Some source rules turn upon the location of the income generating activity, rather than the location of the asset, payor, or payee.
Generally, income resulting from the performance of personal services is sourced to where the services are actually rendered. This remains true regardless whether the services are performed by an individual or by an entity providing the services. If the services are provided outside the U.S. the income from the services is foreign source. If the services are provided within the U.S. the services are U.S. Source.
There are two main exceptions to this general rule. First, a deminimus exception applies if (1) the services are performed in the United States, (2) by a nonresident alien residing in the U.S. for a period less than 90 days of the tax year, (3) the total compensation is less than $3,000, and (4) these services are performed as an employee of a foreign person that is not engaged in a U.S. trade or business (nor for the benefit of a U.S. person’s overseas office) in which the income will be foreign source. Second, income will be foreign source where services are performed by a foreign vessel’s regular crew member during his temporary presence in the U.S., provided the vessel performs international transportation.
The rules for sourcing royalties are counter intuitive. The sourcing of income from royalties for the use (or the right to use) intangible property turns upon the jurisdiction where that royalty’s use (or right to use) extends. A foreign corporation exercising a license for an intangible (e.g. intellectual property) with a U.S. individual or entity will generate U.S. source income for the U.S. individual or entity-to the extent the right is actually exercised in the U.S., even if the license is owned by a foreign corporation (without presence in the U.S.). Both the payor and payee’s residence, organization location, place of business, and the like are disregarded in the analysis. i.e. U.S. Corp licenses foreign Corp. to use U.S. Corp.’s trademark in foreign Corp’s manufacturing and sales all of which are overseas nonetheless this transaction produces U.S. sourced income for the U.S. Corp. because the right to use U.S. Corp’s trademark is sourced to the U.S.
The sourcing of income from gain on the sale of intangible property generally turns upon the nature of consideration the buyer is contractually obligated to pay. Income from the sale of intangibles is sourced in the same manner as royalties are (above) when the proceeds from the sale are contingent upon the intangible property’s use, disposition, or productivity and the intangible is owned by a foreign corporation on individual. However, when the proceeds from the sale do not depend upon (non-contingent) the intangible property’s use, disposition, or productivity, and represent a complete release of all rights in the intangible, the sale will be sourced based upon the residence of the seller under IRC § 865(a).
Some income may have multiple sources. The rule varies according to the type of income-producing asset.
Generally, when a U.S. manufacturer produces inventory that is later sold in a foreign country, the source of the income from the foreign sale will be classified as mixed, part U.S. source, part foreign source under IRC § 863(b). The allocation of the gain, between the country of sale and country of production, depends upon whether an independent factory price (IFP) can be established. If not, the regulations under IRC § 863 indicate it should be split evenly (50/50). However, if the taxpayer is capable of determining the IFP, the amount a third party buyer would have paid for the property immediately after it was made, the taxpayer may use this to calculate the inventory gain (i.e. for the allocation for the country of production – U.S. source income); the remaining part is allocated to the country of sale – Foreign source income. This process will also be reversed where the property is manufactured overseas by a foreign entity or corporation and subsequently sold in the U.S.
Usually, the source for income derived from the transmission of communication (or data) between the U.S. and a foreign country (or U.S. possession) is mixed and sourced on a 50/50 basis. The sourcing allocation turns upon whether the income is derived by a U.S. person or entity or foreign person or entity. If generated by a U.S. person or entity, the income is allocated evenly between the U.S. and the foreign country. If generated by a foreign person or entity, the income is entirely foreign source, unless and to the extent that the communications income is traceable to an office (or fixed place of business) within the U.S. that is maintained by the foreign person or entity.
Generally, income from international transportation is sourced in three different manners. First, the source for income that is derived from the use (or hire) of a vessel or aircraft is wholly a U.S. source, if the transportation (i) is what generates the income, and (ii) the transportation begins and ends within the U.S. Second, transportation income has a wholly foreign source if the transportation ends outside the U.S.. Third, all other transportation income is sourced 50/50 U.S. and Foreign.
Typically, the source of income from personal services that are rendered both inside and outside the U.S. turns on whether the service provider is an employee. If so, employee’s compensation is sourced according to a time basis (hours provided in U.S. versus hours provided outside the U.S.). If services are provided by a non-employee, the income is sourced under a facts and circumstances test.