New grouping rules for FSC calculations and foreign-source income.

New regulations affect taxpayers that may benefit from changing their method of grouping foreign sales corporation (FSC) transactions or obtain FSC benefits from leasing and licensing transactions. Effective for tax years beginning after 1997, taxpayers must irrevocably elect, on a timely filed tax return, to calculate FSC income either on the basis of groupings or on a transaction-by-transaction basis. Moreover, any redeterminations of groupings of FSC transaction income for years beginning before 1998 must be made by the due date (including extensions) of the FSC's tax return for its first year beginning after 1997.

The new regulations also clarify that the special sourcing rules under Sec. 927(e), which limit the amount of foreign-source income on FSC transactions to the analogous amount that would have been earned under the corresponding domestic international sales corporation (DISC) pricing rules, apply to transactions other than the sales of export property (such as lease, license or service giving rise to foreign trading gross receipts of FSCs) and commission agent FSCs.

Before the change in the regulations, taxpayers could elect to calculate FSC income on the basis of groupings set forth in Temp. Regs. Sec. 1.925(a)-1T(c)(8)(i). These groupings could be made on the basis of products or product lines.

Filing Amended Returns 

It had become commonplace for taxpayers to file their original returns and later redetermine the FSC income (and commission expense) through the filing of amended returns. These amended returns took advantage of the flexibility of Temp. Regs. Sec. 1.925(a)-1T(e)(4), which permitted taxpayers to file amended FSC returns for any open tax year. The revised regulations cite the filing of these amended returns "just prior to the expiration of the statute of limitations and many years after the original returns were filed" as placing a "significant burden" on the IRS. Moreover, because the revised groupings are performed with complex software, the Service is concerned about a potential for abuse.

Under the revised regulations, applicable to tax years beginning after 1997, "[n]o untimely or amended returns will be allowed to elect to group, to change a grouping basis, or to change from a grouping basis to a transaction-by-transaction basis for such year" (Temp. Regs. Sec. 1.925(a)-1T(c)(8)(i)). Taxpayers will be required to establish systems that allow them to make the optimal grouping decision by their returns' extended due dates.

The revised regulations also require amended returns that change the grouping of FSC transactions for tax years beginning before 1998 to be filed by the extended due date of the taxpayer's return for its first year beginning after 1997. This transaction rule will preclude the opportunity to change FSC groupings for open years.

The new regulations do not expressly modify a taxpayer's ability to file an amended return claiming additional foreign trading gross receipts (FTGRs) or reflecting a different transfer-pricing method, an adjustment under Sec. 482, or a change to allocated or apportioned expenses under Regs. Sec. 1.861-8.

Sourcing

Temp. Regs. Sec. 1.927(e)-1T(a)(1) stated that the foreign-source income limitation rules of Sec. 927 (a) (1) apply to export property sales. As a result of the Taxpayer Relief Act of 1997, software licensed for reproduction abroad is specifically included in the definition of export property under the FSC rules; see Sec. 927(a)(2)(B).

Under revised Temp. Regs. Sec. 1.927(e)-1T(a)(1), effective for tax years beginning after 1997, the related supplier's foreign-source limit applies to any transactions, including (but not limited to) any sale, lease, license or service that gives rise to FTGRs. This revision provides guidance to taxpayers now using amended Sec. 927(a)(2)(B). Specifically, the IRS wants to extend the Sec. 927(e) limitation to transactions other than export property sales, apparently concerned that taxpayers licensing software that generates FTGRs would treat Sec. 927(e) as inapplicable to a "license transaction."

FROM RICHARD GORDON, J.D., WASHINGTON, D.C.