Territory inventory sales may require source allocation

Plain-English summary

Chief Counsel read section 863(b)(2)'s production sourcing rule as applying when the taxpayer selling inventory also produced it. A taxpayer that merely purchased the property may fall under the general sourcing rule. Section 863(b)(3), however, supplies another exception when inventory is purchased in a U.S. territory and sold in the United States. In that situation, source is allocated between the two jurisdictions. The advice proposed a short disclaimer for Form 5074 explaining that inventory purchased or produced in a territory and sold in the United States is sourced by allocation.

Ruling snapshot

• Question: When do the section 863 allocation rules displace the general source rule for inventory sales?
• Outcome: Advice given, allocation applies to specified territory inventory transactions
• Key authorities: IRC § 863(b)(2) and (3)

Full text (IRS public release)

 ID:       CCA_2023053015371617                        [Third Party Communication:

 UILC:     863.00-00                                   Date of Communication: Month DD, YYYY]

Number: 202346017
Release Date: 11/17/2023
From: --------------------
Sent: Tuesday, May 30, 2023 3:37:16 PM
To: -----------------
Cc: -----------------------------------
Bcc:
Subject: RE: TPC 2023 Form 5074 - WLI#2


My reading of 863(b)(2) is that the production rule for sourcing only applies where the
taxpayer-seller is also the producer (“from the sale or exchange of inventory property
[…] produced (in whole or in part) by the taxpayer”. Where the taxpayer-seller merely
purchased the property, the general rule may apply. However, 863(b)(3) is yet another
exception to the general rule. It applies where inventory is purchased in a territory, and
then sold in the US, in which case source is again allocated between the two
jurisdictions. Therefore, I think a disclaimer along the lines of “However, the income from
the sale of inventory purchased or produced by a seller within a U.S. territory and sold within the United
States is sourced based on an allocation” would be enough to clarify where the general rule does not
apply.