Sourcing Rule Change: Manufacturing and Competitiveness

Abstract

The Tax Cuts and Jobs Act (P.L. 115-97) amended the section 863(b) source rule by sourcing the sale of taxpayer-produced property fully at the location(s) of production. There is no longer any portion that will be sourced at the location of sale. This new rule provides an apparent competitive advantage to some foreign manufacturers over comparable U.S. manufacturers. This amendment benefits foreign-based manufacturers selling their products into the United States or selling them elsewhere in the world through U.S. sales branches. Moreover, this source rule is one more TCJA encouragement for U.S.-based manufacturers to offshore their manufacturing to lower their U.S. tax costs.

Because of the section 865(e)(2) override of other sourcing rules, there is ambiguity in applying the sourcing and effectively connected income rules to foreign manufacturers (whether ultimately foreign-owned or U.S.-owned) selling through a U.S. sales branch.

After explaining these issues, recommendations are provided in this article that outline specific legislative fixes to eliminate the competitiveness issue, the encouragement to offshoring, and the ambiguity arising out of the new sourcing rule.

Keywords: Sourcing Rules, International Taxation, Manufacturing, Section 863(b), Section 865(e), Effectively Connected Income

JEL Classification: H21, H25, K34, E62