Treasury Issues Final Digital Asset Sourcing Regs and Proposed Cloud Transaction Sourcing Regs

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TL Fahring focuses on helping individuals and businesses with a wide variety of matters involving state, federal, and international taxation. He has represented clients in all stages of federal and state tax disputes, including audits, administrative appeals, litigation, and collection matters. Mr. Fahring also has used his tax knowledge to assist clients in planning complex domestic and international transactions, including advising as to potential reporting and withholding requirements.

Mr. Fahring received his J.D. from the University of Texas School of Law, where he graduated with high honors and was inducted into the Order of the Coif and Chancellors honors societies. After clerking for a year at the Texas Eleventh Court of Appeals, he attended New York University School of Law, where he received an LL.M. (Master of Laws) in Taxation and served as a student editor on the Tax Law Review.

On January 14, 2025, the Treasury Department and IRS issued final and proposed regulations on sourcing income from digital content and cloud transactions.

Why is Source Important?

While U.S. persons generally are subject to federal income tax on worldwide income, they are entitled to a credit for certain foreign taxes paid on income that is sourced to foreign country.[1] On the other hand, foreign persons generally are subject to federal income tax only income that is sourced to the United States or that is effectively connected with the conduct of U.S. trade or business. [2]

Final Regulations on Digital Content

The final regulations define “digital content” as a computer program or any other content, such as books, movies, and music, in digital format that is protected by copyright law or not protected by copyright law solely  due to the passage of time or because the creator dedicated the content to the public domain.[3]

In characterizing transactions involving digital content or the provision of services or of know-how with respect to digital content is treated as being solely:

If a transaction has multiple elements, one or more of which would be a transfer of digital content, it is classified in its entirety as a digital content transaction under one of the above categories according to the transaction’s predominant character.[5] The predominant character of a transaction is determined by ascertaining the primary benefit or value received by the customer in the transaction.[6]

Proposed Regulations on Cloud Transactions

The final regulations on digital content transactions define a “cloud transaction” as a transaction through which a person obtains on demand network access to computer hardware, digital content , or other similar resources.[7] But, a cloud transaction does not include network access to download digital content for storage and use on a person’s computer or other electronic device.[8]

The proposed regulations generally treat cloud transactions as the provision of services.[9] The proposed regulations would provide that the location where services associated with a cloud transaction is performed would be determined through a formula involving an intangible property factor (relating to employees performing research and experimentation in the United States), a personnel factor (relating to employees in the United States whose primary function is to contribute to the provision of the cloud transaction other that research and experimentation), and a tangible property factor (relating to depreciable tangible property directly used to provide a cloud transaction that is located United States).[10] As with digital content, however, the proposed rules for cloud transactions call for a transaction to be classified according to its predominant character if the transaction has multiple elements.[11]

 

[1] See I.R.C. §§ 901, 904; Treas. Reg. § 1.1-1(b).

[2] See I.R.C. § 871.

[3] 90  Fed. Reg. 2977, 2988 (final Treas. Reg. § 1.861-18(a)(2)(i)).

[4] 90  Fed. Reg. 2977, 2988 (final Treas. Reg. § 1.861-18(b)(1)).

[5] 90  Fed. Reg. 2977, 2988 (final Treas. Reg. § 1.861-18(b)(2)).

[6] 90  Fed. Reg. 2977, 2988 (final Treas. Reg. § 1.861-18(b)(3)).

[7] 90 Fed. Reg. 2977, 2999 (final Treas. Reg. § 1.861-19(b)).

[8] 90 Fed. Reg. 2977, 2999 (final Treas. Reg. § 1.861-19(b)).

[9] 90 Fed. Reg. 2977, 2999 (final Treas. Reg. § 1.861-19(c)(1)).

[10] 90 Fed. Reg. 3075m, 3081-82 (proposed Treas. Reg. § 1.861-19(d)).

[11] 90 Fed. Reg. 2977, 2999 (final Treas. Reg. § 1.861-19(c)(2)).