Source Rules for Income

I/ Interest:

Rule: Residence of Payor of Interest

Exceptions:

80% or more of U.S. debtor’s gross income is from “active foreign business income.”

Look to 3 taxable years prior to year of interest payment. (Look-thru subsidiaries’ dividends and look at their activities). All interest is foreign source unless lender and borrower are related parties (10% or more ownership), then split according to U.S./foreign source.

Interest paid by foreign branches of U.S. banks is foreign source.

Foreign corporations with U.S. trade or business: income paid by a U.S. T/B of a foreign corporation (e.g. paid by the U.S. branch of foreign co.) is U.S. source income.

II/ Dividends

Rule: Residence of corporation issuing the dividend

Exception:

25% or more of foreign corporation’s income is from U.S. TB. U.S. source portion of dividend equals portion of U.S. TB income. Look at last three years.

III/ Services

Rule: Where services are performed.

Exceptions:

De Minimis Exceptions: Services income is foreign source income if the taxpayer was in the U.S. no more than 90 days AND earned no more than $3000 from performing services in the U.S., AND performed the services on behalf of a foreign party or foreign branch of U.S. corp. AND the recipient is a non-resident alien.

Treaty: No more 183 days.

IV/ Rents

Rule: Where property is located.

V/ Royalties

Rule: Where intangible property is used.

VI/ Gain from the Sale of Real Estate:

Rule: Where property is located.

VII/ Gain from the Sale of Personal Property:

Rule: Residence of the seller.

Residence for this purpose = location of a “tax home” (i.e. taxpayer takes travel deductions when traveling from this location).

U.S. citizens and residents with a foreign tax home will only have foreign source income if they pay a tax of at least 10% of gain in the country…

Exceptions: U.S. resident may have foreign source income from sale of personal property if:

– office/fixed place of business in foreign country

– gain is attributable to that office

– foreign tax of 10% is PAID, and

– property is not inventory, depreciable, intangible or stock of foreign affiliate.

VIII/ Personal Property that is Depreciable/Amortizable Property: US source to the extent depreciation/amortization deductions were taken against U.S. source income.

IX/ Intangible Property

Rule: Residence of the Seller

Exception: Sourced as a royalty if income is contingent on productivity of property.

VIII/ Inventory:

Where the sale occurred: site of property when title was transferred.

IX/ Inventory manufactured in one jurisdiction and sold in another:

Where the inventory is manufactured.

Source Rules for Deductions

A/ General Rule

1 – Allocate to income item (factual relationship between income and deduction). Source is the same as the associated income item.

2- Ratable apportionment for non-related deductions (e.g. charitable contributions, medical expenses…)

B/ Interest Expense

Allocation is based on the basis assets, not income (i.e. assets producing US source income and assets producing foreign source income).

Exceptions:

Non-recourse loan for specific property.