Internal Revenue Bulletin 2020-4 (PDF rendition): IRS Notices

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Bulletin No. 2020–4
January 21, 2020
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
ADMINISTRATIVE, INCOME TAX
NOTICE 2020-5, page 380.
This notice provides the optional 2020 standard mileage
rates for taxpayers to use in computing the deductible
costs of operating an automobile for business, charitable,
medical, or moving expense purposes. This notice also pro-
vides the amount taxpayers must use in calculating reduc-
tions to basis for depreciation taken under the business
standard mileage rate, and the maximum standard auto-
mobile cost that may be used in computing the allowance
under a fixed and variable rate. Additionally, this notice pro-
vides the maximum fair market value of employer-provided
automobiles first made available to employees for personal
use in calendar year 2020 for which employers may use
the fleet-average valuation rule in § 1.61-21(d)(5)(v) of the
Income Tax Regulations or the vehicle cents-per-mile valua-
tion rule in § 1.61-21(e).
EXCISE TAX
NOTICE 2020-4, page 380.
Notice 2020-04 provides an additional extension of the tem-
porary dyed fuel relief initially provided in section 3.02 of No-
tice 2017-30, 2017-21, I.R.B. 1248, then extended through
December 31, 2018, by section 3 of Notice 2018-39, 2018-
20, I.R.B. 582, and further extended through December 31,
2019, by section 3 of Notice 2019-04, 2019-02 I.R.B. 282.
A claimant may submit a refund claim for the § 4081(a)(1)
tax imposed on undyed diesel fuel and kerosene for fuel that
is (1) removed from a Milwaukee or Madison terminal; (2)
entered into a Green Bay terminal within 24 hours; and (3)
subsequently dyed and removed from that Green Bay termi-
nal. The relief provided in this notice takes effect beginning
January 1, 2020, and ending December 31, 2020.
INCOME TAX
REG-100956-19, page 383.
This document contains proposed regulations modify-
ing the rules for determining the source of income from
sales of inventory produced within the United States
and sold without the United States or vice versa. These
proposed regulations also contain new rules for deter-
mining the source of income from sales of personal
property (including inventory) by nonresidents that are
attributable to an office or other fixed place of business
that the nonresident maintains in the United States. Fi-
nally, these proposed regulations modify certain rules
for determining whether foreign source income is ef-
fectively connected with the conduct of a trade or busi-
ness within the United States.
Finding Lists begin on page ii.

The IRS Mission
Provide America’s taxpayers top-quality service by helping
them understand and meet their tax responsibilities and en-
force the law with integrity and fairness to all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing of-
ficial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of inter-
nal management are not published; however, statements of
internal practices and procedures that affect the rights and
duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service
on the application of the law to the pivotal facts stated in
the revenue ruling. In those based on positions taken in rul-
ings to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature are
deleted to prevent unwarranted invasions of privacy and to
comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned
against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions and Other Related Items, and Subpart B,
Legislation and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative
Rulings. Bank Secrecy Act Administrative Rulings are issued
by the Department of the Treasury’s Office of the Assistant
Secretary (Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.
The last Bulletin for each month includes a cumulative index
for the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the last Bulletin of each semiannual period.
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
January 21, 2020 Bulletin No. 2020–4

Part III
Additional Extension of
Temporary Relief for
Fuel Removals Destined
for Nontaxable Use Due
to West Shore Pipeline
Shutdown
Notice 2020-4
SECTION 1. PURPOSE
This notice provides an additional ex-
tension of the temporary dyed fuel relief
initially provided in section 3.02 of No-
tice 2017-30, 2017-21, I.R.B. 1248, then
extended through December 31, 2018,
by section 3 of Notice 2018-39, 2018-20,
I.R.B. 582, and further extended through
December 31, 2019, by section 3 of No-
tice 2019-04, 2019-02 I.R.B. 282. This
additional relief will be available for the
period beginning on January 1, 2020, and
ending on December 31, 2020. A claimant
may submit a refund claim for the Internal
Revenue Code § 4081(a)(1) tax imposed
on undyed diesel fuel and kerosene for
fuel that is (1) removed from a Milwau-
kee or Madison terminal; (2) entered into
a Green Bay terminal within 24 hours of
removal from the Milwaukee or Madison
terminal; and (3) subsequently dyed and
removed from that Green Bay terminal.
SECTION 2. BACKGROUND
Section 3.02 of Notice 2017-30 provid-
ed a temporary refund mechanism for the
§ 4081(a)(1) tax imposed upon removal
of undyed diesel fuel and kerosene from
a Milwaukee terminal when such fuel was
subsequently transported to, then removed
from a Green Bay terminal as dyed fuel
destined for a nontaxable use. This relief
was available for the period beginning on
October 31, 2017, and ending on May 3,
2018. Section 3 of Notice 2018-39 extend-
ed this relief for the period beginning on
May 4, 2018, and ending on December 31,
2018. Additionally, Notice 2018-39 ex-
panded the relief to include refund claims
for fuel that is taxed on removal from a
Madison terminal, transported to a Green
Bay terminal, and then removed from that
Green Bay terminal as dyed fuel. Section
3 of Notice 2019-04 extended this relief
as expanded for the period beginning on
January 1, 2019, and ending on December
31, 2019.
Notice 2017-59, 2017-45 I.R.B. 484,
provides guidance on how persons eligi-
ble for relief under section 3.02 of Notice
2017-30 may submit claims for refund.
Sections 3.02, 3.03, and 3.04 of Notice
2017-59 describe the conditions and pro-
cedures required to make such claims.
SECTION 3. EXTENSION OF
TEMPORARY DYED FUEL RELIEF
For the period beginning on January 1,
2020, and ending on December 31, 2020,
if any person (that is, the position holder)
that removes diesel fuel or kerosene that
satisfies the requirements of § 4082 from a
Green Bay terminal establishes to the sat-
isfaction of the Secretary of the Treasury
or his delegate that a prior tax was paid
with respect to the removal of such fuel
from a Milwaukee or Madison terminal,
then an amount equal to the prior tax paid
shall be allowed as a refund (without in-
terest) to the position holder in the same
manner as if it were an overpayment of tax
imposed by § 4081.
The relief described in this section is not
available with respect to any transaction
for which one or more conditions set forth
in section 3.02 of Notice 2017-59 are not
satisfied or for any refund claim that fails
to comply with the procedures set forth in
sections 3.03 and 3.04 of Notice 2017-59.
For purposes of this notice, any reference
in Notice 2017-59 to removals from a Mil-
waukee terminal shall be read to also in-
clude removals from a Madison terminal.
SECTION 4. EFFECTIVE DATE
The temporary dyed fuel relief de-
scribed in section 3 of this notice applies
to removals of dyed diesel fuel and kero-
sene from Green Bay terminals on or after
January 1, 2020, and on or before Decem-
ber 31, 2020.
SECTION 5. DRAFTING
INFORMATION
The principal author of this notice
is Elisabeth S. Shellan of the Office of
Associate Chief Counsel (Passthroughs &
Special Industries). For further informa-
tion regarding this notice contact Elis-
abeth S. Shellan or Jacob W. Peeples at
(202) 317-6855 (not a toll-free number).
2020 Standard Mileage
Rates
Notice 2020-5
SECTION 1. PURPOSE
This notice provides the optional 2020
standard mileage rates for taxpayers to use
in computing the deductible costs of oper-
ating an automobile for business, charita-
ble, medical, or moving expense purpos-
es. This notice also provides the amount
taxpayers must use in calculating reduc-
tions to basis for depreciation taken under
the business standard mileage rate, and the
maximum standard automobile cost that
may be used in computing the allowance
under a fixed and variable rate (FAVR)
plan. Additionally, this notice provides the
maximum fair market value (FMV) of em-
ployer-provided automobiles first made
available to employees for personal use in
calendar year 2020 for which employers
may use the fleet-average valuation rule
in § 1.61-21(d)(5)(v) of the Income Tax
Regulations or the vehicle cents-per-mile
valuation rule in § 1.61-21(e).
SECTION 2. BACKGROUND
Rev. Proc. 2019-46, 2019-49 I.R.B.
1301, provides rules for computing the
deductible costs of operating an automo-
bile for business, charitable, medical, or
moving expense purposes, and for sub-
stantiating, under § 274(d) of the Internal
Revenue Code and § 1.274-5, the amount
of ordinary and necessary business ex-
January 21, 2020 380 Bulletin No. 2020–4

penses of local transportation or travel
away from home. Taxpayers using the
standard mileage rates must comply with
Rev. Proc. 2019-46. However, a taxpayer
is not required to use the substantiation
methods described in Rev. Proc. 2019-46,
but instead may substantiate using actual
allowable expense amounts if the taxpayer
maintains adequate records or other suffi-
cient evidence.
An independent contractor conducts
an annual study for the Internal Revenue
Service of the fixed and variable costs of
operating an automobile to determine the
standard mileage rates for business, med-
ical, and moving use reflected in this no-
tice. The standard mileage rate for charita-
ble use is set by § 170(i).
Longstanding regulations under § 61
provide special valuation rules for em-
ployer-provided automobiles. The amount
that must be included in the employee’s
income and wages for the personal use of
an employer-provided automobile gener-
ally is determined by reference to the au-
tomobile’s FMV. If an employer chooses
to use a special valuation rule, the special
value is treated as the FMV of the benefit
for income tax and employment tax pur-
poses. Section 1.61-21(b)(4). Two such
special valuation rules, the fleet-average
valuation rule and the vehicle cents-per-
mile valuation rule, are set forth in § 1.61-
21(d)(5)(v) and § 1.61-21(e), respective-
ly. These two special valuation rules are
subject to limitations, including that they
may be used only in connection with auto-
mobiles having values that do not exceed
a maximum amount set forth in the regu-
lations.
SECTION 3. STANDARD MILEAGE
RATES
The standard mileage rate for transpor-
tation or travel expenses is 57.5 cents per
mile for all miles of business use (busi-
ness standard mileage rate). See section 4
of Rev. Proc. 2019-46. However, § 11045
of the Tax Cuts and Jobs Act, Public Law
115-97, 131. Stat. 2054 (December 22,
2017) (the “TCJA”) suspends all miscella-
neous itemized deductions that are subject
to the two-percent of adjusted gross in-
come floor under § 67, including unreim-
bursed employee travel expenses, for tax-
able years beginning after December 31,
2017, and before January 1, 2026. Thus,
the business standard mileage rate provid-
ed in this notice cannot be used to claim
an itemized deduction for unreimbursed
employee travel expenses during the sus-
pension. Notwithstanding the foregoing
suspension of miscellaneous itemized
deductions, deductions for expenses that
are deductible in determining adjusted
gross income are not suspended. For ex-
ample, members of a reserve component
of the Armed Forces of the United States
(Armed Forces), state or local government
officials paid on a fee basis, and certain
performing artists are entitled to deduct
unreimbursed employee travel expenses
as an adjustment to total income on line
11 of Schedule 1 of Form 1040 (2019),
not as an itemized deduction on Sched-
ule A of Form 1040 (2019), and therefore
may continue to use the business standard
mileage rate.
The standard mileage rate is 14 cents
per mile for use of an automobile in ren-
dering gratuitous services to a charitable
organization under § 170. See section 5 of
Rev. Proc. 2019-46.
The standard mileage rate is 17 cents
per mile for use of an automobile: (1) for
medical care described in § 213; or (2) as
part of a move for which the expenses are
deductible under § 217(g). See section
5 of Rev. Proc. 2019-46. Section 11049
of the TCJA suspends the deduction for
moving expenses for taxable years begin-
ning after December 31, 2017, and before
January 1, 2026. However, the suspension
does not apply to members of the Armed
Forces on active duty who move pursuant
to a military order and incident to a per-
manent change of station. Thus, except
for taxpayers to whom § 217(g) applies,
the standard mileage rate provided in this
notice is not applicable for the use of an
automobile as part of a move occurring
during the suspension.
SECTION 4. BASIS REDUCTION
AMOUNT
For automobiles a taxpayer uses for
business purposes, the portion of the busi-
ness standard mileage rate treated as de-
preciation is 24 cents per mile for 2016, 25
cents per mile for 2017, 25 cents per mile
for 2018, 26 cents per mile for 2019, and
27 cents per mile for 2020. See section
4.04 of Rev. Proc. 2019-46.
SECTION 5. MAXIMUM
STANDARD AUTOMOBILE COST
For purposes of computing the allow-
ance under a FAVR plan, the standard au-
tomobile cost may not exceed $50,400 for
automobiles (including trucks and vans).
See section 6.02(6) of Rev. Proc. 2019-46.
SECTION 6. MAXIMUM VALUE
OF EMPLOYER-PROVIDED
AUTOMOBILES
For purposes of the fleet-average val-
uation rule in § 1.61-21(d)(5)(v) and the
vehicle cents-per-mile valuation rule in §
1.61-21(e), the maximum FMV of auto-
mobiles (including trucks and vans) first
made available to employees in calendar
year 2020 is $50,400.
SECTION 7. EFFECTIVE DATE
This notice is effective for: (1) de-
ductible transportation expenses paid or
incurred on or after January 1, 2020; (2)
mileage allowances or reimbursements
paid to a charitable volunteer or a member
of the Armed Forces to whom § 217(g) ap-
plies: (a) on or after January 1, 2020, and
(b) for transportation expenses the char-
itable volunteer or such member of the
Armed Forces pays or incurs on or after
January 1, 2020; and (3) for purposes of
the maximum FMV of employer-provided
automobiles for which employers may use
the fleet-average valuation rule in §1.61-
21(d)(5)(v) or the vehicle cents-per-mile
rule in §1.61-21(e), automobiles first
made available to employees for personal
use on or after January 1, 2020.
SECTION 8. EFFECT ON OTHER
DOCUMENTS
Notice 2019-02 is superseded.
DRAFTING INFORMATION
The principal author of this notice is
Anna Gleysteen of the Office of Asso-
ciate Chief Counsel (Income Tax and
Bulletin No. 2020–4 381 January 21, 2020

January 21, 2020 382 Bulletin No. 2020–4
Accounting). For further information on
this notice regarding the use of an em-
ployee-provided automobile, contact
Ms. Gleysteen at (202) 317-7007 (not a
toll-free number). For further informa-
tion on this notice regarding the use of an
employer-provided automobile, contact
Stephanie Caden of the Office of Asso-
ciate Chief Counsel (Employee Benefits,
Exempt Organizations, and Employment
Taxes), at (202) 317-4774 (not a toll-free
number).

Bulletin No. 2020–4 383 January 21, 2020
Part IV
Notice of Proposed
Rulemaking
Source of Income from
Certain Sales of Personal
Property
REG-100956-19
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking.
SUMMARY: This document contains
proposed regulations modifying the rules
for determining the source of income from
sales of inventory produced within the
United States and sold without the Unit-
ed States or vice versa. These proposed
regulations also contain new rules for de-
termining the source of income from sales
of personal property (including inventory)
by nonresidents that are attributable to an
office or other fixed place of business that
the nonresident maintains in the United
States. Finally, these proposed regula-
tions modify certain rules for determining
whether foreign source income is effec-
tively connected with the conduct of a
trade or business within the United States.
DATES: Comments and requests for a
public hearing must be received by Feb-
ruary 28, 2020.
ADDRESSES: Submit electronic submis-
sions via the Federal eRulemaking Portal
at www.regulations.gov (indicate IRS and
REG-100956-19) by following the online
instructions for submitting comments.
Once submitted to the Federal eRulemak-
ing Portal, comments cannot be edited or
withdrawn. The Department of the Trea-
sury (“Treasury Department”) and the
IRS will publish for public availability
any comment received to its public dock-
et, whether submitted electronically or in
hard copy. Send hard copy submissions
to: CC:PA:LPD:PR (REG-100956-19),
Room 5203, Internal Revenue Service,
P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044.
FOR FURTHER INFORMATION CON-
TACT: Concerning the proposed regula-
tions Brad McCormack, (202) 317-6911 or
Anisa Afshar, (202) 317-4999; concerning
submissions of comments and requests for
a public hearing, Regina L. Johnson, (202)
317-6901 (not toll free numbers).
SUPPLEMENTARY INFORMATION:
Background
These regulations (the “proposed reg-
ulations”) contain proposed amendments
to 26 CFR part 1 revising the rules under
section 863 of the Internal Revenue Code
(the “Code”) for determining the source of
gross income from sales of certain prop-
erty, and under section 864 for treating
foreign source income as effectively con-
nected with the conduct of a trade or busi-
ness within the United States. Conforming
revisions are made to current regulations
that reference section 863. The proposed
regulations also provide guidance under
section 865(e)(2) and (3) regarding the
source of income from the sale of person-
al property, including inventory property,
within the meaning of section 865(i)(1)
(“inventory”), by nonresidents.
The Tax Cuts and Jobs Act, Pub. L. 115-
97 (2017) (the “Act”), enacted on Decem-
ber 22, 2017, amended section 863 of the
Code, which provides special rules for de-
termining the source of income, including
income partly from within and partly from
without the United States. Specifically,
section 14303 of the Act amended section
863(b) to allocate or apportion income from
the sale or exchange of inventory property
produced (in whole or in part) by a taxpay-
er within and sold or exchanged without
the United States or produced (in whole or
in part) by the taxpayer without and sold
or exchanged within the United States (col-
lectively, “Section 863(b)(2) Sales”) solely
on the basis of production activities with
respect to that inventory. Before the Act,
section 863(b) provided that income from
Section 863(b)(2) Sales would be treated
as derived partly from sources within and
partly from sources without the United
States without providing the basis for such
allocation or apportionment.
Current §1.863-3 provides rules for
allocating or apportioning gross income
from Section 863(b)(2) Sales. Those rules
provide several methods for determining
the amount of gross income from Section
863(b)(2) Sales that is attributable to pro-
duction activity and the amount of gross
income attributable to sales activity, with
different rules then applying to source
the portion of the income derived from
production activity versus sales activity.
See current §1.863-3(b). Current §1.863-
3(f) provides rules for gains, profits, and
income that are treated as derived partly
from sources within the United States and
partly from sources within a possession
of the United States (generally referred to
herein as a “U.S. territory”).
With respect to production activity,
current §1.863-3(c)(1)(ii) provides a for-
mula for allocating or apportioning gross
income where there is production activity
both within and without the United States.
Current §1.863-3(c)(1)(ii)(A) determines
the amount of income from sources with-
out the United States by multiplying all the
income attributable to taxpayer’s produc-
tion activities by a fraction, the numerator
of which is the average adjusted basis of
production assets that are located outside
the United States and the denominator of
which is the average adjusted basis of all
the production assets located within and
without the United States. For purposes of
applying this formula, the adjusted basis
of production assets is determined under
section 1011, which is adjusted under sec-
tion 1016 for depreciation deductions al-
lowed. Section 13201 of the Act amended
section 168(k) to allow an additional first-
year depreciation deduction of 100 per-
cent of the basis of certain property placed
in service after September 27, 2017, and
before January 1, 2023. Therefore, certain
new and used production assets placed in
service and used predominantly within the
United States during this period may have
an adjusted basis of zero. After December
31, 2022, qualifying property placed in
service before January 1, 2027 (or, in the
case of certain property, January 1, 2028),
is still subject to accelerated depreciation
for an amount equal to the applicable
percentage of the basis of the property.

January 21, 2020 384 Bulletin No. 2020–4
Section 168(k)(1) and (6). However, pro-
duction assets placed in service or used
predominantly without the United States,
or both, do not qualify for this accelerat-
ed depreciation and must be depreciated
using the straight line method under the
alternative depreciation system (“ADS”)
of section 168(g)(2). See section 168(g)
(1)(A).
Section 865, added to the Code as part
of the Tax Reform Act of 1986, Pub. L.
99-514 (1986) (the “TRA”), provides
rules for sourcing sales of personal prop-
erty. The general rule of section 865(a)
(1) is that income from a sale of personal
property is sourced based on the residence
of the seller. Section 865(b) excepts in-
ventory from this rule and sources income
from the sale of inventory generally based
on either the place of sale (for purchased
inventory under section 861(a)(6) or
862(a)(6)) or based on the allocation and
apportionment rules of section 863 (for
inventory produced by the taxpayer). The
place of sale rules typically depend upon
the location where title to the inventory
passes from the seller to the buyer. See
§1.861-7(c).
Section 865(c) provides special rules
for sourcing gain from the sale of depre-
ciable personal property. Under section
865(c)(1), gain from the sale of deprecia-
ble personal property that is not in excess
of depreciation adjustments is allocated
between sources within and without the
United States by treating the same pro-
portion of such gain as sourced within the
United States as the United States depre-
ciation adjustments (as defined in section
865(c)(3)) with respect to such property
bear to the total depreciation adjustments,
and by treating the remaining portion of
such gain as sourced without the United
States. Under section 865(c)(2), gain in
excess of the depreciation adjustments is
sourced as if such property were invento-
ry.
Section 865(e)(2) provides a further
overlay to these rules with respect to all
sales of personal property (including in-
ventory) by nonresidents, as that term is
defined in section 865(g)(1)(B), attrib-
utable to an office or other fixed place
of business in the United States. Section
865(e)(2)(A) generally provides that in-
come from any sale of personal property
attributable to such an office or other fixed
place of business is sourced in the United
States. An exception is provided in section
865(e)(2)(B) for a sale of inventory for
use, disposition, or consumption outside
the United States if a foreign office of the
nonresident “materially participated” in
the sale. Section 865(e)(3) provides that
the “principles of section 864(c)(5) shall
apply” to determine whether a nonresi-
dent has an office or other fixed place of
business and whether a sale is attributable
to such office or other fixed place of busi-
ness. Where applicable, section 865(e)(2)
applies “[n]otwithstanding any other pro-
visions” of subchapter N, part I, including
sections 863(b), 861(a)(6), and 862(a)(6).
Section 864(c) provides the general
rules for determining whether income is
treated as effectively connected with the
conduct of a trade or business within the
United States. Nonresident alien individ-
uals, foreign corporations, and bona fide
residents of a U.S. territory (“non-U.S.
persons”) engaged in a trade or business
within the United States are generally
subject to U.S. net basis taxation on in-
come that is effectively connected with
that trade or business. Section 864(c)(2)
provides that income described in section
871(a)(1) or (h) or section 881(a) or (c), as
well as U.S. source capital gains or losses,
are determined to be effectively connect-
ed or not based on two tests—whether the
income is “derived from assets” used in
the non-U.S. person’s trade or business or
whether the activities of the trade or busi-
ness were a “material factor” in the real-
ization of the income. Section 864(c)(3)
generally treats U.S. source income not
described in section 864(c)(2) as effec-
tively connected with a non-U.S. person’s
trade or business within the United States.
Section 864(c)(4)(B) sets forth additional
rules that treat certain foreign source in-
come as effectively connected with the
conduct of a U.S. trade or business if a
non-U.S. person has an office or other
fixed place of business within the United
States to which the income is attributable,
including income from certain sales of in-
ventory as described in section 864(c)(4)
(B)(iii).
Section 864(c)(5)(A) provides rules
for determining whether a non-U.S. per-
son has an office or other fixed place of
business to which section 864(c)(4)(B)
may apply as the result of the presence of
an agent in the United States, and section
864(c)(5)(B) provides a threshold require-
ment for determining whether any income
is attributable to such an office or other
fixed place of business. Once it is deter-
mined that an office or other fixed place of
business in the United States exists and in-
come is attributable thereto, section 864(c)
(5)(C) provides that the amount of income
so attributable is generally the amount that
is properly allocable to the office or other
fixed place of business. Section 864(c)(5)
(C) further provides that, with respect to
certain sales of inventory described in sec-
tion 864(c)(4)(B)(iii), the amount attribut-
able to the office or fixed place of business
cannot exceed the income that would oth-
erwise have been U.S. source had the sale
been made in the United States. As noted,
the principles of section 864(c)(5) apply
in the context of section 865(e)(2) pursu-
ant to section 865(e)(3).
Explanation of Provisions
Consistent with the Act’s changes to
section 863(b)(2), these proposed regula-
tions amend §1.863-3 in order to properly
allocate or apportion gross income from
Section 863(b)(2) Sales based solely on
production activity, and remove the meth-
ods for allocating or apportioning gross
income between production and sales
activity. In addition, because of the Act’s
change to section 168(k) to allow acceler-
ated depreciation in some circumstances,
these proposed regulations provide a new
rule for computing the adjusted basis of
production assets for purposes of applying
the formula for allocating or apportioning
gross income where there is production
activity both within and without the Unit-
ed States. These proposed regulations also
contain conforming amendments to other
regulations that allocate or apportion in-
come between production and sales activ-
ity. In addition, these proposed regulations
make minor changes to §§1.937-2, 1.937-
3, and 1.1502-13 to update relevant cross
references and examples.
These regulations also add proposed
§1.865-3 to clarify the proper scope and
application of section 865(e)(2), as well as
the interaction between section 865(e)(2)
and section 865(c) regarding the sourcing
of income from the sale of certain depre-
ciable personal property. The proposed

Bulletin No. 2020–4 385 January 21, 2020
regulations also clarify the interaction be-
tween the section 865(e)(2) rules and the
rules governing effectively connected in-
come under section 864(c)(4)(B)(iii) and
(c)(5). The proposed regulations amend
§1.864-6(c), the current rules for deter-
mining the amount of foreign source ef-
fectively connected income attributable to
an office or other fixed place of business
within the United States, to be consistent
with the proposed sourcing rules applica-
ble to produced inventory sales under sec-
tion 865(e)(2).
I. Modification of Current §1.863-3
and Other Regulations to Reflect the
Amendments of Section 863(b) and
Section 168(k)
A. Proposed changes to §1.863-3 to
reflect the amendment of section 863(b)
Before amendment by the Act, sec-
tion 863(b)(2) provided that gains, prof-
its, and income from Section 863(b)(2)
Sales were sourced partly from sources
within and partly from sources without
the United States, but did not prescribe
a particular method of allocating or ap-
portioning between these two sources.
Accordingly, current §1.863-3 provides
allocation or apportionment methods for
Section 863(b)(2) Sales. Under those reg-
ulations, a taxpayer must allocate or ap-
portion gross income from Section 863(b)
(2) Sales between production activity and
sales activity using one of three meth-
ods described in current §1.863-3(b): the
50/50 method described in paragraph (b)
(1), the independent factory price (“IFP”)
method described in paragraph (b)(2), or
the books and records method described
in paragraph (b)(3). Current §1.863-3(d)
provides rules for allocating and appor-
tioning expenses to gross income from
Section 863(b)(2) Sales, including a re-
quirement to apportion expenses pro rata
based on the source of gross income where
the 50/50 method has been used. Current
§1.863-3(e) provides rules for electing
one of these methods and the related in-
formation that a taxpayer must disclose on
a tax return.
The Act amended section 863(b) to
source income from Section 863(b)(2)
Sales solely on the basis of the produc-
tion activity with respect to the invento-
ry sold, and as a result sales activity is no
longer a relevant factor for allocating or
apportioning income under that section.
Therefore, these proposed regulations
remove the three methods in paragraph
(b) and the related election rules in para-
graph (e). Proposed §1.863-3(b) requires
sourcing of Section 863(b)(2) Sales based
solely on the location of production activ-
ities, consistent with section 863(b)(2),
as amended. Given the elimination of the
50/50 method, the proposed regulations
no longer provide for the apportionment
of expenses based solely on relative gross
income from U.S. and foreign sources.
Instead, the proposed regulations provide
that expenses are allocated and appor-
tioned based on the generally-applicable
rules in §§1.861-8 through 1.861-17.
B. Proposed changes to §1.863-3(e)
Proposed §1.863-3(e) (which replac-
es current §1.863-3(f)) does not provide
a specific rule for sourcing gross income
derived from the sale of inventory pro-
duced (in whole or in part) by the tax-
payer within the United States and sold
within a U.S. territory, or produced (in
whole or in part) by a taxpayer in a U.S.
territory and sold within the United States.
Instead, proposed §1.863-3(e) provides
a cross-reference directing taxpayers to
source such income under the rules pro-
vided by proposed §1.863-3(c). Proposed
§1.863-3(e) modifies the rule for sourcing
gross income derived from the purchase
of personal property within a U.S. terri-
tory and its sale within the United States
under section 863(b)(3). Consistent with
proposed §1.863-3(b), proposed §1.863-
3(e) removes the books and records meth-
od provided by current §1.863-3(f)(3)(i)
(B). Instead, proposed §1.863-3(e)(3)(i)
requires sourcing such income based sole-
ly upon the taxpayer’s business activity.
C. Proposed changes to §1.863-3 to
reflect the amendment of section 168(k)
Notwithstanding the changes to section
863(b) required by the Act, there remains
a need for rules to allocate or apportion
gross income from Section 863(b)(2)
Sales between U.S. and foreign sources
where, with respect to inventory, there
is production activity both within and
without the United States. The proposed
regulations retain the existing rules in cur-
rent §1.863-3(c)(1)(ii) for sourcing gross
income from production activity where
there is production activity both within
and without the United States. The pro-
posed regulations do not amend current
§1.863-3(c)(1)(ii)(A), which determines
the amount of foreign source income in
such cases by multiplying the total gross
income from Section 863(b)(2) Sales by a
fraction, the numerator of which is the av-
erage adjusted basis of production assets
located outside the United States and the
denominator of which is all production as-
sets within and without the United States.
The remaining income is treated as U.S.
source.
Because of the Act’s change to section
168(k) to allow accelerated depreciation
in some circumstances, the Treasury De-
partment and the IRS have determined
that a new rule is needed in current
§1.863-3(c)(1)(ii)(B) for computing the
adjusted basis of production assets for
purposes of the formula for allocating or
apportioning gross income where there is
production activity both within and with-
out the United States. Absent a change to
the rules of current §1.863-3(c)(1)(ii)(B),
the Act’s modifications to the deprecia-
tion treatment of U.S. production assets
will have the unintended effect of skew-
ing the apportionment formula in favor of
foreign source income because non-U.S.
production assets (relative to U.S. produc-
tion assets) will generally have a higher
adjusted basis. Therefore, these proposed
regulations modify the measurement of
the basis of U.S. production assets under
current §1.863-3(c)(1)(ii)(B) for purposes
of the apportionment formula of proposed
§1.863-3(c)(2)(i). The proposed regula-
tions measure the basis of U.S. production
assets based on ADS under section 168(g)
(2) so that the basis of both U.S. and non-
U.S. production assets is measured consis-
tently on a straight line method over the
same recovery period.
The Treasury Department and the
IRS have determined that requiring the
use of ADS for purposes of proposed
§1.863-3 is consistent with other provi-
sions of the Act that require the use of
ADS. For example, sections 951A(d)(3)
and 250(b)(2)(B) (by cross reference to
section 951A(d)) both require the use of

January 21, 2020 386 Bulletin No. 2020–4
ADS for purposes of determining quali-
fied business asset investment to calcu-
late global intangible low-taxed income
and foreign-derived intangible income,
respectively. The use of ADS is also con-
sistent with the interest allocation rules
in §1.861-9(i)(1)(i). Nevertheless, the
Treasury Department and the IRS request
comments regarding the suitability of us-
ing ADS for these purposes and whether
there is a more appropriate way to com-
pare U.S. and non-U.S. production assets
for purposes of proposed §1.863-3, such
as the relative U.S. and non-U.S. produc-
tion assets reported on the taxpayer’s fi-
nancial statements.
The proposed regulations do not other-
wise modify the rules in current §1.863-3
for determining the location or existence
of production activity, a topic the Treasury
Department and the IRS may address in
future guidance. The Treasury Department
and the IRS request comments regarding
other potential approaches to determine
the location or existence of production
activity or other modifications to current
or proposed §1.863-3 that may be appro-
priate.
D. Proposed changes to other regulations
under section 863 to reflect the changes
to §1.863-3
The proposed regulations also modify
current §1.863-1, current §1.863-2, and
current §1.863-8 to reflect the changes to
current §1.863-3. Proposed §1.863-1(b)
provides special rules for allocating or ap-
portioning gross income from the sale of
natural resources, which can be a subset of
inventory generally. See proposed §1.863-
2(b). Current §1.863-1(b)(1) provides a
general “export terminal” rule that allo-
cates sales income at the export terminal,
sourcing gross receipts equal to the fair
market value of the natural resources at
the export terminal to the location of the
farm, mine, well, deposit, or uncut timber,
and gross receipts in excess of that amount
either to the place of sale or according to
the rules in §1.863-3, depending on the
circumstances.
Current §1.863-1(b)(2) provides a
special rule for taxpayers performing
additional production activities before
the relevant product is shipped from the
export terminal. The gross receipts are
allocated between sources within and
without the United States based on the
fair market value of the product imme-
diately before the additional production
activities. Gross receipts equal to the fair
market value of the natural resources im-
mediately before the additional produc-
tion activities are sourced to the location
of the farm, mine, well, deposit or uncut
timber, and the gross receipts in excess of
that fair market value are sourced based
on § 1.863-3.
As it is generally no longer appropri-
ate under section 863(b)(2) to allocate or
apportion any gross income from sales of
inventory, including natural resources, to
sales activity, the proposed regulations
modify current §1.863-1(b) to remove the
export terminal rule so that, where there
is no additional production activity with
respect to the natural resource, all gross
income from sales of natural resources
inventory is based on the location of the
farm, mine, oil or gas well, other natu-
ral deposit, or uncut timber from which
the natural resource is derived. In other
words, where there are no additional pro-
duction activities, the location of the farm,
mine, oil or gas well, other natural depos-
it, or uncut timber is considered the place
of production generally.
1
Where there are additional production
activities with respect to the natural re-
source either within or without the juris-
diction from which the natural resource is
derived, the gross income is allocated or
apportioned first to the jurisdiction where
the farm, mine, oil or gas well, other nat-
ural deposit, or uncut timber is located, in
an amount equal to the fair market value
of the product before the additional pro-
duction activities. Any income in excess
of that fair market value is then allocat-
ed or apportioned between sources with-
in and without the United States under
proposed §1.863-3 principles based on
the location of the assets used in the addi-
tional production activities. See proposed
§1.863-1(b)(2).
In the case of sales of natural resources
by a nonresident that are attributable to an
office or other fixed place of business in
the United States of such nonresident, the
foregoing rules are subject to the rules of
section 865(e)(2) and proposed §1.865-3.
Current §1.863-8(b)(3)(ii) provides a
special rule for allocating and apportion-
ing income under section 863(d) derived
from sales of property (including inven-
tory) produced by a taxpayer if the prop-
erty is produced or sold, at least in part,
in space or international water. This rule
requires the taxpayer to allocate gross
income from such sales between pro-
duction and sales activity under a 50/50
method, whereby half of the taxpayer’s
gross income will be considered income
allocable to production activity and the
remaining half of such gross income
will be considered income allocable to
sales activity. As it is generally no lon-
ger appropriate under section 863(b)(2)
to allocate or apportion any gross income
from sales of inventory produced by a
taxpayer (including production in space
or international water) to sales activity,
the proposed regulations modify current
§1.863-8(b)(3)(ii) to remove the 50/50
method and replace it with a rule that al-
locates gross income solely on the basis
of production activity.
E. Proposed changes to regulations under
section 1502 to reflect the changes to
§1.863-3
To reflect section 863(b)(2), as amend-
ed by the Act, and the proposed regula-
tions’ amendments to §1.863-3, the pro-
posed regulations also amend example 14
of §1.1502-13(c)(7)(ii)(N). This example
illustrates the interaction between the in-
tercompany transaction rules under cur-
rent §1.1502-13 and the sourcing rules in
section 863. As revised by the proposed
regulations, the example continues to il-
lustrate the same matching principles for
intercompany transactions under proposed
§1.1502-13 while updating the facts and
<?>
Treasury Decision 8687, 1996-2 C.B. 47, added the export terminal rule in current §1.863-1(b) partly in response to the decision in Phillips Petroleum Co. v. Commissioner, 97 T.C. 30
(1991), aff’d without published opinion, 70 F.3d 1282 (10th Cir. 1995). These proposed regulations follow Phillips Petroleum in treating natural resources, once extracted, in the same way
as other types of inventory and therefore subject to section 863(b)(2), as amended.

Bulletin No. 2020–4 387 January 21, 2020
analysis to reflect the changes in section
863(b)(2) and §1.863-3.
II. Proposed Rules for Sales of Personal
Property by Nonresidents
A. Proposed source rules under §1.865-3
to take into account section 863(b)
1. Interaction of Section 863(b), as
Amended, with Section 865(e)(2)
In light of the changes made by the Act
to section 863(b), the Treasury Depart-
ment and the IRS are concerned that non-
resident taxpayers may take an improper
position that these changes override the
application of section 865(e)(2) as it ap-
plies to sales
2
of inventory
3
produced by
a nonresident taxpayer and sold through
a U.S. sales office, despite the fact that
section 865(e)(2) applies “[n]otwithstand-
ing any other provisions in [sections 861
through 865].” To address this improper
interpretation of section 865(e)(2), and
to provide guidance for the application of
section 865(e)(2) in general, the proposed
regulations add proposed §1.865-3.
Section 865, enacted in 1986 as part of
the TRA, provides special sourcing rules
for sales of personal property. In partic-
ular, section 865(e)(2) provides that “[n]
otwithstanding any other provisions of
this part,” if a nonresident has an office or
other fixed place of business in the United
States, “income from any sale of person-
al property (including inventory prop-
erty) attributable to such office or other
fixed place of business” is U.S. source.
Accordingly, to the extent that inventory
income described in section 863(b)(2) is
considered to be derived from a sale by
a nonresident attributable to an office or
other fixed place of business in the Unit-
ed States, section 865(e)(2) must be given
effect in determining the source of the in-
come.
For purposes of section 865(e)(2),
section 865(e)(3) provides that the “prin-
ciples of section 864(c)(5)” apply in de-
termining “whether a taxpayer has an of-
fice or other fixed place of business” and
“whether a sale is attributable” thereto.
As described in the Background section
of this preamble, section 864(c)(5)(A)
provides rules for determining whether
a non-U.S. person has an office or other
fixed place of business to which section
864(c)(4)(B) may apply as the result of the
presence of an agent in the United States,
section 864(c)(5)(B) provides a threshold
requirement for determining whether any
income is attributable to such an office
or other fixed place of business, and sec-
tion 864(c)(5)(C) addresses the extent to
which the income, gain, or loss is attrib-
utable to an office or other fixed place of
business and includes a limitation that for
sales of inventory, the income attributable
to an office or other fixed place of busi-
ness within the United States cannot ex-
ceed “the income which would be derived
from sources within the United States if
the sale or exchange were made in the
United States.”
Section 865(e)(2) may properly be read
to treat all income from a sale of personal
property by a nonresident as U.S. source
so long as the sale is “attributable” to the
nonresident’s office or other fixed place of
business in the United States. By its terms,
section 865(e)(3) does not necessarily
change this result because it references
section 864(c)(5) only for purposes of (1)
determining whether a taxpayer has an of-
fice or other fixed place of business and
(2) whether a sale is attributable to such
office or other fixed place of business.
Section 865(e)(3) does not by its terms
reference section 864(c)(5) for determin-
ing the amount of income attributable to
such office or other fixed place of busi-
ness. On this basis, section 865(e) may
fairly be read to override section 863(b)
where Section 863(b)(2) Sales of a non-
resident are attributable to an office or
other fixed place of business in the United
States, with the result that all of the in-
come from such sales is sourced within
the United States.
On the other hand, section 865 con-
cerns the source of income, gain, and
loss, and section 865(e)(3) refers to “the
principles of section 864(c)(5),” which
determines “income, gain or loss” attrib-
utable to an office or other fixed place of
business in the United States (as noted in
subparagraphs 864(c)(5)(B) and 864(c)
(5)(C), which operate together). On this
basis, the Treasury Department and the
IRS have determined that section 864(c)
(5) may serve not only as the basis to attri-
bute a sale to an office or other fixed place
of business in the United States with-
in the meaning of section 865(e)(2), but
also as the basis, in the context of section
865(e)(2) as applicable to Section 863(b)
(2) Sales, for allowing a limitation on the
amount of income and gain from sales of
inventory property attributable to such of-
fice or other fixed place of business and,
therefore, sourced in the United States. In
particular, as relevant here, section 864(c)
(5)(C) limits the amount of “income, gain,
or loss” from sales that meet the “material
factor” threshold of section 864(c)(5)(B)
to the amount of income “properly allo-
cable” to the office or other fixed place of
business in the United States
4
(which is a
lesser amount of income than would be
allocated based on such sale under a liter-
al reading of section 865(e)(2) (the entire
amount of income)).
The last clause of section 864(c)(5)
(C) also imposes a limitation in the case
of sales described in section 864(c)(4)(B)
(iii) (sales outside the United States made
through an office or other fixed place of
business in the United States) that “the in-
come which shall be treated as attributable
to an office or other fixed place of busi-
ness within the United States shall not ex-
ceed the income which would be derived
from sources within the United States if
the sale or exchange were made in the
United States.” Before the enactment of
section 865(e)(2), which generally caused
such sales to result in U.S. source income
and hence fall outside the scope of section
864(c)(4)(B)(iii), this clause was intended
to limit the application of section 864(c)
(4)(B) to income from sales activities,
thus excluding income from production
2
As defined in section 865(i)(2).
3
Inventory property, as defined in section 865(i)(1).
4
Section 864(c)(5)(C) actually states “the income, gain or loss property [sic] allocable thereto.” Based on the legislative history behind The Foreign Investors Tax Act, Pub. L. 89-809 (1966),
which added section 864(c) to the Code, the use of “property” in the final bill appears to be a typographical error. The Senate Report that added this provision used the word “properly” not
“property.” See S. Rep. No. 1707 at 1275 (1966).

January 21, 2020 388 Bulletin No. 2020–4
activities. The clause did not determine
how much income was attributable to
sales versus production activities. Follow-
ing the Act, which did not amend section
865(e)(2), the Treasury Department and
the IRS continue to believe that this clause
has no relevance to the determination of
how much income is attributable to sales
activities or to sales governed by section
865(e)(2).
By incorporating the principles of sec-
tion 864(c)(5), section 865(e)(3) thus au-
thorizes regulations that would bifurcate
the income from a sale of inventory prop-
erty produced by a nonresident outside the
United States and sold through an office or
other fixed place of business in the Unit-
ed States so that only the “properly allo-
cable” amount of income from that sale
is attributable to an office or other fixed
place of business in the United States and
treated as U.S. source. In such a case, this
amount reflects the nonresident’s sales ac-
tivity, not its production activities, with re-
spect to the personal property sale, which
is the portion of the income that Congress
intended to treat as U.S. source when it
enacted section 865(e)(2) in 1986.
5
H.R.
Rep. No. 99-426, at 360-61 (1985).
The 1986 legislative history of section
865(e)(2) shows that Congress intend-
ed, by enacting that provision, to repeal
(in certain cases) the title passage rule
that formerly controlled the source of the
“sales income” from the sale of personal
property, regardless of where the “sales
activities” occurred. See H.R. Rep. No.
99-426, at 360 (1985) (providing that “[a]
lthough the title passage rule operates
clearly, it is manipulable”); see also S.
Rep. No. 99-313, at 330-33 (1986). The
legislative history shows that Congress
rather sought to tax “income derived from
sales” based on the “location of the eco-
nomic activity generating the income.” See
S. Rep. No. 99-313, at 330 (1986); H.R.
Rep. No. 99-426, at 360 (1985). “If the
seller maintains a fixed place of business
outside the seller’s country of residence
which materially participates in a sale, ...
the committee generally believes that the
level of economic activity with respect to
the sale that is associated with that place
of business is high enough such that the
location of that place of business should
govern the source of the sales income.”
H.R. Rep. No. 99-426, at 360-61 (1985).
These statements show, both individually
and in the aggregate, that Congress en-
acted section 865(e)(2) with a focus upon
sourcing income from sales activity based
on the economic location of the activity,
rather than the location of title passage.
The principles of section 864(c)(5) (and in
particular subparagraph (C) thereof) give
effect to this intent through section 865(e)
(3) by limiting the application of section
865(e)(2) to sales income properly allo-
cable to the office or other fixed place of
business in the United States.
Before the issuance of these proposed
regulations, the Treasury Department and
the IRS had never issued formal guidance
on the sourcing rules of section 865(e)(2)
in the case of inventory property produced
outside the United States and sold within
the United States. Nevertheless, in light
of the statutory text of section 865(e)(2)
and (3) (as well as section 864(c)(5)(C)
by reference) and the legislative history of
these provisions, in practice, the IRS has
historically interpreted section 865(e)(2)
to include a limitation that treated as U.S.
source only the sales income allocable to
the office or other fixed place of business
in the United States reflecting the sales ac-
tivity from the transaction. See, e.g., 1996
Field Service Advice (FSA) LEXIS 68
(Sept. 24, 1996); 1996 FSA LEXIS 465
(Feb. 29, 1996). This historical interpre-
tation utilized the rules of section 863(b)
before amendment by the Act (referenced
in current §1.864-6(c)) to determine the
amount of income allocable to the office
or other fixed place of business in the
United States, thereby allowing taxpay-
ers to apply, among other rules, a 50/50
split between U.S. source income (allo-
cable to the office or other fixed place of
business in the United States and reflec-
tive of sales activity) and foreign source
income (reflective of production activi-
ty) for sales subject to section 865(e)(2)
(the “50/50 method”). The IRS has his-
torically allowed the 50/50 method for
establishing the amount allocable to the
office or other fixed place of business in
the United States (and the sales activity)
under section 864(c)(5). Section 865(e)
(3) incorporates into section 865(e)(2) the
principles of section 864(c)(5), and so the
50/50 method approximated the effect of
applying the principles of section 864(c)
(5) under section 865(e)(2).
Although the Act amended section
863(b), it made no changes to section
865(e)(2), which does not explicitly ref-
erence or depend upon section 863. The
2018 Blue Book notes the absence of any
change to section 865(e)(2). See 2018
Blue Book at 397 n.1798. Consistent with
historical IRS practice, in its description
of prior law, the 2018 Blue Book explains
that although sections 863(b) and 865(e)
(2) may appear to conflict, in the case of
a nonresident manufacturing property
without the United States for sale within
the United States, the result is that “the in-
come generally is partly U.S.-source and
partly foreign-source.”
6
Id. at 328 n.1519.
Further, despite the changes to section
863(b) in the Act, structurally, the bifur-
cated approach is maintained, and section
863(b)(2) continues to refer to inventory
that is produced within the United States
and sold without the United States, or
produced without the United States and
sold within the United States. The statu-
tory provision preserves the distinction
between sales and production economic
activity. If Congress intended to eliminate
the sales versus production dichotomy for
all purposes, it presumably would have
deleted those phrases as the new flush
language (that any sale of manufactured
inventory property is sourced in whole
based on the location of production activ-
ities) would have made them surplusage.
In light of Congress’s decision to retain
the underlying structure of section 863(b)
(2) and append the flush language as an
overlay, the IRS’s longstanding interpreta-
tion of the relationship of sections 863(b)
5
In the case of inventory property purchased outside the United States (other than in a U.S. territory of the United States) and sold through an office or other fixed place of business in the
United States, section 863(b) has no application and hence, regardless of where title passage occurs, all of the income is considered attributable to such office or other fixed place of business
and sourced in the United States.
6
This statement appears to conflict with another statement in the 2018 Blue Book with respect to prior law to the effect that the application of section 865(e)(2) to a sale of personal property
made by a nonresident attributable to its office or fixed place of business in the United States results in all income from the sale being sourced in the United States. Id. at 396-97.

Bulletin No. 2020–4 389 January 21, 2020
(2) and 865(e)(2) under pre-Act law, and
the fact that section 865(e)(2) was left
unaltered by the Act, the Treasury Depart-
ment and the IRS have determined that
the relationship between section 863(b)(2)
and section 865(e)(2) should not be inter-
preted differently before and after the Act.
Thus, section 865(e)(2) should continue
to apply to inventory property sales in-
come “properly allocable” to an office or
other fixed place of business in the United
States (reflecting sales activity rather than
production activity) just as before the Act.
As noted, the Treasury Department and
the IRS understand that some nonresident
taxpayers may be taking the position that,
applied after the Act, the last clause of
section 864(c)(5)(C) (limiting the income
treated as attributable to an office or oth-
er fixed place of business in the United
States to the amount that would be U.S.
source if the sale were made in the Unit-
ed States) causes the income from the sale
of inventory produced outside the United
States and subject to section 865(e)(2) to
be foreign source to the same extent that
it would be foreign source under section
863(b), standing alone, which would
cause the sourcing of both the sales and
production income from the disposition to
be based on the location of production ac-
tivities. Such a reading cannot be correct,
because it would inappropriately construe
a provision (section 865(e)(2)) intend-
ed as a separate restriction on the source
rule under section 863(b)(2) (and which
literally can be read as entirely overrid-
ing that rule) to be determined solely by
reference to the terms of such source rule
itself (rather than at most in a manner giv-
ing effect to both rules). Further, such a
construction would cause section 865(e)
(2) to have no effect with respect to sales
of inventory that are also described in sec-
tion 863(b)(2), contrary to longstanding
statutory construction principles. See, e.g.,
Watt v. Alaska, 451 U.S. 259, 267 (1981)
(statutes should be read to give effect to
each if it can be done so while preserving
their sense and purpose).
Moreover, such a reading would, in ef-
fect, import the change in section 863(b)
from the Act into section 865(e)(2), which
Congress did not do. As noted, section
865(e)(2) applies “[n]otwithstanding any
other provisions.” Section 865(e)(3) ap-
plies the “principles” of section 864(c)(5),
which reflects the sometimes imprecise
fit between sections 864(c)(5) and 865(e)
(2), such as the fact that section 864(c)
(5) refers to “income, gain or loss,” rather
than a “sale,” attributable to an office or
other fixed place of business in the United
States. The relevant principles referenced
in section 865(e)(3) are those that apply for
purposes of determining the income, gain,
or loss attributable to an office or fixed
place of business in the United States. As
discussed previously in this section of the
Explanation of Provisions, the last clause
of section 864(c)(5)(C) is not relevant to
that determination and therefore is not rel-
evant to the application of sections 863(b)
or 865(e)(2). The principles of section
864(c)(5) are those self-contained in the
words of the provision itself (“properly
allocable”), and not the limitation provid-
ed in the last clause of section 864(c)(5)
(C) that serves a different purpose. The
amendment to section 863(b)(2) did not
change the traditional analysis regarding
the attribution of inventory sales to an of-
fice or other fixed place of business in the
United States.
In light of the foregoing, these pro-
posed regulations clarify the application
of the principles of section 864(c)(5) in
the context of section 865(e)(2) and pro-
vide that sales of inventory produced out-
side the United States and sold through an
office maintained by the nonresident in
the United States must be sourced in the
United States in part.
2. Overview of the Proposed Regulations
under Section 865(e)(2)
Section 865(e)(2) sources the amount
of income from sales described in section
865(e)(2)(A) to which the exception in
section 865(e)(2)(B) does not apply (Sec-
tion 865(e)(2) Sales) that is determined to
be properly allocable to the nonresident’s
office or other fixed place of business in
the United States under the principles of
section 864(c)(5)(C) as referenced by sec-
tion 865(e)(3). In cases where a sale of
personal property is not a Section 865(e)
(2) Sale, other sourcing provisions contin-
ue to apply.
Proposed §1.865-3(a) sets forth the
general rule in section 865(e)(2)(A), and
proposed §1.865-3(b) sets forth the excep-
tion in section 865(e)(2)(B) and cross-ref-
erences the rules of §1.864-6(b)(3) to
determine if a foreign office materially
participated in the sale. Proposed §1.865-
3(c) sets forth the rules for determining
whether a nonresident has an office or
other fixed place of business in the United
States by incorporating the principles of
§1.864-7, and whether a sale of personal
property is attributable to that office or
other fixed place of business in the United
States by incorporating the principles of
§1.864-6(b) and (c), as amended.
Proposed §1.865-3(d) then provides
rules for determining the amount of in-
come that is treated as U.S. source; the
rules depend on whether the property sold
is inventory (including property treated as
inventory under section 865(c)(2)) or oth-
er personal property of a nonresident sold
in a sale attributable to an office or other
fixed place of business in the United States
of the nonresident. Proposed §1.865-3(d)
provides separate source rules for income
from sales of inventory subject to section
865(e)(2), dependent on whether the non-
resident produced the inventory (either the
default 50/50 method in paragraph (d)(2)
(i) or the elective books and records meth-
od in paragraph (d)(2)(ii)), or purchased
the inventory, 100 percent U.S. source
income in paragraph (d)(3). Proposed
§1.865-3(d)(2)(ii) provides the books and
records method that a taxpayer can elect to
apply in lieu of the default 50/50 method,
including the rules for making that elec-
tion and the records that must be provided
to the Commissioner upon request. To the
extent income from either type of invento-
ry sale is treated as U.S. source under pro-
posed §1.865-3(d)(2) or (3), the income
will generally be effectively connected
with the conduct of a U.S. trade or busi-
ness under section 864(c)(3).
Proposed §1.865-3(e) provides a cross
reference to the rules in §§1.882-4 and
1.882-5, which determine the amount of
expenses that are properly allocated and
apportioned to gross income effectively
connected with the conduct of a trade or
business in the United States.
3. The proposed rules for non-inventory
property
Section 864(c)(2) applies to determine
whether U.S. source gain from the sale of
non-inventory property and other capital

January 21, 2020 390 Bulletin No. 2020–4
assets by a non-U.S. person is effectively
connected with the conduct of a U.S. trade
or business. The proposed regulations im-
plement section 865 and provide source
rules for determining whether gain is U.S.
source for purposes of section 864(c)(2).
In the case of income derived from
the sale of depreciable personal property,
section 865(c) distinguishes between gain
not in excess of depreciation adjustments
and gain in excess of depreciation adjust-
ments, and bifurcates the gain not in ex-
cess of depreciation adjustments pro rata
to depreciation deductions allowable in
computing taxable income from sources
within the United States and without the
United States. Section 865(c)(1). Gain
in excess of depreciation is sourced as if
such property were inventory property.
Section 865(c)(2) and proposed §1.865-
3(d)(4). See section II.A.4 of this Expla-
nation of Provisions for discussion of the
sourcing of inventory property. The leg-
islative history of section 865(c), which
was enacted at the same time as section
865(e)(2), indicates that Congress intend-
ed to create a special rule for depreciable
personal property to source the income
derived from the sale of depreciable per-
sonal property, to the extent of prior de-
preciation deductions, under a recapture
principle. Under this rule, gain from the
sale of depreciable personal property, to
the extent of prior depreciation deduc-
tions, is sourced within the United States
in proportion to the extent of the deprecia-
tion deductions that were previously allo-
cated against U.S. source income. On the
other hand, the gain, to the extent of prior
depreciation deductions, is sourced with-
out the United States in proportion to the
extent of the depreciation deductions that
were previously allocated against foreign
source income. See H.R. Rep. No. 99-426,
at 364 (1985); S. Rep. No. 99-313, at 331-
32 (1986); Joint Committee on Taxation,
General Explanation of the Tax Reform
Act of 1986 (Pub. L. 99-514), JCS-10-87,
at 63 (1987). Thus, Congress intended to
apply the recapture rule to source gain, not
in excess of depreciation, from a sale of
depreciable personal property (as opposed
to sourcing that gain based on the location
of the taxpayer’s office).
Consistent with this legislative history,
the Treasury Department and the IRS have
determined that, to the extent a nonresi-
dent previously allocated depreciation de-
ductions against foreign source income, in
the event of a sale of such property through
an office or other fixed place of business
in the United States, the associated gain
is not “properly allocable” to an office or
other fixed place of business in the Unit-
ed States under the principles of section
864(c)(5), and therefore to such extent
the sale (and gain) is not attributable to a
nonresident’s office or other fixed place of
business in the United States under sec-
tion 865(e)(2). Therefore, in the case of
income subject to section 865(e)(2) from
the sale of depreciable personal property,
the amount of gain, not in excess of de-
preciation deductions, that is allocable to
the nonresident’s office or fixed place of
business within the United States is the
amount of gain that would be attributable
to United States depreciation deductions
under the recapture rule of section 865(c)
(1). To the extent the gain exceeds prior
U.S. and non-U.S. depreciation deduc-
tions, sections 865(c)(2) and 865(e)(2) ap-
ply and source that gain as if the property
were inventory. Thus, the residual gain
in excess of depreciation deductions is
sourced under the rules of section 865(e)
(2) as described in proposed §1.865-3(d)
(2) (for produced inventory, the 50/50
method and the books and records meth-
od) and (d)(3) (for purchased inventory,
100 percent U.S. source income).
4. The proposed rules for inventory
With respect to inventory purchased
and sold by a nonresident in a sale attrib-
utable to an office or other fixed place of
business in the United States and subject
to section 865(e)(2), none of the income
from the sale is attributable to production
activity, and therefore, unless the excep-
tion in section 865(e)(2)(B) applies, all of
the income from the sale is properly allo-
cable to the office or other fixed place of
business in the United States. Thus, the
proposed regulations clarify that in these
cases section 865(e)(2) causes all of the
gross income derived from the disposition
to be U.S. source. See §1.865-3(d)(3).
With respect to inventory produced and
sold by a nonresident in a sale attributable
to an office or other fixed place of business
in the United States and subject to section
865(e)(2), the Treasury Department and
the IRS have determined that the disposi-
tion continues to give rise to gross income
that is partly allocable to the nonresident’s
office or other fixed place of business in
the United States (representative of the
sales activity with respect to the transac-
tion) and sourced under section 865(e)(2),
with the remainder allocable to production
activity and sourced under section 863(b).
Therefore, these proposed regulations
provide a rule specifically for Section
865(e)(2) Sales involving inventory pro-
duced by the nonresident that distinguish-
es generally between sales and production
activities in determining the source of the
income from sales of produced inventory
and is consistent with the overall structure
of subchapter N, part I (sections 861-865).
The Treasury Department and the IRS
understand that Congress intended for the
source rules to “operate clearly without
the necessity for burdensome factual de-
terminations.” H.R. Rep. No. 99-426, at
360 (1985). Additionally, it is noteworthy
that the “principles” of section 864(c)(5)
(C), rather than the exact rules thereof, ap-
ply in the section 865(e)(2) context. Final-
ly, the Treasury Department and the IRS
are mindful of the fact that section 865(e)
(2) was not modified by the Act. Before
the Act, by applying the principles of cur-
rent §1.863-3(b) to determine the amount
of income allocable to the office or oth-
er fixed place of business in the United
States, the 50/50 method allowed for a 50
percent U.S. source result with respect to
sales of produced inventory.
Based on the foregoing considerations,
these proposed regulations continue to ap-
ply the 50/50 method as the general rule
to treat 50 percent of a nonresident’s in-
come with respect to produced inventory
sold through an office or other fixed place
of business in the United States as U.S.
source income attributable to the sales
activity of the office maintained by the
nonresident. The remaining 50 percent
of the income is allocated or apportioned
between U.S. and foreign sources by ap-
plying section 863(b) and the regulations
thereunder (as amended by these proposed
regulations) based upon the location of
production activities. Thus, where inven-
tory is produced entirely outside the Unit-
ed States and sold through a U.S. sales
office in a transaction subject to section
865(e)(2), 50 percent of the gross income

Bulletin No. 2020–4 391 January 21, 2020
is U.S. source income allocable to the U.S.
sales office or other fixed place of busi-
ness, and the remaining 50 percent is for-
eign source income.
In prescribing the 50/50 method for di-
viding gross income from Section 865(e)
(2) Sales between production and sales
activity, the Treasury Department and the
IRS appreciate that this method may not
correspond precisely to the economic gen-
esis of the gross income with respect to
the sales and production activity involved.
Nevertheless, the Treasury Department
and the IRS have determined that this is
an appropriate and administrable way to
give effect to the principles of section
864(c)(5) in allocating income to the of-
fice or other fixed place of business in the
United States (and focusing on sales ac-
tivity) when applying section 865(e)(2).
First, the 50/50 method has historically
been recognized as a reasonable method
for allocating income between production
and sales activity. Before the Act, section
863(b) specified that income from Section
863(b)(2) Sales “be treated as derived
partly from sources within and partly
from sources without the United States,”
and imposed no standard for allocating or
apportioning the income. As discussed,
the 50/50 method was a commonly used
and well-understood sourcing method that
ensured some income was allocated or
apportioned to sales activity and some to
production activity under section 863(b).
For example, in 1984 the Treasury De-
partment stated that “[g]enerally, [income
derived from the manufacture and sale of
property] is allocated one-half on the ba-
sis of the place of manufacture and half
on the basis of the place of sale.” Treasury
Department, Tax Reform for Fairness,
Simplicity, and Economic Growth, Nov.
1984 at 364. The House, Senate, and Con-
ference Committees each stated with re-
spect to the TRA that “[under the 50/50
method], half of such income generally
is sourced in the country of manufacture,
and half of the income is sourced on the
basis of the place of sale.” H.R. Rep. No.
99-426, at 359 (1985); S. Rep. No. 99-
313, at 329 (1986); H.R. Rep. No. 99-841,
at 917 (1986) (“Conf. Rep.”). Finally, the
staff of the Joint Committee on Taxation
has referred to the 50/50 method as the
“production/marketing split” and stated
that under this method “50 percent of such
income generally is attributed to the place
of production.” Joint Committee on Taxa-
tion, Factors Affecting International Com-
petitiveness of the United States, JCS-6-
91, at 148-149 (1991). Second, the 50/50
method was the most administrable of the
permissible means of applying section
865(e)(2) through the application of sec-
tion 864(c)(5)(C) and current §1.864-6(c)
(2) before the Act. Therefore, these pro-
posed regulations adopt the 50/50 meth-
od as the default method for allocating or
apportioning gross income attributable to
Section 865(e)(2) Sales between sources
within and without the United States.
Nevertheless, the Treasury Department
and the IRS are aware that some taxpay-
ers may be able to more precisely allocate
or apportion their gross income between
sales and production activities based on
their books of account. Taxpayers, at their
election, have historically used such a
“books and records” method under current
§1.863-3(b)(3) to allocate or apportion
their gross income from sales of inventory
between production and sales activities.
Therefore, as an elective alternative to
the default 50/50 method, taxpayers may
continue to use a books and records meth-
od as provided in these proposed regula-
tions. However, the proposed regulations
include more detailed guidance regarding
the requirements that must be met before
a taxpayer will be permitted to use this
method.
A taxpayer electing the books and re-
cords method must prepare and maintain
records that are in existence when its re-
turn is filed regarding the allocation of
gross income between sales and produc-
tion activities in its books of account and
indicate in a statement attached to its tax
return that it elects to apply this method.
As part of its records that exist when its re-
turn is filed, the taxpayer must include an
explanation of how such allocation clearly
reflects the taxpayer’s income from pro-
duction and sales activities under the prin-
ciples of section 482. The Treasury De-
partment and the IRS intend the taxpayer’s
explanation to allow a potential examiner
to have a roadmap for understanding the
method by which the taxpayer determined
the allocation of gross income between the
U.S. sales activities and the foreign pro-
duction activities, respectively. The use of
section 482 in the proposed regulations is
not intended to imply that the taxpayer’s
explanation must satisfy the documenta-
tion requirements of section 6662(e) and
§1.6662-6(d). The taxpayer must make
available its books and records for both
its sales activities and its production ac-
tivities and the related explanation upon
request of the Commissioner. If a taxpayer
fails to satisfy these requirements in full,
the default 50/50 method will apply.
These proposed regulations, however,
do not also provide for an elective IFP
method as allowed by current §1.863-3(b)
(2). The Treasury Department and the IRS
have determined that this method is appli-
cable only in very narrow circumstanc-
es when an IFP exists and therefore has
rarely been elected by taxpayers in prac-
tice. Any taxpayer that wishes to contin-
ue using an IFP could generally continue
to reach a similar result by electing the
books and records method and basing the
allocation or apportionment in its books
and records on the IFP. Nevertheless, the
Treasury Department and the IRS request
comments on whether the IFP or any oth-
er methods for allocating or apportion-
ing gross income attributable to Section
865(e)(2) Sales between sources within
and without the United States should be
included in these regulations.
B. Modification of current §1.864-6(c)(2)
to ensure consistency with §1.865-3
Section 864(c)(4)(B)(iii) generally pro-
vides that income derived from the sale of
inventory (outside the United States) by
a non-U.S. person through an office or
other fixed place of business in the Unit-
ed States may be effectively connected
income, notwithstanding that it would
be foreign source income under the title
passage rules in §1.861-7(c). It provides
an exception for inventory sold for use or
consumption outside the United States,
similar to the exception in section 865(e)
(2)(B).
Accordingly, sections 864(c)(4)(B)(iii)
and 865(e)(2), as a statutory matter, ap-
pear to overlap in their treatment of sales
of inventory by non-U.S. persons through
an office or other fixed place of business
in the United States. This was not the case,
however, in 1986 because Congress re-
moved section 864(c)(4)(B)(iii) from the
Code when section 865(e)(2) was added.

January 21, 2020 392 Bulletin No. 2020–4
The Tax Reform Act of 1986, Pub. L. 99-
514 (1986) (section 1211(a) added section
865, while section 1211(b)(2) removed
section 864(c)(4)(B)(iii)). Two years lat-
er, however, in the Technical and Miscel-
laneous Revenue Act of 1988 (“TAMRA
1988”), Congress added section 864(c)(4)
(B)(iii) back to the Code, with the Senate
Report to TAMRA 1988 explaining that
the provision was reinstated because it
“is necessary to ensure that foreign per-
sons who have a substantial presence in
the United States, who may be treated as
U.S. residents for source rule purposes
but as nonresidents for general purposes,
are taxed on income derived from sales of
inventory property.” S. Rep. No. 100-445,
at 239 (1988); see also Joint Committee
on Taxation, Description of the Technical
Correction Act of 1988, JCS-10-88, at 250
(1988); TAMRA 1988 (section 1012(d)(7)
restored section 864(c)(4)(B)(iii)).
The Treasury Department and the IRS
have thus determined that where both
provisions potentially could apply, as in
the case of foreign corporations and most
nonresident alien individuals, section
865(e)(2) takes precedence over section
864(c)(4)(B)(iii) because section 865(e)
(2) applies “[n]otwithstanding any other
provisions of this part.” Consistent with
the TAMRA 1988 legislative history, the
Treasury Department and the IRS have
determined that section 864(c)(4)(B)
(iii) applies solely to nonresident alien
individuals (defined in section 7701(b))
who under section 865(g)(1) have a tax
home (as defined in section 911(d)(3)) in
the United States (and whose inventory
sales thus would not be subject to section
865(e)(2) as those individuals would not
be “nonresidents” under section 865(g)
(1)(B)). Note that these nonresident alien
individuals would be subject to section
864(c)(4)(B)(iii) and section 864(c)(5)
only with respect to income from inven-
tory sales that is determined to be foreign
source after application of sections 861(a)
(6), 862(a)(6), and 863(b) pursuant to sec-
tion 865(b). Thus, for example, a nonres-
ident alien individual engaged in a U.S.
trade or business, with a tax home in the
United States, who purchases inventory
outside the United States and resells in-
ventory attributable to a U.S. office (with
title passing offshore) would have foreign
source income under section 862(a)(6) (by
reference from section 865(b)), but that
foreign source income would then be sub-
ject to section 864(c)(4)(B)(iii) and sec-
tion 864(c)(5) to determine the amount of
the individual’s foreign source effectively
connected income.
Although the scope of section 864(c)
(4)(B)(iii) is narrow, the Treasury De-
partment and the IRS have determined
that income from sales of inventory by
these individuals should be taxable as ef-
fectively connected income to the same
extent as if inventory sales by these indi-
viduals were governed by section 865(e)
(2), depending on whether the inventory
was either purchased abroad or produced
abroad. Section 1.864-6(c)(2)is therefore
modified so that it applies exclusively to
this distinct class of nonresident aliens,
those with a tax home in the United
States who are not covered under section
865(e)(2). Further, in order for these in-
dividuals to be subject to tax to the same
extent as other nonresident taxpayers un-
der section 865(e)(2), the proposed reg-
ulations remove any current references
in §1.864-6(c)(2) to section 863(b) and
§1.863-3, thereby clarifying that the rules
of section 863(b) and §1.863-3 do not ap-
ply in the context of section 864(c)(4)(B)
(iii) to treat inventory sales as exclusive-
ly giving rise to foreign source income if
the inventory sold was produced exclu-
sively outside of the United States. The
proposed regulations do not modify the
treatment of sales by these individuals of
intangible personal property described
in §1.864-5(b)(1) or of stock or securi-
ties described in §1.864-5(b)(2), which
continue to be governed by §1.864-6(c)
(1). Current and proposed §1.864-6(c)(2)
implement the rule in section 864(c)(5)
(C) that applies solely to sales of person-
al property described in section 864(c)(4)
(B)(iii) and §1.864-5(b)(3).
These proposed regulations also may
impact the determination of qualified
business income for purposes of section
199A. Section 199A(c)(3)(A)(i) provides
that “qualified items of income, gain, de-
duction, and loss” under section 199A(c)
(3) are those items that are, among oth-
er things, effectively connected with the
conduct of a trade or business in the Unit-
ed States within the meaning of section
864(c) (subject to certain modifications).
The Treasury Department and the IRS
continue to study the application of sec-
tion 864(c) in the context of section 199A,
and request comments on this topic.
C. U.S. income tax treaties
The Treasury Department and the IRS
are aware that under U.S. income tax trea-
ties, the business profits of foreign treaty
residents may be taxable in the United
States only if the profits are attributable to
a permanent establishment in the United
States. With respect to taxpayers entitled
to the benefits of an income tax treaty, the
amount of profits attributable to a U.S.
permanent establishment will not be af-
fected by these regulations.
Proposed Applicability Date
The regulations are proposed to apply
to taxable years ending on or after Decem-
ber 23, 2019. As proposed, the regulations
will permit taxpayers to apply the rules
therein in their entirety for taxable years
beginning after December 31, 2017, and
before these regulations apply.
In addition, taxpayers may rely on the
rules in the proposed regulations for tax-
able years beginning after December 31,
2017, and before the final regulations are
applicable, provided that the taxpayer and
persons that are related (within the mean-
ing of section 267 or 707) to the taxpay-
er apply the proposed regulations in their
entirety. For taxable years before these
regulations apply, the IRS may, where
appropriate, challenge certain positions
described in this preamble, including
that following the amendment to section
863(b)(2) income earned by nonresidents
from sales of personal property produced
outside the United States and sold through
an office or other fixed place of business
in the United States is 100 percent foreign
source.
Special Analyses
The Administrator of the Office of In-
formation and Regulatory Affairs (OIRA),
Office of Management and Budget, has
determined that this proposed rule is not a
significant regulatory action, as that term
is defined in section 3(f) of Executive Or-
der 12866. Therefore, OIRA has not re-
viewed this proposed rule pursuant to sec-

Bulletin No. 2020–4 393 January 21, 2020
tion 6(a)(3)(A) of Executive Order 12866
and the April 11, 2018, Memorandum of
Agreement between the Treasury Depart-
ment and the Office of Management and
Budget (“OMB”).
I. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibili-
ty Act (5 U.S.C. chapter 6), it is hereby
certified that these proposed regulations,
if adopted, will not have a significant
economic impact on a substantial num-
ber of small entities. Although data are
not readily available to assess the number
of small entities potentially affected, any
economic impact of these regulations is
unlikely to be significant. Specifically,
the regulations in §§1.863-1 and 1.863-3
(with conforming changes in cross-refer-
encing regulations) implement the stat-
utory change made to section 863(b) by
the Act. This change affects sales of in-
ventory property by any taxpayer where
the taxpayer produces the inventory (in
whole or in part) within the United States
and sells that inventory without the Unit-
ed States, or vice versa. The change in
sourcing for those entities is attributable
to the change in section 863(b) made by
the Act. Proposed §§1.863-1 and 1.863-
3 merely implement the statutory change
with limited additional guidance. The
Treasury Department and the IRS do not
anticipate that any differences between
the changes in section 863(b) made by
the Act and the changes in proposed
§§1.863-1 and 1.863-3 made by these
proposed regulations will have a signif-
icant economic impact on a substantial
number of small entities. Notwithstand-
ing this certification, the Treasury De-
partment and the IRS invite comments on
the impact of this rule on small entities.
The other regulations in this publication
(other than changes to ensure consistency
with section 863(b)) are the proposed reg-
ulations in §§1.864-6 and 1.865-3. These
proposed regulations solely affect non-
U.S. taxpayers, which are not subject to
the Regulatory Flexibility Act.
Pursuant to section 7805(f), this no-
tice of proposed rulemaking has been
submitted to the Chief Counsel for Advo-
cacy of the Small Business Administra-
tion for comment on its impact on small
businesses.
II. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates
Reform Act of 1995 requires that agencies
assess anticipated costs and benefits and
take certain other actions before issuing a
final rule that includes any Federal man-
date that may result in expenditures in any
one year by a state, local, or tribal govern-
ment, in the aggregate, or by the private
sector, of $100 million in 1995 dollars,
updated annually for inflation. In 2019,
that threshold is approximately $154 mil-
lion. These proposed regulations do not
include any Federal mandate that may re-
sult in expenditures by state, local, or trib-
al governments, or by the private sector in
excess of that threshold.
III. Executive Order 13132: Federalism
Executive Order 13132 (entitled
“Federalism”) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state law,
unless the agency meets the consultation
and funding requirements of section 6 of
the Executive Order. These proposed reg-
ulations do not have federalism implica-
tions and do not impose substantial direct
compliance costs on state and local gov-
ernments or preempt state law within the
meaning of the Executive Order.
Comments and Requests for Public
Hearing
Before the proposed regulations are
adopted as final regulations, consideration
will be given to any comments that are
submitted timely to the IRS as prescribed
in this preamble under “Addresses.” The
Treasury Department and the IRS request
comments on all aspects of the proposed
rules. See also sections I.C, II.A.4, and
II.B of the Explanation of Provisions (re-
questing specific comments related to the
suitability of using ADS, other potential
approaches to determine the location or
existence of production activity, or oth-
er modifications to §1.863-3 that may be
appropriate; related to whether there are
other suitable methods for allocating or
apportioning income attributable to Sec-
tion 865(e)(2) Sales between U.S. and
foreign sources; and related to the impact
of these proposed regulations on the deter-
mination of qualified business income for
purposes of section 199A, respectively).
All comments will be available at www.
regulations.gov or upon request. A public
hearing will be scheduled if requested in
writing by any person that timely submits
comments. If a public hearing is sched-
uled, notice of the date, time, and place for
the public hearing will be published in the
Federal Register.
Drafting Information
The principal authors of the proposed
regulations are Brad McCormack and
Anisa Afshar of the Office of Associate
Chief Counsel (International). However,
other personnel from the Treasury Depart-
ment and the IRS participated in their de-
velopment.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by:
1. Revising the entries for §§ 1.863-1,
1.863-2, 1.863-3, and 1.863-8.
2. Adding an entry for §1.865-3 in nu-
merical order.
3. Revising the entries for §§1.937-2,
1.937-3, and 1.1502-13.
The revisions and addition read in part
as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.863-1 also issued under 26
U.S.C. 863(a).
Section 1.863-2 also issued under 26
U.S.C. 863(a).
Section 1.863-3 also issued under 26
U.S.C. 863(a).
* * * * *
Section 1.863-8 also issued under 26
U.S.C. 863(a).

January 21, 2020 394 Bulletin No. 2020–4
* * * * *
Section 1.865-3 also issued under 26
U.S.C. 865(j).
* * * * *
Section 1.937-2 also issued under 26
U.S.C. 937(b).
Section 1.937-3 also issued under 26
U.S.C. 937(b).
* * * * *
Section 1.1502-13 also issued under 26
U.S.C. 1502.
* * * * *
Par. 2. Section 1.863-1 is amended as
follows:
1. In paragraph (a):
i. Revising the third sentence.
ii. Removing “§1.863-3(g)” and
adding in its place “§1.863-3(f)”.
2. In paragraph (b)(1):
i. Removing “, must be allocated
between sources within and with-
out the United States based on the
fair market value of the product at
the export terminal (as defined in
paragraph (b)(3)(iii) of this sec-
tion)” from the first sentence and
adding in its place “shall be treat-
ed as income from sources within
the United States”.
ii. Revising the second sentence.
iii. Removing the third, fourth, and
fifth sentences.
3. Removing paragraphs (b)(1)(i) and
(ii).
4. In paragraph (b)(2):
i. Removing “prior to export termi-
nal” from the heading and adding
in its place “activities”.
ii. Removing “before the relevant
product is shipped from the ex-
port terminal” from the first sen-
tence.
5. Removing “§§1.1502-13 or 1.863-
3(g)(2)” from paragraph (b)(3)(i) and
adding in its place Ҥ1.1502-13 or
§1.863-3(f)(2)”.
6. Removing “to or from the export
terminal” from the third sentence of
paragraph (b)(3)(ii).
7. Removing paragraph (b)(3)(iii).
8. In paragraph (b)(6), removing “this
paragraph (b)” from the first sentence
and adding in its place “paragraph (b)
(2) of this section”.
9. Designating Examples 1, 2, 3, 4, and
5 of paragraph (b)(7) as paragraphs
(b)(7)(i) through (v).
10. Revising newly designated para-
graphs (b)(7)(i) through (iv).
11. In newly designated paragraph (b)(7)
(v):
i. Removing “Example 1” from the
first sentence and adding “para-
graph (b)(7)(i) of this section
(Example 1)”.
ii. Removing “country” from the
first sentence and adding in its
place “Country”.
iii. Removing “Mine’s” from the
seventh sentence and adding in
its place “Mines’”.
The revisions read as follows:
§1.863-1 Allocation of gross income
under section 863(a).
(a) * * * See also section 865(b) for
rules for sourcing income from the sale
of inventory property, within the meaning
of section 865(i)(1) (inventory), general-
ly, and section 865(e)(2) and §1.865-3 for
sourcing income from the sale of personal
property (including inventory) by a non-
resident that is attributable to the nonres-
ident’s office or other fixed place of busi-
ness in the United States. * * *
(b) * * *
(1) * * * Notwithstanding any other
provision of this part, except to the extent
provided in paragraph (b)(2) of this sec-
tion or §1.865-3, gross receipts from the
sale within the United States of products
derived from the ownership or operation
of any farm, mine, oil or gas well, oth-
er natural deposit, or timber outside the
United States shall be treated as attribut-
able to production activities without the
United States and therefore treated as
income from sources without the United
States.
* * * * *
(7) * * *
(i) Example 1. No additional production. U.S.
Mines, a domestic corporation, operates a copper
mine and mill in Country X. U.S. Mines extracts
copper-bearing rocks from the ground and transports
the rocks to the mill where the rocks are ground and
processed to produce copper-bearing concentrate.
The concentrate is transported to a port where it
is dried in preparation for export, stored, and then
shipped to purchasers in the United States. Because
there is no additional production, paragraph (b)(3)(ii)
of this section does not apply, and under paragraph
(b)(1) of this section, gross receipts from the sale
of the concentrate will be from sources without the
United States.
(ii) Example 2. No additional production. U.S.
Gas, a domestic corporation, extracts natural gas
within the United States, and transports the natural
gas to a Country X port where it is liquefied in prepa-
ration for shipment. The liquefied natural gas is then
transported via freighter and sold without additional
production activities in a foreign country. Liquefac-
tion of natural gas is not an additional production
activity because liquefaction prepares the natural gas
for transportation. Therefore, under paragraph (b)
(1) of this section, gross receipts from the sale of the
liquefied natural gas will be from sources within the
United States.
(iii) Example 3. Production in United States. U.S.
Gold, a domestic corporation, mines gold in Country
X, produces gold jewelry using production assets lo-
cated in the United States, and sells the jewelry in
Country Y. Assume that the fair market value of the
gold before the additional production activities in the
United States is $40x and that U.S. Gold ultimately
sells the gold jewelry in Country Y for $100x. Under
paragraph (b)(2) of this section, $40x of U.S. Gold’s
gross receipts will be allocated to sources without
the United States, and the remaining $60x of gross
receipts will be U.S. source under §1.863-3.
(iv) Example 4. Production in United States. U.S.
Oil, a domestic corporation, extracts oil in Country
X, transports the oil via a pipeline to the United
States, refines the oil using production assets located
in the United States, and sells the refined product in
the United States to unrelated persons. Assume that
the fair market value of the oil before refinement in
the United States is $80x and U.S. Oil ultimately
sells the refined product for $100x. Under paragraph
(b)(2) of this section, $80 of gross receipts will be
allocated to sources without the United States, and
the remaining $20 of gross receipts will be allocated
to sources within the United States.
* * * * *
Par. 3. Section 1.863-2 is amended as
follows:
1. Removing “(and that is treated as de-
rived partly from sources within and
partly from sources without the Unit-
ed States)” from the third sentence of
paragraph (a) and adding a colon at
the end of the paragraph.
2. Revising paragraph (b).
The revision reads as follows:
§1.863-2 Allocation and apportion-
ment of taxable income.
* * * * *
(b) Determination of source of taxable
income. Income treated as derived from
sources partly within and partly without
the United States under paragraph (a)
of this section may be allocated or ap-
portioned to sources within and without
the United States pursuant to §§1.863-1,
1.863-3, 1.863-4, 1.863-8, and 1.863-9.
To determine the source of certain types
of income described in paragraph (a)
(1) of this section, see §1.863-4. To de-
termine the source of gross income de-
scribed in paragraph (a)(2) of this section,
see §1.863-1 for natural resources and

Bulletin No. 2020–4 395 January 21, 2020
§1.863-3 for all other sales of invento-
ry property. Section 1.865-3 may apply
instead of the provisions in this part to
source gross income from sales of person-
al property (including inventory property)
by nonresidents attributable to an office or
other fixed place of business in the United
States. To determine the source of income
partly from sources within a possession of
the United States, including income de-
scribed in paragraph (a)(3) of this section,
see §1.863-3(e).
* * * * *
Par. 4. Section 1.863-3 is amended as
follows:
1. Revising paragraphs (a) and (b).
2. Removing “and sales activity” from
the heading in paragraph (c).
3. In paragraph (c)(1)(i)(A):
i. Removing “(g)(2)(ii)” and add-
ing in its place “(f)(2)(ii)”;
ii. Removing “the income attribut-
able to production activity” and
adding in its place “gross in-
come”; and
iii. Removing “(c)(1)(ii)” and add-
ing in its place “(c)(2)”.
4. Removing “(g)(2)(ii)” from para-
graph (c)(1)(i)(B) and adding in its
place “(f)(2)(ii)”.
5. Removing “within the United States
and within foreign countries” from
the heading to paragraph (c)(1)(ii)
and adding in its place “within and
without the United States”.
6. Removing “income attributable to
the taxpayer’s production activity”
from paragraph (c)(1)(ii)(A) and add-
ing in its place “gross income”.
7. In paragraph (c)(1)(iii):
i. Removing “(c)(1)” from the first
and second sentences and adding
in its place “(c)”;
ii. Removing “by manipulating the
formula described in paragraph
(c)(1)(ii)(A) of this section”;
iii. Removing “production income”
and adding in its place “gross in-
come”; and
iv. Removing “income from pro-
duction activity” and adding in
its place “gross income”.
8. Removing paragraph (c)(2) and the
paragraph designation and heading
for (c)(1);
9. In paragraphs (c)(i) through (iv), re-
designating the paragraphs in the first
column as the paragraphs in the sec-
ond column:
Old paragraphs
New paragraphs
(c)(i)(c)(1)
(c)(i)(A)(c)(1)(i)
(c)(i)(B)(c)(1)(ii)
(c)(i)(C)(c)(1)(iii)
(c)(ii)(c)(2)
(c)(ii)(A)(c)(2)(i)
(c)(ii)(B)(c)(2)(ii)
(c)(iii)(c)(3)
(c)(iv)
(c)(4)
10. Revising newly redesignated para-
graph (c)(2)(ii).
11. In newly redesignated paragraph (c)
(4):
i. In the introductory text, remov-
ing “(c)(1)” and adding in its
place “(c)”; and
ii. Designating Examples 1, 2, and
3 as paragraphs (c)(4)(i) through
(iii).
12. In newly designated paragraph (c)(4)
(i):
i. Removing “production” from the
heading and adding in its place
“gross”; and
ii. Redesignating paragraphs (c)(1)
(i)(i) and (ii) as paragraphs (c)(4)
(i)(A) and (B).
13. In newly redesignated paragraph (c)
(4)(i)(A), removing the ninth sen-
tence.
14. In newly redesignated paragraph (c)
(4)(i)(B):
i. Removing “production”, “one
half of”, and “or $6,” from the
first sentence;
ii. Removing “production” from the
second sentence; and
iii. In the last sentence, removing
“$2” and “$6” and adding in their
places “$4” and “$12”, respec-
tively.
15. In newly designated paragraph (c)(4)
(ii):
i. Removing “Example 1” from the
first sentence and adding in its
place “in paragraph (c)(4)(i)(A)
of this section (Example 1)”; and
ii. Removing “from production ac-
tivity” from the second sentence.
16. In newly designated paragraph (c)(4)
(iii), redesignating paragraphs (c)(4)
(iii)(i) and (ii) as paragraphs (c)(4)
(iii)(A) and (B).
17. In newly redesignated paragraph (c)
(4)(iii)(A):
i. Removing “Example 1” from the
first sentence and adding in its
place “in paragraph (c)(4)(i)(A)
of this section (Example 1)”; and
ii. Removing “(c)(1)(ii)” and “pro-
duction income” from the fourth
sentence and adding in their plac-
es “(c)(2)” and “gross income”,
respectively.
18. In newly redesignated paragraph (c)
(4)(iii)(B):
i. Removing “(c)(1)(ii)(A)” from
the first sentence and adding in
its place “(c)(2)(i)”; and
ii. Removing “production income”
from the second sentence and
adding in its place “gross in-
come”.
19. Revising paragraph (d).
20. Removing paragraph (e).
21. Redesignating paragraph (f) as para-
graph (e).
22. Revising newly redesignated para-
graphs (e)(1) and (2) and (e)(3)(i).
23. Removing “(f)(3)(ii)” from newly re-
designated paragraph (e)(3)(ii)(B) in-
troductory text and adding in its place
“(e)(3)(ii)”.
24. Revising newly redesignated para-
graph (e)(3)(ii)(C)(1).
25. Removing newly redesignated para-
graph (e)(4).
26. Further redesignating paragraph (e)(3)
(iii) as paragraph (e)(4).
27. In newly redesignated paragraph (e)
(4):
i. Removing “(f)(3)(ii)” from the
introductory text and adding in
its place “(e)(3)(ii)”; and
ii. Designating Examples 1 and 2 as
paragraphs (e)(4)(i) and (ii).
28. In newly designated paragraph (e)(4)
(i), redesignating paragraphs (e)(4)(i)
(i) and (ii) as paragraphs (e)(4)(i)(A)
and (B).
29. In newly designated paragraph (e)(4)
(ii), redesignating paragraphs (e)(4)
(ii)(i) and (ii) as paragraphs (e)(4)(ii)
(A) and (B).
30. In newly redesignated paragraph (e)
(4)(ii)(A), removing “Example 1” and

January 21, 2020 396 Bulletin No. 2020–4
adding “paragraph (e)(4)(i)(A) of this
section (Example 1)”.
31. Removing “(f)” from newly redes-
ignated paragraph (e)(5) and adding
in its place “(e)” and removing “(g)”
and adding in its place “(f)”.
32. Removing newly redesignated para-
graph (e)(6).
33. Redesignating paragraph (g) as para-
graph (f).
34. In newly redesignated paragraph (f)
(1), removing “(g)(2)” and adding in
its place “(f)(2)”.
35. In newly redesignated paragraph (f)
(2)(ii), removing “(g)(2)(i)” and add-
ing in its place “(f)(2)(i)” and remov-
ing “(c)(1)(ii)(B)” and adding in its
place “(c)(2)(ii)”.
36. Removing newly redesignated para-
graph (f)(2)(iv).
37. In newly redesignated paragraph (f)
(3):
i. Removing “(g)” from the intro-
ductory text and adding in its
place “(f)”; and
ii. Designating Examples 1 and 2 as
paragraphs (f)(3)(i) and (ii).
38. In newly designated paragraph (f)(3)
(ii):
i. Removing “Example 1” from the
first sentence and adding in its
place “paragraph (f)(3)(i) of this
section (Example 1)”;
ii. Removing “these regulations” in
the fourth sentence and adding in
its place “this section”;
iii. Removing the fifth sentence; and
iii. Removing “(1)” from the last
sentence.
39. Redesignating paragraph (h) as (g)
and revising newly redesignated
paragraph (g).
The revisions and additions read as fol-
lows:
§1.863-3 Allocation and apportion-
ment of income from certain sales of in-
ventory.
(a) In general—(1) Scope. Subject
to the rules of §1.865-3, paragraphs (a)
through (d) of this section apply to deter-
mine the source of income derived from
the sale of inventory property (inventory)
that a taxpayer produces (in whole or in
part) within the United States and sells
without the United States, or that a tax-
payer produces (in whole or in part) with-
out the United States and sells within the
United States (Section 863(b)(2) Sales).
See section 865(i)(1) for the definition of
inventory. Paragraph (b) of this section
provides that the source of gross income
from the sale or exchange of inventory in
Section 863(b)(2) Sales is based solely on
the production activities with respect to
the inventory. Paragraph (c) of this sec-
tion describes how to determine source
based on production activity, including
where inventory is produced partly within
the United States and partly without the
United States. Paragraph (d) of this sec-
tion determines taxable income from Sec-
tion 863(b)(2) Sales. Paragraph (e) of this
section applies to determine the source of
certain income derived from a possession
of the United States. Paragraph (f) of this
section provides special rules for part-
nerships for all sales subject to §§1.863-
1 through 1.863-3. Paragraph (g) of this
section provides applicability dates for the
rules in this section.
(2) Cross references. To determine the
source of income derived from the sale of
personal property (including inventory)
by a nonresident that is attributable to the
nonresident’s office or other fixed place
of business in the United States under
section 865(e)(2), the rules of §1.865-3
apply, and the rules of this section do not
apply. To determine the source of income
from sales of property produced by the
taxpayer, when the property is either pro-
duced in whole or in part in space or on
or under water not within the jurisdiction
(as recognized by the United States) of a
foreign country, possession of the United
States, or the United States (in interna-
tional water), or is sold in space or in-
ternational water, the rules of §1.863-8
apply, and the rules of this section do not
apply except to the extent provided in
§1.863-8.
(b) Sourcing based solely on produc-
tion activities. Subject to the rules of
§1.865-3, all gain, profit, and income de-
rived from Section 863(b)(2) Sales is allo-
cated and apportioned solely on the basis
of the production activities with respect to
the inventory.
(c) * * *
(2) * * *
(ii) Adjusted basis of production as-
sets—(A) In general. For purposes of
paragraph (c)(2)(i) of this section, the ad-
justed basis of an asset is determined by
using the alternative depreciation system
under section 168(g)(2). The adjusted ba-
sis of all production assets for purposes of
paragraph (c)(2)(i) of this section is deter-
mined as though such production assets
were subject to the alternative deprecia-
tion system set forth in section 168(g)(2)
for the entire period that such property has
been in service. The adjusted basis of the
production assets is determined without
regard to the election to expense certain
depreciable assets under section 179 and
without regard to any additional first-
year depreciation provision (for example,
sections 168(k), 168(l), and 168(m), and
former sections 1400L(b) and 1400N(d)).
The average adjusted basis is computed
by averaging the adjusted basis of the as-
set at the beginning and end of the taxable
year, unless by reason of material changes
during the taxable year such average does
not fairly represent the average for such
year. In this event, the average adjusted
basis is determined upon a more appropri-
ate basis.
(B) Production assets used to produce
other property. If a production asset is
used to produce inventory sold in Section
863(b)(2) Sales and also used to produce
other property during the taxable year, the
portion of its adjusted basis that is includ-
ed in the fraction described in paragraph
(c)(2)(i) of this section will be determined
under any method that reasonably reflects
the portion of the asset that produces in-
ventory sold in Section 863(b)(2) Sales.
For example, the portion of such an as-
set that is included in the formula may
be determined by multiplying the asset’s
average adjusted basis by a fraction, the
numerator of which is the gross receipts
from sales of inventory from Section
863(b)(2) Sales produced by the asset, and
the denominator of which is the gross re-
ceipts from all property produced by that
asset.
* * * * *
(d) Determination of source of taxable
income. Once the source of gross income
has been determined under paragraph (c)
of this section, the taxpayer must proper-
ly allocate and apportion under §§1.861-8
through 1.861-14T and 1.861-17 its ex-
penses, losses and other deductions to its
respective amounts of gross income from
sources within and without the United
States from its Section 863(b)(2) Sales.

Bulletin No. 2020–4 397 January 21, 2020
(e) Income partly from sources with-
in a possession of the United States—(1)
In general. This paragraph (e) relates to
certain sales that give rise to gains, prof-
its, and income that are treated as derived
partly from sources within the United
States and partly from sources within a
possession of the United States (Section
863 Possession Sales). This paragraph
(e) applies to determine the source of
income derived from the sale of inven-
tory produced (in whole or in part) by
the taxpayer within the United States and
sold within a possession, or produced (in
whole or in part) by a taxpayer in a pos-
session and sold within the United States
(Possession Production Sales). It also ap-
plies to determine the source of income
derived from the purchase of personal
property within a possession of the Unit-
ed States and its sale within the United
States (Possession Purchase Sales). A
taxpayer subject to this paragraph (e)
must apportion gross income from Sec-
tion 863 Possession Sales under para-
graph (e)(2) of this section (in the case
of Possession Production Sales) or using
the business activity method described in
paragraph (e)(3)(i) of this section (in the
case of Possession Purchase Sales). The
source of gross income from each type of
activity from Possession Purchase Sales
must then be determined under paragraph
(e)(3)(ii) of this section. The source of
taxable income from Possession Produc-
tion Sales is determined under paragraph
(c) of this section. The source of taxable
income from Section 863 Possession
Sales is determined under paragraph (d)
of this section.
(2) Allocation or apportionment for
Possession Production Sales. The source
of gross income from Possession Produc-
tion Sales is determined under the rules of
paragraph (c) of this section, except that
the term possession of the United States is
substituted for foreign country wherever it
appears.
(3) Allocation or apportionment for
Possession Purchase Sales—(i) Deter-
mination of source of gross income for
Possession Purchase Sales. Gross in-
come from Possession Purchase Sales is
allocated in its entirety to the taxpayer’s
business activity, and is then apportioned
between sources within the United States
and sources within a possession of the
United States under paragraph (e)(3)(ii) of
this section.
(ii) * * *
(C) * * *
(1) Sales activity. The source of the
taxpayer’s income that is attributable to
sales activity will be determined under the
provisions of §1.861-7(c). Notwithstand-
ing any other provision of this part, for
rules regarding the source of income when
a sale takes place in space or international
water, the rules of §1.863-8 apply, and the
rules of this section do not apply except to
the extent provided in §1.863-8.
* * * * *
(g) Applicability dates. This section ap-
plies to taxable years ending on or after
December 23, 2019. However, taxpayers
may apply this section in its entirety for
taxable years beginning after December
31, 2017, and ending before December
23, 2019, provided that the taxpayer and
persons that are related (within the mean-
ing of section 267 or 707) to the taxpayer
apply this section in its entirety.
Par. 5. Section 1.863-8 is amended as
follows:
1. Revising paragraph (b)(3)(ii)(A).
2. In paragraph (b)(3)(ii)(B), removing
“allocable to production activity”
wherever it appears and by remov-
ing “§1.863-3(c)(1)” from the sec-
ond sentence and adding in its place
“§1.863-3(c)”.
3. In paragraph (b)(3)(ii)(C), removing
“allocable to production activity”
wherever it appears and by removing
“§1.863-3(c)(1)” from the fifth sen-
tence and adding in its place Ҥ1.863-
3(c)”.
4. Removing paragraph (b)(3)(ii)(D).
5. Designating Examples 1 through 14
of paragraph (f) as paragraphs (f)(1)
through (14).
6. In newly designated paragraphs (f)
(1) through (14), removing the peri-
od between the second and third lev-
el paragraph headings and adding an
em-dash in its place.
7. Removing “Example 4” from newly
designated paragraph (f)(4)(i) and
adding in its place “paragraph (f)(4)
(i) (Example 4)”.
8. Removing “Example 4” from newly
designated paragraph (f)(5)(i) and
adding in its place “paragraph (f)(4)
(i) of this section (Example 4)”.
9. Revising the first, second, and third
sentences of newly designated para-
graphs (f)(6)(ii).
10. Removing “Example 8” from newly
designated paragraph (f)(9)(i) and
adding in its place “in paragraph (f)
(8)(i) of this section (Example 8)”.
11. Removing “Example 8” from newly
designated paragraph (f)(9)(ii) and
adding in its place “paragraph (f)(8)
(i) of this section (Example 8)”.
12. Revising newly designated paragraph
(f)(11)(ii).
13. In paragraph (g)(1), removing “(C)”
from the first sentence.
14. In paragraph (g)(4) introductory text,
removing “(C)” from the first sen-
tence.
The revisions read as follows:
§1.863-8 Source of income derived
from space and ocean activity under sec-
tion 863(d).
* * * * *
(b) * * *
(3) * * *
(ii) Sales of property produced by the
taxpayer—(A) General. If the taxpay-
er both produces property and sells such
property, the taxpayer must allocate and
apportion all gain, profit, and income de-
rived from sales of such property solely on
the basis of the production activities with
respect to such property, and the source
of that income will be determined under
paragraph (b)(3)(ii)(B) or (C) of this sec-
tion. To determine the source of income
derived from the sale of personal proper-
ty (including inventory) by a nonresident
that is attributable to the nonresident’s of-
fice or other fixed place of business in the
United States under section 865(e)(2), the
rules of §1.865-3 apply, and the rules of
this section do not apply.
* * * * *
(f) * * *
(6) * * *
(ii) Analysis. The collection of data
and creation of images in space is char-
acterized as the creation of property in
space. Because S both produces and sells
the data, the source of the gross income
from the sale of the data is determined
under paragraph (b)(3)(ii) of this section
(by reference to §1.863-3(c)) solely on
the basis of the production activities. The
source of S’s gross income is determined
under §1.863-3(c)(2) because produc-

January 21, 2020 398 Bulletin No. 2020–4
tion activities occur both in space and on
land. * * *
(11) * * *
(ii) Analysis. Because S’s rights, title,
and interest in the satellite pass to the
customer in space, the sale takes place
in space under § 1.861-7(c), and the sale
transaction is space activity under para-
graph (d)(1)(i) of this section. The source
of income derived from the sale of the sat-
ellite in space is determined under para-
graph (b)(3)(ii) of this section (by refer-
ence to §1.863-3(c)) solely on the basis of
the production activities with respect to
the satellite.
* * * * *
Par. 6. Section 1.864-6 is amended by
revising paragraphs (c)(2) and (3) and
adding paragraph (c)(4) to read as follows:
§1.864-6 Income, gain, or loss attrib-
utable to an office or other fixed place of
business in the United States.
* * * * *
(c) * * *
(2) Special limitation in case of sales
of goods or merchandise through U.S. of-
fice. Notwithstanding paragraph (c)(1) of
this section, the special rules described in
this paragraph (c)(2) apply with respect to
a sale of goods or merchandise specified
in §1.864-5(b)(3), to which paragraph (b)
(3)(i) of this section does not apply. In the
case of a nonresident alien with a tax home
within the United States, as defined in sec-
tion 911(d)(3), the amount of income from
the sale of goods or merchandise that is
properly allocable to the individual’s U.S.
office is determined under §1.865-3(d)
(3) Examples. The application of this
paragraph (c) may be illustrated by the
following examples—
(i) Example 1. Nonresident alien individual
A, who has a tax home in the United States, man-
ufactures machinery in a foreign country and sells
the machinery outside the United States through A’s
sales office in the United States for use in foreign
countries. Title to the property sold is transferred
to the foreign purchaser outside the United States,
but no office or other fixed place of business of A
in a foreign country participates materially in the
sale made through its U.S. office. By reason of its
sales activities in the United States, A is engaged in
business in the United States during the taxable year.
During the taxable year, A derives a total income of
$250,000x from these sales. Under section 865(b)(2),
all of A’s income from these sales is foreign source as
production occurs outside the United States. Under
paragraph (c)(2) of this section, the amount of in-
come that is allocable to A’s U.S. office is determined
under §1.865-3(d)(2). The taxpayer does not allocate
income from the sale under the books and records
method described in §1.865-3(d)(2)(ii). Thus, 50
percent of A’s foreign source income, plus any addi-
tional income allocable based on the location of pro-
duction activities under §§1.863-3(b) and 1.865-3(d)
(2)(i) (in this case, $0x), is effectively connected for
the taxable year with the conduct of A’s U.S. trade or
business, or $125,000x.
(ii) Example 2. Nonresident alien individual B,
who has a tax home in the United States, has an office
in a foreign country that purchases merchandise and
sells it through B’s sales office in the United States
for use in various foreign countries, with title to the
property passing outside the United States. No other
office of B participates materially in these sales made
through its U.S. office. By reason of its sales activi-
ties in the United States, B is engaged in business in
the United States during the taxable year. During the
taxable year, B derives income of $300,000x from
these sales made through its U.S. sales office. Under
section 865(b), all of B’s income from these sales
is foreign source as title to the merchandise passes
outside the United States. The amount of income
properly allocable to B’s US office determined under
§1.865-3(d)(3) is $300,000x.
(iii) Example 3. The facts are the same as in para-
graph (c)(3)(ii) of this section (Example 2), except
that B has an office in a foreign country which partic-
ipates materially in the sales which are made through
its U.S. office. The income which is allocable to B’s
U.S. sales office is not effectively connected for the
taxable year with the conduct of a trade or business
in the United States by that corporation.
(4) Applicability date. Paragraphs (c)
(2) and (3) of this section, to the extent
they apply to sales of inventory described
in section 864(c)(4)(B)(iii), apply to sales
occurring in taxable years ending on or af-
ter December 23, 2019. However, taxpay-
ers may apply this section in its entirety
for taxable years beginning after Decem-
ber 31, 2017, and ending before Decem-
ber 23, 2019, provided that the taxpayer
and persons that are related (within the
meaning of section 267 or 707) to the tax-
payer apply this section in its entirety.
Par. 7. Section 1.865-3 is added to read
as follows:
§1.865-3 Source of income from sales
of personal property (including inventory
property) by a nonresident attributable to
an office or other fixed place of business in
the United States.
(a) In general. Notwithstanding any
other provisions of sections 861 through
865 or the regulations in this part except
paragraph (b) of this section, if a nonres-
ident, as defined in section 865(g)(1)(B),
maintains an office or other fixed place
of business in the United States, income
from any sale of personal property (in-
cluding inventory property) attributable to
such office or other fixed place of business
(as determined under paragraph (c) of this
section) is sourced in the United States in
an amount described in paragraph (d) of
this section. See section 865(i)(1) for the
definition of inventory property.
(b) Exceptions for inventory proper-
ty. Paragraph (a) of this section does not
apply with respect to the income derived
by a nonresident from any sale of inven-
tory property that is sold for use, dispo-
sition, or consumption outside the United
States if an office or other fixed place of
business of the nonresident in a foreign
country materially participated in the sale.
See §1.864-6(b)(3) to determine whether
a foreign office materially participated in
the sale and whether the property was des-
tined for foreign use.
(c) Attribution of a sale to a United
States office. In determining whether a
sale of personal property by a nonresident
is attributable to an office or other fixed
place of business in the United States,
the principles of section 864(c)(5)(B) as
prescribed in §1.864-6(b) and (c) apply.
The rule in this paragraph (c) applies
without regard to whether the property is
described in §1.864-5(b)(3)(iii). In deter-
mining whether a nonresident maintains
an office or other fixed place of business
in the United States, the principles of sec-
tion 864(c)(5)(A) as prescribed in §1.864-
7 apply, including the rules of paragraph
(d) of that section regarding the office or
fixed place of business of a dependent
agent of the nonresident.
(d) Amount of income or loss on sale
of personal property attributable to a U.S.
office—(1) In general. Subject to the spe-
cial rules described in paragraphs (d)(2),
(3), and (4) of this section, the amount of
income, gain, or loss from the sale of per-
sonal property attributable to an office or
other fixed place of business in the United
States is determined under §1.864-6(c)(1).
(2) Produced inventory property—(i)
In general. With respect to income from
the sale of inventory property subject to
paragraph (a) of this section that is pro-
duced by a nonresident, 50 percent of
the gross income from such sale is prop-
erly allocable to the office or fixed place
of business in the United States. The re-
maining 50 percent of the gross income
is allocable to production activities and
is sourced in accordance with §1.863-3

Bulletin No. 2020–4 399 January 21, 2020
(the “50/50 method”). However, in lieu
of the 50/50 method, a taxpayer may
elect to allocate income from the sale of
inventory property that is produced by a
nonresident under the books and records
method described in paragraph (d)(2)(ii)
of this section, provided it satisfies all of
the requirements described in that para-
graph to the satisfaction of the Commis-
sioner. For purposes of this paragraph (d)
(2)(i), the term “produced” includes cre-
ated, fabricated, manufactured, extracted,
processed, cured, and aged. See section
864(a) and §1.864-1.
(ii) Books and records method—(A)
Method. A taxpayer may elect to deter-
mine the amount of its gross income from
the sale of inventory property subject to
paragraph (a) of this section and produced
by a nonresident that is allocable to pro-
duction and sales activities for the taxable
year based upon its books of account. The
taxpayer must establish that the taxpayer,
in good faith and unaffected by consider-
ations of tax liability, regularly employs in
its books of account a detailed allocation
of receipts and expenditures that clearly
reflects the amount of the taxpayer’s gross
income from its inventory sales that is at-
tributable to its sales activities, and gross
income from sales that is attributable to its
production activities under the principles
of section 482. For purposes of this para-
graph (d)(2)(ii)(A), section 482 principles
will apply as if the office or fixed place of
business in the United States were a sepa-
rate taxpayer from the nonresident (wheth-
er or not payments are made between the
United States office or other fixed place of
business and the nonresident taxpayer’s
other offices). The gross income allocable
to sales activity under this method is treat-
ed as properly allocable to the office or
other fixed place of business in the United
States. The gross income allocable to pro-
duction activities is sourced in accordance
with §1.863-3.
(B) Election and reporting rules—(1)
In general. A taxpayer making an alloca-
tion of gross income under the books and
records method in paragraph (d)(2)(ii)(A)
of this section must satisfy the require-
ments of paragraphs (d)(2)(ii)(B)(2) and
(3) of this section. Failure to satisfy the re-
quirements in paragraphs (d)(2)(ii)(B)(2)
and (3) in full and to the satisfaction of the
Commissioner will result in application of
the 50/50 method specified in paragraph
(d)(2)(i) of this section.
(2) Required records. A taxpayer elect-
ing the books and records method under
paragraph (d)(2)(ii)(A) of this section
must prepare and maintain records that
are in existence when its return is filed
regarding the allocation of gross income
between sales and production activities in
its books of account. The taxpayer must
also prepare an explanation of how such
allocation clearly reflects the taxpayer’s
income from production and sales activ-
ities under the principles of section 482.
The taxpayer must make available such
explanation and records for both the U.S.
sales office and the entity or entities that
perform the production activities upon
request of the Commissioner, generally
within 30 days or some other time period
as agreed between the Commissioner and
the taxpayer.
(3) Disclosure on a tax return. A tax-
payer who chooses to apply the books and
records method under paragraph (d)(2)(ii)
(A) of this section must indicate in a state-
ment attached to a timely filed return (in-
cluding extensions) that it elects to apply
such method and has prepared the records
described in paragraph (d)(2)(ii)(B)(2) of
this section.
(3) Purchased inventory property.
With respect to income from the sale of
inventory property subject to paragraph
(a) of this section that is purchased by the
nonresident, the entire income from such
sale is properly allocable to the office or
other fixed place of business in the United
States.
(4) Depreciable personal property.
With respect to income from the sale of
depreciable personal property subject to
paragraph (a) of this section—
(i) The gain not in excess of the de-
preciation adjustments is allocable to an
office or other fixed place of business in
the United States to the same extent that
the gain would be allocated to sources
within the United States under the rules
of section 865(c)(1). The remaining gain
not in excess of the depreciation adjust-
ments is allocated to sources without the
United States in accordance with section
865(c)(1). However, notwithstanding the
preceding sentences, if the property was
predominantly used in the United States,
within the meaning of section 865(c)(3)
(B)(i), for a specific year, all of the gain
not in excess of depreciation for that year
is allocated to sources within the United
States.
(ii) The gain in excess of the deprecia-
tion adjustments is treated as if such prop-
erty were inventory and is sourced under
paragraph (d)(2) or (3) of this section as
applicable.
(e) Determination of source of taxable
income. For rules allocating and appor-
tioning expenses to income effectively
connected with the conduct of a trade or
business in the United States, see §§1.882-
4 and 1.882-5.
(f) Export trade corporations. This
section is not applicable for purposes of
defining an export trade corporation under
section 971.
(g) Applicability date. This section ap-
plies to sales occurring in taxable years
ending on or after December 23, 2019.
However, taxpayers may apply this sec-
tion in its entirety for taxable years begin-
ning after December 31, 2017, and ending
before December 23, 2019, provided that
the taxpayer and persons that are related
(within the meaning of section 267 or 707)
to the taxpayer apply this section in its en-
tirety.
§1.937-2 [Amended]
Par. 8. Section 1.937-2 is amended by
removing “§1.863-3(f)” from paragraph
(d) and adding in its place “§1.863-3(e)”.
§1.937-3 [Amended]
Par. 9. Section 1.937-3 is amended by
removing “§1.863-3(f)” from paragraph
(d) and adding in its place “§1.863-3(e)”.
Par. 10. Section 1.1502-13, as pro-
posed to be amended at 83 FR 67490 (De-
cember 28, 2018), is further amended by
revising paragraph (c)(7)(ii)(N) is to read
as follows:
§1.1502-13 Intercompany transactions.
* * * * *
(c) * * *
(7) * * *
(ii) * * *
(N) Example (14): Source of income under
section 863—(1) Intercompany sale—(i) Facts. S
manufactures inventory property solely in the Unit-
ed States, and recognizes $75x of income on sales
to B in Year 1. B conducts further production activ-
ity on the inventory property solely in Country Y
and then sells the inventory property to X in Coun-
try Y and recognizes $25x of income on the sale to
X, also in Year 1. Title passes from S to B, and from
B to X, in Country Y. Assume that applying §1.863-

January 21, 2020 400 Bulletin No. 2020–4
3 on a single entity basis, including the formula for
apportionment of multi-country production activi-
ties by reference to the basis of production assets,
$10x is treated as foreign source income and $90x
is treated as U.S. source income (that is, 10 per-
cent of the production occurred outside the United
States and 90 percent occurred within the United
States, as measured by the basis of assets used in
production activities with respect to the property).
Assume further that, on a separate entity basis, S
would have $0 of foreign source income and $75x
of U.S. source income and all of B’s $25x of in-
come would be foreign source income.
(ii) Analysis. Under the matching rule , both
S’s $75x intercompany income and B’s $25x cor-
responding income are taken into account in Year
1. In determining the source of S and B’s income
from the inventory property sales, the attributes of
S’s intercompany item and B’s corresponding item
are redetermined to the extent necessary to produce
the same effect on consolidated taxable income
(and consolidated tax liability) as if S and B were
divisions of a single corporation. See paragraph (c)
(1)(i) of this section. On a separate entity basis, S
would have $75x of U.S. source income because
the product would be treated as produced wholly
in the United States and sold outside the United
States, and B would have $25x of foreign source
income because the product would be treated as
produced wholly outside the United States and sold
outside the United States. On a single entity basis,
S and B are treated as divisions of a single corpo-
ration, and section 863 applies as if $100x of in-
come were recognized from producing partly in the
United States and partly in Country Y and selling
in Country Y. This results in $10x of foreign source
income and $90x of U.S. source income. Accord-
ingly, under single entity treatment, $15x of B’s
sales income that would be treated as foreign source
income on a separate entity basis is redetermined
to be U.S. source income. Under paragraph (c)(1)
(i) of this section, attributes are redetermined only
to the extent of the $15x necessary to achieve the
same effect as if S and B were divisions of a single
corporation. Under paragraph (c)(4)(ii) of this sec-
tion, the redetermined attribute must be allocated
between S and B using a reasonable method. In this
case, only B would have foreign source income on
a separate entity basis, and thus $15x of B’s for-
eign source income must be recharacterized as U.S.
source income.
(2) Sale of property reflecting intercompany
services or intangibles—(i) Facts. S earns $10x of
income performing services in the United States for
B. B capitalizes S’s fees into the basis of inventory
property that it manufactures in the United States
and sells to an unrelated person in Year 1 at a $90x
profit, with title passing in Country Y. Assume that
on a single entity basis, $100x is treated as U.S.
source income and $0 is treated as foreign source in-
come. Further assume that on a separate entity basis,
S would have $10x of U.S. source income, and B
would have $90x of U.S. source income, with neither
having any foreign source income.
(ii) Analysis. Under the matching rule, S’s $10x
income and B’s $90x income are taken into account
in Year 1. In determining the source of S and B’s
income, the attributes of S’s intercompany item and
B’s corresponding item are redetermined to the ex-
tent necessary to produce the same effect on consoli-
dated taxable income (and consolidated tax liability)
as if S and B were divisions of a single corporation,
such that section 863 applies as if $100x were earned
from manufacturing in the United States and selling
in Country Y. Because the results are the same on a
single entity basis and a separate entity basis ($100x
of U.S. source income and $0x of foreign source
income), the attributes are not redetermined under
paragraph (c)(1)(i) of this section.
* * * * *
Sunita Lough
Deputy Commissioner for Services
and Enforcement
(Filed by the Office of the Federal Register on De-
cember 23, 2019, 4:15 p.m., and published in the is-
sue of the Federal Register for December 30, 2019,
84 F.R. 71836)

Bulletin No. 2020–4 i January 21, 2020
Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the
effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that
the same principle also applies to B, the
earlier ruling is amplified. (Compare with
modified, below).
Clarified is used in those instances
where the language in a prior ruling is be-
ing made clear because the language has
caused, or may cause, some confusion. It
is not used where a position in a prior rul-
ing is being changed.
Distinguished describes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.
Modified is used where the substance
of a previously published position is being
changed. Thus, if a prior ruling held that a
principle applied to A but not to B, and the
new ruling holds that it applies to both A
and B, the prior ruling is modified because
it corrects a published position. (Compare
with amplified and clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transactions.
This term is most commonly used in a ruling
that lists previously published rulings that
are obsoleted because of changes in laws or
regulations. A ruling may also be obsoleted
because the substance has been included in
regulations subsequently adopted.
Revoked describes situations where the
position in the previously published ruling
is not correct and the correct position is
being stated in a new ruling.
Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a
period of time in separate rulings. If the
new ruling does more than restate the sub-
stance of a prior ruling, a combination of
terms is used. For example, modified and
superseded describes a situation where the
substance of a previously published ruling
is being changed in part and is continued
without change in part and it is desired to
restate the valid portion of the previous-
ly published ruling in a new ruling that is
self contained. In this case, the previously
published ruling is first modified and then,
as modified, is superseded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names
in subsequent rulings. After the original
ruling has been supplemented several
times, a new ruling may be published that
includes the list in the original ruling and
the additions, and supersedes all prior rul-
ings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of cas-
es in litigation, or the outcome of a Ser-
vice study.
Abbreviations
The following abbreviations in current use
and formerly used will appear in material
published in the Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.

January 21, 2020 ii Bulletin No. 2020–4
Numerical Finding List
1
Bulletin 2020–4
Notices:
2020-1, 2020-2 I.R.B. 290
2020-2, 2020-3 I.R.B. 327
2020-3, 2020-3 I.R.B. 330
2020-4, 2020-4 I.R.B. 380
2020-5, 2020-4 I.R.B. 380
Proposed Regulations:
REG-107431-19, 2020-3 I.R.B. 332
REG-122180-18, 2020-3 I.R.B. 342
REG-100956-19, 2020-4 I.R.B. 383
Revenue Rulings:
2020-1, 2020-3 I.R.B. 296
2020-2, 2020-3 I.R.B. 298
Treasury Decisions:
9886, 2020-2 I.R.B. 285
9887, 2020-3 I.R.B. 302
9888, 2020-3 I.R.B. 306
Revenue Procedures:
2020-1, 2020-01 I.R.B. 1
2020-2, 2020-01 I.R.B. 107
2020-3, 2020-01 I.R.B. 131
2020-4, 2020-01 I.R.B. 148
2020-5, 2020-01 I.R.B. 241
2020-7, 2020-01 I.R.B. 281
2020-9, 2020-02 I.R.B. 294
2020-10, 2020-02 I.R.B. 295
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2018–27 through 2018–52 is in Internal Revenue Bulletin
2018–52, dated December 27, 2018.

Bulletin No. 2020–4 iii January 21, 2020
Finding List of Current Actions on
Previously Published Items
1
Bulletin 2020–4
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2018–27 through 2018–52 is in Internal Revenue Bulletin
2018–52, dated December 27, 2018.

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Washington, DC 20224
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