Page 16: of Maritime Reporter Magazine (April 2001)
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Legal Beat structure to avoid CFC status.
Sourcing Income of Foreign Persons.
Second, Prop. Reg. § 1.863-8(b)(3) pro- vides that, if a foreign person is engaged in a U.S. trade or business, the foreign person's income derived from ocean activity is presumed to be U.S. source income. The regulations provide that if a foreign person can allocate gross m •m ocean income between (1) income from sources within the United States or international waters, and (2) without the
United States and international water to the satisfaction of the IRS, then income from without the United States and from international waters will be treated as foreign source income. The new regula- tions also provide that when a foreign person is entitled to the benefits of a tax treaty with the United States, the person may elect to be taxed under the rules of that treaty so that the United States would tax only income attributable to a permanent establishment of that foreign person in the United States.
Under these proposed regulations, a greater portion of a foreign person's
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United States.
The proposed regulations must be applied to determine the source of income from sales of property pur- chased or produced by the taxpayer when either the production or the sale occurs in international waters. The new rules are complicated and require quite technical income allocations. Similar rules are provided for sourcing income derived from the performance of ser- vices in international waters. The pro- posed regulations also provide new rules for sourcing the income of partner- ships engaged in ocean activities, basi- cally sourcing U.S. partnership income at the partnership level, and sourcing foreign partnership income at the part- ner level. We recommend that all per- sons engaged in the shipping, offshore oil and gas exploration and production, and cruise ship industries become famil- iar as soon as possible with the new reg- ulations. Treasury regulations go into effect 30 days after the publication of final regulations, and final regulations are typically issued six months to one year after proposed regulations are issued. Taxpayers should seriously con- sider submitting comments to the IRS regarding the impact of the regulations, either individually or in conjunction with trade associations or other persons that will increase the impact of the com- ments.
Given their potential negative effect, the new regulations may warrant a sub- stantial restructuring of the ownership of vessels engaged in the affected activ- ities. Even though taxpayers are permit- ted to produce evidence rebutting the presumptions in the new regulations with respect to the source of income, such evidence must be "satisfactory" to the IRS. The uncertainties inherent in trying to determine what particular evi- dence may ultimately satisfy the IRS suggest that the better option is simply to alter the ownership of vessels and for- eign corporations so that the new regu- lations are not applicable. Since a sig- nificant restructuring may prove time consuming, an examination of the potential impact of the new regulations on a particular company should begin as soon as possible.
Dyer Ellis & Joseph, P.C. is a Washing- ton, DC-based law firm with a domestic and international practice involving transportation, shipping, finance, cor- porate, securities, legislative, environ- mental and trade matters. 16
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