Sec. 864 Definitions and special rules
(a) Produced. For purposes of this part, the term "produced" includes created, fabricated, manufactured, extracted, processed, cured, or aged.
(b) Trade or business within the United States. For purposes of this part, part II, and chapter 3, the term "trade or business within the United States" includes the performance of personal services within the United States at any time within the taxable year, but does not include--
(1) Performance of personal services for foreign employer. The performance of personal services--
(A) for a nonresident alien individual, foreign partnership, or foreign corporation, not engaged in trade or business within the United States, or
(B) for an office or place of business maintained in a foreign country or in a possession of the United States by an individual who is a citizen or resident of the United States or by a domestic partnership or a domestic corporation,
by a nonresident alien individual temporarily present in the United States for a period or periods not exceeding a total of 90 days during the taxable year and whose compensation for such services does not exceed in the aggregate $3,000.
(2) Trading in securities or commodities.
(A) Stocks and securities.
(i) In general. Trading in stocks or securities through a resident broker, commission agent, custodian, or other independent agent.
(ii) Trading for taxpayer's own account. Trading in stocks or securities for the taxpayer's own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such employee or agent has discretionary authority to make decisions in effecting the transactions. This clause shall not apply in the case of a dealer in stocks or securities.
(B) Commodities.
(i) In general. Trading in commodities through a resident broker, commission agent, custodian, or other independent agent.
(ii) Trading for taxpayer's own account. Trading in commodities for the taxpayer's own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such employee or agent has discretionary authority to make decisions in effecting the transactions. This clause shall not apply in the case of a dealer in commodities.
(iii) Limitation. Clauses (i) and (ii) shall apply only if the commodities are of a kind customarily dealt in on an organized commodity exchange and if the transaction is of a kind customarily consummated at such place.
(C) Limitation. Subparagraphs (A)(i) and (B)(i) shall apply only if, at no time during the taxable year, the taxpayer has an office or other fixed place of business in the United States through which or by the direction of which the transactions in stocks or securities, or in commodities, as the case may be, are effected.
(c) Effectively connected income, etc.
(1) General rule. For purposes of this title--
(A) In the case of a nonresident alien individual or a foreign corporation engaged in trade or business within the United States during the taxable year, the rules set forth in paragraphs (2), (3), (4), (6), (7), and (8) shall apply in determining the income, gain, or loss which shall be treated as effectively connected with the conduct of a trade or business within the United States.
(B) Except as provided in paragraph (6), (7), or (8) or in section 871(d) or sections 882(d) and (e), in the case of a nonresident alien individual or a foreign corporation not engaged in trade or business within the United States during the taxable year, no income, gain, or loss shall be treated as effectively connected with the conduct of a trade or business within the United States.
(2) Periodical, etc., income from sources within United States--factors. In determining whether income from sources within the United States of the types described in section 871(a)(1), section 871(h), section 881(a), or section 881(c), or whether gain or loss from sources within the United States from the sale or exchange of capital assets, is effectively connected with the conduct of a trade or business within the United States, the factors taken into account shall include whether--
(A) the income, gain, or loss is derived from assets used in or held for use in the conduct of such trade or business, or
(B) the activities of such trade or business were a material factor in the realization of the income, gain, or loss.
In determining whether an asset is used in or held for use in the conduct of such trade or business or whether the activities of such trade or business were a material factor in realizing an item of income, gain, or loss, due regard shall be given to whether or not such asset or such income, gain, or loss was accounted for through such trade or business.
(3) Other income from sources within United States. All income, gain, or loss from sources within the United States (other than income, gain, or loss to which paragraph (2) applies) shall be treated as effectively connected with the conduct of a trade or business within the United States.
(4) Income from sources without United States.
(A) Except as provided in subparagraphs (B) and (C), no income, gain, or loss from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States.
(B) Income, gain, or loss from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States by a nonresident alien individual or a foreign corporation if such person has an office or other fixed place of business within the United States to which such income, gain, or loss is attributable and such income, gain, or loss--
(i) consists of rents or royalties for the use of or for the privilege of using intangible property described in section 862(a)(4) derived in the active conduct of such trade or business;
(ii) consists of dividends, interest, or amounts received for the provision of guarantees of indebtedness, and either is derived in the active conduct of a banking, financing, or similar business within the United States or is received by a corporation the principal business of which is trading in stocks or securities for its own account; or
(iii) is derived from the sale or exchange (outside the United States) through such office or other fixed place of business of personal property described in section 1221(a)(1), except that this clause shall not apply if the property is sold or exchanged for use, consumption, or disposition outside the United States and an office or other fixed place of business of the taxpayer in a foreign country participated materially in such sale.
Any income or gain which is equivalent to any item of income or gain described in clause (i), (ii), or (iii) shall be treated in the same manner as such item for purposes of this subparagraph.
(C) In the case of a foreign corporation taxable under part I or part II of subchapter L, any income from sources without the United States which is attributable to its United States business shall be treated as effectively connected with the conduct of a trade or business within the United States.
(D) No income from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States if it either--
(i) consists of dividends, interest, or royalties paid by a foreign corporation in which the taxpayer owns (within the meaning of section 958(a)), or is considered as owning (by applying the ownership rules of section 958(b)), more than 50 percent of the total combined voting power of all classes of stock entitled to vote, or
(ii) is subpart F income within the meaning of section 952(a).
(5) Rules for application of paragraph (4)(B). For purposes of subparagraph (B) of paragraph (4)--
(A) in determining whether a nonresident alien individual or a foreign corporation has an office or other fixed place of business, an office or other fixed place of business of an agent shall be disregarded unless such agent (i) has the authority to negotiate and conclude contracts in the name of the nonresident alien individual or foreign corporation and regularly exercises that authority or has a stock of merchandise from which he regularly fills orders on behalf of such individual or foreign corporation, and (ii) is not a general commission agent, broker, or other agent of independent status acting in the ordinary course of his business,
(B) income, gain, or loss shall not be considered as attributable to an office or other fixed place of business within the United States unless such office or fixed place of business is a material factor in the production of such income, gain, or loss and such office or fixed place of business regularly carries on activities of the type from which such income, gain, or loss is derived, and
(C) the income, gain, or loss which shall be attributable to an office or other fixed place of business within the United States shall be the income, gain, or loss properly allocable thereto, but, in the case of a sale or exchange described in clause (iii) of such subparagraph, the income which shall be treated as attributable to an office or other fixed place of business within the United States shall not exceed the income which would be derived from sources within the United States if the sale or exchange were made in the United States.
(6) Treatment of certain deferred payments, etc. For purposes of this title, in the case of any income or gain of a nonresident alien individual or a foreign corporation which--
(A) is taken into account for any taxable year, but
(B) is attributable to a sale or exchange of property or the performance of services (or any other transaction) in any other taxable year,
the determination of whether such income or gain is taxable under section 871(b) or 882 (as the case may be) shall be made as if such income or gain were taken into account in such other taxable year and without regard to the requirement that the taxpayer be engaged in a trade or business within the United States during the taxable year referred to in subparagraph (A).
(7) Treatment of certain property transactions. For purposes of this title, if--
(A) any property ceases to be used or held for use in connection with the conduct of a trade or business within the United States, and
(B) such property is disposed of within 10 years after such cessation,
the determination of whether any income or gain attributable to such disposition is taxable under section 871(b) or 882 (as the case may be) shall be made as if such sale or exchange occurred immediately before such cessation and without regard to the requirement that the taxpayer be engaged in a trade or business within the United States during the taxable year for which such income or gain is taken into account.
(8) Gain or loss of foreign persons from sale or exchange of certain partnership interests.
(A) In general. Notwithstanding any other provision of this subtitle, if a nonresident alien individual or foreign corporation owns, directly or indirectly, an interest in a partnership which is engaged in any trade or business within the United States, gain or loss on the sale or exchange of all (or any portion of) such interest shall be treated as effectively connected with the conduct of such trade or business to the extent such gain or loss does not exceed the amount determined under subparagraph (B).
(B) Amount treated as effectively connected. The amount determined under this subparagraph with respect to any partnership interest sold or exchanged --
(i) in the case of any gain on the sale or exchange of the partnership interest, is --
(I) the portion of the partner's distributive share of the amount of gain which would have been effectively connected with the conduct of a trade or business within the United States if the partnership had sold all of its assets at their fair market value as of the date of the sale or exchange of such interest, or
(II) zero if no gain on such deemed sale would have been so effectively connected, and
(ii) in the case of any loss on the sale or exchange of the partnership interest, is --
(I) the portion of the partner's distributive share of the amount of loss on the deemed sale described in clause (i)(I) which would have been so effectively connected, or
(II) zero if no loss on such deemed sale would be have been so effectively connected.
For purposes of this subparagraph, a partner's distributive share of gain or loss on the deemed sale shall be determined in the same manner as such partner's distributive share of the non-separately stated taxable income or loss of such partnership.
(C) Coordination with United States real property interests. If a partnership described in subparagraph (A) holds any United States real property interest (as defined in section 897(c)) at the time of the sale or exchange of the partnership interest, then the gain or loss treated as effectively connected income under subparagraph (A) shall be reduced by the amount so treated with respect to such United States real property interest under section 897.
(D) Sale or exchange. For purposes of this paragraph, the term "sale or exchange" means any sale, exchange, or other disposition.
(E) Secretarial authority. The Secretary shall prescribe such regulations or other guidance as the Secretary determines appropriate for the application of this paragraph, including with respect to exchanges described in section 332, 351, 354, 355, 356, or 361.
(d) Treatment of related person factoring income.
(1) In general. For purposes of the provisions set forth in paragraph (2), if any person acquires (directly or indirectly) a trade or service receivable from a related person, any income of such person from the trade or service receivable so acquired shall be treated as if it were interest on a loan to the obligor under the receivable.
(2) Provisions to which paragraph (1) applies. The provisions set forth in this paragraph are as follows:
(A) Section 904 (relating to limitation on foreign tax credit).
(B) Subpart F of part III of this subchapter (relating to controlled foreign corporations).
(3) Trade or service receivable. For purposes of this subsection, the term "trade or service receivable" means any account receivable or evidence of indebtedness arising out of--
(A) the disposition by a related person of property described in section 1221(a)(1), or
(B) the performance of services by a related person.
(4) Related person. For purposes of this subsection, the term "related person" means--
(A) any person who is a related person (within the meaning of section 267(b)), and
(B) any United States shareholder (as defined in section 951(b)) and any person who is a related person (within the meaning of section 267(b)) to such a shareholder.
(5) Certain provisions not to apply. The following provisions shall not apply to any amount treated as interest under paragraph (1) or (6):
(A) Section 904(d)(2)(B)(iii)(I) (relating to exceptions for export financing interest).
(B) Subparagraph (A) of section 954(b)(3) (relating to exception where foreign base company income is less than 5 percent or $1,000,000).
(C) Subparagraph (B) of section 954(c)(2) (relating to certain export financing).
(D) Clause (i) of section 954(c)(3)(A) (relating to certain income received from related persons).
(6) Special rule for certain income from loans of a controlled foreign corporation. Any income of a controlled foreign corporation (within the meaning of section 957(a)) from a loan to a person for the purpose of financing--
(A) the purchase of property described in section 1221(a)(1) of a related person, or
(B) the payment for the performance of services by a related person,
shall be treated as interest described in paragraph (1).
(7) Exception for certain related persons doing business in same foreign country. Paragraph (1) shall not apply to any trade or service receivable acquired by any person from a related person if--
(A) the person acquiring such receivable and such related person are created or organized under the laws of the same foreign country and such related person has a substantial part of its assets used in its trade or business located in such same foreign country, and
(B) such related person would not have derived any foreign base company income (as defined in section 954(a), determined without regard to section 954(b)(3)(A)), or any income effectively connected with the conduct of a trade or business within the United States, from such receivable if it had been collected by such related person.
(8) Regulations. The Secretary shall prescribe such regulations as may be necessary to prevent the avoidance of the provisions of this subsection or section 956(c)(3).
(e) Rules for allocating interest, etc. For purposes of this subchapter--
(1) Treatment of affiliated groups. The taxable income of each member of an affiliated group shall be determined by allocating and apportioning interest expense of each member as if all members of such group were a single corporation.
(2) Gross income and fair market value methods may not be used for interest. All allocations and apportionments of interest expense shall be determined using the adjusted bases of assets rather than on the basis of the fair market value of the assets or gross income.
(3) Tax-exempt assets not taken into account. For purposes of allocating and apportioning any deductible expense, any tax-exempt asset (and any income from such an asset) shall not be taken into account. A similar rule shall apply in the case of the portion of any dividend (other than a qualifying dividend as defined in section 243(b)) equal to the deduction allowable under section 243 or 245(a) with respect to such dividend and in the case of a like portion of any stock the dividends on which would be so deductible and would not be qualifying dividends (as so defined).
(4) Basis of stock in nonaffiliated 10-percent owned corporations adjusted for earnings and profits changes.
(A) In general. For purposes of allocating and apportioning expenses on the basis of assets, the adjusted basis of any stock in a nonaffiliated 10-percent owned corporation shall be--
(i) increased by the amount of the earnings and profits of such corporation attributable to such stock and accumulated during the period the taxpayer held such stock, or
(ii) reduced (but not below zero) by any deficit in earnings and profits of such corporation attributable to such stock for such period.
(B) Nonaffiliated 10-percent owned corporation. For purposes of this paragraph, the term "nonaffiliated 10-percent owned corporation" means any corporation if--
(i) such corporation is not included in the taxpayer's affiliated group, and
(ii) members of such affiliated group own 10 percent or more of the total combined voting power of all classes of stock of such corporation entitled to vote.
(C) Earnings and profits of lower tier corporations taken into account.
(i) In general. If, by reason of holding stock in a nonaffiliated 10-percent owned corporation, the taxpayer is treated under clause (iii) as owning stock in another corporation with respect to which the stock ownership requirements of clause (ii) are met, the adjustment under subparagraph (A) shall include an adjustment for the amount of the earnings and profits (or deficit therein) of such other corporation which are attributable to the stock the taxpayer is so treated as owning and to the period during which the taxpayer is treated as owning such stock.
(ii) Stock ownership requirements. The stock ownership requirements of this clause are met with respect to any corporation if members of the taxpayer's affiliated group own (directly or through the application of clause (iii)) 10 percent or more of the total combined voting power of all classes of stock of such corporation entitled to vote.
(iii) Stock owned through entities. For purposes of this subparagraph, stock owned (directly or indirectly) by a corporation, partnership, or trust shall be treated as being owned proportionately by its shareholders, partners, or beneficiaries. Stock considered to be owned by a person by reason of the application of the preceding sentence, shall, for purposes of applying such sentence, be treated as actually owned by such person.
(D) Coordination with subpart F, etc. For purposes of this paragraph, proper adjustment shall be made to the earnings and profits of any corporation to take into account any earnings and profits included in gross income under section 951 or under any other provision of this title and reflected in the adjusted basis of the stock.
(5) Affiliated group. For purposes of this subsection--
(A) In general. Except as provided in subparagraph (B), the term "affiliated group" has the meaning given such term by section 1504. Notwithstanding the preceding sentence, a foreign corporation shall be treated as a member of the affiliated group if--
(i) more than 50 percent of the gross income of such foreign corporation for the taxable year is effectively connected with the conduct of a trade or business within the United States, and
(ii) at least 80 percent of either the vote or value of all outstanding stock of such foreign corporation is owned directly or indirectly by members of the affiliated group (determined with regard to this sentence).
(B) Treatment of certain financial institutions. For purposes of subparagraph (A), any corporation described in subparagraph (C) shall be treated as an includible corporation for purposes of section 1504 only for purposes of applying such section separately to corporations so described. This subparagraph shall not apply for purposes of paragraph (6).
(C) Description. A corporation is described in this subparagraph if--
(i) such corporation is a financial institution described in section 581 or 591,
(ii) the business of such financial institution is predominantly with persons other than related persons (within the meaning of subsection (d)(4)) or their customers, and
(iii) such financial institution is required by State or Federal law to be operated separately from any other entity which is not such an institution.
(D) Treatment of bank holding companies. To the extent provided in regulations--
(i) a bank holding company (within the meaning of section 2(a) of the Bank Holding Company Act of 1956), and
(ii) any subsidiary of a financial institution described in section 581 or 591 or of any bank holding company if such subsidiary is predominantly engaged (directly or indirectly) in the active conduct of a banking, financing, or similar business,
shall be treated as a corporation described in subparagraph (C).
(6) Allocation and apportionment of other expenses. Expenses other than interest which are not directly allocable or apportioned to any specific income producing activity shall be allocated and apportioned as if all members of the affiliated group were a single corporation.
(7) Regulations. The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section, including regulations providing--
(A) for the resourcing of income of any member of an affiliated group or modifications to the consolidated return regulations to the extent such resourcing or modification is necessary to carry out the purposes of this section,
(B) for direct allocation of interest expense incurred to carry out an integrated financial transaction to any interest (or interest-type income) derived from such transaction and in other circumstances where such allocation would be appropriate to carry out the purposes of this subsection,
(C) for the apportionment of expenses allocated to foreign source income among the members of the affiliated group and various categories of income described in section 904(d)(1),
(D) for direct allocation of interest expense in the case of indebtedness resulting in a disallowance under section 246A,
(E) for appropriate adjustments in the application of paragraph (3) in the case of an insurance company, and
(F) preventing assets or interest expense from being taken into account more than once, and
(G) that this subsection shall not apply for purposes of any provision of this subchapter to the extent the Secretary determines that the application of this subsection for such purposes would not be appropriate.
(f) [Repealed by P.L. 117-2]
(g) Allocation of research and experimental expenditures.
(1) In general. For purposes of sections 861(b), 862(b), and 863(b), qualified research and experimental expenditures shall be allocated and apportioned as follows:
(A) Any qualified research and experimental expenditures expended solely to meet legal requirements imposed by a political entity with respect to the improvement or marketing of specific products or processes for purposes not reasonably expected to generate gross income (beyond de minimis amounts) outside the jurisdiction of the political entity shall be allocated only to gross income from sources within such jurisdiction.
(B) In the case of any qualified research and experimental expenditures (not allocated under subparagraph (A)) to the extent--
(i) that such expenditures are attributable to activities conducted in the United States, 50 percent of such expenditures shall be allocated and apportioned to income from sources within the United States and deducted from such income in determining the amount of taxable income from sources within the United States, and
(ii) that such expenditures are attributable to activities conducted outside the United States, 50 percent of such expenditures shall be allocated and apportioned to income from sources outside the United States and deducted from such income in determining the amount of taxable income from sources outside the United States.
(C) The remaining portion of qualified research and experimental expenditures (not allocated under subparagraphs (A) and (B)) shall be apportioned, at the annual election of the taxpayer, on the basis of gross sales or gross income, except that, if the taxpayer elects to apportion on the basis of gross income, the amount apportioned to income from sources outside the United States shall at least be 30 percent of the amount which would be so apportioned on the basis of gross sales.
(2) Qualified research and experimental expenditures. For purposes of this section, the term "qualified research and experimental expenditures" means amounts which are research and experimental expenditures within the meaning of section 174. For purposes of this paragraph, rules similar to the rules of subsection (c) of section 174 shall apply. Any qualified research and experimental expenditures treated as deferred expenses under subsection (b) of section 174 shall be taken into account under this subsection for the taxable year for which such expenditures are allowed as a deduction under such subsection.
(3) Special rules for expenditures attributable to activities conducted in space, etc.
(A) In general. Any qualified research and experimental expenditures described in subparagraph (B)--
(i) if incurred by a United States person, shall be allocated and apportioned under this section in the same manner as if they were attributable to activities conducted in the United States, and
(ii) if incurred by a person other than a United States person, shall be allocated and apportioned under this section in the same manner as if they were attributable to activities conducted outside the United States.
(B) Description of expenditures. For purposes of subparagraph (A), qualified research and experimental expenditures are described in this subparagraph if such expenditures are attributable to activities conducted--
(i) in space,
(ii) 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, or
(iii) in Antarctica.
(4) Affiliated group.
(A) Except as provided in subparagraph (B), the allocation and apportionment required by paragraph (1) shall be determined as if all members of the affiliated group (as defined in subsection (e)(5)) were a single corporation.
(B) For purposes of the allocation and apportionment required by paragraph (1)--
(i) sales and gross income from products produced in whole or in part in a possession by an electing corporation (within the meaning of section 936(h)(5)(E)), and
(ii) dividends from an electing corporation,
shall not be taken into account, except that this subparagraph shall not apply to sales of (and gross income and dividends attributable to sales of) products with respect to which an election under section 936(h)(5)(F) is not in effect.
(C) The qualified research and experimental expenditures taken into account for purposes of paragraph (1) shall be adjusted to reflect the amount of such expenditures included in computing the cost-sharing amount (determined under section 936(h)(5)(C)(i)(I)).
(D) The Secretary may prescribe such regulations as may be necessary to carry out the purposes of this paragraph, including regulations providing for the source of gross income and the allocation and apportionment of deductions to take into account the adjustments required by subparagraph (B) or (C).
(E) Paragraph (6) of subsection (e) shall not apply to qualified research and experimental expenditures.
(5) Regulations. The Secretary shall prescribe such regulations as may be appropriate to carry out the purposes of this subsection, including regulations relating to the determination of whether any expenses are attributable to activities conducted in the United States or outside the United States and regulations providing such adjustments to the provisions of this subsection as may be appropriate in the case of cost-sharing arrangements and contract research.
(6) Applicability. This subsection shall apply to the taxpayer's first taxable year (beginning on or before August 1, 1994) following the taxpayer's last taxable year to which Revenue Procedure 92-56 applies or would apply if the taxpayer elected the benefits of such Revenue Procedure.
