Par 4. Section 1.903-1 is amended: 1. By revising paragraphs (c)(2) introductory text and (c)(2)(iii). 2. By adding paragraph (c)(2)(iv). 3. By revising paragraph (d)(3). 4. By removing and reserving paragraph (d)(4). 5. By adding paragraphs (d)(8) through (11). 6. By revising paragraph (e). The revisions and additions read as follows:
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(c) * * *
(2) Covered withholding tax. A tested foreign tax is a covered withholding tax if, based on the foreign tax law (except as provided in paragraph (c)(2)(iii)(B) of this section), the requirements in paragraphs (c)(1)(i) and (c)(2)(i) through (iii) of this section are met with respect to the tested foreign tax. See also § 1.901-2(d)(1)(iii) for rules treating withholding taxes as separate levies with respect to each class of income subject to the tax, with respect to each subset of a class of income that is subject to different income attribution rules, or with respect to withholding tax that is imposed on a payment giving rise to gross royalty income of a nonresident that is made pursuant to a single-country license (as determined under paragraph (c)(2)(iv) of this section).
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(iii) Source-based attribution requirement. The income subject to the tested foreign tax satisfies the requirements in paragraph (c)(2)(iii)(A) or (B) of this section.
(A) The income subject to the tested foreign tax satisfies the attribution requirement described in § 1.901-2(b)(5)(i)(B).
(B) The income subject to the tested foreign tax is characterized as royalty income and the payment giving rise to such income is made pursuant to a single-country license as determined under paragraph (c)(2)(iv) of this section. For purposes of this paragraph (c)(2)(iii)(B) and paragraph (c)(2)(iv) of this section, whether the income is characterized as royalty income is determined under the foreign tax law, except that income from the sale of a copyrighted article (as determined under rules similar to § 1.861-18) is not characterized as royalty income regardless of the characterization of the income under the foreign tax law.
(iv) Single-country license —(A) In general. Except as otherwise provided in this paragraph (c)(2)(iv), for purposes of paragraph (c)(2)(iii)(B) of this section, a payment is made pursuant to a single-country license if the terms of the license agreement pursuant to which the payment is made characterize the payment as a royalty and limit the territory of the license to the foreign country imposing the tested foreign tax.
(B) Separately stated portions. If a written agreement that is not described in paragraph (c)(2)(iv)(A) of this section separately states a portion (whether as a specified amount or as a formula) of the payment subject to the tested foreign tax and such portion is both characterized as a royalty under the terms of the agreement and is attributable to the part of the territory of the license that is solely within the foreign country imposing the tested foreign tax, then that portion of the payment is treated as made pursuant to a single-country license.
(C) Validity of agreement. A payment is considered not made pursuant to a single-country license if the taxpayer knows, or has reason to know, that the terms of the agreement pursuant to which the payment is made misstate the territory in which the relevant intangible property is used or overstate the amount of the royalty with respect to the part of the territory of the license that is solely within the foreign country imposing the tested foreign tax. A taxpayer is considered to have reason to know if its knowledge of relevant of facts or circumstances is such that a reasonably prudent person in the position of the taxpayer would question whether the terms of the agreement misstate the territory in which the relevant intangible property is used or overstate the amount of a royalty. For purposes of this section, the principles of sections 482 and 861 apply to determine whether the terms of the agreement misstate the territory in which the relevant intangible property is used or overstate the amount of a royalty. See paragraph (d)(11) of this section ( Example 11 ).
(D) Documentation. A taxpayer must provide the agreement described in paragraph (c)(2)(iv)(A) or (B) of this section, as applicable (the “required agreement”), within 30 days of a request by the Commissioner or another period as agreed between the Commissioner and the taxpayer. Except as provided in the next sentence, the required agreement pursuant to which the royalty is paid must be executed no later than the date of payment that gives rise to the gross royalty income that is subject to the tested foreign tax. In the case of a royalty that is paid before the date on which the required agreement is executed, in order to meet the requirement of this paragraph (c)(2)(iv)(D), the required agreement must be executed no later than May 17, 2023, and the agreement must state that royalties paid on or before the date of execution of the agreement are, for purposes of this paragraph (c)(2)(iv), considered paid pursuant to the terms of the agreement.
(d) * * *
(3) Example 3: Withholding tax on royalties; attribution requirement —(i) Facts. YCo, a resident of Country Y, is a controlled foreign corporation wholly owned by USP, a domestic corporation. In Year 1, YCo enters into a written license agreement (the “Agreement”) with XCo, a resident of Country X unrelated to YCo or USP, for the right to use YCo's intangible property (“IP”) in a territory defined by the Agreement as the entire world, including Country X, in exchange for payments that the terms of the Agreement characterize as royalties. The payments made by XCo to YCo under the Agreement are also characterized as royalties under the laws of Country X. Under Country X's tax law, all gross royalty payments made by a Country X resident to a nonresident are treated as giving rise to Country X source income and are subject to a 20 percent withholding tax, regardless of whether the nonresident payee has a taxable presence in Country X. Country X has a generally-imposed net income tax within the meaning of paragraph (c)(1)(i) of this section, and nonresidents subject to the withholding tax on royalties are not also subject to a Country X net income tax on their royalty income. In Year 1, XCo withholds 20u (units of Country X currency) of tax on a 100u royalty paid to YCo under the Agreement.
(ii) Analysis —(A) Separate levy. Under § 1.901-2(d)(1)(iii)(B)( 1 ), Country X's withholding tax imposed on gross royalty income of nonresidents is treated as a separate levy. Under § 1.901-2(d)(1)(iii)(B)( 3 ), the 20u of Country X withholding tax imposed on the 100u of royalties paid by XCo to YCo is treated as a separate levy from the Country X withholding tax on royalties if the Agreement pursuant to which the royalties are paid is a single-country license under paragraph (c)(2)(iv) of this section. The Agreement does not meet the requirements of paragraph (c)(2)(iv) of this section because it neither limits the territory of the license to Country X nor separately states the portion of the payment that is with respect to the part of the territory of the license that is solely within Country X. Thus, the 20u of Country X withholding tax paid by YCo is not treated as a separate levy under § 1.901-2(d)(1)(iii)(B)( 3 ).
(B) Covered withholding tax. Under paragraph (c)(2) of this section, a tested foreign tax is a covered withholding tax if paragraphs (c)(1)(i) and (c)(2)(i) through (iii) of this section are met. Country X's withholding tax on royalties meets the requirements of paragraphs (c)(1)(i) and (c)(2)(i) and (ii) of this section because Country X has a generally-imposed net income tax, Country X's withholding tax on the royalties paid pursuant to the Agreement is imposed on the gross royalty income of persons who are nonresidents of Country X, and nonresidents subject to the withholding tax on royalties are not also subject to the Country X generally-imposed net income tax on their royalty income. However, the Country X withholding tax on royalties paid pursuant to the Agreement does not meet the requirements of § 1.901-2(b)(5)(i)(B) and paragraph (c)(2)(iii)(A) of this section because Country X's sourcing rule for royalties (based on residence of the payor) is not based on the place of use of, or the right to use, the intangible property. Additionally, the payment that is subject to Country X's withholding tax is not made pursuant to a single-country license under paragraph (c)(2)(iv) of this section for the reasons described in paragraph (d)(3)(ii)(A) of this section (the separate levy analysis of this paragraph (d)(3) ( Example 3 )). Therefore, the requirement in paragraph (c)(2)(iii)(B) of this section is not met. Accordingly, the Country X withholding tax paid by YCo is not a covered withholding tax, and none of the 20u Country X withholding tax paid by YCo with respect to the 100u royalty payment made to XCo is a foreign income tax.
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(8) Example 8: Withholding tax on royalties; single-country license —(i) Facts. The facts are the same as in paragraph (d)(3)(i) of this section (the facts of Example 3 ) except that in Year 1, YCo enters into a written license agreement (the “Agreement”) with XCo for the right to use YCo's IP in a territory defined by the Agreement as Country X, in exchange for payments that the terms of the Agreement characterize as royalties, and XCo in fact only uses the IP in Country X. In Year 1, XCo withholds 20u of tax from 100u of royalties paid to YCo under the Agreement.
(ii) Analysis —(A) Separate levy. Under § 1.901-2(d)(1)(iii)(B)( 1 ), Country X's withholding tax imposed on gross royalty income of nonresidents is treated as a separate levy. Under § 1.901-2(d)(1)(iii)(B)( 3 ), the 20u of Country X withholding tax imposed on the 100u of royalties paid by XCo to YCo is treated as a separate levy from the Country X withholding tax on royalties if the Agreement pursuant to which the royalties are paid is a single-country license under paragraph (c)(2)(iv) of this section. The Agreement meets the requirements of paragraph (c)(2)(iv)(A) of this section because it is a written license agreement that characterizes the payment as a royalty and limits the territory of the license to Country X. Thus, the 20u Country X withholding tax paid by YCo is treated as a separate levy under § 1.901-2(d)(1)(iii)(B)( 3 ).
(B) Covered withholding tax. Under paragraph (c)(2) of this section, a tested foreign tax is a covered withholding tax if paragraphs (c)(1)(i) and (c)(2)(i) through (iii) of this section are met. Country X has a generally-imposed net income tax, Country X's withholding tax on the royalties paid pursuant to the Agreement is a withholding tax that is imposed on the gross income of persons who are nonresidents of Country X, and nonresidents subject to the withholding tax on royalties paid pursuant to the Agreement are not also subject to a net income tax on their royalty income. Thus, the requirements of paragraphs (c)(1)(i) and (c)(2)(i) and (ii) of this section are met. The withholding tax paid by YCo does not meet the requirements of § 1.901-2(b)(5)(i)(B) and paragraph (c)(2)(iii)(A) of this section because Country X's source rule for royalties (based on residence of the payor) is not based on the place of use of, or the right to use, the intangible property. However, the payment that is subject to Country X's withholding tax is made pursuant to a single-country license under paragraph (c)(2)(iv) of this section for the reasons described in paragraph (d)(8)(ii)(A) of this section (the separate levy analysis of this Example 8 ). Therefore, the requirement in paragraph (c)(2)(iii)(B) of this section is met. Accordingly, the Country X withholding tax on the payment made by XCo to YCo pursuant to the Agreement is a covered withholding tax and all of the 20u of Country X withholding tax paid by YCo with respect to the 100u of royalties under the Agreement is a foreign income tax.
(9) Example 9: Withholding tax on royalties; separately stated portion —(i) Facts. The facts are the same as in paragraph (d)(3)(i) of this section (the facts of Example 3 ) except that in Year 1, YCo enters into a written agreement (the “Agreement”) with XCo for the right to use YCo's IP in a territory defined by the Agreement as the entire world, as well as for YCo to provide certain services to XCo in Country Y, in exchange for a payment equal to 10 percent of XCo's annual revenue. The Agreement provides a formula for determining the amount of the payment that is characterized as a royalty and that is with respect to the part of the territory that is within Country X (the “separately stated formula”). The separately stated formula provides that the first 30u of the payment represents payment for services provided by YCo, and that 40 percent of the remainder of the payment represents payment of a royalty with respect to the part of the territory of the license that is solely within Country X. The portion of the payment by XCo to YCo that is characterized as services income under the Agreement is also characterized as services income under the laws of Country X. Additionally, all payments by a resident of Country X for services provided by a nonresident are treated as giving rise to Country X source income, regardless of where the services are performed, and gross income from services is subject to the same 20 percent withholding tax as gross royalty income. In Year 1, XCo earns gross income of 1,800u and pays YCo 180u under the Agreement. XCo withholds 12u of tax from the 60u of royalties attributable to the part of the territory of the license that is solely within Country X that are paid to YCo under the separately stated formula in the Agreement. The portion of the payment by XCo to YCo that is characterized as a royalty with respect to the part of the territory of the license that is solely within Country X under the separately stated formula in the Agreement is also characterized as a royalty under the laws of Country X. XCo withholds 24u of tax from the remaining 120u payment paid to YCo under the Agreement, consisting of 6u of tax on the 30u payment for services and 18u of tax on 90u of royalties. YCo does not know, or have reason to know, that the terms of the Agreement misstate the territory in which YCo's IP is used or overstate the amount of the royalty with respect to the part of the territory of the license that is solely within Country X.
(ii) Analysis —(A) Separately stated portion. The analysis is the same as in paragraph (d)(8)(ii) of this section (the analysis of Example 8 ), except that the portion of the payment that is a royalty with respect to the part of the territory of the license that is solely within Country X under the separately stated formula in the Agreement is treated as made pursuant to a single-country license under paragraph (c)(2)(iv) of this section because the Agreement is a written agreement that separately states the portion of the payment that is characterized as a royalty and that is with respect to the part of the territory of the license that is solely within Country X. Thus, the Country X withholding tax on the portion of the payment from XCo to YCo that is a payment of a royalty with respect to the part of the territory of the license that is solely within Country X under the separately stated formula under the Agreement is a separate levy and a covered withholding tax. Accordingly, the 12u Country X withholding tax paid by YCo from the 60u of royalties with respect to the part of the territory of the license that is solely within Country X is a foreign income tax.
(B) Remaining portion of royalties. The analysis is the same as paragraph (d)(3)(ii) of this section (the analysis of Example 3 ). Specifically, the 18u Country X withholding tax on the 90u royalty payment that is not with respect to the part of the territory that is within Country X is neither a separate levy nor a covered withholding tax. Accordingly, none of the 18u Country X withholding tax paid by YCo with respect to the remaining 90u royalty payment under the Agreement is a payment of foreign income tax.
(C) Services portion. Under § 1.901-2(d)(1)(iii)(B)( 1 ), Country X's withholding tax imposed on gross services income of nonresidents is a separate levy. The Country X withholding tax of 6u on the 30u payment for services made by XCo to YCo under the Agreement is not a covered withholding tax. The withholding tax paid by YCo does not meet the requirements of § 1.901-2(b)(5)(i)(B) and paragraph (c)(2)(iii)(A) of this section because Country X's sourcing rule for services (based on residence of the payor) is not reasonably similar to the sourcing rule that applies under the Internal Revenue Code (based on where the services are performed). The special separate levy and covered withholding tax rules for single-country licenses under § 1.901-2(d)(1)(iii)(B)( 3 ) and paragraph (c)(2)(iii)(B) of this section do not apply to withholding taxes on payments for services. Accordingly, none of the 6u of Country X withholding tax paid by YCo with respect to the 30u payment for services under the Agreement is a payment of foreign income tax.
(10) Example 10: Characterization of payment —(i) Facts. The facts are the same as in paragraph (d)(3)(i) of this section (the facts of Example 3 ), except that in Year 1, YCo enters into a written license agreement (the “Agreement”) with XCo for the right to use YCo's IP in a territory defined by the Agreement as Country X, in exchange for a payment that the terms of the Agreement characterize as a royalty, but that is characterized as a payment for services under the laws of Country X, and all payments of services paid by a resident of Country X to a nonresident are treated as giving rise to Country X source income, regardless of where the services are performed, and are subject to a 20 percent withholding tax.
(ii) Analysis. Under § 1.901-2(d)(1)(iii)(B)( 1 ), Country X's withholding tax imposed on gross services income of nonresidents is a separate levy. The Country X withholding tax of 20u on the 100u payment for services made by XCo to YCo under the Agreement is not a covered withholding tax. The withholding tax paid by YCo does not meet the requirements of § 1.901-2(b)(5)(i)(B) and paragraph (c)(2)(iii)(A) of this section because Country X's sourcing rule for services (based on residence of the payor) is not reasonably similar to the sourcing rule that applies under the Internal Revenue Code (based on where the services are performed). The special separate levy and covered withholding tax rules for single-country licenses under § 1.901-2(d)(1)(iii)(B)( 3 ) and paragraph (c)(2)(iii)(B) of this section do not apply to withholding taxes on income that is not characterized as royalty income under the foreign tax law. Accordingly, none of the 20u Country X withholding tax paid by YCo with respect to the 100u paid under the Agreement is a payment of foreign income tax.
(11) Example 11: Withholding tax on royalties, validity of agreement —(i) Facts. The facts are the same as in paragraph (d)(3)(i) of this section (the facts of Example 3 ), except that XCo is a controlled foreign corporation wholly owned by USP. Additionally, in Year 2, XCo and YCo cancel the written license agreement entered into in Year 1 and YCo enters into two new written license agreements with XCo, one agreement which grants XCo the right to use certain YCo IP in a territory defined as Country X (the “Country X Agreement”), and one of which grants XCo the right to use the same YCo IP in a territory defined as the entire world except for Country X (the “Rest of World Agreement”). Both agreements characterize the payments under the agreements as royalties, and the payments are also characterized as royalties under the laws of Country X. In Year 2, XCo withholds a total of 20u of tax from a total of 100u of royalties paid to YCo under the Country X Agreement and the Rest of World Agreement. Based on the terms of each agreement, 18u of tax was withheld from 90u of royalties paid to YCo under the Country X Agreement, and 2u of tax from 10u of royalties paid to YCo under the Rest of World Agreement. YCo knew or had reason to know that under the principles of sections 482 and 861, with respect to the 100u of royalties paid by XCo to YCo, 40u is attributable to XCo's use of YCo IP in Country X and 60u is attributable to use of YCo IP outside Country X.
(ii) Analysis —(A) Rest of World Agreement. The analysis is the same as paragraph (d)(3)(ii) of this section (the analysis of Example 3 ). Specifically, the 2u Country X withholding tax on the 10u royalty payment under the Rest of World Agreement is neither a separate levy nor a covered withholding tax. Accordingly, none of the 2u Country X withholding tax paid by YCo with respect to the 10u royalty payment under the Rest of World Agreement is a payment of foreign income tax.
(B) Country X Agreement. The analysis is the same as paragraph (d)(3)(ii) of this section (the analysis of Example 3 ), except that the reason that the Country X Agreement does not meet the requirements of paragraph (c)(2)(iv) of this section is that YCo knew or had reason to know that the terms of the Country X Agreement overstate the amount of the royalty with respect to Country X. Thus, the 18u Country X withholding tax on the 90u royalty payment under the Country X Agreement is neither a separate levy nor a covered withholding tax. Accordingly, none of the 18u Country X withholding tax paid by YCo with respect to the 90u royalty payment under the Country X Agreement is a payment of foreign income tax.
(e) Applicability dates —(1) In general. Except as provided in paragraphs (e)(2) and (3) of this section, this section applies to foreign taxes paid (within the meaning of § 1.901-2(g)) in taxable years beginning on or after December 28, 2021. For foreign taxes that relate to (and if creditable are considered to accrue in) taxable years beginning before December 28, 2021, and that are remitted in taxable years beginning on or after December 28, 2021, by a taxpayer that accounts for foreign income taxes on the accrual basis, see § 1.903-1 as contained in 26 CFR part 1 revised as of April 1, 2021.
(2) Certain foreign taxes paid to Puerto Rico. For foreign taxes paid to Puerto Rico under section 3070.01 of the Puerto Rico Internal Revenue Code of 2011, as amended (13 L.P.R.A. 31771) (imposing an excise tax on a controlled group member's acquisition from another group member of certain personal property manufactured or produced in Puerto Rico and certain services performed in Puerto Rico), this section applies to foreign taxes paid (within the meaning of § 1.901-2(g)) in taxable years beginning on or after January 1, 2023. For foreign taxes described in the preceding sentence that are paid in taxable years beginning before January 1, 2023, see § 1.903-1 as contained in 26 CFR part 1 revised as of April 1, 2021.
(3) Modifications to the covered withholding tax rules. Paragraphs (c)(2) and (d)(3), (4), and (8) through (11) of this section apply to foreign taxes paid (within the meaning of § 1.901-2(g)) in taxable years ending on or after November 18, 2022. For foreign taxes that are paid in taxable years ending before November 18, 2022, see § 1.903-1(c)(2) and (d)(3) and (4) as contained in 26 CFR part 1 revised as of July 27, 2022. Taxpayers may choose to apply the rules in paragraphs (c)(2) and (d)(3), (4), and (8) through (11) of this section to foreign taxes paid in taxable years beginning on or after December 28, 2021, and ending before November 18, 2022, provided that they consistently apply those rules and the rules of § 1.901-2(b)(5)(i)(B)( 2 ) and (d)(1)(iii) to such taxable years.