[Federal Register Volume 63, Number 182 (Monday, September 21, 1998)]
[Rules and Regulations]
[Pages 50143-50144]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-25045]


=======================================================================
-----------------------------------------------------------------------

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.

-----------------------------------------------------------------------

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