Tax Policy: Historical Tax Treatment of INTELSAT and Current Tax 
Rules for Satellite Corporations (13-SEP-04, GAO-04-994).	 
                                                                 
The International Telecommunications Satellite Organization	 
(INTELSAT)--an intergovernmental organization launched in 1964 to
design, develop, and operate a commercial telecommunications	 
satellite system--enjoyed certain privileges that domestic	 
companies do not, including some related to taxation. Each member
nation designated a Signatory to participate as an investor. The 
U.S. Signatory was COMSAT, a private corporation. Intelsat	 
privatized in 2001, and its tax situation changed. In response to
congressional requests for information on whether Intelsat could 
continue to enjoy any preferential tax treatment as a foreign	 
corporation, GAO did this study to describe how INTELSAT and	 
COMSAT were treated for U.S. tax purposes prior to INTELSAT'S	 
privatization and to describe how current U.S. tax treatment for 
a domestically incorporated satellite company in the United	 
States compares to current U.S. tax treatment for a foreign	 
corporation with operations, services, and revenue in the United 
States. 							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-994 					        
    ACCNO:   A12274						        
  TITLE:     Tax Policy: Historical Tax Treatment of INTELSAT and     
Current Tax Rules for Satellite Corporations			 
     DATE:   09/13/2004 
  SUBJECT:   Communication satellites				 
	     Federal taxes					 
	     Foreign corporations				 
	     Income taxes					 
	     International economic relations			 
	     International organizations			 
	     Tax exempt status					 

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GAO-04-994

                 United States Government Accountability Office

                     GAO Report to Congressional Requesters

September 2004

TAX POLICY

    Historical Tax Treatment of INTELSAT and Current Tax Rules for Satellite
                                  Corporations

                                       a

GAO-04-994

[IMG]

September 2004

TAX POLICY

Historical Tax Treatment of INTELSAT and Current Tax Rules for Satellite
Corporations

                                 What GAO Found

As an international organization, INTELSAT was exempt from all U.S.
federal income taxes, communications taxes with respect to activities
under INTELSAT agreements, and customs duties on imports of communications
satellite equipment. INTELSAT and its property, income, operations, and
other transactions were also exempt from all taxes in the District of
Columbia, except for those not used for, or related to, the purposes of
INTELSAT. In contrast, COMSAT was subject to all applicable U.S. taxes.

Currently, U.S. income tax treatment of satellite corporations, like other
corporations, depends, in part, on whether the corporation is incorporated
domestically or is a foreign corporation. The United States taxes the
worldwide income of U.S. domestic corporations, regardless of where the
income is earned. However, when the tax is due depends on several factors,
including whether the income is from a U.S. or foreign source and, if it
is from a foreign source, whether it is earned through direct operations
or through a subsidiary. Tax on income from a subsidiary may be deferred.
The United States generally taxes foreign corporations on any U.S.-source
income they earn, but taxes them only on certain types of foreign-source
income (and generally only if the latter income is attributable to an
office or fixed place of business in the United States). In order to avoid
double taxation of income earned in a foreign country, the United States
allows corporations to claim a credit for foreign taxes they paid on
foreign-source income. Specific income-sourcing rules exist for
determining the U.S. taxation of income that domestic and foreign
corporations earn from space, ocean, or international communications
activities. The rules differ depending on the type of activity and whether
the corporation is domestic or foreign.

Roles of INTELSAT and COMSAT in the Worldwide Telecommunications Satellite
System

                 United States Government Accountability Office

A

United States Government Accountability Office Washington, D.C. 20548

September 13, 2004

Congressional Requesters

The Communications Satellite Act of 19621 (Satellite Act) provided a
framework for building a commercial satellite system for
telecommunications services that would serve countries throughout the
world. In August 1964, the United States joined with other nations to
launch such a system through an interim agreement signed by the government
of each participating nation, including the United States. This agreement
provided for the establishment of the intergovernmental organization
INTELSAT to develop such a system. INTELSAT enjoyed certain privileges
that domestic companies do not, including some related to taxation. Each
participating nation named a Signatory to act as an investor in INTELSAT.
COMSAT Corporation (COMSAT) was created to serve as the United States'
Signatory. INTELSAT's role was to design, develop, implement, and operate
the global commercial communications satellite system and COMSAT was
responsible for purchasing satellite capacity directly from INTELSAT for
resale in the U.S. market.

During the 1990s, there was considerable criticism from new commercial
satellite companies focused on the difficulty of competing against an
organization with INTELSAT's advantages. The Open-Market Reorganization
for the Betterment of International Telecommunications (ORBIT) Act,2 which
was enacted in 2000, provided for sanctions to be imposed upon Intelsat if
it did not privatize in a manner consistent with the terms of the act. On
July 18, 2001, INTELSAT transferred substantially all of its assets and
liabilities to Intelsat, Ltd.-a holding company incorporated by INTELSAT
under the laws of Bermuda-and its wholly owned subsidiaries.3 By so doing,
INTELSAT lost its tax-exempt status, along with other privileges it had
been granted as an international organization and under international
agreements.

1Pub. L. No. 87-624, 76 Stat. 419 (1962).

2Pub. L. No. 106-180, 114 Stat. 48 (2000). This law amended the Satellite
Act.

3The official name of the intergovernmental organization was INTELSAT-all
capital letters. After privatization, the privatized company is known as
Intelsat. As such, we make this distinction throughout this report.

Given INTELSAT's advantages relating to taxation while it was an
international organization, you expressed an interest in obtaining
information on whether Intelsat, Ltd. could continue to enjoy any
preferential tax treatment over its competitors. Specifically, you asked
us to describe how (1) INTELSAT and COMSAT were treated for U.S. tax
purposes prior to INTELSAT's privatization and (2) current U.S. tax
treatment for a domestically incorporated satellite company in the United
States compares to current U.S. tax treatment for an offshore-incorporated
company with operations, services, and revenue in the United States.4 In
addition, you asked us to provide information related to the
implementation of the ORBIT Act and the status of market access for global
satellite companies in countries around the world. Thus, as agreed, we are
also concurrently issuing a separate report to you on these issues.5

To address both of these objectives, we reviewed relevant provisions of
the Satellite Act, the ORBIT Act, U.S. tax laws, and other relevant laws;
relevant Internal Revenue Service (IRS) regulations and tax rulings;
relevant court cases; relevant Joint Committee on Taxation summaries;
relevant Securities and Exchange Commission filings and Federal
Communications Commission (FCC) filings and orders; relevant executive
orders; relevant international agreements; and other relevant documents
and reports. In addition, we interviewed cognizant Intelsat, Ltd., IRS,
and Treasury officials. We did not determine the taxes that INTELSAT and
COMSAT actually paid prior to INTELSAT's privatization or that Intelsat,
Ltd. or any other specific company or companies would have to pay.

We conducted our review from March 2004 through June 2004 in accordance
with generally accepted government auditing standards.

Results in Brief	While it was an international organization, INTELSAT was
exempt from all U.S. federal income taxes, as well as from federal
communications taxes with respect to activities authorized by INTELSAT
agreements. INTELSAT

4The Internal Revenue Code (I.R.C.) section 7701(a)(4) provides that the
term "domestic," when applied to a corporation, means that the corporation
is created or organized in the United States or under the law of the
United States or of any state. I.R.C. section 7701(a)(5) provides that the
term "foreign," when applied to a corporation, means that the corporation
is not domestic. As such, we use these terms throughout the report.

5GAO, Telecommunications: Intelsat Privatization and the Implementation of
the ORBIT Act, GAO-04-891 (Washington, D.C.: Sept. 13, 2004).

was also exempt from customs duties on imports of communications satellite
equipment. In addition, INTELSAT and its property, income, operations, and
other transactions were exempt from all taxes imposed by the District of
Columbia-where it was headquartered-except for those not used for, or
related to, the purposes of INTELSAT. Moreover, the wages and salaries of
INTELSAT employees who were not U.S. nationals or permanent residents were
exempt from federal and District income taxes. In contrast, COMSAT was
subject to applicable U.S. federal, state, and local taxes, even with
respect to income that it received through its participation in INTELSAT.

Currently, U.S. income tax treatment of satellite corporations, like other
corporations, depends, in part, on whether the corporation is incorporated
domestically or is a foreign corporation. The United States taxes the
worldwide income of domestic corporations, regardless of where the income
is earned. However, when the tax is due depends on several factors,
including whether the income is from a U.S. or foreign source and, if it
is from a foreign source, whether it is earned through direct operations
or through a subsidiary. A domestic corporation may be able to defer U.S.
tax on a foreign subsidiary's income. The United States generally taxes
foreign corporations on any U.S.-source income they earn, but taxes them
only on certain types of foreign-source income (and generally only if the
latter income is attributable to an office or fixed place of business in
the United States). The U.S.-source income is taxed in one of two ways. If
such income is "effectively connected" with a U.S. trade or business, it
is generally subject to the corporate income tax; however, certain types
of U.S.-source investment income that are not effectively connected are
subject, instead, to a flat rate tax known as the 30 percent withholding
tax. Specific income-sourcing rules exist for determining the U.S.
taxation of income that domestic and foreign corporations earn from space,
ocean, or international communications activities. In order to avoid
double taxation of income earned in a foreign country, the United States
allows corporations to claim a credit for foreign taxes they paid on
foreign-source income.

We provided a draft of this report in August 2004 to the Secretary of the
Treasury and the Commissioner of Internal Revenue for their review and
comment. We also provided Intelsat, Ltd. with the opportunity to review
our draft report and provide comments or observations. We received
technical and editorial comments via e-mail from IRS and Intelsat, Ltd.
and oral technical and editorial comments from Treasury. Where
appropriate, we made changes in our report in response to these comments.

Background	With the enactment of the Satellite Act, the United States
began building a framework for a commercial satellite system that would
provide telecommunications services throughout the world. The United
States joined with other nations through an interim agreement6 to form an
international organization7-the International Telecommunications Satellite
Organization (INTELSAT)-to provide such a system. This agreement
established an Interim Communications Satellite Committee to be
responsible for the design, development, construction, establishment,
maintenance, and operation of the satellite system. Pursuant to the
interim agreement, INTELSAT was subsequently established under a formal
international agreement (definitive agreement) among the United States and
other nations in February 1973. Under the definitive agreement, INTELSAT's
purpose was to design, develop, implement, and operate a global commercial
communications satellite system that would provide international
commercial satellite communications on a nondiscriminatory basis to all
areas of the world.

Each member nation that was a party8 to the INTELSAT agreements designated
a single Signatory, usually a telecommunications entity, to participate as
an investor in the system. The Signatory for the United States was COMSAT,
created as a private, profit-seeking, governmentregulated corporation to
provide for the United States' participation in such a system, as
authorized by the Satellite Act. COMSAT also was the only entity
authorized to purchase satellite capacity directly from INTELSAT for
resale in the U.S. market. (See fig. 1.)

6Agreement Establishing Interim Arrangements for the Global Commercial
Communications Satellite System, August 20, 1964, 15 U.S.T. 1705, T.I.A.S.
5646 (entered into force August 20, 1964). A formal INTELSAT agreement was
agreed to in Washington on August 20, 1971, and entered fully into force
on February 12, 1973: Agreement Relating to the International
Telecommunications Satellite Organization "Intelsat", August 20, 1971, 23
U.S.T. 3813, T.I.A.S. 7532 (entered into force February 12, 1973).

7The ORBIT Act and other sources, including Intelsat, Ltd. itself, refer
to INTELSAT as an intergovernmental organization. However, it was
INTELSAT's status as an international organization that was responsible
for its exemptions from federal taxes discussed in this report. Throughout
this report, the terms intergovernmental and international are both used
in reference to INTELSAT.

8According to the definitive agreement, a party was "a State for which the
Agreement has entered into force or been provisionally applied."

Figure 1: Roles of INTELSAT and COMSAT in the Worldwide Telecommunications
Satellite System

Source: Intelsat Global Service Corporation; COMSAT Corporation, used with
permission; GAO.

During the 1970s and early 1980s, INTELSAT was the only wholesale provider
of certain types of global satellite communications services.9 This
changed, however, by the mid-1980s, when the United States began
encouraging the development of commercial satellite communications systems
to provide for competition in the market.10 By the mid-to late1990s,
INTELSAT faced global satellite competitors and commercial satellite
companies were contending that, if the satellite marketplace were to
become fully competitive, INTELSAT needed to be privatized so that it
would operate like commercial companies in the market. In particular,
these companies noted that INTELSAT enjoyed immunity from legal liability
and was often not taxed in the various countries that it served-
advantages that stemmed from its status as an international
intergovernmental organization. By the mid-1990s, INTELSAT began to
recognize that it would be best for the organization to privatize and, in
1999, INTELSAT announced its intention to do so.

9While INTELSAT was the only provider at that time of what is called
global fixed satellite services-that is, services provided between fixed
points on land-another global satellite organization that was also formed,
based on amendments to the Satellite Act, provided global maritime
satellite communications. This organization is commonly known as Inmarsat.
However, a discussion of Inmarsat is outside the scope of this report.

10 See Presidential Determination Number 85-2 (1984).

The ORBIT Act, which became law in March 2000, provided for sanctions to
be imposed upon Intelsat if it did not privatize in a manner consistent
with the terms of the act, so as to promote a competitive global satellite
communication services market. On July 18, 2001, INTELSAT transferred
substantially all of its assets and liabilities to Intelsat, Ltd.-a
holding company incorporated by INTELSAT under the laws of Bermuda-and its
wholly owned subsidiaries.11 Intelsat, Ltd. remains incorporated in
Bermuda and its subsidiaries were incorporated in several countries,
including the United States. The FCC has determined that INTELSAT's 2001
privatization was in accordance with the ORBIT Act, but FCC conditioned
the licenses it has granted to Intelsat LLC12 on the company's holding an
initial public offering (IPO) of securities, as required under the ORBIT
Act.

In May 2004, the deadline for Intelsat, Ltd.'s IPO was extended until June
30, 2005,13 by an amendment to the ORBIT Act.14 On August 16, 2004,
Intelsat, Ltd. announced that its Board of Directors approved the sale of
the company to a consortium of four private investors; the sale requires
the approval of shareholders holding 60 percent of Intelsat's outstanding
shares as well as regulatory approval. Intelsat's announcement stated that
Intelsat and a subsidiary owned by the consortium would be amalgamated
under Bermuda law (in a manner similar to a merger in the United States)
and that the deal could be closed as early as the end of 2004.

11INTELSAT agreed to leave in place a residual intergovernmental
organization, the International Telecommunications Satellite Organization
(ITSO), that would monitor the performance of Intelsat, Ltd.'s remaining
public service obligations. In particular, after the privatization,
Intelsat, Ltd. was tasked with maintaining global connectivity and
honoring connectivity obligations that had been made by INTELSAT to
customers in countries with low levels of telephone service and low
income, having a high degree of dependence on Intelsat for their
communications needs.

12Intelsat LLC is an indirect subsidiary of Intelsat, Ltd. It is a limited
liability company organized under the laws of Delaware and holding
Intelsat, Ltd.'s satellites, satellite licenses, rights to use orbital
locations, and other related assets.

13The FCC is authorized to extend the deadline to December 31, 2005.

14Pub. L. No. 108-228, 118 Stat. 644 (2004).

  Prior to Privatization, INTELSAT Was Exempt from Most U.S. Taxes, but COMSAT
  Was Subject to Tax

While it was an international organization, INTELSAT was exempt from all
U.S. federal income taxes, as well as from federal communications and
property taxes with respect to activities authorized by INTELSAT
agreements. INTELSAT was also exempt from customs duties on imports of
communications satellite equipment. In addition, INTELSAT and its
property, income, operations, and other transactions were exempt from all
taxes imposed by the District of Columbia-where it was headquartered-
except for those not used for, or related to, the purposes of INTELSAT.15
Moreover, the wages and salaries of INTELSAT employees who were not U.S.
nationals or permanent residents were exempt from federal and District
income taxes. In contrast, COMSAT was subject to applicable U.S. federal,
state, and local taxes, even with respect to income that it received
through its participation in INTELSAT.

    As an International Organization, INTELSAT Was Exempted from Most Applicable
    Taxes in the United States

INTELSAT's tax exemptions were based on its designation as an
international organization16 covered under the International Organizations
Immunities Act,17 its specific international agreements, and a law
specifically providing for immunity from taxation in the District of
Columbia. As a designated international organization, INTELSAT was
entitled to certain privileges, exemptions, and immunities, including
exemptions under the I.R.C. In particular, income of international

15According to an Intelsat, Ltd. official, INTELSAT was required to pay
property taxes to the District of Columbia on part of the INTELSAT
headquarters building in the District because INTELSAT had renters in the
building that were subject to U.S. taxes. In addition, another official
said that INTELSAT was not subject to taxes in any of the 50 U.S. states.

16In 1965, Exec. Order No. 11,227, 3 C.F.R. 317 (1964-1965) designated the
Interim Communications Satellite Committee as a public international
organization entitled to enjoy privileges, exemptions, and immunities
conferred by the International Organizations Immunities Act. Similarly, in
1966, Exec. Order No. 11,277, 3 C.F.R. 107 (1966) designated the
International Telecommunications Satellite Consortium (the name by which
INTELSAT was initially known) as an international organization entitled to
enjoy, from and after August 20, 1964 (the date the INTELSAT interim
agreement was signed and became in force), all of the privileges,
exemptions, and immunities in section 4(a) of that act. Following the
in-force date of the INTELSAT definitive agreement, Exec. Order No.
11,718, 3A C.F.R. 177 (1973) revoked Exec. Order Nos. 11,227 and 11,277
and designated INTELSAT as an international organization with such
privileges under the act and, in 1977, Exec. Order No. 11,966, 3 C.F.R. 90
(1977) revoked Exec. Order No. 11,718 and redesignated INTELSAT as a
public international organization, accompanied by the privileges,
exemptions, and immunities conferred by the act.

17International Organizations Immunities Act, 22 U.S.C. section 288 et
seq. (2004).

organizations received from any source within the United States is
generally exempt from taxation. Further, wages, fees, and salaries
received by any employee of an international organization as compensation
for official services to the organization are generally not included in
gross income and are exempt from taxation if the employee is not a citizen
of the United States.18

In 1970, a law to provide for the immunity from taxation in the District
of Columbia for the International Telecommunications Satellite Consortium
and, subsequently, INTELSAT, was enacted.19 This law provided that
INTELSAT and its property, income, operations, and other transactions
would be exempt from all taxes imposed by the District, except for any
property, income, operations, or transactions not used for, or related to,
the purposes of INTELSAT.

In addition, Article XV of the 1973 definitive agreement provided that, in
all nations that were parties to the INTELSAT agreement, INTELSAT and its
property were to be exempt from all national income and direct national
property taxation20 and from customs duties on communications satellites,
including components and parts for such satellites, to be launched for use
in the global system. This article also provided that the United States
was to conclude a Headquarters Agreement with INTELSAT as soon as possible
to cover the appropriate privileges, exemptions, and immunities with
respect to INTELSAT, its officers, those categories of its employees
specified in the headquarters agreement, parties, representatives of
parties, Signatories, representatives of Signatories, and persons
participating in arbitration proceedings. Included was a requirement for a
provision in the Headquarters Agreement that all Signatories acting in
their capacity as such-except for COMSAT, the Signatory of the United
States itself-be exempt from national taxation on income earned from
INTELSAT in the territory of the United States.

18This exemption is provided under I.R.C. section 893. However, an
employee who is a permanent resident of the United States (i.e., a green
card holder) must waive this exemption if he or she desires to retain his
or her status as an immigrant.

19Pub. L. No. 91-494, 84 Stat. 1091 (1970).

20According to an Intelsat, Ltd. official, national property taxes
referred to property taxes that existed in some countries.

The United States and INTELSAT concluded the Headquarters Agreement and it
was brought into effect as of November 24, 1976. 21 Most of the tax
exemptions provided by this agreement duplicated those already available
to INTELSAT as a designated international organization or under the 1970
law. Three additional tax benefits were (1) a federal tax exemption for
income earned outside of the United States, (2) a specific exemption from
all U.S. and District communications taxes, and (3) a District tax
exemption for wages and salaries earned by INTELSAT employees who were not
U.S. nationals or permanent residents.

The exemptions from U.S. and District taxes related to INTELSAT remained
in effect until July 18, 2001, when INTELSAT transferred substantially all
of its assets and liabilities to Intelsat, Ltd.-a holding company
incorporated by INTELSAT under the laws of Bermuda-and its wholly owned
subsidiaries. After its incorporation, Intelsat no longer qualified for
the privileges and exemptions, including tax exemptions that were granted
based on its status as an international organization and its international
agreements.

    As a U.S. Domestic Corporation, COMSAT Was Subject to Federal, State, and
    Local Taxes

As a U.S. domestic corporation, COMSAT was subject to any applicable U.S.
federal, state, and local taxes, as any domestic corporation would be.
COMSAT had no tax exemptions in the United States. INTELSAT Signatories,
including COMSAT, had rights and obligations in INTELSAT analogous to
those of a partner in a partnership. Each owned an investment share, made
proportionate contributions to INTELSAT's capital costs, and received
proportionate distributions of INTELSAT's net revenues after deductions
for operating expenses. Thus, as such, COMSAT was taxed on its
distributive share of its INTELSAT income.

The ORBIT Act ended COMSAT's role as the U.S. Signatory to INTELSAT. Prior
to Intelsat, Ltd.'s incorporation in July 2001, COMSAT merged with the
Lockheed Martin Corporation in August 2000.

21Headquarters Agreement Between the Government of the United States of
America and the International Telecommunications Satellite Organization,
November 22 and 24, 1976, 28 U.S.T. 2248, T.I.A.S. 8542 (entered into
force November 24, 1976).

  Whether Corporations, Including Satellite Corporations, Are Domestic or
  Foreign Determines Their U.S. Income Taxation

The United States taxes domestic corporations (those incorporated in the
United States) differently than foreign corporations. In addition, special
tax rules apply to income from space, ocean, or international
communications activities.

    Domestic Corporations Pay U.S. Tax on Their Worldwide Income

The United States taxes the worldwide income of U.S. domestic
corporations, regardless of where the income is earned. However, when the
tax is due depends on several factors, including whether the income is
U.S. or foreign source and, if it is foreign source, on the structure of
the corporation's business operations. A domestic corporation that earns
income by operating directly in a foreign country, e.g., not through a
partially or wholly owned foreign subsidiary, is liable for tax when the
income is earned. In contrast, a domestic corporation that operates in a
foreign country through such a subsidiary may be able to defer tax on the
domestic corporation's share of the subsidiary's income. Generally, taxes
on the domestic corporation's income from foreign subsidiaries are not due
until the income is repatriated to the United States in the form of
dividends. However, under certain circumstances, antideferral provisions
may apply, causing the income to be taxed currently. One such provision,
known as subpart F, disallows deferral of certain types of income, such as
interest, dividends, other passive investment income, and certain income
from space or ocean activity,22 earned by controlled foreign
corporations.23

In order to avoid double taxation of income earned in a foreign country,
the United States allows domestic corporations to claim a credit for
foreign taxes they paid on foreign-source income, subject to certain
limitations.

22Legislation has been proposed to repeal the subpart F rules relating to
income earned from space or ocean activity. See, e.g., The American Jobs
Creation Act of 2004, H.R. 4520, 108th Cong., section 315 (2004).

23A controlled foreign corporation has more than 50 percent of its stock
(by vote or value) owned by U.S. shareholders, each of which must own at
least 10 percent of the stock (by vote).

    Foreign Corporations Pay U.S. Tax on Their U.S.-Source Income, Subject to
    Certain Conditions

Generally, the United States taxes the U.S.-source income of foreign
corporations, but not their foreign-source income. The tax paid on
U.S.source income generally depends on whether the income is "effectively
connected" with the conduct of a trade or business within the United
States. Foreign corporations that own and operate businesses in the United
States that sell services, products, or merchandise are, with certain
exceptions, engaged in a U.S. trade or business. Generally, any income
from such a business is considered to be effectively connected income and
is subject to the U.S. corporate income tax.

Certain types of U.S.-source investment income, such as dividends or
interest other than portfolio interest, not effectively connected with the
conduct of a trade or business within the United States are subject to a
flat rate tax known as the 30 percent withholding tax. In addition,
certain income of a foreign corporation engaged in a U.S. trade or
business could be subject to the branch profits tax, which taxes foreign
corporations on U.S. earnings and profits shifted out of the corporation's
U.S. branch in a manner similar to the withholding tax on dividends.

There are exceptions to these rules on the U.S. taxation of foreign
corporations. For example, one general exception is that any U.S. income
tax of a foreign corporation may be reduced or eliminated under an
applicable tax treaty. A more specific example is that, while the United
States generally does not tax the foreign-source income of foreign
corporations, certain foreign-source income that is "attributable to" an
office or fixed place of business in the United States is treated as
effectively connected to a U.S. trade or business and is, therefore,
subject to U.S. tax.24 Such income includes rents and royalties for the
use of certain intangible personal property.

U.S. tax rules determine whether the source of income is U.S. or foreign.
Some of the rules are complex, and some apply to particular activities.

24The foreign corporation could claim a credit for foreign taxes paid on
this income, subject to certain limitations.

    Specific Sourcing Rules Exist for Determining the U.S. Taxation of Income
    from a Corporation's Space, Ocean, or International Communications
    Activities

Specific sourcing rules determine the U.S. tax on income from space and
ocean activity and international communications activity. Table 1
summarizes the basic statutory rules. Generally, under these rules, a
domestic corporation's income from space and ocean activity is U.S.
source, and a foreign corporation's income from such activity is foreign
source. A foreign corporation's income from international communications
activity generally is treated as entirely foreign source. However, if a
foreign corporation has an office or fixed place of business in the United
States, all of its international communications activity income
attributable to such an office or business is treated as U.S.-source
income. Generally, a domestic corporation's income from international
communications activity is treated as 50 percent from U.S. sources and 50
percent from foreign sources. If a domestic or foreign corporation's
income from an activity falls under both the sourcing rules governing
space and ocean activity and the rules governing international
communications activity, the rules governing international communications
activity control, and the income is not considered space and ocean
activity income.

Table 1: Basic Statutory Rules for Determining Whether Income Is U.S. or
Foreign Source

            Type of corporation Income from space and ocean activity

Income from international communications activity

                           U.S. corporation    U.S. source    50 percent U.S. 
                                                                      source, 
                                                           50 percent foreign 
                                                                       source 
           Foreign corporation-if income is Foreign source        U.S. source 
           attributable to a fixed place of                
              business in the United States                
           Foreign corporation-if income is Foreign source     Foreign source 
                not attributable to a fixed                
                                   place of                
              business in the United States                

Source: GAO.

The I.R.C. provides Treasury the authority to modify these rules in
certain respects. Pursuant to this authority, IRS issued proposed
regulations in 2001 that, if made final, would change some of the rules
for determining whether income from space or ocean activities and
international communications activities is U.S. or foreign source.25 For
example, the

25Prop. Treas. Reg. sections 1.863-8 and Prop Treas. Reg. sections
1.863-9.

proposed regulations would increase the number of situations in which
international communications income of a foreign corporation would be
treated as U.S.-source income. A public hearing addressing the proposed
regulations was held on May 23, 2001, and the public comment period
specified in these proposed regulations has ended. IRS is reviewing the
extensive public comments received on the proposed rules to determine
whether changes to them are appropriate.

Agency Comments	We provided a draft of this report in August 2004 to the
Secretary of the Treasury and the Commissioner of Internal Revenue. We
also provided Intelsat, Ltd. with the opportunity to review our draft
report. We received technical and editorial comments via e-mail from IRS
and Intelsat, Ltd. and oral technical and editorial comments from
Treasury. Where appropriate, we made changes in our report in response to
these comments.

As agreed with your offices, unless you publicly announce its contents
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If you have any questions about this report, please contact me at (202)
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Key contributors to this report were Joyce Corry, Cheryl Peterson, and
Michael Rose.

James R. White Director, Tax Issues Strategic Issues Team

List of Congressional Requesters

The Honorable Ernest "Fritz" Hollings
Ranking Minority Member,
Committee on Commerce, Science, and Transportation
United States Senate

The Honorable Conrad Burns
Chairman, Subcommittee on Communications
Committee on Commerce, Science, and Transportation
United States Senate

The Honorable Joe Barton
Chairman, Committee on Energy and Commerce
House of Representatives

The Honorable Edward Markey
Ranking Minority Member,
Subcommittee on Telecommunications and the Internet
Committee on Energy and Commerce
House of Representatives

The Honorable W.J. "Billy" Tauzin
House of Representatives

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