Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Proposed Rules 3075 

the applicant or privilege holder. The 

extension request must be made by 

email and received by the Executive 

Director, Trade Policy and Programs, 

Office of Trade, CBP Headquarters, at 

ecommerce@cbp.dhs.gov, within the 30- 

day period. The denial of an application 

or the revocation of a waiver, does not 

preclude a party from reapplying for the 

privilege in the future. 

■ 13. Amend § 143.26 by revising 

paragraph (b) and adding paragraph (c) 

to read as follows: 

§ 143.26 Party who may make informal 

entry of merchandise. 

* * * * * 

(b) Shipments valued at $800 or less. 

Except for merchandise subject to 

paragraph (c) of this section, a shipment 

of merchandise valued at $800 or less 

which qualifies for informal entry under 

19 U.S.C. 1498 and meets the 

requirements in 19 U.S.C. 1321(a)(2) 

(see §§ 10.151, 10.152, 10.153, 

143.23(k), 145.31, 145.32, 148.51, and 

148.64 of this chapter) may be entered, 

using reasonable care, by the owner, 

purchaser, or consignee of the shipment 

or, when appropriately designated by 

one of these persons, a customs broker 

licensed under 19 U.S.C. 1641. 

(c) Exception for the enhanced entry 

process. A shipment of merchandise 

valued at $800 or less, which qualifies 

for informal entry under 19 U.S.C. 1498 

and the administrative exemption under 

19 U.S.C. 1321(a)(2)(C), may be entered 

under § 143.23(l), using reasonable care, 

by the owner or purchaser of the 

shipment, an express consignment 

operator or carrier in possession of the 

shipment (see § 128.1(a) of this chapter), 

or when appropriately designated by the 

owner, purchaser, or consignee of the 

shipment, a customs broker licensed 

under 19 U.S.C. 1641 (see part 141, 

subpart C). When a party eligible to file 

the entry transmits the entry 

information required under 

§§ 143.23(l)(1)(iv)(A) through (D) and 

143.23(l)(2)(iv) through (v) of this part, 

and receives any of that information 

from another party, CBP will take into 

consideration how, in accordance with 

ordinary commercial practices, the 

transmitting party acquired such 

information, and whether and how the 

transmitting party is able to verify this 

information. When the transmitting 

party is not reasonably able to verify 

such information, CBP will permit the 

party to transmit the information on the 

basis of what the party reasonably 

believes to be true. 

PART 145—MAIL IMPORTATIONS 

■ 14. The authority citation for part 145 

and the specific authority citation for 

§§ 145.31 and 145.32 continue to read as 

follows: 

Authority: 19 U.S.C. 66, 1202 (General 

Note 3(i)), Harmonized Tariff Schedule of the 

United States, 1624. 

* * * * * 

Section 145.31 also issued under 19 U.S.C. 

1321; 

Section 145.32 also issued under 19 U.S.C. 

1321, 1498; 

* * * * * 

■ 15. Revise § 145.31 to read as follows: 

§ 145.31 Importations not over $800 in 

value. 

The port director may pass free of 

duty and tax, without preparing an 

entry as provided for in § 145.12, 

packages containing merchandise 

having an aggregate fair retail value in 

the country of shipment of not over 

$800, subject to the requirements set 

forth in §§ 10.151 and 10.153 of this 

chapter. Such merchandise may 

alternatively be entered under 

§ 143.23(l) of this chapter, in which case 

all required information must be 

transmitted to CBP no later than the 

date the merchandise departs from the 

country of posting. 

§ 145.32 [Amended] 

■ 16. Amend § 145.32 by removing the 

word ‘‘shall’’ and adding in its place the 

word ‘‘may’’. 

Robert F. Altneu, 

Director, Regulations & Disclosure Law 

Division, Regulations & Rulings, Office of 

Trade, U.S. Customs and Border Protection. 

[FR Doc. 2025–00551 Filed 1–13–25; 8:45 am] 

BILLING CODE 9111–14–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–107420–24] 

RIN 1545–BR21 

Source of Income From Cloud 

Transactions 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: This document contains 

proposed rules for determining the 

source of income from cloud 

transactions for purposes of the 

international provisions of the Internal 

Revenue Code. These proposed rules 

would generally affect taxpayers who 

earn gross income from engaging in 

cloud transactions. 

DATES: Written or electronic comments 

and requests for a public hearing must 

be received by April 14, 2025. 

ADDRESSES: Commenters are strongly 

encouraged to submit public comments 

electronically. Submit electronic 

submissions via the Federal 

eRulemaking Portal at 

www.regulations.gov (indicate IRS and 

REG–107420–24) by following the 

online instructions for submitting 

comments. Requests for a public hearing 

must be submitted as prescribed in the 

‘‘Comments and Requests for a Public 

Hearing’’ section. Once submitted to the 

Federal eRulemaking Portal, comments 

cannot be edited or withdrawn. The 

Department of the Treasury (Treasury 

Department) and the IRS will publish 

for public availability any comment 

received to its public docket, whether 

submitted electronically or in hard 

copy. Send hard copy submissions to: 

CC:PA:01:PR (REG–107420–24), Room 

5203, Internal Revenue Service, P.O. 

Box 7604, Ben Franklin Station, 

Washington, DC 20044. Submissions 

may be hand-delivered Monday through 

Friday between the hours of 8 a.m. and 

4 p.m. to: CC:PA:01:PR (REG–107420– 

24), Courier’s Desk, Internal Revenue 

Service, 1111 Constitution Avenue NW, 

Washington, DC 20224. 

FOR FURTHER INFORMATION CONTACT: 

Concerning the proposed regulations, 

Christopher E. Fulle at (202) 317–5367 

or Michelle L. Ng at (202) 317–6989 (not 

toll-free numbers); concerning 

submissions of comments and requests 

for a public hearing, contact the 

Publications and Regulations branch at 

(202) 317–6901 (not a toll-free number) 

or by email to publichearings@irs.gov 

(preferred). 

SUPPLEMENTARY INFORMATION: 

Authority 

The proposed 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 

Proposed regulations published in the 

Federal Register (84 FR 40317) in 2019 

(REG–130700–14) (the 2019 proposed 

regulations) set forth proposed rules for 

identifying and classifying cloud 

transactions, and the preamble to the 

2019 proposed regulations requested 


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3076 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Proposed Rules 

comments on rules for sourcing income 

from cloud transactions. Comments 

received addressed the necessity of 

developing specific rules for sourcing 

gross income from cloud transactions 

and provided recommendations on the 

content of such rules. This notice of 

proposed rulemaking, which is being 

published with the final regulations for 

identifying and classifying cloud 

transactions (TD 10022) (the 2024 final 

regulations) that are being published in 

the Final Rules section of this same 

issue of the Federal Register, proposes 

rules for sourcing gross income from 

cloud transactions. 

Explanation of Provisions 

I. Source of Gross Income From Cloud 

Transactions 

A. Overview of Comments Received 

The Treasury Department and the IRS 

received more than a dozen comments 

in response to the request for comments 

on administrable rules for sourcing 

income from cloud transactions in a 

manner consistent with sections 861 

through 865. Comments were split 

almost evenly with regard to whether 

specific sourcing rules are needed in 

this area, with a narrow majority 

expressing support for such guidance. 

Of this majority, several comments 

recommended that services income from 

cloud transactions be sourced according 

to the location of the assets and 

personnel used in providing the service. 

A number of these comments explained 

that this approach would align with the 

result in Piedras Negras Broadcasting 

Co. v. Comm’r, 43 B.T.A. 297 (1941), 

nonacq., 1941–2 C.B. 22, aff’d, 127 F. 

2d. 260 (5th Cir. 1942), in which the 

income of a radio broadcasting 

corporation was determined to be 

foreign source because its broadcasting 

facilities and employees were located in 

Mexico, even though the corporation 

broadcasted programs primarily to 

listeners located in the United States 

and received almost all of its income 

from advertisers located in the United 

States. Other comments voiced the need 

for specific rules for sourcing income 

from cloud transactions, but did not 

recommend a particular sourcing 

approach, with one comment suggesting 

that the location of the cloud service 

provider’s assets and personnel and the 

location of the end-user could be 

evaluated in developing the rules. 

Another comment proposed that given 

the challenges of sourcing cloud 

transactions when the operations, 

employees, and customers are 

dispersed, the sourcing rules could 

provide taxpayers with the option to 

source the income to the place where 

the contract is executed. While almost 

half of the comments received stated 

that regulations for sourcing income 

from cloud transactions are unnecessary 

because existing statutory, regulatory, 

and case law provides sufficient 

guidance, an overwhelming majority of 

those comments recommended that if 

issued, the regulations should take into 

account the location of the assets and 

people that contribute to the delivery of 

the cloud service. 

Many of the comments discussed 

whether the sourcing determination 

should be made by taking into account 

solely the assets and personnel of the 

taxpayer that recognizes the income 

from the performance of the cloud 

service (the taxpayer-by-taxpayer 

approach), or whether taxpayers should 

be required to look through to the 

activities and personnel of other related 

legal entities that contribute to the 

provision of the service (the unitary 

approach). Nearly all comments on this 

issue stated that income from cloud 

transactions should be sourced on a 

taxpayer-by-taxpayer basis. Comments 

explained that the taxpayer-by-taxpayer 

approach is administrable and 

supported by the principles of Miller v. 

Comm’r, 73 T.C.M. 2319 (1997), aff’d 

without published decision, 166 F.3d 

1218 (9th Cir. 1998), in which income 

that a foreign corporation received for 

performing research and development 

services was held to be foreign source 

notwithstanding that the performance of 

those services was subcontracted to 

certain related and unrelated entities, 

including a wholly-owned U.S. 

subsidiary. One comment suggested that 

a taxpayer-by-taxpayer rule for sourcing 

services income from cloud transactions 

could be supplemented with anti-abuse 

provisions requiring the income to be 

sourced on a look-through or unitary 

basis in limited circumstances. 

However, another comment asserted 

that sourcing services income from 

cloud transactions on a look-through or 

unitary basis should be required, 

explaining that this approach more 

accurately reflects the economic 

realities of the transaction because it 

accounts for the contributions made by 

members of the multinational group to 

the provision of the service. That 

comment also expressed the concern 

that sourcing on a taxpayer-by-taxpayer 

basis could cause U.S. source income to 

be understated with respect to 

commonly-used structures in which the 

development, enhancement, 

maintenance, protection, and 

exploitation functions are performed 

primarily by U.S. entities but the 

services income is recorded by a foreign 

entity that contracts directly with the 

end-users to whom the cloud 

transaction is provided. 

B. Need for Proposed Regulations 

The development and advancement of 

cloud technologies has transformed both 

the value that businesses deliver to 

customers and the way that value is 

delivered, giving rise to cloud-based 

business models and cloud transactions. 

The 2024 final regulations classify a 

cloud transaction (within the definition 

of § 1.861–19(b)) as the provision of 

services. See § 1.861–19(c)(1). Under the 

source rules of the Code, which were 

designed in the context of more 

traditional modes of commerce, gross 

income from the provision of services is 

sourced to the place where the service 

is performed. See sections 861(a)(3) and 

862(a)(3). The Code does not provide 

guidance on how to determine the place 

of performance for specific types of 

service transactions, including cloud 

transactions. Further, while section 

863(b)(1) specifies that income from 

services rendered partly within and 

partly without the United States is 

treated as derived partly from each 

source, there is no statutory guidance 

prescribing how to source the services 

income, including income from cloud 

transactions, in such circumstances. The 

distinctive attributes of cloud 

transactions, including the networkbased and increasingly automated 

nature of the service delivery and the 

role of intangible property (such as 

proprietary software and other 

proprietary digital content) in ensuring 

the functionality, reliability, and 

performance of the service, raise 

questions regarding how to determine 

the place of performance of a cloud 

transaction. 

The proposed regulations, which 

would establish specific sourcing rules 

that interpret the place of performance 

in the context of a cloud transaction, are 

therefore necessary to provide clarity 

and certainty to both taxpayers and the 

IRS. To determine the place of 

performance, the proposed sourcing 

rules would take into account the 

location of the employees and assets, 

including both tangible and intangible 

assets, that contribute to the provision 

of the cloud transaction. The Treasury 

Department and the IRS are of the view 

that, because of the technical nature of 

a cloud transaction, the place of 

performance for purposes of sourcing 

gross income is the place where the 

resources and personnel responsible for 

the development, management, and 

delivery of the service are located 

because this is where the key activities 

in the provision of the service occur, as 


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opposed to ancillary activities such as 

marketing, sales, and contracting. This 

approach is consistent with case law on 

the sourcing of income involving 

analogous traditional business models 

where services are provided from a 

location that differs from the customers’ 

location, specifically, the Piedras 

Negras case. See 43 BTA at 297, aff’d, 

127 F.2d at 260. In line with the 

approach in Piedras Negras, the 

proposed rules do not consider the 

location of the customer or end-user, as 

it merely reflects the place where the 

service is consumed, not where the 

performance actually takes place as 

prescribed by sections 861(a)(3) and 

862(a)(3). Similarly, the location where 

a contract for a cloud transaction is 

executed should not dictate the source 

of the resulting gross income because 

that location may not bear any 

connection to where the service is 

performed. 

The proposed cloud transaction 

sourcing rules would apply on a 

taxpayer-by-taxpayer basis and 

therefore, in determining the gross 

income of an entity that recognizes the 

services income, would take into 

account solely the assets and personnel 

of the legal entity. The Treasury 

Department and the IRS agree that this 

approach is administrable and practical. 

By focusing on the economic 

contributions that the contracting entity 

makes to the performance of the cloud 

transaction, the taxpayer-by-taxpayer 

approach provides a clear, 

straightforward way of determining the 

source of gross income from the 

transaction, while allowing for 

appropriate deductions from that gross 

income in respect of amounts paid or 

accrued to affiliated or unaffiliated 

contributors to the provision of the 

cloud services, leading to reduced 

complexity in tax compliance and 

enforcement. This approach is also 

generally consistent with the current 

approach for sourcing other categories 

of income, including non-cloud services 

income such as gross income from 

certain sales of inventory that is sourced 

to the location of production activity 

under § 1.863–3(c)(1)(ii). Further, this 

approach would not impede the IRS’s 

ability to assert common law principles, 

such as the economic substance 

doctrine, the step transaction doctrine, 

and the rules of agency, or existing 

statutory and regulatory provisions, 

such as the section 482 rules, to ensure 

that the Federal income tax 

consequences more properly reflect the 

economic realities of the transaction, 

including the contributions to a cloud 

transaction made by affiliates of the 

taxpayer. Notwithstanding the above, 

the Treasury Department and the IRS 

will continue to study the implications 

of applying the taxpayer-by-taxpayer 

approach in the context of sourcing 

gross income from services generally, 

and may refine or propose revisions to 

the approach if they determine that this 

is necessary to adequately account for 

the interdependencies and collaboration 

across entities in a multinational group, 

and consequently, to ensure a fair and 

accurate representation of where 

services are performed. 

C. Explanation of Proposed Rules for 

Sourcing Gross Income From Cloud 

Transactions 

The proposed regulations state that 

gross income from a cloud transaction is 

sourced as services income under 

section 861(a)(3) or 862(a)(3), as 

appropriate, according to where the 

service is performed. Proposed § 1.861– 

19(d)(1). The place of performance of a 

cloud transaction is established through 

a formula composed of a fraction that 

relies on three factors: the intangible 

property factor, the personnel factor, 

and the tangible property factor (within 

the meaning of proposed § 1.861– 

19(d)(2), (d)(3), and (d)(4), respectively). 

Id. 

As discussed in detail in Parts I.C.1 

through 3 of this Explanation of 

Provisions, the intangible property 

factor is intended to reflect the 

contribution of intangible property to 

the provision of the cloud transaction; 

the personnel factor is intended to 

reflect the contribution of certain 

employees to the provision of the cloud 

transaction; and the tangible property 

factor is intended to reflect the 

contribution of tangible property to the 

provision of the cloud transaction. Each 

factor is determined by taking into 

account certain worldwide expenses by 

the entity that, in the view of the 

Treasury Department and the IRS, 

properly represent the contributions 

made by or through the relevant 

personnel and assets to the performance 

of the cloud transaction. Together, these 

factors make up the denominator of the 

fraction. The numerator of the fraction 

is determined by summing up the 

portion of each factor that is from 

sources within the United States. 

Under the proposed regulations, the 

gross income from a cloud transaction 

multiplied by the fraction yields the 

portion of the gross income that is from 

sources within the United States. 

Proposed § 1.861–19(d)(1). The portion 

of the gross income that remains is gross 

income from sources without the United 

States. Id. 

1. Intangible Property Factor 

a. Determination of the Intangible 

Property Factor 

The Treasury Department and the IRS 

consider intangible property to be a 

significant contributor to the 

performance of cloud transactions. 

Intangible property, such as software, 

algorithms, data processing 

applications, and other proprietary 

technologies, often plays a crucial role 

in the performance of a cloud 

transaction, including by shaping the 

unique features of the service and 

ensuring the service’s functionality, 

reliability, and delivery. This role of 

intangible property is becoming 

particularly important as cloud 

transactions are becoming increasingly 

automated, requiring less and less 

contribution from personnel and 

tangible property to deliver value to 

customers. In such cases, the intangible 

property itself may be the main force 

that is effectively performing the 

service. It would be difficult and 

burdensome, however, to ascertain the 

precise value or contribution of an item 

of intangible property to the 

performance of a cloud transaction 

given the challenges inherent in 

isolating the specific impact of various 

intangibles on the cloud transaction’s 

overall performance. The Treasury 

Department and the IRS are of the view 

that certain research and experimental 

expenses, amortization, and royalties 

incurred during the taxable year in 

which the cloud transaction is 

performed could serve as an 

administrable proxy for reflecting the 

contribution of intangible property to 

the performance of the cloud 

transaction. These expenses serve as the 

foundation for the intangible property 

factor. 

Specifically, the intangible property 

factor is the sum of specified research or 

experimental expenditures (as defined 

under section 174(b)) incurred during 

the taxable year that are associated with 

the cloud transaction as well as royalty 

and certain amortization expenses 

incurred during the taxable year to the 

extent they are for intangible property 

directly used to provide the cloud 

transaction (collectively, ‘‘intangible 

property costs’’). Proposed § 1.861– 

19(d)(2)(i). Intangible property costs 

include payments to third-party and 

related-party research and 

experimentation providers. Because 

specified research or experimental 

expenditures are used as a proxy for 

current use of existing self-developed 

intangible property, those expenditures 

are taken into account as they are 

incurred, regardless of whether and 


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3078 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Proposed Rules 

when they are deductible, in order to 

match the timing of when compensation 

is paid to employees performing 

research or experimentation activities. 

As discussed in Part I.C.1.b. of this 

Explanation of Provisions, the 

intangible property factor is sourced 

based on this compensation; therefore 

the Treasury Department and the IRS 

are of the view that taking the specified 

research or experimental expenditures 

in the year when incurred provides an 

administrable rule that recognizes the 

economic contribution of the intangible 

property and avoids taxpayers having to 

trace section 174(a)(2)(B) amortization 

deductions back to the year in which 

incurred. However, royalty and 

amortization expenses are taken into 

account for the intangible property 

factor when deductible because that is 

the most administrable proxy for 

measuring the economic contribution 

existing licensed or acquired intangible 

property makes to a cloud transaction. 

In computing the intangible property 

factor, the Treasury Department and the 

IRS recognize that some specified 

research or experimental expenditures 

may not be directly traceable to a single 

transaction because intangible property 

developed through research and 

experimentation conducted in a taxable 

year may not be monetized in cloud 

transactions until a future year. In light 

of this, and consistent with the 

approach taken for allocating and 

apportioning deductions for such 

expenditures, the proposed regulations 

provide that the specified research or 

experimental expenditures to be taken 

into account with respect to a cloud 

transaction from which the gross 

income is being sourced are those 

associated with all cloud transactions 

provided in that taxable year that are in 

the same product line as the cloud 

transaction. Id.; cf. § 1.861–17(b) 

(recognizing that research and 

experimentation is an inherently 

speculative activity, which when 

successful ultimately results in the 

creation of intangible income, and 

allocating expenditures for such activity 

to gross intangible income earned in the 

year of the expenditure). The Treasury 

Department and the IRS are of the view 

that the current-year approach in the 

proposed rules serves as a workable, 

reliable, and appropriate proxy for 

existing intangible property in the same 

product line. Under the proposed 

regulations, cloud transactions are 

considered to be in the same product 

line if they are within the same 

Corresponding Index Entry under a 

North American Industry Classification 

System (NAICS) code number. Proposed 

§ 1.861–19(d)(8). The proposed 

regulations also include a consistency 

requirement to prevent taxpayers from 

changing Corresponding Index Entry 

and NAICS code numbers absent a 

change in facts. Id. The intangible 

property factor focuses on work done in 

the same product line as the cloud 

transaction to balance between 

specificity and practicality. The factor 

aims to capture the contribution of 

intangible property to the performance 

of a cloud transaction, so a factual 

relationship between the specified 

research or experimentation 

expenditures and the cloud transaction 

being tested needs to exist. At the same 

time, the Treasury Department and the 

IRS are aware that it is not necessarily 

possible to precisely determine the 

product or products that will benefit 

from a research and experimentation 

process at an early stage. To prevent 

duplication, the proposed regulations 

require expenses that would be 

included in the intangible property 

factor for multiple cloud transactions in 

a taxable year to be allocated among 

those transactions (taking into account 

the aggregation rule described in Part 

I.C.4 of this Explanation of Provisions) 

based on the relative gross income 

earned from each transaction. Proposed 

§ 1.861–19(d)(2)(i). Any intangible 

property costs that support cloud 

transactions in general but that do not 

relate to any specific cloud transaction 

should be allocated in the same manner. 

b. Determination of the Portion of the 

Intangible Property Factor From U.S. 

Sources 

Once the intangible property factor is 

determined, the portion of this factor 

that is attributable to sources within the 

United States must be identified for 

inclusion in the numerator. Given the 

non-physical nature of intangible 

property, its location when used in 

providing a service may be challenging 

to ascertain. Under the proposed rules, 

the portion of the intangible property 

factor that is from sources within the 

United States is determined based on 

the extent to which certain of the 

taxpayer’s employees perform services 

in the United States, determined by 

leveraging the principles of § 1.861– 

4(b)(2)(ii)(E) (relating to sourcing 

compensation from labor or personal 

services on a time basis). The employees 

considered for this purpose are those 

whose primary function is to perform 

research and experimentation activities 

associated with cloud transactions in 

the same product line as the cloud 

transaction the gross income of which is 

being sourced. Proposed § 1.861– 

19(d)(2)(ii). The proposed regulations 

provide that the employee’s primary 

function is the set of tasks to which they 

are assigned to spend the majority of 

their working time. Proposed § 1.861– 

19(d)(5). In order to account for amounts 

paid to third-party research and 

experimentation providers, 

amortization, and royalties, the fraction 

determined by the compensation that 

has been paid to the research and 

experimentation personnel is applied to 

the total research and experimental 

expense determined under § 1.861– 

19(d)(2)(i). See proposed § 1.861– 

19(d)(2)(ii). 

The Treasury Department and the IRS 

are of the view that the location of 

research and experimentation personnel 

is a logical and accurate proxy for the 

location of intangible property that 

contributes to the performance of a 

cloud transactions for a number of 

reasons. First, the research and 

experimentation personnel contribute to 

the creation, design, and refinement of 

the intangible property either through 

their own efforts or by managing and 

facilitating research and 

experimentation work carried out by 

third parties. Therefore, the value of the 

intangible property used to provide the 

cloud transaction depends on their 

personal efforts and expertise. 

Additionally, while intangible property 

does not have a physical form that can 

be easily located, the place where 

research and experimentation personnel 

operate is tangible and verifiable. 

Relatedly, taxpayers generally know or 

should know the location of their 

research and experimentation 

personnel, and thus, relying on the 

location of these personnel would avoid 

a burdensome compliance process that 

might otherwise be required to 

determine the location of intangible 

property used to provide cloud 

transactions. For similar reasons, in 

determining gross income of a taxpayer, 

the rule does not look to research and 

experimentation personnel other than 

those of the taxpayer, and uses the 

taxpayer’s own personnel as a proxy for 

all research and experimentation 

personnel working on the relevant 

intangible property. 

The determination of which research 

and experimentation employees should 

be taken into account focuses on the 

employees whose primary function is 

the performance of research and 

experimentation activities, without 

limiting the analysis to nonmanagerial 

employees or first-line managers who 

undertake these activities. This is 

because research and experimentation 

typically involves contributions from 

personnel across various levels of the 

organization, including senior 


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leadership and technical staff, as an idea 

for a product or service moves from 

concept to design, implementation, and 

testing. Accordingly, focusing solely on 

nonmanagerial employees or first-line 

managers could result in missing key 

contributors to the research and 

experimentation activities associated 

with a cloud transaction, including 

individuals within the organizational 

structure who oversee or engage in 

higher-level experimentation efforts. 

2. Personnel Factor 

a. Determination of the Personnel Factor 

and the Portion From U.S. Sources 

The Treasury Department and the IRS 

are of the view that while the 

underlying technology and 

infrastructure are important in 

providing a cloud transaction to 

customers, the employees who manage, 

operate, and maintain these systems are 

also fundamental to the provision of the 

service. Accordingly, the efforts of 

personnel employed by the taxpayer 

who directly contribute to the provision 

of the cloud transaction must be taken 

into account in sourcing gross income 

from that cloud transaction. To properly 

reflect the contribution of these 

personnel to the provision of the cloud 

transaction, the personnel factor is 

composed of the compensation paid to 

the taxpayer’s employees whose 

primary function is to directly 

contribute to the provision of the cloud 

transaction. See proposed § 1.861– 

19(d)(3)(i). However, to avoid double 

counting income, compensation that is 

paid to research and experimentation 

personnel described in proposed 

§ 1.861–19(d)(2) is excluded. Id. 

As explained in Part I.C.1.b of this 

Explanation of Provisions, an 

employee’s primary function is the set 

of tasks to which they are assigned to 

spend the majority of their working 

time. Proposed § 1.861–19(d)(5). The 

proposed regulations provide a rule to 

account for situations in which an 

employee’s primary function is to 

directly contribute to more than one 

cloud transaction. In those cases, all of 

the employee’s compensation must be 

allocated among those cloud 

transactions based on the relative 

amount of time the employee spends 

contributing to each transaction. 

Proposed § 1.861–19(d)(3)(i). To 

illustrate the application of these rules, 

if an employee spends 30 percent of 

their working time on Cloud 

Transaction 1, 30 percent of their 

working time on Cloud Transaction 2, 

and 40 percent of their working time not 

on cloud transactions, that employee’s 

primary function would be working on 

cloud transactions because a majority of 

their working time (60 percent) is spent 

on cloud transactions. Consequently, all 

of this employee’s compensation would 

be allocated among Cloud Transaction 1 

and Cloud Transaction 2 based on the 

relative amount of time the employee 

spends contributing to each of the two 

cloud transactions. However, where an 

employee contributes to multiple cloud 

transactions simultaneously, their 

compensation must be allocated among 

those transactions based on the relative 

gross income earned from each 

transaction because it would be 

impossible to use a time-based 

allocation in such cases. Id. 

Similar to the determination of the 

numerator of the intangible property 

factor, which is the portion of that factor 

from sources within the United States, 

the proposed regulations provide the 

numerator of the personnel factor, 

which is the portion of that factor from 

sources within the United States, is 

equal to the part of the personnel factor 

that is paid for services performed in the 

United States using the principles of 

§ 1.861–4(b)(2)(ii)(E). Proposed § 1.861– 

19(d)(3)(ii). 

b. Direct Contribution to the Provision 

of the Cloud Transaction 

The proposed regulations set forth 

rules that define which employees are 

considered to directly contribute to the 

provision of the cloud transaction and 

which employees are not considered to 

do so. Under proposed § 1.861– 

19(d)(3)(iii), personnel directly 

contribute to the provision of a cloud 

transaction to the extent they personally 

perform technical or operational 

activities for the provision of the cloud 

transaction, or to the extent they are 

managers who directly support or 

immediately supervise such technical or 

operational personnel. Proposed 

§ 1.861–19(d)(3)(iii) provides a nonexhaustive list of the functions that fall 

within the meaning of ‘‘technical and 

operational activities.’’ These functions 

are the conduct of scientific, 

engineering, or technical activities for 

the configuration, delivery, or 

maintenance of the cloud transaction; 

the provision of monitoring, diagnostics, 

or incident response with respect to the 

cloud transaction’s performance, 

reliability, efficiency, or security; the 

management of the cloud transaction’s 

infrastructure; the delivery of end-user 

support with respect to the cloud 

transaction; and the conduct of any 

similar functions. Id. Further, under 

proposed § 1.861–19(d)(3)(iv), personnel 

are not considered to directly contribute 

to the provision of the cloud transaction 

to the extent they conduct business 

strategy, leadership, legal or 

compliance, marketing, 

communications, sales, business 

development, finance, accounting, 

clerical, human resources or 

administrative duties, or similar 

functions. 

Proposed § 1.861–19(d)(3)(iii) and (iv) 

are intended to identify the individuals 

that generally have the hands-on, dayto-day involvement in the software, 

infrastructure, and processes that enable 

the cloud transaction to be provided to 

the customer and to function as 

intended. The Treasury Department and 

the IRS are of the view that the 

individuals who personally perform the 

technical and operational work and the 

immediate managers who direct and 

supervise that work are essential to the 

performance of the service, and 

therefore, their contributions must be 

included. By contrast, employees in 

higher-level management or executive 

positions who are responsible for setting 

the strategic direction of the business 

and making high-level decisions are too 

far removed from the hands-on, day-today work that ensures the delivery of 

any particular cloud transaction to the 

customer. Therefore, while their roles 

are important to the overall business, 

they do not directly contribute to the 

provision of the transaction itself and 

are not accounted for as part of the 

personnel factor. The Treasury 

Department and the IRS are of the view 

that this distinction properly interprets 

the statutory requirement to source 

gross income from a service to the place 

where the service is performed. 

3. Tangible Property Factor 

a. Determination of the Tangible 

Property Factor and the Portion From 

U.S. Sources 

Cloud transactions depend on 

physical infrastructure and hardware, 

such as servers and networking 

equipment. For this reason, the Treasury 

Department and the IRS are of the view 

that tangible property that directly 

supports the provision of a cloud 

transaction must be taken into account 

in determining the source of gross 

income from a cloud transaction. Under 

the proposed regulations, the tangible 

property factor, which is intended to 

represent the contribution of the 

tangible property to the performance of 

the cloud transaction, is the sum of the 

depreciation and rental expense for the 

taxable year for tangible property owned 

or leased by the taxpayer, to the extent 

the property is directly used to provide 

the cloud transaction. See proposed 

§ 1.861–19(d)(4)(i). To eliminate double 

counting, the proposed regulations 


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require any depreciation or rental 

expense that would be included in the 

tangible property factor for multiple 

cloud transactions in a taxable year to 

be allocated among those transactions 

based on the relative gross income 

earned from each transaction. The 

portion of the tangible property factor 

that is from sources within the United 

States and comprises the numerator is 

equal to the part of the tangible property 

factor attributable to property located 

within the United States. 

b. Determination of the Depreciation 

Expense 

For purposes of computing the 

tangible property factor, depreciation 

expense for a taxable year is determined 

by dividing the adjusted depreciable 

basis (as defined in § 1.168(b)–1(a)(4)) of 

the tangible property by the applicable 

recovery period as though the 

alternative depreciation system in 

section 168(g)(2) applied for the entire 

period the property has been in service. 

Proposed § 1.861–19(d)(4)(iii). The 

Treasury Department and the IRS are of 

the view that the determination must be 

made without taking into account tax 

incentives intended to accelerate the 

recovery of costs in order to provide an 

allocation of depreciation that more 

closely reflects the asset’s actual 

economic life. Thus, the proposed 

regulations explicitly state that the 

depreciation expense is computed 

without regard to the election to 

expense certain depreciable property 

under section 179 and without regard to 

any additional first-year depreciation 

provision (for example, section 168(k)). 

4. Aggregation Rule 

The proposed regulations include an 

aggregation rule, set forth in proposed 

§ 1.861–19(d)(7), that is intended to 

enhance the administrability of these 

regulations and to alleviate the 

compliance burden on taxpayers 

associated with the regulations. The rule 

allows a taxpayer to aggregate 

substantially similar cloud transactions 

and source the gross income from those 

transactions as if they were one 

transaction. However, the rule also 

prohibits a taxpayer from aggregating 

substantially similar cloud transactions 

if the taxpayer knows, or has reason to 

know, that doing so would materially 

distort the source of gross income from 

any cloud transaction. 

For example, assume a cloud provider 

offers two distinct but substantially 

similar cloud transactions, Service 1 

and Service 2, that are not in the same 

product line (within the meaning of 

proposed § 1.861–19(d)(8)). Further, 

assume the cloud provider incurs 

significantly more research and 

experimentation costs associated with 

Service 2 as compared to those incurred 

for Service 1, and all of the research and 

experimentation personnel of the cloud 

provider are located in the United States 

at all times. This leads a significantly 

larger percentage of the income from 

Service 2 to be sourced within the 

United States as compared to that of 

Service 1. Aggregating Service 1 and 

Service 2 would cause a materially 

larger amount of gross income from 

Service 1 to be sourced within the 

United States than if the income were 

sourced without aggregating Service 1 

with Service 2. Therefore, under the 

proposed regulations, the cloud 

provider cannot aggregate Service 1 and 

Service 2 to source the gross income 

from these transactions. 

5. Anti-Abuse Rule 

In order to prevent taxpayers from 

circumventing the purpose of the 

proposed regulations—to attribute the 

source of gross income from a cloud 

transaction to the place where the 

transaction is performed—the proposed 

regulations would provide an anti-abuse 

rule. That anti-abuse rule, included in 

proposed § 1.861–19(d)(9), would 

provide that if the taxpayer has entered 

into or structured one or more 

transactions with a principal purpose of 

reducing its U.S. tax liability in a 

manner inconsistent with the purpose of 

the proposed regulations, appropriate 

adjustments will be made so that the 

source of the taxpayer’s gross income 

reflects the location where the cloud 

transaction is performed. 

II. Request for Comments 

Comments are requested on all 

aspects of the proposed regulations, 

including the following topics: 

(1) whether there are appropriate and 

administrable ways to determine the 

portion of the intangible property factor 

from sources within and without the 

United States other than by relying on 

the location of research and 

experimental personnel; 

(2) whether and to what extent 

companies presently track specified 

research or experimental expenditures 

by product line; 

(3) whether there is a practicable and 

verifiable way to precisely link the 

contribution of intangible property 

developed in one year to a cloud 

transaction provided in a later year; 

(4) whether relative gross income is 

an appropriate allocation method in 

cases in which the same cost or expense 

would be included in a factor for 

multiple cloud transactions during a 

taxable year; 

(5) whether additional operating costs 

incurred with respect to tangible 

property directly used in the provision 

of the cloud transaction, such as 

electricity costs associated with cloud 

transactions, should be included in the 

tangible property factor, and if so, how 

to capture the costs that contribute to 

the performance of the cloud transaction 

in an administrable manner; and 

(6) whether a special rule is needed to 

source the gross income of resellers of 

cloud transactions, for example, 

whether assets and employees other 

than those described in the proposed 

regulations better reflect the reseller’s 

role in the cloud transaction. 

Proposed Applicability Date 

The regulations are proposed to apply 

to taxable years beginning on or after the 

date of publication of the Treasury 

decision adopting these regulations as 

final regulations in the Federal Register. 

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 

This proposed rulemaking does not 

impose or revise any information 

collections subject to 44 U.S.C. Chapter 

35. 

III. Regulatory Flexibility Act 

The Regulatory Flexibility Act 

requires consideration of the regulatory 

impact on small businesses. It is hereby 

certified that these proposed 

regulations, if adopted, 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). 

These proposed regulations would set 

forth specific rules for sourcing income 

from cloud transactions. Specifically, 

the proposed regulations provide 

guidance on sourcing such income 

based on three factors that are broadly 

consistent with existing case law on 

sourcing income from analogous 

transactions. Although data are not 

readily available to estimate the 

economic impact of the proposed 

regulations, the Treasury Department 

and the IRS project that any economic 

impact of the proposed regulations 


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would be minimal for businesses 

regardless of size. This is because the 

proposed regulations adopt an approach 

that is broadly consistent with the 

general principles of existing law and 

reflect current industry practice. 

Therefore, the proposed rules are not 

expected to materially alter taxpayer 

behavior and therefore the Treasury 

Department and the IRS expect no 

material economic impact. 

For the reasons stated, a regulatory 

flexibility analysis under the Regulatory 

Flexibility Act is not required. 

Notwithstanding the above, the 

Treasury Department and the IRS invite 

comments on the impact the proposed 

rules would have on small entities. 

IV. Section 7805(f) 

Pursuant to section 7805(f) of the 

Code, this notice of proposed 

rulemaking will be submitted to the 

Chief Counsel for Advocacy of the Small 

Business Administration for comment 

on its impact on small business. 

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 proposed 

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 statute, or preempts State 

law, unless the agency meets the 

consultation and funding requirements 

of section 6 of the Executive Order. The 

proposed 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. 

Comments and Requests for a Public 

Hearing 

Before these proposed regulations are 

adopted as final regulations, 

consideration will be given to any 

comments that are submitted timely to 

the IRS as prescribed in this preamble 

under the ADDRESSES heading. All 

comments will be available at 

www.regulations.gov. 

A public hearing will be scheduled if 

requested in writing by any person that 

timely submits comments. Requests for 

a public hearing are also encouraged to 

be made electronically. If a public 

hearing is scheduled, notice of the date, 

time, and place for the public hearing 

will be published in the Federal 

Register. 

Drafting Information 

The principal authors of these 

proposed 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. 

Proposed Amendments to the 

Regulations 

Accordingly, the Treasury Department 

and IRS propose to amend 26 CFR part 

1 as follows: 

PART 1—INCOME TAXES 

■ Paragraph 1. The authority citation 

for part 1 continues to read in part as 

follows: 

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

■ Par. 2. Section 1.861–19, as added in 

a final rule published elsewhere in this 

issue of the Federal Register, effective 

January 14, 2025, is amended as follows: 

■ a. Revise the section heading and 

paragraph (a); 

■ b. Redesignate paragraphs (d), (e), and 

(f) as paragraphs (e), (f), and (g), 

respectively; 

■ c. Add new paragraph (d); 

■ d. For each paragraph listed in the 

following table, remove the language in 

the ‘‘Remove’’ column and add in its 

place the language in the ‘‘Add’’ 

column. 

Paragraph Remove Add 

newly redesignated (e), first sentence .................................................... paragraph (d) ................................. paragraph (e). 

newly redesignated (e)(2)(i), first sentence ............................................ paragraph (d)(1)(i) ......................... paragraph (e)(1)(i). 

newly redesignated (e)(2)(ii), first sentence ............................................ paragraph (d)(1) ............................ paragraph (e)(1). 

newly redesignated (e)(5)(i), first sentence ............................................ paragraph (d)(4) ............................ paragraph (e)(4). 

newly redesignated (e)(6)(i), first sentence ............................................ paragraph (d)(5)(i) ......................... paragraph (e)(5)(i). 

newly redesignated (e)(6)(ii)(A), first sentence ....................................... paragraph (d)(5)(ii) ........................ paragraph (e)(5)(ii). 

newly redesignated (g), first sentence .................................................... paragraph (e) ................................. paragraph (f). 

■ e. Add paragraphs (e)(12) and (13); 

and 

■ f. Revise newly redesignated 

paragraph (f). 

The revisions and additions read as 

follows: 

§ 1.861–19 Classification of, and source of 

gross income from, cloud transactions. 

(a) In general. This section provides 

rules for classifying and sourcing gross 

income from 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. 

* * * * * 

(d) Source of income from a cloud 

transaction—(1) In general. Gross 

income from a cloud transaction is 

sourced as services income under 

section 861(a)(3) or 862(a)(3), as 

appropriate, according to where the 

service is performed. The place of 

performance of the cloud transaction is 

based on the intangible property factor 

described in paragraph (d)(2) of this 

section, the personnel factor described 

in paragraph (d)(3) of this section, and 

the tangible property factor described in 

paragraph (d)(4) of this section. To 

determine gross income from a cloud 

transaction from sources within the 

United States, gross income from the 

cloud transaction is multiplied by a 

fraction, the numerator of which is the 

sum of the portion of each of the 

intangible property factor, personnel 

factor, and tangible property factor that 

is from sources within the United States 


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as calculated in paragraphs (d)(2)(ii), 

(d)(3)(ii), and (d)(4)(ii) of this section, 

and the denominator of which is the 

sum of the intangible property factor, 

personnel factor, and tangible property 

factor as calculated in paragraphs 

(d)(2)(i), (d)(3)(i), and (d)(4)(i) of this 

section. See paragraph (e)(12) of this 

section (Example 12). Any remaining 

gross income from a cloud transaction is 

gross income from sources without the 

United States. 

(2) Intangible property factor—(i) 

Total. For purposes of paragraph (d)(1) 

of this section, the intangible property 

factor with respect to any cloud 

transaction performed by the taxpayer 

in a taxable year is equal to the sum of 

the taxpayer’s specified research or 

experimental expenditures (as defined 

in section 174(b) and regardless of 

whether and when the expenses are 

deductible) for that taxable year that are 

associated with cloud transactions in 

the same product line as the cloud 

transaction performed and the 

taxpayer’s amortization (other than 

amounts capitalized under section 

174(a)(2)(A) and amortized under 

section 174(a)(2)(B)) and royalty 

expense for intangible property for the 

taxable year to the extent directly used 

to provide the cloud transaction. If the 

same cost or expense would be included 

by a taxpayer in the intangible property 

factor for more than one cloud 

transaction during a taxable year, such 

cost or expense is allocated among each 

such cloud transaction based on the 

relative gross income earned from each 

cloud transaction. 

(ii) Portion from sources within the 

United States. With respect to a cloud 

transaction provided in a taxable year, 

the portion of the intangible property 

factor from sources within the United 

States is determined using a formula 

based on the location of all of the 

taxpayer’s employees whose primary 

function is to perform research and 

experimentation activities associated 

with cloud transactions in the same 

product line in that taxable year (the 

research and experimentation 

personnel). The formula is as follows: 

applying the principles of § 1.861– 

4(b)(2)(ii)(E) (relating to sourcing 

income from labor or personal services 

on a time basis), divide the sum of the 

total compensation paid to the research 

and experimentation personnel for 

services performed within the United 

States by the sum of the total 

compensation paid to the research and 

experimentation personnel, and 

multiply the resulting quotient by the 

intangible property factor described in 

paragraph (d)(2)(i) of this section. 

(3) Personnel factor—(i) Total. For 

purposes of paragraph (d)(1) of this 

section, the personnel factor with 

respect to a cloud transaction performed 

in a taxable year is equal to the sum of 

the total compensation paid to all of the 

taxpayer’s employees in that taxable 

year whose primary function is to 

directly contribute to the provision of 

the cloud transaction, excluding 

compensation amounts that are paid to 

research and experimentation personnel 

described in paragraph (d)(2) of this 

section. If, however, an employee’s 

primary function is to directly 

contribute to multiple cloud 

transactions, then all of such employee’s 

compensation is allocated among the 

cloud transactions that the employee 

directly contributes to as part of their 

primary function based on the relative 

amount of time the employee spends 

contributing to each cloud transaction. 

If an employee contributes to multiple 

cloud transactions simultaneously, then 

that employee’s compensation is 

allocated among those cloud 

transactions based on the relative gross 

income earned from each cloud 

transaction. 

(ii) Portion from sources within the 

United States. With respect to a cloud 

transaction, the portion of the personnel 

factor described in paragraph (d)(3)(i) of 

this section that is from sources within 

the United States is equal to the part of 

that factor paid for services performed 

in the United States, as determined 

using the principles of § 1.861– 

4(b)(2)(ii)(E) (relating to sourcing 

income from labor or personal services 

on a time basis). 

(iii) Personnel considered to directly 

contribute to the provision of the cloud 

transaction. Personnel are considered to 

directly contribute to the provision of 

the cloud transaction to the extent they 

personally perform technical or 

operational activities for the provision 

of the cloud transaction, or to the extent 

they are a manager who directly 

supports or immediately supervises 

such technical or operational personnel. 

Such technical or operational activities 

are the conduct of scientific, 

engineering, or technical activities for 

the configuration, delivery, or 

maintenance of the cloud transaction; 

the provision of monitoring, diagnostics, 

or incident response with respect to the 

cloud transaction’s performance, 

reliability, efficiency, or security; the 

management of the cloud transaction’s 

infrastructure; the delivery of end-user 

support with respect to the cloud 

transaction; and the conduct of any 

similar functions. 

(iv) Personnel not considered to 

directly contribute to the provision of 

the cloud transaction. Personnel are not 

considered to directly contribute to the 

provision of the cloud transaction to the 

extent they conduct business strategy, 

leadership, legal or compliance, 

marketing, communications, sales, 

business development, finance, 

accounting, clerical, human resources or 

administrative duties, or similar 

functions. 

(4) Tangible property factor—(i) Total. 

For purposes of paragraph (d)(1) of this 

section, the tangible property factor 

with respect to a cloud transaction 

performed in a taxable year is equal to 

the sum of the depreciation expense for 

that taxable year for tangible property 

owned by the taxpayer and rental 

expense for that taxable year for tangible 

property leased by the taxpayer, in each 

case to the extent directly used to 

provide the cloud transaction. If any 

depreciation expense or rental expense 

would be included in the tangible 

property factor for more than one cloud 

transaction during the taxable year, such 

depreciation expense or rental expense 

is allocated among the cloud 

transactions based on relative gross 

income earned from each cloud 

transaction. 

(ii) Portion from sources within the 

United States. The portion of the 

tangible property factor described in 

paragraph (d)(4)(i) of this section from 

sources within the United States is 

equal to the part of that factor 

attributable to property located within 

the United States. 

(iii) Determination of depreciation 

expense. For purposes of paragraph 

(d)(4) of this section, depreciation 

expense for a taxable year is determined 

by dividing the adjusted depreciable 

basis (as defined in § 1.168(b)–1(a)(4)) of 

the tangible property by the applicable 

recovery period as though the 

alternative depreciation system set forth 

in section 168(g)(2) applied for the 

entire period that such property has 

been in service, without regard to the 

election to expense certain depreciable 

property under section 179 and without 

regard to any additional first-year 

depreciation provision (for example, 

section 168(k)). 

(5) Primary function. For purposes of 

this section, an employee’s primary 

function is the set of tasks to which they 

are assigned to spend the majority of 

their working time. 

(6) Employee. For purposes of this 

section, the term employee has the 

meaning given to it in § 31.3121(d)–1(c) 

of this chapter. 

(7) Aggregation rule. For purposes of 

applying this paragraph (d), a taxpayer 

may aggregate substantially similar 

cloud transactions unless it knows or 


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has reason to know that doing so would 

materially distort the source of gross 

income from any cloud transaction. 

(8) Product line. For purposes of this 

section, a product line is defined as all 

products within the same 

Corresponding Index Entry under a 

North American Industry Classification 

System (NAICS) code number. Once a 

taxpayer selects a Corresponding Index 

Entry and NAICS code number for the 

first taxable year for which this section 

applies, it must continue to use that 

Corresponding Index Entry and NAICS 

code number in following years unless 

the taxpayer establishes to the 

satisfaction of the Commissioner that, 

due to changes in the relevant facts, a 

change in Corresponding Index Entry 

and NAICS code number is appropriate. 

(9) Anti-Abuse Rule. The purpose of 

this paragraph (d) is to attribute the 

source of the taxpayer’s gross income 

from a cloud transaction to the location 

where the cloud transaction is 

performed. Therefore, if the taxpayer 

has entered into or structured one or 

more transactions with a principal 

purpose of reducing its U.S. tax liability 

in a manner inconsistent with the 

purpose of this paragraph (d), 

appropriate adjustments will be made so 

that the source of the taxpayer’s gross 

income reflects the location where the 

cloud transaction is performed. 

(e) * * * 

(12) Example 12: Sourcing gross 

income from a cloud transaction—(i) 

Facts. (A) Corp A provides customers 

on-demand network access to Program 

Y in exchange for a monthly fee. All of 

the transactions with customers are 

substantially similar to one another. 

Customers must be connected to the 

internet to access the functionality of 

Program Y. 

(B) Corp A has employees whose 

primary function (as determined under 

paragraph (d)(5) of this section) is to 

conduct research and experimentation 

associated with developing new 

versions of Program Y and other 

products in the same product line (as 

determined under paragraph (d)(8) of 

this section). Corp A paid $160x in 

compensation to such employees, of 

which $80x was paid for services 

performed within the United States as 

determined in accordance with the 

principles of § 1.861–4(b)(2)(ii)(E). 

Besides employee compensation, Corp 

A spent an additional $200x for research 

and experimentation costs associated 

with developing new versions of 

Program Y and other products in the 

same product line. Corp A did not take 

any amortization deductions with 

respect to intellectual property used to 

provide Program Y. 

(C) Corp A paid $400x in 

compensation to employees whose 

primary function was to directly 

contribute (as determined under 

paragraphs (d)(3)(iii) and (iv) of this 

section) to Corp A’s provision of 

Program Y to customers, of which $100x 

was paid for services performed in the 

United States as determined in 

accordance with the principles of 

§ 1.861–4(b)(2)(ii)(E). None of these 

employees were research and 

experimentation personnel (as defined 

in paragraph (d)(2)(ii) of this section). 

(D) Corp A hosts Program Y on servers 

it owns that are located both within and 

without the United States. These servers 

are used only to host Program Y. Corp 

A deducted $140x for depreciation 

expense attributable to these servers, 

$80x of which was attributable to the 

servers located within the United States, 

and $60x of which was attributable to 

the servers located without the United 

States. These depreciation deductions 

are in accordance with the rules of 

section 168(g)(2). 

(E) Corp A earned $800x of gross 

income from providing customers 

access to Program Y. Corp A does not 

know or have reason to know that any 

of the costs, functions or assets 

described in this paragraph are 

disproportionately allocated to certain 

transactions or groups of transactions 

among all of the transactions that 

generated $800x of gross income. 

(ii) Analysis. (A) Under paragraph (b) 

of this section, each transaction between 

Corp A and a customer is a cloud 

transaction because Corp A provides ondemand network access to Program Y. 

Under paragraph (c)(1) of this section, 

each cloud transaction is classified as 

the provision of services. Under 

paragraph (d)(7) of this section, because 

all of these transactions are substantially 

similar and Corp A does not know or 

have reason to know that there is any 

disproportionate allocation of costs, 

functions or assets among them, all of 

the transactions may be considered in 

the aggregate for purposes of applying 

paragraph (d) of this section. 

(B) Under paragraph (d)(1) of this 

section, the source of Corp A’s $800x of 

gross income from providing access to 

Program Y to customers is determined 

based on the intangible property factor 

described in paragraph (d)(2) of this 

section, the personnel factor described 

in paragraph (d)(3) of this section, and 

the tangible property factor described in 

paragraph (d)(4) of this section. 

(C) Under paragraph (d)(2) of this 

section, the intangible property factor is 

equal to $360x because Corp A paid 

$160x in compensation to employees 

whose primary function was to conduct 

research and experimentation associated 

with developing new versions of 

Program Y and other products in the 

same product line, and incurred $200x 

in other research and experimentation 

costs associated with developing new 

versions of Program Y and other 

products in the same product line. 

$80x/$160x of such compensation, or 

50%, is paid to employees for research 

and experimentation services performed 

with respect to Program Y and other 

products in the same product line in the 

United States. Corp A’s $360x intangible 

property factor is multiplied by the 

same quotient to determine that $180x 

is from sources within the United States 

pursuant to paragraph (d)(2)(ii) of this 

section. 

(D) Under paragraph (d)(3) of this 

section, the personnel factor is equal to 

$400x because Corp A paid $400x in 

compensation to employees whose 

primary function was to directly 

contribute to the provision of Program Y 

to customers and none of these 

employees were research and 

experimentation personnel (as defined 

in paragraph (d)(2)(ii) of this section). 

Pursuant to paragraph (d)(3)(ii) of this 

section, $100x of the personnel factor is 

from sources within the United States 

because Corp A paid $100x in 

compensation to employees for services 

performed in the United States that 

directly contributed to the provision of 

Program Y to customers. 

(E) Under paragraph (d)(4) of this 

section, the tangible property factor is 

equal to $140x because Corp A 

deducted $140x in depreciation expense 

for tangible property directly used to 

provide Program Y to customers under 

the method described in section 

168(g)(2). $80x of the tangible property 

factor is from sources within the United 

States because this amount of the $140x 

depreciation expense is attributable to 

tangible property located within the 

United States. 

(F) The sum of the intangible property 

factor ($360x), the personnel factor 

($400x), and the tangible property factor 

($140x) is equal to $900x. The sum of 

these factors from sources within the 

United States is $360x ($180x with 

respect to the intangible property factor, 

$100x with respect to the personnel 

factor, and $80x with respect to the 

tangible property factor). Accordingly, 

Corp A’s $800x of gross income from 

providing Program Y to customers for 

the taxable year is multiplied by the 

quotient of $360x/$900x pursuant to 

paragraph (d)(1) of this section to 

determine that $320x is from sources 

within the United States. Pursuant to 

paragraph (d)(1) of this section, the 


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remaining $480x ($800x¥$320x) is 

from sources without the United States. 

(13) Example 13: Sourcing gross 

income from multiple cloud 

transactions—(i) Facts. (A) The facts are 

the same as in paragraph (e)(12) of this 

section (Example 12), except that Corp 

A also provides customers on-demand 

network access to software platform Z in 

exchange for a monthly fee, and Corp A 

hosts software platform Z on the same 

servers it uses to host Program Y (which 

generate more depreciation than in 

Example 12). All of the transactions for 

software platform Z customers are 

substantially similar to one another. 

Customers must be connected to the 

internet to access the functionality of 

software platform Z. 

(B) Corp A has employees whose 

primary function (as determined under 

paragraph (d)(5) of this section) is to 

conduct research and experimentation 

associated with developing new 

versions of software platform Z and 

other products in the same product line. 

The software platform Z product line is 

not the same as the Program Y product 

line under the definition in paragraph 

(d)(8) of this section. Corp A paid $200x 

in compensation to such employees, all 

of which was paid for services 

performed in the United States as 

determined in accordance with the 

principles of § 1.861–4(b)(2)(ii)(E). Corp 

A also has employees whose primary 

function as determined under paragraph 

(d)(5) of this section is to conduct 

research and experimentation associated 

with developing functionality for new 

versions of both Program Y and software 

platform Z. Corp A paid $100x in 

compensation to such employees, all of 

which was paid for services performed 

in the United States as determined in 

accordance with the principles of 

§ 1.861–4(b)(2)(ii)(E). Corp A did not 

have any other research and 

experimentation costs associated with 

software platform Z. 

(C) Corp A paid $100x in 

compensation to employees whose 

primary function was to directly 

contribute (as determined under 

paragraphs (d)(3)(iii) and (iv) of this 

section) to Corp A’s provision of 

software platform Z to customers, and 

that entire amount was paid for services 

performed in the United States as 

determined in accordance with the 

principles of § 1.861–4(b)(2)(ii)(E). None 

of these employees were research and 

experimentation personnel (as defined 

in paragraph (d)(2)(ii) of this section). 

Corp A also paid $80x in compensation 

to employees whose primary function 

was to directly contribute (as 

determined under paragraphs (d)(3)(iii) 

and (iv) of this section) to Corp A’s 

provision of both Program Y and 

software platform Z to customers, and 

that entire amount was paid for services 

performed in the United States as 

determined in accordance with the 

principles of § 1.861–4(b)(2)(ii)(E). 

These employees spent half their time 

contributing to software platform Z 

transactions and half their time 

contributing to Program Y transactions. 

None of these employees were research 

and experimentation personnel (as 

defined in paragraph (d)(2)(ii) of this 

section). 

(D) Corp A hosts software platform Z 

on servers it owns that are located both 

within and without the United States. 

These servers are used to host both 

Program Y and software platform Z. 

Corp A deducted $180x for depreciation 

expense attributable to these servers, 

$120x of which was attributable to the 

servers located within the United States, 

and $60x of which was attributable to 

the servers located without the United 

States. These depreciation deductions 

are in accordance with the rules of 

section 168(g)(2). 

(E) Corp A earned $800x of gross 

income from providing customers 

access to software platform Z. Corp A 

does not know or have reason to know 

that any of the costs, functions or assets 

described in this paragraph are 

disproportionately allocated to certain 

transactions or groups of transactions 

among all of the transactions that 

generated $800x of gross income. 

(ii) Analysis. (A) Under paragraph (b) 

of this section, each transaction between 

Corp A and a customer for software 

platform Z is a cloud transaction 

because Corp A provides on-demand 

network access to software platform Z. 

Under paragraph (c)(1) of this section, 

each cloud transaction is classified as 

the provision of services. Under 

paragraph (d)(7) of this section, because 

all of these software platform Z 

transactions are substantially similar 

and Corp A does not know or have 

reason to know that there is any 

disproportionate allocation of costs, 

functions or assets among them, all of 

the software platform Z transactions 

may be considered in the aggregate for 

purposes of applying paragraph (d) of 

this section. 

(B) Under paragraph (d)(1) of this 

section, the source of Corp A’s $800x of 

gross income from providing access to 

software platform Z to customers is 

determined based on the intangible 

property factor described in paragraph 

(d)(2) of this section, the personnel 

factor described in paragraph (d)(3) of 

this section, and the tangible property 

factor described in paragraph (d)(4) of 

this section. 

(C) Under paragraph (d)(2) of this 

section, the intangible property factor is 

equal to $250x. Corp A paid $200x in 

compensation to employees whose 

primary function was to conduct 

research and experimentation associated 

with developing new versions of 

software Platform Z and other products 

in the same product line. Corp A also 

paid $100x in compensation to 

employees whose primary function was 

to conduct research and 

experimentation developing 

functionality for new versions of both 

Program Y and software platform Z, of 

which Corp A allocates $50x to software 

Platform Z and $50x to Program Y based 

on Corp A’s relative gross income from 

Program Y and software platform Z 

transactions in the taxable year. $250x/ 

$250x of such compensation, or 100%, 

is paid to employees for research and 

experimentation services performed in 

the United States with respect to 

software Platform Z and other products 

in the same product line. Corp A’s 

$250x intangible property factor is 

multiplied by the same quotient to 

determine that $250x is from sources 

within the United States pursuant to 

paragraph (d)(2)(ii) of this section. 

(D) Under paragraph (d)(3) of this 

section, the personnel factor is equal to 

$140x. Corp A paid $100x in 

compensation to employees whose 

primary function was to directly 

contribute to the provision of software 

platform Z to customers and none of 

these employees were research and 

experimentation personnel (as defined 

in paragraph (d)(2)(ii) of this section). 

Corp A also paid $80x in compensation 

to employees whose primary function 

was to directly contribute to the 

provision of both Program Y and 

software platform Z (and none of these 

employees were research and 

experimentation personnel (as defined 

in paragraph (d)(2)(ii) of this section)), 

and Corp A allocated $40x to software 

platform Z and $40x to Program Y based 

on the relative amount of time these 

employees spent contributing to 

Program Y and software platform Z 

transactions in the taxable year. $140x/ 

$140x of such compensation, or 100%, 

is paid to employees for services 

performed in the United States that 

directly contributed to the provision of 

software platform Z to customers. 

(E) Under paragraph (d)(4) of this 

section, the tangible property factor is 

equal to $90x. Corp A deducted $180x 

in depreciation expense for tangible 

property directly used to provide both 

Program Y and software platform Z 

transactions under the method 

described in section 168(g)(2), of which 

$120x is from sources within the United 


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Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Proposed Rules 3085 

States because this amount is 

attributable to tangible property located 

within the United States. Based on Corp 

A’s relative gross income from Program 

Y and software platform Z transactions 

in the taxable year, Corp A reasonably 

allocates $90x to software platform Z, of 

which $60x is from sources within the 

United States and $90x to Program Y, of 

which $60x is from sources within the 

United States. 

(F) The sum of the intangible property 

factor ($250x), the personnel factor 

($140x), and the tangible property factor 

($90x) is equal to $480x. The sum of 

these factors from sources within the 

United States is $450x ($250x with 

respect to the intangible property factor, 

$140x with respect to the personnel 

factor, and $60x with respect to the 

tangible property factor). Accordingly, 

Corp A’s $800x of gross income from 

providing software platform Z to 

customers for the taxable year is 

multiplied by the quotient of $450x/ 

$480x pursuant to paragraph (d)(1) of 

this section to determine that $750x is 

from sources within the United States. 

Pursuant to paragraph (d)(1) of this 

section, the remaining $50x 

($800x¥$750x) is from sources without 

the United States. 

(f) Applicability date—(1) In general. 

Except as otherwise provided in this 

paragraph (f), this section applies to 

taxable years beginning on or after 

January 14, 2025. Paragraphs (d) and 

(e)(12) and (13) of this section apply to 

taxable years beginning on or after the 

date of publication of the Treasury 

decision adopting those paragraphs as 

final regulations in the Federal Register. 

(2) Early application. Except for 

paragraphs (d) and (e)(12) and (13) of 

this section, 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 

(f)(1) (early application years) if— 

(i) The taxpayer also applies § 1.861– 

18 to the early application years; 

(ii) This section and § 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. 

* * * * * 

Douglas W. O’Donnell, 

Deputy Commissioner. 

[FR Doc. 2024–31373 Filed 1–10–25; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–107895–24] 

RIN 1545–BR20 

Base Erosion and Anti-Abuse Tax 

Rules for Qualified Derivative 

Payments on Securities Lending 

Transactions 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: This document contains 

proposed regulations regarding the base 

erosion and anti-abuse tax imposed on 

certain large corporate taxpayers with 

respect to certain payments made to 

foreign related parties. The proposed 

regulations relate to how qualified 

derivative payments with respect to 

securities lending transactions are 

determined and reported. The proposed 

regulations would affect corporations 

with substantial gross receipts that make 

payments to foreign related parties. 

DATES: Written or electronic comments 

and requests for a public hearing must 

be received by April 14, 2025. 

ADDRESSES: Commenters are strongly 

encouraged to submit public comments 

electronically via the Federal 

eRulemaking Portal at https://

www.regulations.gov (indicate IRS and 

REG–107895–24) by following the 

online instructions for submitting 

comments. Requests for a public hearing 

must be submitted as prescribed in the 

‘‘Comments and Requests for a Public 

Hearing’’ section. Once submitted to the 

Federal eRulemaking Portal, comments 

cannot be edited or withdrawn. The 

Department of the Treasury (Treasury 

Department) and the IRS will publish 

for public availability any comments 

submitted to the IRS’s public docket. 

Send paper submissions to: 

CC:PA:01:PR (REG–107895–24), Room 

5203, Internal Revenue Service, P.O. 

Box 7604, Ben Franklin Station, 

Washington, DC 20044. 

FOR FURTHER INFORMATION CONTACT: 

Concerning the proposed regulations, 

Sheila Ramaswamy at (202) 317–6938; 

concerning submissions of comments, 

requests for a public hearing, and access 

to a public hearing, Publications and 

Regulations Section at (202) 317–6901 

(not toll-free numbers) or by email to 

publichearings@irs.gov (preferred). 

SUPPLEMENTARY INFORMATION: 

Authority 

This document contains proposed 

additions and amendments to 26 CFR 

part 1 (Income Tax Regulations) under 

sections 59A and 6038A of the Internal 

Revenue Code (Code). The proposed 

additions and amendments are issued 

pursuant to the express delegations of 

authority to the Secretary of the 

Treasury (or her delegate) provided 

under sections 59A(i) and 6038A(b)(2). 

The proposed regulations are also 

issued under the express delegation of 

authority under section 7805(a) of the 

Code. 

Background 

I. Statutory Framework 

The base erosion and anti-abuse tax 

(‘‘BEAT’’) of section 59A imposes on 

each applicable taxpayer a tax equal to 

the base erosion minimum tax amount 

for the taxable year. For taxable years 

after 2018 and before 2026, the base 

erosion minimum tax amount for the 

taxable year is the excess of ten percent 

of the modified taxable income of the 

applicable taxpayer minus the 

applicable taxpayer’s regular tax 

liability under section 26(b) reduced 

(but not below zero) by certain credits. 

See section 59A(b)(1) and (2). To be an 

applicable taxpayer, generally the 

taxpayer must meet the following three 

requirements: (1) the taxpayer must be 

a corporation which is not a regulated 

investment company, a real estate 

investment trust, or an S corporation; (2) 

the taxpayer must have average annual 

gross receipts for the three-taxable-year 

period ending with the preceding 

taxable year that are at least $500 

million; and (3) the taxpayer generally 

must have a base erosion percentage for 

the taxable year of at least three percent 

(or two percent for banks and registered 

securities dealers). See section 59A(e). 

The applicable taxpayer determines 

its modified taxable income by 

computing its taxable income without 

regard to any base erosion tax benefit 

with respect to any base erosion 

payment or the base erosion percentage 

of any net operating loss deduction 

allowed under section 172 for the 

taxable year. See section 59A(c)(1). 

Generally, a base erosion payment is 

any deductible amount paid or accrued 

by an applicable taxpayer to a foreign 

person as defined in section 6038A(c)(3) 


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