[Code of Federal Regulations]
[Title 26, Volume 9]
[Revised as of April 1, 2001]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.861-1]

[Page 119-120]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
Normal Taxes and Surtaxes (Continued)--Table of Contents
 
Sec. 1.861-1  Income from sources within the United States.

    (a) Categories of income. Part I (section 861 and following), 
subchapter N, chapter 1 of the Code, and the regulations thereunder 
determine the sources of income for purposes of the income tax. These 
sections explicitly allocate certain important sources of income to the 
United States or to areas outside the United States, as the case may be; 
and, with respect to the remaining income (particularly that derived 
partly from sources within and partly from sources without the United 
States), authorize the Secretary or his delegate to determine the income 
derived from sources within the United States, either by rules of 
separate allocation or by processes or formulas of general 
apportionment. The statute provides for the following three categories 
of income:


    (1) Within the United States. The gross income from sources within 
the United States, consisting of the items of gross income specified in 
section 861(a) plus the items of gross income allocated or apportioned 
to such sources in accordance with section 863(a). See Secs. 1.861-2 to 
1.861-7, inclusive, and Sec. 1.863-1. The taxable income from sources 
within the United States, in the case of such income, shall be 
determined by deducting therefrom, in accordance with sections 861(b) 
and 863(a), the expenses, losses, and other deductions properly 
apportioned or allocated thereto and a ratable part of any other 
expenses, losses, or deductions which cannot definitely

[[Page 120]]

be allocated to some item or class of gross income. See Secs. 1.861-8 
and 1.863-1.

    (2) Without the United States. The gross income from sources without 
the United States, consisting of the items of gross income specified in 
section 862(a) plus the items of gross income allocated or apportioned 
to such sources in accordance with section 863(a). See Secs. 1.862-1 and 
1.863-1. The taxable income from sources without the United States, in 
the case of such income, shall be determined by deducting therefrom, in 
accordance with sections 862(b) and 863(a), the expenses, losses, and 
other deductions properly apportioned or allocated thereto and a ratable 
part of any other expenses, losses, or deductions which cannot 
definitely be allocated to some item or class of gross income. See 
Secs. 1.862-1 and 1.863-1.

    (3) Partly within and partly without the United States. The gross 
income derived from sources partly within and partly without the United 
States, consisting of the items specified in section 863(b) (1), (2), 
and (3). The taxable income allocated or apportioned to sources within 
the United States, in the case of such income, shall be determined in 
accordance with section 863 (a) or (b). See Secs. 1.863-2 to 1.863-5, 
inclusive.

    (4) Exceptions. An owner of certain aircraft or vessels first leased 
on or before December 28, 1980, may elect to treat income in respect of 
these aircraft or vessels as income from sources within the United 
States for purposes of sections 861(a) and 862(a). See Sec. 1.861-9. An 
owner of certain aircraft, vessels, or spacecraft first leased after 
December 28, 1980, must treat income in respect of these craft as income 
from sources within the United States for purposes of sections 861(a) 
and 862(a). See Sec. 1.861-9A.

    (b) Taxable income from sources within the United States. The 
taxable income from sources within the United States shall consist of 
the taxable income described in paragraph (a)(1) of this section plus 
the taxable income allocated or apportioned to such sources, as 
indicated in paragraph (a)(3) of this section.

    (c) Computation of income. If a taxpayer has gross income from 
sources within or without the United States, together with gross income 
derived partly from sources within and partly from sources without the 
United States, the amounts thereof, together with the expenses and 
investment applicable thereto, shall be segregated; and the taxable 
income from sources within the United States shall be separately 
computed therefrom.

[T.D. 6500, 25 FR 11910, Nov. 26, 1960, as amended by T.D. 7928, 48 FR 
55845, Dec. 16, 1983]












[Code of Federal Regulations]
[Title 26, Volume 9]
[Revised as of April 1, 2001]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.862-1]

[Page 261-262]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
Normal Taxes and Surtaxes (Continued)--Table of Contents
 
Sec. 1.862-1  Income specifically from sources without the United States.

    (a) Gross income. (1) The following items of gross income shall be 
treated as income from sources without the United States:

    (i) Interest other than that specified in section 861(a)(1) and 
Sec. 1.861-2 as being derived from sources within the United States;

    (ii) Dividends other than those derived from sources within the 
United States as provided in section 861(a)(2) and Sec. 1.861-3;

    (iii) Compensation for labor or personal services performed without 
the United States;

    (iv) Rentals or royalties from property located without the United 
States or from any interest in such property, including rentals or 
royalties for the use of, or for the privilege of using, without the 
United States, patents, copyrights, secret processes and formulas, 
goodwill, trademarks, trade brands, franchises, and other like property;

    (v) Gains, profits, and income from the sale of real property 
located without the United States; and

    (vi) Gains, profits, and income derived from the purchase of 
personal property within the United States and its sale without the 
United States.

    (2) In applying subparagraph (1)(iv) of this paragraph for taxable 
years beginning after December 31, 1966, gains described in section 
871(a)(1)(D) and section 881(a)(4) from the sale or exchange after 
October 4, 1966, of patents, copyrights, and other like property shall 
be treated, as provided in section 871(e)(2), as rentals or royalties 
for the use of, or privilege of using, property or an interest in 
property. See paragraph (e) of Sec. 1.871-11.

    (3) For determining the time and place of sale of personal property 
for purposes of subparagraph (1)(vi) of this paragraph, see paragraph 
(c) of Sec. 1.861-7.

    (4) Income derived from the purchase of personal property within the 
United States and its sale within a possession of the United States 
shall be treated as derived entirely from within that possession.

    (5) If interest is paid on an obligation of a nonresident of the 
United States by a resident of the United States acting in the 
resident's capacity as a guarantor of the obligation of the nonresident, 
the interest will be treated as income from sources without the United 
States.

    (6) For rules treating certain interest as income from sources 
without the United States, see paragraph (b) of Sec. 1.861-2.

    (7) For the treatment of compensation for labor or personal services 
performed partly within the United States and partly without the United 
States, see paragraph (b) of Sec. 1.861-4.

    (b) Taxable income. The taxable income from sources without the 
United States, in the case of the items of gross income specified in 
paragraph (a) of this section, shall be determined on the same basis as 
that used in Sec. 1.861-8 for determining the taxable income from 
sources within the United States.

    (c) Income from certain property. For provisions permitting a 
taxpayer to elect to treat amounts of gross income

[[Page 262]]

attributable to certain aircraft or vessels first leased on or before 
December 28, 1980, as income from sources within the United States which 
would otherwise be treated as income from sources without the United 
States under paragraph (a) of this section, see Sec. 1.861-9. For 
provisions requiring amounts of gross income attributable to certain 
aircraft, vessels, or spacecraft first leased by the taxpayer after 
December 28, 1980, to be treated as income from sources within the 
United States which would otherwise be treated as income from sources 
without the United States under paragraph (a) of this section, see 
Sec. 1.861-9A.

[T.D. 6500, 25 FR 11910, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7378, 40 FR 45434, Oct. 2, 1975; 40 FR 48508, Oct. 16, 
1975; T.D. 7928, 48 FR 55847, Dec. 16, 1983]



















[Code of Federal Regulations]
[Title 26, Volume 9]
[Revised as of April 1, 2001]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.863-1]

[Page 262-266]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
Normal Taxes and Surtaxes (Continued)--Table of Contents
 
Sec. 1.863-1  Allocation of gross income under section 863(a).

    (a) In general. Items of gross income other than those specified in 
section 861(a) and section 862(a) will generally be separately allocated 
to sources within or without the United States. See Sec. 1.863-2 for 
alternate methods to determine the income from sources within or without 
the United States in the case of items specified in Sec. 1.863-2(a). See 
also sections 865(b) and (e)(2). In the case of sales of property 
involving partners and partnerships, the rules of Sec. 1.863-3(g) apply.

    (b) Natural resources--(1) In general. Notwithstanding any other 
provision, except to the extent provided in paragraph (b)(2) of this 
section, gross receipts from the sale outside the United States of 
products derived from the ownership or operation of any farm, mine, oil 
or gas well, other natural deposit, or timber within the United States, 
must be allocated between sources within and without the United States 
based on the fair market value

[[Page 263]]

of the product at the export terminal (as defined in paragraph 
(b)(3)(iii) of this section). Notwithstanding any other provision, 
except to the extent provided in paragraph (b)(2) of this section, gross 
receipts from the sale within the United States of products derived from 
the ownership or operation of any farm, mine, oil or gas well, other 
natural deposit, or timber outside the United States must be allocated 
between sources within and without the United States based on the fair 
market value of the product at the export terminal. For place of sale, 
see Secs. 1.861-7(c) and 1.863-3(c)(2). The source of gross receipts 
equal to the fair market value of the product at the export terminal 
will be from sources where the farm, mine, well, deposit, or uncut 
timber is located. The source of gross receipts from the sale of the 
product in excess of its fair market value at the export terminal 
(excess gross receipts) will be determined as follows--

    (i) If the taxpayer engages in additional production activities 
subsequent to shipment from the export terminal and outside the country 
of sale, the source of excess gross receipts must be determined under 
Sec. 1.863-3. For purposes of applying Sec. 1.863-3, only production 
assets used in additional production activity subsequent to the export 
terminal are taken into account.

    (ii) In all other cases, excess gross receipts will be from sources 
within the country of sale. This paragraph (b)(1)(ii) applies to a 
taxpayer that engages in additional production activities in the country 
of sale, as well as to a taxpayer that does not engage in additional 
production activities at all.

    (2) Additional production prior to export terminal. Notwithstanding 
any other provision of this section, gross receipts from the sale of 
products derived by a taxpayer who performs additional production 
activities as defined in paragraph (b)(3)(ii) of this section before the 
relevant product is shipped from the export terminal are allocated 
between sources within and without the United States based on the fair 
market value of the product immediately prior to the additional 
production activities. The source of gross receipts equal to the fair 
market value of the product immediately prior to the additional 
production activities will be from sources where the farm, mine, well, 
deposit, or uncut timber is located. The source of gross receipts from 
the sale of the product in excess of the fair market value immediately 
prior to the additional production activities must be determined under 
Sec. 1.863-3. For purposes of applying Sec. 1.863-3, only production 
assets used in the additional production activities are taken into 
account.

    (3) Definitions--(i) Production activity. For purposes of this 
section, production activity means an activity that creates, fabricates, 
manufactures, extracts, processes, cures, or ages inventory. See 
Sec. 1.864-1. Except as otherwise provided in Secs. 1.1502-13 or 1.863-
3(g)(2), only production activities conducted directly by the taxpayer 
are taken into account.

    (ii) Additional production activities. For purposes of this section, 
additional production activities are substantial production activities 
performed directly by the taxpayer in addition to activities from the 
ownership or operation of any farm, mine, oil or gas well, other natural 
deposit, or timber. Whether a taxpayer's activities constitute 
additional production activities will be determined under the principles 
of Sec. 1.954-3(a)(4). However, in no case will activities that prepare 
the natural resource itself for export, including those that are 
designed to facilitate the transportation of the natural resource to or 
from the export terminal, be considered additional production activities 
for purposes of this section.

    (iii) Export terminal. Where the farm, mine, well, deposit, or uncut 
timber is located without the United States, the export terminal will be 
the final point in a foreign country from which goods are shipped to the 
United States. If there is no such final point in a foreign country 
(e.g., the property is extracted and produced on the high seas), the 
export terminal will be the place of production. Where the farm, mine, 
well, deposit, or uncut timber is located within the United States, the 
export terminal will be the final point in the United States from which 
goods are shipped from the United States to a foreign country. The 
location of the export terminal is determined without

[[Page 264]]

regard to any contractual terms agreed to by the taxpayer and without 
regard to whether there is an actual sale of the products at the export 
terminal.

    (4) Determination of fair market value. For purposes of this 
section, fair market value depends on all of the facts and circumstances 
as they exist relative to a party in any particular case. Where the 
products are sold to a related party in a transaction subject to section 
482, the determination of fair market value under this section must be 
consistent with the arm's length price determined under section 482.

    (5) Determination of gross income. To determine the amount of a 
taxpayer's gross income from sources within or without the United 
States, the taxpayer's gross receipts from sources within or without the 
United States determined under this paragraph (b) must be reduced by the 
cost of goods sold properly attributable to gross receipts from sources 
within or without the United States.

    (6) Tax return disclosure. A taxpayer that determines the source of 
its income under this paragraph (b) shall attach a statement to its 
return explaining the methodology used to determine fair market value 
under paragraph (b)(4) of this section, and explaining any additional 
production activities (as defined in paragraph (b)(3)(ii) of this 
section) performed by the taxpayer. In addition, the taxpayer must 
provide such other information as is required by Sec. 1.863-3.

    (7) Examples. The following examples illustrate the rules of this 
paragraph (b):

    Example 1. No additional production. U.S. Mines, a U.S. corporation, 
operates a copper mine and mill in country X. U.S. Mines extracts 
copper-bearing rocks from the ground and transports the rocks to the 
mill where the rocks are ground and processed to produce copper-bearing 
concentrate. The concentrate is transported to a port where it is dried 
in preparation for export, stored and then shipped to purchasers in the 
United States. Because title to the property is passed in the United 
States and, under the facts and circumstances, none of U.S. Mine's 
activities constitutes additional production prior to the export 
terminal within the meaning of paragraph (b)(3)(ii) of this section, 
under paragraph (b)(1) and (b)(1)(ii) of this section, gross receipts 
equal to the fair market value of the concentrate at the export terminal 
will be from sources without the United States, and excess gross 
receipts will be from sources within the United States.

    Example 2. No additional production. US Gas, a U.S. corporation, 
extracts natural gas within the United States, and transports the 
natural gas to a U.S. port where it is liquified in preparation for 
shipment. The liquified natural gas is then transported via freighter 
and sold without additional production activities in a foreign country. 
Liquefaction of natural gas is not an additional production activity 
because liquefaction prepares the natural gas for transportation from 
the export terminal. Therefore, under paragraph (b)(1) and (b)(1)(ii) of 
this section, gross receipts equal to the fair market value of the 
liquefied natural gas at the export terminal will be from sources within 
the United States, and excess gross receipts will be from sources 
without the United States.

    Example 3. Sale in third country. US Gold, a U.S. corporation, mines 
gold in country X, produces gold jewelry in the United States, and sells 
the jewelry in country Y. Assume that the fair market value of the gold 
at the export terminal in country X is $40, and that US Gold ultimately 
sells the gold jewelry in country Y for $100. Under Sec. 1.863-1(b), $40 
of US Gold's gross receipts will be allocated to sources without the 
United States. Under paragraph (b)(1)(i) of this section, the source of 
the remaining $60 of gross receipts will be determined under Sec. 1.863-

3. If US Gold applies the 50/50 method described in Sec. 1.863-3, $20 of 
cost of goods sold is properly attributable to activities subsequent to 
the export terminal, and all of US Gold's production assets subsequent 
to the export terminal are located in the United States, then $20 of 
gross income will be allocated to sources within the United States and 
$20 of gross income will be allocated to sources without the United 
States.

    Example 4. Production in country of sale. US Oil, a U.S. 
corporation, extracts oil in country X, transports the oil via pipeline 
to the export terminal in country Y, refines the oil in the United 
States, and sells the refined product in the United States to unrelated 
persons. Assume that the fair market value of the oil at the export 
terminal in country Y is $80, and that US Oil ultimately sells the 
refined product for $100. Under paragraph (b)(1) of this section, $80 of 
US Oil's gross receipts will be allocated to sources without the United 
States, and under paragraph (b)(1)(ii) of this section the remaining $20 
of gross receipts will be allocated to sources within the United States.

    Example 5. Additional production prior to export. The facts are the 
same as in Example 1, except that U.S. Mines also operates a smelter in 
country X. The concentrate output from the mill is transported to the 
smelter where it is transformed into smelted copper.

[[Page 265]]

The smelted copper is exported to purchasers in the United States. Under 
the facts and circumstances, all of the processes applied to make copper 
concentrate are considered mining. Therefore, under paragraph (b)(2) of 
this section, gross receipts equal to the fair market value of the 
concentrate at the smelter will be from sources without the United 
States. Under the facts and circumstances, the conversion of the 
concentrate into smelted copper is an additional production activity in 
a foreign country within the meaning of paragraph (b)(3)(ii) of this 
section. Therefore, the source of U.S. Mine's excess gross receipts will 
be determined pursuant to paragraph (b)(2) of this section.

    (c) Determination of taxable income. The taxpayer's taxable income 
from sources within or without the United States will be determined 
under the rules of Secs. 1.861-8 through 1.861-14T for determining 
taxable income from sources within the United States.

    (d) Scholarships, fellowship grants, grants, prizes and awards--(1) 
In general. This paragraph (d) applies to scholarships, fellowship 
grants, grants, prizes and awards. The provisions of this paragraph (d) 
do not apply to amounts paid as salary or other compensation for 
services.

    (2) Source of income. The source of income from scholarships, 
fellowship grants, grants, prizes and awards is determined as follows:

    (i) United States source income. Except as provided in paragraph 
(d)(2)(iii) of this section, scholarships, fellowship grants, grants, 
prizes and awards made by a U.S. citizen or resident, a domestic 
partnership, a domestic corporation, an estate or trust (other than a 
foreign estate or trust within the meaning of section 7701(a)(31)), the 
United States (or an instrumentality or agency thereof), a State (or any 
political subdivision thereof), or the District of Columbia shall be 
treated as income from sources within the United States.

    (ii) Foreign source income. Scholarships, fellowship grants, grants, 
prizes and awards made by a foreign government (or an instrumentality, 
agency, or any political subdivision thereof), an international 
organization (as defined in section 7701(a)(18)), or a person other than 
a U.S. person (as defined in section 7701(a)(30)) shall be treated as 
income from sources without the United States.

    (iii) Certain activities conducted outside the United States. 
Scholarships, fellowship grants, targeted grants, and achievement awards 
received by a person other than a U.S. person (as defined in section 
7701(a)(30)) with respect to activities previously conducted (in the 
case of achievement awards) or to be conducted (in the case of 
scholarships, fellowships grants, and targeted grants) outside the 
United States shall be treated as income from sources without the United 
States.

    (3) Definitions. The following definitions apply for purposes of 
this paragraph (d):
    (i) Scholarships are defined in section 117 and the regulations 
thereunder.
    (ii) Fellowship grants are defined in section 117 and the 
regulations thereunder.
    (iii) Prizes and awards are defined in section 74 and the 
regulations thereunder.
    (iv) Grants are amounts described in subparagraph (3) of section 
4945(g) and the regulations thereunder, and are not amounts otherwise 
described in paragraphs (d)(3) (i), (ii), or (iii) of this section. For 
purposes of this paragraph (d), the reference to section 4945(g)(3) is 
applied without regard to the identity of the payor or recipient and 
without the application of the objective and nondiscriminatory basis 
test and the requirement of a procedure approved in advance.

    (v) Targeted grants are grants--

    (A) Issued by an organization described in section 501(c)(3), the 
United States (or an instrumentality or agency thereof), a State (or any 
political subdivision thereof), or the District of Columbia; and

    (B) For an activity undertaken in the public interest and not 
primarily for the private financial benefit of a specific person or 
persons or organization.

    (vi) Achievement awards are awards--

    (A) Issued by an organization described in section 501(c)(3), the 
United States (or an instrumentality or agency thereof), a State (or 
political subdivision thereof), or the District of Columbia; and

    (B) For a past activity undertaken in the public interest and not 
primarily

[[Page 266]]

for the private financial benefit of a specific person or persons or 
organization.

    (4) Effective dates. The following are the effective dates 
concerning this paragraph (d):

    (i) Scholarships and fellowship grants. This paragraph (d) is 
effective for scholarship and fellowship grant payments made after 
December 31, 1986. However, for scholarship and fellowship grant 
payments made after May 14, 1989, and before June 16, 1993, the 
residence of the payor rule of paragraph (d)(2) (i) and (ii) of this 
section may be applied without applying paragraph (d)(2)(iii) of this 
section.

    (ii) Grants, prizes and awards. This paragraph (d) is effective for 
payments made for grants, prizes and awards, targeted grants, and 
achievement awards after September 25, 1995. However, the taxpayer may 
elect to apply the provisions of this paragraph (d) to payments made for 
grants, prizes and awards, targeted grants, and achievement awards after 
December 31, 1986, and before September 26, 1995.

    (e) Effective dates. The rules of paragraphs (a), (b) and (c) of 
this section will apply to taxable years beginning after December 30, 
1996. However, taxpayers may apply the rules of this section for taxable 
years beginning after July 11, 1995, and on or before December 30, 1996. 
For years beginning before December 30, 1996, see Sec. 1.863-1 (as 
contained in 26 CFR part 1 revised as of April 1, 1996).

[T.D. 6500, 25 FR 11910, Nov. 26, 1960, as amended by T.D. 8615, 60 FR 
44275, Aug. 25, 1995; T.D. 8687, 61 FR 60545, Nov. 29, 1996; 61 FR 
65323, Dec. 12, 1996]