Reg-106030-98

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

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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
Internal Revenue Service (IRS),
Treasury.
ACTION: Withdrawal of notice of
proposed rulemaking; notice of
proposed rulemaking; and notice of
public hearing.
AGENCY:

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

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54859

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

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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.

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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

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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

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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.

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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

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54861

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

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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.

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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

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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

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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

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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

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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.

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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.

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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

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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

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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.

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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

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54865

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

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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

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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 50percent 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

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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–

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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

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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

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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

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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

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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 100percent 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

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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

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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 100percent U.S. source under § 1.863–

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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

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54869

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.

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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

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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

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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:

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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

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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

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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

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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

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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;

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(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.

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(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

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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

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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

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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

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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.

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(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

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(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

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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

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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

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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

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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,

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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.

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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.

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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

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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

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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

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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
Department of Defense (DoD),
General Services Administration (GSA),
and National Aeronautics and Space
Administration (NASA).
ACTION: Proposed rule.
AGENCIES:

PO 00000

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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

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