Source of Income from Certain Space & Ocean Activities;
Also, Source of Communications Income

DEPARTMENT OF THE TREASURY 
Internal Revenue Service 26 CFR Part 1 [REG-106030-98] RIN 1545-AW50

TITLE: Source of Income from Certain Space and Ocean Activities;
Also, Source of Communications Income

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations under section
863(d) governing the source of income from certain space and ocean
activities. It also contains proposed regulations under sections
863(a), (d), and (e) governing the source of income from certain
communications activity. This document also contains proposed
regulations under sections 863(a) and (b), amending the regulations
in §1.863-3 to conform those regulations with these proposed
regulations. This document affects persons who conduct activities in
space, or on or under water not within the jurisdiction of a foreign
country, possession of the United States, or the United States
(collectively, in international water). This document also affects
persons who derive income from transmission of communications. In
addition, this document provides notice of a public hearing on these
proposed regulations.

DATES: Comments and outlines of oral comments to be presented at the
public hearing scheduled for March 28, 2001, at 10 a.m. must be
received by March 7, 2001.

ADDRESSES: Send submissions to: CC:M&SP:RU (Reg-106030-98), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday
through Friday between the hours of 8 a.m. and 5 p.m. to: CC:M&SP:RU
(REG-106030-98), Courier's Desk, Internal Revenue Service, 1111
Constitution Avenue NW., Washington, DC. Alternatively, taxpayers
may submit comments electronically via the Internet by selecting the
"Tax Regs" option on the IRS Home Page, or by submitting comments
directly to the IRS Internet site at:
http://www.irs.ustreas.gov/tax_regs/regslist.html. The public
hearing will be held in the auditorium, seventh floor, Internal
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Anne
Shelburne, (202) 874-1490; concerning submissions and the hearing,
and/or to be placed on the building access list to attend the
hearing, La Nita Van Dyke, (202) 622- 7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

      The collection of information contained in this notice of
proposed rulemaking has been submitted to the Office of Management
and Budget (OMB) for review in accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C. 3507(d)).

      Comments on the collection of information should be sent to
the Office of Management and Budget , Attn: Desk Officer for the
Department of Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal Revenue
Service, Attn:

IRS Reports Clearance Officer, W:CAR:MP:FP:S:O, Washington, DC
20224.

Comments on the collection of information should be received by
April 17, 2001. Comments are specifically requested concerning:
Whether the proposed collection of information is necessary for the
proper performance of the functions of the IRS, including whether
the information will have practical utility;

The accuracy of the estimated burden associated with the proposed
collection of information (see below);

How the quality, utility, and clarity of the information to be
collected may be enhanced;

How the burden of complying with the proposed collection of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and

Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.

      The collection of information requirements are in proposed
§1.863-8(g) and in §1.863-9(g). This information is
required by the IRS to monitor compliance with the federal tax rules
for determining the source of income from space or ocean activities,
or from transmission of communications. The likely respondents are
taxpayers who conduct space or ocean activities, or who derive
communications income. Responses to this collection of information
are required to properly determine the source of a taxpayer's income
from such transactions.

      Books or records relating to a collection of information must
be retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26
U.S.C. 6103.

Estimated total annual reporting/recordkeeping burden: 1,200 hours.
The estimated annual burden per respondent varies from 3 hours to 7
hours, depending on individual circumstances, with an estimated
average of 5 hours.

Estimated number of respondents: 250

Estimated annual frequency of responses: One time per year.

      An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless the
collection of information displays a valid control number assigned
by the Office of Management and Budget. Background

      This document contains proposed regulations relating to the
Income Tax Regulations (CFR part 1) under sections 863(a), (b), (d),
and (e) of the Internal Revenue Code (Code). Congress enacted
section 863(d) and section 863(e) as part of the Tax Reform Act of
1986 (Public Law 99-514, 100 Stat. 2085) (the 1986 Act).

Section 863(d) governs the source of income derived from certain
space and ocean activities. Section 863(e) governs the source of
income derived from international communications activity.

Explanation of Provisions

      These proposed regulations provide two sets of rules, one in
§1.863-8 for determining the source of income from space and
ocean activities, the other in §1.863- 9 for determining the
source of income from communications activity. Section 1.863-9
provides rules for both international communications income (ICI)
and other communications income. The IRS and Treasury believe it is
appropriate to provide source rules for both ICI and other
communications income in a single regulation.

       The IRS and Treasury are fully aware of the rapid
technological evolution in the space and communications industries
since Congress enacted sections 863(d) and (e) in 1986, and have
attempted to take into account these changes as well as changes in
the space and communications industries and business practices and
business models. The IRS and Treasury recognize that these
regulations address important issues for many different industries
and have worked closely with the industries in drafting these rules.
The IRS and Treasury are interested in receiving comments from these
industries on how to accommodate issues arising from the use of new
technologies, consistent with the language and purpose of the
statutory provisions.

A. Space and Ocean Activity Under Section 863(d)

1. Scope of §1.863-8 of the proposed regulations

       Section 1.863-8 of the proposed regulations provides rules
for sourcing income derived from space and ocean activity,
notwithstanding other sections. Proposed regulations
§1.863-8(a) provides that a taxpayer derives income from a
space or ocean activity only if the taxpayer conducts such activity
directly. This is consistent with the approach that IRS and Treasury
adopted in the §1.863-3 regulations sourcing income from
inventory sales.

2. Source of gross income from space or ocean activity

a. General

      Section 863(d)(1) states that, except as provided in
regulations, any income derived from space or ocean activity by a
U.S. person will be U.S. source income, and if derived by a foreign
person, foreign source income. Proposed regulations §1.863-
8(b)(1) provides that a U.S. person's space or ocean income is U.S.
source. Proposed regulations §1.863-8(b)(1) also states the
general rule that income derived by a foreign person from a space or
ocean activity is foreign source income. However, the proposed
regulations contain several exceptions to that general rule.

      Proposed regulations §1.863-8(b)(2) provides that if a
foreign corporation is 50 percent or more owned by vote or value
(directly, indirectly, or constructively) by U.S. persons and is not
a controlled foreign corporation within the meaning of section 957
(CFC), all income derived by the corporation from space or ocean
activity is U.S. source income. This rule reflects IRS and
Treasury's concern that U.S. persons may use a foreign corporation
(for example, by incorporating a 50/50 joint venture with a foreign
person, thereby avoiding CFC status) to obtain results that are
inconsistent with the purposes of this section. The IRS and Treasury
believe Congress granted Treasury broad regulatory authority in
section 863(d) to prevent taxpayers from circumventing the purposes
of this section.

      Proposed regulations §1.863-8(b)(3) provides that if a
foreign person is engaged in a U.S. trade or business, the foreign
person's income derived from a space or ocean activity is presumed
to be U.S. source income. The rule reflects IRS and Treasury's
concern that a foreign person could engage in significant economic
activities in the United States and avoid U.S. taxation of space or
ocean income derived from such activities. For example, a foreign
satellite company established in a no-tax jurisdiction could engage
in substantial activity in the United States through launch
facilities, yet pay no U.S. or foreign tax on income arising from
leasing the satellites it launches. The IRS and Treasury believe
Congress intended that a foreign person engaged in substantial U.S.
business in the United States be subject to U.S. tax on related
space or ocean activity.

      The IRS and Treasury recognize that the presumption may be
over-inclusive in certain cases. Therefore, the proposed regulations
provide that if the foreign person can allocate gross space or ocean
income between income from sources within the United States, space,
or international water, and outside the United States and space and
international water, to the satisfaction of the Commissioner, based
on the facts and circumstances, which may include functions
performed, resources employed, risks assumed, or other contributions
to value, income from outside the United States and space and
international water will be treated as foreign source income. When a
foreign person is entitled to the benefits of a tax treaty with the
United States, such person may elect to be taxed under the rules of
that treaty, so that, for example, the United States would tax only
income attributable to a permanent establishment of that foreign
person, regardless of the amount of income considered effectively
connected with a U.S. trade or business.

b. Source Rules for Sales of Certain Property

       Taxpayers must apply the rules of section 863(d) and these
proposed regulations to determine the source of income from sales of
property purchased or produced by the taxpayer, either when
production occurs in whole or in part in space or in international
water, or when the sale occurs in space or in international water.
The rules of sections 861, 862, 863(a) and (b), and 865, and the
regulations thereunder apply only to the extent provided in proposed
regulations §1.863-8(b)(4).

       Proposed regulations §1.863-8(b)(4)(i) provides that
income derived from the sale of purchased property in space or
international water is sourced under paragraph (b)(1), (2), or (3)
of this section. Proposed regulations §1.863-8(d)(2)(iii)
provides that a sale occurs in space or international water if
either property is located in space or international water at the
time the rights, title, and interests pass to the purchaser, or the
property sold is for use in space or international water. This rule
for determining if a sale takes place in space or in international
water modifies for space and ocean activity the rule in
§1.861-7(c) for otherwise determining where a sale takes place.
The IRS and Treasury believe this rule for determining the place of
sale in the case of space or ocean activity is consistent with the
legislative history of section 863(d), indicating Congress intended
that space and ocean activity be broadly defined. See S. Rept. No.
313, 99 Cong., 2d Sess. 357 (1986) (Senate Report). It is also
consistent th with the language of the Senate Report stating that
the committee did not intend to override the title passage rule for
sales of property on the high seas. Consistent with this language,
proposed regulations §1.863-8(d)(1)(ii) excludes from the
definition of ocean activity the sale of inventory on international
water, and the source of income from such sales continues to be
determined under §1.861-7(c).

      Proposed regulations §1.863-8(b)(4)(ii) provides rules
for income derived from the sale of property produced by the
taxpayer. To determine the source of income derived from the sale of
property produced by the taxpayer, proposed regulations
§1.863-8(b)(4)(ii)(A) provides that the taxpayer must divide
gross income from such sale equally between production activity and
sales activity. Thus, one- half of the taxpayer's gross income is
attributed to production activity, and the other one-half of such
gross income is attributed to sales activity.

      Proposed regulations §1.863-8(b)(4)(ii)(A) provides that
income attributable to sales activity is sourced applying the rules
applicable to the sale of purchased property. If the taxpayer sells
such property in space or international water, the source of income
attributable to sales activity is determined under paragraph (b)(1),
(2), or (3). If the taxpayer sells such property outside space and
outside international water, the source of income attributable to
sales activity is determined under §1.863-3(c)(2). Proposed
regulations §1.863-8(b)(4)(ii)(B) provides that income
attributable to production activity, when production occurs only in
space or in international water, is sourced under paragraphs (b)(1),
(2), or (3). When production occurs only outside space and
international water, income attributable to production activity is
sourced under §1.863- 3(c)(1). When production activity occurs
both in space or in international water and outside space and
international water, proposed regulations §1.863-8(b)(4)(ii)(C)
splits the income attributed to production activity between
production activities occurring in space or in international water,
and production activities occurring outside space and international
water. Gross income must be allocated to the satisfaction of the
Commissioner, based on all relevant facts and circumstances, which
may include functions performed, resources employed, risks assumed,
and any other contributions to the value of the property. The source
of gross income attributable to production activities in space or in
international water is sourced under paragraphs (b)(1), (2), or (3).
The source of gross income attributable to production activities
outside space and international water is determined under
§1.863-3(c)(1).

c. Special Rule for Determining the Source of Income from Services

       Proposed regulations §1.863-8(b)(5) provides that income
derived from the performance of services in space or in
international water is sourced under paragraph (b)(1), (2), or (3).
Proposed regulations §1.863-8(d)(2)(ii)(A) provides that a
performance of a service is a space or ocean activity when a part of
the service, even if de minimis, is performed in space or in
international water. The IRS and Treasury believe that Congress
intended a broad range of activities be treated as space or ocean
activities.

       The IRS and Treasury recognize that this rule may be over-
inclusive in certain cases. Therefore, proposed regulations
§1.863-8(b)(5) provides that the taxpayer can allocate gross
income derived from the performance of the service between
activities that occur in space or international water and activities
that occur outside space and international water, to the
satisfaction of the Commissioner, based on facts and circumstances,
which may include functions performed, resources employed, risks
assumed, or other contributions to value. Gross income allocated to
activities occurring outside space and international water will be
sourced under sections 861, 862, 863, and 865 of the Code.

d. Special Rule for Determining the Source of Communications Income

      A communications activity, as defined in proposed regulations
§1.863-9(d), also can be a space or ocean activity. Pursuant to
the authority granted in section 863(d)(1), proposed regulations
§1.863-8(b)(6) provides that income from communications
activity that is also a space or ocean activity is sourced under
proposed regulations §1.863-9(b).

3. Taxable income

      When a taxpayer allocates gross income under paragraph (b)(3)
(allocation for certain foreign persons), paragraph (b)(4)(ii)(C)
(allocation between production occurring in space or international
water and production occurring outside), or paragraph (b)(5)
(allocation between services occurring in space or international
water and those occurring outside) of this section, the taxpayer
must allocate or apportion expenses, losses, and other deductions
under §§1.861-8 through 1.861-14T of the regulations to
the class of gross income, which must include the total income so
allocated in each case. A taxpayer must then apply the rules of
§§1.861-8 through 1.861-14T to properly allocate or
apportion amounts of expenses, losses, and other deductions
allocated or apportioned to such class of gross income between gross
income from sources within the United States and without the United
States.

      When a taxpayer must allocate gross income to the satisfaction
of the Commissioner based on the facts and circumstances, IRS and
Treasury believe that such allocations would be based generally on
section 482 principles. However, IRS and Treasury solicit comments
on this approach, including specific comments and examples on
alternative methods that could be used to make these allocations.

4. Definition of space and ocean activity

a. General Rules

      Section 863(d)(2) provides that space or ocean activity means
any activity conducted in space, and any activity conducted in or
under water not within the jurisdiction of the United States or a
foreign country. Proposed regulations §1.863- 8(d)(1)(i)
defines space as any area not within the jurisdiction (as recognized
by the United States) of a foreign country, possession of the United
States, or the United States, and not in international water.

      Proposed regulations §1.863-8(d)(1)(i) provides that
space activity is any activity conducted in space, with certain
exceptions. Space activity includes performance and provision of
services in space, leasing of equipment or other property, including
spacecraft (e.g., satellites) or transponders, located in space,
licensing of technology or other intangibles for use in space, and
the production, processing, or creation of property in space. Space
activity includes the sale of property in space. Space activity also
includes underwriting income from the insurance of risks on
activities that produce income derived from space activity. The
inclusion of such underwriting income is consistent with language in
the Senate Report. See Senate Report at 357.

      Proposed regulations §1.863-8(d)(1)(ii) provides that
ocean activity is any activity conducted in international water,
with certain exceptions. Ocean activity includes performance and
provision of services in international water, leasing of equipment
or other property located in international water, licensing of
technology or other intangibles for use in international water, and
the production, processing, or creation of property in international
water. Ocean activity includes the sale of property in international
water, and the sale of inventory under international water, but does
not include the selling of inventory if the sale takes place on
international water. Thus, if property sold on international water
is inventory property, income attributable to sales activity is
sourced under §1.861-7(c).

      Ocean activity also includes underwriting income from the
insurance of risks on activities that produce income derived from
ocean activity. The inclusion of such underwriting income is
consistent with language in the Senate Report. See Senate Report at
357.

      Ocean activity also includes any activity performed in
Antarctica. Ocean activity further includes the leasing of a vessel
if such vessel does not transport cargo or persons for hire between
ports-of-call. Thus, for example, income earned by a lessor of a
vessel that is to engage only in research activities in
international water is ocean income. Ocean activity also includes
the leasing of drilling rigs, extraction of minerals, and
performance and provision of services related thereto, to the extent
the mines, oil and gas wells, or other natural deposits are not
within the jurisdiction of the United States, U.S. possessions, or
any foreign country (as defined in section 638).

      Based on legislative history, the IRS and Treasury believe
space and ocean activity should be broadly defined based on
legislative history. The legislative history clearly indicates that
Congress intended to characterize certain land based activity as
space or ocean activity. See Senate Report at 357. Consistent with
that determination, the proposed regulations provide that when
activities occur both in space or in international water and outside
space and international water, and constitute parts of a single
transaction described in §1.863-8(d)(1), the transaction will
be characterized as space or ocean activity. Thus, for example,
income from the lease of equipment located in space will be sourced
in its entirety under section 863(d), even though certain functions
associated with the transaction may be performed outside space and
international water. The rules of this section for defining space or
ocean activity by combining activities occurring both in space or in
international water and outside space and international water simply
reflect existing principles for characterizing a transaction, and
are fully consistent with rules for characterizing income for
purposes of other source rules. Taxpayers enjoy flexibility in
structuring their transactions that will be characterized under
existing principles. To ensure the statutory purpose is not
circumvented, the Commissioner may treat parts of a transaction as
separate transactions, or combine separate transactions as a single
transaction.

       Certain activities occurring in space or international water
are not considered either space or ocean activity. Proposed
regulations §1.863-8(d)(3)(i) provides that space or ocean
activity does not include any activity giving rise to transportation
income as defined in section 863(c). Proposed regulations
§1.863-8(d)(3) (ii) provides that space or ocean activity also
does not include any activity with respect to mines, oil and gas
wells, or other natural deposits to the extent the mines or wells
are located within the jurisdiction (as recognized by the United
States) of any country, including the United States and its
possessions (as defined in section 638). Proposed regulations
§1.863-8(d)(3)(iii) provides that space or ocean activity does
not include any activity giving rise to international communications
income as defined in proposed regulations §1.863-9(d)(3)(ii).
These exceptions are consistent with section 863(d)(2)(B) of the
Code.

b. Special Rules in Determining Space or Ocean Activity

      Proposed regulations §1.863-8(d)(2)(ii)(A) provides that
services are performed in space or in international water if
functions are performed, resources employed, risks assumed, or other
contributions to the value of the transaction occur in space or
international water, whether such contributions are performed by
personnel, or equipment, or otherwise. The IRS and Treasury believe
that all contributions to a transaction's value, whether contributed
by personnel, equipment, or otherwise, should be considered in
determining whether services are performed in space or international
water.

      Proposed regulations §1.863-8(d)(2)(ii)(A) provides that
the performance of a service is treated as a space or ocean activity
if a part of the service is performed in space or international
water. The IRS and Treasury recognize that this rule may be over-
inclusive in certain cases. Therefore, proposed regulations
§1.863-8(d)(2)(ii) (B) provides that the performance of a
service will not be a space or ocean activity if the only activity
of the taxpayer in space or in international water is to facilitate
the taxpayer's own communications, as part of provision or delivery
of a service by the taxpayer, and that service would not otherwise
be in whole or in part a space or ocean activity. Several examples
in the regulations illustrate this facilitation exception. The IRS
and Treasury recognize that taxpayers may use communications
services in conducting a business, and the fact that such
communications may be routed through space or international water
instead of by way of land should not produce differences in the
source of the taxpayer's income derived from such service.

5. Treatment of partnerships

       Proposed regulations §1.863-8(e) provides that for U.S.
partnerships, section 863(d) and the regulations thereunder will be
applied at the partnership level. The IRS and Treasury believe this
rule is consistent with section 7701(a)(30)(B), which defines a U.S.
person as a domestic partnership. For foreign partnerships, section
863(d) and the regulations thereunder will be applied at the partner
level. The proposed regulations provide a different rule for foreign
partnerships because IRS and Treasury are concerned that U.S.
persons may use a foreign partnership to circumvent the purposes of
this section. For example, two U.S. persons by the simple expediency
of forming a foreign partnership can change significantly the U.S.
tax consequences under section 863(d).

6. Reporting and documentation requirements

       When a taxpayer allocates gross income to the satisfaction of
the Commissioner under §1.863-8(b)(3) (income of certain
foreign persons), §1.863-8(b)(4)(ii)(C) (certain production
activity), or under §1.863-8(b)(5) (services) of the proposed
regulations, the taxpayer must do so by making the allocation on a
timely filed original return (including extensions). An amended
return does not qualify, and section 9100 relief will not be
available. In all cases, a taxpayer must maintain contemporaneous
documentation regarding the allocation of gross income, and
allocation of expenses, losses, and other deductions, the
methodology used, and the circumstances justifying use of that
methodology. The taxpayer must produce such documentation within 30
days upon request.

B. Communications Activity Under Sections 863(a), (d), and (e)

1. Scope

      Section 1.863-9 of the proposed regulations provides rules for
sourcing income derived from communications activity,
notwithstanding any other section. Pursuant to proposed regulations
§1.863-8, these source rules apply to communications activity
that is also space or ocean activity.

2. Source of gross income derived from communications activity

a. International Communications Income

      Section 863(e)(1)(A) states that any international
communications income of a U.S. person will be sourced 50 percent to
the United States and 50 percent to foreign sources. Proposed
regulations §1.863-9(b)(2)(i) provides that international
communications income of a U.S. person will be sourced 50 percent to
the United States and 50 percent to foreign sources.

      Section 863(e)(1)(B)(i) provides that any international
communications income of a foreign person will be foreign source
income except as provided in regulations or in section 863(e)(1)(B)
(ii). Proposed regulations §1.863-9(b)(2)(ii)(A) states the
general rule that international communications income of a foreign
person is foreign source income. However, the proposed regulations
contain several exceptions to the general rule.

      Proposed regulations §1.863-9(b)(2)(ii)(B) states that if
a foreign corporation is 50 percent or more owned by vote or value
(directly, indirectly, or constructively) by U.S. persons, or is a
controlled foreign corporation within the meaning of section 957,
all international communications income is U.S. source income. This
rule reflects IRS and Treasury's concern that U.S. persons may use a
foreign corporation to obtain benefits that are inconsistent with
the purposes of this section.

      Section 863(e)(1)(B)(ii) provides that if a foreign person has
a U.S. fixed place of business, international communications income
attributable to the fixed place of business is U.S. source income.
Consistent with section 863(e)(1)(B)(ii), proposed regulations
§1.863-9(b)(2)(ii)(C) states that if a foreign person, other
than a foreign person described in paragraph (b)(2)(ii)(A),
maintains an office or other fixed place of business in the United
States, any international communications income attributable to the
office or other fixed place of business is U.S. source income. The
principles of section 864(c)(5) will apply to determine whether a
foreign person has an office or fixed place of business in the
United States. This rule does not apply if the foreign person is
engaged in a U.S. trade or business.

      Proposed regulations §1.863-9(b)(2)(ii)(D) provides that
if a foreign person is engaged in a U.S. trade or business, the
foreign person's international communications income is presumed to
be U.S. source income. The rule reflects IRS and Treasury's concern
that a foreign person could avoid a U.S. fixed place of business
under section 863(e)(1)(B)(ii), yet engage in significant
communications activity in the United States. The IRS and Treasury
believe Congress intended that a foreign person engaged in
substantial U.S. business in the United States be subject to U.S.
tax on that communications activity.

      The IRS and Treasury recognize that this rule may be over-
inclusive in certain cases. Therefore, the proposed regulations
provide that if the foreign person can allocate income to
international communications activity outside the United States and
space and international water, to the satisfaction of the
Commissioner, based on the facts and circumstances, which may
include functions performed, resources employed, risks assumed, or
other contributions to value, then the income allocated to such
communications activity outside the United States and space and
international water will be foreign source income. When a foreign
person is entitled to the benefits of a tax treaty with the United
States, such person may elect to be taxed under the rules of that
treaty, so that, for example, the United States would tax only
income attributable to a permanent establishment of that foreign
person, regardless of the amount of income considered effectively
connected with a U.S. trade or business.

b. Other Communications Income

      The proposed regulations also provide rules, for both U.S. and
foreign persons, for determining the source of income from
communications activity that does not qualify as international
communications activity. The IRS and Treasury believe rules that
address income from other communications activities are necessary
based on the legislative history. See Senate Report at 357.

      Proposed regulations §1.863-9(b)(3) states that the
source of income derived by either a U.S. or foreign person from
U.S. communications activity is U.S. source income. Proposed
regulations §1.863-9(b)(4) states that the source of income
derived by either a U.S. or foreign person from foreign
communications activity is foreign source income. Proposed
regulations §1.863-9(b)(5) states that the source of income
derived from space/ocean communications activity is determined under
section 863(d) and the regulations thereunder.

3. Taxable income

      When a taxpayer allocates gross income under paragraph (b)(2)
(ii)(D) (certain foreign persons), or (d)(1)(ii) (determining a
communications activity), the taxpayer must allocate or apportion
expenses, losses, and other deductions as prescribed in
§§1.861-8 through 1.861-14T of the regulations to the
class of gross income, which must include the total income so
allocated in each case. A taxpayer must then apply the rules of
§§1.861-8 through 1.861-14T of the regulations to properly
allocate or apportion amounts of expenses, losses, and other
deductions allocated or apportioned to such gross income between
gross income from sources within the United States and without the
United States. For amounts of expenses, losses, and other deductions
allocated or apportioned to gross income derived from international
communications activity, when the source of income is determined
under the 50/50 method of paragraph (b)(2)(i), taxpayers must
apportion expenses and other deductions between U.S. and foreign
sources pro rata based on the relative amounts of U.S. and foreign
source gross income. Research and experimental expenditures
qualifying under §1.861-17 are allocated under that section.

      When a taxpayer must allocate gross income to the satisfaction
of the Commissioner based on the facts and circumstances, IRS and
Treasury believe that such allocations would be based generally on
section 482 principles. However, IRS and Treasury solicit comments
on this approach, including specific comments and examples on
alternative methods that could be used to make these allocations.

4. Definition of communications activity and income derived from
communications activity

a. Communications Activity

      Proposed regulations §1.863-9(d)(1) defines a
communications activity as an activity consisting solely in the
delivery by transmission of communications or data (communications).
The definition of a communications activity is limited to the
function of transmitting a particular communication from point A to
point B. The delivery of communications by means other than
transmission, for example, delivery of a letter is not a
communications activity. The IRS and Treasury believe that this
narrow definition of communications activity is consistent with the
legislative history of section 863(e). See Senate Report at 357.

      The provision of capacity to transmit communications or data
is considered to be a communications activity. For example, the
provision of satellite transponder capacity can qualify as a
communications activity.

      The provision of content or any other additional service will
not be treated as a communications activity unless de minimis. For
example, changes in the form of a voice communication when switching
from analog technology to digital data for Internet telephony would
be disregarded in determining whether there has been a transmission
of communications within the meaning of proposed regulations
§1.863-9(d). However, payment for information from a data base
sent electronically, or for income attributable to an entertainment
event transmitted electronically, would not be income derived from a
communications activity.

      When the provision of content or any other services is de
minimis, such content or services are ignored, and the transaction
will be treated solely as the transmission of communications within
the meaning of proposed regulations §1.863-9(d)(1). The
determination of whether the provision of content or other services
is de minimis should be based on all the facts and circumstances.
The IRS and Treasury believe the exclusion of content and other
services is consistent with the legislative history of section
863(e). No evidence exists in the Congressional testimony or in the
legislative history that content provided by transmission was to be
considered a communications activity.

      Proposed regulations §1.863-9(d)(1)(ii) requires that a
transaction encompassing non-de minimis communications activities
and non-de minimis non- communications activities must be broken
into parts and each part treated as a separate transaction. Proposed
regulations §1.863-9(d)(1)(ii) states that gross income derived
from the activities must be allocated to each separate transaction,
to the satisfaction of the Commissioner, based on all relevant facts
and circumstances, which may include functions performed, resources
employed, risks assumed, and any other contributions to the value of
the respective transactions. For example, a payment by an advertiser
to a TV broadcast station may be in part a payment for transmission
of the advertisement, but could also be a payment for other property
or services, for example the transmitter's ability to reach a
particular market or audience. Such activities, if not de minimis,
must be treated as non-communications activities under
§1.863-9(d) (1)(ii) of the proposed regulations.

       To ensure the statutory purposes are not circumvented, the
Commissioner may treat parts of a transaction as separate
transactions, or construe separate transactions as a single
transaction.

b. Income Derived from Communications Activity

       Income derived from communications activity is defined in
proposed regulations §1.863-9(d)(2) as income derived from the
transmission of communications, including income derived from the
provision of capacity to transmit communications. There is no
requirement that the income recipient perform the transmission
function. This rule reflects IRS and Treasury's understanding that
those providing communications services often use capacity owned or
operated by others. However, income is derived from communications
activity only if the taxpayer is paid to transmit, and bears the
risk of transmitting, the communications.

c. Character of Communications Activity

       Proposed regulations §1.863-9(d)(3) provides rules for
characterizing income derived from a communications activity for
purposes of sourcing the income derived from such activity. The
character of income derived from communications activity is
determined by establishing the two points between which the taxpayer
is paid to transmit, and bears the risk of transmitting, the
communication. Under the paid-to-do rule, the path the communication
takes between the two points is not relevant in determining the
character of the transmission. If a taxpayer is paid to take a
communication from one point to another point, income derived from
the transmission is characterized based on the transmission between
those two points, even though the taxpayer contracts out part of the
transmission to another. This rule reflects IRS and Treasury's
recognition that those providing communications often use the
network owned or operated by others. Several examples in the
proposed regulations illustrate the paid-to-do rule.

      Proposed regulations §1.863-9(d)(3)(ii) defines income
derived from international communications activity as the
transmission from a point in the United States and a point in a
foreign country (or a possession of the United States). Proposed
regulations §1.863-9(d) (3)(iii) defines income derived from
U.S. communications activity as the transmission between two points
in the United States or a point in the United States and a point in
space or international water.

      Proposed regulations §1.863-9(d)(3)(iv) defines income
derived from foreign communications activity as the transmission
between two points either in a foreign country or in foreign
countries or a point in a foreign country and a point in space or
international water. Proposed regulations §1.863-9(d)(3)(v)
defines income derived from space/ocean communications activity as
the transmission between a point in space or international water and
another point in space or international water. The IRS and Treasury
believe these rules are consistent with the legislative history. See
Senate Report at 357.

       When the taxpayer cannot establish the two points between
which the taxpayer is paid to transmit, the source of income derived
from such activity, for either a U.S. or foreign person, is U.S.
source income. Thus, for example, when a provider of communications
services provides both local and international long distance along
with cable services in one-price bundles for a set amount each
month, tracing each transmission may not be possible or practical.
In such cases, the source of income derived from communications
activity is U.S. source income. The IRS and Treasury understand that
many in the communications industry may not consider it practical or
possible to prove the end points of the communications the taxpayer
transmits. The IRS and Treasury solicit comments as to proposals for
those situations when taxpayers cannot establish the points between
which the taxpayer is paid to transmit the communications.

5. Treatment of partnerships

       Proposed regulations §1.863-9(e) provides, in general,
that for U.S. partnerships, section 863(e) and the regulations
thereunder will be applied at the partnership level. The IRS and
Treasury believe this rule is consistent with section 7701(a)(30)
(B), which defines a U.S. person as a domestic partnership. For
foreign partnerships, and in the case of a U.S. partnership in which
50 percent or more of the partnership interests are owned by foreign
persons, section 863(e) and the regulations thereunder will be
applied at the partner level. The proposed regulations provide a
different rule for foreign partnerships and for U.S. partnerships
with substantial foreign ownership because the IRS and Treasury are
concerned that U.S. persons may use such partnerships to circumvent
the purposes of this section.

6. Reporting rules and documentation requirements

       When a taxpayer allocates gross income to the satisfaction of
the Commissioner under proposed regulations §1.863-9(b)(2)(ii)
(D) (certain foreign persons) or -(d)(1)(ii) (determining a
communications activity), it does so by making the allocation on a
timely filed original return (including extensions). An amended
return does not qualify, and section 9100 relief will not be
available. In all cases, a taxpayer must maintain contemporaneous
documentation regarding the allocation of gross income, and
allocation of expenses, losses and other deductions, the methodology
used, and the circumstances justifying use of that methodology. The
taxpayer must produce such documentation within 30 days upon
request.

C. Amendment to the §1.863-3 Regulations

       These proposed regulations amend the regulations under
§1.863-3 for determining the source of income in certain
inventory sales.

       The regulations provide that in determining the source of
income from sales of property when the property is either (i)
produced in whole or in part in space or in international water, or
(ii) sold in space or in international water, the rules of
§1.863-8 of the proposed regulations apply. The rules of
sections 863(a) and (b), and the regulations under those sections,
do not apply to determine the source of income in such cases, except
to the extent provided in §1.863-8 of the proposed regulations.
The proposed regulations in §1.863-8(b)(4)(ii)(A) provide,
however, that the source of income from sales of inventory on
international water continues to be sourced under §1.863-3(c)
(2). The regulations in §1.863-3(a)(1) and -3(c)(1)(i)(A) are
amended to reflect these provisions.

       The proposed regulations also amend §1.863-3(c)(2) to
provide that the place of sale will be presumed to be the United
States, for purposes of that section, when property is produced in
the United States and the property is sold to a U.S. resident for
use, consumption, or disposition in space. See §1.864-6(b)(3)
for determining whether property is used in space and whether the
sale is to a U.S. resident.

       These rules reflect the views of Treasury and the IRS that
sales of satellites or transponders by a U.S. resident in space
should produce U.S. source income. These rules also reflect the view
that sales of such property by a U.S. resident to a U.S. purchaser
should produce U.S. source income. Treasury and the IRS believe that
these provisions are consistent with Congress' intent in enacting
section 863(d) to tax U.S. persons on a residency basis on income
that is not likely to be subject to foreign tax by a foreign
country. It is also consistent with the tax policy of the foreign
tax credit that income not likely to be subject to foreign tax
should not be treated as foreign source income, which would
inappropriately allow taxpayers with excess foreign tax credits to
shelter this income from U.S. tax. Proposed Effective Dates

       These regulations are proposed to apply for taxable years
beginning on or after the date that is 30 days after the date of
publication of final regulations in the Federal Register.

Special Analyses

       It has been determined that this notice of proposed
rulemaking is not a significant regulatory action as defined in
Executive Order 12866. Therefore, a regulatory assessment is not
required. It is hereby certified that these regulations will not
have a significant economic impact on a substantial number of small
entities. This certification is based on the fact that the rules of
this section principally impact large multinationals who pay foreign
taxes on substantial foreign operations and therefore the rules will
impact very few small entities. Moreover, in those few instances
where the rules of this section impact small entities, the economic
impact on such entities is not likely to be significant.
Accordingly, a regulatory flexibility analysis is not required.
Pursuant to section 7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking will be submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its
impact on small business. Comments and Public Hearing

       Before these proposed regulations are adopted as final
regulations, consideration will be given to any comments that are
submitted timely (in the manner described under the ADDRESSES
caption) to the IRS. The IRS and Treasury specifically request
comments on the clarity of the proposed regulations and how they may
be made easier to understand. All comments will be available for
public inspection and copying.

       A public hearing has been scheduled for March 28, 2001, at 10
a.m., in the auditorium, seventh floor, Internal Revenue Building,
1111 Constitution Avenue, NW., Washington, DC. Due to building
security procedures, visitors must enter at the 10th Street
entrance, located between Constitution and Pennsylvania Avenues, NW.
In addition, all visitors must present photo identification to enter
the building. Because of access restrictions, visitors will not be
admitted beyond the immediate entrance area more than 15 minutes
before the hearing starts. For information about having your name
placed on the building access list to attend the hearing, see the
"FOR FURTHER INFORMATION CONTACT" section of this preamble.

      The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons who wish to present oral comments at the hearing must submit
comments and an outline of topics to be discussed and the time to be
devoted to each topic (in the manner described under the ADDRESSES
caption of this preamble) by March 7, 2001.

      A period of 10 minutes will be allotted to each person for
making comments.

      An agenda showing the scheduling of the speakers will be
prepared after the deadline for receiving outlines has passed.
Copies of the agenda will be available free of charge at the
hearing. Drafting Information

      The principal author of these regulations is Anne Shelburne,
Office of Associate Chief Counsel (International). However, other
personnel from the IRS and Treasury Department participated in their
development.

List of Subjects in 26 CFR Part 1 Income taxes, Reporting and
recordkeeping requirements.

Proposed Amendments to the Regulations

       Accordingly, 26 CFR part 1 is proposed to be amended as
follows:

PART 1--INCOME TAXES

       Paragraph 1. The authority citation for part 1 is amended by
adding entries in numerical order to read as follows:

       Authority: 26 U.S.C. 7805 * * *

       Section 1.863-8 also issued under 26 U.S.C. 863(a), (b) and
(d).

       Section 1.863-9 also issued under 26 U.S.C. 863(a), (d) and
(e). * * *

       Par. 2 Section 1.863-3 is amended by:

       1. Adding a sentence after the first sentence in paragraph
(a)(1).

       2. Adding a sentence at the end of paragraph (c)(1)(i)(A).

       3. Adding three sentences, one after the current first
sentence of paragraph (c)(2), and the other two sentences after the
current second sentence of paragraph (c)(2).

       The additions read as follows: §1.863-3 Allocation and
apportionment of income from certain sales of inventory.

       (a) * * * (1) * * *To determine the source of income from
sales of property produced by the taxpayer, when the property is
either produced 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 international water), or is sold in space or in
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. * * *

* * * * *

       (c) * * *

       (1) * * *

       (i) * * *

       (A) * * * For rules regarding the source of income when
production takes place, in whole or in part, in space or in
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.

* * * * *

       (c)(2) * * * Notwithstanding any other provision, for rules
regarding the source of income when a sale takes place in space or
in 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. * * * The place of sale will be presumed to be the
United States under this rule when property is produced in the
United States and the property is sold to a U.S. resident, who uses
the property in space or in international water. In such cases, the
property will be treated as sold for use, consumption, or
disposition in the United States.

* * * * *

       Par. 3 Section 1.863-8 and 1.863-9 are added to read as
follows: §1.863-8 Source of income from space and ocean
activity under section 863(d).

       (a) In general. Income of a U.S. or a foreign person derived
from space or ocean activity (space or ocean income) is sourced
under the rules of this section, notwithstanding any other
provision, including sections 861, 862, 863, and 865. A taxpayer
will not be considered to derive income from space or ocean
activity, as defined in paragraph (d) of this section, if such
activity is performed by another person, subject to the rules for
the treatment of consolidated groups in section §1.1502-13.

     (b) Source of gross income from space or ocean activity--(1) In
general. Income derived by a U.S. person from space or ocean
activity is income from sources within the United States, except as
otherwise provided in this paragraph (b) . Income derived by a
person other than a United States person from space or ocean
activity is income from sources without the United States, except as
otherwise provided in this paragraph (b).

     (2) Income derived by certain foreign corporations. If a U.S.
person or U.S. persons own 50 percent or more of the vote or value
of the stock of a foreign corporation (directly, indirectly or
constructively) that is not a controlled foreign corporation within
the meaning of section 957, all income derived by that foreign
corporation from space or ocean activity is U.S. source income.

     (3) Income derived by foreign persons engaged in a U.S. trade
or business. If a foreign person, other than a controlled foreign
corporation within the meaning of section 957 or a foreign person
described in paragraph (b)(2) of this section, is engaged in a U.S.
trade or business, all income derived by that person from space or
ocean activity is presumed to be U.S. source income. However, if the
foreign person can allocate income between sources within the United
States, or space, or international water, and sources outside the
United States and space and international water, to the satisfaction
of the Commissioner, based on the facts and circumstances, which may
include functions performed, resources employed, risks assumed, or
other contributions to value, then space or ocean income allocated
to sources outside the United States and space and international
water shall be treated as from sources outside the United States.

      (4) Source rules for income from certain sales of property--

      (i) Sales of purchased property. When a taxpayer sells
property in space or in international water, the source of gross
income shall be determined under paragraph (b)(1), (2), or (3) of
this section as applicable. However, if inventory, within the
meaning of section 1221(1), is sold on international water, the
source of income shall be determined under §1.863-3(c)(2).

      (ii) Sales of property produced by the taxpayer--

      (A) General. If the taxpayer both produces property and also
sells such property, the taxpayer must divide gross income from such
sales between production activity and sales activity under the 50/50
method as described in this paragraph (b)(4)(ii)(A). Under the 50/50
method, one-half of the taxpayer's gross income will be considered
income attributable to production activity, and the source of that
income will be determined under paragraphs (b)(4)(ii)(B) or (C) of
this section. The remaining one-half of such gross income will be
considered income attributable to sales activity and the source of
that income will be determined under paragraph (b)(4)(i) of this
section. However, if the taxpayer sells such property outside space
and outside international water, the source of gross income
attributable to sales activity will be determined under
§1.863-3(c) (2).

      (B) Production only in space or in international water, or
only outside space and international water. When production occurs
only in space or in international water, income attributable to
production activity is sourced under paragraph (b)(1), (2), or (3)
of this section as space or ocean income. When production occurs
only outside space and international water, income attributable to
production activity is sourced under §1.863-3(c)(1).

      (C) Production both in space or in international water and
outside space and international water. When property is produced in
space or in international water and outside space and international
water, gross income must be allocated to production occurring in
space or in international water and production occurring outside
space and international water, to the satisfaction of the
Commissioner, based on all the facts and circumstances, which may
include functions performed, resources employed, risks assumed, and
any other contributions to value. The source of gross income
allocated to space or international water is determined under
paragraph (b)(1), (2), or (3) of this section. The source of gross
income allocated outside space and international water is determined
under §1.863-3(c)(1).

      (5) Special rule for determining the source of gross income
from services. If a transaction characterized as the performance of
services constitutes a space or ocean activity by reason of the
performance of part of the service in space or in international
water, as determined under paragraph (d)(2)(ii)(A) of this section,
the source of all gross income derived from such transaction of
which such performance is a part is determined under paragraph (b)
(1), (2), or (3) of this section. However, if the taxpayer can
allocate gross income between performance occurring outside space
and international water, and performance occurring in space or
international water, to the satisfaction of the Commissioner, based
on the facts and circumstances, including functions performed,
resources employed, risks assumed, or other contributions to value,
then the source of income allocated to performance occurring outside
space and international water shall be determined under sections
861, 862, 863, and 865.

       (6) Special rule for determining source of income from
communications activity (other than income from international
communications activity). Space and ocean activity, as defined in
paragraphs (d)(1) and (2) of this section, includes activity
occurring in space or in international water that is characterized
as a communications activity as defined in §1.863-9(d). The
source of gross income from space or ocean activity that is also a
communications activity as defined in §1.863-9(d) is determined
under the rules of §1.863-9(b), rather than under paragraph (b)
of this section.

       (c) Taxable income. When a taxpayer allocates gross income
under paragraph (b)(3), (b)(4)(ii)(C), or(b)(5) of this section, to
the satisfaction of the Commissioner, based on all the facts and
circumstances, the taxpayer must allocate or apportion expenses,
losses, and other deductions as prescribed in §§1.861-8
through 1.861-14T to the class of gross income, which must include
the total income so allocated in each case. A taxpayer must then
apply the rules of §§1.861-8 through 1.861-14T to properly
allocate or apportion amounts of expenses, losses, and other
deductions allocated or apportioned to such gross income between
gross income from sources within the United States and without the
United States.

       (d) Space and Ocean activity--

       (1) Definition--

       (i) Space activity. In general, space activity is any
activity conducted in space. Space activity includes performance and
provision of services in space, as defined in paragraph (d)(2)(ii)
(A) of this section, leasing of equipment located in space,
including spacecraft (e.g., satellites) or transponders located in
space, licensing of technology or other intangibles for use in
space, and the production, processing, or creation of property in
space, as defined in paragraph (d)(2)(i) of this section. Space
activity includes activity occurring in space that is characterized
as communications activity (other than international communications
activity) under §1.863-9(d). Space activity also includes
underwriting income from the insurance of risks on activities that
produce space income. Space activity includes the sale in space of
property, as defined in paragraph (d)(2)(iii) of this section. For
purposes of this section, space means any area not within the
jurisdiction (as recognized by the United States) of a foreign
country, possession of the United States, or the United States, and
not in international water. For purposes of determining space
activity, the Commissioner may separate parts of a single
transaction into separate transactions or combine separate
transactions as parts of a single transaction. Paragraph (d)(3) of
this section lists exceptions to the general rule.

       (ii) Ocean activity. In general, ocean activity is any
activity conducted 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 (collectively, in
international water). Ocean activity includes performance and
provision of services in international water, as defined in
paragraph (d)(2)(ii)(A) of this section, leasing of equipment
located in international water, including underwater cables,
licensing of technology or other intangibles for use in
international water, and the production, processing, or creation of
property in international water, as defined in paragraph (d)(2)(i)
of this section. Ocean activity includes sales of property in
international water, as defined in paragraph (d)(2)(iii) of this
section, but ocean activity does not include the selling of
inventory as defined in section 1221(1) on international water.
Ocean activity includes activity occurring in international water
that is characterized as communications activity (other than
international communications activity) under §1.863-9(d). Ocean
activity also includes underwriting income from the insurance of
risks on activities that produce ocean income. Ocean activity also
includes any activity performed in Antarctica. Ocean activity
further includes the leasing of a vessel if such vessel does not
transport cargo or persons for hire between ports-of-call. Thus, for
example, the leasing of a vessel that is to engage only in research
activities in international water is an ocean activity. Except as
provided in paragraph (d)(3)(ii) of this section, ocean activity
also includes the leasing of drilling rigs, extraction of minerals,
and performance and provision of services related thereto. For
purposes of determining ocean activity, the Commissioner may
separate parts of a single transaction into separate transactions or
combine separate transactions as parts of a single transaction.
Paragraph (d)(3) of this section lists exceptions to the general
rule.

       (2) Determining a space or ocean activity--

       (i) Production of property in space or in international
water. For purposes of this section, production activity means an
activity that creates, fabricates, manufactures, extracts,
processes, cures, or ages property within the meaning of sections
864(a) and §1.864-1.

       (ii) Special rule for performance of services--

       (A) General. If a transaction is characterized as the
performance of a service, then such service will be treated as a
space or ocean activity when a part of the service, even if de
minimis, is performed in space or in international water. Services
are performed in space or in international water if functions are
performed, resources employed, risks assumed, or other contributions
to value occur in space or in international water, regardless of
whether performed by personnel, or equipment, or otherwise.

       (B) Exception to the general rule-facilitating the taxpayer's
own communications. If a taxpayer's only activity in space or in
international water is to facilitate the taxpayer's own
communications as part of the provision or delivery of a service
provided by the taxpayer, and that service would not otherwise be in
whole or in part a space or ocean activity, such service will not be
treated as either space or ocean activity because of such
facilitation.

       (iii) Sale in space or in international water. In applying
§1.861-7(c) to determine where a sale takes place, property
will be sold in space or in international water if the property is
located in space or in international water when rights, title and
interest pass to the buyer (or when bare legal title is retained, at
the time and place of passage of beneficial ownership and risk of
loss), or if property is sold for use in space or in international
water.

       (3) Exceptions to space or ocean activity. Space or ocean
activity does not include the following types of activities--

       (i) Any activity giving rise to transportation income as
defined in section 863(c); or

       (ii) Any activity with respect to mines, oil and gas wells,
or other natural deposits to the extent the mines or wells are
located within the jurisdiction (as recognized by the United States)
of any country, including the United States and its possessions; or

       (iii) Any activity giving rise to international
communications income as defined in §1.863-9(d)(3)(ii).

       (e) Treatment of partnerships. In the case of a U.S.
partnership, this section will be applied at the partnership level.
In the case of a foreign partnership, this section will be applied
at the partner level.

       (f) Examples. The following examples illustrate the rules of
this section:

       Example 1. Space activity-activity occurring on land and in
space.

       (i) Facts. S owns satellites, and leases one of its
satellites to A. S, as lessor, will not operate the satellite. Part
of S's performance as lessor in this transaction occurs on land.

       (ii) Analysis. The combination of S's activities is
characterized as the lease of equipment. Since the equipment is
located in space, the transaction is defined as space activity under
paragraph (d)(1)(i) of this section. Income derived from the lease
will be sourced in its entirety under paragraph (b) of this section.

       Example 2. Space activity.

       (i) Facts. X is an Internet service provider, offering a
service to personal computer users accessing the Internet. This
service permits a customer, C, to make a call, initiated by a modem,
routed to a control center, for connection to the World Wide Web. X
transmits the requested information over its satellite capacity
leased from S to C's personal computer. X charges its customers a
flat monthly fee. Assume neither X nor S derive international
communications income within the meaning of §1.863-9(d)(3)(ii).

       (ii) Analysis. In this case, X performs a service, and X's
activity in space is not simply facilitation within the meaning of
paragraph (d)(2)(ii)(B) of this section, because X's activity is not
simply the facilitation of X's own communications and because X's
activity is not just part of another service provided by X. Thus,
X's activity constitutes space activity in its entirety under
paragraph (d)(2)(ii)(A) of this section, and the source of X's
income is determined under paragraph (b) of this section. To the
extent X derives income from communications activity, within the
meaning of §1.863-9(d), the source of X's income is determined
under §1.863-9(b), as provided in paragraph (b)(6) of this
section. S derives communications income within the meaning of
§1.863-9(d), and therefore the source of S's income is
determined under §1.863-9(b), as provided in paragraph (b)(6)
of this section.

       Example 3. Services as space activity-facilitation of
communications.

      (i) Facts. R owns a retail outlet in the United States. R
employs S to provide a security system for R's premises. S operates
its security system by transmitting images from R's premises to a
satellite, and from there to a group of S employees located in
Country B, who then monitor the premises by viewing the transmitted
images. O provides S with transponder capacity on O's satellite,
which S uses to transmit those images.

       (ii) Analysis. S derives income for providing monitoring
services. Because, in this case, S uses O's satellite transponder to
transmit images to facilitate S's own communications in space as
part of its provision of a security service, S's activity in space
is limited to facilitating communications as described in paragraph
(d)(2)(ii)(B) of this section. Thus, S is not engaged in a space
activity, and none of S's income is space income. Assuming O's
provision of capacity is viewed as the provision of a service, O's
activity in space is not simply the facilitation of communications
as provided in paragraph (d)(2)(ii)(B) of this section, because O is
not just facilitating its own communications. Thus, O's activity is
characterized as space activity in its entirety under paragraph (d)
(2)(ii)(A) of this section (unless O's activity in space qualifies
as international communications activity). To the extent O derives
income from communications activity, within the meaning of
§1.863-9(d), the source of O's income is determined under
§1.863-9(b), as provided in paragraph (b)(6) of this section.
On these facts, R does not derive any income from space activity.

       Example 4. Space activity.

      (i) Facts. L, a U.S. company, offers programming and also
certain services to customers located both in the United States and
in foreign countries. Assume L's provision of programming and
services in this case was viewed as the provision of a service, with
no part of that service occurring in space. L uses satellite
capacity acquired from S to deliver the service directly to
customers' television sets, so that the delivery of the service
occurs in space. Assume the delivery in this case is not considered
de minimis. L also acquires programming from H, and L pays H a
royalty for use of copyrighted material in the United States and in
foreign countries. Customer, C, pays L for delivery of the service
to C's residence in the United States. Assume S's provision of
capacity in this case was viewed as the provision of a service, and
also that S does not derive international communications income
within the meaning of §1.863-9(d)(3)(ii).

       (ii) Analysis. On these facts, S's activity in space is not
just the facilitation of its own communications within the meaning
of paragraph (d)(2)(ii)(B) of this section, because S is
facilitating the communications of others. To the extent S derives
income from a space activity that is also a communications activity
under §1.863-9(d), the source of S's income is determined under
§1.863-9(b), as provided in paragraph (b)(6) of this section.
On these facts, L is treated as providing a service and is paid to
deliver that service to its customers, and each transaction, i.e.,
the provision of the service and the delivery of the service,
constitutes a separate transaction. L's income derived from
provision of the service is not income derived from space activity.
L's income derived from delivery of the service is space activity.
L's delivery of the service is not just the facilitation of L's own
communications within the meaning of paragraph (d)(2)(ii)(B) of this
section, because it is not just a part of the provision of a
service, but instead the entire service. Since L derives
communications income within the meaning of §1.863- 9(d), the
source of L's income is determined under §1.863-9(b), as
provided in paragraph (b)(6) of this section. If on other facts, L
provides a service and delivers that service, and L treats the
provision of the service and the delivery of the service as one
separate transaction, then L performs services in space under
paragraph (d)(2)(ii)(A) of this section, because the delivery of the
service occurs in space. However, L's activity in space would be
limited to facilitating its own communications within the meaning of
paragraph (d)(2)(ii)(B) of this section, because it is part of
another service that would not otherwise be a space activity. As a
result, L's provision of the service would not be a space activity
under paragraph (d)(2)(ii)(A) of this section.

       Example 5. Space activity--treatment of land activity.

       (i) Facts. S, a U.S. person, offers remote imaging products
and services to its customers. In year 1, S uses its satellite's
remote sensors to gather data on certain geographical terrain. In
year 3, C, a construction development company, contracts with S to
obtain a satellite image of an area for site development work. S
pulls data from its archives and transfers to C the images gathered
in year 1, in a transaction that is characterized as a sale of the
data. Title to the data passes to C in the United States. Before
transferring the images to C, S uses computer software to enhance
the images so that the images can be used.

       (ii) Analysis. The collection of data and creation of images
in space is characterized as the creation of property in space. S's
income is derived from production of property in part in space, and
is, therefore, derived in part from space activity. The source of
S's income from production and sale of property is, therefore,
determined under paragraph (b)(4) of this section. Since production
activity occurs both in space and on land, the source of S's
production income is determined under paragraphs (b)(4)(ii)(A) and
(C) of this section. The source of S's income attributable to sales
activity is determined under paragraph (b)(4)(ii)(A) of this section
and §1.863- 3(c)(2) as U.S. source income.

       Example 6. Use of intangible property in space.

       (i) Facts. X acquires a license to use a particular satellite
slot or orbit, which X sublicenses to C. C pays X a royalty.

       (ii) Analysis. Since the royalty is paid for the right to use
intangible property in space, the source of X's royalty is
determined under paragraph (b) of this section.

       Example 7. Performance of services.

      (i) Facts. E, a U.S. company, operates satellites with sensing
equipment that can determine how much heat and light particular
plants emit and reflect. Based on the data, E will provide F, a U.S.
farmer, a report analyzing the data, which F will use in growing
crops. E analyzes the data from U.S. offices.

       (ii) Analysis. Assume E's combined activities are
characterized as the performance of services. Because part of the
service is performed in space, all income E derives from the
transaction will be treated as derived from space activity under
paragraph (d)(2)(ii)(A) of this section. The source of such income
will be determined under paragraph (b)(5) of this section. If,
however, E can allocate gross income, to the satisfaction of the
Commissioner, as prescribed in paragraph (b)(5) of this section,
then the source of gross income attributable to services performed
outside space may be determined as provided in paragraph (b)(5) of
this section.

       Example 8. Separate transactions.

      (i) Facts. The same facts as Example 7, except that E provides
the raw data to F in a transaction characterized as a sale of a
copyrighted article, and in addition also provides an analysis in
the form of a report to F, a U.S. farmer who uses the information in
growing crops. The price F pays E for the raw data is separately
stated.

       (ii) Analysis. To the extent the provision of raw data and
the analysis of the data are each treated as separate transactions,
the source of income from the production and sale of data is
determined under paragraph (b)(4) of this section. The provision of
services would be analyzed in the same manner as in Example 7.

       Example 9. Sale of property under international water.

       (i) Facts. T owns transatlantic cable lying under the ocean,
which it purchased. T sells the cable to B.

       (ii) Analysis. Because the property is sold under
international water as provided in paragraph (d)(2)(iii) of this
section, the transaction is ocean activity under paragraph (d)(1)
(ii) of this section, and the source of income is determined under
paragraph (b)(4)(i) of this section, by reference to paragraph (b)
(1), (2), or (3) of this section.

       Example 10. Sales of property in space.

       (i) Facts. S manufactures a satellite in the United States
and sells it to a U.S. customer, with the rights, title, and
interest passing to the customer when the satellite is located in
space.

       (ii) Analysis. The source of income derived from the sale of
the satellite in space is determined under paragraph (b)(4) of this
section, with the source of income attributable to production
activity determined under paragraphs (b)(4)(ii)(A) and (B) of this
section, and the source of income attributable to sales activity
determined under paragraphs (b)(4)(ii)(A) and (b)(4)(i) of this
section, by reference to paragraph (b)(1), (2), or (3) of this
section.

       Example 11. Sale of property located in space.

       (i) Facts. S has a right to operate from a particular
position in space. S sells the right to operate from that satellite
slot or orbit to P.

        (ii) Analysis. Because the sale takes place in space, as
provided in paragraph (d)(2)(iii) of this section, gain on the sale
of the satellite slot or orbit is income derived from space activity
under paragraph (d)(1)(i) of this section, and income from the sale
is sourced under paragraph (b)(4)(i) of this section, by reference
to paragraph (b)(1), (2), or (3) of this section.

        Example 12. Source of income of a foreign person.

        (i) Facts. FP, a foreign company, not a controlled foreign
corporation within the meaning of section 957, derives income from
the operation of satellites. FP operates a ground station in the
United States and in foreign country, FC.

        (ii) Analysis. In this case, FP is engaged in a U.S. trade
or business of operating the ground station. Thus, under paragraph
(b)(3) of this section, all FP's income derived from space activity
is presumed to be U.S. source income. However, if FP can allocate
space income to contributions occurring outside the United States,
space, and international water, as provided in paragraph (b)(3) of
this section, for example, to the ground station located in FC, then
such space income so allocated will be from sources outside the
United States.

        Example 13. Source of income of a foreign person.

        (i) Facts. FP, a foreign company, not a controlled foreign
corporation within the meaning of Section 957, operates remote
sensing satellites, collecting data and images in space for its
customers. FP uses an independent agent, A, in the United States who
provides marketing, order taking, and other customer service
functions.

        (ii) Analysis. In this case, FP is engaged in a U.S. trade
or business on the basis of A's activities on its behalf in the
United States. Therefore, under paragraph (b)(3) of this section,
all of FP's income derived from space activity is presumed to be
space income. However, if FP can allocate income to contributions
occurring outside the United States, space, and international water,
as provided in paragraph (b)(3) of this section, then such income so
allocated will be from sources outside the United States.

        (g) Reporting and documentation requirements. When a
taxpayer allocates gross income, to the satisfaction of the
Commissioner, under paragraph (b)(3), (b)(4)(ii)(C) , or (b)(5) of
this section, it does so by making the allocation on a timely filed
original return (including extensions). An amended return does not
qualify for this purpose, nor shall the provisions of
§301.9100-1 of this chapter and any guidance promulgated
thereunder apply. In all cases, a taxpayer must maintain
contemporaneous documentation in existence when such return is filed
regarding the allocation of gross income and allocation or
apportionment of expenses, losses and other deductions, the
methodology used, and the circumstances justifying use of that
methodology. The taxpayer must produce such documentation within 30
days upon request.

      (h) Effective date. This section applies to taxable years
beginning on or after the date that is 30 days after the date of
publication of final regulations in the Federal Register.

§1.863-9 Source of income derived from communications activity
under sections 863(a), (d), and (e).

      (a) In general. Income of a U.S. or foreign person derived
from communications activity is sourced under the rules of this
section, notwithstanding any other provision including sections 861,
862, 863, and 865.

      (b) Source of gross income derived from communications
activity--

      (1) In general. The source of gross income derived from each
type of communications activity, as defined in paragraph (d)(3) of
this section, is determined under this paragraph (b). If a
communications activity would qualify as space or ocean activity
under section 863(d) and the regulations thereunder, the source of
income derived from such communications activity is determined under
this section, and not under section 863(d) and the regulations
thereunder. See §1.863-8(b)(6).

      (2) Source of international communications income--

(i) Income derived by a U.S. person. Under the 50/50 method of this
paragraph (b)(2)(i), income derived by a U.S. person from
international communications activity is one-half from sources
within the United States and one-half from sources without the
United States.

      (ii) Income derived by foreign persons-

      (A) General rule. Income derived by a person other than a U.S.
person from international communications activity is, except as
otherwise provided in this paragraph (b), wholly from sources
without the United States.

      (B) Income derived by certain foreign corporations. If a
foreign corporation, including a controlled foreign corporation
within the meaning of section 957, is 50 percent or more owned by
vote or value (directly, indirectly, or constructively) by U.S.
persons, all income derived by that corporation from international
communications activity is from sources within the United States.

      (C) Income derived by foreign persons with a U.S. fixed place
of business. If a foreign person (other than a foreign person
described in paragraph (b)(2)(ii)(B) of this section) maintains an
office or other fixed place of business in the United States, the
foreign person's international communications income, as determined
to the satisfaction of the Commissioner, attributable to the office
or other fixed place of business is from sources within the United
States. The principles of section 864(c)(5) apply in determining
whether a foreign person has an office or fixed place of business in
the United States. See §1.864-6 and -7. This paragraph does not
apply if the foreign person is engaged in a U.S. trade or business.

      (D) Income derived by foreign persons engaged in a U.S. trade
or business. If a foreign person (other than a foreign person
described in paragraph (b)(2)(ii)(B) of this section) is engaged in
a U.S. trade or business, all of the foreign person's international
communications income is presumed to be from sources within the
United States. However, if the foreign person can allocate income
between sources within the United States, or space, or international
water and sources outside the United States and space and
international water, to the satisfaction of the Commissioner, based
on the facts and circumstances, which may include functions
performed, resources employed, risks assumed, or other contributions
to value, then the income allocated to sources outside the United
States and space and international water shall be treated as from
sources without the United States.

      (3) Source of U.S. communications income. The source of income
derived by a U.S. or a foreign person from U.S. communications
activity is from sources within the United States.

      (4) Source of foreign communications income. The source of
income derived by a U.S. or a foreign person from foreign
communications activity is from sources without the United States.

      (5) Source of space/ocean communications income. The source of
income derived by a U.S. or a foreign person from space/ocean
communications activity is determined under section 863(d) and the
regulations thereunder, without regard to §1.863-8(b)(6).

      (6) Source of communications income when taxpayer cannot
establish the two points between which the taxpayer is paid to
transmit the communication. The income derived by a U.S. person or
foreign person from communications activity, when the taxpayer
cannot establish the two points between which the taxpayer is paid
to transmit the communication as required in paragraph (d)(3)(i) of
this section, is from sources within the United States.

       (c) Taxable income. When a taxpayer allocates gross income
under paragraph (b)(2)(ii)(D) or (d)(1)(ii) of this section, to the
satisfaction of the Commissioner, based on all the facts and
circumstances, the taxpayer must allocate or apportion expenses,
losses, and other deductions as prescribed in §§1.861-8
through 1.861-14T to the class of gross income, which must include
the total income so allocated in each case. A taxpayer must then
apply the rules of §§1.861-8 through 1.861-14T to properly
allocate or apportion amounts of expenses, losses, and other
deductions allocated or apportioned to such gross income between
gross income from sources within the United States and without the
United States. For amounts of expenses, losses, and other deductions
allocated or apportioned to gross income derived from international
communications activity, when the source of income is determined
under the 50/50 method of paragraph (b)(2)(i) of this section,
taxpayers must apportion expenses, losses, and other deductions
between sources within and sources without pro rata based on the
relative amounts of gross income from sources within the United
States and without the United States. Research and experimental
expenditures qualifying under §1.861-17 are allocated under
that section, and are not allocated and apportioned pro rata under
the method of paragraph (b)(2)(i) of this section.

       (d) Communications activity and income derived from
communications activity-

       (1) Communications activity--

       (i) General rule. For purposes of this part, communications
activity consists solely of the delivery by transmission of
communications or data (communications). Delivery of communications
other than by transmission, for example, by delivery of physical
packages and letters, is not communications activity within the
meaning of this section. Communications activity also includes the
provision of capacity to transmit communications. Provision of
content or any other additional service provided along with, or in
connection with, a non-de minimis communications activity must be
treated as a separate non- communications activity unless de
minimis.

      (ii) Separate transaction. To the extent a taxpayer's
transaction consists in part of non-de minimis communications
activity and in part of non-de minimis non- communications activity,
such parts of the transaction must be treated as separate
transactions. Gross income must be allocated to each such
transaction involving the communications activity and the non-
communications activity to the satisfaction of the Commissioner,
based on all relevant facts and circumstances, which may include
functions performed, resources employed, risks assumed, and any
other contributions to the value of the respective transactions. For
purposes of determining whether income is derived from
communications activity, the Commissioner may treat communications
activity and non-communications activity, treated as a single
transaction, as separate transactions, or combine separate
communications activity and non-communications activity transactions
into a single transaction.

      (2) Income derived from communications activity. Income
derived from communications activity (communications income) is
income derived from the delivery by transmission of communications,
including income derived from the provision of capacity to transmit
communications. Income may be considered derived from a
communications activity even if the taxpayer itself does not perform
the transmission function, but in all cases, the taxpayer derives
communications income only if the taxpayer is paid to transmit, and
bears the risk of transmitting, the communications.

     (3) Determining the type of communications activity--

     (i) In general. Whether income is derived from international
communications activity, U.S. communications activity, foreign
communications activity, or space/ocean communications activity is
determined by identifying the two points between which the taxpayer
is paid to transmit the communication. The taxpayer must establish
to the satisfaction of the Commissioner the two points between which
the taxpayer is paid to transmit, and bears the risk of
transmitting, the communication. Whether the taxpayer contracts out
part or all of the transmission function is not relevant.

     (ii) Income derived from international communications activity.
Income derived by a taxpayer from international communications
activity (international communications income) is income derived
from communications activity, as defined in paragraph (d)(1) of this
section, when the taxpayer is paid to transmit between a point in
the United States and a point in a foreign country (or a possession
of the United States).

     (iii) Income derived from U.S. communications activity. Income
derived by a taxpayer from U.S. communications activity (U.S.
communications income) is income derived from communications
activity, as defined in paragraph (d)(1) of this section, when the
taxpayer is paid to transmit--

     (A) Between two points in the United States; or

     (B) Between the United States and a point in space or in
	 international water.

     (iv) Income derived from foreign communications activity.
Income derived by a taxpayer from foreign communications activity
(foreign communications income) is income derived from
communications activity, as defined in paragraph (d)(1) of this
section, when the taxpayer is paid to transmit--

     (A) Between two points in a foreign country or countries (or
possession or possessions of the United States); or

     (B) Between a foreign country (or a possession of the United
States) and a point in space or in international water.

     (v) Income derived from space/ocean communications activity.
Income derived by a taxpayer from space/ocean communications
activity (space/ocean communications income) is income derived from
a communications activity, as defined in paragraph (d)(1) of this
section, when the taxpayer is paid to transmit between a point in
space or in international water and another point in space or in
international water.

      (e) Treatment of partnerships--

      (1) General. In the case of a U.S. partnership, this section
will be applied at the partnership level. In the case of a foreign
partnership, this section will be applied at the partner level.

      (2) Exception. In the case of a U.S. partnership in which 50
percent or more of the partnership interests are owned by foreign
persons, this section will be applied at the partner level.

      (f) Examples. The following examples illustrate the rules of
this section:

      Example 1. Income derived from communications activity.

     (i) Facts. D provides its customers in various foreign
countries with access to its data base. A customer, C, places a toll
call to D's telephone number, and can then access D's data base to
obtain certain information, such as C's customers' health care
coverage.

      (ii) Analysis. D is not paid to transmit communications and
does not derive income solely from transmission of communications
within the meaning of paragraph (d) of this section. D instead
derives income from provision of content or provision of services to
its customers.

      Example 2. Income derived from U.S. communications activity.

     (i) Facts. Local telephone company (TC) receives access fees
from an international carrier for picking up calls from a local
telephone customer and delivering the call to a U.S. point of
presence (POP) of the international carrier. The international
carrier picks up the call from its U.S. POP and delivers the call to
a foreign country.

      (ii) Analysis. TC is not paid to carry the transmission
between the United States and a foreign country. It is paid to
transmit communications between two points in the United States. TC
derives income from U.S. communications activity as defined in
paragraph (d)(3)(iii) of this section, which is sourced under
paragraph (b)(3) of this section as U.S. source income.

      Example 3. Income derived from international communications
activity.

(i) Facts. TC, a U.S. company, owns an underwater fiber optic cable.
Pursuant to three year contracts, TC makes capacity to transmit
communications via the cable available to its customers. Such
customers then solicit telephone customers and arrange for
transmitting their calls. The cable runs in part through U.S.
waters, through international waters, and in part through foreign
country waters.

      (ii) Analysis. TC derives income from communications activity
under paragraph (d)(2) of this section. The income is derived from
international communications activity as provided in paragraph (d)
(3)(ii) of this section, since TC is paid to make available capacity
to transmit between the United States and a foreign country, and
vice versa. Since TC is a U.S. person, TC's international
communications income is sourced under paragraph (b)(2)(i) of this
section as one-half from sources within the United States and one-
half from sources without the United States.

      Example 4. Character of communications activity: the paid-to-
do rule.

      (i) Facts. TC is paid to transmit communications from Toronto,
Canada, to Paris, France. TC transmits the communication to New
York. TC pays another communications company, IC, to transmit the
communications from New York to Paris.

      (ii) Analysis. Under the paid-to-do rule of paragraph (d)(3)
(i) of this section, TC derives income from foreign communications
activity under paragraph (d)(3)(iv) of this section, since it is
paid to transmit communications between two foreign points, Toronto
and Paris. Under paragraph (d)(3)(i) of this section, the character
of TC's activity is determined without regard to the fact that TC
pays IC to transmit the communication for some portion of the
delivery path. IC has international communications income under
paragraph (d)(3)(ii) of this section, because it is paid to transmit
the communication between a point in the United States and a point
in a foreign country.

       Example 5. Income derived from international communications
activity.

       (i) Facts. S, a U.S. satellite operator, owns satellites and
the uplink facilities in Country X, a foreign country. B, a resident
of Country X, pays S to deliver its programming from Country X to
its downlink facility in the United States, owned by C, a customer
of B.

       (ii) Analysis. S derives communications income under
paragraph (d) of this section. S's income is characterized as
international communications income under paragraph (d)(3)(ii) of
this section, because S is paid to transmit the communication
between the beginning point in a foreign country to an end point in
the United States. The source of S's international communications
income is determined under paragraph (b)(2)(i) of this section as
one-half from sources within the United States and one-half from
sources without the United States.

       Example 6. Character of income derived from communications
activity: the paid- to- do rule.

     (i) Facts. TC is paid to take a call from North Carolina to
Iowa, two points in the United States, but routes the call through
Canada.

       (ii) Analysis. Under paragraph (d)(3)(i) of this section, the
character of the income derived from communications activity is
determined by the two points between which the taxpayer is paid to
transmit, and bears the risk of transmitting, the communications,
without regard to the path of the transmission between those two
points. Thus, under paragraph (d)(3)(iii) of this section, TC
derives income from U.S. communications activity because it is paid
to transmit between two U.S. points.

       Example 7. Source of income derived from communications
activity.

       (i) Facts. A, a U.S. company, is an Internet access provider.
A charges C a lump sum, paid monthly, for Internet access. A
transmits a call made by C in France to a recipient in England, over
the public Internet. A does not maintain records as to the beginning
and end points of the transmission.

       (ii) Analysis. Although A derives income from communications
activity as defined in paragraph (d)(1) of this section, the source
of income is determined under paragraph (b)(6) of this section as
income from sources within the United States, because A cannot
establish the two points between which it is paid to transmit the
communications.

       Example 8. Income derived from communications and non-
communications activity.

      (i) Facts. A, a U.S. company, offers customers local and long
distance phone service, video, and Internet services. Customers pay
one monthly fee, and in addition 10 cents a minute for all long-
distance calls, including international calls.

      (ii) Analysis. To the extent A derives income from
communications activity, A must allocate income to its
communications activity as provided in paragraph (d)(1)(ii) of this
section. To the extent A can establish that it derives international
communications income as defined in paragraph (d)(3)(ii) of this
section, A would determine the source of such income under paragraph
(b)(2)(i) of this section. If A cannot establish the points between
which it is paid to transmit communications, as required in
paragraph (d)(3)(i) of this section, the source of A's income must
be determined under paragraph (b)(6) of this section as from within
the United States.

      Example 9. Income derived from communications activity.

      (i) Facts. T purchases capacity from TC to transmit telephone
calls. T sells prepaid telephone calling cards, giving customers
access to TC's lines, for a certain number of minutes.

      (ii) Analysis. T derives income from communications activity,
under paragraph (d)(2) of this section, because T makes capacity to
transmit available to its customers. In this case, T cannot
establish the points between which communications are transmitted.
Therefore, the source of its income must be determined under
paragraph (b)(6) of this section as U.S. source income.

      Example 10. Income derived from communications and non-
communications activity.

      (i) Facts. B, a U.S. company, transmits television programs
using its satellite transponder, from the United States to downlink
facilities in foreign country Y, owned by D, a cable system operator
in Country Y. D receives the transmission, unscrambles the signals,
and distributes the broadcast to customers in Country Y.

      (ii) Analysis. B derives income both from communications
activity as defined under paragraph (d)(1)(i) of this section, and
from non-communications activity. Gross income must be allocated to
the communications activity as required in paragraph (d)(1)(ii) of
this section. Income derived by B for transmission to D is
international communications income within paragraph (d)(3)(ii) of
this section, because B is paid to transmit communications from the
United States to a foreign country.

      Example 11. Income derived from communications activity.

      (i) Facts. TC is paid for Internet access. TC replicates
frequently requested sites on its servers, solely to speed up
response time.

      (ii) Analysis. On these facts, the replication service would
be treated as de minimis under paragraph (d)(1)(i) of this section,
so that TC derives income from communications activity. The type and
source of TC's communications income depends on demonstrating the
points between which TC is paid by its customer to transmit the
communications, under paragraph (d)(3)(i) of this section.

       Example 12. Income derived from foreign communications
activity.

       (i) Facts. S leases capacity to B, a broadcaster located in
Australia. B beams programming to the satellite, and S's satellite
picks the communications up in space, and beams the programming over
Southeast Asia.

       (ii) Analysis. S derives income from communications activity
under paragraph (d)(2) of this section. S's income is characterized
as income derived from foreign communications activity under
paragraph (d)(3)(iv) of this section, because S picks up the
communication in space, and beams it to a footprint entirely
covering a foreign area. The source of S's income is determined
under paragraph (b)(4) of this section as from sources without the
United States. If S were beaming the programming over a satellite
footprint that covered area both in the United States and outside
the United States, S would be required to allocate the income
derived from the different types of communications activity.

       (g) Reporting rules and disclosure on tax return. When a
taxpayer allocates gross income to the satisfaction of the
Commissioner under paragraph (b)(2)(ii)(D), or (d)(1)(ii) of this
section, it does so by making the allocation on a timely filed
original return (including extensions). An amended return does not
qualify for this purpose, nor shall the provisions of
§301.9100-1 of this chapter and any guidance promulgated
thereunder apply. In all cases, a taxpayer must maintain
contemporaneous documentation in existence when such return is filed
regarding the allocation of gross income, and allocation and
apportionment of expenses, losses, and other deductions, the
methodology used, and the circumstances justifying use of that
methodology. The taxpayer must produce such documentation within 30
days of a request.

       ( h) Effective date. This section applies to taxable years
beginning on or after the date that is 30 days after the date of
publication of final regulations in the Federal Register.

Commissioner of Internal Revenue

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