Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 54859 

supplemented with a direct source of good 

lighting at an intensity deemed appropriate. 

Inspection aids such as mirror, magnifying 

lenses, etc., may be necessary. Surface 

cleaning and elaborate procedures may be 

required.’’

(i) If no crack is found during the detailed 

inspection required by paragraph (i)(2) of this 

AD, prior to further flight, install a rivet in 

the open hole in accordance with the service 

bulletin. 

(ii) If any crack is found during the 

inspection required by paragraph (i)(2) of this 

AD, prior to further flight, repair the crack in 

accordance with a method approved by the 

Manager, International Branch, ANM–116, or 

the DGAC (or its delegated agent). 

Inspection and/or Replacement of Entry 

Door Structure 

(j) For Model ATR42–300 series airplanes 

having serial numbers listed in ATR Service 

Bulletin ATR42–52–0052, Revision 1, dated 

March 2, 1993: Except as provided by 

paragraph (f) of this AD, prior to the 

accumulation of 10,000 total flight cycles, or 

within 90 days after April 26, 2000, 

whichever occurs later, accomplish the 

requirements of paragraphs (j)(1) and (j)(2) of 

this AD. 

(1) Perform an eddy current inspection of 

the forward entry door stop holes to detect 

cracking, in accordance with the service 

bulletin. If any cracking is detected, prior to 

further flight, replace any cracked forward 

entry door stop fitting with a new fitting, in 

accordance with the service bulletin. 

(2) Perform a detailed inspection of the 

forward entry door friction plates for wear, in 

accordance with the service bulletin. If wear 

is found on any friction plate, and the wear 

has a depth equal to or greater than 0.8mm 

(0.0315 in.), prior to further flight, replace the 

friction plate with a new or serviceable part 

in accordance with the service bulletin. 

(k) For Model ATR42–300 series airplanes 

listed in ATR Service Bulletin ATR42–52–

0052, Revision 1, dated March 2, 1993, 

accomplishment of the requirements of 

paragraph (l) of this AD at the time specified 

in paragraph (j) of this AD constitutes 

terminating action for the requirements of 

paragraph (j) of this AD. 

(l) For Model ATR42–300 series airplanes 

listed in ATR Service Bulletin ATR42–52–

0059, dated February 16, 1995: Prior to the 

accumulation of 18,000 total flight cycles, or 

within 180 days after April 26, 2000, 

whichever occurs later, accomplish the 

requirements of paragraphs (l)(1), (l)(2), and 

(l)(3) of this AD in accordance with the 

service bulletin. 

(1) Replace the forward entry door friction 

plates with improved friction plates. 

(2) Replace the upper corners of the 

forward entry door surround structure with 

improved door surround corners. 

(3) Replace the forward entry door stop 

fittings and bolts with improved fittings and 

bolts. 

New Requirements of This AD 

Replacing Hinges on the Cargo Compartment 

Door and Fuselage 

(m) For airplanes identified as having main 

serial numbers (MSNs) 317, 319, 321, 323, 

325, 327, 329 through 335 inclusive, 360, and 

368 that are equipped with a cargo 

compartment door on which Aerospatiale 

Modification 3191 has not been 

accomplished: Prior to the accumulation of 

27,000 total flight hours, or within 180 days 

after the effective date of this AD, whichever 

occurs later, replace the hinges on the cargo 

compartment door and fuselage (including 

inspections for fastener type and tolerances, 

hole diameters, or cracking, and repair; as 

applicable) with new improved hinges, in 

accordance with the Accomplishment 

Instructions of Avions de Transport Regional 

(ATR) Service Bulletin ATR42–52–0058, 

Revision 2, dated June 22, 2000. 

(n) Where the instructions in ATR Service 

Bulletin ATR42–52–0058, Revision 2, dated 

June 22, 2000, specify that ATR is to be 

contacted for a repair, prior to further flight, 

repair in accordance with a method approved 

by the Manager, International Branch, ANM–

116, FAA; or the DGAC (or its delegated 

agent). 

Alternative Methods of Compliance 

(AMOCs) 

(o) The Manager, International Branch, 

ANM–116, has the authority to approve 

AMOCs for this AD, if requested in 

accordance with the procedures found in 14 

CFR 39.19. 

Related Information 

(p) French airworthiness directive 2000–

337–079(B), dated July 26, 2000, also 

addresses the subject of this AD. 

Issued in Renton, Washington, on 

September 9, 2005. 

Ali Bahrami, 

Manager, Transport Airplane Directorate, 

Aircraft Certification Service. 

[FR Doc. 05–18528 Filed 9–16–05; 8:45 am] 

BILLING CODE 4910–13–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–106030–98] 

RIN 1545–AW50 

Source of Income From Certain Space 

and Ocean Activities; Source of 

Communications Income 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Withdrawal of notice of 

proposed rulemaking; notice of 

proposed rulemaking; and notice of 

public hearing. 

SUMMARY: This document contains 

proposed regulations under section 

863(d) governing the source of income 

from certain space and ocean activities. 

It also contains proposed regulations 

under section 863(a), (d), and (e) 

governing the source of income from 

certain communications activities. This 

document also contains proposed 

regulations under section 863(a) and (b), 

amending the regulations in § 1.863–3 to 

conform those regulations to these 

proposed regulations. This document 

affects persons who derive income from 

activities conducted in space, or on or 

under water not within the jurisdiction 

of a foreign country, possession of the 

United States, or the United States (in 

international water). This document 

also affects persons who derive income 

from transmission of communications. 

In addition, this document provides 

notice of a public hearing on these 

proposed regulations and withdraws the 

notice of proposed rulemaking (66 FR 

3903) published in the Federal Register 

on January 17, 2001. 

DATES: Written or electronic comments 

must be received by November 23, 2005. 

Outlines of topics to be discussed at the 

public hearing scheduled for December 

15, 2005, at 10 a.m., must be received 

by November 23, 2005. 

ADDRESSES: Send submissions to: 

CC:PA:LPD:PR (REG–106030–98), room 

5203, Internal Revenue Service, POB 

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:LPD:PR (REG–106030–98), 

Courier’s Desk, Internal Revenue 

Service, 1111 Constitution Avenue, 

NW., Washington, DC, or sent 

electronically, via either the IRS Internet 

site at http://www.irs.gov/regs or the 

Federal eRulemaking Portal at http:// 

www.regulations.gov (IRS–REG–

106030–98). The public hearing will be 

held in the Auditorium, Internal 

Revenue Building, 1111 Constitution 

Avenue, NW., Washington, DC. 

FOR FURTHER INFORMATION CONTACT: 

Concerning the regulations, Edward R. 

Barret, (202) 622–3880; concerning 

submissions of comments, the hearing, 

and/or to be placed on the building 

access list to attend the hearing, Cynthia 

Grigsby, (202) 622–7180 (not toll-free 

numbers). 

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act 

The collections of information 

contained in this notice of proposed 

rulemaking have been reviewed and 

approved by the Office of Management 

and Budget (OMB) in accordance with 

the Paperwork Reduction Act of 1995 

(44 U.S.C. 3507(d)) under control 

number 1545–1718. 

The collection of information in these 

proposed regulations is in §§ 1.863–8(g) 

and 1.863–9(g). This information is 

required by the IRS to monitor 

54860 Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 

compliance with the Federal tax rules 

for determining the source of income 

from space or ocean activities, or from 

transmission of communications. 

An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless the collection of information 

displays a valid control number 

assigned by the Office of Management 

and Budget. 

Books or records relating to a 

collection of information must be 

retained as long as their contents may 

become material in the administration 

of any internal revenue law. Generally, 

tax returns and tax return information 

are confidential, as required by 26 

U.S.C. 6103. 

Background 

Congress enacted section 863(d) and 

(e) as part of the Tax Reform Act of 

1986, Public Law 99–514 (100 Stat. 

2085) (the 1986 Act). Section 863(d) 

governs the source of income derived 

from certain space and ocean activities. 

Section 863(e) governs the source of 

income derived from international 

communications activity. 

On January 17, 2001, the Treasury 

Department and the IRS published a 

notice of proposed rulemaking (REG–

106030–98) in the Federal Register (66 

FR 3903) under section 863(a), (b), (d), 

and (e) (the 2001 proposed regulations). 

The 2001 proposed regulations provide 

two sets of rules, one in § 1.863–8 for 

determining the source of income from 

space and ocean activities (space and 

ocean income), the other in § 1.863–9 

for determining the source of income 

from communications activity 

(communications income). 

The IRS received numerous written 

comments on the 2001 proposed 

regulations and held a public hearing on 

May 23, 2001. Since that time, the 

aerospace, telecommunications, and 

related industries have experienced 

substantial technological evolution and 

significant business change and 

consolidation. In addition, the 

American Jobs Creation Act of 2004, 

Public Law 108–357, (AJCA) enacted a 

number of materially relevant statutory 

changes that affect the treatment of 

space and ocean income for purposes of 

the foreign tax credit and subpart F. In 

light of the extensive written comments, 

industry evolution, and AJCA changes, 

the Treasury Department and the IRS 

believe it is appropriate to repropose 

these regulations to provide a further 

opportunity for comment. Accordingly, 

this document withdraws the 2001 

proposed regulations and provides new 

proposed regulations, which are referred 

to herein as the reproposed regulations. 

Explanation of Provisions 

A. Space and Ocean Activity Under 

Section 863(d) 

1. Space and Ocean Income 

Section 863(d)(2)(A)(i) defines space 

activity to include any activity 

conducted in space. Section 

863(d)(2)(A)(ii) defines ocean activity to 

include any activity conducted on or 

under water not within the jurisdiction 

(as recognized by the United States) of 

a foreign country, possession of the 

United States, or the United States. 

Section 863(d)(2)(B) excludes three 

specific types of activities from the 

definition of space or ocean activity. 

Section 863(d)(1) generally provides 

that, except as provided in regulations, 

any income derived from a space or 

ocean activity (space and ocean income) 

is U.S. source income if derived by a 

U.S. person and foreign source income 

if derived by a foreign person. 

Pursuant to the statute’s grant of 

regulatory authority, the reproposed 

regulations provide that a U.S. person’s 

space and ocean income will be sourced 

outside the United States to the extent 

the income, based on all the facts and 

circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed in a foreign 

country or countries. This approach to 

allocation of space and ocean income 

between U.S. and foreign sources is 

pursuant to broad regulatory authority 

in section 863(d). The reproposed 

regulations also contain certain 

exceptions to the general foreign source 

rule for space and ocean income of 

foreign persons. 

2. Space and Ocean Income of U.S.- 

Owned Foreign Corporation 

Section 1.863–8(b)(2) of the 2001 

proposed regulations provides that if 

U.S. persons own 50 percent or more of 

a foreign corporation by vote or value 

(directly, indirectly, or constructively) 

and such corporation is not a controlled 

foreign corporation within the meaning 

of section 957 (CFC), all space and 

ocean income derived by the 

corporation (hereinafter a U.S.-owned 

foreign corporation) is U.S. source 

income. 

Several commentators requested that 

§ 1.863–8(b)(2) of the 2001 proposed 

regulations be withdrawn. 

Commentators stated that the rule 

expanded the scope of U.S. taxing 

jurisdiction beyond the apparent intent 

of Congress by subjecting income not 

covered by subpart F to immediate U.S. 

taxation. Several commentators also 

stated that under the rule space and 

ocean income could in some cases be 

subject to multiple levels of taxation. In 

this regard, some commentators noted 

that the space and ocean income of a 

U.S.-owned foreign corporation could 

be subject to potential double taxation at 

the corporate level (by the United States 

and by the U.S.-owned foreign 

corporation’s country of residence or the 

countries where such corporation does 

business) because § 1.863–8(b)(2) of the 

2001 proposed regulations makes such 

space and ocean income U.S. source. 

When the U.S.-owned foreign 

corporation’s space and ocean income is 

distributed as a dividend, that income 

could be subject to an additional level 

of tax in the hands of its shareholders. 

Consequently, some commentators 

suggested that, if the rule were retained, 

the space and ocean income of U.S.- 

owned foreign corporations should be 

considered U.S. source solely for 

purposes of the U.S. shareholder’s 

foreign tax credit limitation under 

section 904(a). Some commentators 

noted that although section 245 may 

partially ameliorate this situation by 

providing a dividends received 

deduction (DRD) to shareholders of 

foreign corporations in certain 

circumstances, the DRD would be 

limited to 80 percent of qualifying 

dividends. 

Some commentators also noted 

potential withholding tax issues with 

the source rules for U.S.-owned foreign 

corporations. In such cases, U.S. source 

fixed or determinable annual or periodic 

income (FDAP) of a U.S.-owned foreign 

corporation would (in the absence of an 

applicable treaty) likely be subject to the 

30-percent gross income tax imposed by 

section 881, which is typically collected 

through withholding by the payors of 

such income. Commentators stated that 

enforcement and administration of the 

30-percent tax and withholding 

requirements could present multiple 

challenges (and potential multiple 

withholding tax obligations) for 

payments between foreign persons. 

Several commentators addressed the 

stock ownership test applicable to U.S.- 

owned foreign corporations. They stated 

that determining whether a foreign 

corporation is 50-percent U.S.-owned, 

especially without regard to the size of 

an owner’s holding, presents potential 

difficulties (for example, when the 

foreign corporation is widely-held). 

Some commentators stated that the 

indirect and constructive ownership 

rules are complex and would make it 

difficult for payors of space and ocean 

income to determine withholding tax 

obligations. Some commentators 

suggested that if the rule were retained, 

the determination whether a foreign 

corporation is 50-percent U.S.-owned 

Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 54861 

should be similar to the determination 

of CFC status, that is, only U.S. persons 

who own or are considered to own 10 

percent or more of the total combined 

voting power of all classes of stock 

entitled to vote should be counted. 

Some commentators stated that the rule 

should not apply to publicly-traded 

foreign corporations. 

In light of the potential complexity in 

determining whether a foreign 

corporation is a U.S.-owned foreign 

corporation and the belief of the 

Treasury Department and the IRS that 

space and ocean income earned by 

foreign corporations should be sourced 

in accord with the rules for foreign 

persons, with the limited exception for 

certain CFCs discussed below, the 

reproposed regulations do not include a 

special source rule for space and ocean 

income earned by a U.S.-owned foreign 

corporation. Instead, the space and 

ocean income of foreign corporations 

(other than CFCs) is sourced under the 

applicable provisions of reproposed 

§ 1.863–8(b)(2)(i) or (iii). Under these 

provisions, space and ocean income of 

a foreign person is generally foreign 

source income. Space and ocean income 

of a foreign person (other than a CFC) 

that is engaged in trade or business 

within the United States is U.S. source 

income to the extent the income, based 

on all the facts and circumstances, is 

attributable to functions performed, 

resources employed, or risks assumed 

within the United States. 

3. Space and Ocean Income of CFCs 

In enacting section 863(d), Congress 

ultimately did not adopt a provision 

included in early versions of the 

legislation that would have treated a 

CFC as a U.S. person for purposes of 

determining the source of a CFC’s space 

and ocean income. The legislative 

history to the 1986 Act indicates that 

Congress at that time viewed the 

provision as unnecessary because ‘‘[t]he 

application of the separate foreign tax 

credit limitation for shipping income to 

any space or ocean income derived by 

a [CFC] provides adequate assurance, in 

the conferee’s view, that high foreign 

taxes on unrelated income will not 

inappropriately offset U.S. taxes on this 

generally low-taxed income.’’ H.R. Conf. 

Rep. No. 99–841, 99th Cong., 2d Sess., 

Vol. II, at II–600 (Sept. 18, 1986); see 

also Staff of Joint Comm. on Taxation, 

General Explanation of the Tax Reform 

Act of 1986, JCS–10–87, at 934 (May 4, 

1987). Consequently, the 2001 proposed 

regulations also did not contain such a 

rule and only treated a U.S.-owned 

foreign corporation as a U.S. person for 

purposes of determining the source of 

space and ocean income. 

In 2004, AJCA enacted a number of 

significant statutory changes to subpart 

F and the foreign tax credit regimes as 

applicable to space and ocean income. 

These statutory changes have been taken 

into account in issuing the reproposed 

regulations. 

Section 415 of AJCA eliminated 

foreign base company shipping income 

from the definition of foreign base 

company income. This change is 

effective for taxable years of foreign 

corporations beginning after December 

31, 2004, and for taxable years with or 

within which such taxable years of 

foreign corporations end. Prior to AJCA, 

foreign base company shipping income 

was defined by section 954(f) to include 

any income derived from a space or 

ocean activity as defined in section 

863(d)(2). 

In addition, section 404 of AJCA 

reduced the number of foreign tax credit 

limitation categories from nine to two 

(i.e., passive category income and 

general category income) in order to 

address Congressional concerns 

regarding the complexity of the foreign 

tax credit calculation. See H.R. Rep. No 

108–548, 108th Cong., 2d Sess., at 190 

(June 16, 2004). This change is effective 

for taxable years beginning after 

December 31, 2006. Prior to AJCA, 

section 904(d) treated shipping income, 

defined as income ‘‘which would be 

foreign base company shipping income 

(as defined in section 954(f)),’’ as a 

separate category of income for foreign 

tax credit limitation purposes. For 

taxable years beginning after December 

31, 2006, space and ocean income will 

generally fall into the general limitation 

category. See H.R. Conf. Rep. No. 108–

755, 108th Cong., 2d Sess., at 383 (Oct. 

7, 2004). 

The Treasury Department and the IRS 

believe that the changes made by AJCA 

with respect to the foreign tax credit 

reflect a decision to reduce the 

complexity in the foreign tax credit 

calculation caused by having nine 

foreign tax credit categories of income 

as well as a willingness to allow 

additional cross-crediting in order to 

minimize such complexity. However, 

the Treasury Department and the IRS 

also believe that for taxable years 

beginning after December 31, 2006, 

Congress’s concern expressed in the 

1986 Act that high foreign taxes on 

unrelated income may inappropriately 

offset U.S. taxes on space and ocean 

income, which is generally subject to 

low foreign taxes, is no longer addressed 

by the foreign tax credit rules because 

space and ocean income likely will be 

general limitation category income. In 

addition, Congress provided a broad 

grant of regulatory authority to the 

Treasury Department and the IRS in 

section 863(d) to issue guidance with 

respect to the source of space and ocean 

income. 

In light of AJCA, the reproposed 

regulations provide that if a foreign 

corporation is a CFC, its space and 

ocean income, like that of a U.S. person, 

is income from sources within the 

United States. However, a CFC’s space 

and ocean income is sourced outside the 

United States to the extent the income, 

based on all the facts and 

circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed in a foreign 

country or countries. This allocation 

approach is pursuant to broad 

regulatory authority under section 

863(d). 

As noted above, several commentators 

stated that under the rule for U.S.- 

owned foreign corporations in the 2001 

proposed regulations, space and ocean 

income could in some cases be subject 

to multiple levels of taxation. The 

Treasury Department and the IRS 

believe that the reproposed regulations 

mitigate such a possibility for CFCs 

because the reproposed regulations 

provide for foreign sourcing when a 

CFC’s space and ocean income is 

attributable to functions performed, 

resources employed, or risks assumed in 

a foreign country or countries. The rule 

for CFCs in the reproposed regulations 

is thus a rule of limited application that, 

consistent with the legislative history of 

the 1986 Act, provides U.S. source 

treatment only with respect to space and 

ocean income attributable to activities 

in space or international water that are 

not likely to be subject to tax in any 

foreign country. The rule for CFCs will 

permit a United States shareholder to 

establish as foreign source the amount 

of income attributable to the CFC’s 

operations in a foreign country or 

countries. 

Several commentators submitted 

comments on potential withholding tax 

issues posed by the 2001 proposed 

regulations. The Treasury Department 

and the IRS recognize that certain 

provisions of the reproposed regulations 

(such as the source rule for the space 

and ocean income of CFCs in 

reproposed § 1.863–8(b)(2)(ii)) may raise 

similar withholding tax issues. The 

Treasury Department and the IRS 

accordingly seek comments on these 

issues, in particular with regard to the 

following: (1) The extent to which Form 

W–8ECI, ‘‘Certificate of Foreign Person’s 

Claim for Exemption From Withholding 

on Income Effectively Connected With 

the Conduct of a Trade or Business in 

the United States’’, may practically 

address these issues; (2) the nature of 

54862 Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 

situations in which withholding tax 

issues will arise (for example, how 

particular businesses involving space, 

ocean, or communications activities are 

conducted, whether payors of income 

potentially subject to withholding under 

the reproposed regulations are typically 

related or unrelated parties, etc.); and 

(3) suggestions to address these issues in 

the cases in which they arise. 

4. Space and Ocean Income of a Foreign 

Person Engaged in a Trade or Business 

Within the United States 

Section 1.863–3(b)(3) of the 2001 

proposed regulations provides that if a 

foreign person is engaged in a trade or 

business within the United States, the 

foreign person’s income derived from a 

space or ocean activity is presumed to 

be U.S. source income. The rule reflects 

the general view of the Treasury 

Department and the IRS that Congress 

intended that a foreign person engaged 

in a substantial business within the 

United States be subject to U.S. tax on 

related space or ocean income. 

However, the Treasury Department and 

the IRS recognize that the presumption 

may be over-inclusive in certain cases. 

Therefore, the 2001 proposed 

regulations provide that if the foreign 

person can allocate gross space or ocean 

income between income from sources 

within the United States, space, or 

international water, and sources without 

the United States, space, and 

international water, to the satisfaction of 

the Commissioner, based on all the facts 

and circumstances, income allocated to 

sources without the United States, 

space, and international water will be 

treated as foreign source income. 

Several commentators stated that the 

presumption is overbroad, given that it 

applies to all space and ocean income 

regardless of any nexus with the foreign 

corporation’s U.S. trade or business. 

Several commentators suggested that if 

the presumption were retained, 

objective standards consistent with 

existing rules for effectively connected 

income should be included to ensure 

that the space and ocean income has a 

meaningful connection with the foreign 

corporation’s U.S. trade or business. In 

the absence of objective standards, 

commentators stated that taxpayers 

should be permitted to apply a 

reasonable allocation method on a 

consistent basis to all of their space and 

ocean income. In addition, as with 

§ 1.863–8(b)(2) of the 2001 proposed 

regulations, several commentators stated 

that under § 1.863–8(b)(3) of the 2001 

proposed regulations space and ocean 

income could in some cases be subject 

to multiple levels of taxation. 

In response to these comments, the 

reproposed regulations provide that if a 

foreign person, other than a CFC, is 

engaged in a trade or business within 

the United States, its space or ocean 

income is from sources within the 

United States to the extent the income, 

based on all the facts and 

circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed within the 

United States. 

The Treasury Department and the IRS 

believe that the revision in reproposed 

§ 1.863–8(b)(2)(iii) providing that space 

or ocean income will be U.S. source 

income to the extent the space or ocean 

income is attributable to functions 

performed, resources employed, or risks 

assumed in the United States should 

mitigate commentators’ concerns about 

potential multiple levels of taxation. 

Examples 12 and 13 in § 1.863–8(f) of 

the 2001 proposed regulations illustrate 

the application of § 1.863–8(b)(3) of 

those regulations to foreign persons that 

conduct certain activities in the United 

States. One commentator noted that 

these examples appear to state that 

engaging in certain activities would 

constitute the conduct of a trade or 

business in the United States. In 

response to this comment, Examples 12 

and 13 have been clarified in the 

reproposed regulations to state that they 

assume, on the facts of the example, that 

the activities constitute the conduct of 

a trade or business within the United 

States within the meaning of section 

864(b). The Treasury Department and 

the IRS intend that the determination 

whether a foreign person is engaged in 

a trade or business in the United States 

continue to be made under general 

section 864(b) principles. 

5. Source Rules for Sales of Property in 

Space or International Water 

The 2001 proposed regulations 

provide generally that taxpayers must 

apply the rules of section 863(d) and the 

2001 proposed regulations to determine 

the source of income from sales of 

property purchased or produced by the 

taxpayer, either when production occurs 

in whole or in part in space or 

international water, or when the sale 

occurs in space or international water. 

Under the 2001 proposed regulations, 

income from sales of inventory property 

(within the meaning of section 

1221(a)(1)) on international water is 

sourced under § 1.863–3(c)(2). Section 

1.863–3(c)(2), as amended by the 2001 

proposed regulations, provides that the 

place of sale will be presumed to be the 

United States when property is 

produced in the United States and the 

property is sold to a U.S. resident for 

use in space or international water; in 

such cases, the property will be treated 

as sold for use, consumption, or 

disposition in the United States. 

Section 1.863–8(d)(1)(i) of the 2001 

proposed regulations defines space 

activity to include the sale of property 

in space. Section 1.863–8(d)(1)(ii) of the 

2001 proposed regulations defines 

ocean activity to include the sale of 

property in international water, but not 

the sale of inventory property on 

international water. Under § 1.863–

8(d)(2)(iii) of the 2001 proposed 

regulations, a sale occurs in space or 

international water if the property is 

located in space or international water 

at the time the rights, title, and interest 

of the seller in the property are 

transferred to the purchaser, or if the 

property is sold for use in space or 

international water. 

For sales in space or international 

water of property produced by the 

taxpayer, § 1.863–8(b)(4)(ii)(A) of the 

2001 proposed regulations generally 

provides that the source of income 

attributable to sales activity is 

determined under § 1.863–8(b)(1), (2), or 

(3) of the 2001 proposed regulations. If, 

however, the taxpayer sells such 

property outside space and international 

water, the source of income attributable 

to sales activity is determined under 

§ 1.863–3(c)(2). 

Commentators stated that the 

inclusion of sales of inventory property 

in space or international water in the 

definitions of space and ocean activity 

is inconsistent with the legislative 

history of the 1986 Act, which indicates 

that the Senate Committee on Finance 

did not intend sales of inventory 

property on the high seas to be 

considered space or ocean activity. See 

S. Rep. No. 99–313, at 359. 

In response to comments, the 

reproposed regulations provide that 

sales of inventory property in space or 

international water will be considered 

space or ocean activity only if the 

inventory property is sold for use, 

consumption, or disposition in space or 

international water. In such cases, the 

source of income will be determined 

under the source rules provided for 

space and ocean income by the 

reproposed regulations. The source of 

income from sales in space or 

international water of inventory 

property when the inventory property is 

sold for use, consumption, or 

disposition outside space and 

international water will be determined 

under §§ 1.861–7(c) and 1.863–3(c)(2). 

The Treasury Department and the IRS 

believe that sales of property in space or 

international water—with the exception 

of sales of inventory property in space 

Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 54863 

or international water for use, 

consumption, or disposition outside 

space or international water—should be 

considered space or ocean activity, and 

that the source of income from such 

sales should be determined under 

section 863(d). The Treasury 

Department and the IRS believe that this 

result is consistent with both the statute 

and the legislative history. The statute 

provides that space or ocean activity 

includes any activity in space or 

international water. However, the 

Senate Report states that the Senate 

Committee on Finance did not intend to 

override the general source rule in 

§ 1.861–7(c) for sales of property on the 

high seas. See S. Rep. No. 99–313, at 

359. Thus, sales of inventory property in 

transit between the United States and a 

foreign country will continue to be 

sourced under sections 861 through 865, 

and not section 863(d). 

The reproposed regulations do not 

contain the presumption in § 1.863–

3(c)(2) of the 2001 proposed regulations 

regarding sales of property produced by 

the taxpayer in the United States to U.S. 

residents for use in space or 

international water. Under the 

reproposed regulations, if such sales 

occur in space or international water, 

the source of income attributable to 

sales activity will be determined under 

reproposed § 1.863–8(b)(3)(ii)(D). 

6. Special Rule for Determining the 

Source of Income From Services 

Section 1.863–8(b)(5) of the 2001 

proposed regulations provides that 

income derived from the performance of 

services in space or international water 

is sourced under § 1.863–8(b)(1), (2), or 

(3) of the 2001 proposed regulations, as 

applicable. Section 1.863–8(d)(2)(ii)(A) 

of the 2001 proposed regulations 

contains a general rule providing that 

the performance of a service is a space 

or ocean activity in its entirety when a 

part of the service, even if de minimis, 

is performed in space or international 

water. 

The Treasury Department and the IRS 

recognized that this rule could be overinclusive in certain cases. Therefore, 

§ 1.863–8(d)(2)(ii)(A) of the 2001 

proposed regulations provides a 

facilitation exception, under which a 

service will not be treated as either 

space or ocean activity if the taxpayer’s 

only activity in space or international 

water is to facilitate the taxpayer’s own 

communications as part of the provision 

or delivery of a service provided by the 

taxpayer, and the service would not 

otherwise be a space or ocean activity. 

Section 1.863–8(b)(5) of the 2001 

proposed regulations also provides that 

if the taxpayer can allocate, to the 

satisfaction of the Commissioner, gross 

income from the services transaction 

between performance occurring outside 

space and international water, and 

performance occurring in space or 

international water, the source of 

income allocated to performance 

occurring outside space and 

international water will be determined 

under sections 861, 862, 863, and 865. 

Several commentators commented 

unfavorably on a rule that characterizes 

an entire services transaction as space or 

ocean activity when only de minimis 

performance occurs in space or 

international water. Several 

commentators noted that even though 

§ 1.863–8(b)(5) of the 2001 proposed 

regulations permits a taxpayer to source 

services income to sources outside 

space or international water, the entire 

transaction continues to be 

characterized as space or ocean activity, 

and all income derived from the 

services transaction is thus included in 

the separate subpart F and foreign tax 

credit limitation category for shipping 

income. Some commentators stated that 

under the 2001 proposed regulations 

significant consequences result from 

characterization as a services 

transaction, even though the 

characterization rules are themselves 

unclear. Some commentators also stated 

that the facilitation exception to space 

or ocean activity characterization is 

confusing, and that the example 

intended to illustrate the application of 

the facilitation exception (Example 4 in 

§ 1.863–8(f) of the 2001 proposed 

regulations) is itself unclear. 

As noted above, subsequent to the 

publication of the 2001 proposed 

regulations, AJCA amended the subpart 

F rules relating to space and ocean 

income by eliminating shipping income 

as a category of subpart F income and 

reduced the number of foreign tax credit 

limitation categories from nine to two 

(with space and ocean income generally 

falling into the general limitation 

category) for taxable years beginning 

after December 31, 2006. The Treasury 

Department and the IRS believe that 

these statutory changes should allay 

commentators’ concerns regarding the 

characterization of a services transaction 

as space or ocean activity. In addition, 

as discussed below, the reproposed 

regulations provide that if the taxpayer 

can demonstrate the value of the service 

attributable to performance in space or 

international water and the value of the 

service attributable to performance 

outside space and international water, 

then the service will be treated as a 

space or ocean activity only to the 

extent of the activity performed in space 

or international water. The value of the 

service is attributable to performance 

occurring in space or international 

water to the extent the performance of 

services, based on all the facts and 

circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed in space or 

international water. 

Based on the comments, the 

reproposed regulations eliminate the 

facilitation exception. Under reproposed 

§ 1.863–8(d)(2)(ii), to the extent, based 

on all the facts and circumstances, the 

value of the service attributable to 

functions performed, resources 

employed, or risks assumed in space or 

international water is de minimis, such 

service is not treated as space or ocean 

activity. The adoption of the de minimis 

rule is intended to address taxpayer 

concerns about potential confusion in 

qualifying for the facilitation exception. 

Example 4 of reproposed § 1.863–8(f) 

has been revised accordingly. 

The rule for determining the source of 

income from performance of services 

that occur in part in space or 

international water and in part outside 

space and international water has been 

adapted to conform to the changes made 

to reproposed § 1.863–8(d)(2)(ii). To the 

extent a service is characterized as space 

or ocean activity under reproposed 

§ 1.863–8(d)(2)(ii), the source of gross 

income derived from such transaction is 

determined under reproposed § 1.863–

8(b)(1) or (2), as applicable, as provided 

by reproposed § 1.863–8(b)(4). 

Accordingly, to the extent the value of 

the service, based on all the facts and 

circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed outside 

space and international water, the 

service will not constitute space or 

ocean activity, and, to that extent, the 

source of income from the service will 

be determined under section 861, 862, 

or 863, as applicable. 

7. Definition of Space and Ocean 

Activity 

a. Foreign Communications Activity as 

Space or Ocean Activity 

Section 1.863–8(b)(6) of the 2001 

proposed regulations provides that 

space and ocean activity include 

communications activity (but not 

international communications activity) 

occurring in space or international 

water. Foreign communications activity 

is thus characterized under the 2001 

proposed regulations as space or ocean 

activity when, for example, part of the 

transmission is via satellite or via 

underwater cable located in 

international water. 

54864 Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 

Commentators requested that the 

regulations characterize income from 

foreign-to-foreign communications as 

international communications income, 

which is specifically excluded from the 

definition of space and ocean activity by 

section 863(d)(2)(B) and § 1.863–8(d)(3) 

of the 2001 proposed regulations, but 

retain the 100 percent foreign source 

rule otherwise provided for foreign 

communications income by § 1.863–

9(b)(4) of the 2001 proposed regulations. 

International communications income is 

defined by section 863(e)(2) as income 

derived from the transmission of 

communications between the United 

States and a foreign country (or 

possession of the United States) and is 

discussed in greater detail below. 

Commentators noted that this rule 

puts telecommunications companies 

using satellite or underwater cable 

methods of transmission at a 

competitive disadvantage vis-a ́-vis 

competitors in foreign marketplaces that 

use solely land-based facilities. For 

example, if a CFC were paid to transmit 

a telephone call between two foreign 

countries and used a land line 

connecting the two countries to transmit 

the call, the CFC’s income from the 

transmission would be included in the 

general limitation category for foreign 

tax credit purposes. If the 

communication were transmitted using 

fiber optic cable located in international 

water or a satellite, the CFC’s income 

from the transmission would be foreign 

source space or ocean income included 

in the separate subpart F and foreign tax 

credit limitation category for shipping 

income. 

The reproposed regulations do not 

characterize income from foreign-toforeign communications as international 

communications income as suggested by 

commentators. Section 863(d)(2)(A) 

broadly defines space and ocean activity 

as any activity conducted in space or 

international water. The statutory 

exception to space and ocean activity in 

section 863(d)(2)(B) removes only 

activities giving rise to international 

communications income from the scope 

of space and ocean activity. In addition, 

if foreign-to-foreign communications 

income were characterized as 

international communications income, 

U.S. persons with such income would 

be subject to the statutory source rule in 

section 863(e)(1)(A), which provides for 

the split-sourcing of a U.S. person’s 

international communications income. 

The Treasury Department and the IRS 

thus consider the language of the statute 

to preclude the approach suggested by 

commentators with respect to the 

characterization and sourcing of income 

from foreign-to-foreign communications. 

The legislative history of the 1986 Act 

also indicates that Congress intended 

income from foreign-to-foreign 

communications to be foreign source 

income. See S. Rep. No. 99–313, at 359, 

‘‘Finally, if the communication is 

between two foreign locations, the 

committee intends income attributable 

thereto to be foreign source.’’. This 

would not be the result, however, if 

foreign-to-foreign communications 

income were included in the definition 

of international communications 

income and thus subject to the statute’s 

50/50 source rule for U.S. persons. 

In addition, as noted above, AJCA 

made significant changes to subpart F 

and the foreign tax credit regime as 

applicable to space and ocean income. 

The Treasury Department and the IRS 

believe that these statutory changes 

should allay commentators’ concerns 

regarding the characterization of 

foreign-to-foreign communications as 

space or ocean activity. 

The Treasury Department and the IRS 

believe that the modifications in the 

reproposed regulations with respect to 

the characterization of services 

involving space or ocean activities 

address some of the commentators’

concerns regarding the characterization 

of foreign-to-foreign communications 

activities involving services performed 

both in space or international water and 

in foreign countries. Reproposed 

§ 1.863–8(d)(2)(ii) provides that a 

transaction characterized as the 

performance of a service will be treated 

as a space or ocean activity only to the 

extent the value of the service, based on 

all the facts and circumstances, is 

attributable to functions performed, 

resources employed, or risks assumed in 

space or international water. 

b. Definition of Space 

Section 1.863–8(d)(1)(i) of the 2001 

proposed regulations defines space as 

any area not within the jurisdiction (as 

recognized by the United States) of a 

foreign country, possession of the 

United States, or the United States, and 

not in international water. Under the 

2001 proposed regulations, space 

comprises the entire area outside the 

jurisdiction of any country or U.S. 

possession, extending from just above 

the surface of international water (and 

Antarctica) through, and beyond, the 

earth’s atmosphere. Space thus includes 

international airspace. 

Several commentators stated that the 

definition of space should be limited to 

the area beyond the earth’s atmosphere. 

One commentator proposed a definition 

of space that conforms to a definition 

used for non-tax purposes (for example, 

beyond the maximum altitude at which 

powered flight by aircraft equipped with 

air-breathing engines is possible). 

Another commentator stated that the 

definition of space could be read to 

include cyberspace, the electronic 

medium in which online 

communication takes place, and 

suggested that cyberspace be 

specifically excluded from the 

definition of space. One commentator 

noted language in the legislative history 

stating that space activities had not been 

very prevalent at the time of the 1986 

Act (see, for example, S. Rep. No. 99–

313, at 358) and argued that Congress 

did not intend to include international 

airspace in space. 

No changes were made to the 

reproposed regulations in response to 

these comments. The Treasury 

Department and the IRS believe a broad 

definition of space that includes 

international airspace is consistent with 

legislative intent to assert primary tax 

jurisdiction over income earned by U.S. 

residents that is not within any foreign 

country’s taxing jurisdiction. See, e.g., 

S. Rep. No. 99–313, at 357. The 

Treasury Department and the IRS also 

believe that providing guidance with 

respect to the place of performance of 

activities involving online 

communications is beyond the scope of 

the present regulations, and that 

taxpayers should rely on generally 

applicable principles to determine 

where functions are performed, 

resources are employed, or risks are 

assumed in a specific online 

transaction. 

c. Transportation Income 

Certain activities occurring in space 

or international water are not 

considered either space or ocean 

activity. Section 1.863–8(d)(3)(i) of the 

2001 proposed regulations, consistent 

with section 863(d), provides that space 

or ocean activity does not include any 

activity that gives rise to transportation 

income as defined in section 863(c). 

One commentator stated that a 

portion of a bareboat charter—the return 

of an empty vessel that has unloaded its 

cargo (backhaul)—may potentially be 

considered ocean activity under the 

2001 proposed regulations. Another 

commentator stated that income from 

container leasing by a party other than 

the ship operator could constitute space 

or ocean income, and could be subject 

to withholding tax. One commentator 

also suggested that the regulations 

should state that they do not apply to 

the income of foreign corporations 

derived from the international operation 

of ships, or to container leasing. 

The reproposed regulations do not 

adopt changes to reflect these 

Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 54865 

comments. The reproposed regulations 

reflect the broad statutory definition of 

ocean activity in section 863(d)(2) as 

‘‘any activity conducted on or under 

water not within the jurisdiction (as 

recognized by the United States) of a 

foreign country, possession of the 

United States, or the United States.’’

The Treasury Department and the IRS 

do not consider it appropriate to 

construe the definition of section 863(c) 

transportation income in the context of 

these regulations. The Treasury 

Department and the IRS will consider 

addressing the definition of section 

863(c) transportation income in separate 

guidance. 

8. Treatment of Partnerships 

Section 1.863–8(e) of the 2001 

proposed regulations generally provides 

that section 863(d) and the regulations 

thereunder will be applied to domestic 

partnerships at the partnership level 

and to foreign partnerships at the 

partner level. Commentators suggested 

that the source rules of § 1.863–8 of the 

2001 proposed regulations be applied to 

all partnerships either at the entity level 

or at the partner level. 

The Treasury Department and the IRS 

believe that section 863(d) should be 

applied to domestic and foreign 

partnerships in the same manner. 

Accordingly, the reproposed regulations 

do not provide a different rule for 

foreign partnerships and domestic 

partnerships. Section 1.863–8(e) of the 

reproposed regulations provides that 

section 863(d) and the regulations 

thereunder will be applied to domestic 

partnerships at the partner level. In 

order to conform the treatment of 

domestic and foreign partnerships, no 

change was made with respect to the 

rule in the 2001 proposed regulations 

that section 863(d) and the regulations 

thereunder will be applied to foreign 

partnerships at the partner level. 

9. Allocations 

When a taxpayer must allocate gross 

income to the satisfaction of the 

Commissioner, based on all the facts 

and circumstances, under the provisions 

of the 2001 proposed regulations, the 

Treasury Department and the IRS 

believe such allocations generally 

should be based on section 482 

principles. 

Several commentators stated that 

allocation of gross income based on 

section 482 principles will be 

burdensome and expensive and will 

create uncertainty. Commentators also 

noted that the 2001 proposed 

regulations provide no guidance on 

allocating income other than a facts and 

circumstances approach. 

The Treasury Department and the IRS 

consider the allocation of gross income 

based on the general guidance of section 

482 to be an approach that is well-suited 

to application in the wide variety of 

factual contexts within the scope of the 

reproposed regulations. The Treasury 

Department and the IRS solicit 

comments on alternative methods of 

allocation for particular industries and 

criteria that could be used to evaluate 

the reasonableness of such methods. 

10. Reporting and Documentation 

Requirements 

In order to satisfy the Commissioner 

with respect to a taxpayer’s allocation of 

gross income under § 1.863–8(b)(3), 

(b)(4)(ii)(C), or (b)(5) of the 2001 

proposed regulations, the taxpayer must 

make the allocation on a timely filed 

original return (including extensions). 

An amended return does not qualify for 

this purpose, and section 9100 relief 

will not be available. In all cases, a 

taxpayer must also maintain 

contemporaneous documentation 

regarding the allocation of gross income, 

allocation and apportionment of 

expenses, losses, and other deductions, 

the methodologies used, and the 

circumstances justifying use of those 

methodologies. The taxpayer must 

produce such documentation within 30 

days upon request. 

Commentators stated that neither the 

statute nor the legislative history 

provides a basis for the reporting, 

recordkeeping, and contemporaneous 

documentation requirements in the 

2001 proposed regulations. 

Commentators also noted that the Code 

and regulations do not contain similar 

requirements with respect to certain 

other expense allocation provisions. 

The reproposed regulations generally 

retain the recordkeeping and 

documentation requirements. The 

Treasury Department and the IRS 

believe that it is appropriate to require 

taxpayers to keep proper records, and 

additionally note the potentially 

considerable difficulties the IRS would 

face in performing the allocations 

required by the reproposed regulations 

without appropriate taxpayer records. 

The Treasury Department and the IRS 

recognize, however, that taxpayers may 

not have all the information necessary 

to make allocations at the time a return 

is originally filed. The reproposed 

regulations therefore provide that a 

taxpayer may make changes to 

allocations made on the taxpayer’s 

original return with respect to any 

taxable year for which the statute of 

limitations has not closed, subject to 

certain conditions. Nonetheless, 

changes to such allocations that are not 

made until an audit of the taxable year 

to which the allocations relate has 

commenced, or a taxpayer’s failure 

timely to provide documentation and 

other information supporting the 

allocations, create administrative 

difficulties for the IRS. Accordingly, 

reproposed § 1.863–8(g)(4) sets forth the 

actions required of taxpayers and the 

procedures the IRS will follow in the 

case of taxpayers that change their 

allocations. 

The reproposed regulations also 

require taxpayers, upon request, to 

provide access to the software programs 

and other systems used by the taxpayer 

to make allocations under these 

regulations. For this purpose, software 

has the meaning provided in section 

7612(d). The Treasury Department and 

the IRS believe that the IRS could face 

significant administrative and other 

difficulties in the examination of 

allocations made under these 

regulations without access to such 

software. 

11. Examples 

Certain examples in § 1.863–8(f) of the 

2001 proposed regulations contain 

statements regarding the 

characterization of certain activities (as, 

for example, the lease of equipment or 

the performance of services). One 

commentator suggested that the 

examples clarify that the character of 

the transactions at issue is only assumed 

for purposes of the specific example. In 

response to this comment, the examples 

in reproposed § 1.863–8(f) have been 

revised to make clear that the 

characterization of certain transactions 

is assumed based on the facts of the 

specific example. The Treasury 

Department and the IRS did not 

consider it necessary to modify certain 

other examples (for example, Example 1 

of reproposed § 1.863–8(f)) in which the 

character of the transaction at issue 

should be clear under the facts 

presented. 

In addition, Examples 2, 3, 4, and 7 

of reproposed § 1.863–8(f), have been 

revised to reflect substantive changes 

made to reproposed § 1.863–8(b)(4) and 

(d)(2)(ii) with respect to services that 

involve activities performed in space or 

international water. 

B. Communications Activity Under 

Section 863(a), (d), and (e) 

1. International Communications 

Income 

International communications income 

is defined by section 863(e)(2) as 

income derived from the transmission of 

communications between the United 

States and a foreign country (or 

54866 Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 

possession of the United States). Section 

863(e)(1)(A) provides that in the case of 

any U.S. person, 50 percent of any 

international communications income 

will be sourced in the United States and 

50 percent of such income will be 

sourced outside the United States. 

Section 863(e)(1)(B)(i) provides that any 

international communications income 

of a foreign person will be foreign 

source income except as provided in 

regulations or in section 863(e)(1)(B)(ii). 

Section 1.863–9(b)(2)(ii)(A) of the 2001 

proposed regulations states the general 

rule that international communications 

income of a foreign person is foreign 

source income. However, the 2001 

proposed regulations contain certain 

exceptions to the general rule. 

2. International Communications 

Income of 50-Percent or More U.S.- 

Owned Foreign Corporations 

The first exception, in § 1.863–

9(b)(2)(ii)(B) of the 2001 proposed 

regulations, provides that if U.S. 

persons own 50 percent or more of a 

foreign corporation by vote or value 

(directly, indirectly, or constructively), 

including a CFC within the meaning of 

section 957, international 

communications income derived by that 

corporation is entirely U.S. source 

income. 

As with the similar rule provided for 

the space and ocean income of U.S.- 

owned foreign corporations in § 1.863–

8(b)(2) of the 2001 proposed regulations, 

several commentators requested that the 

rule be withdrawn because it expands 

the scope of U.S. taxing jurisdiction 

beyond the apparent intent of Congress. 

Commentators stated that the rule is 

punitive in nature because it is less 

favorable than the 50/50 source rule 

applied to international 

communications income earned directly 

by U.S. persons. As with § 1.863–8(b)(2) 

and (3) of the 2001 proposed 

regulations, commentators also stated 

that under the rule the international 

communications income of certain 

foreign corporations may be subject to 

multiple levels of taxation. 

Commentators noted that in certain 

circumstances international 

communications income could be 

subject to the 30-percent gross income 

tax imposed by section 881, which is 

typically collected through withholding 

by the payors of such income. 

Commentators stated that although most 

tax treaties should prevent the 

imposition of the 30-percent tax 

(international communications income 

would likely be characterized as 

business profits under most treaties and 

would accordingly be exempt from U.S. 

taxation unless attributable to a 

permanent establishment in the United 

States), the rule in the 2001 proposed 

regulations would result in disparate 

treatment for corporations from treaty 

countries vis-a`-vis corporations from 

non-treaty countries. The requirement to 

withhold the 30-percent tax could also 

create numerous administrative and 

enforcement difficulties. In addition, 

given the extent of resale of capacity 

between telecommunications providers, 

commentators noted that payments 

relating to the same transmission could 

be subject to multiple withholding. 

Finally, as with the similar rule 

provided for the space and ocean 

income of U.S.-owned foreign 

corporations in § 1.863–8(b)(2) of the 

2001 proposed regulations, 

commentators raised the issue of 

potential difficulties in determining 

whether a foreign corporation is 50- 

percent or more U.S.-owned. 

As noted above, several commentators 

addressed the stock ownership test 

applicable to U.S.-owned foreign 

corporations. They stated that 

determining whether a foreign 

corporation is 50-percent U.S. owned, 

especially without regard to the size of 

an owner’s holding, presents potential 

difficulties (for example, when the 

foreign corporation is widely-held). 

In light of the potential complexity in 

determining whether a foreign 

corporation is a U.S.-owned foreign 

corporation and the belief of the 

Treasury Department and the IRS that 

international communications income 

earned by foreign corporations should 

be sourced in accord with the rules for 

foreign persons, with the limited 

exception for CFCs discussed below, the 

reproposed regulations do not include a 

special source rule for international 

communications income earned by a 50 

percent or more U.S.-owned foreign 

corporation. Instead, the international 

communications income of foreign 

corporations (other than CFCs) is 

sourced under the applicable provisions 

of reproposed § 1.863–9(b)(2)(i), (iii), 

and (iv). 

3. International Communications 

Income of CFCs 

In light of the comments with respect 

to CFCs described above, the reproposed 

regulations provide that in the case of a 

CFC, 50 percent of any international 

communications income will be sourced 

in the United States and 50 percent of 

such income will be sourced outside the 

United States. The 100-percent U.S. 

source rule is eliminated. Consequently, 

the source rule for international 

communications income in the hands of 

a CFC is the same rule that applies to 

U.S. persons. In both cases, the source 

rules take into account that 

international communications activities 

must have both a U.S. and a foreign 

connection (i.e., one endpoint in the 

United States and the other in a foreign 

country or possession of the United 

States). The Treasury Department and 

the IRS believe that the revision of the 

source rule for CFCs deriving 

international communications income 

should mitigate commentators’ concerns 

about potential multiple levels of 

taxation because 50 percent of this 

income is foreign source. 

The Treasury Department and the IRS 

recognize that this and other provisions 

of reproposed § 1.863–9 may raise 

withholding tax issues similar to those 

discussed above in connection with the 

source rule for the space and ocean 

income of CFCs (in reproposed § 1.863–

8(b)(2)(ii)). As noted above, the Treasury 

Department and the IRS seek comments 

on these issues and practical 

suggestions to address them in the 

specific factual contexts in which they 

may arise. 

4. International Communications 

Income Derived by a Foreign Person 

With an Office or Fixed Place of 

Business in the United States 

Section 863(e)(1)(B)(ii) and § 1.863–

9(b)(2)(ii)(C) of the 2001 proposed 

regulations provide that international 

communications income derived by a 

foreign person that is attributable to an 

office or other fixed place of business in 

the United States is from sources within 

the United States. Section 864 and the 

regulations thereunder provide 

guidance in determining ‘‘income * * * 

attributable to an office or other fixed 

place of business’’ in specific contexts. 

However, the Treasury Department and 

the IRS believe that, for purposes of 

section 863(e), international 

communications income should be 

attributed to an office or fixed place on 

business based on functions performed, 

resources employed, and risks assumed. 

Therefore, pursuant to the regulatory 

authority in section 863(e)(1)(B)(i), the 

reproposed regulations provide that, for 

purposes of this section, income is 

attributable to an office or other fixed 

place of business in the United States to 

the extent of functions performed, 

resources employed, or risks assumed 

by the office or other fixed place of 

business. 

5. International Communications 

Income of a Foreign Person Engaged in 

a Trade or Business Within the United 

States 

The second exception to § 1.863–

9(b)(2)(ii)(A) of the 2001 proposed 

regulations is contained in § 1.863–

Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 54867 

9(b)(2)(ii)(D), which provides that if a 

foreign person (other than a 50 percent 

or more U.S.-owned foreign corporation 

described in § 1.863–9(b)(2)(ii)(B) of the 

2001 proposed regulations) is engaged 

in a trade or business within the United 

States, the foreign person’s international 

communications income is presumed to 

be U.S. source income. However, if the 

foreign person can allocate its 

international communications income 

between sources within the United 

States, space, and international water 

and sources outside the United States, 

space, and international water to the 

satisfaction of the Commissioner, based 

on all the facts and circumstances, 

which may include functions 

performed, resources employed, or risks 

assumed, then the income allocated to 

sources outside the United States, space, 

and international water will be foreign 

source income. 

Several commentators stated that the 

presumption is overbroad because it 

applies to all international 

communications income regardless of 

any nexus with the foreign corporation’s 

U.S. trade or business. These 

commentators claimed that the 

presumption is inconsistent with U.S. 

tax policy and international norms that 

require a connection between the 

income and the foreign person’s 

activities in the United States before 

U.S. taxing jurisdiction is exercised. 

In response to comments, the 

reproposed regulations provide that if a 

foreign person, other than a CFC, is 

engaged in a trade or business within 

the United States, gross income derived 

by that person from international 

communications activity is from sources 

within the United States to the extent 

the income, based on all the facts and 

circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed within the 

United States. This rule is similar to the 

rule in the reproposed regulations under 

section 863(d) for foreign persons 

engaged in a trade or business within 

the United States. There is no longer a 

presumption of U.S. source income. 

The Treasury Department and the IRS 

believe that the provision in the 

reproposed regulations that such a 

foreign person’s international 

communications income is U.S. source 

only to the extent attributable to 

functions performed, resources 

employed, or risks assumed in the 

United States addresses taxpayers’

concerns regarding a nexus between the 

foreign person’s international 

communications income and its 

business activities in the United States. 

Several commentators objected to the 

rule that international communications 

income could be foreign source income 

only to the extent that the foreign 

person could allocate international 

communications income to activity 

occurring in a foreign country. Because 

the reproposed regulations provide for 

U.S. sourcing only to the extent that the 

foreign person’s international 

communications income is attributable 

to functions performed, resources 

employed, or risks assumed in the 

United States, this concern should be 

mitigated. 

Several commentators stated that 

section 863(e) makes international 

communications income that is 

attributable to a U.S. office U.S. source 

income, and that the regulations should 

not adopt a broader U.S. trade or 

business rule. Section 863(e)(1)(B)(ii) 

provides that if a foreign person has a 

fixed place of business in the United 

States, international communications 

income attributable to such fixed place 

of business is U.S. source income. The 

Treasury Department and the IRS have 

not made changes to the reproposed 

regulations in response to these 

comments. Section 863(e)(1)(B)(i) by its 

terms gives the Secretary broad 

authority to source international 

communications income of a foreign 

person as U.S. source income. The 

Treasury Department and the IRS 

believe that it is appropriate to exercise 

that authority in this case. The trade or 

business rule reflects the concern of the 

Treasury Department and the IRS that a 

foreign person could avoid a U.S. fixed 

place of business under section 

863(e)(1)(B)(ii), yet engage in significant 

communications activity in the United 

States. The Treasury Department and 

the IRS believe that Congress intended 

that a foreign person engaged in 

substantial business in the United States 

be subject to U.S. tax on that 

communications activity. 

6. Income Derived From 

Communications Activity—The PaidTo-Do Rule 

Income derived from communications 

activity is defined in § 1.863–9(d)(2) of 

the 2001 proposed regulations as 

income derived from the transmission of 

communications, including income 

derived from the provision of capacity 

to transmit communications. There is no 

requirement that the recipient of 

communications income perform the 

transmission function itself. This rule 

reflects the understanding of the 

Treasury Department and the IRS that 

providers of communications services 

often use capacity owned or operated by 

others. However, income is derived 

from communications activity only if 

the taxpayer is paid to transmit, and 

bears the risk of transmitting, the 

communications. 

Section 1.863–9(d)(3) of the 2001 

proposed regulations provides rules for 

characterizing income derived from a 

communications activity for purposes of 

sourcing the income derived from such 

activity. The character of income 

derived from communications activity is 

determined by establishing the two 

points between which the taxpayer is 

paid to transmit, and bears the risk of 

transmitting, the communication (the 

paid-to-do rule). Under the paid-to-do 

rule, the path the communication takes 

between the two points is not relevant 

in determining the character of the 

transmission. If a taxpayer is paid to 

take a communication from one point to 

another point, income derived from the 

transmission is characterized based on 

the transmission between those two 

points, even if the taxpayer contracts 

out part of the transmission to another 

party. This rule reflects the recognition 

by the Treasury Department and the 

IRS, as noted above, that providers of 

communications services often use 

capacity owned or operated by others. 

When the taxpayer cannot establish 

the two points between which the 

taxpayer is paid to transmit the 

communication, § 1.863–9(b)(6) of the 

2001 proposed regulations provides a 

default source rule, under which all 

income from the communications 

activity, whether derived by a U.S. 

person or a foreign person, is deemed to 

be from sources within the United 

States. Thus, for example, when a 

provider of communications services 

provides both local and international 

long distance services in one-price 

bundles for a set amount each month 

and tracing each transmission is not 

possible or practical, the income 

derived from the communications 

activity is U.S. source income. The 

Treasury Department and the IRS 

understand that many taxpayers in the 

communications industry may consider 

it impractical or impossible to prove the 

endpoints of the communications they 

transmit. The Treasury Department and 

the IRS accordingly solicited comments 

as to proposals for those situations 

when taxpayers cannot establish the 

points between which the taxpayer is 

paid to transmit the communication. 

One commentator stated that the 

phrase ‘‘bears the risk of transmitting,’’

contained in § 1.863–9(d)(2) and (d)(3)(i) 

of the 2001 proposed regulations, is 

ambiguous and does not meaningfully 

improve the determination of when 

income is derived from communications 

activity. This commentator noted that 

the nature of the risk a taxpayer must 

bear to be treated as deriving 

54868 Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 

communications income was unclear, 

and that the determination of risk would 

pose administrative difficulties given 

the complexity of business models and 

structures. No change was made to the 

reproposed regulations in response to 

this comment. The Treasury Department 

and the IRS believe that, in determining 

whether a taxpayer derives 

communications income, risk is more 

important than the mere fact of 

payment. The Treasury Department and 

the IRS thus believe that a taxpayer 

should not be considered to derive 

communications income unless the 

taxpayer bears the economic risk of 

nonpayment with respect to the 

transmission of communications or the 

provision of capacity to transmit 

communications. 

Commentators stated that the paid-todo rule is overbroad because it asserts 

primary U.S. taxing jurisdiction over 

certain communications income 

regardless of any nexus between the 

income and the United States. 

Commentators also noted that when 

certain taxpayers cannot establish the 

two points between which they are paid 

to transmit a communication, the 

income from such communications 

activity may be subject to potential 

double taxation at the corporate level 

(for example, a foreign corporation 

could be subject to tax on such 

communications income in both the 

United States and in the foreign 

corporation’s country of residence or 

incorporation or countries where it does 

business). 

Commentators stated that the paid-todo rule places undue burdens on 

taxpayers who want to obtain the 

benefit of foreign source income 

characterization. Commentators noted 

that, in many cases, it may be 

impractical or technologically 

impossible to track the origination and 

termination points of an individual 

transmission, and that development of 

the required technology, software, and 

other systems would require significant 

capital investments. Maintenance of the 

records needed to substantiate proper 

income sourcing could also be onerous 

for those taxpayers who perform 

extremely large numbers of 

transmissions. Commentators thus 

requested that the regulations provide 

assurance that reasonable methods of 

proof, consistent with industry practice 

and consistently applied, would be 

accepted in establishing the points of 

origin and/or destination of a 

communication. 

Commentators submitted suggested 

modifications to the paid-to-do rule. 

One commentator suggested that the 

paid-to-do rule be modified to 

characterize all income from a 

communication based on the two 

endpoints between which the 

transmission is made. Under this 

commentator’s suggested rule, whether 

a particular taxpayer itself carried out 

all, or only a portion, of the 

transmission would be irrelevant, and 

the characterization of the 

communication would be the same for 

all taxpayers involved in the 

transmission. One commentator 

suggested that the paid-to-do rule be 

applied on a single entity basis for 

United States corporations that join in 

the filing of a consolidated U.S. income 

tax return. 

Commentators also suggested 

reasonable method approaches to 

determine the endpoints between which 

a taxpayer is paid to transmit 

communications (for example, based on 

technical characteristics of the 

communication or contractual terms, or 

on a per transaction, per customer, or 

aggregate basis). One commentator 

suggested factors that could be taken 

into account in determining whether a 

particular method is reasonable, 

including the reliability of the method 

chosen, the degree to which the method 

is in line with generally accepted 

industry practices and norms, and the 

extent to which the method takes into 

account all the information available to 

the taxpayer. 

Commentators suggested that the U.S. 

source default rule for income from 

communications for which the 

endpoints of transmission cannot be 

identified should only apply to foreign 

taxpayers that directly own or operate 

communications facilities, or otherwise 

directly hold rights to communications 

capacity, in the United States; when a 

foreign taxpayer does not own or 

otherwise have rights to 

telecommunications capacity in the 

United States, income from such 

communications would thus be foreign 

source. Other commentators suggested 

that income from communications for 

which the endpoints of transmission 

cannot be identified be treated in the 

same manner as international 

communications income, with a 100- 

percent U.S. source exception provided 

for telecommunications service 

providers who are paid to transmit 

communications that are substantially 

all between multiple points located 

within the United States. 

The Treasury Department and the IRS 

continue to believe that 

communications activity is most 

appropriately characterized based on 

the two points between which the 

taxpayer is paid to transmit, and bears 

the risk of transmitting, the 

communication. The Treasury 

Department and the IRS consider the 

endpoint-based source rule in the 

reproposed regulations to be an 

approach that best matches the source of 

communications income to the location 

where functions are performed, 

resources are employed, or risks are 

assumed in a taxpayer’s 

communications transaction. Moreover, 

although commentators noted potential 

difficulties in identifying the endpoints 

of a communication, the industryspecific comments received in response 

to the 2001 proposed regulations 

generally focused on recordkeeping 

burdens. Taxpayers have much better 

access to the relevant information 

regarding the facts and circumstances of 

their communications transactions than 

the IRS. The Treasury Department and 

the IRS accordingly solicit comments on 

the challenges to identifying the 

endpoints of communications in 

specific industries or situations, as well 

as suggestions for rules that are 

responsive to these particular 

challenges. The Treasury Department 

and the IRS also again solicit comments 

on methods to identify the endpoints of 

a communication that may be 

reasonable for particular industries, as 

well as criteria that may be appropriate 

to evaluate the reasonableness of such 

methods. 

7. Treatment of a Content Provider’s 

Communications Activity 

Section 1.863–9(d)(1)(ii) of the 2001 

proposed regulations provides that, to 

the extent a taxpayer’s transaction 

consists in part of non-de minimis 

communications activities and in part of 

non-de minimis non-communications 

activities, such parts of the transaction 

must be treated as separate transactions. 

Section 1.863–9(d)(1)(ii) of the 2001 

proposed regulations then provides that 

gross income derived from the activities 

must be allocated to each separate 

transaction, to the satisfaction of the 

Commissioner, based on all the facts 

and circumstances, which may include 

functions performed, resources 

employed, or risks assumed in the 

respective transactions. 

One commentator suggested that the 

regulations be clarified to provide that 

a content company (for example, the 

creator of a television or radio program) 

that does not possess or operate 

communications equipment or itself 

perform any communications function 

is not engaged in communications 

activities. This commentator did not 

believe that communication activities 

should be attributed to a content 

provider and stated that delivery of a 

content provider’s programming by a 

Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 54869 

third party should not change the 

character of the content provider’s 

income to communications income. 

No changes were made to the 

reproposed regulations in response to 

this comment. The Treasury Department 

and the IRS believe that the 

transmission of any communications, 

including content, is appropriately 

considered a communications activity. 

The Treasury Department and the IRS 

also believe that when a content 

provider is paid to transmit, and bears 

the risk of transmitting, content to a 

customer, the content provider should 

be considered to derive communications 

income. Under reproposed § 1.863–

9(h)(1)(ii), as under the 2001 proposed 

regulations, the content provider will 

derive communications income only to 

the extent of the gross income allocated 

to the separate transaction involving the 

communications activity. The Treasury 

Department and the IRS believe that it 

is appropriate for a content provider to 

derive communications income when 

communications activities make more 

than a de minimis contribution to the 

value of the content provider’s overall 

transaction with its customer. 

8. Treatment of Partnerships 

Section 1.863–9(e)(1) of the 2001 

proposed regulations generally provides 

that section 863(e) and the regulations 

thereunder will be applied to domestic 

partnerships at the partnership level. 

Section 1.863–9(e)(1) of the 2001 

proposed regulations also provides that 

section 863(e) and the regulations 

thereunder will be applied at the 

partner level to foreign partnerships. 

Section 1.863–9(e)(2) of the 2001 

proposed regulations similarly provides 

that section 863(e) and the regulations 

thereunder will be applied at the 

partner level to domestic partnerships 

in which 50 percent or more of the 

partnership interests are owned by 

foreign persons. 

One commentator stated that § 1.863–

9(e)(2) of the 2001 proposed regulations 

conflicts with sections 863(e)(1)(A) 

(which provides that the international 

communications income of any United 

States person shall be 50-percent U.S. 

source and 50-percent foreign source) 

and 7701(a)(3) (which defines United 

States person to include a domestic 

partnership). According to this 

commentator, the rule potentially 

discriminates against foreign partners in 

a domestic partnership owned 50 

percent or more by foreign partners visa ́-vis the U.S. partners in such a 

partnership. For example, the 

international communications income 

of a foreign partner could be 100- 

percent U.S. source under § 1.863–

9(b)(2)(ii)(B) or (C) of the 2001 proposed 

regulations, whereas the international 

communications income of a U.S. 

partner would be 50-percent U.S. source 

and 50-percent foreign source, creating 

the potential for double taxation of the 

foreign partner. Another commentator 

stated that § 1.863–9(e)(1) of the 2001 

proposed regulations could result in the 

double taxation of the U.S. partners of 

foreign partnerships. This commentator 

noted that the international 

communications income of a foreign 

partnership could be subject to tax in 

the country in which the foreign 

partnership is organized. Under § 1.863–

9(e) of the 2001 proposed regulations, a 

U.S. partner’s share of such 

international communications income 

would be subject to the 50/50 source 

rule in § 1.863–9(b)(2)(i) of the 2001 

proposed regulations. As a result, the 

U.S. partner may be unable to credit its 

proportionate share of tax paid in the 

foreign country. Commentators 

suggested that the source rules of 

§ 1.863–9 of the 2001 proposed 

regulations be applied to all 

partnerships at the entity level. 

As is the case for reproposed § 1.863–

8(e) with respect to section 863(d), the 

Treasury Department and the IRS 

believe that section 863(e) should be 

applied to domestic and foreign 

partnerships in the same manner. 

Accordingly, the reproposed regulations 

do not provide a different rule for 

foreign partnerships and domestic 

partnerships. Section 1.863–9(i) of the 

reproposed regulations provides that the 

regulations will be applied at the 

partner level for all partnerships. 

9. Allocations 

When a taxpayer must allocate gross 

income to the satisfaction of the 

Commissioner, based on all the facts 

and circumstances, under § 1.863–

9(b)(2)(ii)(D) or (d)(1)(ii) of the 2001 

proposed regulations, the Treasury 

Department and the IRS believe that 

such allocations should be based 

generally on section 482 principles. As 

with § 1.863–8 of the 2001 proposed 

regulations, commentators stated that 

allocation of income based on section 

482 principles would be burdensome 

and expensive and would create 

uncertainty. 

The Treasury Department and the IRS 

consider the allocation of gross income 

based on the general guidance of section 

482 to be an approach that is well-suited 

to application in the wide variety of 

factual contexts within the scope of the 

reproposed regulations. The Treasury 

Department and the IRS solicit 

comments on alternative methods of 

allocation for particular industries and 

criteria that could be used to evaluate 

the reasonableness of such methods. 

10. Issues With Uplink Functions 

Examples 5, 10, and 12 of § 1.863–9(f) 

of the 2001 proposed regulations 

involve communications activities that 

include the performance of satellite 

uplink and downlink functions. One 

commentator stated that these examples 

do not provide clear guidance as to 

whether the satellite operator must itself 

perform the uplink function in order for 

its income to qualify as international 

communications income, and could be 

read to treat a satellite operator that 

contracts with another party to transmit 

signals as not engaged in international 

communications activity because the 

uplink function is performed by that 

other party. 

No changes were made to the 

reproposed regulations in response to 

this comment. Reproposed § 1.863–

9(h)(2) provides that income may be 

considered derived from a 

communications activity even if the 

taxpayer does not perform the 

transmission function, but, in all cases, 

a taxpayer derives communications 

income only if the taxpayer is paid to 

transmit, and bears the risk of 

transmitting, the communications. The 

Treasury Department and the IRS 

believe that whether a satellite operator 

should be considered to derive 

international telecommunications 

income from a transaction is 

appropriately determined by applying 

reproposed § 1.863–9(h)(2), as well as 

the other substantive provisions of the 

reproposed regulations, to the specific 

facts of the taxpayer’s transaction. 

11. Characterization of Income 

One commentator stated that the 

regulations should be clarified to 

provide that they do not purport to 

establish general rules for the 

characterization of income and that the 

characterization of income items for 

purposes of the application of section 

863(d) and (e) is to be made under 

general principles of tax law. This 

commentator stated that some examples 

in the 2001 proposed regulations could 

suggest conflicting characterizations of 

income from what appear to be the same 

activities. In response to this comment, 

the examples in the reproposed 

regulations have been clarified to state 

that the characterization of the 

transactions at issue is assumed for 

purposes of the specific example. In 

addition, certain examples have been 

reconciled to the extent they could 

suggest different characterizations of the 

same activities. 

54870 Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 

12. Reporting and Documentation 

Requirements 

In order to satisfy the Commissioner 

with respect to a taxpayer’s allocation of 

gross income under § 1.863–

9(b)(2)(ii)(D) or (d)(1)(ii) of the 2001 

proposed regulations, the taxpayer must 

make the allocation on a timely filed 

original return (including extensions). 

An amended return does not qualify for 

this purpose, and section 9100 relief 

will not be available. In all cases, a 

taxpayer must also maintain 

contemporaneous documentation 

regarding the allocation of gross income, 

allocation and apportionment of 

expenses, losses and other deductions, 

the methodologies used, and the 

circumstances justifying use of those 

methodologies. The taxpayer must 

produce such documentation within 30 

days upon request. 

As with the similar requirements 

under § 1.863–8 of the 2001 proposed 

regulations, commentators stated that 

there is no basis in the statute or the 

legislative history for the reporting, 

recordkeeping, and contemporaneous 

documentation requirements in the 

2001 proposed regulations. 

Commentators also noted that the Code 

and regulations do not contain similar 

requirements with respect to other 

expense allocation provisions. 

The reproposed regulations generally 

retain the recordkeeping and 

documentation requirements. The 

Treasury Department and the IRS 

believe that it is appropriate to require 

taxpayers to keep proper records, and 

additionally note the potentially 

considerable difficulties the IRS would 

face in performing the allocations 

required by the reproposed regulations 

without appropriate taxpayer records. 

The Treasury Department and the IRS 

recognize, however, that taxpayers may 

not have all the information necessary 

to make allocations at the time a return 

is originally filed. The reproposed 

regulations therefore provide that a 

taxpayer may make changes to 

allocations made on the taxpayer’s 

original return with respect to any 

taxable year for which the statute of 

limitations has not closed, subject to 

certain conditions. Nonetheless, 

changes to such allocations that are not 

made until an audit of the taxable year 

to which the allocations relate has 

commenced, or a taxpayer’s failure 

timely to provide documentation and 

other information supporting the 

allocations, create administrative 

difficulties for the IRS. Accordingly, 

reproposed § 1.863–9(k)(4) sets forth the 

actions required of taxpayers and the 

procedures the IRS will follow in the 

case of taxpayers changing their 

allocations. 

The reproposed regulations also 

require taxpayers, upon request, to 

provide access to the software programs 

and other systems used by the taxpayer 

to make allocations under these 

regulations. For this purpose, software 

has the meaning provided in section 

7612(d). The Treasury Department and 

the IRS believe that the IRS could face 

significant administrative and other 

difficulties in the examination of 

income allocations made under these 

regulations without access to such 

software. 

Proposed Effective Date 

These regulations are proposed to 

apply for taxable years beginning on or 

after the date of publication of final 

regulations in the Federal Register. 

Special Analyses 

It has been determined that this notice 

of proposed rulemaking is not a 

significant regulatory action as defined 

in Executive Order 12866. Therefore, a 

regulatory assessment pursuant to that 

Order is not required. It has also been 

determined that section 553(b) of the 

Administrative Procedure Act (5 U.S.C. 

chapter 5) does not apply to these 

regulations. Pursuant to the Regulatory 

Flexibility Act (5 U.S.C. chapter 6), it is 

hereby certified that the collection of 

information in these regulations will not 

have a significant economic impact on 

a substantial number of small entities. 

This certification is based on the fact 

that the rules provided in these 

regulations principally affect large 

multinational corporations that pay 

foreign taxes on income derived from 

substantial foreign operations and that 

use these and any other applicable 

source rules in determining their foreign 

tax credit. Accordingly, a Regulatory 

Flexibility Act assessment is not 

required. Pursuant to section 7805(f) of 

the Internal Revenue Code, this notice 

of proposed rulemaking has been 

submitted to the Chief Counsel for 

Advocacy of the Small Business 

Administration for comment on its 

impact on small business. 

Comments and Public Hearing 

Before these proposed regulations are 

adopted as final regulations, 

consideration will be given to any 

written comments (a signed original and 

eight (8) copies) or electronic comments 

that are submitted timely to the IRS. The 

Treasury Department and the IRS 

specifically request comments on the 

clarity of the proposed regulations and 

how they may be made easier to 

understand. All comments will be 

available for public inspection and 

copying. 

A public hearing has been scheduled 

for December 15, 2005, at 10 a.m., in the 

IRS Auditorium, Internal Revenue 

Building, 1111 Constitution Avenue, 

NW., Washington, DC. Due to building 

security procedures, visitors must enter 

at the Constitution Avenue entrance. In 

addition, all visitors must present photo 

identification to enter the building. 

Because of access restrictions, visitors 

will not be admitted beyond the 

immediate entrance area more than 30 

minutes before the hearing starts. For 

information on having your name 

placed on the building access list to 

attend the hearing, see the FOR FURTHER

INFORMATION CONTACT section of this 

preamble. 

The rules of 26 CFR 601.601(a)(3) 

apply to the hearing. Persons who wish 

to present oral comments at the hearing 

must submit written or electronic 

comments and an outline of the topics 

to be discussed and the time to be 

devoted to each topic (a signed original 

and eight (8) copies) by November 23, 

2005. A period of 10 minutes will be 

allotted to each person for making 

comments. An agenda showing the 

scheduling of the speakers will be 

prepared after the deadline for receiving 

outlines has passed. Copies of the 

agenda will be available free of charge 

at the hearing. 

Drafting Information 

The principal author of these 

regulations is Edward R. Barret 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. 

Withdrawal of Previous Notice of 

Proposed Rulemaking 

Accordingly, under the authority of 

26 U.S.C. 7805, the notice of proposed 

rulemaking (REG–106030–98) that was 

published in the Federal Register on 

January 17, 2001 (66 FR 3903), is 

withdrawn as of September 19, 2005. 

Proposed Amendments to the 

Regulations 

Accordingly, 26 CFR part 1 is 

proposed to be amended as follows: 

PART 1—INCOME TAXES 

Paragraph 1. The authority citation 

for part 1 is amended by adding entries 

in numerical order to read, in part, as 

follows: 

Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 54871 

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

Section 1.863–8 also issued under 26 

U.S.C. 863(a), (b) and (d). * * * 

Section 1.863–9 also issued under 26 

U.S.C. 863(a), (d) and (e). * * * 

Par. 2. Section 1.863–3 is amended 

by: 

1. Adding a sentence after the first 

sentence in paragraph (a)(1). 

2. Adding a sentence at the end of 

paragraph (c)(1)(i)(A). 

3. Adding a sentence after the first 

sentence in paragraph (c)(2). 

The additions read as follows: 

§ 1.863–3 Allocation and apportionment of 

income from certain sales of inventory. 

(a) * * * (1) * * * To determine the 

source of income from sales of property 

produced by the taxpayer, when the 

property is either produced in whole or 

in part in space or on or under water not 

within the jurisdiction (as recognized by 

the United States) of a foreign country, 

possession of the United States, or the 

United States (in international water), or 

is sold in space or international water, 

the rules of § 1.863–8 apply, and the 

rules of this section do not apply except 

to the extent provided in § 1.863–8. 

* * * 

* * * * * 

(c) * * * (1) * * * (i) * * * (A) 

* * * For rules regarding the source of 

income when production takes place, in 

whole or in part, in space or 

international water, the rules of § 1.863–

8 apply, and the rules of this section do 

not apply except to the extent provided 

in § 1.863–8. 

* * * * * 

(2) * * * Notwithstanding any other 

provision, for rules regarding the source 

of income when a sale takes place in 

space or international water, the rules of 

§ 1.863–8 apply, and the rules of this 

section do not apply except to the extent 

provided in § 1.863–8. * * * 

* * * * * 

Par. 3. Sections 1.863–8 and 1.863–9 

are added to read as follows: 

§ 1.863–8 Source of income from space 

and ocean activity under section 863(d). 

(a) In general. Income of a United 

States or a foreign person derived from 

space and ocean activity (space and 

ocean income) is sourced under the 

rules of this section, notwithstanding 

any other provision, including sections 

861, 862, 863, and 865. A taxpayer will 

not be considered to derive income from 

space or ocean activity, as defined in 

paragraph (d) of this section, if such 

activity is performed by another person, 

subject to the rules for the treatment of 

consolidated groups in § 1.1502–13. 

(b) Source of gross income from space 

and ocean activity—(1) Space and 

ocean income derived by a U.S. person. 

Space and ocean income derived by a 

U.S. person is income from sources 

within the United States. However, 

space and ocean income derived by a 

U.S. person is income from sources 

without the United States to the extent 

the income, based on all the facts and 

circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed in a foreign 

country or countries. 

(2) Space and ocean income derived 

by a foreign person—(i) In general. 

Space and ocean income derived by a 

person other than a U.S. person is 

income from sources without the United 

States, except as otherwise provided in 

this paragraph (b)(2). 

(ii) Space and ocean income derived 

by a controlled foreign corporation. 

Space and ocean income derived by a 

controlled foreign corporation within 

the meaning of section 957 (CFC) is 

income from sources within the United 

States. However, space and ocean 

income derived by a CFC is income 

from sources without the United States 

to the extent the income, based on all 

the facts and circumstances, is 

attributable to functions performed, 

resources employed, or risks assumed in 

a foreign country or countries. 

(iii) Space and ocean income derived 

by foreign persons engaged in a trade or 

business within the United States. Space 

and ocean income derived by a foreign 

person (other than a CFC) engaged in a 

trade or business within the United 

States is income from sources within the 

United States to the extent the income, 

based on all the facts and 

circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed within the 

United States. 

(3) Source rules for income from 

certain sales of property—(i) Sales of 

purchased property. When a taxpayer 

sells purchased property in space or 

international water, the source of gross 

income from the sale generally will be 

determined under paragraph (b)(1) or (2) 

of this section, as applicable. However, 

if such property is inventory property 

within the meaning of section 1221(a)(1) 

(inventory property) and is not sold for 

use, consumption, or disposition in 

space or international water, the source 

of income from the sale will be 

determined under § 1.861–7(c). 

(ii) Sales of property produced by the 

taxpayer—(A) General. If the taxpayer 

both produces property and sells such 

property, the taxpayer must allocate 

gross income from such sales between 

production activity and sales activity 

under the 50/50 method. Under the 50/ 

50 method, one-half of the taxpayer’s 

gross income will be considered income 

allocable to production activity, and the 

source of that income will be 

determined under paragraph (b)(3)(ii)(B) 

or (C) of this section. The remaining 

one-half of such gross income will be 

considered income allocable to sales 

activity, and the source of that income 

will be determined under paragraph 

(b)(3)(ii)(D) of this section. 

(B) Production only in space or 

international water, or only outside 

space and international water. When 

production occurs only in space or 

international water, income allocable to 

production activity is sourced under 

paragraph (b)(1) or (2) of this section, as 

applicable. When production occurs 

only outside space and international 

water, income allocable to production 

activity is sourced under § 1.863–3(c)(1). 

(C) Production both in space or 

international water and outside space 

and international water. When property 

is produced both in space or 

international water and outside space 

and international water, gross income 

allocable to production activity must be 

allocated to production occurring in 

space or international water and 

production occurring outside space and 

international water. Such gross income 

is allocated to production activity 

occurring in space or international 

water to the extent the income, based on 

all the facts and circumstances, is 

attributable to functions performed, 

resources employed, or risks assumed in 

space or international water. The 

balance of such gross income is 

allocated to production activity 

occurring outside space and 

international water. The source of gross 

income allocable to production activity 

in space or international water is 

determined under paragraph (b)(1) or (2) 

of this section, as applicable. The source 

of gross income allocated to production 

activity occurring outside space and 

international water is determined under 

§ 1.863–3(c)(1). 

(D) Source of income allocable to 

sales activity. When property produced 

by the taxpayer is sold outside space 

and international water, the source of 

gross income allocable to sales activity 

will be determined under §§ 1.861–7(c) 

and 1.863–3(c)(2). When property 

produced by the taxpayer is sold in 

space or international water, the source 

of gross income allocable to sales 

activity generally will be determined 

under paragraph (b)(1) or (2) of this 

section, as applicable. However, if such 

property is inventory property within 

the meaning of section 1221(a)(1) and is 

sold in space or international water for 

use, consumption, or disposition 

outside space, international water, or 

54872 Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 

the United States, the source of gross 

income allocable to sales activity will be 

determined under §§ 1.861–7(c) and 

1.863–3(c)(2). 

(4) Special rule for determining the 

source of gross income from services. To 

the extent a transaction characterized as 

the performance of a service constitutes 

a space or ocean activity, as determined 

under paragraph (d)(2)(ii) of this 

section, the source of gross income 

derived from such transaction is 

determined under paragraph (b)(1) or (2) 

of this section. 

(5) Special rule for determining source 

of income from communications activity 

(other than income from international 

communications activity). Space and 

ocean activity, as defined in paragraph 

(d) of this section, includes activity that 

occurs in space or international water 

that is characterized as a 

communications activity as defined in 

§ 1.863–9(h)(1) (other than international 

communications activity). The source of 

space and ocean income that is also 

communications income as defined in 

§ 1.863–9(h)(2) (but not space/ocean 

communications income as defined in 

§ 1.863–9(h)(3)(v)) is determined under 

the rules of § 1.863–9(c), (d), and (f), as 

applicable, rather than under paragraph 

(b) of this section. The source of space 

and ocean income that is also space/ 

ocean communications income as 

defined in § 1.863–9(h)(3)(v) is 

determined under the rules of paragraph 

(b) of this section. See § 1.863–9(e). 

(c) Taxable income. When a taxpayer 

allocates gross income under paragraph 

(b)(1), (b)(2), (b)(3)(ii)(C), or (b)(4) of this 

section, the taxpayer must allocate 

expenses, losses, and other deductions 

as prescribed in §§ 1.861–8 through 

1.861–14T to the class or classes of gross 

income that include the income so 

allocated in each case. A taxpayer must 

then apply the rules of §§ 1.861–8 

through 1.861–14T to apportion 

properly amounts of expenses, losses, 

and other deductions so allocated to 

such gross income between gross 

income from sources within the United 

States and gross income from sources 

without the United States. 

(d) Space and ocean activity—(1) 

Definition—(i) Space activity. In 

general, space activity is any activity 

conducted in space. For purposes of this 

section, space means any area not 

within the jurisdiction (as recognized by 

the United States) of a foreign country, 

possession of the United States, or the 

United States, and not in international 

water. For purposes of determining 

space activity, the Commissioner may 

separate parts of a single transaction 

into separate transactions or combine 

separate transactions as part of a single 

transaction. Paragraph (d)(3) of this 

section lists specific exceptions to the 

general definition of space activity. 

Activities that constitute space activity 

include but are not limited to—

(A) Performance and provision of 

services in space, as defined in 

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

(B) Leasing of equipment located in 

space, including spacecraft (for 

example, satellites) or transponders 

located in space; 

(C) Licensing of technology or other 

intangibles for use in space; 

(D) Production, processing, or 

creation of property in space, as defined 

in paragraph (d)(2)(i) of this section; 

(E) Activity occurring in space that is 

characterized as communications 

activity (other than international 

communications activity) under 

§ 1.863–9(h)(1); 

(F) Underwriting income from the 

insurance of risks on activities that 

produce space income; and 

(G) Sales of property in space (see 

§ 1.861–7(c)), but not sales of inventory 

property for use, consumption, or 

disposition outside space or 

international water. 

(ii) Ocean activity. In general, ocean 

activity is any activity conducted on or 

under water not within the jurisdiction 

(as recognized by the United States) of 

a foreign country, possession of the 

United States, or the United States 

(collectively, in international water). For 

purposes of determining ocean activity, 

the Commissioner may separate parts of 

a single transaction into separate 

transactions or combine separate 

transactions as part of a single 

transaction. Paragraph (d)(3) of this 

section lists specific exceptions to the 

general definition of ocean activity. 

Activities that constitute ocean activity 

include but are not limited to—

(A) Performance and provision of 

services in international water, as 

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

section; 

(B) Leasing of equipment located in 

international water, including 

underwater cables; 

(C) Licensing of technology or other 

intangibles for use in international 

water; 

(D) Production, processing, or 

creation of property in international 

water, as defined in paragraph (d)(2)(i) 

of this section; 

(E) Activity occurring in international 

water that is characterized as 

communications activity (other than 

international communications activity) 

under § 1.863–9(h)(1); 

(F) Underwriting income from the 

insurance of risks on activities that 

produce ocean income; 

(G) Sales of property in international 

water (see § 1.861–7(c)), but not sales of 

inventory property for use, 

consumption, or disposition outside 

space or international water; 

(H) Any activity performed in 

Antarctica; 

(I) The leasing of a vessel that does 

not transport cargo or persons for hire 

between ports-of-call (for example, the 

leasing of a vessel to engage in research 

activities in international water); and 

(J) The leasing of drilling rigs, 

extraction of minerals, and performance 

and provision of services related 

thereto, except as provided in paragraph 

(d)(3)(ii) of this section. 

(2) Determining a space or ocean 

activity—(i) Production of property in 

space or international water. For 

purposes of this section, production 

activity means an activity that creates, 

fabricates, manufactures, extracts, 

processes, cures, or ages property within 

the meaning of section 864(a) and 

§ 1.864–1. 

(ii) Special rule for performance of 

services—(A) General. Except as 

provided in paragraph (d)(2)(ii)(B) of 

this section, if a transaction is 

characterized as the performance of a 

service, then such service will be treated 

as a space or ocean activity in its 

entirety when any part of the service is 

performed in space or international 

water. Services are performed in space 

or international water if functions are 

performed, resources are employed, or 

risks are assumed in space or 

international water, regardless of 

whether performed by personnel, 

equipment, or otherwise. 

(B) Exception to the general rule. If 

the taxpayer can demonstrate the value 

of the service attributable to 

performance occurring in space or 

international water, and the value of the 

service attributable to performance 

occurring outside space and 

international water, then such service 

will be treated as space or ocean activity 

only to the extent of the activity 

performed in space or international 

water. The value of the service is 

attributable to performance occurring in 

space or international water to the 

extent the performance of the service, 

based on all the facts and 

circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed in space or 

international water. In addition, if the 

taxpayer can demonstrate, based on all 

the facts and circumstances, that the 

value of the service attributable to 

performance in space or international 

water is de minimis, such service will 

not be treated as space or ocean activity. 

Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 54873 

(3) Exceptions to space or ocean 

activity. Space or ocean activity does 

not include the following types of 

activities: 

(i) Any activity giving rise to 

transportation income as defined in 

section 863(c). 

(ii) Any activity with respect to 

mines, oil and gas wells, or other 

natural deposits, to the extent the 

mines, wells, or natural deposits are 

located within the jurisdiction (as 

recognized by the United States) of any 

country, including the United States 

and its possessions. 

(iii) Any activity giving rise to 

international communications income 

as defined in § 1.863–9(h)(3)(ii). 

(e) Treatment of partnerships. This 

section is applied at the partner level. 

(f) Examples. The following examples 

illustrate the rules of this section: 

Example 1. Space activity—activity 

occurring on land and in space—(i) Facts. S, 

a U.S. person, owns satellites in orbit. S 

leases one of its satellites to A. S, as lessor, 

will not operate the satellite. Part of S’s 

performance as lessor in this transaction 

occurs on land. Assume that the combination 

of S’s activities is characterized as the lease 

of equipment. 

(ii) Analysis. Because the leased equipment 

is located in space, the transaction is defined 

as space activity under paragraph (d)(1)(i) of 

this section. Income derived from the lease 

will be sourced in its entirety under 

paragraph (b)(1) of this section. Under 

paragraph (b)(1) of this section, S’s space 

income is sourced outside the United States 

to the extent the income, based on all the 

facts and circumstances, is attributable to 

functions performed, resources employed, or 

risks assumed in a foreign country or 

countries. 

Example 2. Space activity—(i) Facts. X is 

an Internet service provider. X offers a 

service that permits a customer (C) to connect 

to the Internet via a telephone call, initiated 

by the modem of C’s personal computer, to 

a control center. X transmits information 

requested by C to C’s personal computer, in 

part using satellite capacity leased by X from 

S. X charges its customers a flat monthly fee. 

Assume that neither X nor S derive 

international communications income within 

the meaning of § 1.863–9(h)(3)(ii). In 

addition, assume that X is able to 

demonstrate, pursuant to paragraph 

(d)(2)(ii)(B) of this section, the extent to 

which the value of the service is attributable 

to functions performed, resources employed, 

and risks assumed in space. 

(ii) Analysis. Under paragraph (d)(2)(ii) of 

this section, the service performed by X 

constitutes space activity to the extent the 

value of the service is attributable to 

functions performed, resources employed, 

and risks assumed in space. To the extent the 

service performed by X constitutes space 

activity, the source of X’s income from the 

service transaction is determined under 

paragraph (b) of this section. To the extent 

the service performed by X does not 

constitute space or ocean activity, the source 

of X’s income from the service is determined 

under sections 861, 862, and 863, as 

applicable. To the extent that X derives space 

and ocean income that is also 

communications income within the meaning 

of § 1.863–9(h)(2), the source of X’s income 

is determined under paragraph (b) of this 

section and § 1.863–9(c), (d), and (f), as 

applicable, as provided in paragraph (b)(5) of 

this section. S derives space and ocean 

income that is also communications income 

within the meaning of § 1.863–9(h)(2), and 

the source of S’s income is therefore 

determined under paragraph (b) of this 

section and § 1.863–9(c), (d), and (f), as 

applicable, as provided in paragraph (b)(5) of 

this section. 

Example 3. Services as space activity—de 

minimis value attributable to performance 

occurring in space—(i) Facts. R owns a retail 

outlet in the United States. R engages S to 

provide a security system for R’s premises. S 

operates its security system by transmitting 

images from R’s premises directly to a 

satellite, and from the satellite to a group of 

S employees located in Country B, who 

monitor the premises by viewing the 

transmitted images. O provides S with 

transponder capacity on O’s satellite, which 

S uses to transmit those images. Assume that 

S’s transaction with R is characterized as the 

performance of a service. Assume that O’s 

provision of transponder capacity is also 

viewed as the provision of a service and that 

the value of O’s service transaction 

attributable to performance in space is not de 

minimis. In addition, assume that S is able 

to demonstrate, pursuant to paragraph 

(d)(2)(ii) of this section, that a de minimis 

portion of the value of S’s service transaction 

with R is attributable to performance in 

space. Assume also that S is able to 

demonstrate, pursuant to § 1.863–9(h)(1), that 

the value of the transaction with R 

attributable to communications activities is 

de minimis. 

(ii) Analysis. S derives income from 

providing monitoring services. Because S 

demonstrates that the value of S’s service 

transaction attributable to performance in 

space is de minimis, S is not treated as 

engaged in a space activity, and none of S’s 

income from the service transaction is space 

income. In addition, because S demonstrates 

that the value of the transaction with R 

attributable to communications activities is 

de minimis, S is not required under § 1.863–

9(h)(1)(ii) to treat the transaction as separate 

communications and non-communications 

transactions, and none of S’s gross income 

from the transaction is treated as 

communications income within the meaning 

of § 1.863–9(h)(2). Because O’s provision of 

transponder capacity is viewed as the 

provision of a service and the value of O’s 

service transaction attributable to 

performance in space is not de minimis, O’s 

activity will be considered space activity, 

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

section, to the extent the value of the services 

transaction is attributable to performance in 

space (unless O’s activity in space is 

international communications activity). To 

the extent that O derives communications 

income, the source of such income is 

determined under paragraph (b) of this 

section and § 1.863–9(b), (c), (d), and (f), as 

applicable, as provided in paragraph (b)(5) of 

this section. R does not derive any income 

from space activity. 

Example 4. Space activity—(i) Facts. L, a 

domestic corporation, offers programming 

and certain other services to customers 

located both in the United States and in 

foreign countries. Assume that L’s provision 

of programming and other services in this 

Example 4 is characterized as the provision 

of a service, and that no part of the service 

transaction occurs in space or international 

water. Assume that the delivery of the 

programming constitutes a separate 

transaction also characterized as the 

performance of a service. L uses satellite 

capacity acquired from S to deliver the 

programming service directly to customers’

television sets, so that part of the value of the 

delivery transaction derives from functions 

performed and resources employed in space. 

Assume that these contributions to the value 

of the delivery transaction occurring in space 

are not considered de minimis under 

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

Customer C pays L to provide and deliver 

programming to C’s residence in the United 

States. Assume S’s provision of satellite 

capacity in this Example 4 is viewed as the 

provision of a service, and also that S does 

not derive international communications 

income within the meaning of § 1.863–

9(h)(3)(ii). 

(ii) Analysis. S’s activity will be considered 

space activity. To the extent that S derives 

space and ocean income that is also 

communications income under § 1.863–

9(h)(2), the source of S’s income is 

determined under paragraph (b) of this 

section and § 1.863–9(c), (d), and (f), as 

applicable, as provided in paragraph (b)(5) of 

this section. On these facts, L’s activities are 

treated as two separate service transactions: 

the provision of programming (and other 

services), and the delivery of programming. 

L’s income derived from provision of 

programming and other services is not 

income derived from space activity. L’s 

delivery of programming and other services 

is considered space activity, pursuant to 

paragraph (d)(2)(ii) of this section, to the 

extent the value of the delivery transaction is 

attributable to performance in space. To the 

extent that the delivery of programming is 

treated as a space activity, the source of L’s 

income derived from the delivery transaction 

is determined under paragraph (b)(1) of this 

section, as provided in paragraph (b)(4) of 

this section. To the extent that L derives 

space and ocean income that is also 

communications income within the meaning 

of § 1.863–9(h)(2), the source of such income 

is determined under paragraph (b) of this 

section and § 1.863–9(b), (c), (d), (e), and (f), 

as applicable, as provided in paragraph (b)(5) 

of this section. 

Example 5. Space activity—treatment of 

land activity—(i) Facts. S, a U.S. person, 

offers remote imaging products and services 

to its customers. In year 1, S uses its 

satellite’s remote sensors to gather data on 

certain geographical terrain. In year 3, C, a 

construction development company, 

contracts with S to obtain a satellite image of 

54874 Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 

an area for site development work. S pulls 

data from its archives and transfers to C the 

images gathered in year 1, in a transaction 

that is characterized as a sale of the data. S’s 

rights, title, and interest in the data pass to 

C in the United States. Before transferring the 

images to C, S uses computer software in its 

land-based office to enhance the images so 

that the images can be used. 

(ii) Analysis. The collection of data and 

creation of images in space is characterized 

as the creation of property in space. Because 

S both produces and sells the data, S must 

allocate gross income from the sale of the 

data between production activity and sales 

activity under the 50/50 method of paragraph 

(b)(3)(ii)(A). The source of S’s income 

allocable to production activity is determined 

under paragraph (b)(3)(ii)(C) of this section 

because production activities occur both in 

space and on land. The source of S’s income 

attributable to sales activity is determined 

under paragraph (b)(3)(ii)(D) of this section 

(by reference to § 1.863–3(c)(2)) as U.S. 

source income because S’s rights, title, and 

interest in the data pass to C in the United 

States. 

Example 6. Use of intangible property in 

space—(i) Facts. X acquires a license to use 

a particular satellite slot or orbit, which X 

sublicenses to C. C pays X a royalty. 

(ii) Analysis. Because the royalty is paid for 

the right to use intangible property in space, 

the source of the royalty paid by C to X is 

determined under paragraph (b) of this 

section. 

Example 7. Performance of services—(i) 

Facts. E, a domestic corporation, operates 

satellites with sensing equipment that can 

determine how much heat and light 

particular plants emit and reflect. Based on 

the data, E will provide F, a U.S. farmer, a 

report analyzing the data, which F will use 

in growing crops. E analyzes the data from 

offices located in the United States. Assume 

that E’s combined activities are characterized 

as the performance of services. 

(ii) Analysis. E’s activities will be 

considered space activities, pursuant to 

paragraph (d)(2)(ii) of this section, to the 

extent the value of E’s service transaction is 

attributable to performance in space. To the 

extent E’s service transaction constitutes a 

space activity, the source of E’s income 

derived from the service transaction will be 

determined under paragraph (b)(4) of this 

section, by reference to paragraph (b)(1) of 

this section. To the extent that E’s service 

transaction does not constitute a space or 

ocean activity, the source of E’s income 

derived from the service transaction is 

determined under sections 861, 862, and 863, 

as applicable. 

Example 8. Separate transactions—(i) 

Facts. The same facts as Example 7, except 

that E provides the raw data to F in a 

transaction characterized as a sale of a 

copyrighted article. In addition, E provides 

an analysis in the form of a report to F. The 

price F pays E for the raw data is separately 

stated. 

(ii) Analysis. To the extent that the 

provision of raw data and the analysis of the 

data are each treated as separate transactions, 

the source of income from the production 

and sale of data is determined under 

paragraph (b)(3)(ii) of this section. The 

provision of services would be analyzed in 

the same manner as in Example 7. 

Example 9. Sale of property in 

international water—(i) Facts. T purchased 

and owns transatlantic cable that lies in 

international water. T sells the cable to B, 

with T’s rights, title, and interest in the cable 

passing to B in international water. Assume 

that the transatlantic cable is not inventory 

property within the meaning of section 

1221(a)(1). 

(ii) Analysis. Because T’s rights, title, and 

interest in the property pass to B in 

international water, the sale takes place in 

international water under § 1.861–7(c), and 

the sale transaction is ocean activity under 

paragraph (d)(1)(ii) of this section. The 

source of T’s sales income is determined 

under paragraph (b)(3)(i) of this section, by 

reference to paragraph (b)(1) or (2) of this 

section. 

Example 10. Sale of property in space—(i) 

Facts. S, a U.S. person, manufactures a 

satellite in the United States and sells it to 

a customer who is not a U.S. person. S’s 

rights, title, and interest in the satellite pass 

to the customer in space. 

(ii) Analysis. Because S’s rights, title, and 

interest in the satellite pass to the customer 

in space, the sale takes place in space under 

§ 1.861–7(c), and the sale transaction is space 

activity under paragraph (d)(1)(i) of this 

section. The source of income derived from 

the sale of the satellite in space is determined 

under paragraph (b)(3)(ii) of this section, 

with the source of income allocable to 

production activity determined under 

paragraphs (b)(3)(ii)(A) and (B) of this 

section, and the source of income allocable 

to sales activity determined under paragraphs 

(b)(3)(ii)(A) and (D) of this section. Under 

paragraph (b)(1) of this section, S’s space 

income is sourced outside the United States 

to the extent the income, based on all the 

facts and circumstances, is attributable to 

functions performed, resources employed, or 

risks assumed in a foreign country or 

countries. 

Example 11. Sale of property in space—(i) 

Facts. S has a right to operate from a 

particular position (satellite slot or orbit) in 

space. S sells the right to operate from that 

position to P. Assume that the sale of the 

satellite slot is characterized as a sale of 

property and that S’s rights, title, and interest 

in the satellite slot pass to P in space. 

(ii) Analysis. The sale of the satellite slot 

takes place in space under § 1.861–7(c) 

because S’s rights, title, and interest in the 

satellite slot pass to P in space. The sale of 

the satellite slot is space activity under 

paragraph (d)(1)(i) of this section, and 

income or gain from the sale is sourced under 

paragraph (b)(3)(i) of this section, by 

reference to paragraph (b)(1) or (2) of this 

section. 

Example 12. Source of income of a foreign 

person—(i) Facts. FP, a foreign corporation 

that is not a CFC, derives income from the 

operation of satellites. FP operates ground 

stations in the United States and in foreign 

country FC. Assume that FP is considered 

engaged in a trade or business within the 

United States based on FP’s operation of the 

ground station in the United States. 

(ii) Analysis. Under paragraph (b)(2)(iii) of 

this section, FP’s space income is sourced in 

the United States to the extent the income, 

based on all the facts and circumstances, is 

attributable to functions performed, resources 

employed, or risks assumed within the 

United States. 

Example 13. Source of income of a foreign 

person—(i) Facts. FP, a foreign corporation 

that is not a CFC, operates remote sensing 

satellites in space to collect data and images 

for its customers. FP uses an independent 

agent, A, in the United States who provides 

marketing, order-taking, and other customer 

service functions. Assume that FP is 

considered engaged in a trade or business 

within the United States based on A’s 

activities on FP’s behalf in the United States. 

(ii) Analysis. Under paragraph (b)(2)(iii) of 

this section, FP’s space income is sourced in 

the United States to the extent the income, 

based on all the facts and circumstances, is 

attributable to functions performed, resources 

employed, or risks assumed within the 

United States. 

(g) Reporting and documentation 

requirements—(1) General. A taxpayer 

making an allocation of gross income 

under paragraph (b)(1), (b)(2), 

(b)(3)(ii)(C), or (b)(4) of this section must 

satisfy the requirements in paragraphs 

(g)(2), (3), and (4) of this section. 

(2) Required documentation. In all 

cases, a taxpayer must prepare and 

maintain documentation in existence 

when its return is filed regarding the 

allocation of gross income and 

allocation and apportionment of 

expenses, losses, and other deductions, 

the methodologies used, and the 

circumstances justifying use of those 

methodologies. The taxpayer must make 

available such documentation within 30 

days upon request. 

(3) Access to software. If the taxpayer 

or any third party used any computer 

software, within the meaning of section 

7612(d), to allocate gross income, or to 

allocate or apportion expenses, losses, 

and other deductions, the taxpayer must 

make available upon request—

(i) Any computer software executable 

code, within the meaning of section 

7612(d), used for such purposes, 

including an executable copy of the 

version of the software used in the 

preparation of the taxpayer’s return 

(including any plug-ins, supplements, 

etc.) and a copy of all related electronic 

data files. Thus, if software 

subsequently is upgraded or 

supplemented, a separate executable 

copy of the version used in preparing 

the taxpayer’s return must be retained; 

(ii) Any related computer software 

source code, within the meaning of 

section 7612(d), acquired or developed 

by the taxpayer or a related person, or 

primarily for internal use by the 

taxpayer or such person rather than for 

commercial distribution; and 

Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 54875 

(iii) In the case of any spreadsheet 

software or similar software, any 

formulae or links to supporting 

worksheets. 

(4) Use of allocation methodology. In 

general, when a taxpayer allocates gross 

income under paragraph (b)(1), (b)(2), 

(b)(3)(ii)(C), or (b)(4) of this section, it 

does so by making the allocation on a 

timely filed original return (including 

extensions). However, a taxpayer will be 

permitted to make changes to such 

allocations made on its original return 

with respect to any taxable year for 

which the statute of limitations has not 

closed as follows: 

(i) In the case of a taxpayer that has 

made a change to such allocations prior 

to the opening conference for the audit 

of the taxable year to which the 

allocation relates or who makes such a 

change within 90 days of such opening 

conference, if the IRS issues a written 

information document request asking 

the taxpayer to provide the documents 

and such other information described in 

paragraphs (g)(2) and (3) of this section 

with respect to the changed allocations 

and the taxpayer complies with such 

request within 30 days of the request, 

then the IRS will complete its 

examination, if any, with respect to the 

allocations for that year as part of the 

current examination cycle. If the 

taxpayer does not provide the 

documents and information described 

in paragraphs (g)(2) and (3) of this 

section within 30 days of the request, 

then the procedures described in 

paragraph (g)(4)(ii) of this section shall 

apply. 

(ii) If the taxpayer changes such 

allocations more than 90 days after the 

opening conference for the audit of the 

taxable year to which the allocations 

relate or the taxpayer does not provide 

the documents and information with 

respect to the changed allocations as 

requested in accordance with 

paragraphs (g)(2) and (3) of this section, 

then the IRS will, in a separate cycle, 

determine whether an examination of 

the taxpayer’s allocations is warranted 

and complete any such examination. 

The separate cycle will be worked as 

resources are available and may not 

have the same estimated completion 

date as the other issues under 

examination for the taxable year. The 

IRS may ask the taxpayer to extend the 

statute of limitations on assessment and 

collection for the taxable year to permit 

examination of the taxpayer’s method of 

allocation, including an extension 

limited, where appropriate, to the 

taxpayer’s method of allocation. 

(h) Effective date. This section applies 

to taxable years beginning on or after the 

date of publication of final regulations 

in the Federal Register. 

§ 1.863–9 Source of income derived from 

communications activity under sections 

863(a), (d), and (e). 

(a) In general. Income of a United 

States or a foreign person derived from 

each type of communications activity, 

as defined in paragraph (h)(3) of this 

section, is sourced under the rules of 

this section, notwithstanding any other 

provision including sections 861, 862, 

863, and 865. Notwithstanding that a 

communications activity would qualify 

as space or ocean activity under section 

863(d) and the regulations thereunder, 

the source of income derived from such 

communications activity is determined 

under this section, and not under 

section 863(d) and the regulations 

thereunder, except to the extent 

provided in § 1.863–8(b)(5). 

(b) Source of international 

communications income—(1) 

International communications income 

derived by a U.S. person. Income 

derived from international 

communications activity (international 

communications income) by a U.S. 

person is one-half from sources within 

the United States and one-half from 

sources without the United States. 

(2) International communications 

income derived by foreign persons—(i) 

In general. International 

communications income derived by a 

person other than a U.S. person is, 

except as otherwise provided in this 

paragraph (b)(2), wholly from sources 

without the United States. 

(ii) International communications 

income derived by a controlled foreign 

corporation. International 

communications income derived by a 

controlled foreign corporation within 

the meaning of section 957 (CFC) is onehalf from sources within the United 

States and one-half from sources 

without the United States. 

(iii) International communications 

income derived by foreign persons with 

a fixed place of business in the United 

States. International communications 

income derived by a foreign person, 

other than a CFC, that is attributable to 

an office or other fixed place of business 

of the foreign person in the United 

States is from sources within the United 

States. The principles of section 

864(c)(5) apply in determining whether 

a foreign person has an office or fixed 

place of business in the United States. 

See § 1.864–7. International 

communications income is attributable 

to an office or other fixed place of 

business to the extent of functions 

performed, resources employed, or risks 

assumed by the office or other fixed 

place of business. 

(iv) International communications 

income derived by foreign persons 

engaged in a trade or business within 

the United States. International 

communications income derived by a 

foreign person (other than a CFC) 

engaged in a trade or business within 

the United States is income from 

sources within the United States to the 

extent the income, based on all the facts 

and circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed within the 

United States. 

(c) Source of U.S. communications 

income. Income derived by a United 

States or foreign person from U.S. 

communications activity is from sources 

within the United States. 

(d) Source of foreign communications 

income. Income derived by a United 

States or foreign person from foreign 

communications activity is from sources 

without the United States. 

(e) Source of space/ocean 

communications income. Income 

derived by a United States or foreign 

person from space/ocean 

communications activity is determined 

under section 863(d) and the regulations 

thereunder. 

(f) Source of communications income 

when taxpayer cannot establish the two 

points between which the taxpayer is 

paid to transmit the communication. 

Income derived by a United States or 

foreign person from communications 

activity, when the taxpayer cannot 

establish the two points between which 

the taxpayer is paid to transmit the 

communication as required in 

paragraph (h)(3)(i) of this section, is 

from sources within the United States. 

(g) Taxable income. When a taxpayer 

allocates gross income under paragraph 

(b)(2)(iii), (b)(2)(iv), or (h)(1)(ii) of this 

section, the taxpayer must allocate 

expenses, losses, and other deductions 

as prescribed in §§ 1.861–8 through 

1.861–14T to the class or classes of gross 

income that include the income so 

allocated in each case. A taxpayer must 

then apply the rules of §§ 1.861–8 

through 1.861–14T properly to 

apportion amounts of expenses, losses, 

and other deductions so allocated to 

such gross income between gross 

income from sources within the United 

States and gross income from sources 

without the United States. For amounts 

of expenses, losses, and other 

deductions allocated to gross income 

derived from international 

communications activity, when the 

source of income is determined under 

the 50/50 method of paragraph (b)(1) or 

(b)(2)(ii) of this section, taxpayers 

54876 Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 

generally must apportion expenses, 

losses, and other deductions between 

sources within the United States and 

sources without the United States pro 

rata based on the relative amounts of 

gross income from sources within the 

United States and gross income from 

sources without the United States. 

However, the preceding sentence shall 

not apply to research and experimental 

expenditures qualifying under § 1.861–

17, which are to be allocated and 

apportioned under the rules of that 

section. 

(h) Communications activity and 

income derived from communications 

activity—(1) Communications activity—

(i) General rule. For purposes of this 

part, communications activity consists 

solely of the delivery by transmission of 

communications or data 

(communications). Delivery of 

communications other than by 

transmission (for example, by delivery 

of physical packages and letters) is not 

communications activity within the 

meaning of this section. 

Communications activity also includes 

the provision of capacity to transmit 

communications. Provision of content 

or any other additional service provided 

along with, or in connection with, a 

non-de minimis communications 

activity must be treated as a separate 

non-communications activity unless de 

minimis. Communications activity or 

non-communications activity will be 

treated as de minimis to the extent, 

based on the facts and circumstances, 

the value attributable to such activity is 

de minimis. 

(ii) Separate transaction. To the 

extent that a taxpayer’s transaction 

consists in part of non-de minimis 

communications activity and in part of 

non-de minimis non-communications 

activity, each such part of the 

transaction must be treated as a separate 

transaction. Gross income is allocated to 

each such communications activity 

transaction and non-communications 

activity transaction to the extent the 

income, based on all the facts and 

circumstances, is attributable to 

functions performed, resources 

employed, or risks assumed in each 

such activity. 

(2) Income derived from 

communications activity. Income 

derived from communications activity 

(communications income) is income 

derived from the delivery by 

transmission of communications, 

including income derived from the 

provision of capacity to transmit 

communications. Income may be 

considered derived from a 

communications activity even if the 

taxpayer itself does not perform the 

transmission function, but in all cases, 

the taxpayer derives communications 

income only if the taxpayer is paid to 

transmit, and bears the risk of 

transmitting, the communications. 

(3) Determining the type of 

communications activity—(i) In general. 

Whether income is derived from 

international communications activity, 

U.S. communications activity, foreign 

communications activity, or space/ 

ocean communications activity is 

determined by identifying the two 

points between which the taxpayer is 

paid to transmit the communication. 

The taxpayer must establish the two 

points between which the taxpayer is 

paid to transmit, and bears the risk of 

transmitting, the communication. 

Whether the taxpayer contracts out part 

or all of the transmission function is not 

relevant. 

(ii) Income derived from international 

communications activity. Income 

derived by a taxpayer from international 

communications activity (international 

communications income) is income 

derived from communications activity, 

as defined in paragraph (h)(2) of this 

section, when the taxpayer is paid to 

transmit between a point in the United 

States and a point in a foreign country 

(or a possession of the United States). 

(iii) Income derived from U.S. 

communications activity. Income 

derived by a taxpayer from U.S. 

communications activity (U.S. 

communications income) is income 

derived from communications activity, 

as defined in paragraph (h)(2) of this 

section, when the taxpayer is paid to 

transmit—

(A) Between two points in the United 

States; or 

(B) Between the United States and a 

point in space or international water. 

(iv) Income derived from foreign 

communications activity. Income 

derived by a taxpayer from foreign 

communications activity (foreign 

communications income) is income 

derived from communications activity, 

as defined in paragraph (h)(2) of this 

section, when the taxpayer is paid to 

transmit—

(A) Between two points in a foreign 

country or countries (or a possession or 

possessions of the United States); 

(B) Between a foreign country and a 

possession of the United States; or 

(C) Between a foreign country (or a 

possession of the United States) and a 

point in space or international water. 

(v) Income derived from space/ocean 

communications activity. Income 

derived by a taxpayer from space/ocean 

communications activity (space/ocean 

communications income) is income 

derived from communications activity, 

as defined in paragraph (h)(2) of this 

section, when the taxpayer is paid to 

transmit between a point in space or 

international water and another point in 

space or international water. 

(i) Treatment of partnerships. This 

section is applied at the partner level. 

(j) Examples. The following examples 

illustrate the rules of this section: 

Example 1. Income derived from noncommunications activity—remote data base 

access—(i) Facts. D provides its customers in 

various foreign countries with access to its 

data base, which contains information on 

certain individuals’ health care insurance 

coverage. Customer C obtains access to D’s 

data base by placing a call to D’s telephone 

number. Assume that C’s telephone service, 

used to access D’s data base, is provided by 

a third party, and that D assumes no 

responsibility for the transmission of the 

information via telephone. 

(ii) Analysis. D is not paid to transmit 

communications and does not derive income 

from communications activity within the 

meaning of paragraph (h)(2) of this section. 

Rather, D derives income from provision of 

content or provision of services to its 

customers. Therefore, the rules of this section 

do not apply to determine the source of D’s 

income. 

Example 2. Income derived from U.S. 

communications activity—U.S. portion of 

international communication—(i) Facts. TC, 

a local telephone company, receives an 

access fee from an international carrier for 

picking up a call from a local telephone 

customer and delivering the call to a U.S. 

point of presence (POP) of the international 

carrier. The international carrier picks up the 

call from its U.S. POP and delivers the call 

to a foreign country. 

(ii) Analysis. TC is not paid to carry the 

transmission between the United States and 

a foreign country. TC is paid to transmit a 

communication between two points in the 

United States. TC derives U.S. 

communications income as defined in 

paragraph (h)(3)(iii) of this section, which is 

sourced under paragraph (c) of this section as 

U.S. source income. 

Example 3. Income derived from 

international communications activity—

underwater cable—(i) Facts. TC, a domestic 

corporation, owns an underwater fiber optic 

cable. Pursuant to contracts, TC makes 

available to its customers capacity to transmit 

communications via the cable. TC’s 

customers then solicit telephone customers 

and arrange to transmit the telephone 

customers’ calls. The cable runs in part 

through U.S. waters, in part through 

international waters, and in part through 

foreign country waters. 

(ii) Analysis. TC derives international 

communications income as defined in 

paragraph (h)(3)(ii) of this section because TC 

is paid to make available capacity to transmit 

communications between the United States 

and a foreign country. Because TC is a U.S. 

person, TC’s international communications 

income is sourced under paragraph (b)(1) of 

this section as one-half from sources within 

the United States and one-half from sources 

without the United States. 

Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 54877 

Example 4. Income derived from 

international communications activity—

satellite—(i) Facts. S, a U.S. person, owns 

satellites in orbit and uplink facilities in 

Country X, a foreign country. B, a resident of 

Country X, pays S to deliver B’s 

programming from S’s uplink facility, located 

in Country X, to a downlink facility in the 

United States owned by C, a customer of B. 

(ii) Analysis. S derives international 

communications income under paragraph 

(h)(3)(ii) of this section because S is paid to 

transmit the communications between a 

beginning point in a foreign country and an 

endpoint in the United States. Because S is 

a U.S. person, the source of S’s international 

communications income is determined under 

paragraph (b)(1) of this section as one-half 

from sources within the United States and 

one-half from sources without the United 

States. 

Example 5. The paid-to-do rule—foreign 

communications via domestic route—(i) 

Facts. TC is paid to transmit communications 

from Toronto, Canada, to Paris, France. TC 

transmits the communications from Toronto 

to New York. TC pays another 

communications company, IC, to transmit the 

communications from New York to Paris. 

(ii) Analysis. Under the paid-to-do rule of 

paragraph (h)(3)(i) of this section, TC derives 

foreign communications income under 

paragraph (h)(3)(iv) of this section because 

TC is paid to transmit communications 

between two points in foreign countries, 

Toronto and Paris. Under paragraph (h)(3)(i) 

of this section, the character of TC’s 

communications activity is determined 

without regard to the fact that TC pays IC to 

transmit the communications for some 

portion of the delivery path. IC has 

international communications income under 

paragraph (h)(3)(ii) of this section because IC 

is paid to transmit the communications 

between a point in the United States and a 

point in a foreign country. 

Example 6. The paid-to-do rule—domestic 

communication via foreign route—(i) Facts. 

TC is paid to transmit a call between two 

points in the United States, but routes the 

call through Canada. 

(ii) Analysis. Under paragraph (h)(3)(i) of 

this section, the character of income derived 

from communications activity is determined 

by the two points between which the 

taxpayer is paid to transmit, and bears the 

risk of transmitting, the communications, 

without regard to the path of the 

transmission between those two points. 

Thus, under paragraph (h)(3)(iii) of this 

section, TC derives income from U.S. 

communications activity because it is paid to 

transmit the communications between two 

U.S. points. 

Example 7. Indeterminate endpoints—

prepaid telephone calling cards—(i) Facts. S 

purchases capacity from TC to transmit 

telephone calls. S sells prepaid telephone 

calling cards that give customers access to 

TC’s telephone lines for a certain number of 

minutes. Assume that S cannot establish the 

endpoints of its customers’ telephone calls. 

(ii) Analysis. S derives communications 

income as defined in paragraph (h)(2) of this 

section because S makes capacity to transmit 

communications available to its customers. 

In this case, S cannot establish the two points 

between which the communications are 

transmitted. Therefore, S’s communications 

income is U.S. source income, as provided by 

paragraph (f) of this section. 

Example 8. Indeterminate endpoints—

Internet access—(i) Facts. B, a domestic 

corporation, is an Internet service provider. 

B charges its customer, C, a monthly lump 

sum for Internet access. C accesses the 

Internet via a telephone call, initiated by the 

modem of C’s personal computer, to one of 

B’s control centers, which serves as C’s portal 

to the Internet. B transmits data sent by C 

from B’s control center in France to a 

recipient in England, over the Internet. B 

does not maintain records as to the beginning 

and endpoints of the transmission. 

(ii) Analysis. B derives communications 

income as defined in paragraph (h)(2) of this 

section. The source of B’s communications 

income is determined under paragraph (f) of 

this section as income from sources within 

the United States because B cannot establish 

the two points between which it is paid to 

transmit the communications. 

Example 9. De minimis noncommunications activity—(i) Facts. The same 

facts as in Example 8. Assume in addition 

that B replicates frequently requested sites on 

B’s own servers, solely to speed up response 

time. Assume that B’s replication of 

frequently requested sites would be 

considered a de minimis noncommunications activity under this section. 

(ii) Analysis. On these facts, because B’s 

replication of frequently requested sites 

would be considered a de minimis noncommunications activity, B is not required to 

treat the replication activity as a separate 

non-communications activity transaction 

under paragraph (h)(1) of this section. B 

derives communications income under 

paragraph (h)(2) of this section. The character 

and source of B’s communications income 

are determined by demonstrating the points 

between which B is paid to transmit the 

communications, under paragraph (h)(3)(i) of 

this section. 

Example 10. Income derived from 

communications and non-communications 

activity—bundled services—(i) Facts. A, a 

domestic corporation, offers customers local 

and long distance phone service, video, and 

Internet services. Customers pay a flat 

monthly fee plus 10 cents a minute for all 

long-distance calls, including international 

calls. 

(ii) Analysis. Under paragraph (h)(1)(ii) of 

this section, to the extent that A’s transaction 

with its customer consists in part of non-de 

minimis communications activity and in part 

of non-de minimis non-communications 

activity, each such part of the transaction 

must be treated as a separate transaction. A’s 

gross income from the transaction is 

allocated to each such communications 

activity transaction and non-communications 

activity transaction in accordance with 

paragraph (h)(1)(ii) of this section. To the 

extent A can establish that it derives 

international communications income as 

defined in paragraph (h)(3)(ii) of this section, 

A would determine the source of such 

income under paragraph (b)(1) of this section. 

If A cannot establish the points between 

which it is paid to transmit communications, 

as required by paragraph (h)(3)(i) of this 

section, A’s communications income is from 

sources within the United States, as provided 

by paragraph (f) of this section. 

Example 11. Income derived from 

communications and non-communications 

activity—(i) Facts. B, a domestic corporation, 

is paid by D, a cable system operator in 

Foreign Country, to provide television 

programs and to transmit the television 

programs to Foreign Country. Using its own 

satellite transponder, B transmits the 

television programs from the United States to 

downlink facilities owned by D in Foreign 

Country. D receives the transmission, 

unscrambles the signals, and distributes the 

broadcast to D’s customers in Foreign 

Country. Assume that B’s provision of 

television programs is a non-de minimis noncommunications activity, and that B’s 

transmission of television programs is a nonde minimis communications activity. 

(ii) Analysis. Under paragraph 

(h)(1)(ii) of this section, B must treat its 

communications and noncommunications activities as separate 

transactions. B’s gross income is 

allocated to each such separate 

communications and noncommunications activity transaction in 

accordance with paragraph (h)(1)(ii) of 

this section. Income derived by B from 

the transmission of television programs 

to D’s Foreign Country downlink facility 

is international communications income 

as defined in paragraph (h)(3)(ii) of this 

section because B is paid to transmit 

communications from the United States 

to a foreign country. 

Example 12. Income derived from foreign 

communications activity—(i) Facts. S 

provides satellite capacity to B, a broadcaster 

located in Australia. B beams programming 

from Australia to the satellite. S’s satellite 

picks the communications up in space and 

beams the programming over a footprint 

covering Southeast Asia. 

(ii) Analysis. S derives communications 

income as defined in paragraph (h)(2) of this 

section. S’s income is characterized as 

foreign communications income under 

paragraph (h)(3)(iv) of this section because S 

picks up the communication in space, and 

beams it to a footprint entirely covering a 

foreign area. Under paragraph (d) of this 

section, S’s foreign communications income 

is from sources without the United States. If 

S were beaming the programming over a 

satellite footprint that covered area both in 

the United States and outside the United 

States, S would be required to allocate the 

income derived from the different types of 

communications activity. 

(k) Reporting and documentation 

requirements—(1) In general. A taxpayer 

making an allocation of gross income 

under paragraph (b)(2)(iii), (b)(2)(iv), or 

(h)(1)(ii) of this section must satisfy the 

requirements in paragraphs (k)(2) and 

(3) of this section. 

(2) Required documentation. In all 

cases, a taxpayer must prepare and 

54878 Federal Register / Vol. 70, No. 180 / Monday, September 19, 2005 / Proposed Rules 

maintain documentation in existence 

when its return is filed regarding the 

allocation of gross income, and 

allocation and apportionment of 

expenses, losses, and other deductions, 

the methodologies used, and the 

circumstances justifying use of those 

methodologies. The taxpayer must make 

available such documentation within 30 

days upon request. 

(3) Access to software. If the taxpayer 

or any third party used any computer 

software, within the meaning of section 

7612(d), to allocate gross income, or to 

allocate or apportion expenses, losses, 

and other deductions, the taxpayer must 

make available upon request—

(i) Any computer software executable 

code, within the meaning of section 

7612(d), used for such purposes, 

including an executable copy of the 

version of the software used in the 

preparation of the taxpayer’s return 

(including any plug-ins, supplements, 

etc.) and a copy of all related electronic 

data files. Thus, if software 

subsequently is upgraded or 

supplemented, a separate executable 

copy of the version used in preparing 

the taxpayer’s return must be retained; 

(ii) Any related computer software 

source code, within the meaning of 

section 7612(d), acquired or developed 

by the taxpayer or a related person, or 

primarily for internal use by the 

taxpayer or such person rather than for 

commercial distribution; and 

(iii) In the case of any spreadsheet 

software or similar software, any 

formulae or links to supporting 

worksheets. 

(4) Use of allocation methodology. In 

general, when a taxpayer allocates gross 

income under paragraph (b)(2)(iii), 

(b)(2)(iv), or (h)(1)(ii) of this section, it 

does so by making the allocation on a 

timely filed original return (including 

extensions). However, a taxpayer will be 

permitted to make changes to such 

allocations made on its original return 

with respect to any taxable year for 

which the statute of limitations has not 

closed as follows: 

(i) In the case of a taxpayer that has 

made a change to such allocations prior 

to the opening conference for the audit 

of the taxable year to which the 

allocation relates or who makes such a 

change within 90 days of such opening 

conference, if the IRS issues a written 

information document request asking 

the taxpayer to provide the documents 

and such other information described in 

paragraphs (k)(2) and (3) of this section 

with respect to the changed allocations 

and the taxpayer complies with such 

request within 30 days of the request, 

then the IRS will complete its 

examination, if any, with respect to the 

allocations for that year as part of the 

current examination cycle. If the 

taxpayer does not provide the 

documents and information described 

in paragraphs (k)(2) and (3) of this 

section within 30 days of the request, 

then the procedures described in 

paragraph (k)(4)(ii) of this section shall 

apply. 

(ii) If the taxpayer changes such 

allocations more than 90 days after the 

opening conference for the audit of the 

taxable year to which the allocations 

relate or the taxpayer does not provide 

the documents and information with 

respect to the changed allocations as 

requested in accordance with 

paragraphs (k)(2) and (3) of this section, 

then the IRS will, in a separate cycle, 

determine whether an examination of 

the taxpayer’s allocations is warranted 

and complete any such examination. 

The separate cycle will be worked as 

resources are available and may not 

have the same estimated completion 

date as the other issues under 

examination for the taxable year. The 

IRS may ask the taxpayer to extend the 

statute of limitations on assessment and 

collection for the taxable year to permit 

examination of the taxpayer’s method of 

allocation, including an extension 

limited, where appropriate, to the 

taxpayer’s method of allocation. 

(l) Effective date. This section applies 

to taxable years beginning on or after the 

date of publication of final regulations 

in the Federal Register. 

Mark E. Matthews, 

Deputy Commissioner for Services and 

Enforcement. 

[FR Doc. 05–18265 Filed 9–16–05; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF DEFENSE 

GENERAL SERVICES 

ADMINISTRATION 

NATIONAL AERONAUTICS AND 

SPACE ADMINISTRATION 

48 CFR Parts 1, 2, 17, 31, 32, 35, 42, 

45, 49, 51, 52, and 53 

[FAR Case 2004–025] 

RIN: 9000–AK30 

Federal Acquisition Regulation; 

Government Property 

AGENCIES: Department of Defense (DoD), 

General Services Administration (GSA), 

and National Aeronautics and Space 

Administration (NASA). 

ACTION: Proposed rule. 

SUMMARY: The Civilian Agency 

Acquisition Council and the Defense 

Acquisition Regulations Council 

(Councils) are proposing to amend the 

Federal Acquisition Regulation (FAR) to 

simplify procedures, clarify language, 

and eliminate obsolete requirements 

related to the management and 

disposition of Government property in 

the possession of contractors. Various 

FAR parts are amended to implement a 

policy that fosters efficiency, flexibility, 

innovation, and creativity, while 

continuing to protect the Government’s 

interest in the public’s property. The 

proposed rule specifically impacts 

contracting officers, property 

administrators, and contractors 

responsible for the management of 

Government property. 

DATES: Interested parties should submit 

written comments to the FAR 

Secretariat on or before November 18, 

2005 to be considered in the 

formulation of a final rule. 

ADDRESSES: Submit comments 

identified by FAR case 2004–025 by any 

of the following methods: 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• Agency Web Site: http:// 

www.acqnet.gov/far/ProposedRules/ 

proposed.htm. Click on the FAR case 

number to submit comments. 

• E-mail: farcase.2004–025@gsa.gov. 

Include FAR case 2004–025 in the 

subject line of the message. 

• Fax: 202–501–4067. 

• Mail: General Services 

Administration, Regulatory Secretariat 

(VIR), 1800 F Street, NW, Room 4035, 

ATTN: Laurieann Duarte, Washington, 

DC 20405. 

Instructions: Please submit comments 

only and cite FAR case 2004–025 in all 

correspondence related to this case. All 

comments received will be posted 

without change to http:// 

www.acqnet.gov/far/ProposedRules/ 

proposed.htm, including any personal 

and/or business confidential 

information provided. 

FOR FURTHER INFORMATION CONTACT The 

FAR Secretariat at (202) 501–4755 for 

information pertaining to status or 

publication schedules. For clarification 

of content, contact Ms. Jeritta Parnell, 

Procurement Analyst, at (202) 501–

4082. Please cite FAR case 2004–025. 

SUPPLEMENTARY INFORMATION: 

A. Background 

In the late 1990s, the Department of 

Defense (DoD) initiated a complete 

rewrite of FAR Part 45 and associated 

clauses. Beyond attempting to address 

long-standing property management