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September 30, 2020

FIRST IMPRESSIONS | Treasury issues final sourcing regulations on sales of personal property (including inventory)

On September 29, 2020, the Treasury Department released final regulations (TD 9921) (the Final Regulations) with rules for determining the source of income from sales of inventory produced within the United States and sold outside the United States or vice versa. The Final Regulations also include rules for determining whether foreign-source income is effectively connected with the conduct of a US trade or business. Additional rules address the sourcing of a nonresident's income from certain sales of personal property that are attributable to an office maintained in the United States.

The Final Regulations generally follow the proposed regulations issued on December 30, 2019 (REG-100956-19), with certain changes. In particular, the Final Regulations:

  • Require taxpayers electing to use the books-and-records method for apportioning gross income between sales and production activities under Treas. Reg. Section 1.865-3(d) to use that method for 48 months unless the IRS consents to the election's revocation
  • Clarify that the adjusted basis of production assets (used to source income when production occurs both within and outside the United States) is determined by averaging the assets' bases at the beginning and end of the year, unless a change occurred during the year that would materially distort the calculation
  • Modify the rules for determining whether a taxpayer's activities constitute production activity by referring to the rules for foreign base company sales income in Treas. Reg. Section 1.954-3(a)(4), but without applying the "substantial contribution" rules
  • Do not expand the rules for determining the location of production activity to include activities or assets of related parties or unrelated agents
  • Modify the anti-abuse rule in Treas. Reg. Section 1.863-3(c), and add an example illustrating that the rule may apply to certain acquisitions of domestic production assets by related partnerships (or their subsidiaries) if the acquisition has a principal purpose of reducing Treas. Reg. Section 1.863-3 tax liability by treating inventory sales income as subject to IRC Section 862(a)(6) rather than IRC Section 863(b)

The Final Regulations generally apply to tax years ending on or after December 23, 2019. Taxpayers may choose to apply the Final Regulations in their entirety for any tax year beginning after December 31, 2017, if they and all related persons continue to apply the regulations for all subsequent years.

A more detailed Tax Alert on the Final Regulations is forthcoming.