The Sourcing Rules §861-865
The sourcing rules have an important purpose for US persons and non-US persons.
Since a US person is taxed in the US on their worldwide income, they can offset US income taxes with foreign tax credits to prevent double taxation. The source of the income is critical because foreign tax credits can only offset US taxes on foreign source income.
For non-US persons, the sourcing rules are important because they will only be taxed on income from sources within the US.
Determining whether a source of income is from “within the US” (US sourced) or “without the US” (foreign sourced) is dependent on the category of income which will have specific rules on sourcing. For example, interest, dividends, compensation, etc.
Final Regulations issued on Sourcing Rules for Sales of Inventory Property (T.D. 9921, Sept. 29, 2020)
§863 provides special sourcing rules including §863(b)(2) covering the sale of inventory that is produced in the US and sold outside the US, and inventory produced outside the US and sold within the US. Generally, the income is computed by allocating and apportioning expenses.
Prior to the TCJA, the regulations did not specify the basis to allocate and apportion the income and it’s deductions. The final regulations now require that gross income from §863(b)(2) sales be allocated and apportioned based solely on production activity.
The Final Regulations also contain rules for determining whether foreign-source income is effectively connected with the conduct of a US trade or business and covers the sourcing of a nonresident's income from certain sales of personal property that are attributable to an office maintained in the United States.
The Final Regulations generally apply to tax years ending on or after 23 December 2019. Taxpayers may choose to apply the Final Regulations in their entirety for any tax year beginning after 31 December 2017, if they and all related persons continue to apply the regulations for all subsequent years