In January of 2001, the United States Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) unveiled their Proposed Regulation section 1.863-9 (1) under section 863(e) of the Internal Revenue Code of 1986 (Code), as amended, sourcing international communications income. (2) They sought comments from the telecommunications industry on the proposed regulation and recognized that the communications industry is subject to "rapid technological evolution." (3) Domestic, foreign, and multinational commenters from all areas of the telecommunications industry responded to the request for comments with few compliments and many criticisms.
This Article discusses Code section 863(e), its legislative history, the proposed International Communications Income Sourcing Regulations, (4) and the comments submitted by industry professionals (commenters) during the public comment period. The Article also addresses the problems involved in certain rules promulgated in the proposed regulations: the ETB Rule, the Default Rule, the Resourcing Rule, and the Space and Ocean Characterization Rule. (5) The Article discusses, when available, the reasons for the inclusion of the rule in the proposed regulations from the viewpoints of the Treasury and the IRS.
The problems and potential inequities raised by the rules are analyzed from the commenters' points of view and are also analyzed through a fictitious foreign telecommunications joint venture, the X-Land Group. This fictitious joint venture, explained in detail in the following section, includes many, although not all, of the players that are involved in foreign joint ventures providing telecommunications services to the inhabitants of foreign countries. (6)
The IRS is currently revisiting these proposed regulations. It issued a new notice and request for comments on the proposed regulations regulating the sourcing of communications and space and ocean income on October 14, 2003. (7) There have been no changes made to the proposed regulations. (8)
II. DISCUSSION OF THE INTERNATIONAL ASPECTS OF THE TELECOMMUNICATIONS INDUSTRY
The Explanation of Provisions section of the Notice of Proposed Rulemaking for the proposed regulations under Code section 863(e) states: "[t] he IRS and Treasury are fully aware of the rapid technological evolution in the space and communications industries since Congress enacted sections 863(d) and (e) in 1986, and have attempted to take into account these changes as well as changes in the space and communications industries and business practices and business models." (9) While the IRS and Treasury made a valiant effort to propose regulations that could apply fairly to the vast range of complex transactions and relationships in the telecommunications industry, commenters on the proposed regulations raised several areas in which the proposed regulations would have potentially unfair and, in some cases, unexpected results for members of the telecommunications industry, both in the United States and abroad. In order to demonstrate these unfair and unexpected effects, this Article will analyze the tax implications of these proposed regulations for an invented, but representative, group of related telecommunications corporations, the X-Land Group. (10)
In the fictitious country of X-Land, a country with a population of one million and an economy based on tourism, the leaders, after signing the World Trade Organization's Basic Agreement on Telecommunications (BAT) in 1997, (11) agreed to deregulate their telephone service. Prior to X-Land joining the BAT, telephone service was provided by an X-Land government agency called the "Post, Telephone & Telegraph Administration" (PTTA). (12) Under its BAT commitments, X-Land agreed to privatize the PTTA. (13) X-Land also agreed to allow foreign companies to enter into contracts with the new local telecommunications company and own X-Land corporations created to provide long-distance, Internet, cable or satellite television and wireless telephony services inside X-Land. …