Defense Contractor Seeks Tweaks to Proposed FDII, GILTI Regs

April 25, 2019

Internal Revenue Service
CC:PA:LPD:PR (REG-104464-18)
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Comments on Proposed Regulations (REG-104464-18) Relating to the Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income

Dear Sir or Madam:

Raytheon Company (Raytheon") is pleased to offer comments on the notice of proposed rulemaking (REG-104464-18) regarding the deduction for foreign-derived intangible income ("FDII") and global intangible low-taxed income ("GILTI") under section 250 released by the Department of Treasury ("Treasury") and the Internal Revenue Service ("IRS") on March 4, 2019.¹ We commend the efforts of Treasury and the IRS to provide clear and comprehensive guidance under section 250 and appreciate the opportunity to comment.

Raytheon, with 2018 sales of $27 billion and 67,000 employees, is a technology and innovation leader specializing in defense, civil government, and cybersecurity solutions. With a history of innovation spanning 97 years, Raytheon provides state-of-the-art electronics, mission systems integration, C5I (Command, Control, Communications, Computers, Cyber, and Intelligence) products and services, sensing, effects, and mission support for customers in more than 80 countries.

I. Executive Summary

This comment letter respectfully requests that the final regulations under section 250:

• Permit taxpayers to establish that a transaction is a foreign military sale satisfying Prop. Treas. Reg. § 1.250(b)-3(c) through a non-exclusive list of documentation collected or created in the ordinary course of the taxpayer's trade or business, subject to the reliability requirements set forth in Prop. Treas. Reg. § 1.250(b)-3(d);

• Provide that documentation used to establish that a transaction is a foreign military sale satisfying Prop. Treas. Reg. § 1.250(b)-3(c) be treated as satisfying the documentation requirements of Prop. Treas. Reg. §§ 1.250(b)-4(c)(2) (relating to foreign person requirement for foreign-derived deduction eligible income ("FDDEI") sales), -4(d)(3) (relating to foreign use requirement for general property FDDEI sales), -4(e)(3) (relating to foreign use requirement for intangible property FDDEI sales), -5(d)(3) (relating to a consumer's location for general services), and -5(e)(3) (relating to a business recipient's location for general services);

• Include a modified version of the foreign military sales rule (Prop. Treas. Reg. §1.250(b)-3(c)) that (1) removes the phrase "on commercial terms," as it is ambiguous and unnecessary in light of the language of the operative rule, and (2) removes the reference to a contract between the seller or renderer and the United States, instead relying on separate documentation requirements;

• Prevent the misallocation of research and experimental ("R&E") expenditures by adopting one of the following three potential alternatives —

  • Where the use of the results of R&E is restricted to a certain market, allocate the associated R&E expenditures to income from that market;

  • Permit taxpayers to allocate R&E expenditures to non-FDDEI and FDDEI based on books and records, provided that such books and records use cost allocations that are required for a non-tax regulatory purpose and are subject to routine non-tax government audits; or

  • Permit taxpayers to apply a modified exclusive apportionment rule that uses the geographical location of R&E activities as a proxy for the market in which a product or service is sold for use;

• Amend the property service rules to be consistent with the statute by treating a service as a FDDEI service if either the service is provided to a recipient not located within the United States or the service is provided with respect to property not located within the United States;

• If the above suggestion is not adopted, add an exception providing that a property service will be treated as a FDDEI service if performed with respect to tangible property temporarily brought into the United States for the purpose of receiving the service, which may be subject to certain limitations described below to ensure the property's location in the United States is temporary;

• Remove the requirement in Prop. Treas. Reg. § 1.250(b)-3(d) providing that, with respect to FDDEI sales and services, documentation must be obtained no earlier than one year before the date of the sale or service in order to be considered reliable, as this rule would create significant compliance burdens in the case of long-term contracts and is unnecessary in light of the general documentation reliability requirements;

• Modify the requirements for establishing the status of a recipient as a foreign person under Prop. Treas. Reg. § 1.250(b)-4(c)(2) by adopting at least one of the following approaches —

  • Make the Prop. Treas. Reg. § 1.250(b)-4(c)(2)(i) list non-exclusive and permit the taxpayer to rely on any other documentation that is collected or created in the ordinary course of the taxpayer's trade or business;

  • Permit all taxpayers to rely on the Prop. Treas. Reg. § 1.250(b)-4(c)(2)(ii) special rules for small businesses; or

  • If the exclusive list approach in the proposed regulations is retained, permit taxpayers to rely generally on publicly-available information establishing that the recipient is a foreign person; and

• Modify the requirements for establishing foreign use under Prop. Treas. Reg. § 1.250(b)-4(d)(3) by adopting at least one of the following approaches —

  • Make the Prop. Treas, Reg. § 1.250(b)-4(d)(3)(i) list non-exclusive and permit the taxpayer to rely on any other documentation that is collected or created in the ordinary course of the taxpayer's trade or business;

  • Permit all taxpayers to rely on the Prop. Treas. Reg. § 1.250(b)-4(d)(3)(ii) special rules for small businesses.

II. Foreign Military Sales

A. Overview

The proposed section 250 regulations clarify that a sale of property or the provision of services to the U.S. government for resale or on-service to a foreign government under the Arms Export Control Act of 1976² (referred to collectively herein as "foreign military sales") will be treated as a sale of property or a provision of a service to the foreign government and thus may be treated as a FDDEI sale or service.³ We appreciate Treasury and the IRS's guidance on this important issue, and we generally support the approach taken by Treasury and the IRS in the proposed regulations, subject to our comments below in which we request that Prop. Treas. Reg. § 1.250(b)-3(c) be modified to remove the phrase "on commercial terms" and the reference to a contract between the seller or renderer and the United States. Foreign military sales are made for the ultimate benefit of a foreign government and are therefore properly treated as made to a foreign government for purposes of section 250. As noted by Treasury and the IRS in the Preamble, the proposed rule promotes uniform tax treatment between the defense sector and other sectors of the U.S. economy with respect to sales and services that are clearly meant for a foreign use.⁴

This section responds to Treasury and the IRS's request for comments, as described below. We first provide background information about the foreign military sales contracting process under the Arms Export Control Act. We then provide our specific comments on this issue and respectfully request that the final regulations (1) permit taxpayers to establish that a transaction is a foreign military sale through a non-exclusive list of documentation that is collected or created in the ordinary course of the taxpayer's trade or business, subject to the reliability requirements set forth in Prop. Treas. Reg. § 1.250(b)-3(d) and (2) remove from Prop. Treas. Reg. § 1.250(b)-3(c) the phrases "on commercial terms" and "contract between the seller or renderer and the United States or an instrumentality thereof provides that the sale or service is purchased for resale or on-service to such foreign government."

B. Contracting Process

The contracting process with respect to sales or services provided to the U.S. government for resale or on-service to a foreign government under the Arms Export Control Act begins when the foreign government issues a Letter of Request ("LOR") to the U.S. government. Once the U.S. government, after consultations with the foreign government and potential contractors, has determined that the request can be fulfilled, it enters into a Letter of Offer and Acceptance ("LOA") with the foreign government customer. The U.S. government and the contractor then enter into a contract calling for the contractor to provide the goods and services that are the subject of the LOA. The contract between the contractor and the U.S. government typically references a unique case identifier number assigned to the project in the LOA.

Although the government contractor may provide the U.S. government with input on certain terms in the LOA and may see a draft or final LOA in some cases, the government contractor is not entitled to receive the LOA and frequently does not receive it. The price paid by the foreign government is determined after discussions between the U.S. government and foreign government as well as between the U.S. government and the contractor (or, in the case of a competitive procurement, multiple potential contractors). The U.S. government negotiates the pricing with the contractor on behalf of the foreign government customer. The foreign military sales process is operated on a "no-profit, no-cost basis to the U.S. government.

Certain U.S. government forms may be completed by the contractor and/or the U.S. government in connection with the contract performance process. For example, Form DD 250 (Material Inspection and Receiving Report) may be completed in connection with the shipment or delivery of products. When all of the products and services listed in the LOA have been delivered and/or performance of the contract is complete, a foreign military sales case is closed and Defense Finance and Accounting Services (an agency of the Department of Defense) issues a final statement of account, the Form DD 645 (FMS Billing Statement), to the foreign government customer. These forms will not necessarily be completed and/or provided to the government contractor by the date on which the contractor is required to file an income tax return reporting the associated income.

C. Foreign Military Sales Documentation Requirements

The Preamble to the proposed section 250 regulations requests comments "on whether final regulations should provide guidance on how taxpayers can demonstrate that a sale or service has been made pursuant to the Arms Export Control Act."⁵ As described below, there is not a single type of document uniformly available to the taxpayer in all cases that would indicate that the sale or the service is a foreign military sale made pursuant to the Arms Export Control Act. Accordingly, we recommend that the regulations provide a non-exclusive list of documents collected or created in the ordinary course of the taxpayer's trade or business on which the taxpayer may rely. We further recommend that the regulations permit taxpayers to use multiple documents to establish that, in a given situation, a sale or service is a foreign military sale.

As indicated above, a foreign military sale occurs pursuant to two contracts — an LOA between the U.S. government and the foreign government customer and the contract between the government contractor and the U.S. government calling for the government contractor to provide the goods and services that are the subject of the LOA. The contract between the U.S. government and the government contractor does not always specifically state that the provision of such goods and services is pursuant to the Arms Export Control Act. Additionally, while the contract between the U.S. government and the government contractor is consistent with the relevant terms in the LOA, such contract does not consistently identify the foreign government customer nor does it always specifically provide that the contract is for the resale or on-service of goods or services to a foreign customer. The contract will, however, typically specifically identify the jurisdictions to which property is being delivered or in which services are to be performed and may include the unique case identifier assigned to the project. The foreign military sales character of the transaction and the identity of the foreign government customer is always known by the contractor but may not be explicitly stated in a single document. The contractor will know the status of the sale through discussions with the U.S. government as well as information reported in a combination of other documents that the government contractor collects in the ordinary course of business. These documents may include, for example, proposals, contracts, documents related to shipping and billing, export documentation filed with the U.S. Department of State, and other forms completed in the foreign military sales process.

We recommend that the final regulations permit taxpayers to establish that a transaction is a foreign military sale through a non-exclusive list of documentation that is collected or created in the ordinary course of the taxpayer's trade or business, subject to the reliability requirements set forth in Prop. Treas. Reg. § 1.250(b)-3(d). If immediately effective guidance includes a list of exclusive documentation requirements, we request that Treasury and the IRS permit a transition period to allow taxpayers to gather the necessary documentation for existing contracts and to put in place processes to gather the necessary documentation for new contracts.

We further recommend that the final regulations provide that documentation used to demonstrate that a sale or service has been made pursuant to the Arms Export Control Act be treated as satisfying the documentation requirements of Prop. Treas. Reg. §§ 1.250(b)-4(c)(2) (relating to foreign person requirement for FDDEI sales), -4(d)(3) (relating to foreign use requirement for general property FDDEI sales), -4(e)(3) (relating to foreign use requirement for intangible property FDDEI sales), -5(d)(3) (relating to a consumer's location for general services), and -5(e)(3) (relating to a business recipient's location for general services).⁶ Transactions qualifying as foreign military sales under Prop. Treas. Reg. § 1.250(b)-3(c) by definition are made to foreign persons for a foreign use.

The following proposed language could be used as a starting point:

"1.250(b)-3(c) Foreign military sales.

(1) In general . For purposes of determining whether a sale of property . . .

(2) Documentation of foreign military sales. A seller or renderer establishes that a sale of property or a provision of a service is a foreign military sale as described in paragraph (c)(1)  if it obtains one or more of the following types of documentation evidencing that the property or services is purchased by the United States or an instrumentality thereof for resale or on-service to a foreign government or agency or instrumentality thereof, provided that such documentation meets the reliability requirements described in paragraph (d) of this section —

(i) Proposal documents submitted to the United States or an instrumentality thereof or to the foreign government or agency or instrumentality thereof;

(ii) An executed contract between the seller or renderer and the United States or an instrumentality thereof;

(iii) Shipping and/or billing documentation supporting delivery to a foreign government or agency or instrumentality thereof;

(iv) Export documentation filed with the United States or an instrumentality thereof in connection with the transaction.

(v) Written representation from a United States contracting officer that the sale of property or provision of a service constituted a foreign military sale; or

(vi) Any other reasonable documentation collected or created in the ordinary course of a seller's or renderer's trade or business.

(3) Other documentation requirements. If a seller or renderer establishes pursuant to paragraph (c)(2) of this section that a sale of property or a provision of a service is a foreign military sale, the seller or renderer shall be treated as having satisfied the documentation requirements of §§ 1.250(b)-4(c)(2), 1.250(b)-4(d)(3), 1.250(b)-4(e)(3), 1.250(b)-5(d)(3), and 1.250(b)-5(e)(3)."

D. Foreign Military Sales Rule Substantive Requirements

As stated above, we appreciate Treasury and the IRS's proposed guidance on the treatment of foreign military sales under section 250. Prop. Treas. Reg. § 1.250(b)-3(c) provides that, for purposes of determining whether a sale or service gives rise to a FDDEI transaction, "if a sale of property or a provision of a service is made to the United States or an instrumentality thereof pursuant to 22 U.S.C. 2751 et seq. under which the United States or an instrumentality thereof purchases the property or service for resale or on-service, on commercial terms, to a foreign government or agency or instrumentality thereof, and the contract between the seller or renderer and the United States or an instrumentality thereof provides that the sale or service is purchased for resale or on-service to such foreign government or agency or instrumentality thereof, then the sale of property or provision of a service is treated as a sale of property or a provision of a service to the foreign government." We generally support the approach taken by Treasury and the IRS in the proposed regulations and suggest two modifications to Prop. Treas. Reg, § 1.250(b)-3(c) to promote clarity and help ensure that the rule applies in the appropriate circumstances.

First, we request that the phrase "on commercial terms" be removed to avoid unnecessary ambiguity. The phrase "on commercial terms" is not defined in the regulations or explained in the Preamble. It is also not clear if the phrase "on commercial terms" is intended to refer to the terms of the transaction between the U.S. government and the foreign government or the terms of the transaction between the contractor and the U.S. government.

Foreign military sales are arm's length transactions subject to a comprehensive regulatory regime,⁷ As described above, the price paid by the foreign government is determined after discussions between the U.S. government and foreign government as well as U.S. government discussions with the contractor.

In addition, if "on commercial terms" refers to the terms of the transaction between the U.S. government and the foreign government, the government contractor may not have sufficient information about the government-to-government terms to be able to make an assessment of the commerciality of the arrangement. As stated above, the government contractor involved in a foreign military sale is not entitled to receive the LOA and frequently does not receive it, However, the government contractor will know, based on its knowledge of the transaction and associated documentation, that the sale is for a specific foreign government. Further, the FMS process is operated on a "no-profit, no-cost" basis to the U.S. government, and thus it is unclear how the phrase "on commercial terms" would apply to the transaction between the U.S. government and foreign government.

We understand that Treasury and the IRS wish to limit the scope of the foreign military sales rule to sales clearly made for the benefit of a foreign government customer. We believe that the phrase "on commercial terms" is not necessary to do so. Specifically, we understand that Treasury and the IRS wish to distinguish between two types of sales to foreign governments, both of which could occur pursuant to the Arms Export Control Act. The first type is foreign military sales transactions where, as described in the proposed regulations, the United States purchases property or services from a government contractor for resale or on-service to a foreign government. The second type consists of transactions where the U.S. government has property in inventory and sells such property to a foreign government. We believe that the proposed regulations reference to sales made for "resale or on-service . . . to a foreign government" is sufficient to distinguish between the two types of transactions. With respect to the latter, even if a government contractor originally sold such property to the U.S. government, such sales would not have been for "resale or on-service . . . to a foreign government and would not be treated as FDDEI transactions. The phrase "on commercial terms" is thus not necessary.

For these reasons, we recommend that the "on commercial terms" language be removed from the final regulations. If Treasury and the IRS have a specific concern that we have not addressed, we would appreciate the opportunity to discuss.

Second, we request that the reference in Prop. Treas. Reg. § 1.250(b)-3(c) to a contract between the United States and the contractor that identifies that the sale or service is purchased for resale or on-service to "such foreign government" be removed. As discussed above, the contract between the U.S. government and the government contractor does not consistently identify the foreign government customer. Nonetheless, the contractor would be able to establish that the transaction is a foreign military sale through other documentation collected or created in the ordinary course of business. We thus request that the above clause be removed from the final regulations.

In sum, our suggested revisions to Prop. Treas. Reg. § 1.250(b)-3(c) are as follows:

"(c) Foreign military sales. For purposes of determining whether a sale of property or a provision of a service is a FDDEI transaction, if a sale of property or a provision of a service is made to the United States or an instrumentality thereof pursuant to 22 U.S.C. 2751 et seq. under which the United States or an instrumentality thereof purchases the property or service for resale or on-service, on commercial terms, to a foreign government or agency or instrumentality thereof, and the contract between the seller or renderer and the United States or an instrumentality thereof provides that the sale or service is purchased for resale or on service to such foreign government or agency or instrumentality thereof, then the sale of property or provision of a service is treated as a sale of property or a provision of a service to the foreign government."

III. Treatment of Cost of Goods Sold and Allocation anti Apportionment of Deductions

A. Overview

The proposed section 250 regulations provide guidance on how costs of goods sold and deductions should be allocated for purposes of determining the FDII deduction. We appreciate Treasury and the IRS's guidance on these important issues, This section responds to Treasury and the IRS's request for comments on certain of these issues, as described below.

B. Cost of Goods Sold

With respect to cost of goods sold, the proposed regulations provide that, for purposes of determining the gross income included in gross deduction eligible income ("DEI") and gross FDDEI of a domestic corporation or a partnership, the cost of goods sold of the corporation or partnership is attributed to gross receipts with respect to gross DEI or gross FDDEI "under any reasonable method."⁸ The Preamble requests comments on whether additional rules should be provided on this issue.⁹

We support this approach taken by Treasury and the IRS in the proposed regulations. Certain methodologies may be appropriate for some taxpayers but may not be appropriate or feasible for other taxpayers. As a result, a more flexible approach is warranted.

C. Allocation and Apportionment of Deductions

1. In General

The proposed regulations provide that, for purposes of determining a domestic corporation's deductions that are properly allocable to gross DEI and gross FDDEI, the corporation's deductions are allocated and apportioned to gross DEI and gross FDDEI under the rules of Treas. Reg. §§ 1.861-8 through 1.861-14T and 1.861-17 by treating section 250(b) as an operative section described in Treas. Reg. § 1.861-8(f).¹⁰ Gross FDDEI and gross non-FDDEI are treated as separate statutory groupings.¹¹ All items of gross income described in Prop. Treas. Reg. § 1.250(b)-1(c)(14)(i) through (vi) are in the residual grouping.¹² The deductions allocated and apportioned to gross DEI equal the sum of the deductions allocated and apportioned to gross FDDEI and gross non-FDDEI.¹³

We generally support the application of the rules of Treas. Reg. §§ 1.861-8 through 1.861-14T with respect to the allocation and apportionment of deductions to gross DEI and gross FDDEI. This approach is administrable for both taxpayers and the government. However, as discussed in greater detail below, we request that Treasury and the IRS consider modifying certain aspects of the approach to the allocation of R&E expenditures under Treas. Reg. § 1.861-17 for purposes of section 250.

We understand that Treasury and the IRS are undertaking a broader review of Treas. Reg. § 1.861-17 in light of tax reform and other developments in the tax law and global economy since those rules were originally promulgated. If Treasury and the IRS do not incorporate any of our suggestions below into the final section 250 regulations, we request that Treasury and the IRS reserve on the issue and consider the arguments below in connection with potential modifications of Treas. Reg. § 1.861-17.

2. R&E Expenditures

a. Overview of Current Law

Under Treas. Reg, § 1.861-17, R&E expenditures "that a taxpayer deducts under section 174 ordinarily shall be considered deductions that are definitely related to all income reasonably connected with the relevant broad product category (or categories) of the taxpayer and therefore allocable to all items of gross income as a class (including income from sales, royalties, and dividends) related to such product category (or categories)."¹⁴ This approach is based on the premise "that research and experimentation is an inherently speculative activity, that findings may contribute unexpected benefits, and that the gross income derived from successful research and experimentation must bear the cost of unsuccessful research and experimentation."¹⁵

R&E expenditures incurred solely to meet legal requirements imposed by a political entity with respect to improvement or marketing of specific products or processes are allocated solely to the jurisdiction imposing the requirements if expenditures cannot reasonably be expected to generate amounts of gross income (beyond de minimis amounts) outside of that jurisdiction.¹⁶ Under Treas. Reg. § 1.861-17, a taxpayer's remaining R&E expenditures are allocated and apportioned, at the taxpayer's election, by a sales method or a gross income method, subject to an exclusive apportionment rule. For simplicity, this letter focuses on the sales method.¹⁷

Under the exclusive apportionment rule, a taxpayer using the sales method apportions 50 percent of R&E expenditures exclusively to the statutory grouping of gross income or the residual grouping of gross income arising from the geographic source where the R&E activities that account for more than 50 percent of the R&E expenditures were performed.¹⁸ The remaining R&E expenditures are apportioned on a pro rata basis between the statutory grouping (or among the statutory groupings) within the class of gross income and the residual grouping within such class based on the amount of sales from the product category (or categories) that resulted in such gross income within the statutory grouping (or statutory groupings) and in the residual grouping bear, respectively, to the total amount of sales from the product category (or categories).¹⁹

For purposes of calculating the FDII deduction, the proposed section 250 regulations provide that the rules of Treas. Reg. § 1.861-17 shall apply without the exclusive apportionment rule.²⁰ Thus, if the taxpayer adopts the sales method, after the allocation of any legally-mandated R&E expenditures, the remaining R&E expenditures would be allocated and apportioned on a pro rata basis according to sales.

b. Research Expenditures Under Government Contracts

Raytheon respectfully requests that Treasury and the IRS revise Prop. Treas, Reg. § 1.250(b)-1(d)(2)(i) (the "Proposed Expense Allocation Rule") to more accurately reflect the relationship between R&E expenditures and the income generated from those investments. Without revisions, the application of the rule will lead to distortive effects that will uniquely harm the defense industry and other industries that invest heavily in R&E pursuant to government contracts. As described below, there is a direct relationship between many R&E projects and the income from particular government contracts. Further, in general, R&E activities performed pursuant to government contracts generate a high proportion of income in the country in which such activities are performed. In addition, legal restrictions on exports of certain new and cutting-edge military technology outside of the United States often limit when and how defense contractors monetize their rights to use the fruits of their R&E activities outside of the United States. Moreover, because the defense industry is legally required to keep detailed cost-accounting records that accurately match R&E expenditures to the income associated with those expenses, defense contractors could use books and records to accurately allocate and apportion R&E expenditures.

Each year, defense contractors invest billions of dollars of R&E pursuant to government contracts in the United States. Indeed, a significant amount of the R&E expenditures incurred by defense contractors relate to engineering and associated activities specifically mandated or necessary to meet their performance obligations under customer contracts, collectively referred to as research expenditures on government contracts ("REGC"). Unlike many other R&E activities, these REGC do not relate generally to all revenues or a broad category of revenues, as contemplated by the sales method (or gross income methods) under Treas. Reg. § 1.861-17. Instead, the REGC incurred pursuant to a given government contract will generate income specifically related to that contract.

Through the Federal Acquisition Regulations ("FAR") and Cost Accounting Standards ("CAS"), the U.S. government requires defense contractors (and other government contractors) to keep detailed books and records that accurately trace R&E expenditures incurred to satisfy a government contract to the income earned pursuant to that contract. To enforce this obligation, the U.S. government audits these and other costs to ensure they are properly charged to a specific contract.

The application of Treas. Reg. § 1.861-17 to REGC in the FDII context creates a mismatch between revenue and expense, distorting the net income attributable to a company's contracts (i.e., costs with a clearly established factual relationship to income derived from one contract are re-allocated and apportioned to other contracts). Consider the following example:

For a taxable year, DC, a government contractor and domestic corporation, is engaged in the production and sale of a product group in a three-digit Standard Industrial Classification Group, hereinafter referred to as Group AAA. DC manufactures Group AAA products in the United States and sells Group AAA products to U.S. and foreign persons. DC's gross receipts from sales to U.S. persons of Group AAA products are $1000x, and DC attributes $500x of cost of goods sold to such sales. DC's gross receipts from sales to foreign persons of Group AAA products are $600x, and DC attributes $250x of cost of goods sold to such sales. All of the gross income of DC is included in gross DEI, and the manner in which DC attributes the cost of goods sold is a reasonable method. DC incurs $200x of R&E expenditures in the United States that are deducted under section 174. Of this amount, $170x is REGC required to produce products and other deliverables pursuant to the terms of a contract with the U.S. government, and $30x is REGC required to produce products and other deliverables pursuant to the terms of a contract with a foreign government. None of the R&E would satisfy the existing definition of legally-mandated research as described in Treas. Reg. § 1.861-17(a)(4).

Pursuant to the Proposed Expense Allocation Rule, assuming DC elects the sales method, all R&E expenditures would be allocated and apportioned based on sales of Group AAA products. Total sales were $1600x, $600x of which were to foreign persons. Therefore, $75x of R&E expenditures is allocated and apportioned to gross FDDEI ($200x multiplied by $600x/$1600x), and $125x of R&E expenditures is allocated and apportioned to gross non-FDDEI ($200x multiplied by $1000x/$1600x). However, at least $170x of R&E expenditures are directly traceable to (and specifically required to satisfy) the terms of contracts with the U.S. government, and the benefit of that R&E is specifically traceable to the income earned from the relevant contract.

In this fact pattern, a portion of R&E expenditures properly allocable to gross non-FDDEI would nonetheless be allocated and apportioned to gross FDDEI under the Proposed Expense Allocation Rule. The over-allocation of R&E expenditures to gross FDDEI (and therefore the reduction of FDII) is inconsistent with the policy goals of section 250 — eliminating the tax incentive to locate or move intangible income (and potentially connected operations) abroad.²¹

In the case of REGC, there is a clear factual relationship between R&E expenditures and a particular amount of income. Thus, the general premise underlying Treas. Reg. § 1.861-17 — that the connection between R&E and any particular revenue stream is speculative and that the gross income derived from successful R&E must bear the cost of unsuccessful R&E — simply does not hold.²² As a result, the general approach of the regulations should be modified to avoid the distortive effect illustrated above.

c. Recommendations for R&E Allocation

We respectfully request that that Treasury and the IRS adopt one of the following approaches. We first suggest that Treasury and the IRS revise the final regulations to properly match REGC with the associated income stream to prevent expenses associated with gross non-FDDEI from being allocated and apportioned to gross FDDEI, either (1) by adding an exception for certain market-restricted R&E expenses where the legally-mandated rule would not apply to appropriately match that expense and income or (2) through an elective books and records method. If Treasury and the IRS do not adopt either of these approaches, we suggest that the regulations adopt a modified exclusive apportionment approach based on market destination rather than sources of income.

i. Exception for Market-Restricted R&E Expenditures

As discussed above, under Treas. Reg. § 1.861-17(a)(4), R&E expenditures incurred solely to meet legal requirements imposed by a political entity with respect to improvement or marketing of specific products or processes are allocated solely to the jurisdiction imposing the requirements if expenditures cannot reasonably be expected to generate amounts of gross income (beyond de minimis amounts) outside of that jurisdiction.²³ This exception is relatively narrow and applies only in limited circumstances. For example, the regulations specifically mention situations where the U.S. Food and Drug Administration imposes specific research and testing requirements in order for a product to be approved, and such product is sold to countries that do not accept or do not require research performed in the United States for purposes of their own licensing standards.²⁴

The policy behind the legally-mandated restriction should be extended to other situations, such as where the laws of the United States limit the ability to realize income from certain research activities to the market in which the research is performed but where the legally-mandated rule would not apply to appropriately match that expense and income. For example, in the defense industry, the U.S. government may not authorize the export of the technology resulting from certain REGC and may make uncertain a defense industry contractor's ability to generate sales to foreign markets in the future as a result of these research efforts in the current tax year. Thus, exploitation of the results of REGC may be subject to legal limitations such that those results cannot reasonably be expected to generate significant income outside of the United States. These legal limitations and the associated national security considerations should provide a basis for a special allocation rule similar to the existing rule for legally-mandated research. Under these circumstances, the policy justifications for allocating REGC to the relevant market are the same as the justifications for allocating legally-mandated R&E expenditures to the jurisdiction imposing the legal requirements under Treas. Reg. § 1.861-17(a)(4). These expenditures are not reasonably anticipated to generate amounts of gross income outside of the jurisdiction imposing legal or contractual restrictions on the property or services developed by the REGC.

The following proposed language could be used as a starting point if Treasury were to include an exception for market-restricted research:

ii. Books and Records Method

Alternatively, Treasury and the IRS could provide taxpayers with the option to allocate and apportion R&E expenditures in a manner consistent with the taxpayer's books and records to the extent there is a clear factual relationship between the expenditures and a particular amount of income.²⁵

There is regulatory precedent for using a books and records approach. Former section 863(b) applied to determine income from the sale of inventory property produced (in whole or in part) in the United States, or produced (in whole or in part) outside the United States and sold within the United States. Under the regulations, a books and records method could be used to allocate gross income between sales activity and production activity.²⁶ The taxpayer was required to receive advance permission of the District Director having audit responsibility over its tax return.²⁷ Further, the taxpayer was required to establish that the taxpayer, in good faith and unaffected by considerations of tax liability, regularly employed in its books of account a detailed allocation of receipts and expenditures which clearly reflected the amount of the taxpayer's income from production and sales activities.²⁸

If Treasury and the IRS wish to limit the use of a books and records method in the section 250 context, the regulations could impose certain restrictions aimed at ensuring the accuracy and completeness of the books and records as well as the government's ability to audit the taxpayer's use of the method. For example, in order for a taxpayer to be permitted to elect a books and records method with respect to R&E expenditures, the regulations could require that a taxpayer's books and records use cost allocations required for a non-tax regulatory purpose and/or that such books and records be subject to routine non-tax government audits. Additionally, similar to the regulations under former section 863(b), the section 250 regulations could require that the taxpayer obtain advance permission of a designated IRS office having audit responsibility over its return.

The books and records method could potentially be applied by government contractors who are subject to extensive regulation and requirements with respect to contract pricing and costs, including the FAR, which includes detailed guidance on when and to what extent costs can be recovered on a government contract (i.e., "allowability" of costs).²⁹ Government contractors generally are also required to comply with the CAS, which have exclusive authority over the measurement, assignment, and allocation of costs.³⁰ Contractors required to follow CAS must disclose in writing and follow consistently their cost accounting practices.³¹ The CAS contain guidance for consistent determination of direct and indirect costs and for the selection of allocation measures based on the beneficial or causal relationship between an indirect cost pool and cost objectives.³² REGC is a "direct cost" of the relevant contract or grant and thus is charged directly to such contract or grant.³³ Research expenditures that are not REGC are generally allowable as indirect costs on contracts to the extent that those costs are allocable and reasonable.³⁴

A contractor's failure to comply with these regulations and requirements could result in reductions to the value of contracts, contract modifications or termination, and the assessment of penalties and fines, and could lead to suspension or debarment, for cause, from U.S. government contracting or subcontracting for a period of time.³⁵ Government contractors are subject to routine audits and investigations by U.S. government agencies such as the Defense Contract Audit Agency and Defense Contract Management Agency with respect to their cost structure and compliance with applicable laws, regulations, and standards.

This proposed method would be a precise means of ensuring that there is a clear, direct, and factual relationship between the expenditure and the gross income. Further, such method would be administrable for taxpayers eligible to elect the method because they already would be required to keep such books and records for non-tax regulatory purposes. Additionally, this method would be administrable for the IRS and would help ensure compliance because such books and records also would be subject to audit by government agencies other than the IRS.³⁶

The following proposed language could be used as a starting point:

"1.250(b)-1(d)(2) Deductions properly allocable to gross DEI and gross FDDEI —

(i) In general. For purposes of determining a domestic corporation's deductions that are properly allocable to gross DEI and gross FDDEI, the corporation's deductions are allocated and apportioned to gross DEI and gross FDDEI under the rules of §§ 1.861-8 through 1.861-14T and 1.861-17 by treating section 250(b) as an operative section described in § 1.861-8(f). In allocating and apportioning deductions under §§ 1.861-8 through 1.861-14T and 1.861-17, gross FDDEI and gross non-FDDEI are treated as separate statutory groupings. The deductions allocated and apportioned to gross DEI equal the sum of the deductions allocated and apportioned to gross FDDEI and gross non-FDDEI. All items of gross income described in paragraphs (c)(14)(i) through (vi) of this section are in the residual grouping. For purposes of this paragraph (d)(2)(i), research and experimental expenditures are allocated and apportioned in accordance with § 1.861-17 without taking into account the exclusive apportionment rule of § 1.861-17(b).

(ii) Books and records method. In lieu of applying the methods specified in § 1.861-17 as modified by paragraph (d)(2)(i). a taxpayer may elect to allocate and apportion research and experimental expenditures to gross FDDEI and gross non-FDDEI based upon its books of account, provided that such books and records use cost allocations that are required for a non-tax regulatory purpose and the books and records are subject to routine non-tax government audits, and the taxpayer has received in advance the permission of [IRS office to be designated by Treasury and the IRS] having audit responsibility over its return. If a taxpayer receives permission to apply the books and records method, but does not comply with a material condition set forth by the [IRS office to be designated by Treasury and the IRS], the [IRS office to be designated by Treasury and the IRS] may, in its discretion, revoke permission to use the books and records method.

(iii) Determination of deductions to allocate. . . ."

iii. Modified Exclusive Apportionment Method

If Treasury and the IRS decline to adopt either of the approaches above, we recommend that the final regulations adopt a modified exclusive apportionment rule. The proposed "section 250 regulations provide that R&E expenditures are allocated and apportioned without taking into account the exclusive apportionment rule of § 1.861-17(b).³⁷ We understand that applying the exclusive apportionment rule as currently written may not be appropriate given the regulation's reference to an apportionment based on "geographic sources of income."³⁸ The calculation of the FDII deduction does not rely on the sourcing paradigm and instead essentially looks to the market destination of a sale or service.

However, the two main justifications provided for the exclusive apportionment rule in Treas. Reg. § 1.861-17(b)(2) in fact focus on markets, not traditional notions of source, and are also applicable in the FDH context. Treas. Reg. § 1.861-17(b)(2)(i) explains: "The exclusive apportionment provided for in paragraph (b)(1) of this section reflects the view that research and experimentation is often most valuable in the country where it is performed, for two reasons. First, research and experimentation often benefits a broad product category, consisting of many individual products, all of which may be sold in the nearest market but only some of which may be sold in foreign markets. Second, research and experimentation often is utilized in the nearest market before it is used in other markets, and, in such cases, has a lower value per unit of sales when used in foreign markets."

These two justifications support exclusive apportionment in the FDII context. In the defense industry and other industries, R&E performed in the United States is generally most valuable in the U.S. market, as the products benefiting from U.S.-performed R&E are most likely to be sold in the United States and, where products benefiting from U.S.-performed research are sold abroad, the time between the research activities and the sale is more likely to be delayed. As described above, a significant amount of the R&E expenditures incurred by defense contractors relate to U.S. government contracts. Additionally, in most cases, a defense contractor is subject to unique restrictions that could inhibit or make uncertain the contractor's ability to generate sales to foreign markets in the future as a result of research efforts in a current tax year. For example, the U.S. government may not authorize the export of certain technology resulting from certain REGC and may impose limitations on the nature and scope of new technology that can be made available to foreign parties.

The following proposed language would add a modified exclusive apportionment rule under the section 250 regulations to allocate R&E expenses for purposes of calculating the FDII deduction:

"1.250(b)-1(d)(2) Deductions properly allocable to gross DEI and gross FDDEI —

(i) In general. For purposes of determining a domestic corporation's deductions that are properly allocable to gross DEI and gross FDDEI, the corporation's deductions are allocated and apportioned to gross DEI and gross FDDEI under the rules of §§ 1.861-8 through 1.861-14T and 1.861-17 by treating section 250(b) as an operative section described in § 1.861-8(f). In allocating and apportioning deductions under §§ 1.861-8 through 1.861-14T and 1.861-17, gross FDDEI and gross non-FDDEI are treated as separate statutory groupings. The deductions allocated and apportioned to gross DEI equal the sum of the deductions allocated and apportioned to gross FDDEI and gross non-FDDEI. All items of gross income described in paragraphs (c)(14)(i) through (vi) of this section are in the residual grouping. For purposes of this paragraph (d)(2)(i), research and experimental expenditures are allocated and apportioned in accordance with § 1.861-17 without taking into account the exclusive apportionment rule of 1.861-17(b), applying subdivision (ii) of this subparagraph in lieu of paragraph (1) of § 1.861-17(b).

(ii) Exclusive apportionment of research and experimental expenditures. An exclusive apportionment shall be made under this paragraph (d)(2)(ii) as follows:

(A) Exclusive apportionment under the sales method. If the taxpayer apportions on the sales method under § 1.861-17(c), an amount equal to fifty percent of such deduction for research and experimentation shall be apportioned exclusively to gross non-FDDEI if the research and experimental activities that account for more than fifty percent of such deduction are performed in the United States.

(B) Exclusive apportionment under the optional gross income methods. If the taxpayer apportions on the optional gross income methods under § 1.861-17(d). an amount equal to twenty-five percent of such deduction for research and experimentation shall be apportioned exclusively to gross non-FDDEI if the research and experimental activities that account for more than fifty percent of such deduction are performed in the United States.

(C) Exception, If the applicable test of the preceding paragraph (d)(2)(ii)(A) or (B) is not met, then no part of the deduction shall be apportioned under this paragraph (d)(2)(ii)."

(iii) Determination of deductions to allocate. . . .

IV. FDDEI Services

A. Overview

FDDEI transactions consist of FDDEI sales and FDDEI services.³⁹ The proposed section 250 regulations provide guidance on when a transaction qualifies as a FDDEI service, and divides FDDEI services into the following five separate, mutually exclusive categories: (1) a general service to a consumer located outside the United States; (2) a general service provided to a business recipient located outside the United States; (3) a proximate service provided to a recipient located outside the United States; (4) a property service provided with respect to tangible property located outside the United States; and (5) a transportation service provided to a recipient, or with respect to property, located outside the United States.⁴⁰

Under the proposed regulations, the determination of whether a property service is a FDDEI service is based on the location of the relevant property.⁴¹ The Preamble to the proposed section 250 regulations requests comments "on whether to consider an exception for property that is located in the United States temporarily solely for purposes of the performance of certain services, such as maintenance and repairs."⁴²

In response to this request for comments, we respectfully request that the final regulations either (1) provide that a property service is a FDDEI service if it is provided to a recipient, or with respect to tangible property, located outside of the United States or (2) add an exception providing that a property service will be treated as a FDDEI service if performed with respect to tangible property temporarily brought into the United States for the purpose of receiving the service.

B. Property Services

1. Revised Approach Consistent with Statutory Language

As currently drafted, the proposed section 250 regulations provide that even if a service is provided to a recipient located outside of the United States, but with respect to property located in the United States, such service does not qualify as a FDDEI service and is therefore ineligible for the FDII deduction. The relevant statutory provision (section 250(b)(4)(B)), however, provides that FDDEI includes any deduction eligible income that is derived in connection with "services provided by the taxpayer which the taxpayer establishes to the satisfaction of the Secretary are provided to any person, or with respect to property, not located within the United States."⁴³ The use of the disjunctive indicates that a service should be treated as a FDDEI service if either of the following are true: (1) the service is provided to a person not located within the United States, or (2) the service is provided with respect to property not located within the United States. This view is consistent with language in the Preamble with respect to domestic intermediary sales.⁴⁴ Thus, consistent with the statute and Congress's intent that FDII is intangible income derived from "serving foreign markets,"⁴⁵ as long as a property service is provided to a recipient located outside of the United States, the service should be treated as a FDDEI service, regardless of where the property is located at the time of the service.

Under the proposed regulations, however, the term "property service" means a service, other than a transportation service, provided with respect to tangible property, but only if substantially all of the service is performed at the location of the property and results in physical manipulation of the property such as through assembly, maintenance, or repair⁴⁶ Substantially all of a service is performed at the location of property if the renderer spends more than 80 percent of the time providing the service at or near the location of the property.⁴⁷ A property service is provided with respect to tangible property located outside the United States only if the property is located outside the United States for the duration of the period the service is performed.⁴⁸ This approach is inconsistent with both the statute and the interpretation set forth in the Preamble.

The following proposed language would modify the proposed regulations to be consistent with the statute by treating property services as FDDEI services if either the service is provided to a recipient not located within the United States or the service is provided with respect to property not located within the United States:

"1.250(b)-5(b) Definition of FDDEI service. Except as provided in § 1.250(b)-6(d), the term FDDEI service means a provision of a service described in one of paragraphs (b)(1) through (5) of this section. . . .

(4) The provision of a foreign property service with respect to tangible property located outside the United States (as determined under paragraph (g) of this section).

(c) Definitions. This paragraph (c) provides definitions that apply for purposes of this section and § 1.250(b)-6 . . .

(4) General service. The term general service means any service other than a foreign property service, proximate service, or transportation service.

(5) Foreign pProperty service. The term foreign property service means a service, other than a transportation service, provided with respect to tangible property located outside the United States, but only if substantially all of the service is performed outside the United States at the location of the property and results in physical manipulation of the property such as through assembly, maintenance, or repair. Substantially all of a service is performed at the location of property if the renderer spends more than 80 percent of the time providing the service at or near the location of the property.

(6) Proximate service. The term proximate service means a service, other than a foreign property service or a transportation service, provided to a recipient, but only if substantially all of the service is performed in the physical presence of the recipient or, in the case of a business recipient, its employees. . . .

(g) Property services. A foreign property service is provided with respect to tangible property located outside the United States only if the property is located outside the United States for the duration of the period the service is performed.

Under this approach, only services with respect to property located outside the United States would be considered a foreign property service. Such service would qualify as a FDDEI service under Prop. Treas. Reg. § 1.250(b)-5(g) only if the property is held outside the United States for the duration of the period the service is performed. Any service not meeting the definition of foreign property service, such as a service with respect to property in the United States, would be tested under the general services rules. Thus, a service performed with respect to tangible property temporarily brought into the United States for the purpose of receiving the service would be tested as a general service and therefore treated as a FDDEI service as long as the recipient of the service is located outside of the United States.⁴⁹

2. Property Temporarily Located in the United States

Alternatively, or in addition, we request that Treasury and the IRS provide an exception to the proposed regulations that would treat a property service as a FDDEI service where the relevant property is temporarily located in the United States for the purpose of receiving such service.

In many industries, it is neither practical nor feasible for the taxpayer to perform services, such as repairs and maintenance, on property located outside the United States in light of the taxpayer's current business operations. Additionally, many companies have existing business models where repair and maintenance activities are performed in the United States by U.S. personnel. For example, in the defense industry, it is common for property sold to a foreign government either as a direct commercial sale or as a foreign military sale to be transferred to the United States for recertification or repairs because the equipment and personnel necessary for the repairs are located in the United States. Bringing the property temporarily into the United States so that the taxpayer can perform certain services, such as maintenance and repairs, with respect to such property should not cause the transaction to fail to qualify as a FDDEI service where the service is provided to a recipient located outside of the United States. Without an exception, there will be an incentive for taxpayers to move operations and personnel outside the United States to provide repairs and maintenance to foreign customers from abroad, thus putting U.S. jobs at risk.

Treasury and the IRS could limit the scope of an exception in several ways. For example, an exception could require that the recipient of such services be located outside the United States. In addition, the exception could contain a limitation on the amount of time that the property may remain in the United States, unless the taxpayer is subject to legal or contractual restrictions requiring that the property remain in the United States for a limited period of time. For example, in the defense industry, a government contractor may obtain a temporary import license exemption under 22 C.F.R. § 123.4(a)(1), which permits the temporary import (and subsequent export) without a license for a period of up to four years of unclassified U.S. origin defense items if the item is serviced and subsequently returned to the country from which it was imported.

The following proposed language could be used as a starting point:

"1.250(b)-5(g) Property services.

(1) General. A property service is provided with respect to tangible property located outside the United States only if the property is located outside the United States for the duration of the period the service performed, unless subparagraph (2) of this paragraph applies.

(2) Exception. If a property service is provided with respect to tangible property that is temporarily located in the United States for the purpose of receiving such service the property service shall be treated as provided with respect to tangible property located outside the United States if —

(i) The service is provided to a recipient located outside the United States, and

(ii) Either —

V. Documentation

A. Overview

The proposed regulations require certain documentation to establish that transactions qualify as FDDEI sales or services. We appreciate Treasury and the IRS' s attention to, as described in the Preamble, "balance[ing] the rigor and reliability of the proof that transactions are foreign-derived with the cost to taxpayers of obtaining such documentation."⁵⁰ As Treasury and the IRS observe, regulations allowing taxpayers to rely on documents already obtained in the normal course of business minimizes documentation costs.

We respectfully request that Treasury and the IRS consider several modifications to the documentation rules in the proposed regulations to minimize compliance costs while providing the government with sufficient comfort that a transaction is foreign-derived.

We responded above to Treasury and the IRS's request for comments on documentation with respect to foreign military sales. As discussed above, we recommend that the final regulations provide that documentation used to demonstrate that a sale or service has been made pursuant to the Arms Export Control Act be treated as satisfying the documentation requirements of Prop. Treas. Reg. §§ 1.250(b)-4(c)(2), -4(d)(3), -4(e)(3), -5(d)(3), and -5(e)(3).

B. Reliability of Documentation

Prop. Treas. Reg. § 1.250(b)-3(d) provides rules for determining the reliability of documentation with respect to FDDEI sales and services. In order for a document to be considered reliable, three requirements must be satisfied: (1) as of the FDII filing date, the seller or renderer does not know and does not have reason to know that the documentation is unreliable or incorrect; (2) the documentation is obtained by the seller or renderer by the FDII filing date with respect to the sale or service; and (3) the documentation is obtained no earlier than one year before the date of the sale or service.

We request that the third requirement be eliminated. Requiring that documentation is obtained no earlier than one year before the date of the sale or service creates significant compliance burdens in the case of long-term contracts that are effective over a period of years. For example, a service contract may have a five-year term. If the current rule is retained, documentation gathered at the start of the arrangement would not suffice in later years because the documentation will have been obtained more than one year before the date of the service. As a result, taxpayers would be required to "refresh" documentation annually, even where there has been no change in facts. Foreign counterparties may have little incentive to provide refreshed documentation, especially where the seller or renderer is already contractually obligated to provide the sales or services.

We understand that Treasury and the IRS may be concerned that older documentation may not properly reflect current arrangements. We believe this concern is adequately addressed by the first requirement — that, as of the FDII filing date, the seller or renderer does not know or have reason to know that the documentation is unreliable or incorrect. This requirement itself imposes an annual test as of the FDII filing date. Where a change in the arrangement is significant enough to change whether the transaction would qualify as a FDDEI sale or service (e.g., a sale is no longer to a foreign person or for a foreign use), the seller or renderer should know or have reason to know that the documentation has become unreliable or incorrect.

C. FDDEI Sales

The rules governing whether the sale of general property qualifies as a FDDEI sale generally require that the seller obtain documentation establishing that the sale is made to a foreign person for a foreign use.⁵¹ The documentation also must meet the reliability requirements of Prop. Treas. Reg. § 1.250(b)-3(d), discussed above. We suggest below several modifications to these rules to reduce taxpayer compliance costs.

1. Foreign Person

Prop, Treas. Reg. § 1.250(b)-4(c)(2)(i) provides five types of documentation that the seller may use to establish the status of a recipient as a foreign person: (1) a written statement by the recipient that the recipient is a foreign person; (2) with respect to a recipient that is an entity, documentation that establishes that the entity is organized or created under the laws of a foreign jurisdiction; (3) with respect to an individual, any valid identification issued by a foreign government or an agency thereof that is typically used for identification purposes; (4) documents filed with a government or an agency or instrumentality thereof that provide the foreign jurisdiction of organization or residence of an entity (for example, a publicly traded corporation's annual report); or (5) any other forms of documentation as prescribed by the Secretary in forms, instructions, or other guidance.

The list in Prop. Treas. Reg. § 1.250(b)-4(c)(2)(i) is exclusive, i.e., taxpayers may only establish the status of a recipient as a foreign person by obtaining one of the specified types of documentation. We request that Treasury and the IRS modify this approach and permit taxpayers to establish a recipient's status with any of the five types of documentation specified in the proposed regulations or any other documentation that is collected or created in the ordinary course of the taxpayer's trade or business.

In the alternative, or in addition, we request that Treasury and the IRS modify the list of acceptable documentation in the final regulations by adding additional categories. Specifically, we request that Treasury and the IRS permit all taxpayers to rely on the Prop. Treas. Reg. § 1.250(b)-4(b)(2)(ii) special rules for small businesses, which permit a taxpayer to establish the status of a recipient as a foreign person if the seller's shipping address for the recipient is outside the United States. This would considerably reduce the compliance burdens for establishing foreign person status by allowing taxpayers to rely on information already obtained in the ordinary course of business. As a result of the reliability rule of Prop. Treas. Reg. § 1.250(b)-3(d), a taxpayer could not rely on a shipping address to establish foreign status where the taxpayer knows or has reason to know that the address is incorrect or unreliable.

In addition, if the exclusive list approach is maintained, we request that Treasury and the IRS permit taxpayers to rely on publicly-available information establishing that the recipient is a foreign person. Such a rule could be similar to the FDDEI services rules for establishing the location of a business recipient, which permit a service renderer to rely on publicly-available information that establishes the locations of the operations of the business recipient.⁵² When adopted in the sales context, such a rule would allow taxpayers to establish the status of a counterparty as a foreign person in situations where a counterparty does not already provide documentation sufficient under Prop. Treas. Reg. § 1.250(b)-4(c)(2)(i).

2. Foreign Use

With respect to foreign use, Prop. Treas. Reg. § 1.250(b)-4(d)(2) generally provides that the sale of general property is for a foreign use if (1) the property is not subject to a domestic use within three years of the date of delivery or (2) the property is subject to manufacture, assembly, or other processing outside the United States before the property is subject to a domestic use. Prop. Treas. Reg. § 1.250(b)-4(d)(3) provides that a seller establishes foreign use only if the seller obtains one or more of the following types of documentation with respect to the sale: (1) a written statement from the recipient or a related party of the recipient that the recipient's use or intended use of the property is for a foreign use; (2) a binding contract between the seller and the recipient which provides that the recipient's use or intended use of the property is for a foreign use; (3) documentation of shipment of the general property (including both property located within the United States or outside the United States, such as in a warehouse, storage facility, or assembly site located outside United States) to a location outside the United States (for example, a copy of the export bill of lading issued by the carrier which delivered the property, or a copy of the certificate of lading for the property executed by a customs officer of the country to which the property is delivered); or (4) any other forms of documentation as prescribed by the Secretary in forms, instructions, or other guidance.

Similar to our comments with respect to documenting foreign status, we request that Treasury and the IRS provide that, in addition to the currently listed items, taxpayers may establish foreign use with any other documentation that is collected or created in the ordinary course of the taxpayer's trade or business. In the alternative, or in addition, we request that Treasury and the IRS permit a taxpayer to establish foreign use if the recipient's shipping address is outside the United States, which is permitted under the proposed regulations for small businesses.⁵³

VI. Conclusion

We appreciate the opportunity to provide these comments. We would welcome the opportunity to meet with Treasury and the IRS to discuss these comments in greater detail. We would be pleased to answer any questions or provide any further information.

Respectfully submitted,

Mark W. March
Vice President, Taxes
Raytheon Company
Waltham, MA

Cc:
David J. Kautter
Assistant Secretary of the Treasury (Tax Policy)
Department of the Treasury

Charles P. Rettig
Commissioner
Internal Revenue Service

Michael J. Destnond
Chief Counsel
Internal Revenue Service

Lafayette "Chip" G. Harter III
Deputy Assistant Secretary (International Tax Affairs)
Department of the Treasury

Douglas L. Poms
International Tax Counsel
Department of the Treasury

Gary Scanlon
Attorney-Advisor
Department of the Treasury

Jason Yen
Attorney-Advisor
Department of the Treasury

Peter Blessing
Associate Chief Counsel (International)
Internal Revenue Service

Daniel M. McCall
Deputy Associate Chief Counsel (International — Technical)
Internal Revenue Service

Marissa Rensen
Office of the Associate Chief Counsel (International)
Internal Revenue Service

Kenneth Jeruchim
Office of the Associate Chief Counsel (International)
Internal Revenue Service