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Monday,

April 11, 2005

Part III

Department of the
Treasury
Internal Revenue Service

26 CFR Parts 1, 301, and 602


Residence and Source Rules Involving
U.S. Possessions and Other Conforming
Changes; Final and Temporary
Regulations; Notice of Proposed
Rulemaking

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18920 Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations

DEPARTMENT OF THE TREASURY pending receipt and evaluation of restated and supplemented certain
public comments, approved by the aspects of these provisions. See section
Internal Revenue Service Office of Management and Budget under 908 of Public Law 108–357 (enacting
control number 1545–1930. Responses section 937 of the Code). These
26 CFR Parts 1, 301, and 602 to this collection of information are regulations conform the existing
[TD 9194] mandatory. regulations to the amended statutes and
An agency may not conduct or provide additional guidance on the
RIN 1545–BE22 sponsor, and a person is not required to proper application of the statutory
respond to, a collection of information provisions.
Residence and Source Rules Involving unless the collection of information This document contains amendments
U.S. Possessions and Other displays a valid control number. to 26 CFR parts 1, 301, and 602. The
Conforming Changes For further information concerning cross-referenced notice of proposed
AGENCY: Internal Revenue Service (IRS), this collection of information, and rulemaking is published elsewhere in
Treasury. where to submit comments on the this issue of the Federal Register.
collection of information and the
ACTION: Final and temporary Explanation of Provisions
accuracy of the estimated burden, and
regulations. suggestions for reducing this burden, I. Operative Provisions
SUMMARY: This document contains please refer to the preamble to the cross-
referencing notice of proposed Many of the substantive and
temporary regulations that provide rules procedural provisions of the Code
under section 937(a) of the Internal rulemaking published in the Proposed
Rules section of this issue of the Federal specifically relating to the possessions
Revenue Code (Code) for determining were amended by the 1986 Act. The
whether an individual is a bona fide Register.
Books and records relating to a 2004 Act further amended certain of
resident of the following U.S. these provisions. These regulations
possessions: American Samoa, Guam, collection of information must be
retained as long as their contents may implement the statutory changes by
the Northern Mariana Islands, Puerto modifying or replacing existing
Rico, and the United States Virgin become material in the administration
of any internal revenue law. Generally, regulations as discussed below.
Islands. The temporary regulations also
provide rules under section 937(b) for tax returns and tax return information A. Puerto Rico
determining whether income is derived are confidential, as required by 26
U.S.C. 6103. Individuals who are U.S. citizens
from sources within a U.S. possession generally are subject to U.S. Federal
and whether income is effectively Background income tax on their worldwide income,
connected with the conduct of a trade The income tax laws of the United regardless of source, under section 1 of
or business within a U.S. possession. States have always contained special the Code. As discussed in section I.F. of
Section 937 was added to the Code by provisions concerning the income this explanation, alien individuals who
section 908 of the American Jobs taxation of individuals residing in U.S. qualify as bona fide residents of Puerto
Creation Act (2004 Act). possessions and corporations created or Rico (and certain other possessions)
The temporary regulations also organized in U.S. possessions. See e.g., likewise are subject to U.S. Federal
provide updated guidance under sections 260 and 261 of Public Law 65– income tax on their worldwide income
sections 876, 881, 884, 931, 932, 933, 254 (40 Stat. 1057). The current rules for under section 1.
934, 935, 957, and 6688 of the Code to residents of the Commonwealth of Under section 933, income from
reflect amendments made by the Tax Puerto Rico (Puerto Rico) were first sources within Puerto Rico is excluded
Reform Act of 1986 (1986 Act) and the enacted in 1950. See sections 220 and from gross income of bona fide residents
2004 Act. Conforming changes are also 221 of Public Law 81–814 (64 Stat. 906) of Puerto Rico (whether U.S. citizens or
made to regulations under sections (enacting the predecessors to sections alien individuals) for U.S. Federal
170A, 243, 702, 861, 863, 871, 901, 876 and 933 of the Code). Special rules income tax purposes. Consequently,
1402, 6038, 6046, and 7701 of the Code. for residents of the United States Virgin such individuals have a U.S. Federal
The text of the temporary regulations Islands (USVI) were added in 1960. See income tax return filing obligation only
also serves as the text of the proposed section 4 of Public Law 86–779 (74 Stat. if their income from sources outside
regulations set forth in the cross- 998) (enacting section 934 of the Code). Puerto Rico exceeds their deductions
referenced notice of proposed Special rules for residents of Guam were under section 151 relating to personal
rulemaking on this subject in the added in 1972. See Public Law 92–606 exemptions. To the extent such income
Proposed Rules section in this issue of (86 Stat. 1494) (1972 Act) (enacting constitutes income from sources outside
the Federal Register. sections 935 and 7654 of the Code). the United States, such individuals
DATES: Effective Date: These regulations These special rules for residents of generally may claim a foreign tax credit
are effective April 11, 2005. Guam were made applicable to residents under section 901(b) for income taxes
FOR FURTHER INFORMATION CONTACT: J. of the Commonwealth of the Northern paid to foreign countries and U.S.
David Varley (202) 435–5165 (not a toll- Mariana Islands (NMI) for tax years possessions (including Puerto Rico) to
free number). beginning after December 31, 1978. See offset their U.S. Federal income tax
SUPPLEMENTARY INFORMATION: section 601 of Public Law 94–241 (90 liability, subject to certain limitations.
Stat. 263) and Presidential Proclamation Deductions (other than the deduction
Paperwork Reduction Act 4534. under section 151, relating to personal
These temporary regulations are being The 1986 Act substantially revised the exemptions) properly allocable to or
issued without prior notice and public provisions governing the income chargeable against amounts excluded
procedure pursuant to the taxation of individuals residing in U.S. from gross income under section 933
Administrative Procedure Act (5 U.S.C. possessions. See sections 1271 through generally have been disallowed since
553). For this reason, the collection of 1277 of Public Law 99–514 (amending the statute was enacted in 1950. The
information contained in these sections 876, 931 through 935, 957(c), 1986 Act amended section 933 to
regulations has been reviewed and and 7654 of the Code). The 2004 Act provide for a similar disallowance of

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Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations 18921

credits. These regulations amend the in force with respect to bona fide benefit of a tax credit or exemption
existing regulations under section 933 to residents of Guam and the NMI. provided under USVI law but subject to
reflect this statutory change. Section 935, as in effect prior to its the limitations of section 934(b)).
repeal, refers only to Guam. Pursuant to With respect to U.S. citizens and
B. American Samoa, Guam, and the section 601 of the Covenant to Establish resident alien individuals who are not
Northern Mariana Islands a Commonwealth of the Northern bona fide residents of the USVI but have
Section 931, as enacted in the 1986 Mariana Islands in Political Union with income from sources within the USVI or
Act, operates in a similar fashion to the United States, Public Law 94–241, income effectively connected with the
section 933. For U.S. citizens and alien however, the income tax laws of the conduct of a trade or business in the
individuals who are bona fide residents United States entered into force in the USVI, section 932(a) generally provides
of possessions to which it applies NMI in the same manner as those laws that each such individual must file his
(section 931 possessions), income from are in force in Guam, and references in or her income tax return with both the
sources within such possessions or the Code to Guam generally are deemed IRS and with the USVI Bureau of
effectively connected with the conduct also to refer to the NMI. Consequently, Internal Revenue. In addition, under
of a trade or business in such section 935 currently applies to bona section 932(b), such an individual must
possessions is excluded from gross fide residents of Guam and of the NMI. pay to the USVI the ‘‘applicable
income for U.S. Federal income tax These regulations amend the existing percentage’’ of the taxes imposed under
purposes. Consequently, such regulations under section 935 to reflect Chapter 1 of the Code. For this purpose,
individuals have a U.S. Federal income the fact that the section currently the term applicable percentage means
tax return filing obligation only if their applies not only to bona fide residents the percentage which the individual’s
income from sources outside section of Guam but also to bona fide residents Virgin Islands adjusted gross income
931 possessions and not effectively of the NMI, and may in the future apply bears to the individual’s adjusted gross
connected with the conduct of a trade only to bona fide residents of one or the income; the term Virgin Islands
or business in such possessions exceeds other and will not apply to bona fide adjusted gross income means the
their deductions under section 151 residents of either possession if both individual’s adjusted gross income
relating to personal exemptions. To the enter into the implementing agreements determined by taking into account only
extent such income constitutes income contemplated in the 1986 Act. income derived from sources within the
from sources outside the United States, Similarly, these regulations set forth the Virgin Islands and deductions properly
U.S. citizens who are bona fide post-1986 Act statutory framework for apportioned or allocable thereto. On the
residents of section 931 possessions residents of section 931 possessions in individual’s U.S. Federal income tax
generally may claim a foreign tax credit a manner that reflects the potential for return, he or she may claim a credit for
under section 901(b) for income taxes bona fide residents of Guam and the the tax required to be paid to the USVI,
paid to foreign countries and U.S. NMI to be covered by its provisions so that only the remainder is due to the
possessions (including section 931 upon entry into force of such United States.
possessions) to offset their U.S. Federal implementing agreements. In general, the USVI administers
income tax liability, subject to certain income tax laws that are identical
C. United States Virgin Islands
limitations. As under section 933, any (except for the substitution of the name
deductions (other than the deduction Section 932, as enacted in the 1986 of the USVI for the term United States
under section 151, relating to personal Act, provides two sets of operative where appropriate) to those in force in
exemptions) and credits properly rules: one for bona fide residents of the the United States (commonly referred to
allocable or chargeable against amounts USVI, and one for U.S. citizens and as the mirror code). However, subject to
excluded from gross income under resident alien individuals who are not the limitations of section 934(b), as
section 931 are disallowed. bona fide residents of the USVI but have amended by the 1986 Act, the USVI has
Although section 931 by its terms income from sources within the USVI or the authority to reduce or remit tax
applies to bona fide residents of income effectively connected with the liabilities under the mirror code in
American Samoa, Guam, and the NMI conduct of a trade or business in the certain situations.
(collectively, the Pacific possessions), USVI. First, under section 934(b)(1), the
the statute takes effect with respect to With respect to individuals who are USVI may reduce or remit the tax
any such possession only when the bona fide residents of the USVI otherwise imposed on the income of any
possession enters into an implementing (whether U.S. citizens or alien person (other than a U.S. citizen or
agreement with the Internal Revenue individuals), section 932(c) generally resident alien individual who is not a
Service as required under the relevant provides that an income tax return must bona fide resident of the USVI) from
effective date provisions of the 1986 be filed with the USVI tax authorities. sources within the USVI or effectively
Act. See sections 1271(b) and 1277(b) of If the individual properly reports on this connected with the conduct of a trade
Public Law 99–514. To date, only return his or her income from all or business in the USVI.
American Samoa has entered into such sources and identifies the source of each Second, under section 934(b)(3), the
an agreement. Consequently, section item of income, and pays all of the tax USVI may reduce or remit the tax
931 currently applies only to bona fide properly due with respect to such otherwise imposed on the income (other
residents of American Samoa. income, then such income is excluded than income from sources within the
Although section 935 was repealed by from gross income for U.S. Federal United States or effectively connected
the 1986 Act, the effective date of its income tax purposes. Consequently, with the conduct of a trade or business
repeal is contingent on the entry into such individuals have a U.S. Federal in the United States) of a foreign
force of implementing agreements, as income tax return filing obligation only corporation, provided that less than ten
described above, by the possessions to if they fail to report or properly identify percent of its stock (by vote and value)
which section 935 historically has the source of some of their income on is owned by United States persons.
applied (section 935 possessions), their USVI income tax return, or if they Given that a corporation created or
namely, Guam and the NMI. Given that fail to pay all of the tax properly due organized outside of the USVI can only
neither has agreed to the entry into force with respect to their income (for have a mirror code tax liability with
of such agreements, section 935 remains example, by improperly claiming the respect to income from sources within

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18922 Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations

the USVI or effectively connected with effect for corporations created or organized in the United States, pursuant
the conduct of a trade or business organized in section 931 possessions to section 1274(c) of the 1986 Act.
within the USVI (all of which is within and in the USVI. Under these rules,
E. Application of Subpart F to Bona
the scope of section 934(b)(1)), the such corporations effectively are exempt
Fide Residents of a Possession
additional waiver of the limitations of from tax under section 881(a) and
section 934(a) provided by section section 884, provided that the following With respect to bona fide residents of
934(b)(3) generally will have no conditions (1986 conditions) are section 935 possessions and the USVI
practical effect for such corporations. satisfied— (mirror code possessions), corporations
Instead, section 934(b)(3) generally is (1) At all times during the taxable created or organized in the possession
relevant only to corporations created or year, less than 25 percent in value of the in which they reside are treated as
organized in the USVI (which are stock of such corporation is beneficially domestic corporations for mirror code
treated as ‘‘foreign’’ corporations for owned (directly or indirectly) by foreign tax purposes. Thus, provisions such as
U.S. Federal income tax purposes). persons; subpart F of part III of subchapter N of
These regulations amend the existing (2) At least 65 percent of the gross chapter 1 of the Code (relating to
regulations under section 934 and income of such corporation is shown to controlled foreign corporations) as
provide new regulations under section the satisfaction of the Secretary to be mirrored do not apply with respect to
932 to reflect this post-1986 Act effectively connected with the conduct their ownership of such corporations.
statutory framework. of a trade or business in such a With respect to bona fide residents of
D. U.S. Tax Liabilities of Certain possession or the United States for the section 931 possessions and Puerto
Possessions Corporations 3-year period ending with the close of Rico, corporations created or organized
the taxable year of such corporation (or in the possession in which they reside
Section 881(a) generally imposes a 30 are treated as foreign corporations for
for such part of such period as the
percent tax on U.S.-source fixed or U.S. Federal income tax purposes. Thus,
corporation or any predecessor has been
determinable annual or periodical in cases where, after the application of
in existence); and
income of foreign corporations. Section section 931 or 933 as the case may be,
(3) No substantial part of the income
884 imposes certain branch-level taxes such individuals are required to file
of such corporation is used (directly or
on foreign corporations that are engaged U.S. Federal income tax returns, they
indirectly) to satisfy obligations to
in a trade or business in the United generally must treat such corporations
persons who are not bona fide residents
States. Section 881(b) provides for the as foreign corporations for purposes of
of such a possession or the United
reduction or elimination of the taxes applying provisions, such as subpart F,
States.
otherwise imposed under sections to determine their U.S. Federal income
Corporations that are created or
881(a) and 884 on corporations created tax liability.
organized in section 935 possessions
or organized in U.S. possessions
and satisfy the 1986 conditions also are Section 957(c), however, provides a
(possessions corporations) under certain
exempt from the U.S. tax imposed under significant exception for bona fide
circumstances.
Section 881(b), as enacted by the 1972 section 884. Similarly, corporations that residents of section 931 possessions and
Act, provides the rules currently in are created or organized in the United Puerto Rico. In cases where it applies,
effect for corporations created or States and satisfy the 1986 conditions the individual is not treated as a United
organized in section 935 possessions. are exempt from the tax imposed under States person for purposes of subpart F.
Under these rules, such corporations mirrored versions of section 884 in Consequently, such individual is not
effectively are exempt from tax under section 935 possessions. treated as a United States shareholder
section 881(a), provided that the Section 881(b), as amended by the under section 951(b), and possession
following conditions are satisfied— 2004 Act, provides a special rule for corporations described in section 957(c)
(1) At all times during the taxable corporations created or organized in that are controlled by such individuals
year, less than 25 percent in value of the Puerto Rico. Under this rule, such are not treated as controlled foreign
stock of such corporation is owned corporations are subject to tax under corporations under section 957(a).
(directly or indirectly) by foreign section 881(a) at a rate of 10 percent In the case of a bona fide resident of
persons; and (rather than the generally applicable rate Puerto Rico, section 957(c)(1) applies
(2) At least 20 percent of the gross of 30 percent) on their U.S.-source with respect to a corporation organized
income of such corporation is shown to dividend income, provided that the under the laws of the Commonwealth of
the satisfaction of the Secretary to have 1986 conditions are satisfied. However, Puerto Rico if a dividend received by
been derived from sources within such if, on or after October 22, 2004, there is such individual during the taxable year
possession for the 3-year period ending an increase in the rate of Puerto Rico’s from such corporation would, for
with the close of the preceding taxable withholding tax which is generally purposes of section 933(1), be treated as
year of such corporation (or for such applicable to dividends paid to United income derived from sources within
part of such period as the corporation States corporations not engaged in a Puerto Rico. (As discussed in more
has been in existence). trade or business in Puerto Rico to a rate detail below in section II.B. of this
Section 881(b), as enacted by the 1972 greater than 10 percent, this special rule explanation, such would be the case if,
Act, also provides the rules currently in shall not apply to dividends received on during a three-year testing period
effect for corporations created or or after the effective date of the increase. ending with the taxable year, the
organized in the United States that These regulations amend the existing corporation’s gross income was derived
otherwise might incur a tax liability to regulations under sections 881 and 884 entirely from sources within Puerto Rico
a section 935 possession under a to reflect this post-1986 Act and post- or the corporation met certain gross
mirrored version of section 881(a). 2004 Act statutory framework. These income and trade or business
Under these rules, such corporations regulations also provide rules similar to requirements.)
effectively are exempt from tax in the the 1972 Act rules applicable to section In the case of a bona fide resident of
section 935 possession in all cases. 935 possessions for purposes of a section 931 possession, section
Section 881(b), as amended by the determining tax liability incurred to the 957(c)(2) applies with respect to a
1986 Act, provides the rules currently in USVI by corporations created or corporation organized under the laws of

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Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations 18923

such a possession if the following business entities for U.S. and mirror to the possessions, determinations must
conditions are satisfied— code tax purposes. be made regarding whether an
(1) 80 percent or more of the gross Under these rules, if an entity status individual is a bona fide resident of a
income of the corporation for the 3-year election (such as a subchapter S election particular possession, or whether
period ending at the close of the taxable or an election under § 301.7701–3(c)) is income is derived from sources within
year (or for such part of such period as filed with the IRS but not with the a particular possession or is effectively
such corporation or any predecessor has relevant mirror code possession, then connected with the conduct of a trade
been in existence) was derived from the appropriate tax authority of the or business in a particular possession.
sources within such a possession or was mirror code possession may, at his or Section 937 and these regulations
effectively connected with the conduct her discretion, deem the election also to provide guidance on these issues, as
of a trade or business in such a have been made for mirror code tax discussed below.
possession; and purposes. Similarly, if any such election
is filed in a mirror code possession but A. Bona Fide Residency in a Possession
(2) 50 percent or more of the gross
income of the corporation for such not with the IRS, the Commissioner The term bona fide resident has been
may, at his discretion, deem the election an integral part of the special provisions
period (or part) was derived from the
to have been made for U.S. Federal of the Code relating to U.S. possessions
active conduct of a trade or business
income tax purposes. In the event that since 1950. See sections 220 and 221 of
within such a possession.
inconsistent elections are filed with the Public Law 81–814. From the beginning,
These regulations amend the existing
IRS and the mirror code possession, this term has been used to identify the
regulations under section 957 to reflect
both the Commissioner and the class of persons entitled to Federal tax
this post-1986 Act statutory framework.
appropriate tax authority of the mirror exemptions or other special treatment
These regulations also make
code possession may, at their individual under these provisions, and its meaning
corresponding changes to the
discretion, deem the elections they has remained essentially unchanged
regulations under sections 6038 and
received to be invalid and may deem the through all of the expansions and
6046 (relating to information reporting
election filed with the other jurisdiction revisions of these provisions.
requirements with respect to certain Historically, the determination of
to have been made also for tax purposes
foreign corporations owned by United whether an individual is a bona fide
in their own jurisdiction. Further, in the
States persons). resident of a possession has turned on
absence of an election, the default
F. Taxation of Aliens Residing in a characterization of an eligible entity the facts and circumstances and,
Possession organized in a mirror code possession specifically, on an individual’s
shall be determined under the rules intentions with respect to the length and
Under section 876, individuals who nature of his or her stay in the
applicable to domestic eligible entities
are nonresident aliens with respect to possession. See, e.g., §§ 1.933–1(a),
under § 301.7701–3(b). These
the United States and are bona fide 1.934–1(c)(2), and 1.935–1(a)(3)
consistency rules apply to elections
residents of certain possessions are (generally applying the principles of
under section 1362(a) and § 301.7701–
subject to U.S. Federal income tax on §§ 1.871–2 through 1.871–5). But see
3(c), and to other similar elections. The
their worldwide income under section 1 § 301.7701(b)–1(d) (applying the rules of
IRS and Treasury request comments
(rather than solely on their income from section 7701(b) for determining whether
relating to elections that should be
sources within the United States or alien individuals qualified as residents
specifically mentioned or excluded from
effectively connected with the conduct of mirror code possessions for taxable
the regulations.
of a trade or business in the United These special rules generally apply to years beginning after December 31,
States under section 871). Prior to the elections made after, and entities 1984). The qualifier ‘‘bona fide’’
1986 Act, section 876 applied only to created after, April 11, 2005. Transition indicates that a claim of residence in a
alien individuals who were bona fide rules are provided for existing entities, possession is respected for Federal tax
residents of Puerto Rico. As amended by under which these special rules purposes when it is made in good faith.
the 1986 Act, section 876 applies also to generally apply as of the beginning of As enacted by the 2004 Act, section
alien individuals who are bona fide the next taxable year. 937(a) provides that an individual
residents of section 931 possessions. generally will be considered a bona fide
These regulations amend the existing H. Effective Date resident of a possession only if he or she
regulations under section 876 to reflect To the extent they provide rules satisfies all three of the following
this post-1986 Act statutory framework. under the operative provisions of the conditions—
G. Entity Status Code relating to the possessions, as (1) He or she is physically present in
amended by 1986 Act and the 2004 Act, the possession for 183 days during the
The IRS and Treasury are aware that these regulations generally apply to taxable year (physical presence test);
some taxpayers have deliberately treated taxable years ending after October 22, (2) He or she does not have a tax
business entities in an inconsistent 2004. The underlying statutory rules, home (determined under the principles
manner for U.S. Federal income tax however, generally apply to taxable of section 911(d)(3) without regard to
purposes and for purposes of years beginning after December 31, the second sentence thereof) outside the
determining income tax liabilities 1986. Accordingly, taxpayers may rely possession during the taxable year (tax
incurred to mirror code possessions, in upon the guidance provided in these home test); and
order to reduce their overall tax liability regulations with respect to prior years (3) He or she does not have a closer
below what otherwise would be due in for which the underlying statutory rules connection (determined under the
the absence of the mirror system. The are in effect, provided that they do so principles of section 7701(b)(3)(B)(ii)) to
IRS and Treasury believe that such consistently. the United States or a foreign country
inconsistent treatment is inappropriate than to the possession (closer
and contrary to the purpose of the II. Definitional Provisions connection test).
mirror system. Accordingly, these As indicated above in section I of this Section 937(a) further provides that,
regulations contain special rules explanation, when applying the for purposes of the physical presence
requiring consistent treatment of operative provisions of the Code relating test, the determination as to whether a

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18924 Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations

person is present for any day shall be A final alternative is that the that an individual’s absence from or
made under the principles of section individual have no permanent presence in a possession in compliance
7701(b). The legislative history explains connection to the United States. For this with military orders generally does not
that, under this rule, an individual is to purpose, the term permanent affect whether the individual qualifies
be considered present in a possession connection to the United States includes as a bona fide resident of such
for a particular day if he is physically a permanent residence and a spouse or possession.
present in such possession during any dependent with a principal place of Finally, consistent with existing law
time during such day, and in certain abode in the United States. In other (see Notice 2000–61 (2000–2 C.B. 569)),
circumstances (e.g., certain medical words, the absence of a permanent these regulations provide that only
emergencies), an individual’s presence connection will enable an individual to natural persons may be considered bona
outside a possession is ignored. See H.R. satisfy the physical presence test. Thus, fide residents of a possession for U.S.
Rep. No. 108–755, at 780 (2004). for example, an individual who lives in Federal income tax purposes. Thus,
The tax home and closer connection a possession but travels extensively in juridical persons such as corporations,
tests are similar to the conditions that the United States for business reasons or partnerships, trusts, and estates cannot
individuals historically have needed to to receive medical treatment may satisfy be considered bona fide residents of a
meet to be considered residents of a the physical presence requirement possession for U.S. Federal income tax
possession. under this alternative. purposes.
Congress also provided regulatory For purposes of determining whether It should be noted that the 2004 Act
authority for the IRS and Treasury to the above-mentioned alternatives are modified sections 932 and 935, to
create exceptions to this general satisfied, certain days spent in the conform the treatment of individuals
definition, for cases in which an United States are disregarded. In who acquire or relinquish residency in
individual’s absence from the particular, days spent as a full-time mirror code possessions with the
possession is motivated by reasons other student, as a full-time government historical treatment of individuals who
than tax avoidance. In particular, the official or employee of a possession, or
acquire or relinquish residency in
legislative history indicates that as a professional athlete participating in
Puerto Rico and section 931
Congress anticipated that exceptions a charitable event generally are
possessions. Thus, for example, in order
would be provided for military disregarded. In addition, days spent in
to be subject to the special rules of
personnel, workers in the fisheries transit and days that an individual is
section 932(c), an individual must
trade, and retirees who may travel prevented from leaving the United
qualify as a bona fide resident of the
outside of a possession for personal States because of a medical condition
USVI during the entire year.
that arose while the individual was
reasons. At the same time, the Accordingly, an individual generally is
present in the United States generally
legislative history makes clear that not subject to such special rules for any
will also be disregarded.
Congress wished to ensure that The above-mentioned alternatives year during which he or she moves to
individuals who live and work stateside apply with respect to individuals who or from the USVI.
cannot avail themselves of the tax are U.S. citizens or resident aliens (as The 2004 Act provisions and these
benefits that Congress intended to defined in section 7701(b)). A different regulations as they relate to the
provide only to individuals who approach is appropriate in the case of determination of bona fide residency in
actually reside in the possessions. See individuals who are nonresident aliens a possession generally apply to taxable
H.R. Rep. No. 108–755, at 780 (2004). with respect to the United States. For years ending after October 22, 2004,
Consistent with this legislative such individuals, in lieu of the above- except that the physical presence
history, these regulations include mentioned alternatives, a mirrored requirement applies only to taxable
several exceptions to the general version of the section 7701(b) years beginning after October 22, 2004.
statutory rules of section 937(a). substantial presence test applies. In addition, taxpayers may choose to
First, these regulations provide For purposes of the tax home test, apply the rules set forth in these
several alternatives to the 183-day rule these regulations provide a special rule regulations in their entirety (including
for purposes of satisfying the physical for seafarers. Under this special rule, an the physical presence test) to any open
presence test. One alternative is that the individual will not be considered to taxable years by notifying the IRS upon
individual spend no more than 90 days have a tax home outside the relevant examination of their intent to do so.
in the United States during the taxable possession solely by reason of Alternatively, for such years, U.S.
year. Thus, for example, workers in the employment on a ship or other seafaring citizens and resident alien individuals
fisheries trade who spend considerable vessel that is predominantly used in (as well as nonresident aliens in
periods at sea, and individuals who local and international waters. possessions other than mirror code
travel extensively to neighboring islands For purposes of the closer connection possessions) may continue to apply the
to provide goods and services, may test, these regulations provide a special principles of §§ 1.871–2 through 1.871–
satisfy the physical presence rule under which another possession is 5, and nonresident alien individuals in
requirement under this alternative. not considered a foreign country. Thus, mirror code possessions may continue
Another alternative is that the for example, an individual who has a to apply the rules of § 301.7701(b)–1(d)
individual spend more days in the tax home in the USVI and a closer (as in effect for such years).
possession than in the United States and connection to Puerto Rico, and who B. Income From Sources in a Possession
have no earned income (as defined in satisfies the presence test with respect
§ 1.911–3(b)) in the United States during to both possessions, generally will be In general, the rules for determining
the taxable year. Thus, for example, considered a bona fide resident of the whether income is derived from sources
retirees who spend several months each USVI, and not of Puerto Rico. within the United States have applied
year stateside for vacation, for medical Special rules apply under Federal law for purposes of determining whether
treatment, or to visit relatives, and some for determining the residence of military income is derived from sources within
time traveling in foreign countries, may personnel for tax purposes. See 50 App. a possession. See § 1.863–6. The 2004
satisfy the physical presence U.S.C. 571(a). Consistent with these Act codified this rule in section 937(b),
requirement under this alternative. special rules, these regulations provide with two exceptions.

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First, section 937(b)(2) (U.S. income Under this special conduit rule, income created or organized in a possession
rule) provides that an item of income is considered to be from sources within (possessions corporations). In general,
shall not be considered to be derived the United States for purposes of the such dividends constitute income from
from sources within a possession (or U.S. income rule if, pursuant to a plan sources within a possession under the
effectively connected with the conduct or arrangement, (i) the income is principles of section 861(a)(2)(A). A
of a trade or business within a received in exchange for consideration special look-through rule applies,
possession) if such item of income provided to another person, and (ii) however, when the shareholder owns,
constitutes income from sources within such person (or another person) directly or indirectly, at least 10 percent
the United States or income effectively provides the same consideration (or of the voting stock of the corporation.
connected with the conduct of a trade consideration of a like kind) to a third Under this special rule, only a ratable
or business in the United States under person in exchange for one or more portion of any dividend paid or accrued
the general rules of sections 861 through payments constituting income from by a possessions corporation to such a
865. sources within the United States. This shareholder is treated as income from
Second, section 937(b) provides an rule supplements, and does not sources within the possession. The
express grant of authority, consistent supersede, other potentially applicable ratable portion is determined by
with the authority contained in sections conduit rules. See, for example, Aiken applying to the dividend the ratio of the
931, 934, and 957 as amended by the Indus., Inc. v. Commissioner, 56 T.C. corporation’s income from sources
1986 Act, for Treasury and the IRS to 925 (1971). Unlike more generally within the possession over its total
provide appropriate exceptions to the applicable conduit rules, however, the income over a three-year testing period
general source rules. special conduit rule in these regulations ending with the year in which the
The legislative history to the 2004 Act applies only for purposes of section 937 dividend is paid. (See also sections
indicates that Congress intended for (and provisions for which the rules of 881(b) and 957(c) for which a similar
Treasury and the IRS to use this section 937 apply); it does not cause the three-year testing period applies.) This
authority to continue the existing income to be treated as income from look-through rule does not apply,
treatment of income from the sale of sources within the United States for however, if the corporation meets the
goods manufactured in a possession. other purposes of the Code. following conditions (the 80/50
The 2004 Act legislative history further Third, the regulations preserve the conditions)—
indicates that Congress intended for this existing treatment of income from the (1) 80 percent or more of the gross
authority to be used to prevent abuse, sale of goods manufactured in a income of the corporation for the three-
for example, to prevent U.S. persons possession under § 1.863–3(f). These year testing period was derived from
from avoiding U.S. tax on appreciated existing rules reflect a careful sources within the possession or was
property by acquiring residency in a consideration of the relevant policy effectively connected with the conduct
possession prior to its disposition. See considerations arising with respect to of a trade or business in the possession;
H.R. Rep. No. 108–755, at 781 (2004). the transactions to which they apply, and
The legislative history to the 1986 Act and Congress did not intend for this (2) 50 percent or more of the gross
reflects similar concerns. For example, result to be changed through a income of the corporation for such
Congress did not believe that a mechanical application of the general period was derived from the active
mainland resident who moves to a source rules of section 937(b). For the conduct of a trade or business within
possession while owning appreciated same reason, these regulations contain the possession.
personal property such as corporate rules to preserve the results with respect Sixth, the regulations provide rules
stock or precious metals and who sells to the allocation of income between the for determining the extent to which
that property in the possession should United States and its possessions under income inclusions (for example, under
escape all tax, both in the United States sections 863(c), 863(e), 865(g)(3), and section 951(a)) may be considered to be
and the possession, on that 865(h)(2)(B). derived from sources within a
appreciation. Similarly, Congress did Fourth, the regulations provide possession. Specifically, for
not believe that a resident of a special rules for gains from dispositions shareholders owning at least 10 percent
possession who owns financial assets of certain property held by a U.S. person of the voting stock of the corporation,
such as stocks or debt of companies prior to becoming a resident of a the regulations generally apply the
organized in, but the underlying value possession. Under these rules, such principles of section 904(h)(2), under
of which is primarily attributable to gains generally are treated as income which the source of income inclusions
activities performed outside, the from sources outside of the possession. ordinarily is determined for foreign tax
possession should escape tax on the These rules supplement, and do not credit purposes. For all other
income from those assets. supersede, the special source rule of shareholders, income inclusions are
Accordingly, Congress anticipated section 1277(e) of the 1986 Act, which considered to be derived from sources
that regulations would treat such applies to individuals who become within the jurisdiction in which the
income as sourced outside the residents of Pacific possessions. Under corporation is created or organized.
possession where the taxpayer resides. this 1986 Act special source rule, gains Seventh, the regulations provide rules
See H.R. Rep. No. 99–426, at 487 and from dispositions of certain property for determining the extent to which
489 (1985); S. Rep. No. 99–313, at 481 held by a U.S. person prior to becoming interest payments may be considered to
and 484 (1986). a resident in a Pacific possession is be derived from sources within a
These regulations include several treated as income from sources within possession. In general, interest paid by
exceptions to the general statutory rules the United States for all purposes of the possessions corporations and
of section 937(b). Code (including section 7654 of the noncorporate residents of a possession
First, the regulations provide that the 1954 Code as applicable to Guam and constitutes income from sources within
U.S. income rule only applies for the NMI). The regulations also contain the possession under the principles of
income earned after December 31, 2004. rules that are designed to prevent the section 861(a)(1). A special look-through
Second, the regulations contain a avoidance of these special gain rules. rule applies, however, when the interest
special conduit rule to prevent the Fifth, the regulations provide special is paid by a possessions corporation to
avoidance of the U.S. income rule. rules for dividends from corporations a shareholder who owns, directly or

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indirectly, at least 10 percent of the the paragraph regarding dispositions of Congress expressed concerns similar to
voting stock of the corporation. Under certain property held by a U.S. person those expressed in 1960:
this special rule, which is applied in prior to becoming a resident of a ‘‘While the committee believes it is
accordance with the principles of possession), nonetheless may constitute appropriate to provide more local
§§ 1.861–9 through 1.861–12, the income from sources within the USVI autonomy to these possessions, the
interest is treated as income from for purposes of mirrored section 904. In committee does not intend to allow
sources within the possession only to addition, in order to avoid unintended them to be used as tax havens. The
the extent that such interest is allocable reduction of the tax base of mirror code committee believes that it may be
to assets giving rise to income from possessions, certain of the special rules appropriate for these possessions to
sources within the possession or income described above do not apply for reduce tax on local income in some
effectively connected with the conduct determining whether individuals who cases, but the committee has included
of a trade or business within the are not bona fide residents of such antiabuse rules to prevent use of these
possession. This look-through rule does possessions have income from sources possessions to avoid U.S. tax. The
not apply, however, if the corporation within such possessions for purposes of complexity and ambiguity of the present
meets the 80/50 conditions described sections 932 and 935. law rules have provoked taxpayers to
above. The regulations further provide The 2004 Act provisions concerning take return positions that, while
that interest paid by a partnership is the determination of whether income is plausible under a literal reading, would
treated as income from sources within a derived from sources within a result in tax avoidance beyond what
possession only to the extent that such possession generally apply to taxable taxpayers would ask from this
interest is allocable (under the years ending after October 22, 2004, committee or from Congress. The
principles of § 1.882–5) to income except that the U.S. income rule applies committee is seeking to prevent this in
effectively connected with the conduct only to income earned after October 22, the future.’’ H.R. Rep. No. 99–426, at
of a trade or business in the possession. 2004. The regulations generally adopt 485–486 (1985). See also S. Rep. No. 99–
Special rules apply under Federal law these effective dates, except that the 313, at 479 (1986).
for determining, for tax purposes, the regulations provide that the U.S. income This concern was also expressed in
source of income from the performance rule only applies for income earned the legislative history regarding how the
of services by military personnel. See 50 after December 31, 2004. Also, the IRS and Treasury might exercise their
App. U.S.C. 571(b). Consistent with special rules provided for gains from authority under sections 931 and 934 as
these special rules, these regulations dispositions of certain personal property enacted and modified, respectively, by
provide that income from military
apply to dispositions after April 11, the 1986 Act, to define the scope of
services performed stateside (or in
2005, and the conduit rule and the look- income that would be considered
another possession) by a bona fide
through rules for dividends and interest derived from sources within a
resident of a possession is considered to
from possessions corporations apply to possession or effectively connected with
be income from sources within such
amounts paid or accrued after April 11, the conduct of a trade or business in a
possession, and income from military
2005. For taxable years beginning after possession (possession ECI). The
services performed in a possession by
December 31, 1986, and ending before discussion in the legislative history was
an individual who is not a bona fide
October 23, 2004, the rules of § 1.863– devoted exclusively to ways in which
resident of such possession is not
6 (as in effect for such years) remain the IRS and Treasury might narrow the
considered to be income from sources
within such possession. applicable. scope of these concepts (as compared to
Lastly, the regulations continue the the scope they otherwise would have
C. Income Effectively Connected With
existing treatment of income from under a mirrored application of the
the Conduct of Trade or Business in a
services performed within a possession existing principles for determining
Possession
and from dividends paid by whether income is considered to be
corporations created or organized In 1960, in response to concerns about derived from sources within the United
outside of a possession. Thus, the reach of a local, tax-related subsidy States or effectively connected with the
compensation received for services program, section 934 was enacted to conduct of a trade or business in the
performed in a possession constitutes provide explicit limits on the ability of United States). H.R. Rep. No. 99–426, at
income from sources within the the USVI to reduce income tax 487 and 489 (1985); S. Rep. No. 99–313,
possession without regard to the de liabilities. The legislative history at 481 and 484 (1986).
minimis exception in section 861(a)(3), explains that, ‘‘while recognizing the In 2004, in response to certain abusive
and dividends paid by corporations desirability of economic development’’ cases that had been identified, the rules
created or organized outside of a in the USVI, Congress believed that ‘‘in relating to the possessions were again
possession constitute income from no case should this be attained by modified. In so doing, Congress once
sources outside of the possession in all granting windfall gains to taxpayers again expressed its concern about how
cases. with respect to income derived from such rules might be used as an
The rules of section 937(b) and these investments in corporations in the inappropriate means to reduce U.S.
regulations generally apply for purposes continental United States, or with taxes: ‘‘The conferees are further
of all provisions of the Code for which respect to income in any other manner concerned that the general rules for
a determination must be made regarding derived from sources outside of the determining whether income is
whether income is derived from sources Virgin Islands.’’ S. Rep. No. 1767, 86th effectively connected with the conduct
within a possession. They generally do Cong., 2nd Sess. 4 (1960). of a trade or business in a possession
not apply, however, for purposes of In 1986, in response to certain present numerous opportunities for
applying mirrored provisions of the identified abuses and other problems erosion of the U.S. tax base.’’ H.R. Rep.
Code in mirror code possessions. Thus, related to tax administration in the No. 108–755, at 780 (2004). The U.S.
for example, gain that is treated as possessions, section 934 was modified income rule discussed above (see
income from sources outside the USVI and current section 931 was enacted section II.B. of this explanation) was
for purposes of section 934(b) under the (among other changes to the rules enacted in order to prevent such U.S.
special gain rules described above (in relating to the possessions). In so doing, tax avoidance.

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Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations 18927

Reflecting the concern that tax the U.S. income rule only applies for same $1,000 penalty under section 6688
benefits intended to foster economic income earned after December 31, 2004. will apply in cases of failure to file this
development in the possessions should In addition, the conduit rule applies form when required.
not be permitted to be used as a means only to amounts paid or accrued after
IV. Removal of Obsolete Regulations
to reduce U.S. taxes on income derived April 11, 2005. For taxable years
from U.S. economic activity, these beginning after December 31, 1986, and This document also removes certain
regulations incorporate the U.S. income ending before October 23, 2004, the regulations, and cross-references to such
rule of section 937(b)(2), as well as a principles of section 864(c) (including regulations, which became obsolete
conduit rule (as described above in section 864(c)(4)) remain applicable. with the enactment of the 1986 Act. The
section II.B. of this explanation) that is 1986 Act amendments that rendered
III. Information Reporting by Residents
intended to prevent the avoidance of the them obsolete were effective for tax
of a Possession
U.S. income rule. Accordingly, income years beginning after December 31,
from U.S. sources generally will not be Section 7654(e), as enacted by the 1986. For example, the regulations
considered possession ECI. 1972 Act and still applicable with promulgated by TD 6500, 25 FR 11910;
Section 937(b) also includes respect to section 935 possessions, TD 7283, 38 FR 20825; and TD 7385, 40
regulatory authority for the IRS and provides an express grant of authority FR 50260, relating to former section 931,
Treasury to provide exceptions to this for the IRS and Treasury to issue were rendered obsolete with the
rule. As noted above in section II.B. of regulations prescribing information enactment of the 1986 Act. Thus, such
this explanation, the legislative history reporting requirements for individuals regulations have no legal effect for
to the 2004 Act indicates that Congress to whom section 935 applies, as taxable years beginning after December
intended for Treasury and the IRS to use necessary to carry out the provisions of 31, 1986. See, e.g., Specking v.
this authority to continue the existing sections 935 and 7654. Section 7654(e), Commissioner, 117 T.C. 95 (2001), aff’d
treatment of income from the sale of as amended by the 1986 Act, provides sub nom. Umbach v. Commissioner, 357
goods manufactured in a possession. a similar express grant of authority for F. 3d 1108 (10th Cir. 2004).
Accordingly, these regulations provide the IRS and Treasury to issue
an exception from the U.S. income rule regulations prescribing information Special Analyses
for such income. In addition, the reporting requirements for individuals It has been determined that this
regulations provide that the U.S. income to whom sections 931 and 932 apply, as Treasury decision is not a significant
rule only applies for income earned necessary to carry out the provisions of regulatory action as defined in
after December 31, 2004. those sections and section 7654. The Executive Order 12866. Therefore, a
Apart from the U.S. income rule, penalty provided under section 6688, as regulatory assessment is not required. It
these regulations apply the same amended by the 2004 Act, for failure to also has been determined that section
principles for determining whether satisfy such reporting requirements is 553(b) of the Administrative Procedure
income is possession ECI as have $1,000. Act (5 U.S.C. chapter 5) does not apply
applied since the 1986 Act. See The 2004 Act supplemented this
to these regulations. For the
Francisco v. Commissioner, 119 T.C. general grant of authority with a specific
applicability of the Regulatory
317 (2002) aff’d, 370 F.3d 1228 (DC Cir. requirement under section 937(c) for
Flexibility Act (5 U.S.C. chapter 6) refer
2004) (principles of section 864(c)(4) information reporting by individuals
to the Special Analyses section of the
apply for determining whether U.S. who take the position for U.S. income
preamble to the cross-referencing notice
source income is possession ECI for U.S. tax reporting purposes that they became,
of proposed rulemaking published in
Federal income tax purposes). or ceased to be, bona fide residents of
the Proposed Rules section in this issue
The rules of section 937(b) and these Guam, American Samoa, the NMI,
of the Federal Register. Pursuant to
regulations generally apply for purposes Puerto Rico, or the USVI. For taxable
section 7805(f) of the Code, these
of all provisions of the Code for which years ending after October 22, 2004, as
well as for any of an individual’s temporary regulations will be submitted
a determination must be made regarding
preceding three taxable years, section to the Chief Counsel for Advocacy of the
whether income is possession ECI. They
937(c) requires that such individuals Small Business Administration for
generally do not apply, however, for
purposes of applying mirrored provide notice of their change in comment on their impact on small
provisions of the Code in mirror code residency. Thus, for calendar year business.
possessions. Thus, for example, U.S. taxpayers, such information reporting Drafting Information
source income that is treated as income generally is required if they changed
The principal authors of these
not effectively connected with the their residency to or from a possession
regulations are W. Edward Williams and
conduct of a trade or business within during 2001, 2002, 2003, or 2004 (or if
J. David Varley, Office of the Associate
the USVI for purposes of section 934(b) they do so in any future year).
Section 937(c) authorizes the IRS and Chief Counsel (International), IRS.
under the U.S. income rule described
Treasury to prescribe the time and However, other personnel from the IRS
above nonetheless may constitute
manner by which taxpayers are to and Treasury Department participated
income effectively connected with the
provide such notice. In early 2005, the in their development.
conduct of a trade or business within
the USVI for purposes of mirrored IRS will provide a form on which the List of Subjects
section 871 or 882. notice required by section 937(c) is to be
The 2004 Act provisions concerning made, as well as instructions specifying 26 CFR Part 1
the determination of whether income is the time and manner for filing the form. Income taxes, Reporting and
possession ECI generally apply to The IRS and Treasury anticipate issuing recordkeeping requirements.
taxable years ending after October 22, guidance that will provide appropriate
2004, except that the U.S. income rule exceptions to the general statutory rules 26 CFR Part 301
applies only to income earned after in order to minimize the reporting Employment taxes, Estate taxes,
October 22, 2004. The regulations burden on taxpayers. Reporting will not Excise taxes, Gift taxes, Income taxes,
generally adopt these effective dates, be required until the form and Penalties, Reporting and recordkeeping
except that the regulations provide that instructions are made available. The requirements.

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26 CFR Part 602 (relating to income from sources within sources within and without the United
Reporting and recordkeeping possessions of the UnitedStates), as in States shall generally be applied in
requirements. effect for taxable years beginning before determining the gross and the taxable
January 1, 1976, applied. income from sources within and
Amendments to the Regulations ■ Par. 5. In § 1.702–1, paragraph without a particular foreign country
■ Accordingly, 26 CFR parts 1, 301, and (c)(1)(iii) is revised to read as follows: when such a determination must be
602 are amended as follows: made under any provision of Subtitle A
§ 1.702–1 Income and credits of partner. of the Internal Revenue Code, including
PART 1—INCOME TAXES * * * * * section 952(a)(5). This section shall not
(c)(1) * * * apply, however, to the extent it is
■ Paragraph 1. The authority citation for (iii) In computing the amount of gross determined by applying § 1.863–3 that a
part 1 is amended by adding entries in income received from sources within portion of the taxable income is from
numerical order to read, in part, as possessions of the United States (section sources within the United States and the
follows: 937). balance of the taxable income is from
Authority: 26 U.S.C. 7805 * * * * * * * * sources within a foreign country. In the
Section 1.931–1T also issued under 26 application of this section, the name of
■ Par. 6. In § 1.861–3, paragraph (a)(2) is
U.S.C. 7654(e). the particular foreign country shall be
Section 1.932–1T also issued under 26 revised to read as follows:
used instead of the term United States,
U.S.C. 7654(e). § 1.861–3 Dividends. and the term domestic shall be
Section 1.935–1T also issued under 26
U.S.C. 7654(e). * * * * * * * * construed to mean created or organized
Section 1.937–1T also issued under 26 (a)(2) [Reserved]. For further in such foreign country. In applying
U.S.C. 937(a). guidance, see § 1.861–3T(a)(2). section 861 and the regulations
Section 1.937–2T also issued under 26 ■ Par. 7. Section 1.861–3T is added to thereunder for purposes of this section,
U.S.C. 937(b). read as follows: references to sections 243 and 245 shall
Section 1.937–3T also issued under 26 be excluded, and the exception in
U.S.C. 937(b). * * * § 1.861–3T Dividends (temporary). section 861(a)(3) shall not apply. In the
Section 1.957–3T also issued under 26 case of any item of income, the income
(a)(1) [Reserved]. For further
U.S.C. 957(c). * * * from sources within a foreign country
guidance, see § 1.861–3(a)(1).
■ Par. 2. In § 1.170A–1, paragraph (j)(9) (2) Dividend from a domestic shall not exceed the amount which, by
is revised to read as follows: corporation. A dividend described in applying any provision of sections 861
this paragraph (a)(2) is a dividend from through 863 and section 865 and the
§ 1.170A–1 Charitable, etc., contributions a domestic corporation other than a regulations thereunder without
and gifts; allowance of deduction. reference to this section, is treated as
corporation which has an election in
* * * * * effect under section 936. See paragraph income from sources without the United
(j)(9) [Reserved]. For further guidance (a)(5) of this section for the treatment of States. See § 1.937–2T for rules for
see § 1.170A–1T(j)(9). certain dividends from a DISC or former determining income from sources
* * * * * DISC. within a possession of the United States.
■ Par. 3. Section 1.170A–1T is added to (a)(3) through (c) [Reserved]. For ■ Par. 10. Section 1.871–1 is amended
read as follows: further guidance, see § 1.861–3(a)(3) by:
through (c). ■ 1. Removing paragraph (b)(6).
§ 1.170A–1T Charitable, etc., contributions (d) Effective date. This section shall ■ 2. Redesignating paragraph (b)(7) as
and gifts; allowance of deduction
apply for taxable years ending after (b)(6).
(temporary).
October 22, 2004. ■ Par. 11. Section 1.876–1 is revised to
(a) through (j)(8) [Reserved]. For read as follows:
■ Par. 8. In § 1.861–8, paragraphs
further guidance, see § 1.170A–1(a)
through (j)(8). (f)(1)(vi)(E), (F), and (H) are revised to § 1.876–1 Alien residents of Puerto Rico,
(j)(9) Charitable contributions paid by read as follows: Guam, American Samoa, or the Northern
bona fide residents of a section 931 Mariana Islands.
§ 1.861–8 Computation of taxable income
possession as defined in § 1.931– from sources within the United States and [Reserved]. For further guidance, see
1T(c)(1) or Puerto Rico are deductible from other sources and activities. § 1.876–1T.
only to the extent allocable to income * * * * * ■ Par. 12. Section 1.876–1T is added to
that is not excluded under section 931 (f) * * * read as follows:
or 933. For the rules for allocating (1) * * *
deductions for charitable contributions, § 1.876–1T Alien residents of Puerto Rico,
(vi) * * * Guam, American Samoa, or the Northern
see the regulations under section 861. (E) [Reserved]. Mariana Islands (temporary).
(j)(10) and (11) [Reserved]. For further (F) [Reserved].
guidance, see § 1.170–1(j)(10) and (11). (a) Scope. Section 876 and this
(k) Effective date. This section shall * * * * * section apply to any nonresident alien
apply for taxable years ending after (H) [Reserved]. individual who is a bona fide resident
October 22, 2004. * * * * * of Puerto Rico or of a section 931
■ Par. 4. In § 1.243–3, paragraph ■ Par. 9. Section 1.863–6 is revised to possession during the entire taxable
(a)(2)(iii) is revised to read as follows: read as follows: year.
(b) In general. An individual to whom
§ 1.243–3 Certain dividends from foreign § 1.863–6 Income from sources within a this section applies is, in accordance
corporations. foreign country. with the provisions of section 876,
* * * * * The principles applied in sections 861 subject to tax under sections 1 and 55
(a)(2) * * * through 863 and section 865 and the in generally the same manner as an
(iii) by a domestic corporation during regulations thereunder for determining alien resident of the United States. See
any period to which section 931 the gross and the taxable income from §§ 1.1–1(b) and 1.871–1. The tax

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generally is imposed upon the taxable principal place of abode in the United tax imposed by section 881(a) on U.S.
income of such individual, determined States. For example, the credits source dividends received is 10 percent
in accordance with section 63(a) and the provided by the following sections are (rather than the generally applicable 30
regulations thereunder, from sources not allowable against the tax determined percent).
both within and without the United in accordance with this section except (c) U.S.V.I. and section 931
States, except for amounts excluded to the extent otherwise provided under possessions. A corporation created or
from gross income under the provisions such sections— organized in, or under the law of, the
of section 931 or 933. For determining (i) Section 22 (relating to the credit for United States Virgin Islands or a section
the form of return to be used by such an the elderly and disabled); 931 possession is described in this
individual, see section 6012 and the (ii) Section 25A (relating to the Hope paragraph (c) for a taxable year when
regulations thereunder. Scholarship and Lifetime Learning the following conditions are satisfied—
(c) Exceptions. Though subject to the Credits); and (1) At all times during such taxable
tax imposed by section 1, an individual (iii) Section 32 (relating to the earned year, less than 25 percent in value of the
to whom this section applies shall income credit). stock of such corporation is beneficially
nevertheless be treated as a nonresident (e) Definitions. For purposes of this owned (directly or indirectly) by foreign
alien individual for the purpose of many section: persons;
provisions of the Internal Revenue Code (1) Bona fide resident is defined in (2) At least 65 percent of the gross
relating to nonresident alien § 1.937–1T. income of such corporation is shown to
individuals. Thus, for example, such an (2) Section 931 possession is defined the satisfaction of the Commissioner
individual is not allowed the standard in § 1.931–1T(c)(1). upon examination to be effectively
deduction (section 63(c)(6)); is subject to (f) Effective date. This section shall
connected with the conduct of a trade
withholding of tax at source under apply for taxable years ending after
or business in such a possession or the
chapter 3 of the Internal Revenue Code October 22, 2004.
United States for the 3-year period
(e.g., section 1441(e)); is generally ■ Par. 13. In § 1.881–1(c), revise the third
ending with the close of the taxable year
excepted from the collection of income and fourth sentences to read as follows: of such corporation (or for such part of
tax at source on wages for services such period as the corporation or any
performed in the possession (section § 1.881–1 Manner of taxing foreign
corporations. predecessor has been in existence); and
3401(a)(6)); is not allowed to make a (3) No substantial part of the income
joint return (section 6013(a)(1)); and, if * * * * *
(c) * * * The term foreign of such corporation for the taxable year
described in section 6072(c), must pay is used (directly or indirectly) to satisfy
his first installment of estimated income corporation has the meaning assigned to
it by section 7701(a)(3) and (5) and the obligations to persons who are not bona
tax on or before the 15th day of the 6th fide residents of such a possession or
month of the taxable year (section regulations thereunder. However, for
special rules relating to possessions of the United States.
6654(j) and (k)) and must pay his (d) Section 935 possessions. A
income tax on or before the 15th day of the United States, see § 1.881–5T.
* * * * * corporation created or organized in, or
the 6th month following the close of the under the law of, a section 935
taxable year (sections 6072(c) and ■ Par. 14. Section 1.881–5T is added to
possession is described in this
6151(a)). In addition, under section read as follows: paragraph (d) for a taxable year when
152(b)(3), an individual is not allowed the following conditions are satisfied—
a deduction for a dependent who is a § 1.881–5T Exception for certain
possessions corporations (temporary). (1) At all times during such taxable
resident of the relevant possession year, less than 25 percent in value of the
unless the dependent is a citizen or (a) Scope. Section 881(b) and this
section provide special rules for the stock of such corporation is owned
national of the United States. (directly or indirectly) by foreign
(d) Credits against tax—(1) Certain application of sections 881 and 884 to
certain corporations created or persons; and
credits under the Internal Revenue Code
organized in possessions of the United (2) At least 20 percent of the gross
are available to any taxpayer subject to
States. Paragraph (g) of this section income of such corporation is shown to
the tax imposed by section 1, including
provides special rules for the the satisfaction of the Commissioner
individuals to whom this section
application of sections 881 and 884 to upon examination to have been derived
applies. For example, except as
corporations created or organized in the from sources within such possession for
otherwise provided under section 931 or
United States for purposes of the 3-year period ending with the close
933, the credits provided by the
determining tax liability incurred to of the preceding taxable year of such
following sections are allowable to the
certain possessions that administer corporation(or for such part of such
extent provided under such sections
income tax laws that are identical period as the corporation has been in
against the tax determined in
(except for the substitution of the name existence).
accordance with this section—
(i) Section 23 (relating to the credit for of the possession for the term United (e) Puerto Rico. A corporation created
adoption expenses); States where appropriate) to those in or organized in, or under the law of,
(ii) Section 31 (relating to the credit force in the United States. See § 1.884- Puerto Rico is described in this
for tax withheld on wages); 0T(b) for special rules relating to the paragraph (e) for a taxable year when
(iii) Section 33 (relating to the credit application of section 884 with respect the conditions of paragraphs (c)(1)
for tax withheld at source on to possessions of the United States. through (3) are satisfied(using the
nonresident aliens); and (b) Operative rules. (1) Corporations language ‘‘Puerto Rico’’ instead of ‘‘such
(iv) Section 34 (relating to the credit described in paragraphs (c) and (d) of a possession’’).
for certain uses of gasoline and special this section are not treated as foreign (f) Definitions and other rules. For
fuels). corporations for purposes of section purposes of this section:
(2) Certain credits under the Internal 881. Accordingly, they are exempt from (1) Section 931 possession is defined
Revenue Code are not available to the tax imposed by section 881(a). in § 1.931–1T(c)(1).
nonresident aliens or are subject to (2) For corporations described in (2) Section 935 possession is defined
limitations based on such factors as paragraph (e) of this section, the rate of in § 1.935–1T(a)(3)(i).

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(3) Foreign person means any person satisfied, because 26 percent of X is owned (g) [Reserved]. For further guidance,
other than— indirectly by foreign persons (A, B, and C). see § 1.901–1T(g).
(i) A United States person (as defined Accordingly, X is treated as a foreign
corporation for purposes of section 881. * * * * *
in section 7701(a)(30) and the ■ Par. 18. Section 1.901–1T is added to
regulations thereunder); or (i) Effective dates. Except as provided read as follows:
(ii) A person who would be a United in this paragraph (i), this section applies
States person if references to the United to payments made after April 11, 2005. § 1.901–1T Allowance of credit for taxes
States in section 7701 included The rules of paragraphs (b)(2) and (e) (temporary).
references to a possession of the United apply to dividends paid after October (a) through (f) [Reserved]. For further
States. 22, 2004. However, if, on or after guidance, see § 1.901–1(a) through (f).
(4) Bona fide resident— October 22, 2004, an increase in the rate (g) Taxpayers to whom credit not
(i) With respect to a possession, is of the Commonwealth of Puerto Rico’s allowed. Among those to whom the
defined in § 1.937–1T; and withholding tax which is generally credit for taxes is not allowed are the
(ii) With respect to the United States, applicable to dividends paid to United following—
means an individual who is a citizen or States corporations not engaged in a (1) Except as provided in section 906,
resident of the United States and who trade or business in the Commonwealth a foreign corporation;
does not have a tax home (as defined in to a rate greater than 10 percent takes (2) Except as provided in section 906,
section 911(d)(3)) in a foreign country. effect, the rules of paragraphs (b)(2) and a nonresident alien individual who is
(5) Source. The rules of § 1.937–2T (e) shall not apply to dividends received not described in section 876 (see
shall apply for determining whether on or after the effective date of the sections 874(c) and 901(b)(4));
income is from sources within a increase. (3) A nonresident alien individual
possession. described in section 876 other than a
■ Par. 15. In § 1.884–0, paragraph (b) is
(6) Effectively connected income. The bona fide resident (as defined in section
redesignated as paragraph (c), and a new
rules of § 1.937–3T (other than 937(a) and the regulations thereunder)
paragraph (b) is added.
paragraph (c) of that section) shall apply of Puerto Rico during the entire taxable
for determining whether income is The addition reads as follows: year (see sections 901(b)(3) and (4)); and
effectively connected with the conduct § 1.884–0 Overview of regulation (4) A U.S. citizen or resident alien
of a trade or business in a possession. provisions for section 884. individual who is a bona fide resident
(7) Indirect ownership. The rules of * * * * * of a section 931 possession (as defined
section 318(a)(2) shall apply except that in § 1.931–1T(c)(1)), the U.S. Virgin
(b) Special rules for U.S. possessions.
the language ‘‘5 percent’’ shall be used Islands, or Puerto Rico, and who
[Reserved]. For further guidance, see
instead of ‘‘50 percent’’ in section excludes certain income from U.S. gross
§ 1.884–0T(b).
318(a)(2)(C). income to the extent of taxes allocable
(g) Mirror code jurisdictions. For * * * * * to the income so excluded (see sections
purposes of applying mirrored section ■ Par. 16. Section 1.884–0T is added as 931(b)(2), 933(1), and 932(c)(4)).
881 to determine tax liability incurred follows. (h) [Reserved]. For further guidance,
to a section 935 possession or the see § 1.901–1(h).
§ 1.884–0T Overview of regulation (i) [Reserved]. For further guidance,
United States Virgin Islands— provisions for section 884 (temporary).
(1) The rules of paragraphs (b) see § 1.901–1(i).
through (d) of this section shall not (a) [Reserved]. For further guidance, (j) Effective date. This section shall
apply; and see § 1.884–0(a). apply for taxable years ending after
(2) A corporation created or organized (b) Special rules for U.S. possessions. October 22, 2004.
in, or under the law of, such possession (1) Section 884 does not apply to a ■ Par. 19. Section 1.931–1 is revised to
or the United States shall not be corporation created or organized in, or read as follows:
considered a foreign corporation. under the law of, American Samoa,
Guam, the Northern Mariana Islands, or § 1.931–1 Exclusion of certain income
(h) Example. The principles of this
the United States Virgin Islands, from sources within Guam, American
section are illustrated by the following Samoa, or the Northern Mariana Islands.
example: provided that the conditions of § 1.881–
5T(c)(1) through (3) are satisfied with [Reserved]. For further guidance, see
Example 1. X is a corporation organized § 1.931–1T.
under the law of the United States Virgin respect to such corporation. The
preceding sentence applies for taxable ■ Par. 20. Section 1.931–1T is added to
Islands (USVI) with a branch located in State
F. At least 65 percent of the gross income of years ending after April 11, 2005. read as follows:
X is effectively connected with the conduct (2) Section 884 does not apply for § 1.931–1T Exclusion of certain income
of a trade or business in the USVI and no purposes of determining tax liability from sources within Guam, American
substantial part of the income of X for the incurred to a section 935 possession or Samoa, or the Northern Mariana Islands
taxable year is used to satisfy obligations to the United States Virgin Islands by a (temporary).
persons who are not bona fide residents of
the United States or the USVI. Seventy-four
corporation created or organized in, or (a) General rule. (1) An individual
percent of the stock of X is owned by under the law of, such possession or the (whether a United States citizen or an
unrelated individuals who are residents of United States. The preceding sentence alien), who is a bona fide resident of a
the United States or the USVI. Y, a applies for taxable years ending after section 931 possession during the entire
corporation organized under the law of State April 11, 2005. taxable year, shall exclude from gross
D, and Z, a partnership organized under the (c) [Reserved]. For further guidance, income the income derived from
law of State F, each own 13 percent of the see § 1.884–0(c). sources within any section 931
stock of X. A, an unrelated foreign
individual, owns 100 percent of the stock of ■ Par. 17. In § 1.901–1, paragraph (g) is possession and the income effectively
corporation Y. B and C, unrelated foreign revised to read as follows: connected with the conduct of a trade
individuals, each own a 50 percent interest or business by such individual within
in partnership Z. Thus, the condition of § 1.901–1 Allowance of credit for taxes. any section 931 possession, except
paragraph (c)(1) of this section is not * * * * * amounts received for services performed

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as an employee of the United States or ■ Par. 21. Section 1.932–1 is revised to the taxable year shall pay the applicable
any agency thereof. read as follows: percentage of the taxes imposed by this
(2) The following example illustrates chapter for such taxable year
§ 1.932–1 Coordination of United States
the application of the general rule in (determined without regard to
and Virgin Islands income taxes.
paragraph (a)(1) of this section: paragraph (b)(2)(ii) of this section) to the
[Reserved]. For further guidance, see Virgin Islands.
Example. D, a United States citizen, files § 1.932–1T.
returns on a calendar year basis. In April (ii) There shall be allowed as a credit
■ Par. 22. Section 1.932–1T is added to against the tax imposed by this chapter
2005, D moves to American Samoa,
purchases a house, and accepts a permanent read as follows: for the taxable year an amount equal to
position with a local employer. For the § 1.932–1T Coordination of United States the taxes required to be paid to the
remainder of the year and throughout 2006, and Virgin Islands income taxes Virgin Islands under paragraph (b)(2)(i)
D continues to live and work in American (temporary). of this section which are so paid. Such
Samoa, and establishes a closer connection to taxes shall be considered creditable in
American Samoa than to the United States or (a) Scope—(1) In general. Section 932
any foreign country. In September 2007, as a and this section set forth the special the same manner as taxes paid to the
result of the termination of his employment rules relating to the filing of income tax United States (e.g., under section 31)
in American Samoa, D sells his house and returns and income tax liabilities of and not as taxes paid to a foreign
moves to State H. D is entitled to the individuals described in paragraph government (e.g., under sections 27 and
exclusion provided in section 931 for 2006, (a)(2) of this section. Paragraph (h) of 901).
but not for 2005 or 2007 (assuming that this section also provides special rules (iii) For purposes of this paragraph
during the first quarter of 2005 and the last requiring consistent treatment of (b)(2):
quarter of 2007, D has a tax home outside of business entities in the United States (A) The term applicable percentage
American Samoa or a closer connection to
and in the United States Virgin Islands means the percentage which Virgin
the United States or a foreign country).
(Virgin Islands). Islands adjusted gross income bears to
(b) Deductions and credits. In any (2) Individuals covered. This section adjusted gross income.
case in which any amount otherwise shall apply to any individual who: (B) The term Virgin Islands adjusted
constituting gross income is excluded (i) Is a bona fide resident of the Virgin gross income means adjusted gross
from gross income under the provisions Islands during the entire taxable year; income determined by taking into
of section 931, there shall not be (ii)(A) Is a citizen or resident of the account only income derived from
allowed as a deduction from gross United States (other than a bona fide sources within the Virgin Islands and
income any items of expenses or losses resident of the Virgin Islands) during deductions properly apportioned or
or other deductions (except the the entire taxable year; and allocable thereto. For purposes of the
deduction under section 151, relating to (B) Has income derived from sources preceding sentence, the rules of § 1.861–
personal exemptions), or any credit, within the Virgin Islands, or effectively 8 shall apply.
properly allocable to, or chargeable connected with the conduct of a trade (C) Pursuant to § 1.937–2T(a), the
against, the amounts so excluded from or business within the Virgin Islands, rules of § 1.937–2T(c)(1)(ii) and (c)(2) do
gross income. For purposes of the for the taxable year; or not apply.
preceding sentence, the rules of § 1.861– (iii) Files a joint return for the taxable (c) Bona fide residents of the Virgin
8 shall apply (with creditable year with any individual described in Islands. Subject to paragraph (d) of this
expenditures treated in the same paragraph (a)(2)(i) or (ii) of this section. section, an individual described in
manner as deductible expenditures). (3) Definitions. For purposes of this
paragraph (a)(2)(i) of this section shall
(c) Definitions. For purposes of this section:
(i) The rules of § 1.937–1T shall apply be subject to the following income tax
section: return filing requirements:
for determining whether an individual
(1) The term section 931 possession (1) V.I. filing requirements. An
is a bona fide resident of the Virgin
means a possession that is a specified individual to whom this paragraph (c)
Islands.
possession and that has entered into an (ii) The rules of § 1.937–2T shall applies shall file an income tax return
implementing agreement, as described apply for determining whether income for the taxable year with the Virgin
in section 1271(b) of the Tax Reform Act is from sources within the Virgin Islands. On this return, the individual
of 1986 (Public Law 99–514 (100 Stat. Islands. shall report income from all sources and
2085)), with the United States that is in (iii) The rules of § 1.937–3T shall identify the source of each item of
effect for the entire taxable year. apply for determining whether income income shown on the return.
(2) The term specified possession is effectively connected with the (2) U.S. filing requirements. For
means Guam, American Samoa, or the conduct of a trade or business within purposes of calculating the income tax
Northern Mariana Islands. the Virgin Islands. liability to the United States of an
(3) The rules of § 1.937–1T shall apply (b) U.S. individuals with V.I. individual to whom this paragraph (c)
for determining whether an individual income—(1) Dual filing requirement. applies, gross income shall not include
is a bona fide resident of a section 931 Subject to paragraph (d) of this section, any amount included in gross income
possession. an individual described in paragraph on the return filed with the Virgin
(4) The rules of § 1.937–2T shall apply (a)(2)(ii) of this section shall make an Islands pursuant to paragraph (c)(1) of
for determining whether income is from income tax return for the taxable year to this section, and deductions and credits
sources within a section 931 possession. the United States and file a copy of such allocable to such income shall not be
(5) The rules of § 1.937–3T shall apply return with the Virgin Islands. Such taken into account, provided that—
for determining whether income is individuals must also attach Form 8689, (i) The individual fully satisfied the
effectively connected with the conduct ‘‘Allocation of Individual Income Tax to reporting requirements of paragraph
of a trade or business within a section the Virgin Islands,’’ to the U.S. income (c)(1) of this section; and
931 possession. tax return and to the income tax return (ii) The individual fully paid the tax
(d) Effective date. This section shall filed with the Virgin Islands. liability referred to in section 934(a) to
apply for taxable years ending after (2) Tax payments. (i) Each individual the Virgin Islands with respect to such
October 22, 2004. to whom this paragraph (b) applies for income.

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(d) Joint returns. In the case of under the rules of paragraph (b) or (c) for purposes of determining whether a
married persons, if one or both spouses of this section. corporation created or organized in the
is an individual described in paragraph (ii) The term single filing taxpayer Virgin Islands may make an election
(a)(2) of this section and they file a joint means a taxpayer who is required to file under section 1362(a) to be a subchapter
return of income tax, the spouses shall a return only with the United States S corporation, it shall be treated as a
file their joint return with, and pay the (because the individual is not described domestic corporation and a shareholder
tax due on such return to, the in paragraph (a)(2) of this section) or to whom section 932(a) applies shall not
jurisdiction (or jurisdictions) where the only with the Virgin Islands (because be treated as a nonresident alien
spouse who has the greater adjusted the individual is described in paragraph individual with respect to such
gross income for the taxable year would (a)(2)(i) of this section and satisfies the corporation. While such an election is
be required under paragraph (b) or (c) of conditions of paragraphs (c)(2)(i) and (ii) in effect, the corporation shall be treated
this section to file a return if separate of this section) for the taxable year. as a domestic corporation for all
returns were filed and all of their (iii) The term tax accounting purposes of the Internal Revenue Code.
income were the income of such spouse. standards includes the taxpayer’s For the consistency requirement with
For this purpose, adjusted gross income accounting period, methods of respect to entity status elections, see
of each spouse is determined under accounting, and any election to which paragraph (h) of this section.
section 62 and the regulations the taxpayer is bound with respect to (D) The treatment of items carried
thereunder but without regard to the reporting of taxable income. over from other tax years. Thus, for
community property laws; and, if one of (g) Extension of territory—(1) Section example, if an individual to whom
the spouses dies, the taxable year of the 932(a) taxpayers—(i) General rule. With section 932(a) applies has for a taxable
surviving spouse shall be treated as respect to an individual to whom year a net operating loss carryback or
ending on the date of such death. section 932(a) applies for a taxable year, carryover under section 172, a foreign
for purposes of taxes imposed by tax credit carryback or carryover under
(e) Place for filing returns—(1) U.S.
Chapter 1 of the Internal Revenue Code, section 904, a business credit carryback
returns. A return required under the
the United States generally shall be or carryover under section 39, a capital
rules of paragraphs (b) and (c) of this
treated, in a geographical and loss carryover under section 1212, or a
section to be filed with the United
governmental sense, as including the charitable contributions carryover under
States shall be filed as directed in the
Virgin Islands. The purpose of this rule section 170, the carryback or carryover
applicable forms and instructions.
is to facilitate the coordination of the tax will be reported on the return filed in
(2) V.I. returns. A return required systems of the United States and the
under the rules of paragraphs (b) and (c) accordance with paragraph (b)(1) of this
Virgin Islands. Accordingly, the rule section, even though the return of the
of this section to be filed with the Virgin will have no effect where it is taxpayer for the taxable year giving rise
Islands shall be filed as directed in the manifestly inapplicable or its to the carryback or carryover was
applicable forms and instructions. application would be incompatible with required to be filed with the Virgin
(f) Tax accounting standards—(1) In the intent of any provision of the Islands under section 932(c).
general. A dual filing taxpayer must use Internal Revenue Code. (E) The treatment of property
the same tax accounting standards on (ii) Application of general rule. exchanged for property of a like kind
the returns filed with the United States Contexts in which the general rule of (section 1031). Thus, for example, if an
and the Virgin Islands. A taxpayer who paragraph (g)(1)(i) of this section apply individual to whom section 932(a)
has filed a return only with the United include: applies exchanges real property located
States or only with the Virgin Islands as (A) The characterization of taxes paid in the United States for real property
a single filing taxpayer for a prior to the Virgin Islands. An individual to located in the Virgin Islands,
taxable year and is required to file a whom section 932(a) applies may take notwithstanding the provisions of
return only with the other jurisdiction income tax required to be paid to the section 1031(h), such exchange may
as a single filing taxpayer for a later Virgin Islands under section 932(b) into qualify as a like-kind exchange under
taxable year may not, for such later account under sections 31, 6315, and section 1031 (provided that all the other
taxable year, use different tax 6402(b) as payments to the United requirements of section 1031 are
accounting standards unless the second States. Taxes paid to the Virgin Islands satisfied).
jurisdiction consents to such change. and otherwise satisfying the (iii) Nonapplication of the general
However, such change will not be requirements of section 164(a) will be rule. Contexts in which the general rule
effective for returns filed thereafter with allowed as a deduction under that of paragraph (g)(1)(i) of this section does
the first jurisdiction unless before such section, but income taxes required to be not apply include:
later date of filing the taxpayer also paid to the Virgin Islands under section (A) The application of any rules or
obtains the consent of the first 932(b) will be disallowed as a deduction regulations that explicitly treat the
jurisdiction to make such change. Any under section 275(a). United States and any (or all) of its
request for consent to make a change (B) The determination of the source of possessions as separate jurisdictions
pursuant to this paragraph (f) must be income for purposes of the foreign tax (e.g., sections 931 through 937, 7651,
made to the office where the return is credit (e.g., sections 901 through 904). and 7654).
required to be filed under paragraph (e) Thus, for example, after an individual to (B) The determination of any aspect of
of this section and in sufficient time to whom section 932(a) applies determines an individual’s residency (e.g., sections
permit a copy of the consent to be which items of income constitute 937(a) and 7701(b)). Thus, for example,
attached to the return for the taxable income from sources within the Virgin an individual whose principal place of
year. Islands under the rules of section abode is in the Virgin Islands is not
(2) Definitions. For purposes of this 937(b), such income shall be treated as considered to have a principal place of
paragraph (f): income from sources within the United abode in the United States for purposes
(i) The term dual filing taxpayer States for purposes of section 904. of section 32(c).
means a taxpayer who is required to file (C) The eligibility of a corporation to (C) The characterization of a
returns with the United States and the make a subchapter S election (sections corporation for purposes other than
Virgin Islands for the same taxable year 1361 through 1379). Thus, for example, subchapter S (e.g., sections 367, 951

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through 964, 1291 through 1298, 6038, individual with respect to such constitute services performed in the
and 6038B). Thus, for example, if an corporation. While such an election is Virgin Islands under mirrored section
individual to whom section 932(a) in effect, the corporation shall be treated 3401(a)(8).
applies transfers appreciated tangible as a domestic corporation for all (h) Entity status consistency
property to a corporation created or purposes of the territorial income tax. requirement—(1) In general. Taxpayers
organized in the Virgin Islands in a For the consistency requirement with should make consistent entity status
transaction described in section 351, he respect to entity status elections, see elections (as defined in paragraph (h)(3)
or she must recognize gain unless an paragraph (h) of this section. of this section), where applicable, in
exception under section 367(a) applies. (D) The treatment of items carried both the United States and the Virgin
Also, if a corporation created or over from other tax years. Thus, for Islands. In the case of a business entity
organized in the Virgin Islands qualifies example, if an individual to whom to which this paragraph (h) applies:
as a passive foreign investment section 932(c) applies has for a taxable (i) If an entity status election is filed
company under sections 1297 and 1298 year a net operating loss carryback or with the Internal Revenue Service but
with respect to an individual to whom carryover under mirrored section 172, a not with the Virgin Islands Bureau of
section 932(a) applies, a dividend paid foreign tax credit carryback or carryover Internal Revenue (BIR), the Director of
to such shareholder does not constitute under mirrored section 904, a business the BIR or his delegate, at his discretion,
qualified dividend income under credit carryback or carryover under may deem the election also to have been
section 1(h)(11)(B). mirrored section 39, a capital loss made for Virgin Islands tax purposes.
(2) Section 932(c) taxpayers—(i) carryover under mirrored section 1212, (ii) If an entity status election is filed
General rule. With respect to an or a charitable contributions carryover with the BIR but not with the Internal
individual to whom section 932(c) under mirrored section 170, the Revenue Service, the Commissioner, at
applies for a taxable year, for purposes carryback or carryover will be reported his discretion, may deem the election
of the territorial income tax of the Virgin on the return filed in accordance with also to have been made for U.S. Federal
Islands (i.e., mirrored sections of the paragraph (c)(1) of this section, even tax purposes.
Internal Revenue Code), the Virgin though the return of the taxpayer for the (iii) If inconsistent entity status
Islands generally shall be treated, in a taxable year giving rise to the carryback elections are filed with the BIR and the
geographical and governmental sense, as or carryover was required to be filed Internal Revenue Service, both the
including the United States. The with the United States. Commissioner and the Director of the
purpose of this rule is to facilitate the (E) The treatment of property BIR or his delegate may, at their
coordination of the tax systems of the exchanged for property of a like kind individual discretion, treat the elections
United States and the Virgin Islands. (mirrored section 1031). Thus, for they each received as invalid and may
Accordingly, the rule will have no effect example, if an individual to whom deem the election filed in the other
where it is manifestly inapplicable or its section 932(c) applies exchanges real jurisdiction to have been made also for
application would be incompatible with property located in the United States for tax purposes in their own jurisdiction.
the intent of any provision of the real property located in the Virgin (See Rev. Proc. 89–8 (1989–1 C.B. 778)
Internal Revenue Code. Islands, notwithstanding the provisions for procedures for requesting the
(ii) Application of general rule. of mirrored section 1031(h), such assistance of the Internal Revenue
Contexts in which the general rule of exchange may qualify as a like-kind Service when a taxpayer is or may be
paragraph (g)(2)(i) of this section apply exchange under mirrored section 1031 subject to inconsistent tax treatment by
include: (provided that all the other the Internal Revenue Service and a U.S.
(A) The characterization of taxes paid requirements of mirrored section 1031 possession tax agency.)
to the United States. A taxpayer are satisfied). (2) Scope. This paragraph (h) applies
described in section 932(c)(1) may take (iii) Nonapplication of general rule. to the following business entities:
income tax paid to the United States Contexts in which the general rule of (i) A business entity (as defined in
into account under mirrored sections paragraph (g)(2)(i) of this section does § 301.7701–2(a) of this chapter) that is
31, 6315, and 6402(b) as payments to not apply include: domestic (as defined in § 301.7701–5 of
the Virgin Islands. (A) The determination of any aspect this chapter), or otherwise treated as
(B) The determination of the source of of an individual’s residency (e.g., domestic for purposes of the Internal
income for purposes of the foreign tax mirrored section 7701(b)). Thus, for Revenue Code, and that is owned in
credit (e.g., mirrored sections 901 example, an individual whose principal whole or in part by any person who is
through 904). Thus, for example, any place of abode is in the United States is either a bona fide resident of the Virgin
item of income that constitutes income not considered to have a principal place Islands or a business entity created or
from sources within the United States of abode in the Virgin Islands for organized in the Virgin Islands.
under the rules of sections 861 through purposes of mirrored section 32(c). (ii) A business entity that is created or
865 shall be treated as income from (B) The determination of the source of organized in the Virgin Islands and that
sources within the Virgin Islands for income for purposes other than the is owned in whole or in part by any U.S.
purposes of mirrored section 904. foreign tax credit (e.g., sections 932(a) person (other than a bona fide resident
(C) The eligibility of a corporation to and (b), 934(b), and 937). Thus, for of the Virgin Islands).
make a subchapter S election (mirrored example, compensation for services (3) Definition. For purposes of this
sections 1361 through 1379). Thus, for performed in the United States and section, the term entity status election
example, for purposes of determining rentals or royalties from property includes an election under § 301.7701–
whether a corporation created or located in the United States do not 3(c) of this chapter, an election under
organized in the United States may constitute income from sources within section 1362(a), and any other similar
make an election under mirrored section the Virgin Islands for purposes of elections.
1362(a) to be a subchapter S section 934(b). (4) Default status. Solely for the
corporation, it shall be treated as a (C) The definition of wages (mirrored purpose of determining classification of
domestic corporation and a shareholder section 3401). Thus, for example, an eligible entity under § 301.7701–3(b),
to whom section 932(c) applies shall not services performed by an employee for and § 301.7701–3(b) as mirrored in the
be treated as a nonresident alien an employer in the United States do not Virgin Islands, an eligible entity subject

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18934 Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations

to this paragraph (h) shall be classified Example 2. B, a U.S. citizen, files returns services performed in the USVI in the
for both U.S. Federal and Virgin Islands on a calendar year basis. In April 2005, B amount of $40x. J prepares and files an
tax purposes using the rule that applies moves to the U.S. Virgin Islands (USVI), Individual Income Tax Return, Form 1040,
purchases a house, and accepts a permanent with the USVI and reports gross income of
to domestic eligible entities.
position with a local employer. For the only $30x. J has not satisfied the conditions
(5) Transition rules—(i) In the case of remainder of the year and throughout 2006, of section 932(c)(4) and paragraph (c) of this
an election filed prior to April 11, 2005, B continues to live and work in the USVI, section for an exclusion from gross income
except as provided in paragraph and establishes a closer connection to the for U.S. Federal income tax purposes and,
(h)(5)(ii) of this section, the rules of USVI than to the United States or any foreign therefore, must file a Federal income tax
paragraph (h)(1) of this section shall country. In September 2007, as a result of the return in accordance with the Internal
apply as of the first day of the first termination of his employment in the USVI, Revenue Code and the regulations.
taxable year of the entity beginning after B sells his house and moves to State G. As Example 6. (i) N is a U.S. citizen and a
April 11, 2005. a consequence of his employment in the bona fide resident of the U.S. Virgin Islands.
USVI, B earns income from the performance In 2004, N receives compensation for services
(ii) In the unlikely circumstance that
of services in the USVI from April 2005 performed in Country M. N prepares and files
inconsistent elections described in through September 2007. Section 932(c) and an Individual Income Tax Return, Form
paragraph (h)(1)(iii) are filed prior to paragraph (c) of this section apply to B for 1040, with the USVI and reports the
April 11, 2005, and the entity cannot 2006, but not for 2005 or 2007 (assuming that compensation as income effectively
change its classification to achieve during the first quarter of 2005 and the last connected with the conduct of a trade or
consistency because of the sixty-month quarter of 2007, B has a tax home outside of business in the USVI. N claims a special
limitation described in § 301.7701– the USVI or a closer connection to the United credit against the tax on this compensation
3(c)(1)(iv) of this chapter, then the entity States or a foreign country). For 2005 and purportedly pursuant to a USVI law enacted
may nevertheless request permission 2007, B is subject to the rules of sections within the limits of its authority under
932(a) and (b) and paragraph (b) of this section 934.
from the Commissioner or the Director
section because he has income derived from (ii) Under the principles of section
of the BIR or his delegate to change such sources within the USVI as determined under 864(c)(4) as applied pursuant to section
election to avoid inconsistent treatment the rules of section 937(b) and § 1.937–2T. 937(b)(1) and § 1.937-3T(b), compensation for
by the Commissioner and the Director of Example 3. H and W are U.S. citizens. H services performed outside the USVI may not
the BIR or his delegate. resides in State T and W is a bona fide be treated as income effectively connected
(iii) Except as provided in paragraphs resident of the U.S. Virgin Islands (USVI). with the conduct of a trade or business in the
(h)(5)(i) and (h)(5)(ii) of this section, in For 2004, H and W prepare a joint Individual USVI for purposes of section 934(b).
the case of an election filed with respect Income Tax Return, Form 1040, which Consequently, N is not entitled to claim the
to an entity before it became an entity reports total adjusted gross income of $75x of special credit under USVI law with respect
described in paragraph (h)(2) of this which $40x is attributable to compensation to N’s income from services performed in
that W received for services performed in the Country M. Given that N has not fully paid
section, the rules of paragraph (h)(1) of USVI and $35x to compensation that H his tax liability referred to in section 934(a),
this section shall apply as of the first received for services performed in State T. he has not satisfied the conditions of section
day that such entity is described in Pursuant to section 932(d) and paragraph (d) 932(c)(4) and paragraph (c) of this section for
paragraph (h)(2) of this section. of this section, the joint income tax return of an exclusion from gross income for U.S.
(iv) In the case of an entity created or H and W is filed with the USVI as required Federal income tax purposes. Accordingly, N
organized prior to April 11, 2005, by section 932(c) and paragraph (c) of this must file a Federal income tax return in
paragraph (h)(4) of this section shall section. H and W may claim a tax credit on accordance with the Internal Revenue Code
take effect for U.S. Federal income tax such return for income tax withheld during and the regulations.
purposes (or Virgin Islands income tax 2004 and paid to the Internal Revenue (j) Effective date. This section shall
Service.
purposes, as the case may be) as of the apply for taxable years ending after
first day of the first taxable year of the Example 4. (i) The facts are the same as in October 22, 2004.
example 3, except that H also earns $25x for
entity beginning after April 11, 2005. ■ Par. 23. Section 1.933–1 is amended by
services performed in the USVI, so that H
(i) Examples. The rules of this section and W’s total adjusted gross income is $100x, revising paragraphs (a) and (c) and
are illustrated by the following and their total income tax liability is $20x. adding paragraphs (d) and (e) to read as
examples: (ii) Pursuant to section 932(d) and follows:
Example 1. (i) A is a U.S. citizen who paragraph (d) of this section, H and W must
file a copy of their joint Federal Form 1040 § 1.933–1 Exclusion of certain income
resides in State R. The Federal Individual
with the Bureau of Internal Revenue of the from sources within Puerto Rico.
Income Tax Return, Form 1040, that A
prepares for 2004 reports adjusted gross USVI as required by section 932(a)(2) and (a) [Reserved]. For further guidance,
income of $90x, including $30x from sources paragraph (b)(1) of this section, and pay the see § 1.933–1T(a).
in the U.S. Virgin Islands (USVI). The income applicable percentage of their Federal income * * * * *
tax liability reported on A’s Form 1040 is tax liability to the USVI as required by
(c) [Reserved]. For further guidance,
$18x. A files a copy of his Federal Form 1040 section 932(b) and paragraph (b)(2) of this
section, computed as follows: see § 1.933–1T(c).
with the USVI Bureau of Internal Revenue as (d) [Reserved]. For further guidance,
required by section 932(a)(2) and paragraph 65/100 × 20x = $13x income tax liability to
see § 1.933–1T(d).
(b)(1) of this section, and pays the applicable the USVI
percentage of his Federal income tax liability
(e) [Reserved]. For further guidance,
(iii) H and W claim a credit against their see § 1.933–1T(e).
to the USVI as required by section 932(b) and Federal income tax liability reported on the
paragraph (b)(2) of this section, computed as Form 1040 in the amount of $13x, the portion ■ Par. 24. Section 1.933–1T is added to
follows: of their Federal income tax liability required read as follows:
30/90 × 18x = $6x income tax liability to the to be paid to the USVI. H and W attach a
§ 1.933–1T Exclusion of certain income
USVI Form 8689, ‘‘Allocation of Individual Income
from sources within Puerto Rico
(ii) A claims a credit against his Federal Tax to the Virgin Islands,’’ to the Form 1040
(temporary).
income tax liability reported on his Form filed with the Internal Revenue Service and
1040 in the amount of $6x. A attaches a Form to the copy of the Form 1040 filed with the (a) General rule—(1) An individual
8689, ‘‘Allocation of Individual Income Tax USVI. (whether a United States citizen or an
to the Virgin Islands,’’ to the Form 1040 filed Example 5. J is a U.S. citizen and a bona alien), who is a bona fide resident of
with the Internal Revenue Service and to the fide resident of the U.S. Virgin Islands Puerto Rico during the entire taxable
copy of the Form 1040 filed with the USVI. (USVI). In 2005, J receives compensation for year, shall exclude from gross income

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the income derived from sources within § 1.934–1T Limitation on reduction in (D) Subtract the portion of any credit
Puerto Rico, except amounts received income tax liability incurred to the Virgin allowed under mirrored section 901
for services performed as an employee Islands (temporary). (other than credits for taxes paid to the
of the United States or any agency (a) General rule. Section 934(a) United States) determined by
thereof. provides that tax liability incurred to multiplying the amount of taxable
the United States Virgin Islands (Virgin income from sources outside the Virgin
(2) The following example illustrates
Islands) shall not be reduced or remitted Islands or the United States that is
the application of the general rule in
in any way, directly or indirectly, effectively connected to the conduct of
paragraph (a)(1) of this section:
whether by grant, subsidy, or other a trade or business in the Virgin Islands
Example. E, a United States citizen, files similar payment, by any law enacted in
returns on a calendar year basis. In April
divided by the total amount of taxable
the Virgin Islands, except to the extent income from such sources.
2005, E moves to Puerto Rico, purchases a provided in section 934(b). For purposes
house, and accepts a permanent position (ii) Limitation. Tax liability incurred
with a local employer. For the remainder of
of the preceding sentence, the term ‘‘tax to the Virgin Islands attributable to
the year and throughout 2006, E continues to liability’’ means the liability incurred to income derived from sources within the
live and work in Puerto Rico, and establishes the Virgin Islands pursuant to subtitle A Virgin Islands or income effectively
a closer connection to Puerto Rico than to the of the Internal Revenue Code, as made connected with the conduct of a trade
United States or any foreign country. In applicable in the Virgin Islands by the or business within the Virgin Islands, as
September 2007, as a result of the Act of July 12, 1921 (48 U.S.C. 1397), or computed in this paragraph (b)(3),
termination of his employment in Puerto pursuant to section 28(a) of the Revised however, shall not exceed the total
Rico, E sells his house and moves to State J. Organic Act of the Virgin Islands (48
E is entitled to the exclusion provided in
amount of income tax liability actually
U.S.C. 1642), as modified by section incurred.
section 933 for 2006, but not for 2005 or 2007
7651(5)(B). (4) Definitions. For purposes of this
(assuming that during the first quarter of
2005 and the last quarter of 2007, E has a tax
(b) Exception for V.I. income—(1) In section:
home outside of Puerto Rico or a closer general. Section 934(b)(1) provides an (i) Bona fide resident. The rules of
connection to the United States or a foreign exception to the application of section § 1.937–1T shall apply for determining
country). 934(a). Under this exception, section whether an individual is a bona fide
934(a) does not apply with respect to tax resident of the Virgin Islands.
(b) [Reserved]. For further guidance, liability incurred to the Virgin Islands to (ii) Source. The rules of § 1.937–2T
see § 1.933–1(b). the extent that such tax liability is shall apply for determining whether
(c) Deductions and credits. In any attributable to income derived from income is from sources within the
case in which any amount otherwise sources within the Virgin Islands or Virgin Islands.
constituting gross income is excluded income effectively connected with the (iii) Effectively connected income.
from gross income under the provisions conduct of a trade or business within The rules of § 1.937–3T shall apply for
of section 933, there shall not be the Virgin Islands. determining whether income is
allowed as a deduction from gross (2) Limitation. Section 934(b)(2) limits effectively connected with the conduct
income any items of expenses or losses the scope of the exception provided by of a trade or business in the Virgin
or other deductions (except the section 934(b)(1). Pursuant to this Islands.
deduction under section 151, relating to limitation, the exception does not apply (c) Exception for qualified foreign
personal exemptions), or any credit, with respect to an individual who is a corporations—(1) In general. Section
properly allocable to, or chargeable citizen or resident of the United States 934(b)(3) provides an exception to the
against, the amounts so excluded from (other than a bona fide resident of the application of section 934(a). Under this
gross income. For purposes of the Virgin Islands). For the rules for exception, section 934(a) does not apply
preceding sentence, the rules of § 1.861– determining tax liability incurred to the with respect to tax liability incurred to
8 shall apply (with creditable Virgin Islands by such an individual, the Virgin Islands by a qualified foreign
expenditures treated in the same see section 932(a) and the regulations corporation to the extent that such tax
manner as deductible expenditures). thereunder. liability is attributable to income which
(d) Definitions. For purposes of this (3) Computation rule—(i) Operative is derived from sources outside the
section: rule. For purposes of section 934(b)(1) United States and which is not
and this paragraph (b), tax liability effectively connected with the conduct
(1) The rules of § 1.937–1T shall apply incurred to the Virgin Islands for the of a trade or business within the United
for determining whether an individual taxable year attributable to income States.
is a bona fide resident of Puerto Rico. derived from sources within the Virgin (2) Qualified foreign corporation. For
(2) The rules of § 1.937–2T shall apply Islands or income effectively connected purposes of paragraph (c)(1) of this
for determining whether income is from with the conduct of a trade or business section, the term qualified foreign
sources within Puerto Rico. within the Virgin Islands shall be corporation means any foreign
(e) Effective date. This section shall computed as follows: corporation if 1 or more United States
apply for taxable years ending after (A) Add to the income tax liability persons own or are treated as owning
October 22, 2004. incurred to the Virgin Islands any credit (within the meaning of section 958) less
against the tax allowed under mirrored than 10 percent of—
■ Par. 25. Section 1.934–1 is revised to section 901(a); (i) The total voting power of the stock
read as follows: (B) Multiply by taxable income from of such corporation; and
§ 1.934–1 Limitation on reduction in sources within the Virgin Islands and (ii) The total value of the stock of such
income tax liability incurred to the Virgin income effectively connected with the corporation,
Islands. conduct of a trade or business within (3) Computation rule—(i) Operative
the Virgin Islands (applying the rules of rule. For purposes of section 934(b)(3)
[Reserved]. For further guidance, see and this paragraph (c), tax liability
§ 1.861–8 to determine deductions
§ 1.934–1T. incurred to the Virgin Islands for the
allocable to such income);
■ Par. 26. Section 1.934–1T is added to (C) Divide by total taxable income; taxable year attributable to income
read as follows: and which is derived from sources outside

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18936 Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations

the United States and which is not Compensation for services per- (USVI) in the amount of $90x. Z’s tax liability
effectively connected with the conduct formed in the USVI .................. $50,000 incurred to the USVI pursuant to section
of a trade or business within the United Compensation for services per- 871(a) of the Internal Revenue Code as
formed in the United States .... 40,000 applicable in the USVI (mirror code) is $27x.
States shall be computed as follows— (ii) Pursuant to a USVI law that was duly
(A) Add to the income tax liability Compensation for services per-
formed in Mexico ..................... 30,000 enacted within the limits of its authority
incurred to the Virgin Islands any credit under section 934, Z may claim a special
Income from inventory sales in
against the tax allowed under mirrored Latin America attributable to
exemption for income relating to his
section 901(a); investment in the USVI. The maximum
USVI Office .............................. 20,000
(B) Multiply by taxable income which amount of the reduction in Z’s mirror code
Interest on a U.S. bank account .. 6,000
is derived from sources outside the tax liability that may result from claiming
Interest on a V.I. bank account ... 5,000
this exemption, computed in accordance
United States and which is not Dividends from a U.S. corpora-
with paragraph (b)(3) of this section, is as
effectively connected with the conduct tion ............................................ 4,000
follows:
of a trade or business within the United (ii) Accordingly, S has total gross income 27x (90x /90x) = $27x
States (applying the rules of § 1.861–8 to of $155,000, comprising income from sources
(iii) Accordingly, depending on the terms
determine deductions allocable to such within the USVI or effectively connected to
of the exemption as provided under USVI
income); the conduct of a trade or business in the
law, Z’s net tax liability incurred to the USVI
USVI (USVI ECI) of $75,000, income from
(C) Divide by total taxable income; may be reduced or eliminated entirely.
sources within the United States of $50,000,
and and income from other sources (not USVI Example 4. (i) A Corp is organized under
(D) Subtract any credit allowed under ECI) of $30,000. After taking into account the laws of the U.S. Virgin Islands (USVI)
mirrored section 901 (other than credits allowable deductions, S’s total taxable and is engaged in a trade or business in the
for taxes paid to the United States or income is $120,000, of which $45,000 is United States through an office in State N.
taxable income from sources within the All of A Corp’s outstanding stock is owned
taxes for which a credit is allowable for
USVI, $15,000 is taxable income from other by U.S. citizens who are bona fide residents
U.S. Federal income tax purposes under of the USVI. During 2005, A Corp had $50x
section 906 of the Internal Revenue sources that is USVI ECI under the rules of
section 937(b) and §§ 1.937–2T and 1.937– in gross income from sources within the
Code). 3T, and $22,500 is taxable income from USVI (as determined under section 937(b)
(ii) Limitation Tax liability incurred to sources outside the USVI (and outside the and § 1.937–2T) that is not effectively
the Virgin Islands attributable to income United States) that is not USVI ECI. S’s tax connected with the conduct of a trade or
which is derived from sources outside liability incurred to the USVI pursuant to the business in the United States; $20x in gross
income from sources in Country H that is
the United States and which is not Internal Revenue Code as applicable in the
USVI (mirror code) is $30,000. S is entitled effectively connected with the conduct of A
effectively connected with the conduct Corp’s trade or business in the United States;
of a trade or business within the United to claim a credit under section 901 of the
mirror code in the amount of $10,000 for and $10x in gross income from sources in
States, as computed in this paragraph Country R that is not effectively connected
income tax paid to Mexico and other Latin
(c)(3), however, shall not exceed the American countries, for a net income tax
with the conduct of A Corp’s trade or
total amount of income tax liability business in the United States.
liability of $20,000.
actually incurred. (ii) Section 934(b)(3) permits the USVI to
(iii) Pursuant to a USVI law that was duly
reduce or remit the income tax liability of a
(4) U.S. income—(i) In general. For enacted within the limits of its authority
qualified foreign corporation arising under
purposes of this section, except as under section 934, S may claim a special
the Internal Revenue Code as applicable in
provided in paragraph (c)(4)(ii) of this deduction relating to his business activities
the USVI (mirror code) with respect to
section, the rules of sections 861 in the USVI. However, under section 934(b),
income that is derived from sources outside
S’s ability to claim this special deduction is
through 865 and the regulations the United States and that is not effectively
limited. Specifically, the maximum amount connected with the conduct of a trade or
thereunder shall apply for determining of the reduction in S’s mirror code tax
whether income is from sources outside business in the United States. A foreign
liability that may result from claiming this corporation constitutes a ‘‘qualified foreign
the United States or effectively deduction, computed in accordance with corporation’’ under section 934(b)(3)(B) if
connected with the conduct of a trade paragraph (b)(3) of this section, is as follows: less than 10 percent of the total voting power
or business within the United States. (20,000 + 10,000) × ((45,000 + 15,000) / and value of the stock of the corporation is
(ii) Conduit arrangements. Income 120,000) / (10,000 × (15,000 / (15,000 / owned or treated as owned (within the
shall be considered to be from sources 22,500)) = 30,000 × (.5) ¥ 10,000 × (.4) meaning of section 958) by one or more
within the United States for purposes of = 15,000 ¥ 4,000 = $11,000 United States persons. A U.S. citizen is a
paragraph (c)(1) of this section if, (iv) Accordingly, S’s net tax liability United States person as defined in section
pursuant to a plan or arrangement— incurred to the USVI must be at least $19,000 7701(a)(30)(A). Given that 10 percent or more
(30,000 ¥ 11,000), prior to taking into of the voting power and value of its stock is
(A) The income is received in owned by U.S. citizens, A Corp does not
account any foreign tax credit.
exchange for consideration provided to constitute a ‘‘qualified foreign corporation’’
Example 2. The facts are the same as
another person; and Example 1, except that S is a U.S. citizen under section 934(b)(3)(B). Accordingly, the
(B) Such person (or another person) who resides in the United States. As required USVI may only reduce or remit A Corp’s
provides the same consideration (or by section 932(a) and (b), S files with the U.S. mirror code income tax liability with respect
consideration of a like kind) to a third Virgin Islands (USVI) a copy of his Federal to its $50x in gross income from sources
person in exchange for one or more income tax return and pays to the USVI the within the USVI.
payments constituting income from portion of his Federal income tax liability Example 5. (i) The facts are the same as in
sources within the United States. that his Virgin Islands adjusted gross income Example 4, except that the outstanding stock
bears to his adjusted gross income. Under of A Corp is owned by the following
(d) Examples. The rules of this section individuals:
section 934(b)(2), S may not claim the special
are illustrated by the following deduction offered under USVI law relating to U.S. citizens who are bona fide
examples: business activities like his in the USVI to residents of the USVI ................... 5%
Example 1. (i) S is a U.S. citizen and a bona reduce any of his tax liability payable to the U.S. citizens who are not bona fide
fide resident of the U.S. Virgin Islands USVI under section 932(b). residents of the USVI ................... 3%
(USVI). For 2005, S files a Form 1040INFO, Example 3. (i) Z is a nonresident alien who Nonresident aliens who are bona
‘‘Non-Virgin Islands Source Income of Virgin resides in Country FC. In 2005, Z receives fide residents of the USVI ........... 42%
Islands Residents,’’ with the USVI on which dividends from a corporation organized Nonresident aliens who are not
S reports total gross income as follows: under the law of the U.S. Virgin Islands bona fide residents of the USVI .. 50%

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(ii) Given that less than 10 percent of the business entities in the United States 935 possession but not otherwise a
voting power and value of its stock is owned and in section 935 possessions. citizen of the United States. The term
by United States persons, A Corp constitutes (2) Individuals covered. This section citizen of a section 935 possession but
a qualified foreign corporation under section shall apply to any individual who— not otherwise a citizen of the United
934(b)(3)(B). Accordingly, the USVI may (i) Is a bona fide resident of a section
reduce or remit A Corp’s mirror code income
States means any individual who has
tax liability with respect to its $50x in gross
935 possession during the entire taxable become a citizen of the United States by
income from sources within the USVI and its year, whether or not such individual is birth or naturalization in the section 935
$10x in gross income from sources in a citizen of the United States or a possession.
Country R that is not effectively connected resident alien (as defined in section (vi) With respect to the United States,
with the conduct of A Corp’s trade or 7701(b)(1)(A)); the term resident means an individual
business in the United States. In no event, (ii) Is a citizen of a section 935 who is a citizen (as defined in § 1.1–
however, may the USVI reduce or remit A possession but not otherwise a citizen of 1(c)) or resident alien (as defined in
Corp’s mirror code income tax liability with the United States; section 7701(b)) and who does not have
respect to its $20x in gross income from (iii) Has income from sources within a tax home (as defined in section
sources in Country H that is effectively a section 935 possession for the taxable
connected with the conduct of A Corp’s trade 911(d)(3)) in a foreign country during
or business in the United States.
year, is a citizen of the United States or the entire taxable year. The term does
a resident alien (as defined in section not include an individual who is a bona
(e) Effective date. Except as otherwise 7701(b)(1)(A)) and is not a bona fide fide resident of a section 935
provided in this paragraph (e), this resident of a section 935 possession possession.
section applies for taxable years ending during the entire taxable year; or (vii) The term U.S. taxpayer means an
after October 22, 2004. Paragraph (iv) Files a joint return for the taxable individual described in paragraph
(c)(4)(ii) of this section applies to year with any individual described in (b)(1)(i) or (iii)(B) of this section.
amounts paid or accrued after April 11, paragraph (a)(2)(i), (ii), or (iii) of this (b) Filing requirement—(1) Tax
2005. section. jurisdiction. An individual described in
■ Par. 27. Section 1.935–1 is amended as (3) Definitions. For purposes of this paragraph (a)(2) of this section shall file
follows: section: an income tax return for the taxable
■ 1. Revise the heading and paragraphs (i) The term section 935 possession year—
(a)(1) through (a)(3). means Guam or the Northern Mariana (i) With the United States if such
■ 2. Revise paragraphs (b)(1) and (b)(3), Islands, unless such possession has individual is a resident of the United
and add paragraphs (b)(5) through (b)(7). entered into an implementing States;
■ 3. Revise paragraphs (c) through (f). agreement, as described in section (ii) With the relevant possession if
■ 4. Add paragraph (g). 1271(b) of the Tax Reform Act of 1986 such individual is described in
The revisions and additions are as (Pub. L. 99–514 (100 Stat. 2085)), with paragraph (a)(2)(i) of this section; or
follows: the United States that is in effect for the (iii) If neither paragraph (b)(1)(i) nor
entire taxable year. paragraph (b)(1)(ii) of this section
§ 1.935–1 Coordination of individual (ii) The term relevant possession applies—
income taxes with Guam and the Northern
means: (A) With the relevant possession if
Mariana Islands.
(A) With respect to an individual such individual is described in
(a)(1) through (a)(3) [Reserved]. For described in paragraph (a)(2)(i) of this paragraph (a)(2)(ii) of this section; or
further guidance, see § 1.935–1T(a)(1) section, the section 935 possession of (B) With the United States if such
through (a)(3). which such individual is a bona fide individual is a citizen of the United
(b)(1) [Reserved]. For further resident. States, as defined in paragraph (a)(3) of
guidance, see § 1.935–1T(b)(1). (B) With respect to an individual this section.
* * * * * described in paragraph (a)(2)(ii) of this (2) [Reserved]. For further guidance,
(b)(3) [Reserved]. For further section, the section 935 possession of see § 1.935–1(b)(2).
guidance, see § 1.935–1T(b)(3). which such individual is a citizen. (3) Place for filing returns—(i) U.S.
* * * * * (C) With respect to an individual returns. A return required under this
(b)(5) through (b)(7) [Reserved]. For described in paragraph (a)(2)(iii) of this paragraph (b) to be filed with the United
further guidance, see § 1.935–1T(b)(5) section, the section 935 possession from States shall be filed as directed in the
through (b)(7). which such individual derives income. applicable forms and instructions.
(c) through (f) [Reserved]. For further (iii) The rules of § 1.937–1T shall (ii) Guam returns. A return required
guidance, see § 1.935–1T(c) through (f). apply for determining whether an under this paragraph (b) to be filed with
(g) [Reserved]. For further guidance, individual is a bona fide resident of a Guam shall be filed as directed in the
see § 1.935–1T(g). section 935 possession. applicable forms and instructions.
■ Par. 28. Section 1.935–1T is added to
(iv) The rules of § 1.937–2T generally (iii) NMI returns. A return required
read as follows: shall apply for determining whether under this paragraph (b) to be filed with
income is from sources within a section the Northern Mariana Islands shall be
§ 1.935–1T Coordination of individual 935 possession. Pursuant to § 1.937– filed as directed in the applicable forms
income taxes with Guam and the Northern 2T(a), however, the rules of § 1.937– and instructions.
Mariana Islands (temporary). 2T(c)(1)(ii) and (c)(2) do not apply for (4) [Reserved]. For further guidance,
(a) Application of section—(1) Scope. purposes of section 935(a)(3) (as in see § 1.935–1(b)(4).
Section 935 and this section set forth effect before the effective date of its (5) Tax payments. The tax shown on
the special rules relating to the filing of repeal) and paragraph (a)(2)(iii) of this the return shall be paid to the
income tax returns, income tax section. jurisdiction with which such return is
liabilities, and estimated income tax of (v) The term citizen of the United required to be filed and shall be
individuals described in paragraph States means any individual who is a determined by taking into account any
(a)(2) of this section. Paragraph (e) of citizen within the meaning of § 1.1–1(c), credit under section 31 for tax withheld
this section also provides special rules except that the term does not include an by the relevant possession or the United
requiring consistent treatment of individual who is a citizen of a section States on wages, any credit under

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18938 Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations

section 6402(b) for an overpayment of treated as income from sources within not considered to have a principal place
income tax to the relevant possession or the United States for purposes of section of abode in the United States for
the United States, and any payments 904. purposes of section 32(c).
under section 6315 of estimated income (C) The eligibility of a corporation to (C) The determination of the source of
tax paid to the relevant possession or make a subchapter S election (sections income for purposes other than the
the United States. 1361 through 1379). Thus, for example, foreign tax credit (e.g., sections 935,
(6) Liability to other jurisdiction—(i) for purposes of determining whether a 937, and 7654). Thus, for example,
Filing with the relevant possession. In corporation created or organized in the income determined to be derived from
the case of an individual who is relevant possession may make an sources within the relevant possession
required under paragraph (b)(1) of this election under section 1362(a) to be a under section 937(b) shall not be
section to file a return with the relevant subchapter S corporation, it shall be considered income from sources within
possession for a taxable year, if such treated as a domestic corporation and a the United States for purposes of Form
individual properly files such return U.S. taxpayer shareholder shall not be 5074, ‘‘Allocation of Individual Income
and fully pays his or her income tax treated as a nonresident alien individual Tax to Guam or the Commonwealth of
liability to the relevant possession, such with respect to such corporation. While the Northern Mariana Islands’’.
individual is relieved of liability to file such an election is in effect, the (D) The definition of wages (section
an income tax return with, and to pay corporation shall be treated as a 3401). Thus, for example, services
an income tax to, the United States for domestic corporation for all purposes of performed by an employee for an
the taxable year. the Internal Revenue Code. For the employer in the relevant possession do
(ii) Filing with the United States. In consistency requirement with respect to not constitute services performed in the
the case of an individual who is entity status elections, see paragraph (e) United States under section 3401(a)(8).
required under paragraph (b)(1) of this of this section. (E) The characterization of a
section to file a return with the United (D) The treatment of items carried corporation for purposes other than
States for a taxable year, such individual over from other tax years. Thus, for subchapter S (e.g., sections 367, 951
is relieved of liability to file an income example, if a U.S. taxpayer has for a through 964, 1291 through 1298, 6038,
tax return with, and to pay an income taxable year a net operating loss and 6038B). Thus, for example, if a U.S.
tax to, the relevant possession for the carryback or carryover under section taxpayer transfers appreciated tangible
taxable year. 172, a foreign tax credit carryback or property to a corporation created or
(7) Information reporting. [Reserved]. carryover under section 904, a business organized in the relevant possession in
(c) Extension of territory—(1) U.S. credit carryback or carryover under a transaction described in section 351,
taxpayers—(i)General rule. With respect section 39, a capital loss carryover he or she must recognize gain unless an
to a U.S. taxpayer, for purposes of taxes under section 1212, or a charitable exception under section 367(a) applies.
imposed by Chapter 1 of the Internal contributions carryover under section Also, if a corporation created or
Revenue Code, the United States 170, the carryback or carryover will be organized in the relevant possession
generally shall be treated, in a reported on the return filed with the qualifies as a passive foreign investment
geographical and governmental sense, as United States in accordance with company under sections 1297 and 1298
including the relevant possession. The paragraph (b)(1)(i) or (b)(1)(iii)(B) of this with respect to a U.S. taxpayer, a
purpose of this rule is to facilitate the section, even though the return of the dividend paid to such shareholder does
coordination of the tax systems of the taxpayer for the taxable year giving rise not constitute qualified dividend
United States and the relevant to the carryback or carryover was income under section 1(h)(11)(B).
possession. Accordingly, the rule will required to be filed with a section 935 (2) Application in relevant possession.
have no effect where it is manifestly possession. In applying the territorial income tax of
inapplicable or its application would be (E) The treatment of property the relevant possession, such possession
incompatible with the intent of any exchanged for property of a like kind generally shall be treated, in a
provision of the Internal Revenue Code. (section 1031). Thus for example, if a geographical and governmental sense, as
(ii) Application of general rule. U.S. taxpayer exchanges real property including the United States. Thus, for
Contexts in which the general rule of located in the United States for real example, income tax paid to the United
paragraph (c)(1)(i) of this section apply property located in the relevant States may be taken into account under
include: possession, notwithstanding the sections 31, 6315, and 6402(b) as
(A) The characterization of taxes paid provisions of section 1031(h), such payments to the relevant possession.
to the relevant possession. Income tax exchange may qualify as a like-kind Moreover, a citizen of the United States
paid to the relevant possession may be exchange under section 1031 (provided (as defined in paragraph (a)(3) of this
taken into account under sections 31, that all the other requirements of section section) not a resident of the relevant
6315, and 6402(b) as payments to the 1031 are satisfied). possession will not be treated as a
United States. Taxes paid to the relevant (iii) Nonapplication of general rule. nonresident alien individual for
possession and otherwise satisfying the Contexts in which the general rule of purposes of the territorial income tax of
requirements of section 164(a) will be paragraph (c)(1)(i) of this section does the relevant possession. Thus, for
allowed as a deduction under that not apply include: example, a citizen of the United States
section, but income taxes paid to the (A) The application of any rules or (as so defined), or a resident of the
relevant possession will be disallowed regulations that explicitly treat the United States, will not be treated as a
as a deduction under section 275(a). United States and any (or all) of its nonresident alien individual for
(B) The determination of the source of possessions as separate jurisdictions purposes of section 1361(b)(1)(C) of the
income for purposes of the foreign tax (e.g.,, sections 931 through 937, 7651, Guamanian Territorial income tax.
credit (e.g.,, sections 901 through 904). and 7654). (d) Special rules for estimated income
Thus, for example, after a U.S. taxpayer (B) The determination of any aspect of tax—(1) In general. An individual must
determines which items of income an individual’s residency (e.g., sections make each payment of estimated income
constitute income from sources within 937(a) and 7701(b)). Thus, for example, tax (and any amendment to the
the relevant possession under the rules an individual whose principal place of estimated tax payment) to the
of section 937(b), such income shall be abode is in the relevant possession is jurisdiction with which the individual

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Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations 18939

reasonably believes, as of the date of (6) Underpayments. The liability of an (i) The term appropriate tax authority
that payment (or amendment), that he or individual described in paragraph (a)(2) of the relevant possession means the
she will be required to file a return for of this section for underpayments of individual responsible for tax
the taxable year under paragraph (b)(1) estimated income tax for a taxable year, administration in such possession or his
of this section. In determining the as determined under section 6654, shall delegate.
amount of such estimated income tax, be to the jurisdiction with which the (ii) The term entity status election
income tax paid to the relevant individual is required under paragraph includes an election under § 301.7701–
possession may be taken into account (b) of this section to file his or her return 3(c) of this chapter, an election under
under sections 31 and 6402(b) as for the taxable year. section 1362(a), and any other similar
payments to the United States, and vice (e) Entity status consistency elections.
versa. For other rules relating to requirement—(1) In general. Taxpayers (4) Default status. Solely for the
estimated income tax, see section 6654. should make consistent entity status purpose of determining classification of
(2) Joint estimated income tax. In the elections (as defined in paragraph an eligible entity under § 301.7701–3(b),
case of married persons making a joint (e)(3)(ii) of this section), when and § 301.7701–3(b) as mirrored in the
payment of estimated income tax, the applicable, in both the United States relevant possession, an eligible entity
taxpayers must make each payment of and section 935 possessions. In the case subject to this paragraph (e) shall be
estimated income tax (and any of a business entity to which this classified for both U.S. Federal and the
amendment to the estimated tax paragraph (e) applies: relevant possession tax purposes using
payment) to the jurisdiction where the (i) If an entity status election is filed the rule that applies to domestic eligible
spouse who has the greater estimated with the Internal Revenue Service but entities.
adjusted gross income for the taxable not with the relevant possession, the (5) Transition rules—(i) In the case of
year would be required under paragraph appropriate tax authority of the relevant an election filed prior to April 11, 2005,
(d)(1) of this section to pay estimated possession, at his discretion, may deem except as provided in paragraph
income tax if separate payments were the election also to have been made for (e)(5)(ii) of this section, the rules of
made. For this purpose, estimated the relevant possession tax purposes. paragraph (e)(1) of this section shall
adjusted gross income of each spouse (ii) If an entity status election filed apply as of the first day of the first
for the taxable year is determined with the relevant possession but not taxable year of the entity beginning after
without regard to community property with the Internal Revenue Service, the April 11, 2005.
laws. Commissioner, at his discretion, may (ii) In the unlikely circumstance that
(3) Erroneous payment. If the deem the election also to have been inconsistent elections described in
individual or spouses erroneously pay made for U.S. Federal tax purposes. paragraph (e)(1)(iii) are filed prior to
estimated income tax to the United (iii) If inconsistent entity status April 11, 2005, and the entity cannot
States instead of the relevant possession elections are filed with the relevant change its classification to achieve
or vice versa, only subsequent payments possession and the Internal Revenue consistency because of the sixty-month
or amendments of the payments are Service, both the Commissioner and the limitation described in § 301.7701–
required to be made pursuant to appropriate tax authority of the relevant 3(c)(1)(iv) of this chapter, then the entity
paragraph (d)(1) or (d)(2) of this section possession may, at their individual may nevertheless request permission
with the other jurisdiction. discretion, treat the elections they each from the Commissioner or appropriate
(4) Place for payment. Estimated received as invalid and may deem the tax authority of the relevant possession
income tax required under this election filed in the other jurisdiction to to change such election to avoid
paragraph (d) to be paid to Guam or the have been made also for tax purposes in inconsistent treatment by the
Northern Mariana Islands shall be paid their own jurisdiction. (See Rev. Proc. Commissioner and the appropriate tax
as directed in the applicable forms and 89–8 (1989–1 C.B. 778) for procedures authority of the relevant possession.
instructions issued by the relevant for requesting the assistance of the (iii) Except as provided in paragraphs
possession. Estimated income tax Internal Revenue Service when a (e)(5)(i) and (e)(5)(ii) of this section, in
required under paragraph (d)(1) of this taxpayer is or may be subject to the case of an election filed with respect
section to be paid to the United States inconsistent tax treatment by the to an entity before it became an entity
shall be paid as directed in the Internal Revenue Service and a U.S. described in paragraph (e)(2) of this
applicable forms and instructions. possession tax agency.) section, the rules of paragraph (e)(1) of
(5) Liability to other jurisdiction—(i) (2) Scope. This paragraph (e) applies this section shall apply as of the first
Filing with Guam or the Northern to the following business entities: day that such entity is described in
Mariana Islands. Subject to paragraph (i) A business entity (as defined in paragraph (e)(2) of this section.
(d)(6) of this section, an individual § 301.7701–2(a) of this chapter) that is (iv) In the case of an entity created or
required under this paragraph (d) to pay domestic (as defined in § 301.7701–5 of organized prior to April 11, 2005,
estimated income tax (and amendments this chapter), or otherwise treated as paragraph (e)(4) of this section shall take
thereof) to Guam or the Northern domestic for purposes of the Internal effect for U.S. Federal income tax
Mariana Islands is relieved of liability to Revenue Code, and that is owned in purposes (or the relevant possession
pay estimated income tax (and whole or in part by any person who is income tax purposes, as the case may
amendments thereof) to the United either a bona fide resident of a section be) as of the first day of the first taxable
States. 935 possession or a business entity year of the entity beginning after April
(ii) Filing with the United States. created or organized in a section 935 11, 2005.
Subject to paragraph (d)(6) of this possession. (f) Examples. The application of this
section, an individual required under (ii) A business entity that is created or section is illustrated by the following
this paragraph (d) to pay estimated organized in a section 935 possession examples:
income tax (and amendments thereof) to and that is owned in whole or in part Example 1. B, a United States citizen, files
the United States is relieved of liability by any U.S. person (other than a bona returns on a calendar year basis. In April
to pay estimated income tax (and fide resident of such possession). 2005, B moves to Possession G, which is a
amendments thereof) to the relevant (3) Definitions. For purposes of this section 935 possession, purchases a house,
possession. section— and accepts a permanent position with a

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18940 Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations

local employer. For the remainder of the year (g) Effective date. This section shall of being present in such possession
and throughout 2006, B continues to live and apply for taxable years ending after solely in compliance with military
work in Possession G, and establishes a October 22, 2004. orders. Armed Forces of the United
closer connection to Possession G than to the
■ Par. 29. Section 1.937–1T is added to States is defined (and members of the
United States or any foreign country. In
September 2007, as a result of the read as follows: Armed Forces are described) in section
termination of his employment in Possession 7701(a)(15).
§ 1.937–1T Bona fide residency in a (3) Juridical persons. Only natural
G, B sells his house and moves to State H.
possession (temporary). persons may qualify as bona fide
As a consequence of his employment in
Possession G, B earns income from the (a) Scope—(1) In general. Section residents of a possession. The rules
performance of services in Possession G from 937(a) and this section set forth the governing the tax treatment of bona fide
April 2005 through September 2007. Section rules for determining whether an residents of a possession do not apply
935(b)(1)(B) and paragraph (b)(1)(ii) of this individual qualifies as a bona fide to juridical persons (e.g., corporations,
section apply to B for 2006, but not for 2005 resident of a particular possession (the
or 2007 (assuming that during the first
partnerships, trusts, and estates).
relevant possession) for purposes of the (4) Transition rule. For taxable years
quarter of 2005 and the last quarter of 2007, Internal Revenue Code, including
B has a tax home outside of Possession G or beginning before October 23, 2004, and
a closer connection to the United States or a
Subpart D, Part III, Subchapter N, ending after October 22, 2004, an
foreign country). For 2005 and 2007, B is Chapter 1 of the Internal Revenue Code individual will be considered to qualify
subject to the rules applicable to individuals as well as section 865(g)(3), section 876, as a bona fide resident of the relevant
described in paragraph (a)(2)(iii) of this section 881(b), paragraphs (2) and (3) of possession if such individual satisfies
section because he has income derived from section 901(b), section 957(c), section the requirements of paragraphs (d) and
sources within Possession G as determined 3401(a)(8)(C), and section 7654(a). (e) of this section with respect to such
under the rules of section 937(b) and § 1.937– (2) Definitions. For purposes of this
2T.
possession for such year.
section and §§ 1.937–2 and 1.937–3— (c) Presence test—(1) In general. A
Example 2. The facts are the same as in (i) Possession means one of the United States citizen or resident alien
Example 1 except that B’s employment following United States possessions:
terminated in September 2008 rather than (as defined in section 7701(b)(1)(A))
American Samoa, Guam, the Northern individual satisfies the requirements of
2007. B properly pays his April 2005
Mariana Islands, Puerto Rico, or the this paragraph (c) for a taxable year if
estimated tax to the United States, continues
to pay estimated tax for the 2005 tax year to Virgin Islands. When used in a during that taxable year such
the United States under paragraph (d) of this geographical sense, the term comprises individual—
section, and properly files his 2005 return only the territory of each such (i) Was present in the relevant
with the United States. possession (without application of possession for at least 183 days;
(i)(A) On the date of each payment of sections 932(c)(3) and 935(c)(2) (as in (ii) Was present in the United States
estimated tax in 2006, B reasonably believes effect before the effective date of its for no more than 90 days;
that he would be required to file his return repeal)). (iii) Had no earned income (as defined
for 2006 with Possession G under paragraph (ii) United States, when used in a
(b)(1) of this section. in § 1.911–3(b)) in the United States and
geographical sense, is defined in section was present for more days in the
(B) In August 2006, B determines that he
has overpaid tax for the previous year in the 7701(a)(9), and without application of relevant possession than in the United
amount of $1000. B properly pays all sections 932(a)(3) and 935(c)(1) (as in States; or
estimated taxes to Possession G for 2006, effect before the effective date of its (iv) Had no permanent connection
subtracting the $1000 overpayment from his repeal). (see paragraph (c)(4) of this section) to
estimated tax payments pursuant to section (b) Bona fide resident—(1) General the United States.
6402(b), and properly files his tax return with rule. An individual qualifies as a bona (2) Special rule for alien individuals.
Possession G. fide resident of the relevant possession A nonresident alien individual (as
(ii) In April 2007, B reasonably believes if such individual satisfies the defined in section 7701(b)(1)(B))
that he would be returning to the United requirements of paragraphs (c) through
States in the Fall of 2007, and properly pays satisfies the requirements of this
estimated tax to the United States. By June
(e) of this section with respect to such paragraph (c) for a taxable year if during
2007, B reasonably believes that he would possession. that taxable year such individual
not be moving from Possession G and would (2) Special rule for members of the satisfies the substantial presence test of
be a bona fide resident of Possession G for Armed Forces. A member of the Armed § 301.7701(b)–1(c) of this chapter
the entire taxable year. B makes his Forces of the United States who (except for the substitution of the name
remaining estimated tax payments to qualified as a bona fide resident of the of the relevant possession for the term
Possession G. On his 2007 tax return filed relevant possession in a prior taxable United States where appropriate).
with Possession G, pursuant to section 6315, year shall be deemed to have satisfied (3) Days of presence. For purposes of
B properly takes into account payments made the requirements of paragraphs (c)
to both the United States and Possession G
paragraph (c)(1) of this section—
through (e) of this section for a (i) An individual is considered to be
as estimated taxes.
(iii) In April and June 2008, B reasonably
subsequent taxable year if such present in the relevant possession on
believes that he would be a bona fide individual otherwise is unable to satisfy any day that he or she is physically
resident of Possession G for the entire taxable such requirements by reason of being present in such possession at any time
year 2008 and properly pays estimated taxes absent from such possession or present during the day.
to Possession G. By the time B pays his in the United States during such year (ii) An individual is considered to be
estimated taxes for September 2008, B’s solely in compliance with military present in the United States on any day
employment terminates and he moves to orders. Conversely, a member of the that he or she is physically present in
State H. B properly makes his remaining Armed Forces of the United States who the United States at any time during the
estimated tax payments to the United States. did not qualify as a bona fide resident
On his return for 2008, properly filed with
day. However, the following days shall
the United States, B determines that he has
of the relevant possession in a prior be excluded and will not count as days
underpaid estimated taxes throughout 2008 taxable year shall not be considered to of presence in the United States:
in an amount subject to penalty under have satisfied the requirements of (A) Any day that an individual is
section 6654. B owes the United States an paragraphs (c) through (e) of this section prevented from leaving the United
estimated tax penalty under section 6654. for a subsequent taxable year by reason States because of a medical condition

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that arose while the individual was purposes of section 937 and this section, benefits. In 2005, H and W are only present
present in the United States (as an individual’s tax home is determined in Possession P for a total of 175 days
described in § 301.7701(b)–3(c) of this under the principles of section 911(d)(3) because of a 70 day vacation to Europe and
Asia. Thus, in 2005, H and W are not present
chapter); without regard to the second sentence
in Possession P for at least 183 days, are
(B) Any day that an individual is in thereof. Thus, under section 937, an present in the United States for more than 90
transit between two points outside the individual’s tax home is considered to days, and have a permanent connection to
United States (as described in be located at the individual’s regular or the United States by reason of their
§ 301.7701(b)–3(d) of this chapter), and principal (if more than one regular) permanent home. However, under paragraph
is physically present in the United place of business. If the individual has (c)(1)(iii) of this section, H and W each still
States for fewer than 24 hours; no regular or principal place of business satisfy the presence test in paragraph (c) of
(C) Any day that an individual is because of the nature of the business, or this section with respect to Possession P
temporarily present in the United States because the individual is not engaged in because they have no earned income in the
as a professional athlete to compete in United States and are physically present for
carrying on any trade or business within more days in Possession P than in the United
a charitable sports event (as described in the meaning of section 162(a), then the States.
§ 301.7701(b)–3(b)(5) of this chapter); individual’s tax home is the individual’s Example 2. Presence test. T, a U.S. citizen,
(D) Any day during which the regular place of abode in a real and is a sales representative for a company based
individual is temporarily in the United substantial sense. in Possession V. T lives with his wife and
States as a student (as defined in section (2) Special rule for seafarers. For minor children in their house in Possession
152(f)(2)); and purposes of section 937 and this section, V, where he is also registered to vote. T’s
(E) In the case of an individual who an individual will not be considered to business travel requires T to spend 120 days
is an elected representative of the have a tax home outside the relevant in the United States and another 120 days in
relevant possession, or who serves full possession solely by reason of foreign countries. When traveling on
time as an elected or appointed official employment on a ship or other seafaring business, T generally stays at hotels but
or employee of the government of the sometimes stays with his brother, who lives
vessel that is predominantly used in
relevant possession (or any political in State A. Under paragraphs (c)(1)(iv) and
local and international waters. For this (c)(4) of this section, T satisfies the presence
subdivision thereof), any day spent purpose, a vessel will be considered to test in paragraph (c) of this section because
serving the relevant possession in such be predominantly used in local and he has no permanent connection to the
role. international waters if, during the United States.
(iii) If, during a single day, an taxable year, the aggregate amount of Example 3. Alien resident of possession—
individual is physically present— time it is used in international water presence test. F is a citizen of Country G. F’s
(A) In the United States and in the and in the water within three miles of tax home is in Possession C and F has no
relevant possession, such day shall be the relevant possession exceeds the closer connection to the United States or a
considered a day of presence in the aggregate amount of time it is used in foreign country than to Possession C. F is
relevant possession; the territorial water of the United States physically present in Possession C for 123
(B) In two possessions, such day shall days and in the United States for 110 days
or any foreign country.
be considered a day of presence in the every year. Accordingly, F is a nonresident
(3) Special rule for students and alien with respect to the United States under
possession where the individual’s tax government officials. Any days section 7701(b), and a bona fide resident of
home is located (applying the rules of described in paragraphs (c)(3)(ii)(D) and Possession C under paragraphs (b), (c)(2), (d),
paragraph (d) of this section). (E) of this section shall be disregarded and (e) of this section.
(4) Permanent connection. For for purposes of determining whether an Example 4. Seafarers—tax home. S, a U.S.
purposes of paragraph (c)(1) of this individual has a tax home outside the citizen, is employed by a fishery and spends
section— relevant possession under paragraph 250 days at sea on a fishing vessel. When not
(i) A permanent connection to the (d)(1) of this section during any part of at sea, S resides with his wife at a house they
United States includes— the taxable year. own in Possession G. The fishing vessel upon
(A) A permanent home (as described (e) Closer connection test. An which S works departs and arrives at various
in § 301.7701(b)–2(d)(2) of this chapter) individual satisfies the requirements of ports in Possession G, other possessions, and
in the United States; foreign countries, but is in international or
this paragraph (e) for a taxable year if
(B) A spouse or dependent (as defined local waters (within the meaning of
such individual did not have a closer paragraph (d)(2) of this section) for 225 days.
in section 152 and the regulations connection to the United States or a
thereunder) whose principal place of Under paragraph (d)(2) of this section, S will
foreign country than to the relevant not be considered to have a tax home outside
abode is in the United States; or possession. For purposes of the Possession G for purposes of section 937 and
(C) Current registration to vote in any preceding sentence— this section solely by reason of S’s
political subdivision of the United (1) The principles of section employment on board the fishing vessel.
States. 7701(b)(3)(B)(ii) and § 301.7701(b)–2(d) Example 5. Seasonal workers—tax home
(ii) However, a permanent connection of this chapter shall apply; and and closer connection. P, a U.S. citizen, is a
to the United States does not include— (2) Another possession shall not be permanent employee of a hotel in Possession
(A) A valid professional license considered a foreign country. I, but works only during the tourist season.
conferred by any political subdivision of (f) Examples. The principles of this For the remainder of each year, P lives with
the United States; or section are illustrated by the following her husband and children in Possession Q,
(B) Relatives (other than those examples:
where she has no outside employment. Most
specified in paragraph (c)(4)(B) of this of P’s personal belongings, including her
section) whose principal place of abode Example 1. Presence test. H and W are U.S. automobile, are located in Possession Q. P is
is in the United States. citizens who live for part of the taxable year registered to vote in, and has a driver’s
in a condominium, which they own, located license issued by, Possession Q. P does her
(d) Tax home test—(1) General rule.
in Possession P. H and W also own a house personal banking in Possession Q and P
An individual satisfies the requirements in State N where they live for 120 days a year routinely lists her address in Possession Q on
of this paragraph (d) for a taxable year to be near their grown children and forms and documents. P satisfies the
if such individual did not have a tax grandchildren. H and W are retired and their presence test of paragraph (c) of this section
home outside the relevant possession income consists solely of pension payments, with respect to both Possession Q and
during any part of the taxable year. For dividends, interest, and Social Security Possession I, because, among other reasons,

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under paragraph (c)(1)(ii) of this section she for U.S. tax reporting purposes that they (c) U.S. income—(1) In general.
does not spend more than 90 days in the qualify as bona fide residents of such Except as provided in paragraph (d) of
United States during the taxable year. P possession for a tax year subsequent to this section, income from sources
satisfies the tax home test of paragraph (d) of
a tax year for which they were required within the relevant possession shall not
this section only with respect to Possession
I, because her regular place of business is in to file income tax returns as bona fide include any item of income determined
Possession I. P satisfies the closer connection residents of the United States Virgin under the rules of sections 861 through
test of paragraph (e) of this section with Islands or a section 935 possession (as 865 and the regulations thereunder to
respect to both Possession Q and Possession defined in § 1.935–1T(a)(3)(i)). be—
I, because she does not have a closer (h) Effective date. Except as provided (i) From sources within the United
connection to the United States or to any in this paragraph (h), this section shall States; or
foreign country (and for this purpose, under apply to taxable years ending after (ii) Effectively connected with the
paragraph (e)(2) of this section, Possession Q October 22, 2004. Paragraph (g) of this conduct of a trade or business within
is not treated as a foreign country with
respect to Possession I). Therefore, P is a
section also applies to the 3 taxable the United States.
bona fide resident of Possession I for years preceding the first taxable year (2) Conduit arrangements. Income
purposes of the Internal Revenue Code. ending after October 22, 2004. shall be considered to be from sources
Example 6. Closer connection to United ■ Par. 30. Section 1.937–2T is added to within the United States for purposes of
States than to possession. Z, a U.S. citizen, read as follows: paragraph (c)(1) of this section if,
relocates to Possession V in 2003 to start an pursuant to a plan or arrangement—
investment consulting and venture capital § 1.937–2T Income from sources within a (i) The income is received in
business. Z’s wife and two teen-aged children possession (temporary). exchange for consideration provided to
remain in State C to allow the children to (a) Scope. Section 937(b) and this another person; and
complete high school. Z travels back to the section set forth the rules for (ii) Such person (or another person)
United States regularly to see his wife and determining whether income is provides the same consideration (or
children, to engage in business activities, and considered to be from sources within a consideration of a like kind) to a third
to take vacations. He has an apartment particular possession (the relevant
available for his full-time use in Possession person in exchange for one or more
V, but he remains a joint-owner of the
possession) for purposes of the Internal payments constituting income from
residence in State C where his wife and Revenue Code, including section 957(c) sources within the United States.
children reside. Z and his family have and Subpart D, Part III, Subchapter N, (d) Income from certain sales of
automobiles and personal belongings such as Chapter 1 of the Internal Revenue Code, inventory property. For special rules
furniture, clothing, and jewelry located at as well as section 7654(a) of the 1954 that apply to determine the source of
both residences. Although Z is a member of Internal Revenue Code (until the income from certain sales of inventory
the Possession V Chamber of Commerce, Z effective date of its repeal). Paragraphs property, see § 1.863–3(f).
also belongs to and has current relationships (c)(1)(ii) and (c)(2) of this section do not (e) Income from services—(1) No de
with social, political, cultural, and religious apply, however, for purposes of sections
organizations in State C. Z receives mail in
minimis rule. In applying the principles
State C, including brokerage statements,
932(a) and (b) and 935(a)(3) (as in effect of section 861 and the regulations
credit card bills, and bank advices. Z is not before the effective date of its repeal). In thereunder pursuant to paragraph (b) of
a bona fide resident of Possession V because the case of a possession or territory that this section, the exception in section
he has a closer connection to the United administers income tax laws that are 861(a)(3) shall not apply.
States than to Possession V and therefore identical (except for the substitution of (2) Service in the Armed Forces. In the
fails to satisfy the requirements of paragraphs the name of the possession or territory case of a member of the Armed Forces
(b)(1) and (e) of this section. for the term United States where of the United States, the following rules
(g) Information reporting requirement. appropriate) to those in force in the shall apply for determining the source
The following individuals are required United States, these rules do not apply of compensation for services performed
to file notice of their new tax status in for purposes of the application of such in compliance with military orders:
such time and manner as the laws. These rules also do not affect the (i) If the individual is a bona fide
Commissioner may prescribe by notice, determination of whether income is resident of a possession and such
form, instructions, or other publication considered to be from sources without services are performed in the United
(see § 601.601(d)(2) of this chapter): the United States for purposes of the States or in another possession, the
(1) Individuals who take the position Internal Revenue Code. compensation constitutes income from
for U.S. tax reporting purposes that they (b) In general. Except as provided in sources within the possession of which
qualify as bona fide residents of a paragraphs (c) through (i) of this section, the individual is a bona fide resident
possession for a tax year subsequent to the principles of sections 861 through (and not from sources within the United
a tax year for which they were required 865 and the regulations thereunder States or such other possession).
to file Federal income tax returns as (relating to the determination of the (ii) If the individual is not a bona fide
citizens or residents of the United States gross and the taxable income from resident of a possession and such
who did not so qualify. sources within and without the United services are performed in a possession,
(2) Citizens and residents of the States) generally shall be applied in the compensation constitutes income
United States who take the position for determining the gross and the taxable from sources within the United States
U.S. tax reporting purposes that they do income from sources within and (and not from sources within such
not qualify as bona fide residents of a without the relevant possession. In the possession).
possession for a tax year subsequent to application of such principles, the name (f) Gains from certain dispositions of
a tax year for which they were required of the relevant possession shall be used property— (1) Property of former U.S.
to file income tax returns (with the instead of the term United States, the residents. (i) Income from sources
Internal Revenue Service, the tax term bona fide resident of followed by within the relevant possession shall not
authorities of a possession, or both) as the name of the relevant possession include gains from the disposition of
individuals who did so qualify. shall be used instead of the term United property described in paragraph (f)(1)(ii)
(3) Bona fide residents of Puerto Rico States resident, and the term domestic of this section by an individual
or a section 931 possession (as defined shall be construed to mean created or described in paragraph (f)(1)(iii) of this
in § 1.931–1T(c)(1)) who take a position organized in such possession. section. See also section 1277(e) of

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Public Law 99–514 (100 Stat. 2985) shall be considered income from part of such period as the corporation
(providing that gains from the sources within the possession in which has been in existence).
disposition of certain property by the liquidating corporation is created or (iv) Subsidiary look-through rule. For
individuals who acquired residency in organized. purposes of this paragraph (g)(1), if a
certain possessions shall be considered (ii) In applying the principles of possessions corporation owns (directly
to be from sources within the United section 865 and the regulations or indirectly) at least 25 percent (by
States). thereunder pursuant to paragraph (b) of value) of the stock of another
(ii) Property is described in this this section, the rules of section 865(g) corporation, such possessions
paragraph (f)(1)(ii) when the following shall not apply, but the special rule of corporation shall be treated as if it—
conditions are satisfied— section 865(h)(2)(B) shall apply with (A) Directly received its proportionate
(A) The property is of a kind respect to gain recognized upon the share of the income of such other
described in section 731(c)(3)(C)(i) or liquidation of corporations created or corporation; and
954(c)(1)(B); and organized in the United States. (B) Actively conducted any trade or
(B) The property was owned by the (g) Dividends—(1) Dividends from business actively conducted by such
individual before such individual certain possessions corporations—(i) In other corporation.
became a bona fide resident of the general. Except as provided in (2) Dividends from other corporations.
relevant possession. paragraph (g)(1)(ii) of this section, with In applying the principles of section 861
(iii) An individual is described in this respect to any possessions shareholder, and the regulations thereunder pursuant
paragraph (f)(1)(iii) when the following only the possessions source ratio of any to paragraph (b) of this section, the
conditions are satisfied— dividend paid or accrued by a special rules relating to dividends for
(A) For the taxable year for which the corporation created or organized in a which deductions are allowable under
source of the gain must be determined, possession (possessions corporation) section 243 or 245 shall not apply.
the individual is a bona fide resident of shall be treated as income from sources (h) Income inclusions. For purposes of
the relevant possession; and within such possession. For purposes of determining whether an amount
(B) For any of the 10 years preceding this paragraph (g)— described in section 904(h)(1)(A)
such year, the individual was a citizen (A) The possessions source ratio shall constitutes income from sources within
or resident of the United States (other be a fraction, the numerator of which the relevant possession—
than a bona fide resident of the relevant equals the gross income of the (1) If the individual owns (directly or
possession). possessions corporation from sources indirectly) at least 10 percent of the total
(iv) If an individual described in within the possession in which it is voting stock of the corporation from
paragraph (f)(1)(iii) of this section created or organized (applying the rules which such amount is derived, the
exchanges property described in of this section) for the testing period, principles of section 904(h)(2) shall
paragraph (f)(1)(ii) of this section for and the denominator of which equals apply. In the case of an individual who
other property in a transaction in which the total gross income of the corporation is not a possessions shareholder (as
gain or loss is not required to be for the testing period; and defined in paragraph (g)(1)(i)(B) of this
recognized (in whole or in part) under (B) The term possessions shareholder section), the preceding sentence shall
U.S. income tax principles, such other means any individual who is a bona fide apply only if the corporation qualifies as
property shall also be considered resident of the possession in which the a United States-owned foreign
property described in paragraph (f)(1)(ii) corporation is created or organized and corporation for purposes of section
of this section. who owns, directly or indirectly, at least 904(h); and
(v) If an individual described in 10 percent of the total voting stock of (2) In all other cases, the amount shall
paragraph (f)(1)(iii) of this section owns, the corporation. be considered income from sources in
directly or indirectly, at least 10 percent (ii) Dividends from corporations the jurisdiction in which the
(by value) of any entity to which engaged in the active conduct of a trade corporation is created or organized.
property described in paragraph (f)(1)(ii) or business in the relevant possession. (i) Interest—(1) Interest from certain
of this section is transferred in a The entire amount of any dividend paid possessions corporations—(i) In general.
transaction in which gain or loss is not or accrued by a possessions corporation Except as provided in paragraph
required to be recognized (in whole or shall be treated as income from sources (i)(1)(ii) of this section, with respect to
in part) under U.S. income tax within the possession in which it is any possessions shareholder (as defined
principles, any gain recognized upon a created or organized when the following in paragraph (g)(1)(i)(B) of this section),
disposition of the property by such conditions are met— interest paid or accrued by a
entity shall be treated as income from (A) 80 percent or more of the gross possessions corporation shall be treated
sources outside the relevant possession income of the corporation for the testing as income from sources within the
if any gain recognized upon a direct or period was derived from sources within possession in which it is created or
indirect disposition of the individual’s such possession (applying the rules of organized to the extent that such
interest in such entity would have been this section) or was effectively interest is allocable to assets that
so treated under paragraph (f)(1)(iv) of connected with the conduct of a trade generate, have generated, or could
this section. or business in such possession reasonably have been expected to
(2) Special rules under section 865 for (applying the rules of § 1.937–3T); and generate income from sources within
possessions—(i) Except as provided in (B) 50 percent or more of the gross such possession (under the rules of this
paragraph (f)(1) of this section— income of the corporation for the testing section) or income effectively connected
(A) Gain that is considered to be period was derived from the active with the conduct of a trade or business
derived from sources outside of the conduct of a trade or business within within such possession (under the rules
United States under section 865(g)(3) such possession. of § 1.937–3T). For purposes of the
shall be considered income from (iii) Testing period. For purposes of preceding sentence, the principles of
sources within Puerto Rico; and this paragraph (g)(1), the term testing §§ 1.861–9 through 1.861–12 shall
(B) Gain that is considered to be period means the 3-year period ending apply.
derived from sources outside of the with the close of the taxable year of the (ii) Interest from corporations engaged
United States under section 865(h)(2)(B) payment of the dividend (or for such in the active conduct of a trade or

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18944 Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations

business in the relevant possession. The pursuant to paragraph (c)(1)(ii) of this section 861(a)(3) as applied pursuant to
entire amount of any interest paid or section, but nonetheless shall continue to be paragraph (b) of this section, the
accrued by a possessions corporation treated as income from sources without the compensation that X receives for services
United States under section 862 (for example, performed in the NMI is treated as income
shall be treated as income from sources from sources within the NMI.
for purposes of section 904).
within the possession in which it is
created or organized when the Example 4. (i) X, a bona fide resident of
Possession I, owns 25 percent of the (l) Effective date. Except as otherwise
conditions of paragraphs (g)(1)(ii) (A) outstanding shares of A Corp, a corporation provided in this paragraph (l), this
and (B) of this section are met (applying organized under the laws of Possession I. In section applies to income earned in tax
the rules of paragraphs (g)(1) (iii) and 2006, X receives a dividend of $70x from A years ending after October 22, 2004.
(iv) of this section). Corp. During 2004 through 2006, A Corp has Paragraph (c)(1) of this section applies
(2) Interest from partnerships. Interest gross income from the following sources: to income earned after December 31,
paid or accrued by a partnership shall 2004. Paragraph (f) of this section
be treated as income from sources Possession I Sources out- applies to dispositions after April 11,
within a possession only to the extent Year side posses-
sources 2005. Paragraphs (c)(2), (g)(1), (h), and
sion I
that such interest is allocable to income (i) of this section apply to amounts paid
effectively connected with the conduct 2004 .......... $10x $20x or accrued after April 11, 2005.
of a trade or business in such 2005 .......... 20x 10x ■ Par. 31. Section 1.937–3T is added to
possession. For purposes of the 2006 .......... 25x 15x read as follows:
preceding sentence, the principles of
§ 1.882–5 shall apply (as if the (ii) A Corp owns 50 percent of the § 1.937–3T Income effectively connected
partnership were a foreign corporation outstanding shares of B Corp, a corporation with the conduct of a trade or business in
and as if the trade or business in the organized under the laws of Country FC. a possession (temporary).
possession were a trade or business in During 2004 through 2006, B Corp has gross (a) Scope. Section 937(b) and this
income from the following sources: section set forth the rules for
the United States).
(j) Indirect ownership. For purposes of determining whether income is
Sources out-
this section, the rules of section Year Possession I side posses- effectively connected with the conduct
318(a)(2) shall apply except that the sources of a trade or business within a particular
sion I
language ‘‘5 percent’’ shall be used possession (the relevant possession) for
instead of ‘‘50 percent’’ in section 2004 .......... $10x $6x purposes of the Internal Revenue Code,
318(a)(2)(C). 2005 .......... 14x 8x including sections 881(b) and 957(c)
(k) Examples. The provisions of this 2006 .......... 10x 4x and Subpart D, Part III, Subchapter N,
section may be illustrated by the Chapter 1 of the Internal Revenue Code.
following examples: (iii) A Corp is treated as having received Paragraph (c) of this section does not
50 percent of the gross income of B Corp.
Example 1. X, a U.S. citizen, resides in Therefore, for 2004 through 2006, the gross
apply, however, for purposes of section
State N and acquires the stock of Corporation income of A Corp is from the following 881(b). In the case of a possession or
C, a domestic corporation, in 2000. X moves sources: territory that administers income tax
to the Northern Mariana Islands (NMI) in laws that are identical (except for the
2003. In 2004, while a bona fide resident of substitution of the name of the
Sources out-
the NMI, X recognizes gain on the sale of the Possession I
Year sources side posses- possession or territory for the term
Corporation C stock. Pursuant to section sion I
1277(e) of the Tax Reform Act of 1986, Public
United States where appropriate) to
Law 99–514 (100 Stat. 2085) (October 22, those in force in the United States, these
2004 .......... $15x $23x
1986), this gain is treated as income from 2005 .......... 27x 14x
rules do not apply for purposes of the
sources within the United States for all 2006 .......... 30x 17x application of such laws.
purposes of the Internal Revenue Code (b) In general. Except as provided in
(including section 7654, as in effect with Totals 72x 54x paragraphs (c) and (d) of this section,
respect to the NMI), and not as income from the principles of section 864(c) and the
sources in the NMI. (iv) Pursuant to paragraph (g) of this regulations thereunder (relating to the
Example 2. X, a U.S. citizen, resides in section, the portion of the dividend of determination of income, gain or loss
State F and acquires a 5 percent interest in $70x that X receives from Corp A in which is effectively connected with the
Partnership P in 2003. X moves to the U.S. conduct of a trade or business within
Virgin Islands (USVI) in 2004. In 2006, while
2006 that is treated as income from
a bona fide resident of the USVI, X sources within Possession I is 72/126 of the United States) shall generally be
recognizes gain on the sale of the interest in $70x, or $40x. applied in determining whether income
Partnership P. Pursuant to paragraph (f)(1) of Example 5. X is a U.S. citizen and a bona is effectively connected with the
this section, the gain shall not be treated as fide resident of the Northern Mariana Islands conduct of a trade or business within
income from sources within the USVI for (NMI). In 2005, X receives compensation for the relevant possession (except for the
purposes of the Internal Revenue Code (for services performed as a member of the crew substitution of the name of the relevant
example, for purposes of section 934(b)). of a fishing boat. Ten percent of the services possession for the term United States
Example 3. X, a bona fide resident of for which X receives compensation are where appropriate), without regard to
Possession I, a section 931 possession (as performed in the NMI, and 90 percent of X’s whether the taxpayer qualifies as a
defined in § 1.931-1T(c)(1)), is engaged in a services are performed in international nonresident alien individual or a foreign
trade or business in the United States waters. X is a ‘‘United States person’’ as
corporation with respect to such
through an office in State H. In 2005, this defined in section 7701(a)(30)(A).
Accordingly, pursuant to section possession. For purposes of the
office materially participates in the sale of
inventory property in Possession I, such that 863(d)(1)(A), the compensation that X preceding sentence, all income other
the income from these inventory sales is receives for services performed in than income from sources within the
considered effectively connected to this trade international waters is treated as income relevant possession (as determined
or business in the United States under from sources within the United States for under the rules of 1.937–2T) shall be
section 864(c)(4)(B)(iii). This income shall purposes of the Internal Revenue Code considered income from sources
not be treated as income from sources within (including section 7654, as in effect with
Possession I for purposes of section 931(a)(1) respect to the NMI). Under the principles of

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without the relevant possession, and active banking business from offices in the of the Internal Revenue Code under generally
subject to the rules of this section, the U.S. Virgin Islands (USVI). In connection applicable conduit principles will depend on
principles of section 864(c)(4) shall with this banking business, F Bank makes the facts and circumstances. See, for
loans to and receives interest payments from example, Aiken Indus., Inc. v. Commissioner,
apply for purposes of determining 56 T.C. 925 (1971).
borrowers who reside in the USVI, in the
whether such income constitutes United States, and in Country FC. (iii) If Possession I administers income tax
income effectively connected with the (ii) Under the principles of section laws that are identical (except for the
conduct of a trade or business in the 861(a)(1) as applied pursuant to § 1.937– substitution of the name of the possession for
relevant possession. 2T(b), interest payments received by F Bank the term ‘‘United States’’ where appropriate)
(c) U.S. income—(1) In general. from borrowers who reside in the United to those in force in the United States, the
Except as provided in paragraph (d) of States or in Country FC constitute income interest received by G may be treated as
from sources outside of the USVI. Under the income effectively connected with the
this section, income considered to be
principles of section 864(c)(4) as applied conduct of a trade or business in Possession
effectively connected with the conduct I under mirrored section 864(c)(4) for
pursuant to paragraph (b) of this section,
of a trade or business within the interest income from sources outside of the purposes of determining the Possession I
relevant possession shall not include USVI generally may constitute income that is territorial income tax liability of N under
any item of income determined under effectively connected with the conduct of a mirrored section 871.
the rules of sections 861 through 865 trade or business within the USVI for (f) Effective date. Except as otherwise
and the regulations thereunder to be— purposes of the Internal Revenue Code. provided in this paragraph (f), this
(i) From sources within the United However, interest payments received by F
Bank from borrowers who reside in the
section applies to income earned in
States; or taxable years ending after October 22,
United States constitute income from sources
(ii) Effectively connected with the 2004. Paragraph (c)(1) of this section
within the United States under section
conduct of a trade or business within 861(a)(1). Accordingly, under paragraph applies to income earned after
the United States. (c)(1) of this section, such interest income December 31, 2004. Paragraph (c)(2) of
(2) Conduit arrangements. Income shall not be treated as effectively connected this section applies to amounts paid or
shall be considered to be from sources with the conduct of a trade or business in the accrued after April 11, 2005.
within the United States for purposes of USVI for purposes of the Internal Revenue
■ Par. 32. Section 1.957–3 is revised to
paragraph (c)(1) of this section if, Code (for example, for purposes of section
934(b)). Interest payments received by F Bank read as follows:
pursuant to a plan or arrangement—
(i) The income is received in from borrowers who reside in Country FC, § 1.957–3 United States person defined.
however, may be treated as effectively
exchange for consideration provided to connected with the conduct of a trade or [Reserved]. For further guidance, see
another person; and business in the USVI for purposes of the § 1.957–3T.
(ii) Such person (or another person) Internal Revenue Code (including section ■ Par. 33. Section 1.957–3T is added to
provides the same consideration (or 934(b)). read as follows:
consideration of a like kind) to a third (iii) To the extent that, as described in
person in exchange for one or more section 934(a), the USVI administers income § 1.957–3T United States person defined
payments constituting income from tax laws that are identical (except for the (temporary).
sources within the United States. substitution of the name of the USVI for the (a) Basic rule—(1) In general. The
term United States where appropriate) to term United States person has the same
(d) Income from certain sales of those in force in the United States, interest
inventory property. Paragraph (c) of this meaning for purposes of sections 951
payments received by F Bank from borrowers through 965 which it has under section
section shall not apply to income from who reside in the United States or in Country
sales of inventory property described in FC may be treated as income that is
7701(a)(30) and the regulations
§ 1.863–3(f). effectively connected with the conduct of a thereunder, except as provided in
(e) Examples. The provisions of this trade or business in the USVI for purposes of paragraphs (b) and (c) of this section
section may be illustrated by the F Bank’s income tax liability to the USVI which provide, with respect to
following examples: under mirrored section 882. corporations organized in possessions of
Example 3. (i) G is a partnership that is the United States, that certain residents
Example 1. X is a bona fide resident of organized under the laws of, and that of such possessions are not United
Possession I, a section 931 possession (as operates an active financing business from States persons. The effect of
defined in § 1.931–1T(c)(1)). X has an office offices in, Possession I. Interests in G are
in Possession I from which X conducts a
determining that an individual is not a
owned by D, a bona fide resident of United States person for such purposes
business consisting of the development and Possession I, and N, an alien individual who
sale of specialized computer software. A is to exclude such individual in
resides in Country FC. Pursuant to a pre- determining whether a foreign
purchaser of software will frequently pay X arrangement, G loans $x to T, a business
an additional amount to install the software entity organized under the laws of Country
corporation created or organized in, or
on the purchaser’s operating system and to FC, and T in turn loans $y to E, a U.S. under the laws of, a possession of the
ensure that the software is functioning resident. In accordance with the United States is a controlled foreign
properly. X performs the installation services arrangement, E pays interest to T, which in corporation. See § 1.957–1 for the
at the purchaser’s place of business which turn pays interest to G. definition of the term controlled foreign
may be in Possession I, in the United States, (ii) The arrangement constitutes a conduit corporation.
or in another country. The provision of such arrangement under paragraph (c)(2) of this (2) Special provisions applicable to
services is not de minimis and constitutes a section, and the interest payments received
separate transaction under the rules of possessions of the United States. For
by G are treated as income from sources purposes of this section—
§ 1.861–18. Under the principles of section within the United States for purposes of
864(c)(4) as applied pursuant to paragraph (b) (i) The term possession of the United
paragraph (c)(1) of this section. Accordingly, States means the Commonwealth of
of this section, the compensation that X the interest received by G shall not be treated
receives for personal services performed as effectively connected with the conduct of
Puerto Rico (Puerto Rico) or any section
outside of Possession I is not considered to a trade or business in Possession I for 931 possession.
be effectively connected with the conduct of purposes of the Internal Revenue Code (ii) The term section 931 possession
a trade or business in Possession I for (including sections 931(a)(2) and 934(b), if has the same meaning which it has
purposes of section 931(a)(2). applicable with respect to D). Whether such under § 1.931–1T(c)(1).
Example 2. (i) F Bank is organized under interest constitutes income from sources (iii) The rules of § 1.937–1T shall
the laws of Country FC and operates an within the United States for other purposes apply for determining whether an

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individual is a bona fide resident of a § 1.957–4 [Removed] relating to the continental shelf, see
possession of the United States. ■ Par. 34. Section 1.957–4 is removed. section 638 and § 1.638–1.
(iv) The rules of § 1.937–2T shall (c) Effective date. This section shall
■ Par. 35. In § 1.1402(a)–11, paragraph apply for taxable years ending after
apply for determining whether income
(b) is revised to read as follows: October 22, 2004.
is from sources within a possession of
the United States. § 1.1402(a)–11 Ministers and members of ■ Par. 38. In § 1.6038–2, paragraph (d) is
(v) The rules of § 1.937–3T shall apply religious orders. revised to read as follows:
for determining whether income is * * * * * § 1.6038–2 Information returns required of
effectively connected with the conduct (b) In employ of American employer. United States persons with respect to
of a trade or business in a possession of If a minister or member of a religious annual accounting periods of certain
the United States. order engaged in a trade or business foreign corporations.
(b) Puerto Rico corporation and described in section 1402(c) and * * * * *
resident. An individual (who, without § 1.1402(c)–5 is a citizen of the United (d) [Reserved]. For further guidance,
regard to this paragraph (b), is a United States and performs service, in his see § 1.6038–2T(d).
States person) shall not be considered a capacity as a minister or member of a ■ Par. 39. Section 1.6038–2T is added to
United States person with respect to a religious order, as an employee of an read as follows:
foreign corporation created or organized American employer, as defined in
in, or under the laws of, Puerto Rico for section 3121(h) and the regulations § 1.6038–2T. Information returns required
the taxable year of such corporation thereunder in part 31 of this chapter of United States persons with respect to
which ends with or within the taxable (Employment Tax Regulations), his net annual accounting periods of certain
year of such individual if— earnings from self-employment derived foreign corporations (temporary).
(1) Such individual is a bona fide from such service shall be computed as (a) through (c) [Reserved]. For further
resident of Puerto Rico during his entire provided in paragraph (a) of this section guidance, see § 1.6038–2(a) through (c).
taxable year in which or with which the but without regard to the exclusions (d) U.S. person—(1) In general. For
taxable year of such foreign corporation from gross income provided in section purposes of section 6038 and this
ends; and 911, relating to earned income from section, the term United States person
(2) A dividend received by such sources without the United States, and has the meaning assigned to it by
individual from such corporation during section 931, relating to income from section 7701(a)(30), except as provided
the taxable year of such corporation sources within certain possessions of in paragraphs (d)(2) and (3) of this
would, for purposes of section 933(1), the United States. Thus, even though all section.
be treated as income derived from the income of the minister or member (2) Special rule for individuals
sources within Puerto Rico. for service of the character to which this residing in certain possessions. With
(c) Section 931 possession corporation paragraph is applicable was derived respect to individuals who are bona fide
and resident. An individual (who, from sources without the United States, residents of Puerto Rico or any section
without regard to this paragraph (c), is or from sources within certain 931 possession, as defined in § 1.931–
a United States person) shall not be possessions of the United States, and 1T(c)(1), the term United States person
considered a United States person with therefore may be excluded from gross has the meaning assigned to it by
respect to a foreign corporation created income, such income is included in § 1.957–3T.
or organized in, or under the laws of, a (3) Special rule for certain
computing net earnings from self-
section 931 possession for the taxable nonresident aliens. An individual for
employment.
year of such corporation which ends whom an election under section 6013(g)
* * * * * or (h) is in effect shall, subject to the
with or within the taxable year of such
■ Par. 36. Section 1.1402(a)–12 is exceptions contained in paragraph (d)(2)
individual if—
revised to read as follows: of this section, be considered a United
(1) Such individual is a bona fide
resident of such section 931 possession States person for purposes of section
§ 1.1402(a)–12 Continental shelf and
during his entire taxable year in which certain possessions of the United States.
6038 and this section.
(e) through (l)(2) [Reserved]. For
or with which the taxable year of such [Reserved]. For further guidance, see further guidance, see § 1.6038–2(e)
foreign corporation ends; and § 1.1402(a)–12T. through (l)(2).
(2) Such corporation satisfies the ■ Par. 37. Section 1.1402(a)–12T is (m) Effective date. This section shall
following conditions— added to read as follows: apply for taxable years ending after
(i) 80 percent or more of its gross October 22, 2004.
income for the 3-year period ending at § 1.1402(a)–12T Continental shelf and
■ Par. 40. Section 1.6046–1 is amended
the close of the taxable year (or for such certain possessions of the United States
(temporary). as follows:
part of such period as such corporation ■ 1. Revise the heading.
or any predecessor has been in (a) Certain possessions. For purposes ■ 2. Revise paragraph (f)(3).
existence) was derived from sources of the tax on self-employment income, ■ 3. Remove the undesignated paragraph
within section 931 possessions or was the exclusion from gross income that follows paragraph (f)(3)(iii).
effectively connected with the conduct provided by section 931 (relating to The revisions are as follows:
of a trade or business in section 931 bona fide residents of certain
possessions; and possessions of the United States) shall § 1.6046–1 Returns as to organization or
(ii) 50 percent or more of its gross not apply. Net earnings from self- reorganization of foreign corporations and
as to acquisitions of their stock.
income for such period (or part) was employment are subject to the tax on
derived from the active conduct of a self-employment income even if such * * * * *
trade or business within section 931 amounts are excluded from gross (f)(3) [Reserved]. For further guidance,
possessions. income under section 931. see § 1.6046–1T(f)(3).
(d) Effective date. This section shall (b) Continental shelf. For the * * * * *
apply for taxable years ending after definition of the term United States and ■ Par. 41. Section 1.6046–1T is added to
October 22, 2004. for other geographical definitions read as follows:

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§ 1.6046–1T Returns as to organization or under the authority of sections 937(c) 1T(a)(3)(i) of this chapter) to be
reorganization of foreign corporations and and 7654(e) include the following: provided to the tax authorities of a
as to acquisitions of their stock (1) The requirement to file Form 8689, section 935 possession, the appropriate
(temporary). ‘‘Allocation of Individual Income Tax to tax authority is the person responsible
(a) through (f)(2) [Reserved]. For the Virgin Islands,’’ under § 1.932– for tax administration in such
further guidance, see § 1.6046–1(a) 1T(b)(1) of this chapter, for certain possession or his delegate. See § 1.935–
through (f)(2). individuals with income from sources 1(b) of this chapter for the rules that
(f)(3) U.S. person—(i) In general. For within the United States Virgin Islands. specify where returns of income tax
purposes of section 6046 and this (2) [Reserved]. must be filed for the taxable year by
section, the term United States person (3) [Reserved]. individuals to whom section 935
has the meaning assigned to it by (4) The requirement for individuals to applies.
section 7701(a)(30), except as provided report that they became or ceased to be (d) Effective date. This section shall
in paragraphs (f)(3)(ii) and (iii) of this a bona fide resident of a possession apply for taxable years ending after
section. under § 1.937–1T(g) of this chapter. October 22, 2004.
(ii) Special rule for individuals (b) Manner of payment. The penalty
■ Par. 45. In § 301.7701(b)–1, paragraph
residing in certain possessions. With set forth in paragraph (a) of this section
(d) is revised to read as follows:
respect to individuals who are bona fide shall be paid in the same manner as tax
residents of Puerto Rico or any section upon the issuance of a notice and § 301.7701(b)–1 Resident alien.
931 possession, as defined in § 1.931– demand therefor. * * * * *
1T(c)(1), the term United States person (c) Reasonable cause—(1) In general. (d) [Reserved]. For further guidance,
has the meaning assigned to it by The penalty set forth in paragraph (a) of see § 301.7701(b)–1T(d).
§ 1.957–3T. this section shall not apply if it is
* * * * *
(iii) Special rule for certain established to the satisfaction of the
appropriate tax authority (as defined in ■ Par. 46. Section 301.7701(b)–1T is
nonresident aliens. An individual for added to read as follows:
whom an election under section 6013(g) paragraph (c)(2) of this section) that the
or (h) is in effect shall, subject to the failure to file the information return or § 301.7701(b)–1T Resident alien.
exceptions contained in paragraph furnish the information within the (a) through (c) [Reserved]. For further
(f)(3)(ii) of this section, be considered a prescribed time was due to reasonable guidance, see § 301.7701(b)–1(a)
United States person for purposes of cause and not to willful neglect. An through (c).
section 6046 and this section. individual who wishes to avoid the (d) Application of section 7701(b) to
(f)(4) through (k) [Reserved]. For penalty must make an affirmative the possessions and territories—(1)
further guidance, see § 1.6046–1(f)(4) showing of all facts alleged as a Application to aliens for purposes of
through (k). reasonable cause for failure to file the mirror systems. Section 7701(b)
(l) Effective date. This section shall information return on time, or furnish provides the basis for determining
apply for taxable years ending after the information on time, in the form of whether an alien individual is a resident
October 22, 2004. a written statement containing a of a United States possession or territory
declaration that it is made under that administers income tax laws that
PART 301—PROCEDURE AND penalties of perjury. Such statement are identical (except for the substitution
ADMINISTRATION must be filed with the appropriate tax of the name of the possession or
authority. In determining whether there territory for the term United States
■ Par. 42. The authority citation for part was reasonable cause for failure to where appropriate) to those in force in
301 continues to read, in part, as follows: furnish the required information,
the United States, for purposes of
Authority: 26 U.S.C. 7805 * * * account will be taken of the fact that the applying such laws with respect to
individual was unable to furnish the income tax liability incurred to such
■ Par. 43. Section 301.6688–1 is revised required information in spite of the
to read as follows: possession or territory.
exercise of ordinary business care and (2) Non-application for bona fide
§ 301.6688–1 Assessable penalties with prudence in his effort to furnish the resident determination. Section 7701(b)
respect to information required to be information. An individual will be does not provide the basis for
furnished with respect to possessions. considered to have exercised ordinary determining whether an individual
[Reserved]. For further guidance, see business care and prudence in his effort (including an alien individual) is a bona
§ 301.6688–1T. to furnish the required information if he fide resident of a United States
made reasonable efforts to furnish the possession or territory for U.S. Federal
■ Par. 44. Section 301.6688–1T is added
information but was unable to do so income tax purposes. For the applicable
to read as follows:
because of a lack of sufficient facts on rules for making this determination, see
§ 301.6688–1T Assessable penalties with which to make a proper determination. section 937(a) and the regulations
respect to information required to be (2) Appropriate tax authority. For thereunder.
furnished with respect to possessions purposes of this section, the appropriate (e) [Reserved]. For further guidance,
(temporary). tax authority is the person responsible see § 301.7701(b)–1(e).
(a) In general. Each individual who is for tax administration in the jurisdiction (f) Effective date. This section shall
subject to an information reporting to which the information is required to apply for taxable years ending after
requirement promulgated under the be provided. Thus, in the case of October 22, 2004.
authority of section 937(c) or 7654 and information required under section
who fails to fully satisfy such 937(c) or under section 7654 to be PART 602—OMB CONTROL NUMBERS
requirement within the time prescribed provided to the Internal Revenue UNDER THE PAPERWORK
for reporting such information shall, in Service, the appropriate tax authority is REDUCTION ACT
addition to any criminal penalty the Commissioner. In the case of
provided by law, pay a penalty of $1000 information required under section 7654 ■ Par. 47. The authority citation for part
for each such failure. Information (as in effect with respect to section 935 602 continues to read as follows:
reporting requirements promulgated possessions (as defined in § 1.935– Authority: 26 U.S.C. 7805.

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18948 Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules and Regulations

■ Par. 48. In § 602.101, paragraph (b) is Linda M. Kroening,


amended by adding an entry in Acting Deputy Commissioner for Services and
numerical order to the table to read as Enforcement.
follows: Approved: March 25, 2005.
§ 602.101 OMB Control numbers. Eric Solomon,
* * * * * Acting Deputy Assistant Secretary of the
Treasury.
(b) * * *
[FR Doc. 05–7087 Filed 4–6–05; 11:05 am]
Current BILLING CODE 4830–01–P
CFR part or section where OMB control
identified and described No.

* * * * *
1.937–1T ................................... 1545–1930

* * * * *

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