Page 14: of Maritime Reporter Magazine (April 2001)

Legal Beat

Proposed Regulations Regarding Source of Income From Activities In Intl. Waters

By Edward M. Barberic, partner,

Dyer Ellis & Joseph, P.C.

The Internal Revenue Service (the "IRS") has issued proposed regulations under section 863 of the Internal Rev- enue Code of 1986, as amended (the "Code"), providing new rules for deter- mining the source of income from activ- ities conducted in international waters for purposes of U.S. income taxation.

These new regulations come shortly after the release last year of regulations under Section 883 of the Code that sig- nificantly affected the exemption from

U.S. income tax of income from the international operation of a vessel owned by a non-U.S. corporation.

While the new regulations also apply to

H ROXSYSTEM space activities and similar new regula- tions apply to communication activities, the new rules may have the most signif- icant impact on both U.S. persons engaged in shipping activities through a foreign corporation and foreign ship- ping companies currently doing busi- ness in the United States. The IRS is accepting written comments on the pro- posed regulations and there will be a public hearing that is currently sched- uled for March 28, 2001, although we understand that, because of the interest generated by the proposed regulations, the IRS intends to delay the hearing until May.

While U.S. citizens, resident aliens and domestic corporations are generally taxed by the United States on all of their worldwide income regardless of where such income is earned, the source of income remains important for such pur- poses as determining eligibility for the foreign tax credit. For nonresident alien individuals and foreign corporations doing business in the United States, only income derived from U.S. sources is normally taxable. Whether income is from sources within or without the Unit- ed States is determined for U.S. tax pur- poses by a set of technical rules con- tained in Sections 861 through 865 of the Code.

The determination of the source of income from activities conducted in international waters is made under Sec- tion 863 of the Code (which also pro- vides sourcing rules for certain trans- portation activities, space and ocean activities and international communica- tions activities). In general, income from ocean activities conducted by a

U.S. person is sourced to the United

States, and income from ocean activities conducted by a non-U.S. person is sourced outside the United States. The new regulations alter this treatment in certain situations so that ocean activity income derived by a foreign person may now be sourced to and taxable in the

United States. Definition of Ocean

Activity. Prop. Reg. § 1.863-8(d)(l)(ii) provides that ocean activity is any activ- ity conducted in international waters, with certain exceptions. Under the broad definition in the new regulations, ocean activity includes: • the performance and provision of ser- vices; • the leasing of equipment or other proper- ty located in international waters; • the licensing of technology or other intangibles for use in international waters; • the production, processing, or creation of property in international waters; • the sale of property in international waters; • the leasing of drilling rigs, the extraction

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