Generally, income from the sale of personal property is “derived” from the seller’s residence. If the seller is a US tax resident, the source of income is deemed to be US IRC § 865(a)(1). On the other hand, if the seller is a non-resident, the income is generally from a foreign source. IRC § 865(a)(2).
The policy underlying the applicable residency rule for determining the source of income from the sale of unlisted personal property has been clearly stated by Congress as follows:
Rules of origin applicable to sales of personal property should reflect the location of the economic activity generating the income in question or the place of use of the assets generating that income. In addition, the source rules should operate clearly without the need for binding factual determinations, limit the erosion of the U.S. tax base and, as part of the foreign tax credit limitation , generally do not treat as foreign income any income that foreign countries do not or should not tax.
Since the seller’s residence is generally the location of much of the underlying activity that generates income from the sale of personal property, the committee believes that sales income should generally come from there.
Rep. 99–426, at 360 (1985), 1986–3 CB (Vol.2) 1, 360. Courts have recognized the policy underlying the residency rule set forth in Section 865, “In enacting Section 865, Congress has determined that ‘the seller’s residence is generally the location of a substantial portion of the ‘underlying activity that generates income from the sale of personal property’. See
Int’l Multifoods Corp. vs. Comm’r of Internal Revenue, 108 TC 579, 589 (USTC 1997).In this regard, the term “sale” includes any exchange or other disposition. IRC § 865(i)(2).
For purposes of source of income, the concept of residence is modified from the general tax definition of residence and is based on the location of the seller’s “tax domicile”. A U.S. citizen or resident alien is deemed to be a U.S. resident for purposes of determining the source of personal property, if that person has no tax domicile outside the United States. A nonresident alien is also considered a resident of the United States if they have a tax domicile in the United States. IRC § 865(g)(1)(A). For these purposes, the concept of “tax household” is defined as the domicile of the individual for the purposes of § 162(a)(2). IRC § 865(g)(1)(A)(i)(I), IRC § 911(d)(3) and IRC § 162(a)(2). However, a natural person cannot be considered to have a tax domicile in a foreign country for any period during which he resides in the United States. IRC § 911(d)(3).
Applying the seller’s residency-based supply rule under § 865(a), for example, courts have held that a loss of inventory realized by a U.S. resident on the sale of stock of a foreign company was a US source loss based on the residency of the seller. To see International Multifoods Corp., et al., 108 TC 579, 589. In other cases not directly related to § 865(a), courts have mentioned that if “a U.S. resident receives dividends from foreign corporations or gains from the sale of stock in such corporations, such income are generally taxed. See sec. 862(a)(2), 865(a)(1).”, referring to the applicability of § 865(a) to sales of shares of foreign corporations. To see Roberto Toso, et al. vs. Commissioner, 151 TC 27, 35.
Under the residency rule, for example, in cases where there are losses in respect of shares, the loss is allocated to the category of gross income and in respect of which the gain from a sale of those shares would give place in the hands of the seller. For example, the loss recognized by a US resident on the sale of shares is generally allocated to reduce US source income. Treasures. Reg. § 1.865-2(a)(1).
In a partnership, the partner’s distributive share of the loss recognized by the partnership in respect of the shares is allocated and distributed as if the partner had recognized the loss. If the loss is attributed to an office or a fixed place of business of the partnership, this office or this fixed place of business is considered to be the office of the partner for the purposes of the allocation of the loss. Treasures. Reg. § 1.865-2(c).
The general rule for earning income from the sale of personal property has several exceptions, including the following:
- Inventory sales. IRC § 865(b).
- Sales of depreciable property. IRC § 865(c).
- Sales of personal property through a US or foreign office or fixed place of business. IRC § 865(e).
- Sales of personal property by a partnership. IRC § 865(i)(5).
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.