Proposed amendment of export-source rule

Proposed amendment of export-source rule – Tax Executives Institute’s International Tax Committee

Tax Executives Institute (TEI) understands that there is a proposal in pending Uruguay Round GATT funding legislation that would amend the export-source rule under section 863(b) of the Internal Revenue Code. The proposal, which reportedly has been approved by the House Ways and Means Committee, would effectively reverse the Tax Court’s 1993 pro-taxpayer decision in Intel Corp. v. Commissioner.

As the principal association of corporate tax executives in North America, TEI opposes the proposal. The Institute urges the House and Senate conferees to reject the proposal on the following grounds: the proposal has not been the subject of legislative hearings; it would increase administrative complexity and uncertainty in respect of taxation of international business and thereby threatens to significantly impair U.S. competitiveness; it is premature inasmuch as the Intel case is still pending in the courts; and it would undermine a core purpose of the GATT agreement–ensuring that U.S. business can compete effectively in the global marketplace.


Section 863 of the Internal Revenue Code provides special rules for determining the source (whether foreign or domestic) of a taxpayer’s income. The Treasury Regulations under section 863 provide two examples, one using an “independent factory price” (Example 1) and another using the so-called 50-50 method for sourcing foreign and domestic income (Example 2). Specifically, Treas. Reg. [sections] 1.863-3(b) permits taxpayers to apportion 50 percent of the income derived from the sale outside the United States of products manufactured within the United States on the basis of the location of the assets held to produce the income; the other 50 percent of the income is sourced under the title-passage rule (i.e., where title to the goods shifts to the purchaser and hence where the place of sale is determined to occur).

In Intel Corp. v. Commissioner,(1) the United States Tax Court rejected an argument by the Internal Revenue Service that the taxpayer was required to use an independent factory price (IFP) analysis to determine its foreign-source income. The court held that the regulations under section 863(b) mandate the use of the IFP method only where (i) an IFP can be established and (ii) the taxpayer has a sales or distribution branch in a foreign country; the court confirmed that the 50-50 method is to be used where taxpayers sell their U.S.-manufactured products directly to either unrelated parties or subsidiaries (where title passes outside the United States).


A. Modification of the Export-Source Rule Requires A Proper Hearing. At the outset, TEI strongly objects to the process that has been used to develop the propsal to overturn the export-source rule. There have been no hearings held on the GATT funding proposals generally, and no legislative language concerning the export-source rule amendment has been released. Rather, the legislative process has been marked by skeletal descriptions of proposed changes and media reports on what has been adopted (or not adopted) and why. This is clearly not the proper atmosphere in which to consider a change to a provision as important to U.S. trade and as longstanding as the 50/50 export-source rule.

It is only by openly and fully analyzing legislative proposals that Congress can fulfill its obligations to pass rational, necessary, and effective tax legislation. Concededly, holding public hearings and otherwise opening up the process may require more time, but we believe it would produce better results than those that emerge from behind closed doors. In other words, if there is to be a legislative overturning of the long-standing 50/50 export-source rule, it should only come after full public debate by the tax-writing committees. TEI stands ready to work with Congress to review proposals relating to the exportsource rule.

B. The Proposed Amendment Would Increase Tax Law Uncertainty and Complexity and Thereby Harm U.S. Competitiveness. Although no legislative language has been released, it appears that the proposal would generally require taxpayers to use the IFP method to determine the portion of their export sales that is considered “foreign” source income. The proposal would adversely affect U.S. companies that manufacture in the United States and use a foreign subsidiary to market their exports in two ways–it would negate the titlepassage rule and would unnecessarily increase uncertainty and complexity. In some cases, the repeal of the export-source rule could tip the scales in a company’s decision whether to locate a manufacturing facility in the United States or aborad.(2)

In 1986, the Senate Finance Committee considered changes to the title passage rule that would have adversely affected the export-source rule. The committee ultimately rejected these changes, finding that “with the substantial trade deficits of the United States, [the Committee] does not want to impose any obstacles on U.S. businesses that may exacerbate the problems of U.S. competitiveness abroad.” S. Rep. No. 99-313, 99th Cong., 2d Sess. 329 (1986). The reservations expressed in 1986 are just as valid today.

Moreover, the proposal would raise significant compliance issues and create huge administrative burdens for U.S. multinational corporations and the taxing authority that must audit them. Requiring the use of an IFP would doubtless create enormous audit controversies–and ultimately litigation–between taxpayers and the government concerning what constitutes an IFP.(3) This is a high price to pay for a proposal that is estimated to raise a relatively small ($138 million) amount of revenue. In the interest of simplification, the proposal should be rejected.(4)

C. Amendment of the Export-Source Rule Is Premature. TEI also believes that consideration of a legislative reversal of the Intel decision is premature. The case is on appeal in the Ninth Circuit. After full briefing and argument, its reasoning will rise or fall on its merits. TEI respectfully submits that Congress should not short-circuit the judicial process, but rather allow the case to run its course. Indeed, the Institute believes Congress should generally avoid embracing spurious, judicially-rejected IRS positions; such a practice runs the risk of sullying both the legislative and the judicial processes.

D. It Is Especially Perverse to Overturn the Intel Decision as Part of the GATT Process. The 50/50 exportsource rule operates as an export incentive, encouraging companies to manufacture in the United States goods for export that, in the absence of such a rule, might well be manufactured abroad. It defies logic that a Congress might vote to significantly restrict such a domestic manufacturing/export incentive in order to fund the GATT agreement–the whole purpose of which is to encourage trade and enhance competitiveness. The GATT agreement should not be funded by increasing the tax liability of U.S. multinational corporations that manufacture products in the United States and sell them abroad.


For the foregoing reasons, TEI opposes the proposal to amend the export-source rule by overturning the Intel case.

(1)100 T.C. No. 39 (June 28, 1993).

(2)Consider this evidence of the effect of the repeal of the export-source rule from TEI’s membership: his company earns 60 percent of its revenues from sources outside the United States, but locates 90 percent of its manufacturing facilities inside the country. Were it not for the export source rule, this company would give serious consideration to locating more manufacturing operations in low-tax countries such as Taiwan and Korea–where significant tax incentives are available to companies.

(3)In the Intel case, the taxpayer and the government agreed that at least six-week trial would be required to determine whether an IFP even existed.

(4)There is virtually no guidance on how to establish an IFP. Although the IRS has issued two notices (Notices 89-10 and 89-11) that deal with the IFP method, this guidance does not prescribe clear rules for cases in which an IFP rule may be applied; rather, the notices merely help establish when an IFP cannot be applied.

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