Par. 4. Section 1.250(b)-1 is amended by: 1. Adding a sentence at the end of paragraph (a); 2. Revising paragraph (c)(12); 3. Removing the second “and” from paragraph (c)(15)(v); 4. Removing the period at the end of paragraph (c)(15)(vi) and adding the language “; and” in its place; 5. Adding new paragraph (c)(15)(vii); and 6. Adding new paragraph (h). The additions and revision read as follows:
(a) * * * Paragraph (h) of this section provides rules regarding excluded property sales income.
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(c) * * *
(12) The term foreign-derived deduction eligible income or FDDEI means, with respect to a domestic corporation for a taxable year, the excess (if any, and not to exceed DEI) of the corporation's gross FDDEI for the year, over the deductions properly allocable to gross FDDEI for the year, as determined under paragraph (d)(2) of this section.
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(15) * * *
(vii) Excluded property sales income (as defined in paragraph (h) of this section).
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(h) Excluded property sales income. —(1) Scope. This paragraph (h) provides rules for determining “excluded property sales income,” which consists of certain income and gain excluded from DEI under section 250(b)(3)(A)(i)(VII) and paragraph (c)(15)(vii) of this section. Except as provided in paragraph (h)(3) of this section, the term excluded property sales income means any income and gain derived from the sale or other disposition (as defined in paragraph (h)(2)(iii) of this section) of the following—
(i) Intangible property (as defined in § 1.250(b)-3(b)(11)); or
(ii) Other excluded property (as defined in paragraph (h)(2)(ii) of this section).
(2) Definitions. This paragraph (h)(2) provides definitions that apply for purposes of this paragraph (h).
(i) Excluded seller. The term excluded seller means the domestic corporation or partnership (whether domestic or foreign) that sells or otherwise disposes of intangible property or other excluded property.
(ii) Other excluded property. The term other excluded property means property that is not intangible property under paragraph (h)(1)(i) of this section and that, in the hands of the excluded seller—
(A) Is or has been property that is of a character subject to the allowance for depreciation under section 167;
(B) Is or has been subject to an allowance for amortization that is not described in paragraph (h)(2)(ii)(A) of this section; or
(C) Is or has been subject to the allowance for depletion under section 611.
(iii) Sale or other disposition. The term sale or other disposition means a sale or other disposition as determined under general Federal income tax principles, including deemed sales, other deemed dispositions, and transactions subject to section 367(d). A deemed sale or other deemed disposition includes any transaction or election that is treated as a sale or other disposition of property for Federal income tax purposes. A sale or other disposition does not include a transaction that would be characterized under general tax principles as a lease or license. See paragraphs (h)(4)(i)(C) and (ii)(C) of this section ( Examples 1 and 2 ). For purposes of §§ 1.250(b)-3 through 1.250(b)-6, see the definition of “sale” under § 1.250(b)-3(b)(16).
(3) Related-party anti-abuse rule. (i) In general. Property that was other excluded property in the hands of a member of the excluded seller's modified affiliated group is treated as other excluded property with respect to the excluded seller, if the excluded seller acquires that property—
(A) In a transaction (or series of transactions) in which the basis of the property is determined, in whole or in part, by reference to the basis in the hands of the member in whose hands the property was other excluded property; and
(B) With a principal purpose of avoiding the application of section 250(b)(3)(A)(i)(VII)(bb).
(ii) Modified affiliated group. Solely for purposes of this paragraph (h)(3), the term modified affiliated group has the meaning given in paragraph (c)(17) of this section but without the substitution of “more than 50 percent” for “at least 80 percent” each place it appears, and by substituting “at least 80 percent” for “more than 50 percent” for purposes of determining control within the meaning of section 954(d)(3).
(4) Examples. The following examples illustrate the application of this paragraph (h).
(i) Example 1: Sale of intangible property —(A) Facts. DC, a domestic corporation, owns the copyright to a computer program, Program X. DC enters into an agreement with FP, an unrelated foreign person, under which DC grants FP an exclusive irrevocable license for the remaining term of the copyright, to copy and distribute an unlimited number of copies of Program X, prepare derivative works based upon Program X, make public performances of Program X, and publicly display Program X. FP will pay DC a royalty each year equal to y percent of net revenue derived from exploiting Program X during the year, for the remaining term of the copyright. Under general tax principles, DC is treated as having sold the copyright to Program X, notwithstanding that the agreement is labeled a license.
(B) Analysis. The copyright to Program X is intangible property within the meaning of § 1.250(b)-3(b)(11). Because DC has sold intangible property (the copyright) under general tax principles (including under § 1.861-18(f)(1)), DC's income or gain resulting from the sale is excluded property sales income.
(C) Alternative facts—license. The facts are the same as in paragraph (h)(4)(i)(A) of this section, except the license from DC to FP is a nonexclusive revocable license for the remaining term of the copyright and, therefore, is treated as a license under general tax principles (including § 1.861-18(f)(1)). DC's income or gain resulting from the license is not excluded property sales income.
(ii) Example 2: Sale of copyrighted article.
(A) Facts. DC, a domestic corporation, owns the copyright to a computer program, Program X. DC transfers copies of Program X to unrelated foreign customers who receive the right to use the copies in perpetuity. DC also uses different copies of Program X in its own trade or business. DC has never used the copies of Program X it transfers to unrelated foreign customers in DC's own trade or business.
(B) Analysis. DC's income or gain from the transfer of copies of Program X, whether through an electronic or physical medium, is from the sale of copyrighted articles, as defined in § 1.861-18(c)(3). The copies of Program X are not intangible property because intangible property does not include copyrighted articles. See § 1.250(b)-3(b)(11). The copies of Program X sold to unrelated foreign customers are not other excluded property because, in the hands of DC, those copies of Program X are not property that is of a character subject to the allowance for depreciation under section 167 or amortization. The fact that DC also uses copies of Program X in its business does not affect this analysis, even if DC's internal use copies are other excluded property. Therefore, DC's income or gain from the sales of copies of Program X to unrelated foreign customers is not excluded property sales income.
(C) Alternative facts—lease of a copyrighted article. The facts are the same as in paragraph (h)(4)(ii)(A) of this section, except that the unrelated foreign customers receive the right to use the copy of Program X for a period of only two years. The transfers of the copies of Program X to unrelated foreign customers are properly classified as leases of copyrighted articles under § 1.861-18(f)(2). Therefore, because there has been no sale or other disposition of other excluded property, DC's income or gain from the lease of copies of Program X is not excluded property sales income.
(iii) Example 3: Sale of fully depreciated property— (A) Facts. DC, a domestic corporation, holds a machine for use in its trade or business. The machine has an adjusted depreciable basis of zero because it has been fully depreciated under section 167. During the taxable year, DC sells the machine to FP, an unrelated foreign person.
(B) Analysis. In the hands of DC, the machine is treated as property that is of a character subject to the allowance for depreciation under section 167. Therefore, the machine constitutes other excluded property, and DC's income or gain from the sale of the machine to FP is excluded property sales income.
(C) Alternative facts—nonrecognition transaction. The facts are the same as in paragraph (h)(4)(iii)(A) of this section, except that DC acquired the machine in a nonrecognition transaction for use in DC's trade or business and, at the time of the acquisition, the machine was fully depreciated by the previous owner. Notwithstanding the fact that the machine was not depreciated in the hands of DC (because it had been fully depreciated when acquired by DC), the machine is property that is of a character subject to the allowance for depreciation under section 167 in the hands of DC. Therefore, DC's income or gain from the sale of the machine to FP is excluded property sales income.
(iv) Example 4: Sales of inventory and other excluded property used in a trade or business —(A) Facts. DC, a domestic corporation, owns 100 airplanes. DC holds five of the airplanes for use in its trade or business and, accordingly, the planes are property that is of a character subject to the allowance for depreciation under section 167. DC holds the remaining 95 airplanes in inventory. During the taxable year, DC sells to FP, an unrelated foreign person, two airplanes that DC uses in its trade or business and 35 airplanes that DC holds in inventory.
(B) Analysis. DC's sales of the two airplanes are sales of other excluded property because the two airplanes are property that is of a character subject to the allowance for depreciation under section 167. Therefore, DC's income or gain from the sales of the two airplanes is excluded property sales income. DC's sales of the 35 airplanes to FP are not sales or other dispositions of other excluded property because the 35 airplanes are held as inventory and are not property that is of a character subject to the allowance for depreciation under section 167. Therefore, DC's income or gain from the sales of the 35 airplanes is not excluded property sales income.
(v) Example 5: Sales involving members of a consolidated group. —(A) Facts. P is the common parent of a consolidated group (as defined in § 1.1502-1(h)). P owns all of the only class of stock of subsidiaries DC1 and DC2, which are members (as defined in § 1.1502-1(b)) of the P consolidated group. DC1 owns ten airplanes that are property that is of a character subject to the allowance for depreciation under section 167. In Year 1, DC1 sells all ten airplanes to DC2, recognizing $100x of gain, which is deferred. DC2 holds these airplanes in inventory. In Year 2, DC2 sells all ten airplanes to an unrelated foreign person, recognizing $85x of gains.
(B) Analysis. The treatment of DC1's and DC2's gains on their respective sales is subject to redetermination under § 1.1502-13(c) to the extent necessary to achieve single entity treatment for the group. If DC1 and DC2 were divisions of a single corporation, the ten airplanes would be, or would have been, property that is of a character subject to the allowance for depreciation under section 167. Therefore, to achieve single entity treatment, both DC1's $100x of gain and DC2's $85x of gains are treated in Year 2 as income or gain from the sales of other excluded property and are excluded property sales income.
(vi) Example 6: Related-party anti-abuse rule —(A) Facts. DC1 is a domestic corporation that owns an 80 percent interest in the profits and capital of a domestic partnership, PRS. Unrelated persons own the remaining interests in PRS. PRS owns all of the only class of stock of DC2, a domestic corporation. DC1 owns 20 cars that are other excluded property in the hands of DC1. With a principal purpose of avoiding the application of section 250(b)(3)(A)(i)(VII)(bb), DC1 transfers all 20 cars to PRS in an exchange described in section 721(a), and PRS transfers all 20 cars to DC2 in an exchange described in section 351(a). Under section 723, PRS's basis in the cars transferred to it by DC1 is the same as DC1's basis in the cars at the time of the transfer. Under section 362, DC2's basis in the cars transferred to it by PRS is the same as the basis of the cars in the hands of PRS. DC2 holds the cars in inventory and recognizes gain on the subsequent sales of all 20 cars to an unrelated foreign person.
(B) Analysis. DC1, PRS, and DC2 are members of a modified affiliated group for purposes of paragraph (h)(3) of this section. Because DC2 acquired property that was other excluded property in the hands of DC1, a member of DC2's modified affiliated group for purposes of paragraph (h)(3) of this section, in a series of transactions in which the basis of the property was determined by reference to the basis in the hands of the transferor and with a principal purpose of avoiding the application of section 250(b)(3)(A)(i)(VII)(bb), the 20 cars are treated as other excluded property in the hands of DC2. Therefore, DC2's gain from the sales of the 20 cars are excluded property sales income.