Individual Seeks Expansion of Example in FTC Regs

Proposed Regulation §1.902-1(c)

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(3) Example. . . .

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(v) Alternative Facts. In addition to the facts provided in clause (iii), non-resident taxpayer A has established a branch in Country X. Employees of the branch conduct routine sales and marketing as well as routine customer support functions in support of the electronically supplied services supplied by taxpayer A from outside Country X to users located in Country X. The branch also holds equipment, including servers that host taxpayer A's internet-based platform through which taxpayer A furnishes electronically supplied services to customers located in Country X. Employees of the branch maintain this equipment for taxpayer A, though they perform solely routine functions and are neither responsible for nor involved in the management or operations of taxpayer A's internet-based platform. Taxpayer A is subject to the ESS tax. Although Country X imposes tax on resident and non-resident companies (with the tax base for non-residents being based on a non-resident's activities located in Country X), this tax is not imposed on taxpayer A's branch activities because taxpayer A is subject to the ESS tax.

(vi) Analysis. Country X tax law's rule for sourcing electronically supplied services is not based on where the services are performed, but is based on the location of the service recipient. Therefore, the ESS tax, which is imposed on the basis of source, does not meet the requirement in paragraph (c)(1)(ii) of this section. The ESS tax also does not meet the requirement in paragraph (c)(1)(i) of this section because it is not imposed on the basis of a nonresident's activities located in Country X, and it does not meet the requirement in paragraph (c)(1)(iii) of this section because it is not imposed on the sale or other disposition of property. However, to the extent that a portion of any Country A tax paid or accrued would meet the requirement in paragraph (c)(1)(i) of this section based on the actual activities performed by the branch, that portion of the ESS tax will be considered to meet the requirement of paragraph (c)(1)(i) of this section. This portion may not exceed an amount determined under arm's length principles, without taking into account as a significant factor the location of customers, users, or any other similar destination-based criterion. In this example, the amount determined under arm's length principles would reflect only the routine functions performed by the taxpayer A's Country X branch and not any non-routine profits earned by taxpayer A.

(vii) Alternative Facts. In addition to the facts provided in clause (iii), non-resident taxpayer A has established a subsidiary in Country X that is treated as a disregarded entity for federal tax purposes under the entity classification rules of section 301.7701-3. Employees of the subsidiary conduct routine sales and marketing as well as routine customer support functions in support of the electronically supplied services supplied by taxpayer A from outside Country X to users located in Country X. The subsidiary also owns equipment, including servers that host taxpayer A's internet-based platform through which taxpayer A furnishes electronically supplied services to customers located in Country X. Employees of the subsidiary maintain this equipment for taxpayer A's benefit, though they perform solely routine functions and are neither responsible for nor involved in the management or operations of taxpayer A's internet-based platform. Under a service agreement, taxpayer A pays a service fee to the subsidiary with the amount of the fee being based on the arm's length principle as applied to the routine functions that the subsidiary performs. Taxpayer A is subject to the ESS tax. The subsidiary is subject to Country X's generally imposed tax on resident and non-resident companies. The tax base for the subsidiary under Country A law reflects arm's length principles that consider only the routine functions performed by the subsidiary and not any profits earned by taxpayer A.

(viii) Analysis. Country X tax law's rule for sourcing electronically supplied services is not based on where the services are performed, but is based on the location of the service recipient. Therefore, the ESS tax, which is imposed on the basis of source, does not meet the requirement in paragraph (c)(1)(ii) of this section. The ESS tax also does not meet the requirement in paragraph (c)(1)(i) of this section because it is not imposed on the basis of a nonresident's activities located in Country X, and it does not meet the requirement in paragraph (c)(1)(iii) of this section because it is not imposed on the sale or other disposition of property. Despite the subsidiary's status as a disregarded entity, the Country X tax imposed on the subsidiary is considered to meet the requirement in paragraph (c)(2) oof this section. This is because the subsidiary's tax base is determined under arm's length principles, without taking into account as a significant factor the location of customers, users, or any other similar destination-based criterion.