It used to be common for U.S. taxpayers to transfer title to product sales destined for a foreign buyer to occur outside the U.S. This was done to produce additional foreign source income that would allow for the claiming of additional foreign tax credit. This was especially important where the U.S. taxpayer was in an excess credit position. The IRS has released final regulations modifying this rule and no longer allows for title transfer outside the U.S. to result in foreign source income.

The final regulations also contain new rules for determining the source of income from sales of personal property, including inventory, by nonresidents attributed to an office or other fixed place of business the nonresident maintains in the U.S. These regulations also modify certain rules for determining whether foreign source income is effectively connected with the conduct of a trade or business within the U.S.

Sales Contract Terms

With this change, taxpayers may want to consider the terms in their sales contract and make modifications. While previously they may have changed the terms to produce additional foreign source income, this may have resulted in additional exposure to taxation in a foreign country.  This has become more of an issue lately as tax authorities have become more aggressive in asserting a taxable presence if a taxpayer has tangible property in their jurisdiction, even for an instant as title is transferred.

With this change to the regulations, taxpayers should examine their sales contract terms to determine if this type of provision is in their contracts, and if so, whether it should be deleted or changed. Changing this title transfer provision would not hurt a taxpayer who is taking advantage of the new foreign-derived intangible income (FDII) incentive. 

Impact to Corporations

U.S. corporations will be impacted by the final regulations that expanded the term “produced” to include items that are created, fabricated, manufactured, extracted, processed, cured and aged, as determined under the principles of the regulations. Also, an election to apply the books and records method will now continue until revoked and may not be revoked without IRS consent for any tax year beginning within 48 months of the end of the tax year in which the election was made.

Foreign corporations may be impacted by a revision providing that gross income, gain or loss from the sale of personal property treated as from sources within the U.S. will generally be effectively connected with the conduct of a trade or business in the U.S. Absent treaty protection, this would mean the foreign corporation is subject to U.S. taxation on the sale of its products where title passes in the U.S. In this situation, the foreign corporation should be careful to review its sales contract terms.

Our international tax advisors are here to help if you would like to discuss these final regulation changes and how it might impact your tax situation.