Final Regulations modify sourcing rules

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October 2020

Overview

Treasury and the IRS on September 29 released Final regulations (the Final Regulations) under Sections 863, 865, 937, and 1502.  

The Final Regulations generally adopt the rules for determining source of income from the sales of manufactured inventory property under Section 863(b) has not been set forth in the proposed regulations issued in December of 2019 (the Proposed Regulations), but with various modifications. These changes include incorporating certain principles of the Section 954(d) foreign base company sales income rules for purposes of defining production activities and expanding the anti-abuse rule.  

The Final Regulations also retain the approach in the Proposed Regulations for determining the source of income from sales of property by nonresidents attributable to an office or fixed place of business in the United States under Section 865(e)(2), but add rules with respect to the use of the books and records method for purposes of determining the portion of gross income from sales attributable to the US office or fixed place of business. Other revisions in the Final Regulations include clarifying the treatment of certain foreign source income as effectively connected with the conduct of a trade or business within the United States. 

The Final Regulations generally apply to tax years ending after December 23, 2019, but taxpayers can apply the Final Regulations to tax years beginning after December 31, 2017, so long as they apply the regulations in their entirety and consistently.

The takeaway

The Final Regulations provide important guidance for taxpayers with cross-border supply chains, particularly those that manufacture inventory outside the United States for sale into the United States as well as foreign corporations where a US office materially participates in the sale. 

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Doug McHoney

International Tax Services Leader, PwC US

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