Source Rules for Foreign Sales Corporation Transfer Pricing

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8782]

RIN 1545-AV90

Source Rules for Foreign Sales Corporation Transfer Pricing

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that provide guidance

to taxpayers who have made an election to be treated as a foreign sales

corporation (FSC). The regulations clarify that the special source rule

under section 927(e)(1) applies only to income of related suppliers

from sales of export property giving rise to foreign trading gross

receipts of a FSC.

DATES: Effective date. These regulations are effective March 3, 1998.

Applicability date. These regulations apply to taxable years

beginning after December 31, 1997.

FOR FURTHER INFORMATION CONTACT: Elizabeth Beck (202) 622-3880 (not a

toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to the Income Tax Regulations (26

CFR part 1) under section 927 which was added by the Deficit Reduction

Act of 1984, applicable for taxable years of foreign sales corporations

beginning after December 31, 1984. Temporary regulations (TD 8126) were

published in the Federal Register (52 FR 6468) on March 3, 1987. These

temporary regulations were amended by temporary regulations published

in the Federal Register (63 FR 10305) as a Treasury decision (TD 8764)

on March 3, 1998. On the same date, a notice of proposed rulemaking

cross-referencing TD 8764 was published in the Federal Register (63 FR

10351). The proposed rule proposed changes to the grouping and source

rules for foreign sales corporation transfer pricing. Comments

responding to this notice were received. On June 24, 1998, a public

hearing was held limited to the proposed changes to the grouping rules,

since no hearing was requested with respect to the source rule. After

consideration of all comments received, the proposed regulations

regarding the source rule are adopted as revised by this Treasury

decision.

Explanation of Provisions

A. Current Temporary Regulations

Section 927(e)(1) provides that ``under regulations, the income of

a person described in section 482 from a transaction giving rise to

foreign trading gross receipts of a FSC which is treated as from

sources outside the United States shall not exceed the amount which

would be treated as foreign source income earned by such person if the

pricing rule under section 994 which corresponds to the rule used under

section 925 with respect to such transaction applied to such

transaction.'' Transactions giving rise to foreign trading gross

receipts include qualifying sales, leases, licenses and services.

Because TD 8126 could be interpreted to apply the special foreign

source limit only to sales of export property, Sec. 1.927(e)-1T was

amended by TD 8764 to clarify that the regulation applies to any

transaction giving rise to foreign trading gross receipts of a FSC,

including but not limited to sales, leases, licenses and services. TD

8764 also made conforming changes, added special rules and gave

examples regarding the special source rule.

B. Discussion of Comments

No comments were received on the special rules added in proposed

Sec. 1.927(e)-1(a)(3)(ii). These rules clarify how the corresponding

DISC transfer pricing rules are to be applied for purposes of the

foreign source limit and are generally taxpayer favorable. No comments

were received on Examples (1) and (3) set forth in proposed

Sec. 1.927(e)-1(b). These examples illustrate how the limit is applied

under different transfer pricing methods for sales transactions.

Comments received did suggest that the rule distinguish between the

foreign source income limitation applicable to sales and the limitation

applicable to other transactions giving rise to foreign trading gross

receipts. In light of these comments, Treasury and the IRS believe that

additional consideration should be given to the appropriate scope of

the special source rule of section 927(e)(1) and that the expanded

special source rule should be withdrawn. Accordingly, the final

regulation applies the special source rule only to sales of export

[[Page 50144]]

property. Example (2) of the proposed regulation, which addressed a

licensing transaction, has been removed.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in E.O. 12866. Therefore, a

regulatory assessment 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, and because the regulation does

not impose a collection of information on small entities, the

Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.

Pursuant to section 7805(f) of the Internal Revenue Code, the notice of

proposed rulemaking preceding these regulations was submitted to the

Chief Counsel for Advocacy of the Small Business Administration for

comment on their impact on small business.

Drafting Information

The principal author of these regulations is Elizabeth Beck of the

Office of the Associate Chief Counsel (International). Other personnel

from the IRS and Treasury Department also participated in the

development of these regulations.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by

removing the entry for Sec. 1.927(e)-1T and adding an entry in

numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * * Section 1.927(e)-1 also issued

under 26 U.S.C. 927(e)(1). * * *

Sec. 1.927(e)-1T [Removed]

Par. 2. Section 1.927(e)-1T is removed.

Par. 3. Section 1.927(e)-1 is added to read as follows:

Sec. 1.927(e)-1 Special sourcing rule.

(a) Source rules for related persons--(1) In general. The income of

a person described in section 482 from a sale of export property giving

rise to foreign trading gross receipts of a FSC that is treated as from

sources outside the United States shall not exceed the amount that

would be treated as foreign source income earned by such person if the

pricing rule under section 994 that corresponds to the rule used under

section 925 with respect to such transaction applied to such

transaction. This special sourcing rule also applies if the FSC is

acting as a commission agent for the related supplier with respect to

the transaction described in the first sentence of this paragraph

(a)(1) that gives rise to foreign trading gross receipts and the

transfer pricing rules of section 925 are used to determine the

commission payable to the FSC. No limitation results under this section

with respect to a transaction to which the section 482 pricing rule

under section 925(a)(3) applies.

(2) Grouping of transactions. If, for purposes of determining the

FSC's profits under the administrative pricing rules of sections 925(a)

(1) and (2), grouping of transactions under Sec. 1.925(a)-1T(c)(8) was

elected, the same grouping shall be used for making the determinations

under the special sourcing rule in this section.

(3) Corresponding DISC pricing rules--(i) In general. For purposes

of this section--

(A) The DISC gross receipts pricing rule of section 994(a)(1)

corresponds to the gross receipts pricing rule of section 925(a)(1);

(B) The DISC combined taxable income pricing rule of section

994(a)(2) corresponds to the combined taxable income pricing rule of

section 925(a)(2); and

(C) The DISC section 482 pricing rule of section 994(a)(3)

corresponds to the section 482 pricing rule of section 925(a)(3).

(ii) Special rules. For purposes of this section--

(A) The DISC pricing rules of section 994(a)(1) and (2) shall be

determined without regard to export promotion expenses;

(B) Qualified export receipts under section 994(a)(1) and

(2) shall be deemed to be an amount equal to the foreign trading

gross receipts arising from the transaction; and

(C) Combined taxable income for purposes of section 994(a)(2) shall

be deemed to be an amount equal to the combined taxable income for

purposes of section 925(a)(2) arising from the transaction.

(b) Examples. The provisions of this section may be illustrated by

the following examples:

Example 1. (i) R and F are calendar year taxpayers. R, a

domestic manufacturing company, owns all the stock of F, which is a

FSC acting as a commission agent for R. For the taxable year, R and

F used the combined taxable income pricing rule of section

925(a)(2). For the taxable year, the combined taxable income of R

and F is $100 from the sale of export property, as defined in

section 927(a), manufactured by R using production assets located in

the United States. Title to the export property passed outside of

the United States.

(ii) Under section 925(a)(2), 23 percent of the $100 combined

taxable income of R and F ($23) is allocated to F and the remaining

$77 is allocated to R. Absent the special sourcing rule, under

section 863(b) the $77 income allocated to R would be sourced $38.50

U.S. source and $38.50 foreign source. Under the special sourcing

rule, the amount of foreign source income earned by a related

supplier of a FSC shall not exceed the amount that would result if

the corresponding DISC pricing rule applied. The DISC combined

taxable income pricing rule of section 994(a)(2) corresponds to the

combined taxable income pricing rule of section 925(a)(2). Under

section 994(a)(2), $50 of the combined taxable income ($100 x .50)

would be allocated to the DISC and the remaining $50 would be

allocated to the related supplier. Under section 863(b), the $50

income allocated to the DISC's related supplier would be sourced $25

U.S. source and $25 foreign source. Accordingly, under the special

sourcing rule, the foreign source income of R shall not exceed $25.

Example 2. (i) Assume the same facts as in Example 1 except that

R and F used the gross receipts pricing rule of section 925(a)(1).

In addition, for the taxable year foreign trading gross receipts

derived from the sale of the export property are $2,000.

(ii) Under section 925(a)(1), 1.83 percent of the $2,000 foreign

trading gross receipts ($36.60) is allocated to F and the $63.40

remaining combined taxable income ($100-$36.60) is allocated to R.

Absent the special sourcing rule, under section 863(b) the $63.40

income allocated to R would be sourced $31.70 U.S. source and $31.70

foreign source. Under the special sourcing rule, the amount of

foreign source income earned by a related supplier of a FSC shall

not exceed the amount that would result if the corresponding DISC

pricing rule applied. The DISC gross receipts pricing rule of

section 994(a)(1) corresponds to the gross receipts pricing rule of

section 925(a)(1). Under section 994(a)(1), $80 ($2,000 x .04)

would be allocated to the DISC and the $20 remaining combined

taxable income would be allocated to the related supplier. Under

section 863(b), the $20 income allocated to the DISC's related

supplier would be sourced $10 U.S. source and $10 foreign source.

Accordingly, under the special sourcing rule, the foreign source

income of R shall not exceed $10.

(c) Effective date. The rules of this section are applicable to

taxable years beginning after December 31, 1997.

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

Approved: August 18, 1998.

Donald C. Lubick,

Assistant Secretary of the Treasury.

[FR Doc. 98-25045 Filed 9-17-98; 8:45 am]

BILLING CODE 4830-01-U