The Treasury Department and Internal Revenue Service today released proposed regulations (REG-100956-19) that would provide rules for sourcing certain income within or outside the United States. The regulations also include rules on (i) attributing other income to an office or other fixed place of business, and (ii) determining whether foreign-source income is effectively connected with the conduct of a trade or business within the United States. The regulations would apply to tax years ending on or after the date on which they are filed in the Federal Register, though taxpayers may elect in certain circumstances to apply the regulations to earlier tax years.

The proposed regulations include rules under IRC Section 863(b)(2). The rules provide the first guidance on this section since its amendment by the 2017 Tax Cuts and Jobs Act.

Among other things, the proposed regulations would:

• Specify how new IRC Section 863(b)(2) and IRC Section 865(e)(2) interact in cases of "Section 865(e)(2) Sales" by a nonresident, with the result that the portion of the income attributable to the sales activity of the nonresident's US office always would be sourced within the United States
• Adopt the "50/50 method" as the default rule for allocating income from IRC Section 865(e)(2) Sales between sales and production activities, but permit taxpayers to elect to use a modified "books and record method"
• Retain the rule that sources income in proportion to the basis of the US and foreign production assets when production activity corresponding to Section 863(b)(2) Sales is both within and outside the United States
• Measure the basis of US production assets based on the "alternative depreciation system" under IRC Section 168(g)(2) — given that such assets might otherwise, due to "bonus depreciation," have zero basis

A more detailed Tax Alert on the proposed regulations is forthcoming.