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[Federal Register Volume 90, Number 8 (Tuesday, January 14, 2025)]
[Rules and Regulations]
[Pages 2977-3003]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-31372]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 10022]
RIN 1545-BM41

Classification of Digital Content Transactions and Cloud 
Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations modifying the rules 
for classifying transactions involving computer programs, including by 
applying the rules to transfers of digital content. These final 
regulations also provide rules for the classification of cloud 
transactions. These rules apply for purposes of the international 
provisions of the Internal Revenue Code and generally affect taxpayers 
engaging in transactions involving digital content or cloud 
transactions.

DATES: 
    Effective date: These regulations are effective on January 14, 
2025.
    Applicability date: For dates of applicability, see Sec. Sec.  
1.861-18(i) and 1.861-19(e).

FOR FURTHER INFORMATION CONTACT: Christopher E. Fulle, (202) 317-5367, 
or Michelle L. Ng, (202) 317-6989 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Authority

    These final regulations are issued under the express delegation of 
authority under section 7805 of the Internal Revenue Code (Code). 
Section 7805(a) directs the Secretary of the Treasury or her delegate 
to prescribe all needful rules and regulations for the enforcement of 
that section and others in the Code, including all rules and 
regulations as may be necessary by reason of any alteration of law in 
relation to internal revenue.

Background

    On August 14, 2019, the Department of the Treasury (Treasury 
Department) and the Internal Revenue Service (IRS) published proposed 
regulations (REG-130700-14) under section 861 of the Code in the 
Federal Register (84 FR 40317) (the proposed regulations). The Treasury 
Department and the IRS received written comments on the proposed 
regulations, and a public hearing was held on February 11, 2020. All 
written comments received in response to the proposed regulations are 
available at www.regulations.gov or upon request. Terms used but not 
defined in this preamble have the meaning provided in these final 
regulations.
    These regulations (the final regulations) extend the classification 
rules in existing Sec.  1.861-18 to transfers of digital content other 
than computer programs and clarify the source of income for certain 
transfers of digital content. The final regulations also clarify the 
classification of transactions involving on-demand network access to 
computing and other similar resources.
    The final regulations retain the overall approach of the proposed 
regulations, with certain revisions discussed in the preamble. The 
preamble also discusses comments received in response to the 
solicitation of comments in the notice of proposed rulemaking.

Summary of Comments and Explanation of Revisions

I. General Classification Issues

A. Replacement of De Minimis Rule With a Predominant Character Rule
    Section 1.861-18(b)(1), as in effect before this Treasury decision, 
described four transactions involving computer programs: the transfer 
of a copyright right, the transfer of a copyrighted article, the 
provision of services for the development or modification of a computer 
program, and the provision of know-how relating to the development of a 
computer program. Section 1.861-18(b)(2) required any transaction that 
consisted of more than one of the transactions described in Sec.  
1.861-18(b)(1) to be treated as separate transactions, unless a 
transaction was de minimis, in which case it would be treated as part 
of another transaction. The proposed regulations generally retained the 
four types of transactions (with the expansions described in Part II.A 
of this Summary of Comments and Explanation of Revisions) and preserved 
the de minimis rule, but for clarification purposes, Sec.  1.861-
18(b)(2) was proposed to be modified by introducing the term

[[Page 2978]]

``arrangement'' and providing that multiple transactions in an 
arrangement generally must be characterized separately.
    Proposed Sec.  1.861-19(b) defined a cloud transaction as a 
transaction through which a person obtains on-demand network access to 
computer hardware, digital content (as defined in proposed Sec.  1.861-
18(a)(3)), or other similar resources, other than on-demand network 
access that is de minimis taking into account the overall arrangement 
and the surrounding facts and circumstances. Similar to proposed Sec.  
1.861-18(b)(2), proposed Sec.  1.861-19(c)(3) required separate 
classification of each transaction comprising an arrangement, except 
that any transaction that was de minimis would be treated as part of 
another transaction rather than being classified separately.
    Comments recommended replacing these rules in proposed Sec. Sec.  
1.861-18(b)(1) and (b)(2), and 1.861-19(c)(3), with a predominant 
character rule, such that a transaction consisting of more than one 
category of transactions described in proposed Sec.  1.861-18(b)(1), or 
a transaction consisting of one or more categories of transactions 
described in both proposed Sec. Sec.  1.861-18(b)(1) and 1.861-19(b), 
would be characterized as only one of those categories of digital 
content transactions or as a cloud transaction in accordance with the 
predominant character of that transaction. As an example of a mixed 
transaction that would be difficult to characterize under the proposed 
regulations, comments pointed to video game business models where the 
customer purchases a copy of the game but primarily plays the video 
game online with other players. As another example, comments pointed to 
software antivirus programs that include code that executes on the 
user's equipment as well as code that is deployed in the cloud to 
detect and capture viruses before they reach the user's equipment. The 
comments argued that the predominant character rule would avoid the 
difficult and burdensome task of determining whether an element is de 
minimis in the context of the overall transaction and allocating income 
from the transaction among the non-de minimis categories as if they 
were separate transactions. The comments also argued that a de minimis 
standard is imprecise, and a predominant character rule that compares 
components of a transaction to determine which component is predominant 
would be much more administrable. Furthermore, one comment suggested 
that a predominant character standard would better align with existing 
Treasury regulations and other authorities, for instance, Sec.  1.954-
1(e)(3), which provides for a predominant character approach in the 
subpart F context. Finally, the comments noted confusion arising from 
the use of the term ``transaction'' to mean two different things in the 
same provision under proposed Sec.  1.861-18(b)(2), and also 
recommended removing the term ``arrangement'' on the grounds that the 
term was unclear, particularly because it was not defined and rarely 
appears in other tax rules.
    The comments recommended that the predominant character of a 
transaction be determined based on the facts and circumstances. 
Comments suggested that the relevant facts may include the overall 
commercial purpose, the taxpayer's treatment for non-tax purposes, the 
relative cost of each component (including the cost of maintaining 
online and offline components), and a comparison of unit prices for 
components sold separately. Comments suggested that the facts and 
circumstances should provide at least a reasonable basis for 
determining the predominant character of the transaction.
    Further, the comments suggested defining a transaction based on the 
facts and circumstances or as an agreement entered into in the ordinary 
course. Several comments suggested that relevant factors for 
determining the scope of a transaction could include the availability 
of separate pricing, the use of separate stock keeping units 
(``SKUs''), and the taxpayer's definition for non-tax purposes.
    The final regulations adopt these comments, in part. The final 
regulations replace the de minimis rule and the concept of an 
arrangement with a predominant character rule, which applies to both 
digital content transactions and cloud transactions. The Treasury 
Department and the IRS agree that, for purposes of the final 
regulations, a transaction with multiple elements (including de minimis 
elements) should be characterized based on the predominant character of 
the transaction. Predominant character rules also exist in other 
regulations for international provisions of the Code, such as foreign-
derived intangible income and subpart F, and thus are familiar to 
taxpayers. See Sec. Sec.  1.250(b)-3(d) and 1.954-1(e)(3). Further, in 
many business models that include both online and offline functionality 
it may be difficult to bifurcate a single transaction into a digital 
content transaction and a cloud transaction. The Treasury Department 
and the IRS expect that bifurcation will remain difficult and may 
increase in difficulty as business models and technology evolve. 
Therefore, Sec.  1.861-18(b)(2) of the final regulations provides that, 
taking into account the overall transaction and the surrounding facts 
and circumstances, a transaction that has multiple elements, one or 
more of which would be a digital content transaction if considered 
separately, is classified in its entirety as a digital content 
transaction under one of the categories described in Sec.  1.861-
18(b)(1) if the predominant character of the transaction is described 
in one of the categories in that paragraph. Section 1.861-19(c)(2) of 
the final regulations provides a corresponding rule for transactions 
that have multiple elements, one or more of which is a cloud 
transaction. Further, the references to ``de minimis'' and 
``arrangement'' are also removed in Sec.  1.861-19(a) of the final 
regulations so that the final regulations define a cloud transaction as 
a transaction through which a person obtains on-demand network access 
to computer hardware, digital content (as defined in Sec.  1.861-
18(a)(2)), or other similar resources.
    The final regulations define a digital content transaction as a 
transaction that constitutes a transfer of digital content or the 
provision of modification or development services or of know-how with 
respect to digital content. See Sec.  1.861-18(b)(1). The final 
regulations do not, however, define the term transaction. The Treasury 
Department and the IRS have concluded that it is not necessary to 
introduce a specialized definition in these regulations because the 
concept is already well-established under general tax principles, case 
law, and existing administrative guidance.
    Section 1.861-18(b)(3) of the final regulations (cross-referenced 
in Sec.  1.861-19(c)(2)) provides a general rule and a special rule for 
determining the predominant character of a transaction that contains 
multiple elements, one or more of which would be a digital content 
transaction or a cloud transaction if considered separately. Under the 
general rule, the predominant character is determined by the primary 
benefit or value received by the customer. If that information is not 
reasonably ascertainable, the special rule provides that the 
predominant character is determined by the primary benefit or value 
received by a typical customer in a substantially similar transaction, 
which is determined by data on how a typical customer uses or accesses 
the digital content. If data on how a typical customer uses or accesses 
the digital content is not available, then all factors indicative of 
the primary benefit or value received by a typical

[[Page 2979]]

customer must be examined, including how the transaction is marketed, 
the relative development costs of each element of the transaction, and 
the relative price paid in an uncontrolled transaction for one or more 
elements compared to the total contract price of the transaction in 
question.
B. Distinction Between Temporary Downloads and Streaming
    One comment requested guidance on ``streaming'' and ``temporary 
downloading'' transactions. The comment expressed the view that whether 
a customer can download digital content should not determine whether a 
transaction is characterized as a service or a lease. The comment noted 
that when a customer's rights are limited to downloading and viewing a 
discrete item of digital content, such as a movie, for a limited time, 
the transaction would be treated as a lease of digital content. 
However, if the customer can access and download as many movies as 
desired from a catalog of thousands of movies for a monthly fee, and 
once the subscription ends access to the downloaded movies ends, the 
transaction would be treated as a cloud transaction and classified as a 
service according to the comment. The comment suggested that the 
characterization of these two transactions should not depend on whether 
the content is actually downloaded by any particular customer.
    Another comment asserted that on-demand access to digital content 
should not be treated differently than temporary downloads of digital 
content because the two transactions are functionally equivalent in 
that both provide temporary access to digital content. The comment 
observed that the decision to provide on-demand access or temporary 
downloads of digital content is typically driven by the nature of the 
technology involved (for example, the memory capacity of a user's 
computer or the download speeds available), and generally has no 
bearing on the economic substance of the transaction.
    Where the provider chooses whether to offer either temporary 
downloads or streaming the Treasury Department and the IRS disagree 
that these two types of transactions should be treated the same. A 
fundamental requirement of a digital content transaction, unlike a 
cloud transaction involving digital content, is that there must be a 
transfer of digital content to the customer. This distinction between 
property and services transactions has been in place since the original 
issuance of Sec.  1.861-18 in 1998 and applying it consistently 
provides a degree of certainty for an otherwise factual case-by-case 
determination.
    When a customer downloads digital content, there is a transfer of a 
copy of that digital content to the customer and the customer must use 
its own device to host the copy of content for viewing or listening, 
for example. In contrast, when a customer streams digital content, 
there is no transfer of digital content. Instead, the customer receives 
access to the digital content through the provider's servers. 
Especially for large file-size content, performing the hosting function 
in order to allow the customer continuous access places a higher burden 
on the provider. Similarly, for a temporary download, the customer must 
have sufficient storage on its device for the temporary download that 
is not necessary in a streaming transaction. There are also differences 
in how the customer may experience the digital content. For example, 
once a customer downloads digital content, the customer is able to 
access the content regardless of whether the customer is connected to 
the internet and could thus watch a downloaded movie or read a 
downloaded book when the customer is unable to connect to the internet. 
In these ways, there are fundamental differences in character between a 
temporary download and streaming that warrant different 
characterization and sourcing rules for each type of transaction. Where 
the customer may choose whether to temporarily download or stream 
content, the predominant character rule in the final regulations would 
apply to characterize the transaction. See Sec.  1.861-19(d)(7) 
(Example 7) and (d)(9) (Example 9) of the final regulations.

II. Transactions Involving Digital Content

A. Definition of Digital Content
    Section 1.861-18, as in effect before this Treasury decision, 
applied only to computer programs. The proposed regulations expanded 
the scope of Sec.  1.861-18 to apply to transactions involving 
``digital content,'' defined as ``a computer program or any other 
content in digital format that is either protected by copyright law or 
no longer protected by copyright law solely due to the passage of 
time.''
    Several comments recommended broadening the definition of digital 
content to encompass content not protected by copyright law that is 
transferred electronically and is similar to copyrightable content, 
such as consumer or user data, text files of recipes, government-
produced documents, and sets of font and typefaces. One comment 
suggested expansion to any property in digital format in which a person 
has a right or interest, including any property bought and sold in real 
marketplaces, in virtual marketplaces and in in-game economies. These 
comments generally suggested that transfers of this non-copyrightable 
digital property are economically and functionally equivalent to the 
transfer of digital content and that characterization of the transfers 
should be treated the same. One comment asserted that such content may 
be subject to other forms of intellectual property protection such as 
contractual restrictions and non-disclosure agreements, such that 
transfers of that content are functionally similar to transfers of 
digital content.
    The final regulations do not broaden the definition of digital 
content beyond content protectable by copyright law. Section 1.861-18, 
as in effect before this Treasury decision, generally followed 
copyright law, and the Treasury Department and the IRS are of the view 
that it is appropriate to continue to apply this longstanding copyright 
law framework. This framework is not workable for non-copyrightable 
content given that the legal rights associated with such content 
generally are not the same as those associated with content protectable 
by copyright law. For example, in a digital transfer of property that 
is not protected by copyright law, the transferee may (unless otherwise 
restricted, such as by contract) have the unfettered ability to make 
and distribute copies to the public, to prepare derivative works, or to 
publicly display or publicly perform the property. As a result, if the 
framework of Sec.  1.861-18 were applied to the transaction, such a 
transfer would generally be characterized as a license or sale of a 
copyright right, regardless of whether the transferee intends to 
exploit those abilities or whether those powers have any value or 
relevance in the context of the transaction. Therefore, the existing 
framework could result in a classification at odds with the economics 
and reality of the transaction. Further, where non-copyrightable 
digital property is transferred subject to contractual or other 
restrictions, those restrictions may not fit cleanly within the 
existing framework and may require a different analysis to determine 
the correct characterization. Accordingly, including non-copyrightable 
content would require a different set of rules that are beyond the 
scope of Sec.  1.861-18.
    One comment noted that under the proposed regulations, an online 
database that allows customers on-demand access to a collection of non-

[[Page 2980]]

copyrightable content such as recipes or court opinions is a cloud 
transaction. See Sec.  1.861-19(d)(8) (Example 8). This is because the 
definition of a cloud transaction in proposed Sec.  1.861-19(b) refers 
to on-demand network access to computer hardware, digital content, or 
``other similar resources.'' The comment suggested that the inclusion 
of ``other similar resources'' in the definition of cloud transaction 
may provide a road map for expanding the definition of digital content 
in proposed Sec.  1.861-18. The Treasury Department and the IRS 
disagree. The cloud transaction definition includes access to non-
copyrightable content because curation of such content is a common 
business model that, unlike the framework of Sec.  1.861-18, does not 
depend on whether the content is copyrightable because there is no 
transfer to the customer.
    The final regulations therefore do not adopt these comments and 
continue to characterize digital content transactions based on the 
distinction between a transfer of a copyrighted article and a transfer 
of copyright rights, which depends on whether the customer receives 
copyright rights as part of the transfer. The Treasury Department and 
the IRS may, however, consider these comments for possible future 
guidance specific to types of digital property that are not protectable 
by copyright law. The final regulations do provide, however, that 
digital content includes content that is not protected by copyright law 
solely because the creator dedicated the content to the public domain. 
The regulations include this refinement because monetization of such 
content generally also involves digital content that is protected by 
copyright law and therefore fits within the framework of Sec.  1.861-
18. See Sec.  1.861-18(a)(2).
B. Provision of Know-How Relating To Development of Digital Content
    Section 1.861-18(b)(1)(iv), as in effect before this Treasury 
decision, provided that one of the categories of transactions relating 
to computer programs was ``[t]he provision of know-how relating to 
computer programming techniques.'' Section 1.861-18(e) provided that 
the provision of information with respect to computer programs will be 
treated as the provision of know-how for purposes of Sec.  1.861-18 
only if the information (1) relates to computer programming techniques; 
(2) is furnished under conditions preventing unauthorized disclosure, 
specifically contracted for between the parties; and (3) is considered 
property subject to trade secret protection. The proposed regulations 
would modify Sec.  1.861-18(b)(1)(iv) and (e)(1) by replacing 
``computer programming techniques'' with ``development of digital 
content,'' but would not otherwise change Sec.  1.861-18(b)(1)(iv) and 
(e)(1).
    One comment asked for confirmation that the changes to Sec.  1.861-
18(b)(1)(iv) and (e)(1) would not change the scope of Sec.  1.861-
18(b)(1)(iv), and that Sec.  1.861-18(b)(1)(iv) in the final 
regulations describes only know-how transferred under terms that 
constitute a license for United States Federal tax purposes. The 
Treasury Department and the IRS confirm that Sec.  1.861-18(b)(1)(iv) 
in the proposed and final regulations is intended to describe the same 
type of know-how covered by Sec.  1.861-18(b)(1)(iv) as in effect 
before this Treasury decision, except that know-how may relate to any 
development of digital content and not merely computer programming 
techniques. The Treasury Department and the IRS have determined that 
Sec.  1.861-18(b)(1)(iv) and (e)(1) are sufficiently clear in this 
regard and that additional guidance on the treatment of such know-how 
is unnecessary.
C. Rights To Prepare Derivative Digital Content
    Section 1.861-18(c)(2)(ii), as in effect before this Treasury 
decision, provided that one of the copyright rights referred to in that 
paragraph was the right to prepare derivative computer programs based 
upon a copyrighted computer program. The proposed regulations would 
replace the references to computer programs with references to digital 
content but would not otherwise change Sec.  1.861-18(c)(2)(ii). One 
comment recommended that the right to prepare derivative digital 
content based upon digital content should be treated as a copyright 
right only if it is coupled with the right to distribute the derivative 
digital content to the public. The comment expressed the belief that 
this change would be consistent with one of the underlying policies of 
these regulations, which is to treat as a license a transaction in 
which the transferee exercises a copyright right to exploit the rights 
in the market, and to treat as a sale or lease a transaction in which 
the transferee consumes the digital content. The comment also suggested 
that this change would address the ambiguity in copyright law as to 
what modifications of a copyrighted work are necessary to create a 
derivative work, and whether, for example, rights to modify software 
during installation or customization would constitute rights to create 
a derivative work.
    The final regulations do not adopt this comment. The preamble to 
Treasury Decision 8785 (which promulgated Sec.  1.861-18 in 1998) 
stated in response to similar comments to the proposed regulations 
(REG-251520-96) that were finalized in Treasury Decision 8785 that the 
right to make copies (which must be coupled with the right to 
distribute the copies to the public to constitute a copyright right 
under the regulations, despite such a requirement not being present 
under copyright law) is treated differently from the other copyright 
rights in the context of the regulations because of the unique 
characteristics of computer programs, including the ease with which 
computer programs can be copied. However, as explained in that 
preamble, it is generally consistent with copyright law to treat as a 
copyright right a non-de minimis right to make a derivative work, 
regardless of whether it is coupled with the right to distribute to the 
public, and there is no sufficiently unique aspect of digital content 
that would compel a different result for purposes of Sec.  1.861-18. 
The Treasury Department and the IRS continue to be of the view that 
that the right to make a derivative work without further rights to 
distribute to the public should be treated as a copyright right and 
that the unique characteristics of digital content do not compel a 
different result. However, the predominant character rule in Sec.  
1.861-18(b)(2) and (3) of the final regulations (discussed in Part I.A 
of this Summary of Comments and Explanation of Revisions) should 
alleviate concerns about minor customization rights causing what would 
otherwise be a transfer of digital content to be treated as a license 
of a copyright right. See Sec.  1.861-18(h)(18) (Example 18) of the 
final regulations.
D. Right To Make a Public Performance or Public Display for Purposes of 
Advertising
    Section 1.861-18(c)(2), as in effect before this Treasury decision, 
designated as copyright rights the right to make a public performance 
of a computer program and the right to display a computer program to 
the public. The proposed regulations would replace the references to 
computer programs with references to digital content, and also provide 
exceptions for the right to publicly perform or publicly display 
digital content for the purpose of advertising the sale of the digital 
content performed or displayed. Proposed Sec.  1.861-18(c)(2)(iii) and 
(iv). The preamble to the proposed regulations used an example of 
rights provided to a video game retailer that allow the retailer to 
display screenshots of a video game on television commercials promoting 
the game, and

[[Page 2981]]

noted that these rights, on their own, would not be significant. Two 
comments agreed with the addition of the regulatory language and one of 
the comments suggested that the preamble example be included in the 
regulatory text.
    The final regulations retain the exceptions for the public 
performance or public display of digital content for the purpose of 
advertising the sale of the digital content performed or displayed. See 
Sec.  1.861-18(c)(2)(iii) and (iv). The Treasury Department and the IRS 
have determined, however, that the language of the regulation is 
sufficiently clear without an example and therefore the final 
regulations do not include the example in the regulatory text.
E. Copyright Rights Related to Digital Content Used for Cloud 
Transactions
    One comment questioned whether the transfer of the right to use 
software or other digital content for a cloud transaction should be 
treated as the transfer of a copyright right. The comment included an 
example wherein A, a domestic corporation, transfers computer software 
to B, a foreign affiliate. B also gets the right to use the software to 
provide software-as-a-service transactions, but does not get the right 
to sell copies of the software or make derivative works. The comment 
stated that it appears that a copyright right has been transferred in 
this scenario, but that it is not clear which of the enumerated 
copyright rights is transferred. The comment recommend that the final 
regulations allow taxpayers to elect to characterize this type of 
transaction as a transfer of a copyright right.
    The Treasury Department and the IRS agree that a transfer of 
digital content accompanied by the right to use the digital content to 
provide a cloud transaction will generally result in the transfer of 
the right to either publicly display or publicly perform the digital 
content, depending on the type of digital content and specific rights 
transferred. To display a work means to show a copy of it, either 
directly or by means of a film, slide, television image, or any other 
device or process or, in the case of a motion picture or other 
audiovisual work, to show individual images nonsequentially. 17 U.S.C. 
101. To perform a work means to recite, render, play, dance, or act it, 
either directly or by means of any device or process or, in the case of 
a motion picture or other audiovisual work, to show its images in any 
sequence or to make the sounds accompanying it more audible. Id. 
Further, 17 U.S.C. 101 includes a ``transmit clause'' that provides 
that to publicly display or perform a work means, in relevant part, to 
transmit or otherwise communicate a performance or display of the work 
to the public, by means of any device or process, whether the members 
of the public capable of receiving the performance or display receive 
it in the same place or in separate places and at the same time or at 
different times. Reading these provisions of 17 U.S.C. 101, the 
Treasury Department and the IRS have concluded that the use of digital 
content to provide a cloud transaction should be treated as the 
exercise of a copyright right under both copyright law and the final 
regulations. See American Broadcasting Companies, Inc. v. Aereo, Inc., 
573 U.S. 431 (2014) (holding that capture of broadcast copyrighted 
content and retransmission to subscribers who stream the content to 
their personal devices was a public performance of a copyrighted work 
under the transmit clause of 17 U.S.C. 101). However, whether the 
transferred right is a right to display or a right to perform will 
depend on the type of digital content, the type of copyright obtained, 
and the manner in which the digital content is used in the cloud 
transaction. Due to the factual nature of these issues and the 
important role of copyright law in those determinations, the final 
regulations do not specify which copyright right has been transferred 
when digital content is transferred for use in a cloud transaction.
F. Examples Illustrating Sec.  1.861-18
    Several comments requested new examples describing common business 
models or modifications to examples provided in the proposed 
regulations. In response to these comments, the final regulations 
contain several new examples and make certain modifications to the 
examples in the proposed regulations. In addition, pre-existing 
examples that were in effect before the issuance of this Treasury 
decision have been modified to follow the same analytical structure as 
the examples added by the final regulations.
    One comment requested an example of a wholesaler of computer 
software buying and selling a limited number of product keys. A product 
key is a specific software-based key for a computer program that 
certifies the copy of the program is original. Instead of using 
physical media such as a CD or DVD to install software onto a computer 
or other electronic device, a user can enter a product key to download 
the software and then install it from their computer's hard drive. A 
customer that purchases software through electronic channels often 
receives a link to download and a product key to activate the software. 
The comment asserted that an underlying principle of these regulations 
is to treat economically similar income equally, regardless of whether 
the income is earned through electronic means or through more 
conventional channels of commerce, and therefore the income earned by a 
wholesaler of product keys for software should be treated the same as a 
wholesaler of physical copies of software. The Treasury Department and 
the IRS agree that Sec.  1.861-18 does not characterize otherwise 
similar transactions differently solely because one transaction was 
effected through electronic means and the other was not. See Sec.  
1.861-18(g)(2) of the final regulations. In response to the comment, a 
new example added in the final regulations, Sec.  1.861-18(h)(24) 
(Example 24), addresses a business model in which a video game 
copyright owner transfers product keys to retailers, and then the 
retailers transfer those keys to customers. Based on the facts in the 
example, the transfer of product keys to the retailers is characterized 
as a sale of copyrighted articles, and the transfer of product keys 
from the retailers to customers is also classified as the sale of 
copyrighted articles.
    Two comments asked for an example addressing a business model in 
which an operator of a platform offers for download digital content 
(for example, video games or electronic books) as an agent of the 
digital content developers. The platform operator receives the 
copyright right to make and sell digital copies of the digital content, 
but this right is granted only so that the platform operator can act in 
its capacity as an agent facilitating sales of the digital content 
between digital content developers and customers. As such, the comments 
asserted that the transaction between the platform operator and digital 
content developers should not be treated as the transfer of copyright 
rights. One of these comments also suggested several clarifying changes 
to proposed Sec.  1.861-18(h)(19) (Example 19) to distinguish the 
business model described in that example, which involves a licensed 
reseller that utilizes an online platform, from the agency platform 
operator described in the comment.
    The Treasury Department and the IRS recognize that an agency 
platform operator business model exists, and therefore the final 
regulations include a new example at Sec.  1.861-18(h)(20) (Example 20) 
that describes a scenario in which a platform operator offers 
applications for sale as an agent of the

[[Page 2982]]

application developers. The facts in Example 20 assume that the 
platform operator acts as an agent of the application developers under 
general tax principles and concludes that the characterization of the 
transaction between the platform operator and application developers is 
not a digital content transaction nor a cloud transaction. Whether a 
taxpayer is acting as an agent on behalf of another taxpayer is 
determined under general tax principles and that determination is 
outside the scope of these final regulations. Additionally, Sec.  
1.861-18(h)(19) (Example 19) of the final regulations contains certain 
changes to the facts in the proposed regulations that are intended to 
distinguish the licensed reseller platform operator business model 
described in that example from the agency platform operator model 
described in Example 20, namely that the primary benefit or value that 
the distributor (Corp A) receives in the transaction in Example 19 is 
the right to reproduce and distribute an unlimited number of copies of 
the book.
    One comment recommended adding an example describing a business 
model in which a video game that can be played on a particular game 
console or a computer is sold in physical copies through retailers, or 
digitally through the game console's store or through an internet store 
for a one-time fee. The game's core functionality is accessed online 
and, if played on the game console, requires paying an annual or 
monthly subscription fee to the console maker which grants the customer 
access to the online functionality of the console, thereby allowing the 
customer to play the online component of the video game (and all other 
video games) on the console. This fee is charged by the console maker 
for purposes of using the console online, so if the game is played on a 
computer, there is no additional fee to access the online content. The 
example in the comment concluded that the purchase of the console 
version of the video game, whether from a retailer, the game console 
store, or the internet store, is a cloud transaction because most 
customers purchase the game primarily to enjoy the online 
functionality. This comment also recommended another similar example, 
except the core functionality of the video game is offline content, and 
therefore the purchase of the video game is the sale of a copyrighted 
article.
    The comment underscores the fact that there are many different 
business models and types of transactions in the video game industry. 
The determination of the character of each transaction will necessarily 
be fact-specific based on the rights obtained by the customer and, if 
relevant, the predominant character of the transaction. However, to 
address certain aspects of these scenarios, a new example at Sec.  
1.861-18(h)(24) (Example 24) of the final regulations describes the 
purchase of a video game for a one-time fee that has online and offline 
functionality, and that does not require paying a periodic subscription 
fee that is specific to that game to access the online content. 
Additionally, a new example at Sec.  1.861-19(d)(11) (Example 11) of 
the final regulations describes the purchase of a video game for a one-
time fee whose primary functionality is online and requires paying a 
monthly fee to the game developer to access the online content specific 
to the game. The examples conclude in both cases that, under the facts 
presented, a customer's purchase of a game has the predominant 
character of a sale of a copyrighted article. Neither example 
introduces additional complexity by describing a separate subscription 
fee that the customer must pay to a console maker to enable the online 
functionality of the console for all games played on that console. The 
Treasury Department and the IRS have concluded that such a fee would 
not be relevant to determining the character of transactions specific 
to the game itself under the final regulations. Such a fee is more akin 
to the monthly amount that a customer may pay to an internet service 
provider for internet access to play games online in general, because 
the fee is not specific to the game and is instead required to enable 
online functionality on a device that has other functions.
    One comment recommended changes to the facts in Sec.  1.861-
18(h)(19) through (21) (Examples 19 through 21) of the proposed 
regulations, which contained a restriction on the transfer of the 
digital content by limiting the number of devices onto which the 
customer could download the content. Specifically, the comment 
recommended modernizing these examples by replacing the ``limited 
number of devices'' restriction with more general background that 
explains that the user agreement and the conditions and features of the 
provider's website and applications adequately restrict the end-user's 
ability to lend or otherwise transfer the digital content. In Sec.  
1.861-18(h)(19) and (21) (Examples 19 and 21) of the final regulations, 
the restriction on the number of devices is removed, and facts were 
added to make clear that no copyright rights were granted. Proposed 
Sec.  1.861-18(h)(20) (Example 20), which discussed a business that 
offered end-users membership to a catalog of copyrighted music and 
required the end-users to download the songs, was removed from the 
final regulations because the Treasury Department and the IRS 
determined the facts described in the example were unrealistic.

III. Cloud Transactions

A. Classification of Cloud Transactions
    Proposed Sec.  1.861-19(c)(1) would provide that a cloud 
transaction is classified solely as either a lease of property or the 
provision of services, based on all relevant factors. Proposed Sec.  
1.861-19(c)(2) would enumerate a non-exhaustive list of potentially 
relevant factors, most of which come from section 7701(e) of the Code. 
The preamble to the proposed regulations requested comments as to 
whether the classification as either a lease or a service was correct, 
or whether cloud transactions are more properly classified in another 
category of income. The preamble also requested comments on realistic 
examples of cloud transactions that would be treated as leases under 
proposed Sec.  1.861-19.
    Several comments recommended that all cloud transactions be 
classified as services because the commentators could not identify any 
realistic cloud transaction that could be classified as a lease. One 
comment requested that the final regulations include an example of a 
cloud transaction that would be treated as a lease, but did not suggest 
a scenario in which a cloud transaction would be a lease. 
Alternatively, the comments recommended that the final regulations 
include a rebuttable presumption that all cloud transactions are 
classified as services.
    In the absence of a rule stating all cloud transactions are 
services, several comments expressed concerns with, and suggested 
modifications to, certain factors listed in proposed Sec.  1.861-
19(c)(2). For example, some comments suggested that certain factors 
were not relevant for cloud transactions, or would generally weigh 
towards a lease characterization, but that overall, a cloud transaction 
should still be classified as the provision of services. Comments also 
recommended clarifying the treatment as services of related party data 
hosting transactions that involve cost-plus payments from a company 
under common control with the hosting company.
    One comment suggested adding an example that commonly exists in 
practice that is similar to proposed Sec.  1.861-19(d)(2) (Example 2), 
involving the provision of designated servers to

[[Page 2983]]

the customer, but with a shifted focus to analyze the access that a 
remote user may have to data and software on those servers.
    Two comments expressed concerns that the proposed regulations may 
be used to characterize transactions of infrastructure providers, such 
as real estate investment trusts, who lease and otherwise make 
available real property and other infrastructure to cloud providers and 
similar tenants. These comments were concerned that the proposed 
regulations referenced the section 7701(e) factors to determine whether 
a cloud transaction was a service or a lease, and that these 
interpretations could affect the interpretation of the section 7701(e) 
factors in the context of non-cloud transactions.
    The final regulations treat all cloud transactions solely as the 
provision of services and remove the section 7701(e) and other factors 
listed in the proposed regulations. Like the comments, the Treasury 
Department and the IRS could not identify a transaction that satisfies 
the definition of a cloud transaction that would be properly classified 
as a lease. Further, the Treasury Department and the IRS would expect 
future business models that meet the definition of a cloud transaction 
to constitute services rather than leases or other types of 
transactions. The services classification is appropriate because in a 
typical business model that includes a cloud transaction, the cloud 
provider retains economic control and possession over the relevant 
property (such as servers, software, or digital content, depending on 
the transaction) and the cloud transaction meets other hallmarks of a 
service transaction such as the provider having the ability to 
determine the specific property used to provide the cloud transaction 
and to replace such property with similar property. Note, however, that 
business models may include transactions involving computer hardware, 
such as a server, that is located at the customer's premises, and such 
a transaction may fall outside the definition of a cloud transaction 
(for example, because there is no on-demand network access provided in 
that transaction) and would therefore be classified under section 
7701(e) and general tax principles. The Treasury Department and the IRS 
have also concluded that a more definite rule for characterization 
based on the definition of a cloud transaction will allow for better 
compliance and tax administration than the factors test in the proposed 
regulations. Because the final regulations classify all cloud 
transactions as the provision of services, examples applying the 
factors from the proposed regulations to determine whether a cloud 
transaction is a service or a lease have been removed (and no example 
concluding that the cloud transaction is a lease has been added).
    Finally, one comment recommended expanding the characterization of 
cloud transactions to include licenses for transactions in which non-de 
minimis copyright rights are transferred. The comment described an 
example where an owner of digital content (a movie) streams that 
digital content to a movie theater and grants the movie theater the 
right to show the streamed content to customers. The comment concluded 
that the transaction between the content owner and the movie theater is 
a license. The comment expressed the belief that the manner in which 
digital content and accompanying public display or performance rights 
are delivered should not alone change the character of a transaction 
from a license to a service or lease.
    The final regulations do not adopt this comment. In the scenario 
posited by the comment, the movie theater would be much more likely to 
download or otherwise obtain a copy of the movie than to stream the 
movie simultaneously with displaying the movie to customers, given the 
possibility of buffering or other technology issues that might occur 
while streaming and negatively impact the movie theater's customers. 
However, a somewhat similar scenario could occur if a bar or similar 
establishment streams music, sporting events, or other content as 
entertainment for customers eating or drinking at the establishment. 
While the agreement with the streaming service may grant the bar the 
right to perform or to display the streamed content to its customers, 
if there is no transfer of digital content (that is, no option to 
download of digital content), the transaction falls outside the digital 
content rules in Sec.  1.861-18 and may be properly characterized as a 
cloud transaction. Whether there is a transfer of a copyright right 
that is not described in Sec.  1.861-18(c)(2) would depend on copyright 
law. As described in Part I.B of this Summary of Comments and 
Explanation of Revisions, a fundamental requirement for a digital 
content transaction such as a license of copyright rights, as opposed 
to a cloud transaction involving digital content, is that the former 
involves a transfer of the digital content to the customer. If, 
however, the theater or the bar has the choice to download or stream 
the content, then Sec.  1.861-18, including the predominant character 
rule, would apply to the transaction.
B. Inclusion of Common Cloud Business Models
    One comment suggested that the final regulations explicitly include 
as cloud transactions certain common cloud-based business models, 
namely: (1) advertising models where customers obtain ``free'' services 
and advertisers pay for access to those customers; (2) marketplace 
sites and apps that function as sales agents; (3) gig-economy sites and 
apps that put service providers and customers together; (4) job 
recruiting sites and apps that find candidates for employers; (5) 
travel sites and apps that act like sales agents for hotels, flights, 
etc.; and (6) game sites that allow users access to a range of games 
for a subscription price.
    The final regulations do not adopt this comment, though some 
similar examples are included in Sec.  1.861-18(h). Although each of 
the comment's suggested scenarios include services or goods accessed 
through the internet, whether each scenario is a cloud transaction (as 
defined by Sec.  1.861-19(b)) is fact-specific and cannot be determined 
solely on the basis of the type of offering provided. Section 1.861-
19(b) defines a cloud transaction as a transaction through which a 
person obtains on-demand network access to computer hardware, digital 
content (as defined in Sec.  1.861-18(a)(2)), or other similar 
resources. The first scenario, involving customers' ``free'' access to 
content that is funded by advertising, is similar to Sec.  1.861-
18(h)(22) (Example 22) of the final regulations. The example addresses 
the transfer of content to the platform by content creators (a digital 
content transaction) and the access to the content by customers (a 
cloud transaction). However, the example does not address the 
transaction between the advertisers and the platform because while the 
ads are viewable online, the advertising services are likely not cloud 
transactions because there is likely no on-demand network access to 
computer hardware, digital content, or similar resources provided by 
the platform to the advertisers (though specific fact patterns may 
differ). The second scenario, involving marketplace sites and apps that 
function as sales agents, may result in a transaction that has a 
digital content transaction element and a cloud transaction element if 
the marketplace site or app is used to transfer digital content to 
customers. See Sec.  1.861-18(h)(20) (Example 20). Similarly, the sixth 
scenario, involving game sites allowing access to a range of games for 
a subscription price, may require a predominant character analysis to 
determine whether the

[[Page 2984]]

primary benefit to the customer (or a typical customer) is the download 
of games or access to play the games online. See Sec.  1.861-18(h)(24) 
(Example 24). In the remaining scenarios proposed by the comment, the 
website or app may provide a service, but it is likely that the service 
would not be a cloud transaction because the recipient of the service 
does not receive on-demand network access to computer hardware, digital 
content, or similar resources. The framework of the final regulations 
should be applied to the facts of each specific transaction rather than 
making generalizations about broad categories of content offerings.
C. Examples Illustrating Sec.  1.861-19
    Many comments requested modifications to the examples provided in 
proposed Sec.  1.861-19, or new examples describing common business 
models. In response to these comments, the final regulations contain 
several new examples and make certain modifications to the pre-existing 
examples. The final regulations also remove examples illustrating the 
proposed regulations' application of factors to distinguish between the 
characterization of a cloud transaction as a service or a lease because 
the final regulations characterize all cloud transactions as services.
    Proposed Sec.  1.861-19(d)(11) (Example 11) would describe a 
scenario in which a taxpayer operates an online database of industry-
specific materials that utilizes a proprietary search engine. Certain 
materials in the database constitute digital content. The example 
concluded that the taxpayer's provision of on-demand access to its 
computer hardware and software is a cloud transaction. One comment 
requested clarification that the characterization of this transaction 
would not be different if the online database contained no 
copyrightable materials. In the final regulations, the analysis of this 
example (which has been redesignated Sec.  1.861-19(d)(8) (Example 8)) 
explains that the cloud transaction is access to the search engine and 
online database, rather than online access to the digital content, and 
therefore the conclusion that the transaction is a cloud transaction 
would not change if none of the content in the database was 
copyrightable. This conclusion is consistent with Sec.  1.861-19(b)'s 
definition of a cloud transaction as a transaction through which a 
person obtains on-demand network access to computer hardware, digital 
content (as defined in Sec.  1.861-18(a)(2)), or other similar 
resources. In this case, the content accessed would be an ``other 
similar resource.''
    Two comments expressed concern that certain jurisdictions around 
the world treat income earned by a reseller of services, such as 
software-as-a-service, as royalties subject to withholding. These 
comments asked for an example in the final regulations addressing a 
reseller of services that concludes the reseller's income is services 
income. In response to these comments, section 1.861-19(d)(10) (Example 
10) of the final regulations addresses a reseller of software-as-a-
service and concludes the transaction between the reseller and its 
customers is a cloud transaction classified as the provision of 
services.
    Proposed Sec.  1.861-19(d)(9) (Example 9) would describe a scenario 
in which a taxpayer maintains a catalogue of videos and music that it 
streams to customers in exchange for a monthly fee. To better reflect 
current and developing business practices, comments recommended adding 
a fact to this example that customers have the ability to download the 
digital content for offline viewing, and that such ability is de 
minimis in the context of the overall transaction. Proposed Sec.  
1.861-19(d)(9) (Example 9) is redesignated Sec.  1.861-19(d)(7) 
(Example 7) of the final regulations, and the ability to download the 
digital content has been added to the facts in the example. As 
discussed in Part I.A of this Summary of Comments and Explanation of 
Revisions, a predominant character rule in the final regulations 
replaced the de minimis rule in the proposed regulations. Under the 
facts described in Example 7 of the final regulations, the predominant 
character of the transaction is a cloud transaction.

IV. Sourcing Rules

A. Source Rule for Sales of Copyrighted Articles Transferred Through an 
Electronic Medium
1. In General
    Section 1.861-18(f)(2), as in effect before this Treasury decision, 
provided that income from sales of copyrighted articles is sourced 
under sections 861(a)(6), 862(a)(6), 863, 865(a), (b), (c), or (e), as 
appropriate. Proposed Sec.  1.861-18(f)(2)(ii) would provide that when 
a copyrighted article is sold and transferred through an electronic 
medium, the sale is deemed to have occurred at the location of download 
or installation onto the end-user's device used to access the digital 
content for purposes of Sec.  1.861-7(c). If information about the 
location of download or installation was not available, proposed Sec.  
1.861-18(f)(2)(ii) would provide that the sale is deemed to have 
occurred at the location of the customer, as determined based on the 
taxpayer's recorded sales data for business or financial reporting 
purposes.
    Comments observed practical challenges with applying a rule based 
on the location of download or installation, including that: (i) data 
privacy laws may prevent taxpayers from collecting or retaining this 
information, (ii) internet Protocol (IP) addresses may be unreliable 
because virtual private networks may obscure an end-user's IP address, 
(iii) it would be burdensome and expensive for taxpayers to collect new 
data on the location of download or installation, (iv) there may be 
difficulties in determining the location of download or installation 
onto an end-user's device when software is sold through multi-level 
distribution channels, and (v) it may be difficult to identify the end-
user. One comment suggested that the final regulations provide examples 
that illustrate the application of the download test in various 
circumstances.
    Instead of endorsing the proposed rule, most comments addressing 
this topic recommended a rule that uses the billing address of the 
first unrelated purchaser to determine the location of the sale. Some 
comments observed that the billing address of the purchaser is 
information sellers already collect and is a more reliable indicator of 
where the purchaser will use the digital content. Several comments 
suggested that taxpayers be permitted to elect to use the location of 
download or installation instead of the billing address of the 
purchaser if the taxpayer has access to that information. Some comments 
recommended permitting taxpayers to elect to use the location of actual 
use of the digital content, such as when an employer purchases digital 
content that is used by an employee not located in the same 
jurisdiction as the employer.
    Finally, another comment recommended that the rule in Sec.  1.861-
7(c) (which provides that the place of sale is the place where the 
rights, title, and interest of the seller in the property are 
transferred to the buyer (the title passage rule)) should be retained 
for purposes of sourcing sales of copyrighted articles transferred 
through an electronic medium.
    The final regulations adopt these comments in part. Consistent with 
the proposed regulations, Sec.  1.861-18(f)(2)(ii) of the final 
regulations moves away from the ``title passage'' rule for sales of 
copyrighted articles transferred through an electronic medium. One 
reason for the change is that the title passage rule allowed taxpayers 
to artificially elect the source of income from sales of copyrighted 
articles through an

[[Page 2985]]

electronic medium using contractual terms that had no real-world impact 
due to the nature of digital content. A digital download is an almost 
instantaneous transfer that occurs with limited risk of loss; even when 
a file is corrupted in the download or installation process, a 
noncorrupted copy can be provided to the customer at virtually no cost 
to the seller, and the precise location of the corruption is typically 
not relevant. In contrast, a contractual agreement as to when and where 
title passes for physical property moved through physical distribution 
chains has real-world impact because the property may be lost or become 
damaged in transit and the location of title passage determines whether 
the seller or buyer bears the burden of that loss. Because the nature 
of the supply chain means that the seller retains risk of loss until a 
successful download, Sec.  1.861-18(f)(2)(ii) treats the sale as having 
occurred at the customer's location, using the customer's billing 
address as a proxy. The Treasury Department and IRS generally agree 
that a billing address is more administrable than the location of 
download or installation as a suitable proxy for the place of sale of 
electronically transferred copyrighted articles (subject to the anti-
abuse rule discussed below).
    The Treasury Department and IRS disagree, however, that the billing 
address of a subsequent unrelated purchaser of the same copyrighted 
article should be the general rule for sales between related parties, 
given the focus of the statutory sourcing provisions on place of sale. 
See sections 861 through 865. It would also be complex and potentially 
inaccurate to attempt to determine whether every sale is intended for a 
related or unrelated purchaser. Therefore, Sec.  1.861-18(f)(2)(ii) of 
the final regulations provides that when a copyrighted article is sold 
and transferred through an electronic medium, the sale is deemed to 
have occurred at the location of the billing address of the purchaser 
for purposes of Sec.  1.861-7(c), regardless of whether that purchaser 
is a related or unrelated party. This billing address rule also 
resolves the issue raised by comments regarding who the end-user is in 
certain transactions because the sourcing rule is based on the 
immediate purchaser in the transaction. See Sec.  1.861-18(h)(25) 
(Example 25).
    The final regulations also do not provide for an election to treat 
the sale of a copyrighted article as occurring at the location of 
download or installation. As noted earlier in this part, one of the 
reasons for moving away from ``title passage'' for sales of copyrighted 
articles transferred through an electronic medium was that it allowed 
sellers the ability to artificially elect the source of the income. 
Consistent with this concern about electivity, the final regulations 
provide a single, administrable rule that applies to all sales (subject 
to the anti-abuse rule).
    The final regulations also add a new anti-abuse rule for any case 
in which the sales transaction is arranged in a particular manner for a 
principal purpose of tax avoidance. See Sec.  1.861-18(f)(2)(ii) and 
(h)(26) (Example 26). In such cases, the foregoing billing address rule 
will not be applied, and instead all relevant facts and circumstances 
of the transaction will be considered to treat the sale as having 
occurred where the substance of the transaction occurred. This anti-
abuse rule replaces the anti-abuse rule in Sec.  1.861-7(c) with 
respect to sales of copyrighted articles sold and transferred through 
an electronic medium.
    Finally, several comments asked for clarification that this source 
rule applies solely for purposes of the title passage rule of Sec.  
1.861-7(c). The Treasury Department and the IRS have concluded that 
these comments were already addressed in proposed Sec.  1.861-
18(f)(2)(ii) by the language that limited application of the rule ``for 
purposes of Sec.  1.861-7(c),'' and the final regulations retain this 
language.
2. Coordination With Section 863(b)
    Some comments recommended allowing taxpayers to elect to apply a 
billing address source rule for sales of digital content where section 
863(b) may otherwise apply. Section 863(b) provides, in part, that the 
gains, profits, and income from the sale or exchange of inventory 
property produced (in whole or in part) by the 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, shall be 
allocated and apportioned between sources within and without the United 
States solely on the basis of the production activities with respect to 
the property.
    The final regulations do not adopt the comment recommending 
allowing taxpayers to elect to apply a billing address source rule for 
sales of digital content where section 863(b) would apply. When section 
863(b) applies, property produced and sold by a taxpayer must be 
sourced ``solely on the basis of the production activities with respect 
to the property.'' There is nothing to suggest that the billing address 
of the customer is relevant to this statutory rule based on place of 
production, and so the final regulations do not adopt this comment.
3. Interaction With Rules for Sourcing Leases and Licenses of Digital 
Content
    One comment supported the location of download or installation rule 
for determining the place of sale for copyrighted articles, and 
recommended the final regulations explicitly adopt a uniform rule for 
sourcing income from sales, leases, and licenses of digital content 
based on the location of the end-user. The comment also recommended 
allowing taxpayers to rely on recorded sales data to determine the 
location of the end-user for purposes of determining place of use for 
leases and licenses of digital content.
    The final regulations do not adopt this comment. Section 1.861-
18(f)(2)(ii) clarifies how the place of sale of digital content is 
determined for purposes of sections 861 through 865. Those sections 
contain different rules for determining the source of income from 
leases and licenses, for which the place of transfer is not the 
relevant statutory rule (generally, the determination is based on where 
the property subject to the lease or license is used, or where the 
possessor of the interest has the right to use the property). See 
sections 861(a)(4), 862(a)(4). Section 1.861-18(f)(2)(ii) looks to the 
customer's billing address for purposes of determining the place of 
sale for purposes of Sec.  1.861-7(c). While that may sometimes also be 
the location in which the digital content is used, that is not 
necessarily the case. For example, where copyright rights are 
transferred in a transaction that is classified as a license, the 
copyright rights may be used in multiple locations, and not just the 
location of the customer's billing address. Similarly, not all income 
from sales is sourced to the place where the sale occurred. In those 
cases, the statute provides the relevant determination, such as the 
place of production in section 863(b) or the residence of the seller in 
section 865(a). The location of download or installation is not 
necessarily indicative of any of those things, and the Treasury 
Department and the IRS only intend for the rule in Sec.  1.861-
18(f)(2)(ii) to be used to determine the place where the sale occurred 
for purposes of statutory sourcing rules that rely on that 
determination. Therefore, Sec.  1.861-18(f)(2)(ii) of the final 
regulations is not extended to provide a sourcing rule for all sales, 
licenses, and leases of digital content.
    Finally, a comment suggested that the regulations clarify that a 
license of copyright rights from a copyright owner

[[Page 2986]]

to a distributor is sourced under section 861(a)(4) or 862(a)(4). 
Because Sec.  1.861-18(f)(2), as in effect before this Treasury 
decision, already provides that income derived from licensing copyright 
rights is sourced under section 861(a)(4) or 862(a)(4), no changes have 
been made in response to this comment.
B. Source Rule for Gross Income From a Cloud Transaction
    Proposed Sec.  1.861-19 would not provide a source rule for cloud 
transactions. As such, the proposed regulations indicated that existing 
law, regulations, and IRS guidance regarding sourcing services and 
leases would apply to sourcing cloud transactions. Numerous comments 
were received regarding whether a specific source rule for cloud 
transactions would be appropriate and several of these comments 
included suggestions for such a rule.
    The Treasury Department and the IRS are of the view that that there 
would be benefits for taxpayer compliance and administrability if gross 
income from cloud transactions were sourced using a uniform rule. Thus, 
the Treasury Department and the IRS are issuing proposed regulations 
(REG-107420-24) published elsewhere in this same issue of the Federal 
Register that provide rules for determining the source of gross income 
from a cloud transaction.
C. Removal of Example 5 From Sec.  1.937-3(e)
    The proposed regulations would have removed Examples 4 and 5 from 
Sec.  1.937-3(e). Section 937 provides residence and source rules 
involving territories. Examples 4 and 5 of Sec.  1.937-3(e) relate to 
the sourcing of income from digital content transactions and cloud 
transactions, respectively. One comment suggested that the proposal to 
remove Example 5 was premature because the proposed regulations did not 
include a source rule for cloud transactions. The final regulations do 
not accept this comment. As discussed in Part IV.B of this Summary of 
Comments and Explanation of Revisions, the Treasury Department and the 
IRS are issuing a companion notice of proposed rulemaking addressing 
the source of income from cloud transactions concurrent with these 
final regulations. Therefore, to avoid potentially inconsistent 
inferences, the final regulations remove both Examples 4 and 5 of Sec.  
1.937-3(e).

V. Comments Outside the Scope of This Treasury Decision

    The preamble to Treasury Decision 8785, which promulgated Sec.  
1.861-18 in 1998, stated that the Treasury Department and the IRS were 
considering whether to issue guidance regarding whether transactions in 
copyrighted articles are transactions in tangible property, and whether 
transactions in copyright rights are transactions in intangible 
property, in each case for purposes of section 482. The proposed 
regulations did not contain further guidance on this topic.
    One comment to the proposed regulations recommended that the 
Treasury Department and the IRS reconsider this matter and issue 
guidance on this topic because the characterization of a transfer of 
digital content as tangible or intangible property is important for 
purposes of sections 250, 367(d), and 482. The Treasury Department and 
IRS have determined that guidance on whether the categories of 
transactions in Sec.  1.861-18 are considered tangible or intangible 
property for purposes of such Code sections is outside the scope of 
these regulations.
    One comment suggested that section 904 should be amended as it 
relates to certain sales income earned by U.S. residents to prevent 
``cross-crediting'' of high-taxed income and zero- or low-taxed income 
within the same foreign tax credit basket under section 904(d)(1). The 
comment noted that such ``cross-crediting'' results in the U.S. 
partially or fully bearing the cost of the high tax rates in some 
foreign jurisdictions because a credit related to the high-taxed income 
may offset U.S. tax on the income from low-tax jurisdictions. 
Amendments to section 904 are outside the scope of this Treasury 
Decision.
    Two comments suggested changes to the regulations under section 250 
pertaining to foreign-derived intangible income (FDII). One comment 
requested that the Treasury Department and the IRS introduce a rule 
under Sec.  1.250(b)-4 stating that intangible property used in 
providing a service that is a cloud transaction within the meaning of 
Sec.  1.861-19 is, for purposes of section 250, used at the location of 
the employees engaged in, and tangible property used in, providing the 
cloud transaction service. That comment also suggested adding a de 
minimis rule under Sec.  1.250(b)-4 providing that any de minimis use 
of intangible property is disregarded in a cloud transaction. A second 
comment noted that the characterization of a cloud transaction would 
impact whether income is eligible for the FDII deduction because there 
are different rules for establishing ``foreign use'' for services and 
lease transactions. That comment also suggested that the ``foreign 
use'' rule for intangible property should replicate the rule governing 
foreign use of general property. These comments are outside the scope 
of this Treasury Decision, but were considered in finalizing the 
section 250 regulations. See T.D. 9901 (85 FR 43042, July 15, 2020).

VI. Final Regulations Apply Only for Certain International Provisions 
of the Code

    Section 1.861-18, as in effect before this Treasury decision, 
applied only to certain listed international provisions of the Code. 
When Sec.  1.861-18 was promulgated in 1998, the preamble stated that 
the Treasury Department and the IRS were considering whether the 
principles of Sec.  1.861-18 should apply to other provisions of the 
Code. The proposed regulations retained the scope of Sec.  1.861-18 by 
applying only to certain listed international provisions of the Code, 
although additional sections of the Code were added to the scope of the 
proposed regulations due to changes in law between 1998 and the date of 
the proposed regulations. Proposed Sec.  1.861-19 would also apply only 
to the same listed international provisions of the Code.
    The Treasury Department and the IRS received comments recommending 
expanding the scope of the final regulations to apply for all purposes 
of the Code, particularly with respect to Sec.  1.861-18 for which all 
comments received on this topic recommended expansion to all purposes 
of the Code. Multiple comments expressed that the framework of the 
proposed regulations provides sensible rules and certainty with respect 
to transactions involving digital content. One comment also expressed 
concern that limiting the scope of the final regulations to only 
international provisions of the Code could lead to the same transaction 
being characterized differently depending on which Code section was 
applied. Another comment expressed the belief that both taxpayers and 
the IRS will utilize the guidance in the final regulations by analogy 
even if the final regulations apply only to international provisions of 
the Code, and that it would be better to make it clear that the final 
regulations apply to all provisions of the Code so that taxpayers and 
the IRS will not have to go through the rigors of trying to convince 
the other party that the final regulations are relevant in a particular 
case.
    Unlike Sec.  1.861-18, some comments recommended that Sec.  1.861-
19 not be applied beyond the scope provided in the proposed 
regulations. These comments expressed concern that the

[[Page 2987]]

preamble to Sec.  1.861-19 referenced section 7701(e) (pertaining to 
the treatment of certain contracts as leases rather than service 
contracts), and recommended against any guidance providing that section 
7701(e) could apply throughout the Code, including Subchapter M. One 
comment explained that the extent to which the provision of services 
affects the definition of ``rents from real property'' for real estate 
investment trust purposes is addressed not only in Subchapter M and the 
regulations thereunder, but also in numerous items of IRS sub-
regulatory guidance and private letter rulings specifically 
interpreting Subchapter M. The comments recommended adding an explicit 
disclaimer in the preamble and the text of the final regulations that 
any purported interpretation and application of section 7701(e) 
principles in the final regulations do not apply outside the intended 
scope of the final regulations, and therefore do not apply to lease-
versus-service determinations under other provisions of chapter 1 of 
the Code. As discussed under Part III.A of this Summary of Comments and 
Explanation of Revisions, the final regulations treat all cloud 
transactions as the provision of services, and accordingly remove the 
section 7701(e) factors from the regulatory text.
    More broadly, the Treasury Department and the IRS continue to study 
issues related to applying the final regulations to all provisions of 
the Code. Concurrently with the issuance of the final regulations, the 
Treasury Department and the IRS are issuing a Notice (Notice 2025-6) 
requesting comments regarding issues to consider in deciding whether to 
apply the characterization rules in Sec. Sec.  1.861-18 and 1.861-19, 
as amended and added, respectively, by the final regulations to all 
provisions of the Code.

VII. Change in Method of Accounting

    The proposed regulations would treat a change in method of 
accounting that a taxpayer made in order to comply with the proposed 
regulations as a change initiated by the taxpayer. Accordingly, the 
change in method of accounting would have to be implemented under the 
rules of Sec.  1.446-1(e) and the applicable administrative procedures 
that govern voluntary changes in method of accounting under section 
446(e).
    Two comments suggested that if a taxpayer must change its method of 
accounting in order to comply with the final regulations, then such 
change should be eligible for automatic consent.
    The final regulations do not adopt these comments. The Treasury 
Department and the IRS generally do not anticipate taxpayers needing to 
change methods of accounting as a result of the final regulations. 
Additionally, in light of the aforementioned Notice requesting comments 
on applying the characterization rules in Sec. Sec.  1.861-18 and 
1.861-19, as amended and added, respectively, by the final regulations 
for all purposes of the Code, the Treasury Department and IRS have 
determined that it is important to ensure that any accounting method 
changes due to these regulations are consistent with the appropriate 
treatment of the transactions at issue under all appropriate Code or 
regulation sections.

VIII. Applicability Date

    The proposed regulations were proposed to apply to transactions 
entered into pursuant to contracts entered into in taxable years 
beginning on or after the date of publication of final regulations.
    Comments recommended the final regulations apply to transactions 
entered into in taxable years beginning on or after the date that final 
regulations are published, regardless of the date of the contracts 
pursuant to which such transactions were entered into. One comment 
noted that it would be difficult to trace particular transactions to 
contracts that were entered into in taxable years that begin on or 
after the date of publication of final regulations. Other comments 
noted that the proposed applicability date may result in different 
rules applying to similar transactions of the same taxpayer long after 
these regulations are finalized.
    One comment suggested allowing taxpayers to elect application of 
the final regulations to taxable years ending after the date of 
publication of the proposed regulations. Another comment recommended 
that taxpayers be allowed to elect to apply the final regulations to 
transactions taking place before the effective date of the final 
regulations.
    In response to these comments, the final regulations generally 
apply to taxable years beginning on or after the date of publication of 
this Treasury decision in the Federal Register. However, taxpayers may 
elect to apply all of the rules of the final regulations to taxable 
years beginning on or after August 14, 2019 and all subsequent taxable 
years as long as all related persons (within the meaning of sections 
267(b) and 707(b)) also apply all of the rules of the final regulations 
to taxable years beginning on or after August 14, 2019 and all 
subsequent taxable years, the period of limitations on assessment for 
each taxable year of the taxpayer and all related parties (within the 
meaning of sections 267(b) and 707(b)) is open under section 6501, and 
the taxpayer would not be required under this section to change its 
method of accounting as a result of such election.

Special Analyses

I. Regulatory Planning and Review--Economic Analysis

    Pursuant to the Memorandum of Agreement, Review of Treasury 
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory 
actions issued by the IRS are not subject to the requirements of 
section 6 of Executive Order 12866, as amended. Therefore, a regulatory 
impact assessment is not required.

II. 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 the 
Office of Management and Budget (OMB) before collecting information 
from the public, whether such collection of information is mandatory, 
voluntary, or required to obtain or retain a benefit. An agency may not 
conduct or sponsor, and a person is not required to respond to, a 
collection of information unless it displays a valid control number 
assigned by the Office of Management and Budget.
    The collections of information in these final regulations contain 
reporting and recordkeeping requirements that are necessary to ensure 
the correct classification of digital content transactions and cloud 
transactions. The collections will be used by the IRS for tax 
compliance purposes.
    The final regulation mentions a reporting requirement where a 
taxpayer may be required to change its method of accounting. For PRA 
purposes, Form 3115, Application for Change in Accounting Method, is 
already approved by OMB under Control Numbers 1545-0047 for tax-exempt 
entities, 1545-0074 for individuals, 1545-0123 for business filers and 
1545-0092 for trust and estate filers.
    The recordkeeping requirements include that entities keep records 
of their transactions to substantiate the transaction classification. 
These recordkeeping requirements are considered general tax records 
under Sec.  1.6001-1(e). For PRA purposes, general tax records are 
already approved by OMB under 1545-0047 for tax-exempt entities, 1545-
0074 for individuals, 1545-0123 for business filers and 1545-0092 for 
trust and estate filers.

[[Page 2988]]

    These final regulations are not creating new information 
collections or changing information collections already approved by 
OMB.

III. Regulatory Flexibility Act

    The Regulatory Flexibility Act requires consideration of the 
regulatory impact on small businesses. It is hereby certified that 
these final regulations will not have a significant economic impact on 
a substantial number of small entities within the meaning of section 
601(6) of the Regulatory Flexibility Act (5 U.S.C. chapter 6).
    Although data are not readily available to estimate the number of 
small entities that would be affected by the final regulations, the 
Treasury Department and the IRS project that any economic impact of the 
regulations would be minimal for businesses regardless of size. These 
final regulations generally provide clarification of definitions 
regarding how transactions are classified, and thus are not expected to 
have an impact on burden for large or small businesses. The Treasury 
Department and the IRS project that any economic impact would be small 
because current industry practice is generally consistent with the 
principles underlying the final regulations.

IV. Section 7805(f)

    Pursuant to section 7805(f) of the Code, the proposed regulations 
(REG-130700-14) preceding these final regulations were submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on the impact on small businesses and no comments were 
received.

V. 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. The final 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.

VI. 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 statutes, or preempts State law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive order. The final regulations do not have 
federalism implications, do not impose substantial direct compliance 
costs on State and local governments, and do not preempt State law 
within the meaning of the Executive order.

Drafting Information

    The principal authors of these final regulations are Christopher E. 
Fulle and Michelle L. Ng of the Office of the Associate Chief Counsel 
(International). However, other personnel from the Treasury Department 
and the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, the Treasury Department and the IRS amend 26 CFR part 
1 as follows:

PART 1--INCOME TAXES

0
Paragraph 1.The authority citation for part 1 continues to read in part 
as follows:

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

0
Par. 2. Section 1.861-7 is amended by revising paragraph (c) to read as 
follows:

Sec.  1.861-7   Sale of personal property.

* * * * *
    (c) Country in which sold. For purposes of part I (section 861 and 
following), subchapter N, chapter 1 of the Code, and the regulations 
thereunder, a sale of personal property is consummated at the time 
when, and the place where, the rights, title, and interest of the 
seller in the property are transferred to the buyer. Where bare legal 
title is retained by the seller, the sale shall be deemed to have 
occurred at the time and place of passage to the buyer of beneficial 
ownership and the risk of loss. However, in any case in which the sales 
transaction is arranged in a particular manner for the primary purpose 
of tax avoidance, the foregoing rules will not be applied. In such 
cases, all factors of the transaction, such as negotiations, the 
execution of the agreement, the location of the property, and the place 
of payment, will be considered, and the sale will be treated as having 
been consummated at the place where the substance of the sale occurred. 
For determining the place of sale of copyrighted articles transferred 
through an electronic medium, see Sec.  1.861-18(f)(2)(ii).
* * * * *

0
Par. 3. Section 1.861-18 is amended by:
0
a. Revising the section heading;
0
b. Revising paragraphs (a), (b), (c)(1), (c)(2)(i) through (iv), 
(c)(3), (d), (e), (f)(1) through (3), (g)(2), (g)(3)(i) and (ii), and 
(h) through (j); and
0
c. Removing paragraph (k).
    The revisions read as follows:

Sec.  1.861-18   Classification of, and source of gross income from, 
digital content transactions.

    (a) General--(1) Scope. This section provides rules for classifying 
digital content transactions (as defined in paragraph (b)(1) of this 
section) for purposes of subchapter N of chapter 1 of the Internal 
Revenue Code, sections 59A, 245A, 250, 267A, 367, 404A, 482, 679, 
1059A, chapters 3 and 4, sections 842 and 845 (to the extent involving 
a foreign person), and transfers to foreign trusts not covered by 
section 679.
    (2) Digital content--(i) Digital content defined. For purposes of 
this section, digital content means a computer program or any other 
content, such as books, movies, and music, in digital format that is--
    (A) Protected by copyright law; or
    (B) Not protected by copyright law solely--
    (1) Due to the passage of time; or
    (2) Because the creator dedicated the content to the public domain.
    (ii) Computer program defined. For purposes of this section, a 
computer program is a set of statements or instructions to be used 
directly or indirectly in a computer in order to bring about a certain 
result and includes any media, user manuals, documentation, data base, 
or similar item if the media, user manuals, documentation, data base, 
or other similar item is incidental to the operation of the computer 
program.
    (b) Categories of transactions--(1) General. A transaction that 
constitutes a transfer of digital content, or the provision of services 
or of know-how with respect to digital content (each a digital content 
transaction), is treated as being solely one of the following--
    (i) A transfer of a copyright right in the digital content;
    (ii) A transfer of a copy of the digital content (a copyrighted 
article);
    (iii) The provision of services for the development or modification 
of the digital content; or
    (iv) The provision of know-how relating to development of digital 
content.
    (2) Transaction with multiple elements. Taking into account the

[[Page 2989]]

overall transaction and the surrounding facts and circumstances, a 
transaction that has multiple elements, one or more of which would be a 
digital content transaction if considered separately, is classified in 
its entirety as a digital content transaction under one of the 
categories described in paragraph (b)(1) of this section if the 
predominant character of the transaction is described in one of the 
categories in that paragraph.
    (3) Determination of predominant character--(i) General rule. For 
purposes of paragraph (b)(2) of this section and Sec.  1.861-19(c)(2), 
the predominant character of a transaction is determined by 
ascertaining the primary benefit or value received by the customer in 
the transaction.
    (ii) Special rule. If the primary benefit or value received by the 
customer in the transaction is not reasonably ascertainable, the 
predominant character of a transaction is instead determined by 
ascertaining the primary benefit or value received by a typical 
customer in a substantially similar transaction as determined under 
paragraphs (b)(3)(ii)(A) and (B) of this section.
    (A) The primary benefit or value received by a typical customer is 
determined by data on how a typical customer uses or accesses the 
digital content. See paragraph (h)(17) of this section (Example 17).
    (B) If data described in paragraph (b)(3)(ii)(A) of this section is 
not available, then the predominant character of a transaction subject 
to the special rule in paragraph (b)(3)(ii) of this section is 
determined by examining other factors that are indicative of the 
primary benefit or value received by a typical customer, including the 
following--
    (1) How the transferor or provider markets the transaction;
    (2) The relative development costs to the transferor or provider of 
each element of the transaction; and
    (3) The relative price paid in an uncontrolled transaction for one 
or more elements compared to the total contract price of the 
transaction in question.
    (iii) Identification and development of data. A transferor or 
provider must use reasonable efforts to identify the data specified in 
paragraphs (b)(3)(i) and (ii)(A) of this section, or if necessary, to 
apply the factors relevant to paragraph (b)(3)(ii)(B) of this section. 
However, a transferor or provider is not required to develop any of the 
data specified in those paragraphs that it does not develop in the 
course of business.
    (c) * * *
    (1) Transfers involving transfers of copyright rights. A digital 
content transaction involves a transfer of a copyright right if, as a 
result of the transaction, a person acquires one or more of the rights 
described in paragraphs (c)(2)(i) through (iv) of this section.
    (2) * * *
    (i) The right to make copies of the digital content for purposes of 
distribution to the public by sale or other transfer of ownership, or 
by rental, lease or lending;
    (ii) The right to prepare derivative digital content based upon the 
digital content;
    (iii) The right to make a public performance of digital content, 
other than a right to publicly perform digital content for the purpose 
of advertising the sale of the digital content performed; or
    (iv) The right to publicly display digital content, other than a 
right to publicly display digital content for the purpose of 
advertising the sale of the digital content displayed.
    (3) Copyrighted articles. A copyrighted article includes a copy of 
digital content from which the work can be perceived, reproduced, or 
otherwise communicated, either directly or with the aid of a machine or 
device. The copy of the digital content may be fixed in any medium.
    (d) Provision of services. The determination of whether a 
transaction involving newly developed or modified digital content 
involves the provision of services described in paragraph (b)(1) of 
this section is based on all the facts and circumstances of the 
transaction, including, as appropriate, the intent of the parties (as 
evidenced by their agreement and conduct) as to which party is to own 
the copyright rights in the digital content and how the risks of loss 
are allocated between the parties. See paragraph (h)(15) of this 
section (Example 15).
    (e) Provision of know-how. The provision of information with 
respect to digital content involves the provision of know-how for 
purposes of this section only if the information is--
    (1) Information relating to the development of digital content;
    (2) Furnished under conditions preventing unauthorized disclosure, 
specifically contracted for between the parties; and
    (3) Considered property subject to trade secret protection.
    (f) * * *
    (1) Transfers of copyright rights. The determination of whether a 
transfer of a copyright right is a sale or exchange of property is made 
on the basis of whether, taking into account all facts and 
circumstances, there has been a transfer of all substantial rights in 
the copyright. A transfer of a copyright right that does not constitute 
a sale or exchange because not all substantial rights have been 
transferred will be classified as a license. For this purpose, the 
principles of sections 1222 and 1235 apply. Income derived from the 
sale or exchange of a copyright right will be sourced under section 
865(a), (c), (d), (e), or (h), as appropriate. Income derived from the 
licensing of a copyright right will be sourced under section 861(a)(4) 
or 862(a)(4), as appropriate.
    (2) Transfers of copyrighted articles--(i) Classification. The 
determination of whether a transfer of a copyrighted article is a sale 
or exchange is made on the basis of whether, taking into account all 
facts and circumstances, the benefits and burdens of ownership have 
been transferred. A transfer of a copyrighted article that does not 
constitute a sale or exchange because insufficient benefits and burdens 
of ownership of the copyrighted article have been transferred, such 
that a person other than the transferee is properly treated as the 
owner of the copyrighted article, will be classified as a lease.
    (ii) Source. Income from transactions that are classified as sales 
or exchanges of copyrighted articles will be sourced under section 
861(a)(6), 862(a)(6), 863, or 865(a), (b), (c), or (e), as appropriate. 
When a copyrighted article is sold and transferred through an 
electronic medium, the sale is deemed to have occurred at the location 
of the billing address of the purchaser for purposes of Sec.  1.861-
7(c). However, in any case in which the sales transaction is arranged 
in a particular manner for a principal purpose of tax avoidance, the 
foregoing rules will not be applied. In such a case, all of the facts 
and circumstances relevant to the transaction, such as the place where 
the copyrighted article will be used, the place where negotiations and 
the execution of the agreement occurred, and the terms of the 
agreement, will be considered, and the sale will be treated as having 
occurred where the substance of the sale occurred. Income derived from 
leasing a copyrighted article will be sourced under section 861(a)(4) 
or 862(a)(4), as appropriate.
    (3) Special circumstances of digital content. In connection with 
determinations under this paragraph (f), consideration must be given as 
appropriate to the special characteristics of digital content in 
transactions that take advantage of these characteristics (such as the 
ability to make perfect

[[Page 2990]]

copies at minimal cost). For example, a transaction in which a person 
acquires a copy of digital content on a disk subject to a requirement 
that the disk be destroyed after a specified period is generally the 
equivalent of a transaction subject to a requirement that the disk be 
returned after such period. Similarly, a transaction in which the 
digital content deactivates itself after a specified period is 
generally the equivalent of a transaction subject to a requirement that 
the disk be returned after a specified period.
    (g) * * *
    (2) Means of transfer not to be taken into account. The rules of 
this section shall be applied irrespective of the physical or 
electronic or other medium used to effectuate a digital content 
transaction.
    (3) * * *
    (i) In general. For purposes of paragraph (c)(2)(i) of this 
section, a transferee of digital content shall not be considered to 
have the right to distribute copies of the digital content to the 
public if it is permitted to distribute copies of the digital content 
to only either a related person, or to identified persons who may be 
identified by either name or by legal relationship to the original 
transferee. For purposes of this subparagraph, a related person is a 
person who bears a relationship to the transferee specified in section 
267(b)(3), (10), (11), or (12), or section 707(b)(1)(B). In applying 
section 267(b), 267(f), 707(b)(1)(B), or 1563(a), ``10 percent'' shall 
be substituted for ``50 percent.''
    (ii) Use by individuals. The number of employees of a transferee of 
digital content who are permitted to use the digital content in 
connection with their employment is not relevant for purposes of this 
paragraph (g)(3). In addition, the number of individuals with a 
contractual agreement to provide services to the transferee of digital 
content who are permitted to use the digital content in connection with 
the performance of those services is not relevant for purposes of this 
paragraph (g)(3).
    (h) Examples. The examples in this paragraph (h) illustrate the 
provisions of this section. Unless otherwise specified, assume that 
Corp A is a domestic corporation, the digital content described in each 
example does not contain any online functionality, and all facts in 
each example occur as part of a single transaction.
    (1) Example 1: Sale of a computer program on a disk--(i) Facts. 
Corp A owns the copyright in a computer program, Program X. It copies 
Program X onto disks. The disks are placed in boxes covered with a 
wrapper on which is printed what is generally referred to as a shrink-
wrap license. The license is stated to be perpetual. Under the license 
no reverse engineering, decompilation, or disassembly of the computer 
program is permitted. The transferee receives, first, the right to use 
the program on two of its own computers (for example, a laptop and a 
desktop) provided that only one copy is in use at any one time, and 
second, the right to make one copy of the program on each machine as an 
essential step in the utilization of the program. The transferee is 
permitted by the shrink-wrap license to sell the copy so long as it 
destroys any other copies it has made and imposes the same terms and 
conditions of the license on the purchaser of its copy. These disks are 
made available for sale to the general public in Country Z. In return 
for valuable consideration, P, a Country Z resident, receives one such 
disk.
    (ii) Analysis. (A) Under paragraph (b)(1) of this section, the 
transfer of a disk containing a copy of Program X from Corp A to P is a 
digital content transaction with one element, which is the transfer of 
a copy of Program X. Therefore, the transaction is treated solely as a 
transfer of a copyrighted article under paragraph (b)(1)(ii) of this 
section. Under paragraph (g)(1) of this section, the label license is 
not determinative.
    (B) Taking into account all of the facts and circumstances, P is 
properly treated as the owner of a copyrighted article. Therefore, 
under paragraph (f)(2) of this section, there has been a sale of a 
copyrighted article rather than the grant of a lease.
    (2) Example 2: Sale of a computer program via download from the 
internet--(i) Facts. The facts are the same as those in paragraph 
(h)(1) of this section (Example 1), except that instead of selling 
disks, Corp A decides to make Program X available, for a fee, on a 
World Wide Web home page on the internet. P, the Country Z resident, in 
return for payment made to Corp A, downloads Program X (via modem) onto 
the hard drive of his computer. As part of the electronic 
communication, P signifies his assent to a license agreement with terms 
identical to those in Example 1, except that in this case P may make a 
back-up copy of the program on to a disk.
    (ii) Analysis. (A) Under paragraph (b)(1) of this section, the 
digital transfer of a copy of Program X from Corp A to P is a digital 
content transaction with one element, which is the transfer of a copy 
of Program X. Therefore, the transaction is treated solely as a 
transfer of a copyrighted article under paragraph (b)(1)(ii) of this 
section. Although P did not buy a physical copy of the disk with the 
program on it, paragraph (g)(2) of this section provides that the means 
of transferring the program is irrelevant.
    (B) As in paragraph (h)(1) of this section (Example 1), P is 
properly treated as the owner of a copyrighted article. Therefore, 
under paragraph (f)(2) of this section, there has been a sale of a 
copyrighted article rather than the grant of a lease.
    (3) Example 3: Lease of a computer program with requirement to 
return disk--(i) Facts. The facts are the same as those in paragraph 
(h)(1) of this section (Example 1), except that Corp A only allows P, 
the Country Z resident, to use Program X for one week. At the end of 
that week, P must return the disk with Program X on it to Corp A. P 
must also destroy any copies made of Program X. If P wishes to use 
Program X for a further period he must enter into a new agreement to 
use the program for an additional charge.
    (ii) Analysis. (A) Under paragraph (b)(1) of this section, the 
transfer of a disk with a copy of Program X from Corp A to P is a 
digital content transaction with one element, which is the transfer of 
a copy of Program X. Therefore, the transaction is treated solely as a 
transfer of a copyrighted article under paragraph (b)(1)(ii) of this 
section.
    (B) Taking into account all of the facts and circumstances, P is 
not properly treated as the owner of a copyrighted article. Therefore, 
under paragraph (f)(2) of this section, there has been a lease of a 
copyrighted article rather than a sale. Taking into account the special 
characteristics of digital content as provided in paragraph (f)(3) of 
this section, the result would be the same if P were required to 
destroy the disk at the end of the one-week period instead of returning 
it since Corp A can make additional copies of the program at minimal 
cost.
    (4) Example 4: Lease of a computer program with electronic lock--
(i) Facts. * * *
    (ii) Analysis. (A) Under paragraph (b)(1) of this section, the 
digital transfer of a copy of Program X from Corp A to P is a digital 
content transaction with one element, which is the transfer of a copy 
of Program X. Therefore, the transaction is treated solely as a 
transfer of a copyrighted article under paragraph (b)(1)(ii) of this 
section.
    (B) As in paragraph (h)(3) of this section (Example 3), P is not 
properly treated as the owner of a copyrighted article. Therefore, 
under paragraph (f)(2) of this section, there has been a lease of a 
copyrighted article rather than a sale.

[[Page 2991]]

While P does retain Program X on its computer at the end of the one-
week period, as a legal matter P no longer has the right to use the 
program (without further payment) and, indeed, cannot use the program 
without the electronic key. Functionally, Program X is no longer on the 
hard drive of P's computer. Instead, the hard drive contains only a 
series of numbers which no longer perform the function of Program X. 
Although in Example 3, P was required to physically return the disk, 
taking into account the special characteristics of digital content as 
provided in paragraph (f)(3) of this section, the result in this 
paragraph (h)(4) (Example 4) is the same as in Example 3.
    (5) Example 5: Sale of copyright rights to a computer program--(i) 
Facts. Corp A transfers a disk containing Program X to Corp B, a 
Country Z corporation, and grants Corp B an exclusive license for the 
remaining term of the copyright to copy and distribute an unlimited 
number of copies of Program X in the geographic area of Country Z, 
prepare derivative works based upon Program X, make public performances 
of Program X, and publicly display Program X. Corp B will pay Corp A a 
royalty of $y a year for three years, which is the expected period 
during which Program X will have commercially exploitable value (a 
period shorter than the copyright term). Corp A has ascertained that 
the primary benefit or value from the transaction to Corp B is derived 
from the four legal rights obtained in Program X from Corp A and not 
from the receipt of a copy of Program X. The transfer of a copy of 
Program X is merely the means by which Corp A provides Corp B access to 
Program X in order to exercise its copyright rights.
    (ii) Analysis. (A) The transaction between Corp A and Corp B has 
multiple elements. One element is the transfer of a disk with a copy of 
Program X, which would be a digital content transaction described under 
paragraph (b)(1)(ii) of this section (transfer of a copyrighted 
article) if considered separately. Another element is the grant of the 
right to make an unlimited number of copies of Program X and distribute 
those copies to the public, the right to prepare derivative works based 
upon Program X, the right to make public performances of Program X, and 
the right to publicly display Program X, which would be described under 
paragraphs (b)(1)(i) and (c)(2) of this section (transfer of a 
copyright right) if considered separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a digital content transaction if considered separately, 
paragraph (b)(2) of this section provides that the transaction is 
classified within a single category under paragraph (b)(1) of this 
section if its predominant character is described in that paragraph. 
Pursuant to paragraph (b)(3)(i) of this section, the predominant 
character of the transaction is based on the primary benefit or value 
of the transaction to the customer, if it is reasonably ascertainable. 
The predominant character of this transaction is therefore the transfer 
of copyright rights because the primary benefit or value received by 
Corp B from the transaction is the ability to exercise the copyright 
rights described in paragraph (c)(2) of this section. Therefore, this 
transaction is classified solely as a transfer of copyright rights 
described in paragraph (b)(1)(i) of this section.
    (C) Applying the all substantial rights test under paragraph (f)(1) 
of this section, Corp A will be treated as having sold copyright rights 
to Corp B. Corp B has acquired all of the copyright rights in Program 
X, has received the right to use them exclusively within Country Z, and 
has received the rights for the remaining life of the copyright in 
Program X. The fact the payments cease before the copyright term 
expires is not controlling. Under paragraph (g)(1) of this section, the 
fact that the agreement is labelled a license is not controlling nor is 
the fact that Corp A receives a sum labelled a royalty. (The result in 
this case would be the same if the copy of Program X to be used for the 
purposes of reproduction were transmitted electronically to Corp B, as 
a result of the application of the rule of paragraph (g)(2) of this 
section.)
    (6) Example 6: License of copyright right to make copies of a 
computer program and distribute to the public--(i) Facts. Corp A 
transfers a disk containing Program X to Corp B, a Country Z 
corporation, and grants Corp B the non-exclusive right to reproduce and 
distribute for sale to the public an unlimited number of disks 
containing Program X at its factory in Country Z in return for a 
payment related to the number of disks copied and sold. The term of the 
agreement is two years, which is less than the remaining life of the 
copyright. Corp A has ascertained that the primary benefit or value 
from the transaction to Corp B is derived from the right to reproduce 
and distribute Program X and not from the receipt of a copy of Program 
X. The transfer of a copy of Program X is merely the means by which 
Corp A provides Corp B access to Program X in order to exercise its 
copyright rights.
    (ii) Analysis. (A) The transaction between Corp A and Corp B has 
multiple elements. One element is the transfer of a disk with a copy of 
Program X, which would be described under paragraph (b)(1)(ii) of this 
section (transfer of a copyrighted article) if considered separately. 
Another element is the grant of the right to reproduce and distribute 
for sale to the public an unlimited number of disks containing Program 
X, which would be described under paragraphs (b)(1)(i) and (c)(2)(i) of 
this section (transfer of a copyright right) if considered separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a digital content transaction if considered separately, 
paragraph (b)(2) of this section provides that the transaction is 
classified within a single category under paragraph (b)(1) of this 
section if its predominant character is described in that paragraph. 
Pursuant to paragraph (b)(3) of this section, the predominant character 
of the transaction is based on the primary benefit or value of the 
transaction to the customer, if it is reasonably ascertainable. The 
predominant character of this transaction is therefore the transfer of 
a copyright right because the primary benefit or value received by Corp 
B is the right to reproduce and distribute for sale to the public 
copies of Program X. Therefore, this transaction is classified solely 
as a transfer of copyright rights described in paragraph (b)(1)(i) of 
this section.
    (C) Taking into account all of the facts and circumstances, there 
has been a license of Program X to Corp B. Under paragraph (f)(1) of 
this section, there has not been a transfer of all substantial rights 
in the copyright to Program X because Corp A has the right to enter 
into other licenses with respect to the copyright of Program X, 
including licenses in Country Z (or even to sell that copyright, 
subject to Corp B's interest). Corp B has acquired no right itself to 
license the copyright rights in Program X. Finally, the term of the 
license is for less than the remaining life of the copyright in Program 
X.
    (7) Example 7: Sale of disks containing copies of a computer 
program to a distributor--(i) Facts. Corp C, a distributor, enters into 
an agreement with Corp A to purchase as many copies of Program X on 
disk as it may from time-to-time request. Corp C will then sell these 
disks to retailers. The disks are shipped in boxes covered by shrink-
wrap licenses (identical to the license described in paragraph (h)(1) 
of this section (Example 1)).
    (ii) Analysis. (A) Under paragraph (b)(1) of this section, the 
transfers of

[[Page 2992]]

disks with copies of Program X from Corp A to Corp C are digital 
content transactions with one element, which is the transfer of copies 
of Program X. Therefore, the transactions are classified solely as the 
transfer of copyrighted articles under paragraph (b)(1)(ii) of this 
section. The use of the term license is not dispositive under paragraph 
(g)(1) of this section.
    (B) Taking into account all of the facts and circumstances, Corp C 
is properly treated as the owner of copyrighted articles. Therefore, 
under paragraph (f)(2) of this section, there has been a sale of 
copyrighted articles.
    (8) Example 8: License to a computer manufacturer of copyright 
rights to make and load copies of a computer program onto the hard 
drive of computers--(i) Facts. Corp A transfers a disk containing 
Program X to Corp D, a foreign corporation engaged in the manufacture 
and sale of personal computers in Country Z. Corp A grants Corp D the 
non-exclusive right to copy Program X onto the hard drive of an 
unlimited number of computers, which Corp D manufactures, and to 
distribute those copies (on the hard drive) to the public. The term of 
the agreement is two years, which is less than the remaining life of 
the copyright in Program X. Corp D pays Corp A an amount based on the 
number of copies of Program X it loads on to computers. Corp A has 
ascertained that the primary benefit or value from the transaction to 
Corp D is the ability to copy and distribute Program X onto computers 
manufactured by Corp D, not from the receipt of a copy of Program X. 
The transfer of a copy of Program X is merely the means by which Corp A 
provides Corp D access to Program X in order to exercise its right to 
make and distribute copies.
    (ii) Analysis. (A) The transaction between Corp A and Corp D has 
multiple elements. One element is the transfer of a disk with a copy of 
Program X, which would be described in paragraph (b)(1)(ii) of this 
section (transfer of a copyrighted article) if considered separately. 
Another element is the grant of the non-exclusive right to copy Program 
X onto the hard drive of an unlimited number of computers and 
distribute those copies (on the hard drive) to the public, which would 
be described in paragraphs (b)(1)(i) and (c)(2)(i) of this section 
(transfer of a copyright right) if considered separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a digital content transaction if considered separately, 
paragraph (b)(2) of this section provides that the transaction is 
classified within a single category under paragraph (b)(1) of this 
section if its predominant character is described in that paragraph. 
Pursuant to paragraph (b)(3) of this section, the predominant character 
of the transaction is based on the primary benefit or value of the 
transaction to the customer, if it is reasonably ascertainable. The 
predominant character of this transaction is therefore the transfer of 
copyright rights because the primary benefit or value received by Corp 
D is the right to copy Program X onto the hard drive of an unlimited 
number of computers and sell those copies (on the hard drive) to the 
public. Therefore, this transaction is classified solely as a transfer 
of copyright rights described in paragraph (b)(1)(i) of this section.
    (C) Taking into account all of the facts and circumstances, there 
has been a license of Program X to Corp D. Under paragraph (f)(1) of 
this section, there has not been a transfer of all substantial rights 
in the copyright to Program X because Corp A has the right to enter 
into other licenses with respect to the copyright of Program X, 
including licenses in Country Z (or even to sell that copyright, 
subject to Corp D's interest). Corp D has acquired no right itself to 
license the copyright rights in Program X. Finally, the term of the 
license is for less than the remaining life of the copyright in Program 
X. The result would be the same if Corp D included with the computers 
it sells a copy of Program X on a disk.
    (9) Example 9: Sale of disks containing a copy of computer program 
to a computer manufacturer--(i) Facts. The facts are the same as those 
in paragraph (h)(8) of this section (Example 8), except that Corp D, 
the Country Z corporation, receives physical disks. The disks are 
shipped in boxes covered by shrink-wrap licenses (identical to the 
licenses described in paragraph (h)(1) of this section (Example 1)). 
The terms of these licenses do not permit Corp D to make additional 
copies of Program X. Corp D uses each individual disk only once to load 
a single copy of Program X onto each separate computer. Corp D 
transfers the disk with the computer when it is sold.
    (ii) Analysis. (A) Under paragraph (b)(1) of this section, the 
transfers of disks with copies of Program X from Corp A to Corp D are 
digital content transactions with one element, which is the transfer of 
copies of Program X. Therefore, the transaction is classified solely as 
the transfer of copyrighted articles under paragraph (b)(1)(ii) of this 
section. Corp D acquires the disks without the right to reproduce and 
distribute publicly further copies of Program X.
    (B) Taking into account all of the facts and circumstances, Corp D 
is properly treated as the owner of copyrighted articles. Therefore, 
under paragraph (f)(2) of this section, the transaction is classified 
as the sale of a copyrighted article. The result would be the same if 
Corp D used a single physical disk to copy Program X onto each 
computer, and transferred an unopened box containing Program X with 
each computer, if Corp D were not permitted to copy Program X onto more 
computers than the number of individual copies purchased.
    (10) Example 10: Sale of a computer program with right to load onto 
multiple employee workstations--(i) Facts. Corp A transfers a disk 
containing Program X to Corp E and grants Corp E the right to load 
Program X onto 50 individual workstations for use only by Corp E 
employees at one location in return for a one-time per-user fee 
(generally referred to as a site license or enterprise license). If 
additional workstations are subsequently introduced, Program X may be 
loaded onto those machines for additional one-time per-user fees. The 
license which grants the rights to operate Program X on 50 workstations 
also prohibits Corp E from selling the disk (or any of the 50 copies) 
or reverse engineering the program. The term of the license is stated 
to be perpetual.
    (ii) Analysis. (A) It must be determined whether the transfer from 
Corp A to Corp E of a disk containing a copy of Program X and the right 
to load Program X onto 50 individual workstations is a transaction with 
multiple elements. There is at least one element, which is the transfer 
of a disk containing a copy of Program X, which either is a digital 
content transaction under paragraph (b)(1) of this section or would be 
a digital content transaction if considered separately. If there is no 
additional element, then the transaction is classified as a transfer of 
a copyrighted article pursuant to paragraph (b)(1)(ii) of this section. 
If there is a second element, then paragraph (b)(2) of this section 
applies and the transaction is classified within a single category 
under paragraph (b)(1) of this section if its predominant character is 
described in that paragraph. The grant of a right to copy, 
unaccompanied by the right to distribute those copies to the public, is 
not the transfer of a copyright right described in paragraph (c)(2) of 
this section. Therefore, there is no second element in this transaction 
and it is classified solely as the transfer of

[[Page 2993]]

copyrighted articles (50 copies of Program X).
    (B) Taking into account all of the facts and circumstances, Corp E 
is properly treated as the owner of copyrighted articles. Therefore, 
under paragraph (f)(2) of this section, there has been a sale of 
copyrighted articles rather than the grant of a lease. Notwithstanding 
the restriction on sale, other factors such as, for example, the risk 
of loss and the right to use the copies in perpetuity outweigh, in this 
case, the restrictions placed on the right of alienation.
    (C) The result would be the same if Corp E were permitted to copy 
Program X onto an unlimited number of workstations used by employees of 
either Corp E or other persons that had a relationship to Corp E 
specified in paragraph (g)(3) of this section.
    (11) Example 11: Sale of a computer program with right to make 
available to multiple employees via local area network--(i) Facts. The 
facts are the same as those in paragraph (h)(10) of this section 
(Example 10), except that Corp E, the Country Z corporation, acquires 
the right to make Program X available to workstation users who are Corp 
E employees by way of a local area network (LAN). The number of users 
that can use Program X on the LAN at any one time is limited to 50. 
Corp E pays a one-time fee for the right to have up to 50 employees use 
the program at the same time.
    (ii) Analysis. Under paragraph (g)(2) of this section the mode of 
utilization is irrelevant. Therefore, as in paragraph (h)(10) of this 
section (Example 10), this is a digital content transaction with a 
single element that is classified as the transfer of a copyrighted 
article pursuant to paragraph (b)(1)(ii) of this section. Under the 
benefits and burdens test of paragraph (f)(2) of this section, this 
transaction is a sale of copyrighted articles. The result would be the 
same if an unlimited number of Corp E employees were permitted to use 
Program X on the LAN or if Corp E were permitted to copy Program X onto 
LANs maintained by persons that had a relationship to Corp E specified 
in paragraph (g)(3) of this section.
    (12) Example 12: Lease of a computer program with right to receive 
upgrades and technical support services--(i) Facts. The facts are the 
same as in paragraph (h)(11) of this section (Example 11), except that 
instead of paying a one-time fee, Corp E pays a monthly fee to Corp A 
calculated with reference to the permitted maximum number of users 
(which can be changed) and the computing power of Corp E's server. In 
return for this monthly fee, Corp E receives the right to receive 
upgrades of Program X when they become available. The agreement may be 
terminated by either party at the end of any month. When the disk 
containing the upgrade is received, Corp E must return the disk 
containing the earlier version of Program X to Corp A. If the contract 
is terminated, Corp E must delete (or otherwise destroy) all copies 
made of the current version of Program X. The agreement also requires 
Corp A to provide technical support in the form of troubleshooting and 
configuration assistance to Corp E, but the agreement does not allocate 
the monthly fee between the right to use Program X, the right to 
receive upgrades of Program X, and the technical support services. The 
amount of technical support that Corp A will provide to Corp E is not 
foreseeable when the contract is entered into but is expected to be 
minimal. Corp A has ascertained that the primary benefit or value to 
Corp E from the transaction is the right to use Program X on the LAN 
(without the ability to exercise any of the rights described in 
paragraphs (c)(2)(i) through (iv) of this section), not the receipt of 
technical support services with respect to Program X.
    (ii) Analysis. (A) The transaction between Corp A and Corp E has 
multiple elements. One element is the transfer of a disk with a copy of 
Program X, which would be described in paragraph (b)(1)(ii) of this 
section (transfer of a copyrighted article) if considered separately. 
Another element is the provision of technical support services, which 
are not services for the development or modification of Program X 
described in paragraph (d) of this section because Corp E has received 
no copyright rights with respect to Program X. Thus, the technical 
support services would not be described in any of the categories in 
paragraph (b)(1) of this section if considered separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a digital content transaction if considered separately, 
paragraph (b)(2) of this section provides that the transaction is 
classified within a single category under paragraph (b)(1) of this 
section if its predominant character is described in that paragraph. 
Pursuant to paragraph (b)(3) of this section, the predominant character 
of the transaction is based on the primary benefit or value of the 
transaction to the customer. The predominant character of this 
transaction is therefore the transfer of a copyrighted article because 
the primary benefit or value received by Corp E is the right to use 
Program X. Accordingly, this transaction is classified solely as a 
transfer of a copyrighted article described in paragraph (b)(1)(ii) of 
this section.
    (C) Taking into account all facts and circumstances, under the 
benefits and burdens test Corp E is not properly treated as the owner 
of the copyrighted article. Corp E does not receive the right to use 
Program X in perpetuity, but only for so long as it continues to make 
payments. Corp E does not have the right to purchase Program X on 
advantageous (or, indeed, any) terms once a certain amount of money has 
been paid to Corp A or a certain period has elapsed (which might 
indicate a sale). Once the agreement is terminated, Corp E will no 
longer possess any copies of Program X, current or superseded. 
Therefore, under paragraph (f)(2) of this section there has been a 
lease of a copyrighted article.
    (13) Example 13: Sale of a computer program along with right to 
receive upgrades--(i) Facts. The facts are the same as those in 
paragraph (h)(12) of this section (Example 12), except that, while Corp 
E must return copies of Program X as new upgrades are received, if the 
agreement terminates, Corp E may keep the latest version of Program X 
(although Corp E is still prohibited from selling or otherwise 
transferring any copy of Program X).
    (ii) Analysis. For the reasons stated in paragraph (h)(10)(ii)(B) 
of this section (Example 10), the transfer of the program will be 
treated as a sale of a copyrighted article rather than as a lease.
    (14) Example 14: Sale of a modified computer program--(i) Facts. 
Corp G enters into a contract with Corp A for Corp A to modify Program 
X so that it can be used at Corp G's facility in Country Z. Under the 
contract, Corp G is to acquire one copy of the program on a disk and 
the right to use the program on 5,000 workstations. The contract 
requires Corp A to rewrite elements of Program X so that it will 
conform to Country Z accounting standards and states that Corp A 
retains all copyright rights in the modified Program X. The agreement 
between Corp A and Corp G is otherwise identical as to rights and 
payment terms as the agreement described in paragraph (h)(10) of this 
section (Example 10).
    (ii) Analysis. (A) It must be determined whether the transfer of 
disks with modified copies of Program X from Corp A to Corp G is a 
transaction with multiple elements. There is at least one element, the 
transfer of copies of Program X, which either is a digital content 
transaction under paragraph (b)(1) of this section or would be a 
digital content transaction if considered separately. If there is no 
additional

[[Page 2994]]

element, then the transaction is classified as a transfer of a 
copyrighted article pursuant to paragraph (b)(1)(ii) of this section. 
If there is a second element, then paragraph (b)(2) of this section 
applies and the transaction is classified within a single category 
under paragraph (b)(1) of this section if its predominant character is 
described in that paragraph. Pursuant to paragraph (d) of this section, 
the modifications made by Corp A before transferring Program X to Corp 
G do not constitute the provision of services for the development or 
modification of digital content because Corp A retains all copyright 
rights with respect to the modified software. Therefore, there is no 
second element in this transaction and it is classified solely as the 
transfer of copyrighted articles.
    (B) Taking into account all facts and circumstances, Corp G is 
properly treated as the owner of copyrighted articles. Therefore, under 
paragraph (f)(2) of this section, there has been the sale of a 
copyrighted article rather than the grant of a lease.
    (15) Example 15: Provision of services for development of a 
computer program--(i) Facts. Corp H enters into a license agreement for 
a new computer program. Program Q is to be written by Corp A. Corp A 
and Corp H agree that Corp A is writing Program Q for Corp H and that, 
when Program Q is completed, the copyright in Program Q will belong to 
Corp H. Corp H gives instructions to Corp A programmers regarding 
program specifications. Corp H agrees to pay Corp A a fixed monthly sum 
during development of the program. If Corp H is dissatisfied with the 
development of the program, it may cancel the contract at the end of 
any month. In the event of termination, Corp A will retain all 
payments, while any procedures, techniques or copyrightable interests 
will be the property of Corp H. All of the payments are labelled 
royalties. There is no provision in the agreement for any continuing 
relationship between Corp A and Corp H, such as the furnishing of 
updates of the program, after completion of the modification work.
    (ii) Analysis. Under paragraph (b)(1) of this section, the 
provision of computer program development services by Corp A to Corp H 
is a digital content transaction with one element, which is the 
provision of services for the development or modification of digital 
content. Under paragraph (d) of this section, the transaction between 
Corp A and Corp H involves the provision of services for the 
development of a computer program because Corp H bears all of the risks 
of loss associated with the development of Program Q and is the owner 
of all copyright rights in Program Q. Taking into account all of the 
facts and circumstances, Corp A is treated as providing services to 
Corp H described in paragraph (b)(1)(iii) of this section. Under 
paragraph (g)(1) of this section, the fact that the agreement is 
labelled a license is not controlling (nor is the fact that Corp A 
receives a sum labelled a royalty).
    (16) Example 16: Provision of know-how by computer programmers--(i) 
Facts. Corp A and Corp I, a Country Z corporation, agree that a 
development engineer employed by Corp A will travel to Country Z to 
provide know-how relating to certain techniques not generally known to 
computer programmers, which will enable Corp I to more efficiently 
create computer programs. These techniques represent the product of 
experience gained by Corp A from working on many computer programming 
projects, and are furnished to Corp I under nondisclosure conditions. 
Such information is property subject to trade secret protection.
    (ii) Analysis. The provision of know-how with respect to computer 
programming techniques by Corp A's development engineer to Corp I is 
described in paragraph (e) of this section. Therefore, the transaction 
is a digital content transaction with one element, which is the 
provision of know-how. The transaction is classified solely as the 
provision of know-how pursuant to paragraph (b)(1)(iv) of this section.
    (17) Example 17: Sale of development program in transaction with 
multiple elements--(i) Facts. Corp A transfers a disk containing 
Program Y to Corp E in exchange for a single fixed payment. Program Y 
is a computer program development program, which is used to create 
other computer programs, consisting of several components, including 
libraries of reusable software components that serve as general 
building blocks in new software applications. Because a computer 
program created with the use of Program Y will not operate unless the 
libraries are also present, the license agreement between Corp A and 
Corp E grants Corp E the right to distribute copies of the libraries 
with any program developed using Program Y. The license agreement is 
otherwise identical to the license agreement in paragraph (h)(1) of 
this section (Example 1). Corp A cannot reasonably ascertain the 
primary benefit or value of the transaction to Corp E. A customer like 
Corp E derives two benefits from this or a substantially similar 
transaction, the first of which is the ability to use Program Y to 
develop new software and the second of which is the right to utilize 
the libraries and reusable software components in Program Y in 
distributed programs. Corp A possesses data arising from market 
research and customer surveys indicating that customers utilize Program 
Y primarily for its computer program development features and do not 
make significant use of the libraries of reusable software components. 
The libraries and reusable software components are not significant 
components of any overall new program created by using Program Y.
    (ii) Analysis. (A) The transaction between Corp A and Corp E has 
multiple elements. One element is the transfer of a disk with a copy of 
Program Y, which would be described in paragraph (b)(1)(ii) of this 
section (transfer of a copyrighted article) if considered separately. 
Another element is the grant of the right to distribute copies of the 
libraries of reusable software components with any program developed 
using Program Y, which would be described in paragraphs (b)(1)(i) and 
(c)(2)(i) of this section (transfer of a copyright right) if considered 
separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a digital content transaction if considered separately, 
paragraph (b)(2) of this section provides that the transaction is 
classified within a single category under paragraph (b)(1) of this 
section if its predominant character is described in that paragraph. 
Pursuant to paragraph (b)(3)(i) of this section, the predominant 
character of a transaction is generally based on the primary benefit or 
value of the transaction to the customer. If the primary benefit or 
value is not reasonably ascertainable, paragraph (b)(3)(ii) of this 
section provides that the predominant character of a transaction may be 
determined based on the primary benefit or value to a typical customer 
of a substantially similar transaction. This primary benefit or value 
to a typical customer can be identified through actual data about use 
or access pursuant to paragraph (b)(3)(ii)(A) of this section, or if 
that data is not available, by other evidence indicative of the primary 
benefit or value to a typical customer pursuant to paragraph 
(b)(3)(ii)(B) of this section. Although there are two benefits in this 
type of transaction, Corp A possesses data indicating that a typical 
customer primarily uses Program Y because of its computer program 
development features, rather than the right to

[[Page 2995]]

distribute reusable components. This is reinforced by the fact that 
programs created using Program Y do not contain libraries of reusable 
software components as significant components. These facts indicate 
that the primary benefit or value to a typical customer arises from the 
ability to use Program Y, rather than the right to distribute reusable 
components. Therefore, the predominant character of this transaction is 
the transfer of a copy of Program Y, and this transaction is thus 
classified solely as the transfer of a copyrighted article described in 
paragraph (b)(1)(ii) of this section.
    (C) Taking into account all the facts and circumstances, Corp E is 
properly treated as the owner of a copyrighted article. Therefore, 
under paragraph (f)(2) of this section, there has been the sale of a 
copyrighted article rather than the grant of a lease.
    (18) Example 18: Sale of a computer program with right to make 
modifications--(i) Facts. Corp A transfers a disk containing Program X 
to Corp E. The disk contains both the object code and the source code 
to Program X, and the license agreement grants Corp E the right to 
modify the source code to correct minor errors and make minor 
adaptations to Program X so it will function on Corp E's computer; as 
well as the right to recompile the modified source code. The license 
does not grant Corp E the right to distribute the modified Program X to 
the public. The license is otherwise identical to the license agreement 
in paragraph (h)(1) of this section (Example 1). Corp A has ascertained 
that the primary benefit or value received by Corp E from the 
transaction is the core functionality of Program X rather than the 
limited rights to modify the source code.
    (ii) Analysis. (A) The transaction between Corp A and Corp E has 
multiple elements. One element is the transfer of a disk with a copy of 
Program X, which would be described in paragraph (b)(1)(ii) of this 
section (transfer of a copyrighted article) if considered separately. 
Another element is the grant of the right to modify the source code to 
Program X and recompile the modified source code to create new code to 
correct minor errors, and to make minor adaptations to Program X, which 
would be described in paragraphs (b)(1)(i) and (c)(2)(ii) of this 
section (transfer of a copyright right) if considered separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a digital content transaction if considered separately, 
paragraph (b)(2) of this section provides that the transaction is 
classified within a single category under the categories described 
under paragraph (b)(1) of this section if its predominant character is 
described in that paragraph. Pursuant to paragraph (b)(3) of this 
section, the predominant character of the transaction is based on the 
primary benefit or value of the transaction to the customer, if it is 
reasonably ascertainable. Since the primary benefit or value received 
by Corp E is the core functionality of Program X, rather than the 
limited rights to modify the source code, the predominant character of 
this transaction is the transfer of a copyrighted article. Therefore, 
this transaction is classified solely as a transfer of a copyrighted 
article under paragraph (b)(1)(ii) of this section.
    (C) Taking into account all the facts and circumstances, Corp E is 
properly treated as the owner of a copyrighted article. Therefore, 
under paragraph (f)(2) of this section, there has been the sale of a 
copyrighted article rather than the grant of a lease.
    (19) Example 19: License to website operator to make and sell 
copies of electronic books via download--(i) Facts. Corp A operates a 
website that offers electronic books for download onto customers' 
computers or other electronic devices. The books offered are protected 
by copyright law. In a transaction between Corp A and a content owner, 
Corp A receives from the content owner a digital master copy of a book, 
which Corp A downloads onto its server. Corp A receives the non-
exclusive right to reproduce an unlimited number of copies of the book 
for purposes of distribution and sale to the public. Corp A pays the 
content owner a specified amount for each copy sold to a customer. Corp 
A may not transfer any of the rights it receives from the content 
owner. The term of the agreement Corp A has with the content owner is 
shorter than the remaining life of the copyright. The content owner has 
ascertained that the primary benefit or value Corp A receives in the 
transaction is the right to reproduce and distribute an unlimited 
number of copies of the book and not the transfer of a copy of the 
book. In a separate transaction, Corp A charges a customer a fixed fee 
for each book purchased. When purchasing a book from Corp A on Corp A's 
website, the customer must acknowledge the terms of a license agreement 
with the content owner that states that the customer may download and 
view the electronic book in perpetuity but may not reproduce, 
distribute, or sell copies of it. Once the customer downloads the book 
from Corp A's server onto a device, the customer may access and view 
the book from that device, which does not need to be connected to the 
internet for the customer to view the book. The customer owes no 
additional payment to Corp A for the ability to view the book in the 
future.
    (ii) Analysis. (A) Notwithstanding the license agreement between 
each customer and the content owner granting the customer rights to use 
the book, the relevant transactions are the transfer of a master copy 
of the book along with the grant from the content owners to Corp A of 
the right to reproduce and sell to the public copies of the books, and 
the transfers of copies of the books by Corp A to customers. Although 
the content owner is identified as a party to the license agreement 
memorializing the customer's rights with respect to the book, each 
customer obtains those rights directly from Corp A, not from the 
content owner. Under paragraph (b)(1) of this section, the download of 
a copy of a book by a customer is a digital content transaction with 
one element, which is the transfer of a digital copy of a book. 
Therefore, the transaction is treated solely as a transfer of a 
copyrighted article under paragraph (b)(1)(ii) of this section. Under 
the benefits and burdens test of paragraph (f)(2) of this section, the 
transaction is classified as a sale and not a lease, because the 
customer receives the right to view the book in perpetuity on its 
device.
    (B) The transaction between the content owner and Corp A has 
multiple elements. One element is the transfer of a master copy of the 
book, which would be described in paragraph (b)(1)(ii) of this section 
(transfer of a copyrighted article) if considered separately. Another 
element is the grant of the right to reproduce and sell an unlimited 
number of copies to customers, which would be described in paragraphs 
(b)(1)(i) and (c)(2)(i) of this section (transfer of a copyright right) 
if considered separately. Because the transaction has multiple 
elements, one or more of which would be a digital content transaction 
if considered separately, paragraph (b)(2) of this section provides 
that the transaction is classified within a single category under the 
categories described under paragraph (b)(1) of this section if its 
predominant character is described in that paragraph. Pursuant to 
paragraph (b)(3) of this section, the predominant character of the 
transaction is based on the primary benefit or value of the transaction 
to the customer, if it is reasonably ascertainable. Since the primary 
benefit or value Corp A receives in the transaction is the right to 
reproduce and distribute an unlimited

[[Page 2996]]

number of copies, the predominant character of this transaction is the 
transfer of a copyright right. Therefore, this transaction is 
classified solely as a transfer of copyright rights described in 
paragraph (b)(1)(i) of this section.
    (C) Taking into account all of the facts and circumstances, there 
has been a license of books to Corp A. Under paragraph (f)(1) of this 
section, there has not been a transfer of all substantial rights in the 
copyright rights to the books because each content owner has the right 
to enter into other licenses with respect to the copyright of their 
book. Corp A has acquired no right itself to license the copyrights in 
the books. Finally, the terms of the licenses are for less than the 
remaining lives of the copyrights in the books.
    (20) Example 20: internet platform operator as agent for 
application developers--(i) Facts. Corp A operates a platform on the 
internet that offers applications for download onto a customer's mobile 
phone. Under general tax principles, Corp A and an application 
developer establish an agency relationship whereby Corp A acts as the 
agent to offer the application for sale to customers on behalf of the 
application developer. The applications are protected by copyright law. 
Under the agreement between Corp A and the application developer, Corp 
A agrees to provide the application developer with platform and agency 
services to facilitate the sale of the application to customers. Corp A 
also provides the application developer with hosting services to host 
the application on Corp A's servers for download by the customers. Corp 
A receives a digital master copy of the application along with a non-
exclusive right to make copies of the application and allow customers 
to download copies of the application from Corp A's platform. Corp A 
has ascertained that the primary benefit or value from the transaction 
received by the application developer is the platform and agency 
services that Corp A provides. Corp A receives the right to make copies 
of the application merely to perform its activities as an agent on 
behalf of the application developer. When purchasing an application on 
Corp A's platform, the customer must acknowledge the terms of a license 
agreement with the application developer that states that the customer 
may use the application but may not reproduce or distribute copies of 
it. In addition, the agreement provides that the customer may download 
the application onto only one mobile phone at a time. A customer does 
not need to be connected to the internet to access the application. The 
customer owes no additional payment to Corp A or the application 
developer for the ability to use the application in perpetuity. Corp A 
retains a fixed percentage of each purchase price of the application 
and remits the remaining balance to the application developer.
    (ii) Analysis. (A) The transaction between Corp A and the 
application developer has multiple elements. One element is the 
transfer of a master copy of an application by the application 
developer to Corp A, which would be described in paragraph (b)(1)(ii) 
of this section (transfer of a copyrighted article) if considered 
separately. Another element is the transfer of the right to make and 
distribute copies of the application by the application developer to 
Corp A, which would be described in paragraphs (b)(1)(i) and (c)(2) of 
this section (transfer of a copyright right) if considered separately. 
A third element is the platform and agency services provided by Corp A 
to the application developer, which would not be described in this 
section if considered separately. A fourth element is the hosting 
services provided by Corp A to the application developer, which would 
be described in Sec.  1.861-19 if considered separately. Under the 
facts and circumstances, although Corp A receives a copy of the 
application and the right to make and distribute copies of the 
application, Corp A receives this copy and right merely to facilitate 
the sale of applications on behalf of the application developer.
    (B) Because the transaction has multiple elements, one or more of 
which would be a digital content transaction if considered separately, 
paragraph (b)(2) of this section provides that the transaction is 
classified within a single category under the categories described 
under paragraph (b)(1) of this section if its predominant character is 
described in that paragraph. Pursuant to paragraph (b)(3) of this 
section, the predominant character of the transaction is based on the 
primary benefit or value of the transaction to the customer, if it is 
reasonably ascertainable. Since the primary benefit or value the 
application developer receives in the transaction is the platform and 
agency services, the predominant character of this transaction is the 
platform and agency services and not a digital content transaction nor 
a cloud transaction.
    (C) The transfer of a copy of an application from the application 
developer to a customer is a digital content transaction with one 
element, which is the transfer of a copy of a digital program. 
Therefore, the transaction is treated solely as a transfer of a 
copyrighted article under paragraph (b)(1)(ii) of this section. Under 
the benefits and burdens test of paragraph (f)(2) of this section, this 
transaction is a sale of a copyrighted article because a customer has 
the right to use the application in perpetuity.
    (21) Example 21: Movies and TV shows available for stream, rent, or 
purchase--(i) Facts. Corp A offers a catalog of movies and TV shows, 
all of which are subject to copyright protection. Corp A gives 
customers several options for viewing the content, each of which has a 
separate price. A ``streaming'' option allows a customer to view the 
video, which is hosted on Corp A's servers, while connected to the 
internet for as many times as the customer wants during a limited 
period. A ``rent'' option allows a customer to download the video to 
its computer or other electronic device (which does not need to be 
connected to the internet for viewing) and watch the video as many 
times as the customer wants for a limited period, after which an 
electronic lock is activated and the customer may no longer view the 
content. A ``purchase'' option allows a customer to download the video 
and view it as many times as the customer chooses with no end date. 
Under all three options, the customer may view the video but may not 
reproduce or distribute copies of it, prepare derivative works based on 
it, or publicly display it.
    (ii) Analysis. (A) With respect to the ``rent'' option, under 
paragraph (b)(1) of this section the download of a video by a customer 
is a digital content transaction with one element, which is the 
transfer of a copy of the video. Therefore, the transaction is treated 
solely as the transfer of a copyrighted article under paragraph 
(b)(1)(ii) of this section. Although a customer will retain a copy of 
the content at the end of the payment term, the customer cannot access 
the content after the electronic lock is activated. The activation of 
the electronic lock is the equivalent of having to return the copy. 
Therefore, the transaction is classified as a lease of a copyrighted 
article under paragraph (f)(2) of this section because the customer's 
right to view the videos is for a limited period.
    (B) With respect to the ``purchase'' option, under paragraph (b)(1) 
of this section the download of a video by a customer is a digital 
content transaction with one element, which is the transfer of a copy 
of the video. Therefore, the transaction is treated solely as the 
transfer of a copyrighted article under paragraph (b)(1)(ii) of this 
section. The transaction is classified as a sale of a copyrighted 
article under paragraph

[[Page 2997]]

(f)(2) of this section because the customer receives the right to view 
the videos in perpetuity.
    (C) With respect to the ``streaming'' option, the transaction is 
Corp A's grant of the right to its customers to view the movies or 
shows while connected to the internet for a limited period. There is no 
transfer of any copyright rights described in paragraph (c)(2) of this 
section. There is also no transfer of a copyrighted article because the 
content is not downloaded by a customer, but rather, is accessed 
through an on-demand network. The transaction also does not constitute 
the provision of services for the development of digital content or the 
provision of know-how under paragraph (b)(1) of this section. 
Therefore, the transaction is not a digital content transaction 
described in paragraph (b)(1) of this section. Instead, the transaction 
is a cloud transaction that is classified under Sec.  1.861-19. See 
Sec.  1.861-19(b).
    (22) Example 22: Website offering third-party videos via stream--
(i) Facts. Corp A operates a website that allows customers to stream 
videos that third-party content creators upload to Corp A's website. 
Corp A has advertising contracts with third-party advertisers pursuant 
to which Corp A earns advertising revenue when a customer views a 
video. Customers can either stream videos for free with advertisements 
or can pay a subscription fee to stream videos without advertisements. 
Under the contract between Corp A and content creators, content 
creators retain all ownership rights in their videos and must own or 
have the necessary rights to publish their videos. The contract also 
states that content creators grant Corp A a non-exclusive license to 
use, reproduce, distribute, and display their videos in connection with 
Corp A's website, and grant customers a non-exclusive license to view 
the videos. These licenses terminate within a commercially reasonable 
time after a content creator removes or deletes a video from Corp A's 
website. Content creators have ascertained that the primary benefit or 
value Corp A receives from transactions with content creators is the 
right to use, reproduce, distribute, and display their videos. Corp A 
pays content creators a percentage of advertising revenue generated 
from the videos and a percentage of subscription fees.
    (ii) Analysis. (A) The transaction between Corp A and the content 
creators has multiple elements. One element is the uploading of a video 
by a content creator, which would be described in paragraph (b)(1)(ii) 
of this section (transfer of a copyrighted article) if considered 
separately. Another element is the grant by content creators to Corp A 
of the right to use, reproduce, distribute, and display their videos, 
which would be described in paragraph (b)(1)(i) of this section 
(transfer of a copyright right) if considered separately. Content 
creators are not providing content development services to Corp A under 
paragraph (d) of this section because content creators own the 
copyright rights in the videos.
    (B) Because the transaction has multiple elements, one or more of 
which would be a digital content transaction if considered separately, 
paragraph (b)(2) of this section provides that the transaction is 
classified within a single category under the categories described 
under paragraph (b)(1) of this section if its predominant character is 
described in that paragraph. Pursuant to paragraph (b)(3) of this 
section, the predominant character of the transaction is based on the 
primary benefit or value of the transaction to the customer. The 
predominant character of the transaction is therefore the transfer of 
copyright rights because the primary benefit or value received by Corp 
A is the right to use, reproduce, distribute, and display videos. 
Accordingly, this transaction is characterized solely as a transfer of 
a copyright right as described in paragraphs (b)(1)(i) of this section.
    (C) Taking into account all of the facts and circumstances, there 
has been a license of videos to Corp A. Under paragraph (f)(1) of this 
section, there has not been a transfer of all substantial rights in the 
copyright rights to the videos because each content owner has the right 
to enter into other licenses with respect to the copyright of their 
videos. Corp A has acquired no right itself to license the copyrights 
in the videos. Finally, the terms of the licenses are for less than the 
remaining lives of the copyrights in the videos.
    (D) For both the free streaming and subscription streaming 
transactions between Corp A and customers, there is no transfer of any 
copyright rights described in paragraph (c)(2) of this section. There 
is also no transfer of a copyrighted article, because the content is 
not downloaded by a customer, but rather is accessed through an on-
demand network. The transactions also do not constitute the provision 
of services for the development of digital content or the provision of 
know-how under paragraph (b)(1) of this section. Therefore, paragraph 
(b)(1) of this section does not apply to such transactions. Instead, 
both transactions are cloud transactions that are classified under 
Sec.  1.861-19. See Sec.  1.861-19(b).
    (23) Example 23: Sale of computer programs electronically through a 
reseller--(i) Facts. Corp A owns the copyright to software (Program S). 
Corp A hosts Program S on its servers. Corp A grants Corp B, a foreign 
corporation wholly owned by Corp A, the right to distribute copies of 
Program S (without the right to reproduce copies of Program S) to Corp 
B's customers that are located in Corp B's country. Under the agreement 
between Corp A and Corp B, Corp B pays Corp A a fixed fee for each copy 
of Program S that Corp A delivers to a customer. In separate 
transactions, customers pay Corp B for the right to receive digital 
copies of Program S that they may then use in perpetuity without 
further payment. Corp B is responsible for managing the purchase/sale 
interaction with Corp B's customers, including invoicing and 
collections. Corp A is responsible for creating and delivering the 
digital copies of Program S to Corp B's customers from Corp A's 
servers. Corp B does not perform any functions to provide access to 
Program S.
    (ii) Analysis. (A) Although there is a single contract between Corp 
A and Corp B that grants a legal right to Corp B with respect to 
Program S, that right (the right to distribute) is not a copyright 
right described in paragraphs (b)(1)(i) and (c)(2) of this section. 
Instead, the transactions between Corp A and Corp B and then Corp B and 
its customers are functionally and economically equivalent to back-to-
back transfers of copyrighted articles. The transfers are only 
superficially different from those described in paragraph (h)(24) of 
this section (Example 24) where the reseller acquires product keys and 
sells them on to customers. Therefore, each sale of a copy of Program S 
by Corp B to a customer should be viewed as a transfer of a copyrighted 
article from Corp A to Corp B and then from Corp B to the customer.
    (B) The transaction between Corp A and Corp B is a digital content 
transaction with a single element that is classified as a transfer of a 
copyrighted article described in paragraph (b)(1)(ii) of this section. 
There are no additional elements because Corp B's receipt of the right 
to distribute copies of Program S (without the right to make copies) is 
not a copyright right described in paragraph (c)(2) of this section. 
Under the benefits and burdens test of paragraph (f)(2) of this 
section, the transfer is classified as the sale of a copyrighted 
article.
    (C) The transaction between Corp B and a customer is a digital 
content transaction with a single element that is classified as a 
transfer of a copyrighted article described in paragraph (b)(1)(ii)

[[Page 2998]]

of this section. Under the benefits and burdens test of paragraph 
(f)(2) of this section, this transaction is a sale of a copyrighted 
article because the customer has the right to use the application in 
perpetuity.
    (24) Example 24: Sale of video games with online and offline 
functionality through retailers using digital keys--(i) Facts. Corp A 
owns the copyright in a computer program (Program Y). Corp A creates 
digital keys that allow for the download of one copy of Program Y from 
Corp A's website. Corp A sells these digital keys to retailers for a 
one-time fee per key, and the retailers do not use Program Y, but 
instead sell them in separate transactions to customers for a one-time 
fee per key. Corp A ascertains that the primary benefit or value to 
retailers from the purchase of digital keys from Corp A is the right to 
further transfer the digital keys to customers. The retailers cannot 
reasonably ascertain the primary benefit or value that their specific 
customers derive from Program Y, nor is there data available to the 
retailers about how their customers typically use Program Y. Program Y 
is a video game that contains online and offline features, both of 
which can be played without paying an additional game-specific cost 
after paying the one-time fee to purchase a key. The offline feature is 
comprised of a single-player story that does not require any internet 
connection to play. The online feature is comprised of the ability to 
play competitive matches against other players that are hosted on 
servers owned by Corp A. The competitive matches require an ongoing 
connection to the internet to play. Neither the customers nor the 
retailer receives any copyright rights described in paragraph (c)(2) of 
this section with respect to Program Y. Customers can use Program Y in 
perpetuity. Program Y is primarily marketed as a single-player game in 
television and online advertising, with only brief mentions of the 
multiplayer mode in print advertising. The development cost for Program 
Y was allocated 40% to developing the single-player content, 20% to 
developing the multiplayer content, and 40% to developing content that 
is used by both types of content (e.g., cost of developing the game 
engine).
    (ii) Analysis. (A) The transaction between Corp A and a retailer 
has multiple elements. One element is the transfer of a key with the 
right to download a copy of Program Y for use to play the offline 
story, which would be a digital content transaction described in 
paragraph (b)(1)(ii) of this section (transfer of a copyrighted 
article) if considered separately. Another element is the transfer of 
the same key with a copy of Program Y providing on-demand network 
access to digital content in the form of competitive multiplayer 
functionality, which would be a cloud transaction described in Sec.  
1.861-19(b) if considered separately.
    (B) Because the transaction has multiple elements, one of which 
would be a digital content transaction if considered separately and one 
of which would be a cloud transaction if considered separately, 
paragraph (b)(2) of this section provides that the transaction is 
classified within a single category under paragraph (b)(1) of this 
section if its predominant character is described in that paragraph, or 
the transaction is classified solely as a cloud transaction if its 
predominant character is a cloud transaction pursuant to Sec.  1.861-
19(c)(2). Pursuant to paragraph (b)(3)(i) of this section, the 
predominant character of the transaction is based on the primary 
benefit or value of the transaction to the customer, if it is 
reasonably ascertainable. The predominant character of this transaction 
is therefore the transfer of copyrighted articles because the primary 
benefit or value received by a retailer is the right to further 
transfer the same copyrighted articles to customers in the form of 
digital keys. The retailers do not have any intent to utilize the cloud 
functionality of the digital keys, although they do have the right to 
do so. Therefore, this transaction is classified solely as a transfer 
of copyrighted articles described in paragraph (b)(1)(ii) of this 
section.
    (C) Under the benefits and burdens test of paragraph (f)(2) of this 
section, the transfer between Corp A and a retailer is classified as 
the sale of a copyrighted article because the retailer has the right to 
use, or sell, Program Y in perpetuity without further payment.
    (D) The transfer of a key (with the right to download a copy of 
Program Y) by a retailer to a customer also contains the same two 
elements as each transaction between Corp A and a retailer. However, a 
retailer cannot reasonably ascertain the primary benefit or value 
derived by a specific customer from Program Y. In such situations, 
paragraph (b)(3)(ii) of this section provides that the predominant 
character of a transaction may be determined based on the primary 
benefit or value to a typical customer of a substantially similar 
transaction. This primary benefit or value to a typical customer can be 
identified through actual data about use or access pursuant to 
paragraph (b)(3)(ii)(A) of this section, or if that data is not 
available, by using other evidence indicative of the primary benefit or 
value to a typical customer pursuant to paragraph (b)(3)(ii)(B) of this 
section. Because the retailers do not have available data about how 
customers use Program Y, they may use the marketing with respect to 
Program Y to determine that its predominant character is that of a 
transfer of a copyrighted article described in paragraph (b)(1)(ii) of 
this section. The relative development costs of the offline and online 
components of the game could also be used if they are known to a 
retailer. Therefore, the transfer between a retailer and a customer of 
a digital key containing the right to download a copy of Program Y is 
classified solely as a transfer of a copyrighted article.
    (E) Under the benefits and burdens test of paragraph (f)(2) of this 
section, the transfer between a retailer and a customer is classified 
as the sale of a copyrighted article because the customer has the right 
to use Program Y in perpetuity without further payment.
    (25) Example 25: Source of income from the sale of a copyrighted 
article transferred through an electronic medium--(i) Facts. Corp A is 
the parent company of a world-wide group of affiliated companies. Corp 
B is a foreign corporation wholly owned by Corp A. In the ordinary 
course of business, Corp B acts as a procurement hub for Corp A's 
affiliated companies. In this role, Corp B regularly purchases products 
that will be distributed amongst Corp A's affiliated companies to be 
used by them in their respective businesses. Corp B purchases digital 
copies of a computer program (Program Y) from Corp C, an unrelated 
company. Corp B may use Program Y in perpetuity without further 
payment. Corp B receives no copyright rights in Program Y. Corp B does 
not use Program Y, and instead distributes all of its copies of Program 
Y to various affiliates. Corp C sources income from the sale of Program 
Y using sections 861(a)(6) and 862(a)(6).
    (ii) Analysis. (A) Under paragraph (b)(1) of this section, the 
transfer of Program Y from Corp C to Corp B is a digital content 
transaction with one element, which is the transfer of a copy of 
Program Y. Therefore, the transaction is treated solely as transfers of 
a copyrighted articles under paragraph (b)(1)(ii) of this section. 
Taking into account all of the facts and circumstances, there have been 
sales of copies of Program Y to Corp B under paragraph (f)(2) of this 
section.
    (B) Income from the sale of Program Y by Corp C is sourced pursuant 
to sections 861(a)(6) and 862(a)(6) to the place where the sale 
occurred. Pursuant to paragraph (f)(2)(ii) of this section, a transfer 
of a copyrighted article through

[[Page 2999]]

an electronic medium is treated as occurring at the billing address of 
the purchaser, in this case Corp B, unless the sales transaction is 
arranged for a principal purpose of tax avoidance. In this case, the 
sale is treated as occurring at the billing address of Corp B, and Corp 
C's income is foreign source, even though Corp B will not use Program 
Y, because Corp B regularly purchases products that will be distributed 
amongst its affiliates to be used in their respective businesses, and 
therefore there is no evidence that Corp B was used by Corp A to 
purchase Program Y with a principal purpose of tax avoidance.
    (26) Example 26: Application of anti-abuse rule for sale of a 
copyrighted article transferred through an electronic medium--(i) 
Facts. Corp A is the parent company of a world-wide group of affiliated 
companies. Corp B is a foreign affiliate of Corp A. In the ordinary 
course of business, Corp B does not act as a procurement hub regularly 
purchasing products for use by Corp A's affiliated companies. Corp A 
negotiates an agreement with Corp C, an unrelated company, to purchase 
digital copies of a computer program (Program Y) for use in Corp A's 
business. The agreement grants Corp A the right to use Program Y in 
perpetuity for a one-time payment. Corp C requests that Corp B be the 
purchaser of the copies of Program Y even though Corp B will not use 
Program Y and is not otherwise involved in the transaction between Corp 
A and Corp C for a principal purpose of tax avoidance. Corp A agrees, 
and Corp B purchases the copies of Program Y and subsequently 
distributes them to Corp A. Corp C sources income from the sale of 
Program Y using sections 861(a)(6) and 862(a)(6).
    (ii) Analysis. (A) Under paragraph (b)(1) of this section, the 
transfer of Program Y from Corp C to Corp B is a digital content 
transaction with one element, which is the transfer of a copy of 
Program Y. Therefore, the transaction is classified solely as a 
transfer of a copyrighted article under paragraph (b)(1)(ii) of this 
section. Taking into account all of the facts and circumstances, there 
have been sales of copies of Program Y to Corp B under paragraph (f)(2) 
of this section.
    (B) Income from the sale of Program Y by Corp C is sourced pursuant 
to sections 861(a)(6) and 862(a)(6) to the place where the sale 
occurred. Pursuant to paragraph (f)(2)(ii) of this section, a transfer 
of a copyrighted article through an electronic medium is treated as 
occurring at the billing address of the purchaser, in this case Corp B, 
unless the sales transaction is arranged for a principal purpose of tax 
avoidance. In this case, Corp B does not regularly purchase products 
that will be used by other companies within Corp A's group of 
affiliated companies, and Corp B was instead used as the purchaser of 
Program Y on behalf of Corp A with a principal purpose of tax 
avoidance. Therefore, the place where the sale occurred must be 
determined based on all relevant facts and circumstances. Corp A 
negotiated the purchase, and the software will be used by Corp A in its 
business. As a result, under paragraph (f)(2)(ii) of this section, the 
sale is treated as occurring at the location of Corp A and the income 
derived by Corp C from the sale is U.S. source.
    (C) The same result would apply if, instead of using Corp B for the 
purchase, Corp A made the purchase but rented a P.O. Box outside the 
United States to serve as the billing address for the transaction with 
a principal purpose of tax avoidance.
    (i) Applicability date--(1) In general. This section applies to 
taxable years beginning on or after January 14, 2025.
    (2) Early application. A taxpayer can apply this section to taxable 
years beginning on or after August 14, 2019 and all subsequent taxable 
years not described in paragraph (i)(1) of this section (early 
application years) if--
    (i) The taxpayer also applies Sec.  1.861-19 to the early 
application years;
    (ii) This section and Sec.  1.861-19 are applied to the early 
application years by all persons related to the taxpayer (within the 
meaning of sections 267(b) and 707(b));
    (iii) The period of limitations on assessment for each early 
application year of the taxpayer and all related parties (within the 
meaning of sections 267(b) and 707(b)) is open under section 6501; and
    (iv) The taxpayer would not be required under this section to 
change its method of accounting as a result of such election.
    (j) Change in method of accounting required by this section. In 
order to comply with this section, a taxpayer may be required to change 
its method of accounting. If so required, the taxpayer must secure the 
consent of the Commissioner in accordance with the requirements of 
Sec.  1.446-1(e) and the applicable administrative procedures for 
obtaining the Commissioner's consent under section 446(e) for voluntary 
changes in methods of accounting.

0
Par. 4 Section 1.861-19 is added to read as follows:

Sec.  1.861-19   Classification of cloud transactions.

    (a) In general. This section provides rules for classifying cloud 
transactions (as defined in paragraph (b) of this section). The rules 
of this section apply for purposes of Internal Revenue Code sections 
59A, 245A, 250, 267A, 367, 404A, 482, 679, and 1059A; subchapter N of 
chapter 1; chapters 3 and 4; and sections 842 and 845 (to the extent 
involving a foreign person), and apply with respect to transfers to 
foreign trusts not covered by section 679.
    (b) Cloud transaction defined. A cloud transaction is a transaction 
through which a person obtains on-demand network access to computer 
hardware, digital content (as defined in Sec.  1.861-18(a)(2)), or 
other similar resources. A cloud transaction does not include network 
access to download digital content for storage and use on a person's 
computer or other electronic device.
    (c) Classification of cloud transactions--(1) In general. A cloud 
transaction is classified as the provision of services.
    (2) Transaction with multiple elements. Taking into account the 
overall transaction and the surrounding facts and circumstances, a 
transaction that has multiple elements, one or more of which would be a 
cloud transaction if considered separately, is classified in its 
entirety as a cloud transaction if the predominant character of the 
transaction as determined under Sec.  1.861-18(b)(3) is a cloud 
transaction.
    (d) Examples. The examples in this paragraph (d) illustrate the 
provisions of this section. Unless otherwise specified, assume that 
Corp A is a domestic corporation, no rights described in Sec.  1.861-
18(c)(2) (copyright rights) are transferred as part of the transactions 
described, and all facts in each example occur as part of a single 
transaction.
    (1) Example 1: Computing capacity--(i) Facts. Corp A operates data 
centers on its premises in various locations. Corp A provides Corp B 
computing capacity on Corp A's servers in exchange for a monthly fee 
based on the amount of computing power made available to Corp B. Corp B 
provides its own software to run on Corp A's servers.
    (ii) Analysis. The provision of on-demand network computing 
capacity by Corp A to Corp B is a cloud transaction with one element. 
Therefore, the transaction is treated solely as a cloud transaction 
under paragraph (b) of this section and is classified as the provision 
of services under paragraph (c)(1) of this section.

[[Page 3000]]

    (2) Example 2: Computing capacity on dedicated on-premises 
servers--(i) Facts. The facts are the same as in paragraph (d)(1)(i) of 
this section (the facts in Example 1), except that, in order to offer 
more security to Corp B, Corp A provides Corp B computing capacity 
exclusively through designated servers, which are owned and operated by 
Corp A and located at Corp B's facilities. Corp A agrees not to use the 
designated server for any other customer for the duration of its 
arrangement with Corp B. Although the server is located at Corp B's 
facilities, Corp B accesses the server through Corp A's network and the 
monthly fee is based on the amount of computing power made available to 
Corp B.
    (ii) Analysis. As in paragraph (d)(1) of this section (Example 1), 
the transaction between Corp A and Corp B is the provision of on-demand 
network computing capacity and is therefore a cloud transaction with 
one element. Therefore, the transaction is treated solely as a cloud 
transaction under paragraph (b) of this section and is classified as 
the provision of services under paragraph (c)(1) of this section. If 
the transaction between Corp A and Corp B involved only the provision 
of a server by Corp A for use by Corp B, and not on-demand network 
access to computing capacity, the transaction would not be a cloud 
transaction and this section would not apply.
    (3) Example 3: Access to software development platform and website 
hosting--(i) Facts. Corp A provides Corp B a software platform that 
Corp B uses to develop and deploy websites with a range of features, 
including blogs, message boards, and other collaborative knowledge 
bases. The software development platform consists of an operating 
system, web server software, scripting languages, libraries, tools, and 
back-end relational database software and allows Corp B to use in its 
websites certain visual elements subject to copyrights held by Corp A. 
The software development platform is hosted on servers owned by Corp A 
and located at Corp A's facilities. Corp B's finished websites are also 
hosted on Corp A's servers. Corp B accesses the software development 
platform via a standard web browser. Corp B has no ability to alter the 
software code. A small amount of copyrighted scripting code is 
downloaded onto Corp B's computers to facilitate secure logins and 
access to the software development platform. All other functions of the 
software development platform execute on Corp A's servers, and no 
portion of the core software code is ever downloaded by Corp B or Corp 
B's customers. Corp A has ascertained that the primary benefit or value 
to Corp B from the transaction is the right to use the software 
development platform. Corp B pays Corp A a monthly fee for the platform 
and website hosting.
    (ii) Analysis. (A) There is one transaction with multiple elements 
between Corp A and Corp B. One element is Corp A's provision to Corp B 
of on-demand network access to the software platform, which would be a 
cloud transaction described in paragraph (b) of this section if 
considered separately. Another element is Corp A's hosting of Corp B's 
finished websites, which would be a cloud transaction described in 
paragraph (b) of this section if considered separately. A third element 
is the grant by Corp A to Corp B of the right to use in Corp B's 
websites certain visual elements subject to copyrights held by Corp A, 
which would be a transfer of copyright rights under Sec.  1.861-
18(b)(1)(i) if considered separately. A fourth element is the download 
of scripting code by Corp B, which would be a transfer of a copyrighted 
article under Sec.  1.861-18(b)(1)(ii) if considered separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a cloud transaction if considered separately, paragraph 
(c)(2) of this section provides that the transaction is classified as a 
cloud transaction if its predominant character is a cloud transaction. 
Pursuant to Sec.  1.861-18(b)(3), the predominant character of the 
transaction is based on the primary benefit or value of the transaction 
to the customer, if it is reasonably ascertainable. The predominant 
character of this transaction is therefore a cloud transaction because 
the primary benefit or value received by Corp B is the right to use the 
software development platform. Accordingly, this transaction is 
classified solely as a cloud transaction described in paragraph (b) of 
this section and is classified as the provision of services under 
paragraph (c)(1) of this section.
    (4) Example 4: Access to online software via an application--(i) 
Facts. Corp A provides Corp B word processing, spreadsheet, and 
presentation software and allows employees of Corp B to access the 
software over the internet through a web browser or an application 
(``app'') that can be downloaded from Corp A's servers onto a computer 
or mobile device. Corp B's employees usually download Corp A's app onto 
their mobile devices. To access the full functionality of the app, the 
device must be connected to the internet. Only a limited number of 
features on the app are available without an internet connection. Corp 
B has no ability to alter the software code. The software is hosted on 
servers owned by Corp A and located at Corp A's facilities and is used 
concurrently by other Corp A customers in addition to Corp B. Corp B 
pays a monthly fee based on the number of employees with access to the 
software. Users have the option to save files either online using the 
storage provided by Corp B, or offline on their own hard drives. Corp 
B's employees can also download updates to the app as part of the 
monthly fee arrangement. Upon termination of the arrangement, Corp A 
activates an electronic lock preventing Corp B's employees from further 
utilizing the app, and Corp B's employees are no longer able to access 
the software via a web browser. Corp A has ascertained that the primary 
benefit or value to Corp B from the transaction is the right to access 
Corp A's software over the internet, whether via web browser or after 
downloading the app.
    (ii) Analysis. (A) There is one transaction with multiple elements 
between Corp A and Corp B. One element is Corp A's provision to Corp B 
of on-demand network access to Corp A's computer hardware and software 
resources for the purpose of fully utilizing Corp A's software, which 
would be a cloud transaction described in paragraph (b) of this section 
if considered separately. Another element is the download of Corp A's 
app by Corp B employees, which would be a transfer of a copyrighted 
article under Sec.  1.861-18(b)(1)(ii) if considered separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a cloud transaction if considered separately, paragraph 
(c)(2) of this section provides that the transaction is classified as a 
cloud transaction if its predominant character is a cloud transaction. 
Pursuant to Sec.  1.861-18(b)(3), the predominant character of the 
transaction is based on the primary benefit or value of the transaction 
to the customer, if it is reasonably ascertainable. The predominant 
character of this transaction is therefore a cloud transaction because 
the primary benefit or value received by Corp B is the right to access 
Corp A's software over the internet. Accordingly, this transaction is 
classified solely as a cloud transaction described in paragraph (b) of 
this section and is classified as the provision of services under 
paragraph (c)(1) of this section.
    (5) Example 5: Access to offline software with limited online 
functions--

[[Page 3001]]

(i) Facts. Corp A provides Corp B word processing, spreadsheet, and 
presentation software that is functionally similar to the software in 
paragraph (d)(4) of this section (Example 4). The software is made 
available for access over the internet but only to download the 
software from servers owned by Corp A onto a computer or mobile device 
in the form of an app. The downloaded software contains all the core 
functions of the software. Employees of Corp B can use the software on 
their computers or mobile devices regardless of whether their computer 
or mobile device is online. When online, the software provides a few 
ancillary functions that are not available offline, such as access to 
document templates and data collection for diagnosing problems with the 
software. Whether working online or offline, Corp B employees can store 
their files only on their own computer or mobile device, and not on 
Corp A's data storage servers. Corp B's employees can also download 
updates to the software as part of the monthly fee arrangement. Upon 
termination of the arrangement, an electronic lock is activated so that 
the software can no longer be accessed. Corp A has ascertained that the 
primary benefit or value to Corp B from the transaction is the right to 
download and use Corp A's software offline.
    (ii) Analysis. (A) The transaction between Corp A and Corp B 
contains multiple elements. One element is the transfer of a copy of 
Corp A's software via download, which would be a transfer of a 
copyrighted article described under Sec.  1.861-18(b)(1)(ii) if 
considered separately. Another element is the provision of online 
ancillary functionality of the software, which would be a cloud 
transaction described in paragraph (b) of this section if considered 
separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a cloud transaction if considered separately, paragraph 
(c)(2) of this section provides that the transaction is classified as a 
cloud transaction if its predominant character is a cloud transaction. 
Pursuant to Sec.  1.861-18(b)(3), the predominant character of the 
transaction is based on the primary benefit or value of the transaction 
to the customer, if it is reasonably ascertainable. The predominant 
character of this transaction is therefore the transfer of a 
copyrighted article because the primary benefit or value received by 
Corp B is the right to download and use Corp A's software offline. 
Accordingly, this transaction is classified solely as a transfer of a 
copyrighted article described in Sec.  1.861-18(b)(1)(ii). The 
provision of the software constitutes a lease of a copyrighted article 
under Sec.  1.861-18 because access to the app is terminated when the 
monthly fee is no longer paid, even though Corp B employees retain the 
locked files on their devices. See Sec.  1.861-18(h)(4).
    (6) Example 6: Data storage, separate from access to offline 
software--(i) Facts. The facts are the same as in paragraph (d)(5)(i) 
of this section (the facts in Example 5), except that Corp A also 
provides on-demand network data storage to Corp B on Corp A's servers 
in exchange for a monthly fee based on the amount of data storage used 
by Corp B. Under the data storage terms, Corp B employees may store 
files created by Corp B employees using Corp A's software or other 
software. Although Corp A's word processing software is compatible with 
Corp A's data storage systems, the core functionality of Corp A's 
software is not dependent on Corp B's purchase of the storage plan. 
Corp A's provision of software and data storage capacity constitute 
separate transactions.
    (ii) Analysis. (A) As explained in paragraph (d)(5)(ii) of this 
section, Corp B's download of fully functional software, along with on-
demand network access to certain limited online features, does not 
constitute a cloud transaction, but rather constitutes a lease of a 
copyrighted article under Sec.  1.861-18.
    (B) The provision of on-demand network data storage by Corp A to 
Corp B is a cloud transaction with one element. Therefore, the 
transaction is treated solely as a cloud transaction under paragraph 
(b) of this section and is classified as the provision of services 
under paragraph (c)(1) of this section.
    (7) Example 7: Streaming and temporary download of digital content 
using third-party servers--(i) Facts. Corp A offers via stream or 
temporary download digital content in the form of videos and music to 
customers from servers located in data centers owned and operated by 
Data Center Operator. Each customer uses a computer or other electronic 
device to access unlimited streaming or temporary downloads of video 
and music in exchange for payment of a flat monthly fee to Corp A. The 
customer may select from among the available content the particular 
video or song to be streamed or downloaded. Corp A continually updates 
its content catalog, replacing content with higher quality versions and 
adding new content at no additional charge to the customer. It also 
provides additional functionality such as various methods of filtering 
and sorting the library, a watchlist, and recommendations based on a 
customer's preferences. Content that is streamed to the customer is not 
stored locally on the customer's computer or other electronic device 
and therefore can be played only while the customer's computer or other 
electronic device is connected to the internet. Content that is 
temporarily downloaded is stored on the customer's computer or other 
electronic device for 1 week and therefore can be played while the 
customer's computer or other electronic device is not connected to the 
internet. Corp A cannot reasonably ascertain the primary benefit or 
value that its specific customers derive from accessing Corp A's 
catalog of digital content. Data collected by Corp A indicates that the 
vast majority of customers stream digital content rather than 
temporarily download the content. Corp A pays Data Center Operator a 
fee based on the amount of data storage used and computing power made 
available in connection with Corp A's content offerings.
    (ii) Analysis. (A) The provision of data storage and computing 
power by Data Center Operator to Corp A is a cloud transaction with one 
element. Therefore, the transaction is treated solely as a cloud 
transaction under paragraph (b) of this section, and is classified as 
the provision of services under paragraph (c)(1) of this section.
    (B) A transaction between Corp A and a customer has two elements. 
One element is streaming access to a curated and routinely updated 
library of digital content, which would be a cloud transaction 
described in paragraph (b) of this section if considered separately. 
Another element is the transfer of a copy of digital content via 
temporary download, which would be a transfer of a copyrighted article 
under Sec.  1.861-18(b)(1)(ii) if considered separately.
    (C) Because the transaction has multiple elements, one or more of 
which would be a cloud transaction if considered separately, paragraph 
(c)(2) of this section provides that the transaction is classified as a 
cloud transaction if its predominant character is a cloud transaction. 
Pursuant to Sec.  1.861-18(b)(3), the predominant character of the 
transaction is based on the primary benefit or value of the transaction 
to the customer if it is reasonably ascertainable. However, Corp A 
cannot reasonably ascertain the primary benefit or value derived by a 
specific customer from Corp A's offering. In such situations, Sec.  
1.861-18(b)(3)(ii) provides that the predominant character of a 
transaction may be determined based on the

[[Page 3002]]

primary benefit or value to a typical customer of a substantially 
similar transaction. This primary benefit or value to a typical 
customer can be identified through actual data about use or access 
pursuant to Sec.  1.861-18(b)(3)(ii)(A), or if that data is not 
available, by using other evidence indicative of the primary benefit or 
value to a typical customer pursuant to Sec.  1.861-18(b)(3)(ii)(B). 
Because Corp A has data that shows the typical customer streams digital 
content rather than temporarily downloading it, the primary benefit or 
value received by a typical customer is streaming access to digital 
content. Therefore, the predominant character of the transaction is a 
cloud transaction. Under paragraph (c)(1) of this section, the cloud 
transaction is classified as the provision of services.
    (8) Example 8: Access to online database--(i) Facts. Corp A offers 
an online database of industry-specific materials. Customers access the 
materials through Corp A's website, which aggregates and organizes 
information topically and hosts a proprietary search engine. Corp A 
hosts the website and database on its own servers and provides multiple 
customers access to the website and database concurrently. Most 
materials in Corp A's database are publicly available by other means, 
but Corp A's website offers an efficient way to locate and obtain the 
information on demand. Certain materials in Corp A's database 
constitute digital content within the meaning of Sec.  1.861-18(a)(2), 
and Corp A pays the copyright owners a license fee for using them. Each 
customer may download any of the materials to its own computer and keep 
such materials without further payment. The customer pays Corp A a fee 
based on the number of searches or the amount of time spent on the 
website, and such fee is not dependent on the amount of materials the 
customer downloads. The fee that the customer pays is substantially 
higher than the stand-alone charge for accessing the same digital 
content outside of Corp A's system. Corp A cannot reasonably ascertain 
the primary benefit or value that a specific customer derives from 
accessing Corp A's database. Corp A does not have data indicating 
whether the typical customer downloads materials from the database. 
Corp A markets its website and online database as user-friendly and an 
efficient way to find relevant materials because of its proprietary 
search engine. Developing the proprietary search engine was the largest 
cost Corp A incurred in creating its website and online database.
    (ii) Analysis. (A) The transaction between Corp A and a customer 
has multiple elements. One element is Corp A's provision to a customer 
of access to Corp A's website and online database, which is a cloud 
transaction described in paragraph (b) of this section if considered 
separately. Another element is the transfer of digital content via 
download, which is the transfer of a copyrighted article under Sec.  
1.861-18 if considered separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a cloud transaction if considered separately, paragraph 
(c)(2) of this section provides that the transaction is classified as a 
cloud transaction if its predominant character is a cloud transaction. 
Pursuant to Sec.  1.861-18(b)(3), the predominant character of the 
transaction is based on the primary benefit or value of the transaction 
to the customer, if it is reasonably ascertainable. However, Corp A 
cannot reasonably ascertain the primary benefit or value derived by a 
specific customer from access to Corp A's database. In such situations, 
Sec.  1.861-18(b)(3)(ii) provides that the predominant character of a 
transaction may be determined based on the primary benefit or value to 
a typical customer of a substantially similar transaction. This primary 
benefit or value to a typical customer can be identified through actual 
data about use or access pursuant to Sec.  1.861-18(b)(3)(ii)(A), or if 
that data is not available, by using other evidence indicative of the 
primary benefit or value to a typical customer pursuant to Sec.  1.861-
18(b)(3)(ii)(B). That Corp A focuses on its proprietary search engine 
when marketing its website and database, as well as the facts that the 
search engine was the most expensive cost incurred by Corp A in 
creating its website and database, and that customers pay a 
substantially higher fee to access Corp A's system than they would 
otherwise pay to access the content outside of Corp A's system, 
indicates that the primary benefit or value received by a typical 
customer is the right to use the search engine. Therefore, under 
paragraph (c)(2) of this section, the predominant character of the 
transaction between Corp A and a customer is a cloud transaction. Under 
paragraph (c)(1) of this section the cloud transaction is classified as 
the provision of services.
    (9) Example 9: Temporary or perpetual access to a single movie via 
stream or download--(i) Facts. Corp A hosts movies on its website and 
allows customers to view a single movie for a limited period or 
perpetually for a one-time fee, with perpetual viewing rights costing a 
higher fee. Corp A does not charge customers a separate fee for access 
to the website. In addition, Corp A's website provides recommendations 
for movies based on a customer's search for a particular title and/or 
the customer's purchase history. Customers have no ability to alter the 
servers, website, or movies available on the website. The movies in 
Corp A's database constitute digital content within the meaning of 
Sec.  1.861-18(a)(2), and Corp A pays the copyright owners a license 
fee for using them. Corp A allows customers to view the movies by 
either streaming the movies from Corp A's servers, or by downloading 
the movies onto the customer's computer or other electronic device. The 
file size of movies offered by Corp A is generally large and so 
customers may be expected to download movies only in certain situations 
such as when traveling without internet access. Upon the expiration of 
the rental period, customers will no longer have access to stream the 
movies, and any movie that was downloaded onto a customer's computer or 
other electronic device will auto-delete from the customer's computer 
or other electronic device. Whether a customer chooses to view the 
movie via stream or download, Corp A charges the same one-time fee. 
Corp A cannot reasonably ascertain the primary benefit or value that a 
specific customer derives from accessing Corp A's website. Corp A 
maintains aggregate data on whether a given movie is viewed via stream 
or download, and this data shows that most movies are viewed by 
streaming, even in the case where a customer pays for the right to view 
a movie in perpetuity.
    (ii) Analysis. (A) A transaction between Corp A and a customer 
contains multiple elements. One element is Corp A's provision to a 
customer of access to Corp A's website in order to view a movie via 
stream, which is a cloud transaction described in paragraph (b) of this 
section if considered separately. Another element is Corp A's provision 
to a customer of access to Corp A's website in order to download a 
movie, which is the transfer of a copyrighted article under Sec.  
1.861-18 if considered separately.
    (B) Because the transaction has multiple elements, one or more of 
which would be a cloud transaction if considered separately, paragraph 
(c)(2) of this section provides that the transaction is classified as a 
cloud transaction if its predominant character is a cloud transaction. 
Pursuant to Sec.  1.861-18(b)(3), the predominant character of the 
transaction is based on

[[Page 3003]]

the primary benefit or value of the transaction to the customer, if it 
is reasonably ascertainable. However, Corp A cannot reasonably 
ascertain the primary benefit or value derived by a specific customer 
from access to Corp A's database. In such situations, Sec.  1.861-
18(b)(3)(ii) provides that the predominant character of a transaction 
may be determined based on the primary benefit or value to a typical 
customer of a substantially similar transaction. This primary benefit 
or value to a typical customer can be identified through actual data 
about use or access pursuant to Sec.  1.861-18(b)(3)(ii)(A), or if that 
data is not available, by using other evidence indicative of the 
primary benefit or value to a typical customer pursuant to Sec.  1.861-
18(b)(3)(ii)(B). Corp A has data that shows that the typical customer 
views movies by streaming rather than download. Accordingly, under 
paragraph (c)(2) of this section, the predominant character of the 
transaction is a cloud transaction because the primary benefit or value 
a typical customer receives is access to stream movies on Corp A's 
website. Under paragraph (c)(1) of this section, the cloud transaction 
is classified as the provision of services.
    (10) Example 10: Reseller of software as a service--(i) Facts. Corp 
A owns the copyright to software (Program S). Corp A hosts Program S on 
its servers. Customers access Program S only through an internet 
connection. Corp A grants Corp B, a foreign corporation wholly owned by 
Corp A, the right to sell access to Program S to Corp B's customers 
that are located in Corp B's country. Corp B is responsible for 
managing the purchase/sale interaction with Corp B's customers, 
including invoicing and collections. Corp A is responsible for 
providing customers with access to Program S. Corp B does not perform 
any functions to provide access to Program S.
    (ii) Analysis. (A) The transaction between Corp A and Corp B is 
treated as Corp A providing on-demand access to Program S to Corp B 
even though Corp B resells that access. This transaction is a cloud 
transaction with one element. Under paragraph (c)(1) of this section, 
the cloud transaction is classified as the provision of services. The 
transaction does not involve the transfer of any copyright rights 
described in Sec.  1.861-18(c)(2), and therefore is governed solely by 
this section.
    (B) The transaction between Corp B and its customers is the 
provision of on-demand access to Program S by Corp B, which is a cloud 
transaction with one element. Under paragraph (c)(1) of this section, 
the cloud transaction is classified as the provision of services. The 
transaction does not involve the transfer of any copyright rights 
described in Sec.  1.861-18(c)(2), and therefore is governed solely by 
this section.
    (11) Example 11: Computer game with online functionality and in-
game purchases--(i) Facts. Corp A owns the copyright to a computer game 
(Game X). Customers can purchase Game X for a one-time fee and download 
it onto their computers. A customer may play certain aspects of Game X 
while not connected to the internet, but most of the core functionality 
of Game X is available only when the customer is connected to the 
internet, including the ability to play with other customers. In order 
to access the additional online functionality specific to Game X, 
customers must pay a monthly fee to Corp A. The additional 
functionality of Game X is hosted on servers owned by Corp A. Customers 
may also pay a one-time fee to access an in-game item that can be 
utilized only when playing Game X online.
    (ii) Analysis. (A) There are three transactions between Corp A and 
a customer. The first transaction is the transfer of a copy of Game X, 
which is a digital content transaction with one element because a 
customer receives from Corp A access only to offline content in 
exchange for purchasing a copy of the game. Therefore, this transaction 
is treated solely as a transfer of a copyrighted article under Sec.  
1.861-18.
    (B) The second transaction between Corp A and a customer is the 
payment of a monthly fee to play Game X online on Corp A's servers, 
which is a cloud transaction with one element. Therefore, this 
transaction is treated solely as a cloud transaction, and is classified 
as the provision of services under paragraph (c)(1) of this section.
    (C) The third transaction between Corp A and a customer is the 
payment of a one-time fee in exchange for an in-game item. Because a 
customer can utilize the item only when playing Game X through an 
internet connection, the transaction is a cloud transaction with one 
element. Therefore, this transaction is treated solely as a cloud 
transaction, and is classified as the provision of services under 
paragraph (c)(1) of this section.
    (e) Applicability date--(1) In general. This section applies to 
taxable years beginning on or after January 14, 2025.
    (2) Early application. A taxpayer can apply this section to taxable 
years beginning on or after August 14, 2019 and all subsequent taxable 
years not described in paragraph (e)(1) (early application years) if--
    (i) The taxpayer also applies Sec.  1.861-18 to the early 
application years;
    (ii) This section and Sec.  1.861-18 are applied to the early 
application years by all persons related to the taxpayer (within the 
meaning of sections 267(b) and 707(b));
    (iii) The period of limitations on assessment for each early 
application year of the taxpayer and all related parties (within the 
meaning of sections 267(b) and 707(b)) is open under section 6501; and
    (iv) The taxpayer would not be required under this section to 
change its method of accounting as a result of such election.
    (f) Change in method of accounting required by this section. In 
order to comply with this section, a taxpayer may be required to change 
its method of accounting. If so required, the taxpayer must secure the 
consent of the Commissioner in accordance with the requirements of 
Sec.  1.446-1(e) and the applicable administrative procedures for 
obtaining the Commissioner's consent under section 446(e) for voluntary 
changes in methods of accounting.

Sec.  1.937-3  [Amended]

0
Par. 5. Section 1.937-3 is amended by removing Examples 4 and 5 from 
paragraph (e).

Douglas W. O'Donnell,
Deputy Commissioner.

    Approved: December 18, 2024.
Aviva R. Aron-Dine,
Deputy Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2024-31372 Filed 1-10-25; 8:45 am]
BILLING CODE 4830-01-P
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