Proposed Regulations Issued on Source of Income for Certain Sales of Personal Property

The Treasury Department and Internal Revenue Service recently released proposed regulations (REG-100956-19) that modify the rules for determining the source of income from sales of inventory produced within the United States and sold outside of the United States. The rules are important to both U.S. residents and non-residents.

Residents

Section 863 provides rules for determining the source of income, including income derived from sales of inventory produced partly within and partly outside of the United States.

Before the Tax Cuts and Jobs Act 2017 (TCJA), the 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 abroad, or vice versa, would be treated as derived partly from sources within and partly from sources outside of the United States. However, the pre-TCJA rules did not provide the basis for such allocation or apportionment.

The TCJA amended Section 863 to allocate or apportion income from Section 863 sales based solely on production activities. The new rules represent significant change especially for U.S. taxpayers operating in a cross-border environment. Thus, the income from the sale or exchange of inventory property is now allocated based only on production activities with respect to that inventory.

Non-residents

The regulations propose 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 nonresidents maintain in the United States. Moreover, regulations introduce a change to the rules for determining whether foreign-source income is effectively connected with the conduct of a trade or business within the United States. For instance, the regulations adopt the “50/50 method” as the default rule for allocating income from IRC Section 865(e)(2) – sales between sales and production activities – but permit taxpayers to elect to use a modified “books and record” method.

Conclusion

Federal Register published proposed regulations on December 30, 2019. The proposed regulations apply to tax years ending on or after December 23, 2019. Additionally, taxpayers have an option to rely on the rules in the proposed regulations for tax years beginning after December 31, 2017.

The application of the proposed regulations could change the amount of foreign-source income and the amount of foreign tax credits. The taxpayers should assess the impact of the proposed regulations changes to determine if they should be applied before regulations are finalized.

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