
Possession Sales).
1. Methods for Allocating or Apportioning Gross Income From Section 863
Possession Sales
a. Property produced and sold. Under the final regulations, income
from sales of inventory produced in the United States and sold in a
possession of the United States or produced in a possession and sold in
the United States (collectively, Possession Production Sales), is
allocated or apportioned according to one of three methods.
Paragraph (f)(2)(i)(A) of the regulations makes the 50/50 method
the general rule to allocate gross income from Possession Production
Sales between production activity and business sales activity, so that
the income from each type of activity can then be apportioned between
U.S. and foreign sources. The taxpayer, however, may elect to apply the
independent factory price (IFP) method (described in paragraph
(f)(2)(i)(B)), or, with the consent of the District Director, the books
and records method (described in paragraph (f)(2)(i)(C)).
Under the possession 50/50 method, the final regulations allocate
half of the taxpayer's gross income from Possession Production Sales to
production activity and half to business sales activity. The income is
then apportioned between U.S. and possession sources based on a
property fraction and a business sales activity fraction.
The final regulations apply the property fraction in Sec. 1.863-
3(c) to apportion the half of a taxpayer's income allocated to
production activity. Thus, income is apportioned to the United States
or to a possession or to other foreign sources based on the location of
the taxpayer's production assets. Consistent with the changes made to
the regulations under Sec. 1.863-3(c), production assets are defined as
tangible and intangible assets owned directly by the taxpayer that are
directly used by the taxpayer to produce inventory sold in Possession
Production Sales. Production assets are included in the fraction at
their adjusted tax basis, consistent with the changes made to the
regulations under Sec. 1.863-3(c).
The other half of the taxpayer's gross income, allocated to
business sales activity, is apportioned according to a business sales
activity fraction. The portion of this income that is possession source
income is determined by multiplying the income by a fraction, the
numerator being the business sales activity of the taxpayer in the
possession, and the denominator being the business sales activity of
the taxpayer within the possession and outside the possession. The
remaining income is sourced in the United States. Although some of the
business sales activity factors not incurred in a possession may be
incurred in a foreign country, Treasury and the IRS believe that the
business sales activity fraction is only intended to source the
business sales activity portion of Possession Production Sales outside
the United States to the extent of business sales activity located in a
possession.
Under the final regulations, as opposed to the current regulations,
business sales activity is measured by the sum of certain expenses,
including amounts paid for labor, materials, advertising, and marketing
(but excluding any expenses or other amounts that are nondeductible
under section 263A, interest, and research and development), plus
receipts for the sale of goods. This formula is intended to reflect
better the business sales activity producing the income by including
more of the factors responsible for producing that income. Also, cost
of goods sold is now excluded from the business sales activity fraction
apportioning income from Possession Production Sales, because such
costs generally reflect production activity. Production activity is
already represented in the formula by the one-half of the taxpayer's
income apportioned according to the location of production assets.
The final regulations provide explicit guidance for attributing
business sales activity between the United States and a possession. In
attributing business sales activity between the United States and a
possession, expenses are allocated and apportioned between the United
States and a possession based on the rules in Secs. 1.861-8 through
1.861-14T. Gross sales are allocated to the United States or a
possession based on the place of sale.
The final regulations make the IFP method elective, and thus
eliminate any bias against taxpayers choosing to export through
independent distributors. The regulations rely upon the regulations
under Sec. 1.863-3 for rules in applying the IFP method.
The final regulations permit taxpayers to request permission from
the District Director to use their books and records to determine the
source of their income. The final regulations refer to Sec. 1.863-
3(b)(3) in applying the method to Possession Production Sales.
b. Property purchased and sold. Paragraph (f)(3)(i)(A) makes the
business activity method the general rule to apportion income between
the United States and a possession, from sales of property purchased in
a possession and sold in the United States (Possession Purchase Sales).
The taxpayer may, however, elect to apply, with consent of the District
Director, the books and records method.
The final regulations apportion the taxpayer's income from
Possession Purchase Sales on the basis of a business activity fraction.
The portion of this income that is possession source income is
determined by multiplying the income by a fraction, the numerator being
the business of the taxpayer in the possession, and the denominator
being the business of the taxpayer within the possession and outside
the possession.
[[Page 55022]]
The remaining income is sourced in the United States.
The business activity fraction is similar to the business sales
activity fraction discussed previously, used to apportion the
taxpayer's income in Possession Production Sales, except that the
fraction applies only to expenses, cost of goods sold, and sales
attributable to Possession Purchase Sales. In addition, the business
activity fraction apportioning Possession Purchase Sales includes
amounts paid for cost of goods sold. Such costs are attributed to the
possession, however, only to the extent the property purchased is
manufactured, produced, grown, or extracted in the possession. Treasury
and the Internal Revenue Service anticipate that if a taxpayer acts in
the reasonable belief that the products were manufactured in the
possession, the taxpayer could act on that basis in preparing its tax
return. The business activity fraction reflects the view of Treasury
and the IRS that the purchase rule of section 863(b)(3) was intended to
apply only to purchase and resale transactions where the goods
purchased are created or derived from the possession.
The final regulations permit taxpayers to request permission from
the District Director to use their books and records to determine the
source of their income. The proposed regulations refer to Sec. 1.863-
3(b)(3) in applying the method to Possession Purchase Sales.
2. Determination of Source of Gross Income
Under the final regulations, once gross income attributable to
production activity, business activity, or sales activity has been
determined under one of the prescribed methods, the source of the gross
income is determined separately for each type of income. The source of
gross income attributable to production activity (when applying the
possession 50/50 method) is determined under paragraph (c)(1), based on
the location of production assets. The source of gross income
attributable to sales activity (when applying the IFP method or the
books and records method) is determined under paragraph (c)(2), based
generally on the location of the sale. The source of gross income
attributable to business sales activity (when applying the possession
50/50 method) is determined under paragraph (f)(2)(ii)(B), based on
expenses and gross sales attributable to Possession Production Sales.
The source of gross income attributable to business activity (when
applying the business activity method) is determined under paragraph
(f)(3)(ii), based on expenses, cost of goods sold, and gross sales
attributable to Possession Purchase Sales.
3. Determination of Source of Taxable Income
Once the source of gross income is determined under paragraph
(f)(2) or (3), taxpayers then determine the source of taxable income.
Under paragraph (f)(4), taxpayers must allocate and apportion under
Secs. 1.861-8 through 1.861-14T the amounts of expenses, losses and
other deductions to gross income determined under each of the
prescribed methods. In the case of amounts of expenses, losses and
other deductions allocated and apportioned to gross income determined
under the IFP method or the books and records method, the taxpayer must
apply the rules of Secs. 1.861-8 through 1.861-14T to allocate and
apportion these amounts between gross income from sources within the
United States and within a possession. However, for expenses, losses
and other deductions allocated and apportioned to gross income
determined under the possessions 50/50 method or gross income from
Possession Purchase Sales determined under the business activity
method, taxpayers must apportion expenses and other deductions pro rata
based on the relative amounts of U.S. and possession source gross
income. Nevertheless, the research and experimental (R&E) expense
allocation rules in Sec. 1.861-17 apply to taxpayers using the 50/50
method, so that the R&E set aside (described in Sec. 1.861-17) remains
available to such taxpayers.
4. Treatment of Gross Income Derived From Certain Purchases From a
Corporation That Has an Election in Effect Under Section 936.
The final regulations clarify that section 863 does not apply to
determine the source of a taxpayer's gross income derived from a
purchase of inventory from a corporation that has an election in effect
under section 936, if the taxpayer's income from sales of that
inventory is taken into account to determine benefits under section
936(h)(5)(C) for the section 936 corporation.
5. Treatment of Partners and Partnerships
The final regulations rely on the rules in Sec. 1.863-3(g) for
determining the appropriate treatment in transactions involving
partnerships. Under those rules, the aggregate approach applies to a
partnership's production and sales activity for two purposes only.
First, the aggregate approach applies in determining the character of a
partner's distributive share of partnership income. Second, the
aggregate approach applies in sourcing income from sales of inventory
property that is transferred in-kind from or to a partnership.
6. Election and Reporting Rules
Under paragraph (f)(6)(i) of the final regulations, a taxpayer must
use the 50/50 method to determine the source of income from Possession
Production Sales unless the taxpayer elects to use the IFP method, or
elects the books and records method. For Possession Purchase Sales, a
taxpayer must use the business activity method, unless the taxpayer
elects the books and records method. The taxpayer makes an election by
using the method on its timely filed original tax return. That method
must be used in later taxable years unless the Commissioner or his
delegate consents to a change. Permission to change methods in later
years will be granted unless the change would result in a substantial
distortion of the source of income.
A taxpayer must fully explain the methodology used in applying
either paragraph (f)(2) or (3), and the amount of income allocated or
apportioned to U.S. and foreign sources, in a statement attached to its
tax return.
II. Income Derived From Certain Purchases From a Corporation That Has
an Election in Effect Under Section 936
These regulations clarify that, where a taxpayer purchases a
product from a corporation that has an election in effect under section
936, the source of the taxpayer's gross income derived from sales of
that product (in whatever form sold) in the United States is U.S.
source, if the taxpayer's income from sales of that product is taken
into account to determine benefits under section 936(h)(5)(C)(i) for
the section 936 corporation. The taxpayer's income is U.S. source
without regard to whether a possession product is a component, end-
product form, or integrated product. No inference should be drawn
concerning the treatment of transactions involving sales of property
purchased from a section 936 corporation entered into before the
regulations are applicable.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It is hereby certified that
these regulations will not have a significant economic impact on a
substantial number of small entities. This certification is based on
the fact that the rules of this section principally
[[Page 55023]]
impact large multinationals who pay foreign taxes on substantial
foreign operations and therefore the rules will impact very few small
entities. Moreover, in those few instances where the rules of this
section impact small entities, the economic impact on such entities is
not likely to be significant. Accordingly, a regulatory flexibility
analysis is not required. Pursuant to section 7805(f) of the Internal
Revenue Code, the notice of proposed rulemaking preceding these
regulations was submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
Drafting Information
The principal author of these regulations is Anne Shelburne, Office
of Associate Chief Counsel (International). However, other personnel
from the IRS and Treasury Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
revising the entry for ``Section 1.863-3'', removing the entry for
``Sections 1.936-4 through 1.936-7'' and adding entries in numerical
order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.863-3 also issued under 26 U.S.C. 863(a) and (b), and
26 U.S.C. 936(h).* * *
Section 1.936-4 also issued under 26 U.S.C. 936(h).
Section 1.936-5 also issued under 26 U.S.C. 936(h).
Section 1.936-6 also issued under 26 U.S.C. 863(a) and (b), and
26 U.S.C. 936(h).
Section 1.936-7 also issued under 26 U.S.C. 936(h).* * *
Par. 2. Section 1.863-3 is amended as follows:
1. Paragraph (f) is revised.
2. Paragraph (h) is amended by adding a sentence at the end of the
paragraph.
The revision and addition read as follows:
Sec. 1.863-3 Allocation and apportionment of income from certain sales
of inventory.
* * * * *
(f) Income partly from sources within a possession of the United
States--(1) In general. This paragraph (f) relates to gains, profits,
and income, which are 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 (f) applies to
determine the source of income derived from the sale of inventory
produced (in whole or in part) by the taxpayer within the United States
and sold within a possession, or produced (in whole or in part) by a
taxpayer in a possession and sold within the United States (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 (f) must divide
gross income from Section 863 Possession Sales using one of the methods
described in either paragraph (f)(2)(i) of this section (in the case of
Possession Production Sales) or paragraph (f)(3)(i) of this section (in
the case of Possession Purchase Sales). Once a taxpayer has elected a
method, the taxpayer must separately apply that method to the
applicable category of Section 863 Possession Sales in the United
States and to those in a possession. The source of gross income from
each type of activity must then be determined under either paragraph
(f)(2)(ii) or (3)(ii) of this section, as appropriate. The source of
taxable income from Section 863 Possession Sales is determined under
paragraph (f)(4) of this section. The taxpayer must apply the rules for
computing gross and taxable income by aggregating all Section 863
Possession Sales to which a method in this section applies after
separately applying that method to Section 863 Possession Sales in the
United States and to Section 863 Possession Sales in a possession. This
section does not apply to determine the source of a taxpayer's gross
income derived from a sale of inventory purchased from a corporation
that has an election in effect under section 936, if the taxpayer's
income from sales of that inventory is taken into account to determine
benefits under section 936 for the section 936 corporation. For rules
to be applied to determine the source of such income, see Sec. 1.936-
6(a)(5) Q&A 7a and 1.936-6(b)(1) Q&A 13.
(2) Allocation or apportionment for Possession Production Sales--
(i) Methods for determining the source of gross income for Possession
Production Sales--(A) Possession 50/50 method. Under the possession 50/
50 method, gross income from Possession Production Sales is allocated
between production activity and business sales activity as described in
this paragraph (f)(2)(i)(A). Under the possession 50/50 method, one-
half of the taxpayer's gross income will be considered income
attributable to production activity and the source of that income will
be determined under the rules of paragraph (f)(2)(ii)(A) of this
section. The remaining one-half of such gross income will be considered
income attributable to business sales activity and the source of that
income will be determined under the rules of paragraph (f)(2)(ii)(B) of
this section.
(B) IFP method. In lieu of the possession 50/50 method, a taxpayer
may elect the independent factory price (IFP) method. Under the IFP
method, gross income from Possession Production Sales is allocated to
production activity or sales activity using the IFP method, as
described in paragraph (b)(2) of this section, if an IFP is fairly
established under the rules of paragraph (b)(2) of this section. See
paragraphs (f)(2)(ii)(A) and (C) of this section for rules for
determining the source of gross income attributable to production
activity and sales activity.
(C) Books and records method. A taxpayer may elect to allocate
gross income using the books and records method described in paragraph
(b)(3) of this section, if it has received in advance the permission of
the District Director having audit responsibility over its return. See
paragraph (f)(2)(ii) of this section for rules for determining the
source of gross income.
(ii) Determination of source of gross income from production,
business sales, and sales activity--(A) Gross income attributable to
production activity. The source of gross income from production
activity is determined under the rules of paragraph (c)(1) of this
section, except that the term possession is substituted for foreign
country wherever it appears.
(B) Gross income attributable to business sales activity--(1)
Source of gross income. Gross income from the taxpayer's business sales
activity is sourced in the possession in the same proportion that the
amount of the taxpayer's business sales activity for the taxable year
within the possession bears to the amount of the taxpayer's business
sales activity for the taxable year both within the possession and
outside the possession, with respect to Possession Production Sales.
The remaining income is sourced in the United States.
[[Page 55024]]
(2) Business sales activity. For purposes of this paragraph
(f)(2)(ii)(B), the taxpayer's business sales activity is equal to the
sum of--
(i) The amounts for the taxable period paid for wages, salaries,
and other compensation of employees, and other expenses attributable to
Possession Production Sales (other than amounts that are nondeductible
under section 263A, interest, and research and development); and
(ii) Possession Production Sales for the taxable period.
(3) Location of business sales activity. For purposes of
determining the location of the taxpayer's business activity within a
possession, the following rules apply:
(i) Sales. Receipts from gross sales will be attributed to a
possession under the provisions of paragraph (c)(2) of this section.
(ii) Expenses. Expenses will be attributed to a possession under
the rules of Secs. 1.861-8 through 1.861-14T.
(C) Gross income attributable to sales activity. The source of the
taxpayer's income that is attributable to sales activity, as determined
under the IFP method or the books and records method, will be
determined under the provisions of paragraph (c)(2) of this section.
(3) Allocation or apportionment for Possession Purchase Sales--(i)
Methods for determining the source of gross income for Possession
Purchase Sales--(A) Business activity method. Gross income from
Possession Purchase Sales is allocated in its entirety to the
taxpayer's business activity, and is then apportioned between U.S. and
possession sources under paragraph (f)(3)(ii) of this section.
(B) Books and records method. A taxpayer may elect to allocate
gross income using the books and records method described in paragraph
(b)(3) of this section, subject to the conditions set forth in
paragraph (b)(3) of this section. See paragraph (f)(2)(ii) of this
section for rules for determining the source of gross income.
(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 (f)(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);
(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. Receipts from gross sales will be attributed to a
possession under the provisions of paragraph (c)(2) of this section.
(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 Secs. 1.861-8 through 1.861-14T.
(iii) Examples. The following examples illustrate the rules of
paragraph (f)(3)(ii) of this section relating to the determination of
source of gross income from business activity:
Example 1. (i) 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.
(ii) 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.
Example 2. (i) Assume the same facts as in Example 1, except
that A manufactures X outside the possession.
(ii) 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 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.
(4) Determination of source of taxable income. Once the source of
gross income has been determined under paragraph (f)(2) or (3) of this
section, the taxpayer must properly allocate and apportion separately
under Secs. 1.861-8 through 1.861-14T the amounts of its expenses,
losses, and other deductions to its respective amounts of gross income
from Section 863 Possession Sales determined separately under each
method described in paragraph (f)(2) or (3) of this section. In
addition, if the taxpayer deducts expenses for research and development
under section 174 that may be attributed to its Section 863 Possession
Sales under Sec. 1.861-17, the taxpayer must separately allocate or
apportion expenses, losses, and other deductions to its respective
amounts of gross income from each relevant product category that the
taxpayer uses in applying the rules of Sec. 1.861-17. Thus, in the case
of gross income from Section 863 Possession Sales determined under the
IFP method or books and records method, a taxpayer must apply the rules
of Secs. 1.861-8 through 1.861-14T to properly allocate or apportion
amounts of expenses, losses and other deductions, allocated and
apportioned to such gross income, between gross income from sources
within and without the United States. However, in the case of gross
income from Possession Production Sales determined under the
possessions 50/50 method or gross income from Possession Purchase Sales
computed under the business activity method, the amounts of expenses,
losses, and other deductions allocated and apportioned to such gross
income must be apportioned between sources within and without the
United States pro rata based on the relative amounts of gross income
from sources within and without the United States determined under
those methods, except that the rules regarding the allocation and
apportionment of research and experimental expenditures in Sec. 1.861-
17 shall apply to such expenditures of taxpayers using the 50/50
method.
(5) Special rules for partnerships. In applying the rules of this
paragraph (f) to transactions involving partners and partnerships, the
rules of paragraph (g) of this section apply.
(6) Election and reporting rules--(i) Elections under paragraph
(f)(2) or (3) of this section. If a taxpayer does not elect one of the
methods specified in
[[Page 55025]]
paragraph (f)(2) or (3) of this section, the taxpayer must apply the
possession 50/50 method in the case of Possession Production Sales or
the business activity method in the case of Possession Purchase Sales.
The taxpayer may elect to apply a method specified in either paragraph
(f)(2) or (3) of this section by using the method on a timely filed
original return (including extensions). Once a method has been used,
that method must be used in later taxable years unless the Commissioner
consents to a change. Permission to change methods from one year to
another year will be granted unless the change would result in a
substantial distortion of the source of the taxpayer's income.
(ii) Disclosure on tax return. A taxpayer who uses one of the
methods described in paragraph (f)(2) or (3) of this section must fully
explain in a statement attached to the tax return the methodology used,
the circumstances justifying use of that methodology, the extent that
sales are aggregated, and the amount of income so allocated.
* * * * *
(h) Effective dates. * * * However, the rules of paragraph (f) of
this section apply to taxable years beginning on or after November 13,
1998.
Par. 3. In Sec. 1.936-6, paragraph (a)(5) Q&A 7a is added to read
as follows:
Sec. 1.936-6 Intangible property income when an election out is made:
Cost sharing and profit split options; covered intangibles.
* * * * *
(a) * * *
(5) * * *
Q.7a: What is the source of the taxpayer's gross income derived
from a sale in the United States of a possession product purchased by
the taxpayer (or an affiliate) from a corporation that has an election
in effect under section 936, if the income from such sale is taken into
account to determine benefits under cost sharing for the section 936
corporation? Is the result different if the taxpayer (or an affiliate)
derives gross income from a sale in the United States of an integrated
product incorporating a possession product purchased by the taxpayer
(or an affiliate) from the section 936 corporation, if the taxpayer (or
an affiliate) processes the possession product or an excluded component
in the United States?
A.7a: Under either scenario, the income is U.S. source, without
regard to whether the possession product is a component, end-product,
or integrated product. Section 863 does not apply in determining the
source of the taxpayer's income. This Q&A 7a is applicable for taxable
years beginning on or after November 13, 1998.
* * * * *
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 4. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 5. In Sec. 602.101, paragraph (c) is amended in the table by
revising the entry for 1.863-3 to read as follows:
Sec. 602.101 OMB Control numbers.
* * * * *
(c) * * *
------------------------------------------------------------------------
Current OMB
identified
CFR part or section where and
described
control No.
------------------------------------------------------------------------
* * * * *
1.863-3.................................................... 1545-1476
1545-1556
* * * * *
------------------------------------------------------------------------
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
Approved: September 18, 1998.
Donald C. Lubick,
Assistant Secretary of the Treasury for Tax Policy.
[FR Doc. 98-27395 Filed 10-13-98; 8:45 am]
BILLING CODE 4830-01-U
