Rule2024-31372
Classification of Digital Content Transactions and Cloud Transactions
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
January 14, 2025
Effective
January 14, 2025
Issuing agencies
Treasury DepartmentInternal Revenue Service
Abstract
This document contains final regulations modifying the rules for classifying transactions involving computer programs, including by applying the rules to transfers of digital content. These final regulations also provide rules for the classification of cloud transactions. These rules apply for purposes of the international provisions of the Internal Revenue Code and generally affect taxpayers engaging in transactions involving digital content or cloud transactions.
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[Federal Register Volume 90, Number 8 (Tuesday, January 14, 2025)]
[Rules and Regulations]
[Pages 2977-3003]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-31372]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 10022]
RIN 1545-BM41
Classification of Digital Content Transactions and Cloud
Transactions
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations modifying the rules
for classifying transactions involving computer programs, including by
applying the rules to transfers of digital content. These final
regulations also provide rules for the classification of cloud
transactions. These rules apply for purposes of the international
provisions of the Internal Revenue Code and generally affect taxpayers
engaging in transactions involving digital content or cloud
transactions.
DATES:
Effective date: These regulations are effective on January 14,
2025.
Applicability date: For dates of applicability, see Sec. Sec.
1.861-18(i) and 1.861-19(e).
FOR FURTHER INFORMATION CONTACT: Christopher E. Fulle, (202) 317-5367,
or Michelle L. Ng, (202) 317-6989 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Authority
These final regulations are issued under the express delegation of
authority under section 7805 of the Internal Revenue Code (Code).
Section 7805(a) directs the Secretary of the Treasury or her delegate
to prescribe all needful rules and regulations for the enforcement of
that section and others in the Code, including all rules and
regulations as may be necessary by reason of any alteration of law in
relation to internal revenue.
Background
On August 14, 2019, the Department of the Treasury (Treasury
Department) and the Internal Revenue Service (IRS) published proposed
regulations (REG-130700-14) under section 861 of the Code in the
Federal Register (84 FR 40317) (the proposed regulations). The Treasury
Department and the IRS received written comments on the proposed
regulations, and a public hearing was held on February 11, 2020. All
written comments received in response to the proposed regulations are
available at <a href="http://www.regulations.gov">www.regulations.gov</a> or upon request. Terms used but not
defined in this preamble have the meaning provided in these final
regulations.
These regulations (the final regulations) extend the classification
rules in existing Sec. 1.861-18 to transfers of digital content other
than computer programs and clarify the source of income for certain
transfers of digital content. The final regulations also clarify the
classification of transactions involving on-demand network access to
computing and other similar resources.
The final regulations retain the overall approach of the proposed
regulations, with certain revisions discussed in the preamble. The
preamble also discusses comments received in response to the
solicitation of comments in the notice of proposed rulemaking.
Summary of Comments and Explanation of Revisions
I. General Classification Issues
A. Replacement of De Minimis Rule With a Predominant Character Rule
Section 1.861-18(b)(1), as in effect before this Treasury decision,
described four transactions involving computer programs: the transfer
of a copyright right, the transfer of a copyrighted article, the
provision of services for the development or modification of a computer
program, and the provision of know-how relating to the development of a
computer program. Section 1.861-18(b)(2) required any transaction that
consisted of more than one of the transactions described in Sec.
1.861-18(b)(1) to be treated as separate transactions, unless a
transaction was de minimis, in which case it would be treated as part
of another transaction. The proposed regulations generally retained the
four types of transactions (with the expansions described in Part II.A
of this Summary of Comments and Explanation of Revisions) and preserved
the de minimis rule, but for clarification purposes, Sec. 1.861-
18(b)(2) was proposed to be modified by introducing the term
[[Page 2978]]
``arrangement'' and providing that multiple transactions in an
arrangement generally must be characterized separately.
Proposed Sec. 1.861-19(b) defined a cloud transaction as a
transaction through which a person obtains on-demand network access to
computer hardware, digital content (as defined in proposed Sec. 1.861-
18(a)(3)), or other similar resources, other than on-demand network
access that is de minimis taking into account the overall arrangement
and the surrounding facts and circumstances. Similar to proposed Sec.
1.861-18(b)(2), proposed Sec. 1.861-19(c)(3) required separate
classification of each transaction comprising an arrangement, except
that any transaction that was de minimis would be treated as part of
another transaction rather than being classified separately.
Comments recommended replacing these rules in proposed Sec. Sec.
1.861-18(b)(1) and (b)(2), and 1.861-19(c)(3), with a predominant
character rule, such that a transaction consisting of more than one
category of transactions described in proposed Sec. 1.861-18(b)(1), or
a transaction consisting of one or more categories of transactions
described in both proposed Sec. Sec. 1.861-18(b)(1) and 1.861-19(b),
would be characterized as only one of those categories of digital
content transactions or as a cloud transaction in accordance with the
predominant character of that transaction. As an example of a mixed
transaction that would be difficult to characterize under the proposed
regulations, comments pointed to video game business models where the
customer purchases a copy of the game but primarily plays the video
game online with other players. As another example, comments pointed to
software antivirus programs that include code that executes on the
user's equipment as well as code that is deployed in the cloud to
detect and capture viruses before they reach the user's equipment. The
comments argued that the predominant character rule would avoid the
difficult and burdensome task of determining whether an element is de
minimis in the context of the overall transaction and allocating income
from the transaction among the non-de minimis categories as if they
were separate transactions. The comments also argued that a de minimis
standard is imprecise, and a predominant character rule that compares
components of a transaction to determine which component is predominant
would be much more administrable. Furthermore, one comment suggested
that a predominant character standard would better align with existing
Treasury regulations and other authorities, for instance, Sec. 1.954-
1(e)(3), which provides for a predominant character approach in the
subpart F context. Finally, the comments noted confusion arising from
the use of the term ``transaction'' to mean two different things in the
same provision under proposed Sec. 1.861-18(b)(2), and also
recommended removing the term ``arrangement'' on the grounds that the
term was unclear, particularly because it was not defined and rarely
appears in other tax rules.
The comments recommended that the predominant character of a
transaction be determined based on the facts and circumstances.
Comments suggested that the relevant facts may include the overall
commercial purpose, the taxpayer's treatment for non-tax purposes, the
relative cost of each component (including the cost of maintaining
online and offline components), and a comparison of unit prices for
components sold separately. Comments suggested that the facts and
circumstances should provide at least a reasonable basis for
determining the predominant character of the transaction.
Further, the comments suggested defining a transaction based on the
facts and circumstances or as an agreement entered into in the ordinary
course. Several comments suggested that relevant factors for
determining the scope of a transaction could include the availability
of separate pricing, the use of separate stock keeping units
(``SKUs''), and the taxpayer's definition for non-tax purposes.
The final regulations adopt these comments, in part. The final
regulations replace the de minimis rule and the concept of an
arrangement with a predominant character rule, which applies to both
digital content transactions and cloud transactions. The Treasury
Department and the IRS agree that, for purposes of the final
regulations, a transaction with multiple elements (including de minimis
elements) should be characterized based on the predominant character of
the transaction. Predominant character rules also exist in other
regulations for international provisions of the Code, such as foreign-
derived intangible income and subpart F, and thus are familiar to
taxpayers. See Sec. Sec. 1.250(b)-3(d) and 1.954-1(e)(3). Further, in
many business models that include both online and offline functionality
it may be difficult to bifurcate a single transaction into a digital
content transaction and a cloud transaction. The Treasury Department
and the IRS expect that bifurcation will remain difficult and may
increase in difficulty as business models and technology evolve.
Therefore, Sec. 1.861-18(b)(2) of the final regulations provides that,
taking into account the overall transaction and the surrounding facts
and circumstances, a transaction that has multiple elements, one or
more of which would be a digital content transaction if considered
separately, is classified in its entirety as a digital content
transaction under one of the categories described in Sec. 1.861-
18(b)(1) if the predominant character of the transaction is described
in one of the categories in that paragraph. Section 1.861-19(c)(2) of
the final regulations provides a corresponding rule for transactions
that have multiple elements, one or more of which is a cloud
transaction. Further, the references to ``de minimis'' and
``arrangement'' are also removed in Sec. 1.861-19(a) of the final
regulations so that the final regulations define a cloud transaction as
a transaction through which a person obtains on-demand network access
to computer hardware, digital content (as defined in Sec. 1.861-
18(a)(2)), or other similar resources.
The final regulations define a digital content transaction as a
transaction that constitutes a transfer of digital content or the
provision of modification or development services or of know-how with
respect to digital content. See Sec. 1.861-18(b)(1). The final
regulations do not, however, define the term transaction. The Treasury
Department and the IRS have concluded that it is not necessary to
introduce a specialized definition in these regulations because the
concept is already well-established under general tax principles, case
law, and existing administrative guidance.
Section 1.861-18(b)(3) of the final regulations (cross-referenced
in Sec. 1.861-19(c)(2)) provides a general rule and a special rule for
determining the predominant character of a transaction that contains
multiple elements, one or more of which would be a digital content
transaction or a cloud transaction if considered separately. Under the
general rule, the predominant character is determined by the primary
benefit or value received by the customer. If that information is not
reasonably ascertainable, the special rule provides that the
predominant character is determined by the primary benefit or value
received by a typical customer in a substantially similar transaction,
which is determined by data on how a typical customer uses or accesses
the digital content. If data on how a typical customer uses or accesses
the digital content is not available, then all factors indicative of
the primary benefit or value received by a typical
[[Page 2979]]
customer must be examined, including how the transaction is marketed,
the relative development costs of each element of the transaction, and
the relative price paid in an uncontrolled transaction for one or more
elements compared to the total contract price of the transaction in
question.
B. Distinction Between Temporary Downloads and Streaming
One comment requested guidance on ``streaming'' and ``temporary
downloading'' transactions. The comment expressed the view that whether
a customer can download digital content should not determine whether a
transaction is characterized as a service or a lease. The comment noted
that when a customer's rights are limited to downloading and viewing a
discrete item of digital content, such as a movie, for a limited time,
the transaction would be treated as a lease of digital content.
However, if the customer can access and download as many movies as
desired from a catalog of thousands of movies for a monthly fee, and
once the subscription ends access to the downloaded movies ends, the
transaction would be treated as a cloud transaction and classified as a
service according to the comment. The comment suggested that the
characterization of these two transactions should not depend on whether
the content is actually downloaded by any particular customer.
Another comment asserted that on-demand access to digital content
should not be treated differently than temporary downloads of digital
content because the two transactions are functionally equivalent in
that both provide temporary access to digital content. The comment
observed that the decision to provide on-demand access or temporary
downloads of digital content is typically driven by the nature of the
technology involved (for example, the memory capacity of a user's
computer or the download speeds available), and generally has no
bearing on the economic substance of the transaction.
Where the provider chooses whether to offer either temporary
downloads or streaming the Treasury Department and the IRS disagree
that these two types of transactions should be treated the same. A
fundamental requirement of a digital content transaction, unlike a
cloud transaction involving digital content, is that there must be a
transfer of digital content to the customer. This distinction between
property and services transactions has been in place since the original
issuance of Sec. 1.861-18 in 1998 and applying it consistently
provides a degree of certainty for an otherwise factual case-by-case
determination.
When a customer downloads digital content, there is a transfer of a
copy of that digital content to the customer and the customer must use
its own device to host the copy of content for viewing or listening,
for example. In contrast, when a customer streams digital content,
there is no transfer of digital content. Instead, the customer receives
access to the digital content through the provider's servers.
Especially for large file-size content, performing the hosting function
in order to allow the customer continuous access places a higher burden
on the provider. Similarly, for a temporary download, the customer must
have sufficient storage on its device for the temporary download that
is not necessary in a streaming transaction. There are also differences
in how the customer may experience the digital content. For example,
once a customer downloads digital content, the customer is able to
access the content regardless of whether the customer is connected to
the internet and could thus watch a downloaded movie or read a
downloaded book when the customer is unable to connect to the internet.
In these ways, there are fundamental differences in character between a
temporary download and streaming that warrant different
characterization and sourcing rules for each type of transaction. Where
the customer may choose whether to temporarily download or stream
content, the predominant character rule in the final regulations would
apply to characterize the transaction. See Sec. 1.861-19(d)(7)
(Example 7) and (d)(9) (Example 9) of the final regulations.
II. Transactions Involving Digital Content
A. Definition of Digital Content
Section 1.861-18, as in effect before this Treasury decision,
applied only to computer programs. The proposed regulations expanded
the scope of Sec. 1.861-18 to apply to transactions involving
``digital content,'' defined as ``a computer program or any other
content in digital format that is either protected by copyright law or
no longer protected by copyright law solely due to the passage of
time.''
Several comments recommended broadening the definition of digital
content to encompass content not protected by copyright law that is
transferred electronically and is similar to copyrightable content,
such as consumer or user data, text files of recipes, government-
produced documents, and sets of font and typefaces. One comment
suggested expansion to any property in digital format in which a person
has a right or interest, including any property bought and sold in real
marketplaces, in virtual marketplaces and in in-game economies. These
comments generally suggested that transfers of this non-copyrightable
digital property are economically and functionally equivalent to the
transfer of digital content and that characterization of the transfers
should be treated the same. One comment asserted that such content may
be subject to other forms of intellectual property protection such as
contractual restrictions and non-disclosure agreements, such that
transfers of that content are functionally similar to transfers of
digital content.
The final regulations do not broaden the definition of digital
content beyond content protectable by copyright law. Section 1.861-18,
as in effect before this Treasury decision, generally followed
copyright law, and the Treasury Department and the IRS are of the view
that it is appropriate to continue to apply this longstanding copyright
law framework. This framework is not workable for non-copyrightable
content given that the legal rights associated with such content
generally are not the same as those associated with content protectable
by copyright law. For example, in a digital transfer of property that
is not protected by copyright law, the transferee may (unless otherwise
restricted, such as by contract) have the unfettered ability to make
and distribute copies to the public, to prepare derivative works, or to
publicly display or publicly perform the property. As a result, if the
framework of Sec. 1.861-18 were applied to the transaction, such a
transfer would generally be characterized as a license or sale of a
copyright right, regardless of whether the transferee intends to
exploit those abilities or whether those powers have any value or
relevance in the context of the transaction. Therefore, the existing
framework could result in a classification at odds with the economics
and reality of the transaction. Further, where non-copyrightable
digital property is transferred subject to contractual or other
restrictions, those restrictions may not fit cleanly within the
existing framework and may require a different analysis to determine
the correct characterization. Accordingly, including non-copyrightable
content would require a different set of rules that are beyond the
scope of Sec. 1.861-18.
One comment noted that under the proposed regulations, an online
database that allows customers on-demand access to a collection of non-
[[Page 2980]]
copyrightable content such as recipes or court opinions is a cloud
transaction. See Sec. 1.861-19(d)(8) (Example 8). This is because the
definition of a cloud transaction in proposed Sec. 1.861-19(b) refers
to on-demand network access to computer hardware, digital content, or
``other similar resources.'' The comment suggested that the inclusion
of ``other similar resources'' in the definition of cloud transaction
may provide a road map for expanding the definition of digital content
in proposed Sec. 1.861-18. The Treasury Department and the IRS
disagree. The cloud transaction definition includes access to non-
copyrightable content because curation of such content is a common
business model that, unlike the framework of Sec. 1.861-18, does not
depend on whether the content is copyrightable because there is no
transfer to the customer.
The final regulations therefore do not adopt these comments and
continue to characterize digital content transactions based on the
distinction between a transfer of a copyrighted article and a transfer
of copyright rights, which depends on whether the customer receives
copyright rights as part of the transfer. The Treasury Department and
the IRS may, however, consider these comments for possible future
guidance specific to types of digital property that are not protectable
by copyright law. The final regulations do provide, however, that
digital content includes content that is not protected by copyright law
solely because the creator dedicated the content to the public domain.
The regulations include this refinement because monetization of such
content generally also involves digital content that is protected by
copyright law and therefore fits within the framework of Sec. 1.861-
18. See Sec. 1.861-18(a)(2).
B. Provision of Know-How Relating To Development of Digital Content
Section 1.861-18(b)(1)(iv), as in effect before this Treasury
decision, provided that one of the categories of transactions relating
to computer programs was ``[t]he provision of know-how relating to
computer programming techniques.'' Section 1.861-18(e) provided that
the provision of information with respect to computer programs will be
treated as the provision of know-how for purposes of Sec. 1.861-18
only if the information (1) relates to computer programming techniques;
(2) is furnished under conditions preventing unauthorized disclosure,
specifically contracted for between the parties; and (3) is considered
property subject to trade secret protection. The proposed regulations
would modify Sec. 1.861-18(b)(1)(iv) and (e)(1) by replacing
``computer programming techniques'' with ``development of digital
content,'' but would not otherwise change Sec. 1.861-18(b)(1)(iv) and
(e)(1).
One comment asked for confirmation that the changes to Sec. 1.861-
18(b)(1)(iv) and (e)(1) would not change the scope of Sec. 1.861-
18(b)(1)(iv), and that Sec. 1.861-18(b)(1)(iv) in the final
regulations describes only know-how transferred under terms that
constitute a license for United States Federal tax purposes. The
Treasury Department and the IRS confirm that Sec. 1.861-18(b)(1)(iv)
in the proposed and final regulations is intended to describe the same
type of know-how covered by Sec. 1.861-18(b)(1)(iv) as in effect
before this Treasury decision, except that know-how may relate to any
development of digital content and not merely computer programming
techniques. The Treasury Department and the IRS have determined that
Sec. 1.861-18(b)(1)(iv) and (e)(1) are sufficiently clear in this
regard and that additional guidance on the treatment of such know-how
is unnecessary.
C. Rights To Prepare Derivative Digital Content
Section 1.861-18(c)(2)(ii), as in effect before this Treasury
decision, provided that one of the copyright rights referred to in that
paragraph was the right to prepare derivative computer programs based
upon a copyrighted computer program. The proposed regulations would
replace the references to computer programs with references to digital
content but would not otherwise change Sec. 1.861-18(c)(2)(ii). One
comment recommended that the right to prepare derivative digital
content based upon digital content should be treated as a copyright
right only if it is coupled with the right to distribute the derivative
digital content to the public. The comment expressed the belief that
this change would be consistent with one of the underlying policies of
these regulations, which is to treat as a license a transaction in
which the transferee exercises a copyright right to exploit the rights
in the market, and to treat as a sale or lease a transaction in which
the transferee consumes the digital content. The comment also suggested
that this change would address the ambiguity in copyright law as to
what modifications of a copyrighted work are necessary to create a
derivative work, and whether, for example, rights to modify software
during installation or customization would constitute rights to create
a derivative work.
The final regulations do not adopt this comment. The preamble to
Treasury Decision 8785 (which promulgated Sec. 1.861-18 in 1998)
stated in response to similar comments to the proposed regulations
(REG-251520-96) that were finalized in Treasury Decision 8785 that the
right to make copies (which must be coupled with the right to
distribute the copies to the public to constitute a copyright right
under the regulations, despite such a requirement not being present
under copyright law) is treated differently from the other copyright
rights in the context of the regulations because of the unique
characteristics of computer programs, including the ease with which
computer programs can be copied. However, as explained in that
preamble, it is generally consistent with copyright law to treat as a
copyright right a non-de minimis right to make a derivative work,
regardless of whether it is coupled with the right to distribute to the
public, and there is no sufficiently unique aspect of digital content
that would compel a different result for purposes of Sec. 1.861-18.
The Treasury Department and the IRS continue to be of the view that
that the right to make a derivative work without further rights to
distribute to the public should be treated as a copyright right and
that the unique characteristics of digital content do not compel a
different result. However, the predominant character rule in Sec.
1.861-18(b)(2) and (3) of the final regulations (discussed in Part I.A
of this Summary of Comments and Explanation of Revisions) should
alleviate concerns about minor customization rights causing what would
otherwise be a transfer of digital content to be treated as a license
of a copyright right. See Sec. 1.861-18(h)(18) (Example 18) of the
final regulations.
D. Right To Make a Public Performance or Public Display for Purposes of
Advertising
Section 1.861-18(c)(2), as in effect before this Treasury decision,
designated as copyright rights the right to make a public performance
of a computer program and the right to display a computer program to
the public. The proposed regulations would replace the references to
computer programs with references to digital content, and also provide
exceptions for the right to publicly perform or publicly display
digital content for the purpose of advertising the sale of the digital
content performed or displayed. Proposed Sec. 1.861-18(c)(2)(iii) and
(iv). The preamble to the proposed regulations used an example of
rights provided to a video game retailer that allow the retailer to
display screenshots of a video game on television commercials promoting
the game, and
[[Page 2981]]
noted that these rights, on their own, would not be significant. Two
comments agreed with the addition of the regulatory language and one of
the comments suggested that the preamble example be included in the
regulatory text.
The final regulations retain the exceptions for the public
performance or public display of digital content for the purpose of
advertising the sale of the digital content performed or displayed. See
Sec. 1.861-18(c)(2)(iii) and (iv). The Treasury Department and the IRS
have determined, however, that the language of the regulation is
sufficiently clear without an example and therefore the final
regulations do not include the example in the regulatory text.
E. Copyright Rights Related to Digital Content Used for Cloud
Transactions
One comment questioned whether the transfer of the right to use
software or other digital content for a cloud transaction should be
treated as the transfer of a copyright right. The comment included an
example wherein A, a domestic corporation, transfers computer software
to B, a foreign affiliate. B also gets the right to use the software to
provide software-as-a-service transactions, but does not get the right
to sell copies of the software or make derivative works. The comment
stated that it appears that a copyright right has been transferred in
this scenario, but that it is not clear which of the enumerated
copyright rights is transferred. The comment recommend that the final
regulations allow taxpayers to elect to characterize this type of
transaction as a transfer of a copyright right.
The Treasury Department and the IRS agree that a transfer of
digital content accompanied by the right to use the digital content to
provide a cloud transaction will generally result in the transfer of
the right to either publicly display or publicly perform the digital
content, depending on the type of digital content and specific rights
transferred. To display a work means to show a copy of it, either
directly or by means of a film, slide, television image, or any other
device or process or, in the case of a motion picture or other
audiovisual work, to show individual images nonsequentially. 17 U.S.C.
101. To perform a work means to recite, render, play, dance, or act it,
either directly or by means of any device or process or, in the case of
a motion picture or other audiovisual work, to show its images in any
sequence or to make the sounds accompanying it more audible. Id.
Further, 17 U.S.C. 101 includes a ``transmit clause'' that provides
that to publicly display or perform a work means, in relevant part, to
transmit or otherwise communicate a performance or display of the work
to the public, by means of any device or process, whether the members
of the public capable of receiving the performance or display receive
it in the same place or in separate places and at the same time or at
different times. Reading these provisions of 17 U.S.C. 101, the
Treasury Department and the IRS have concluded that the use of digital
content to provide a cloud transaction should be treated as the
exercise of a copyright right under both copyright law and the final
regulations. See American Broadcasting Companies, Inc. v. Aereo, Inc.,
573 U.S. 431 (2014) (holding that capture of broadcast copyrighted
content and retransmission to subscribers who stream the content to
their personal devices was a public performance of a copyrighted work
under the transmit clause of 17 U.S.C. 101). However, whether the
transferred right is a right to display or a right to perform will
depend on the type of digital content, the type of copyright obtained,
and the manner in which the digital content is used in the cloud
transaction. Due to the factual nature of these issues and the
important role of copyright law in those determinations, the final
regulations do not specify which copyright right has been transferred
when digital content is transferred for use in a cloud transaction.
F. Examples Illustrating Sec. 1.861-18
Several comments requested new examples describing common business
models or modifications to examples provided in the proposed
regulations. In response to these comments, the final regulations
contain several new examples and make certain modifications to the
examples in the proposed regulations. In addition, pre-existing
examples that were in effect before the issuance of this Treasury
decision have been modified to follow the same analytical structure as
the examples added by the final regulations.
One comment requested an example of a wholesaler of computer
software buying and selling a limited number of product keys. A product
key is a specific software-based key for a computer program that
certifies the copy of the program is original. Instead of using
physical media such as a CD or DVD to install software onto a computer
or other electronic device, a user can enter a product key to download
the software and then install it from their computer's hard drive. A
customer that purchases software through electronic channels often
receives a link to download and a product key to activate the software.
The comment asserted that an underlying principle of these regulations
is to treat economically similar income equally, regardless of whether
the income is earned through electronic means or through more
conventional channels of commerce, and therefore the income earned by a
wholesaler of product keys for software should be treated the same as a
wholesaler of physical copies of software. The Treasury Department and
the IRS agree that Sec. 1.861-18 does not characterize otherwise
similar transactions differently solely because one transaction was
effected through electronic means and the other was not. See Sec.
1.861-18(g)(2) of the final regulations. In response to the comment, a
new example added in the final regulations, Sec. 1.861-18(h)(24)
(Example 24), addresses a business model in which a video game
copyright owner transfers product keys to retailers, and then the
retailers transfer those keys to customers. Based on the facts in the
example, the transfer of product keys to the retailers is characterized
as a sale of copyrighted articles, and the transfer of product keys
from the retailers to customers is also classified as the sale of
copyrighted articles.
Two comments asked for an example addressing a business model in
which an operator of a platform offers for download digital content
(for example, video games or electronic books) as an agent of the
digital content developers. The platform operator receives the
copyright right to make and sell digital copies of the digital content,
but this right is granted only so that the platform operator can act in
its capacity as an agent facilitating sales of the digital content
between digital content developers and customers. As such, the comments
asserted that the transaction between the platform operator and digital
content developers should not be treated as the transfer of copyright
rights. One of these comments also suggested several clarifying changes
to proposed Sec. 1.861-18(h)(19) (Example 19) to distinguish the
business model described in that example, which involves a licensed
reseller that utilizes an online platform, from the agency platform
operator described in the comment.
The Treasury Department and the IRS recognize that an agency
platform operator business model exists, and therefore the final
regulations include a new example at Sec. 1.861-18(h)(20) (Example 20)
that describes a scenario in which a platform operator offers
applications for sale as an agent of the
[[Page 2982]]
application developers. The facts in Example 20 assume that the
platform operator acts as an agent of the application developers under
general tax principles and concludes that the characterization of the
transaction between the platform operator and application developers is
not a digital content transaction nor a cloud transaction. Whether a
taxpayer is acting as an agent on behalf of another taxpayer is
determined under general tax principles and that determination is
outside the scope of these final regulations. Additionally, Sec.
1.861-18(h)(19) (Example 19) of the final regulations contains certain
changes to the facts in the proposed regulations that are intended to
distinguish the licensed reseller platform operator business model
described in that example from the agency platform operator model
described in Example 20, namely that the primary benefit or value that
the distributor (Corp A) receives in the transaction in Example 19 is
the right to reproduce and distribute an unlimited number of copies of
the book.
One comment recommended adding an example describing a business
model in which a video game that can be played on a particular game
console or a computer is sold in physical copies through retailers, or
digitally through the game console's store or through an internet store
for a one-time fee. The game's core functionality is accessed online
and, if played on the game console, requires paying an annual or
monthly subscription fee to the console maker which grants the customer
access to the online functionality of the console, thereby allowing the
customer to play the online component of the video game (and all other
video games) on the console. This fee is charged by the console maker
for purposes of using the console online, so if the game is played on a
computer, there is no additional fee to access the online content. The
example in the comment concluded that the purchase of the console
version of the video game, whether from a retailer, the game console
store, or the internet store, is a cloud transaction because most
customers purchase the game primarily to enjoy the online
functionality. This comment also recommended another similar example,
except the core functionality of the video game is offline content, and
therefore the purchase of the video game is the sale of a copyrighted
article.
The comment underscores the fact that there are many different
business models and types of transactions in the video game industry.
The determination of the character of each transaction will necessarily
be fact-specific based on the rights obtained by the customer and, if
relevant, the predominant character of the transaction. However, to
address certain aspects of these scenarios, a new example at Sec.
1.861-18(h)(24) (Example 24) of the final regulations describes the
purchase of a video game for a one-time fee that has online and offline
functionality, and that does not require paying a periodic subscription
fee that is specific to that game to access the online content.
Additionally, a new example at Sec. 1.861-19(d)(11) (Example 11) of
the final regulations describes the purchase of a video game for a one-
time fee whose primary functionality is online and requires paying a
monthly fee to the game developer to access the online content specific
to the game. The examples conclude in both cases that, under the facts
presented, a customer's purchase of a game has the predominant
character of a sale of a copyrighted article. Neither example
introduces additional complexity by describing a separate subscription
fee that the customer must pay to a console maker to enable the online
functionality of the console for all games played on that console. The
Treasury Department and the IRS have concluded that such a fee would
not be relevant to determining the character of transactions specific
to the game itself under the final regulations. Such a fee is more akin
to the monthly amount that a customer may pay to an internet service
provider for internet access to play games online in general, because
the fee is not specific to the game and is instead required to enable
online functionality on a device that has other functions.
One comment recommended changes to the facts in Sec. 1.861-
18(h)(19) through (21) (Examples 19 through 21) of the proposed
regulations, which contained a restriction on the transfer of the
digital content by limiting the number of devices onto which the
customer could download the content. Specifically, the comment
recommended modernizing these examples by replacing the ``limited
number of devices'' restriction with more general background that
explains that the user agreement and the conditions and features of the
provider's website and applications adequately restrict the end-user's
ability to lend or otherwise transfer the digital content. In Sec.
1.861-18(h)(19) and (21) (Examples 19 and 21) of the final regulations,
the restriction on the number of devices is removed, and facts were
added to make clear that no copyright rights were granted. Proposed
Sec. 1.861-18(h)(20) (Example 20), which discussed a business that
offered end-users membership to a catalog of copyrighted music and
required the end-users to download the songs, was removed from the
final regulations because the Treasury Department and the IRS
determined the facts described in the example were unrealistic.
III. Cloud Transactions
A. Classification of Cloud Transactions
Proposed Sec. 1.861-19(c)(1) would provide that a cloud
transaction is classified solely as either a lease of property or the
provision of services, based on all relevant factors. Proposed Sec.
1.861-19(c)(2) would enumerate a non-exhaustive list of potentially
relevant factors, most of which come from section 7701(e) of the Code.
The preamble to the proposed regulations requested comments as to
whether the classification as either a lease or a service was correct,
or whether cloud transactions are more properly classified in another
category of income. The preamble also requested comments on realistic
examples of cloud transactions that would be treated as leases under
proposed Sec. 1.861-19.
Several comments recommended that all cloud transactions be
classified as services because the commentators could not identify any
realistic cloud transaction that could be classified as a lease. One
comment requested that the final regulations include an example of a
cloud transaction that would be treated as a lease, but did not suggest
a scenario in which a cloud transaction would be a lease.
Alternatively, the comments recommended that the final regulations
include a rebuttable presumption that all cloud transactions are
classified as services.
In the absence of a rule stating all cloud transactions are
services, several comments expressed concerns with, and suggested
modifications to, certain factors listed in proposed Sec. 1.861-
19(c)(2). For example, some comments suggested that certain factors
were not relevant for cloud transactions, or would generally weigh
towards a lease characterization, but that overall, a cloud transaction
should still be classified as the provision of services. Comments also
recommended clarifying the treatment as services of related party data
hosting transactions that involve cost-plus payments from a company
under common control with the hosting company.
One comment suggested adding an example that commonly exists in
practice that is similar to proposed Sec. 1.861-19(d)(2) (Example 2),
involving the provision of designated servers to
[[Page 2983]]
the customer, but with a shifted focus to analyze the access that a
remote user may have to data and software on those servers.
Two comments expressed concerns that the proposed regulations may
be used to characterize transactions of infrastructure providers, such
as real estate investment trusts, who lease and otherwise make
available real property and other infrastructure to cloud providers and
similar tenants. These comments were concerned that the proposed
regulations referenced the section 7701(e) factors to determine whether
a cloud transaction was a service or a lease, and that these
interpretations could affect the interpretation of the section 7701(e)
factors in the context of non-cloud transactions.
The final regulations treat all cloud transactions solely as the
provision of services and remove the section 7701(e) and other factors
listed in the proposed regulations. Like the comments, the Treasury
Department and the IRS could not identify a transaction that satisfies
the definition of a cloud transaction that would be properly classified
as a lease. Further, the Treasury Department and the IRS would expect
future business models that meet the definition of a cloud transaction
to constitute services rather than leases or other types of
transactions. The services classification is appropriate because in a
typical business model that includes a cloud transaction, the cloud
provider retains economic control and possession over the relevant
property (such as servers, software, or digital content, depending on
the transaction) and the cloud transaction meets other hallmarks of a
service transaction such as the provider having the ability to
determine the specific property used to provide the cloud transaction
and to replace such property with similar property. Note, however, that
business models may include transactions involving computer hardware,
such as a server, that is located at the customer's premises, and such
a transaction may fall outside the definition of a cloud transaction
(for example, because there is no on-demand network access provided in
that transaction) and would therefore be classified under section
7701(e) and general tax principles. The Treasury Department and the IRS
have also concluded that a more definite rule for characterization
based on the definition of a cloud transaction will allow for better
compliance and tax administration than the factors test in the proposed
regulations. Because the final regulations classify all cloud
transactions as the provision of services, examples applying the
factors from the proposed regulations to determine whether a cloud
transaction is a service or a lease have been removed (and no example
concluding that the cloud transaction is a lease has been added).
Finally, one comment recommended expanding the characterization of
cloud transactions to include licenses for transactions in which non-de
minimis copyright rights are transferred. The comment described an
example where an owner of digital content (a movie) streams that
digital content to a movie theater and grants the movie theater the
right to show the streamed content to customers. The comment concluded
that the transaction between the content owner and the movie theater is
a license. The comment expressed the belief that the manner in which
digital content and accompanying public display or performance rights
are delivered should not alone change the character of a transaction
from a license to a service or lease.
The final regulations do not adopt this comment. In the scenario
posited by the comment, the movie theater would be much more likely to
download or otherwise obtain a copy of the movie than to stream the
movie simultaneously with displaying the movie to customers, given the
possibility of buffering or other technology issues that might occur
while streaming and negatively impact the movie theater's customers.
However, a somewhat similar scenario could occur if a bar or similar
establishment streams music, sporting events, or other content as
entertainment for customers eating or drinking at the establishment.
While the agreement with the streaming service may grant the bar the
right to perform or to display the streamed content to its customers,
if there is no transfer of digital content (that is, no option to
download of digital content), the transaction falls outside the digital
content rules in Sec. 1.861-18 and may be properly characterized as a
cloud transaction. Whether there is a transfer of a copyright right
that is not described in Sec. 1.861-18(c)(2) would depend on copyright
law. As described in Part I.B of this Summary of Comments and
Explanation of Revisions, a fundamental requirement for a digital
content transaction such as a license of copyright rights, as opposed
to a cloud transaction involving digital content, is that the former
involves a transfer of the digital content to the customer. If,
however, the theater or the bar has the choice to download or stream
the content, then Sec. 1.861-18, including the predominant character
rule, would apply to the transaction.
B. Inclusion of Common Cloud Business Models
One comment suggested that the final regulations explicitly include
as cloud transactions certain common cloud-based business models,
namely: (1) advertising models where customers obtain ``free'' services
and advertisers pay for access to those customers; (2) marketplace
sites and apps that function as sales agents; (3) gig-economy sites and
apps that put service providers and customers together; (4) job
recruiting sites and apps that find candidates for employers; (5)
travel sites and apps that act like sales agents for hotels, flights,
etc.; and (6) game sites that allow users access to a range of games
for a subscription price.
The final regulations do not adopt this comment, though some
similar examples are included in Sec. 1.861-18(h). Although each of
the comment's suggested scenarios include services or goods accessed
through the internet, whether each scenario is a cloud transaction (as
defined by Sec. 1.861-19(b)) is fact-specific and cannot be determined
solely on the basis of the type of offering provided. Section 1.861-
19(b) defines a cloud transaction as a transaction through which a
person obtains on-demand network access to computer hardware, digital
content (as defined in Sec. 1.861-18(a)(2)), or other similar
resources. The first scenario, involving customers' ``free'' access to
content that is funded by advertising, is similar to Sec. 1.861-
18(h)(22) (Example 22) of the final regulations. The example addresses
the transfer of content to the platform by content creators (a digital
content transaction) and the access to the content by customers (a
cloud transaction). However, the example does not address the
transaction between the advertisers and the platform because while the
ads are viewable online, the advertising services are likely not cloud
transactions because there is likely no on-demand network access to
computer hardware, digital content, or similar resources provided by
the platform to the advertisers (though specific fact patterns may
differ). The second scenario, involving marketplace sites and apps that
function as sales agents, may result in a transaction that has a
digital content transaction element and a cloud transaction element if
the marketplace site or app is used to transfer digital content to
customers. See Sec. 1.861-18(h)(20) (Example 20). Similarly, the sixth
scenario, involving game sites allowing access to a range of games for
a subscription price, may require a predominant character analysis to
determine whether the
[[Page 2984]]
primary benefit to the customer (or a typical customer) is the download
of games or access to play the games online. See Sec. 1.861-18(h)(24)
(Example 24). In the remaining scenarios proposed by the comment, the
website or app may provide a service, but it is likely that the service
would not be a cloud transaction because the recipient of the service
does not receive on-demand network access to computer hardware, digital
content, or similar resources. The framework of the final regulations
should be applied to the facts of each specific transaction rather than
making generalizations about broad categories of content offerings.
C. Examples Illustrating Sec. 1.861-19
Many comments requested modifications to the examples provided in
proposed Sec. 1.861-19, or new examples describing common business
models. In response to these comments, the final regulations contain
several new examples and make certain modifications to the pre-existing
examples. The final regulations also remove examples illustrating the
proposed regulations' application of factors to distinguish between the
characterization of a cloud transaction as a service or a lease because
the final regulations characterize all cloud transactions as services.
Proposed Sec. 1.861-19(d)(11) (Example 11) would describe a
scenario in which a taxpayer operates an online database of industry-
specific materials that utilizes a proprietary search engine. Certain
materials in the database constitute digital content. The example
concluded that the taxpayer's provision of on-demand access to its
computer hardware and software is a cloud transaction. One comment
requested clarification that the characterization of this transaction
would not be different if the online database contained no
copyrightable materials. In the final regulations, the analysis of this
example (which has been redesignated Sec. 1.861-19(d)(8) (Example 8))
explains that the cloud transaction is access to the search engine and
online database, rather than online access to the digital content, and
therefore the conclusion that the transaction is a cloud transaction
would not change if none of the content in the database was
copyrightable. This conclusion is consistent with Sec. 1.861-19(b)'s
definition of a cloud transaction as a transaction through which a
person obtains on-demand network access to computer hardware, digital
content (as defined in Sec. 1.861-18(a)(2)), or other similar
resources. In this case, the content accessed would be an ``other
similar resource.''
Two comments expressed concern that certain jurisdictions around
the world treat income earned by a reseller of services, such as
software-as-a-service, as royalties subject to withholding. These
comments asked for an example in the final regulations addressing a
reseller of services that concludes the reseller's income is services
income. In response to these comments, section 1.861-19(d)(10) (Example
10) of the final regulations addresses a reseller of software-as-a-
service and concludes the transaction between the reseller and its
customers is a cloud transaction classified as the provision of
services.
Proposed Sec. 1.861-19(d)(9) (Example 9) would describe a scenario
in which a taxpayer maintains a catalogue of videos and music that it
streams to customers in exchange for a monthly fee. To better reflect
current and developing business practices, comments recommended adding
a fact to this example that customers have the ability to download the
digital content for offline viewing, and that such ability is de
minimis in the context of the overall transaction. Proposed Sec.
1.861-19(d)(9) (Example 9) is redesignated Sec. 1.861-19(d)(7)
(Example 7) of the final regulations, and the ability to download the
digital content has been added to the facts in the example. As
discussed in Part I.A of this Summary of Comments and Explanation of
Revisions, a predominant character rule in the final regulations
replaced the de minimis rule in the proposed regulations. Under the
facts described in Example 7 of the final regulations, the predominant
character of the transaction is a cloud transaction.
IV. Sourcing Rules
A. Source Rule for Sales of Copyrighted Articles Transferred Through an
Electronic Medium
1. In General
Section 1.861-18(f)(2), as in effect before this Treasury decision,
provided that income from sales of copyrighted articles is sourced
under sections 861(a)(6), 862(a)(6), 863, 865(a), (b), (c), or (e), as
appropriate. Proposed Sec. 1.861-18(f)(2)(ii) would provide that when
a copyrighted article is sold and transferred through an electronic
medium, the sale is deemed to have occurred at the location of download
or installation onto the end-user's device used to access the digital
content for purposes of Sec. 1.861-7(c). If information about the
location of download or installation was not available, proposed Sec.
1.861-18(f)(2)(ii) would provide that the sale is deemed to have
occurred at the location of the customer, as determined based on the
taxpayer's recorded sales data for business or financial reporting
purposes.
Comments observed practical challenges with applying a rule based
on the location of download or installation, including that: (i) data
privacy laws may prevent taxpayers from collecting or retaining this
information, (ii) internet Protocol (IP) addresses may be unreliable
because virtual private networks may obscure an end-user's IP address,
(iii) it would be burdensome and expensive for taxpayers to collect new
data on the location of download or installation, (iv) there may be
difficulties in determining the location of download or installation
onto an end-user's device when software is sold through multi-level
distribution channels, and (v) it may be difficult to identify the end-
user. One comment suggested that the final regulations provide examples
that illustrate the application of the download test in various
circumstances.
Instead of endorsing the proposed rule, most comments addressing
this topic recommended a rule that uses the billing address of the
first unrelated purchaser to determine the location of the sale. Some
comments observed that the billing address of the purchaser is
information sellers already collect and is a more reliable indicator of
where the purchaser will use the digital content. Several comments
suggested that taxpayers be permitted to elect to use the location of
download or installation instead of the billing address of the
purchaser if the taxpayer has access to that information. Some comments
recommended permitting taxpayers to elect to use the location of actual
use of the digital content, such as when an employer purchases digital
content that is used by an employee not located in the same
jurisdiction as the employer.
Finally, another comment recommended that the rule in Sec. 1.861-
7(c) (which provides that the place of sale is the place where the
rights, title, and interest of the seller in the property are
transferred to the buyer (the title passage rule)) should be retained
for purposes of sourcing sales of copyrighted articles transferred
through an electronic medium.
The final regulations adopt these comments in part. Consistent with
the proposed regulations, Sec. 1.861-18(f)(2)(ii) of the final
regulations moves away from the ``title passage'' rule for sales of
copyrighted articles transferred through an electronic medium. One
reason for the change is that the title passage rule allowed taxpayers
to artificially elect the source of income from sales of copyrighted
articles through an
[[Page 2985]]
electronic medium using contractual terms that had no real-world impact
due to the nature of digital content. A digital download is an almost
instantaneous transfer that occurs with limited risk of loss; even when
a file is corrupted in the download or installation process, a
noncorrupted copy can be provided to the customer at virtually no cost
to the seller, and the precise location of the corruption is typically
not relevant. In contrast, a contractual agreement as to when and where
title passes for physical property moved through physical distribution
chains has real-world impact because the property may be lost or become
damaged in transit and the location of title passage determines whether
the seller or buyer bears the burden of that loss. Because the nature
of the supply chain means that the seller retains risk of loss until a
successful download, Sec. 1.861-18(f)(2)(ii) treats the sale as having
occurred at the customer's location, using the customer's billing
address as a proxy. The Treasury Department and IRS generally agree
that a billing address is more administrable than the location of
download or installation as a suitable proxy for the place of sale of
electronically transferred copyrighted articles (subject to the anti-
abuse rule discussed below).
The Treasury Department and IRS disagree, however, that the billing
address of a subsequent unrelated purchaser of the same copyrighted
article should be the general rule for sales between related parties,
given the focus of the statutory sourcing provisions on place of sale.
See sections 861 through 865. It would also be complex and potentially
inaccurate to attempt to determine whether every sale is intended for a
related or unrelated purchaser. Therefore, Sec. 1.861-18(f)(2)(ii) of
the final regulations provides that when a copyrighted article is sold
and transferred through an electronic medium, the sale is deemed to
have occurred at the location of the billing address of the purchaser
for purposes of Sec. 1.861-7(c), regardless of whether that purchaser
is a related or unrelated party. This billing address rule also
resolves the issue raised by comments regarding who the end-user is in
certain transactions because the sourcing rule is based on the
immediate purchaser in the transaction. See Sec. 1.861-18(h)(25)
(Example 25).
The final regulations also do not provide for an election to treat
the sale of a copyrighted article as occurring at the location of
download or installation. As noted earlier in this part, one of the
reasons for moving away from ``title passage'' for sales of copyrighted
articles transferred through an electronic medium was that it allowed
sellers the ability to artificially elect the source of the income.
Consistent with this concern about electivity, the final regulations
provide a single, administrable rule that applies to all sales (subject
to the anti-abuse rule).
The final regulations also add a new anti-abuse rule for any case
in which the sales transaction is arranged in a particular manner for a
principal purpose of tax avoidance. See Sec. 1.861-18(f)(2)(ii) and
(h)(26) (Example 26). In such cases, the foregoing billing address rule
will not be applied, and instead all relevant facts and circumstances
of the transaction will be considered to treat the sale as having
occurred where the substance of the transaction occurred. This anti-
abuse rule replaces the anti-abuse rule in Sec. 1.861-7(c) with
respect to sales of copyrighted articles sold and transferred through
an electronic medium.
Finally, several comments asked for clarification that this source
rule applies solely for purposes of the title passage rule of Sec.
1.861-7(c). The Treasury Department and the IRS have concluded that
these comments were already addressed in proposed Sec. 1.861-
18(f)(2)(ii) by the language that limited application of the rule ``for
purposes of Sec. 1.861-7(c),'' and the final regulations retain this
language.
2. Coordination With Section 863(b)
Some comments recommended allowing taxpayers to elect to apply a
billing address source rule for sales of digital content where section
863(b) may otherwise apply. Section 863(b) provides, in part, that the
gains, profits, and income from the sale or exchange of inventory
property produced (in whole or in part) by the taxpayer within the
United States and sold or exchanged without the United States, or
produced (in whole or in part) by the taxpayer without the United
States and sold or exchanged within the United States, shall be
allocated and apportioned between sources within and without the United
States solely on the basis of the production activities with respect to
the property.
The final regulations do not adopt the comment recommending
allowing taxpayers to elect to apply a billing address source rule for
sales of digital content where section 863(b) would apply. When section
863(b) applies, property produced and sold by a taxpayer must be
sourced ``solely on the basis of the production activities with respect
to the property.'' There is nothing to suggest that the billing address
of the customer is relevant to this statutory rule based on place of
production, and so the final regulations do not adopt this comment.
3. Interaction With Rules for Sourcing Leases and Licenses of Digital
Content
One comment supported the location of download or installation rule
for determining the place of sale for copyrighted articles, and
recommended the final regulations explicitly adopt a uniform rule for
sourcing income from sales, leases, and licenses of digital content
based on the location of the end-user. The comment also recommended
allowing taxpayers to rely on recorded sales data to determine the
location of the end-user for purposes of determining place of use for
leases and licenses of digital content.
The final regulations do not adopt this comment. Section 1.861-
18(f)(2)(ii) clarifies how the place of sale of digital content is
determined for purposes of sections 861 through 865. Those sections
contain different rules for determining the source of income from
leases and licenses, for which the place of transfer is not the
relevant statutory rule (generally, the determination is based on where
the property subject to the lease or license is used, or where the
possessor of the interest has the right to use the property). See
sections 861(a)(4), 862(a)(4). Section 1.861-18(f)(2)(ii) looks to the
customer's billing address for purposes of determining the place of
sale for purposes of Sec. 1.861-7(c). While that may sometimes also be
the location in which the digital content is used, that is not
necessarily the case. For example, where copyright rights are
transferred in a transaction that is classified as a license, the
copyright rights may be used in multiple locations, and not just the
location of the customer's billing address. Similarly, not all income
from sales is sourced to the place where the sale occurred. In those
cases, the statute provides the relevant determination, such as the
place of production in section 863(b) or the residence of the seller in
section 865(a). The location of download or installation is not
necessarily indicative of any of those things, and the Treasury
Department and the IRS only intend for the rule in Sec. 1.861-
18(f)(2)(ii) to be used to determine the place where the sale occurred
for purposes of statutory sourcing rules that rely on that
determination. Therefore, Sec. 1.861-18(f)(2)(ii) of the final
regulations is not extended to provide a sourcing rule for all sales,
licenses, and leases of digital content.
Finally, a comment suggested that the regulations clarify that a
license of copyright rights from a copyright owner
[[Page 2986]]
to a distributor is sourced under section 861(a)(4) or 862(a)(4).
Because Sec. 1.861-18(f)(2), as in effect before this Treasury
decision, already provides that income derived from licensing copyright
rights is sourced under section 861(a)(4) or 862(a)(4), no changes have
been made in response to this comment.
B. Source Rule for Gross Income From a Cloud Transaction
Proposed Sec. 1.861-19 would not provide a source rule for cloud
transactions. As such, the proposed regulations indicated that existing
law, regulations, and IRS guidance regarding sourcing services and
leases would apply to sourcing cloud transactions. Numerous comments
were received regarding whether a specific source rule for cloud
transactions would be appropriate and several of these comments
included suggestions for such a rule.
The Treasury Department and the IRS are of the view that that there
would be benefits for taxpayer compliance and administrability if gross
income from cloud transactions were sourced using a uniform rule. Thus,
the Treasury Department and the IRS are issuing proposed regulations
(REG-107420-24) published elsewhere in this same issue of the Federal
Register that provide rules for determining the source of gross income
from a cloud transaction.
C. Removal of Example 5 From Sec. 1.937-3(e)
The proposed regulations would have removed Examples 4 and 5 from
Sec. 1.937-3(e). Section 937 provides residence and source rules
involving territories. Examples 4 and 5 of Sec. 1.937-3(e) relate to
the sourcing of income from digital content transactions and cloud
transactions, respectively. One comment suggested that the proposal to
remove Example 5 was premature because the proposed regulations did not
include a source rule for cloud transactions. The final regulations do
not accept this comment. As discussed in Part IV.B of this Summary of
Comments and Explanation of Revisions, the Treasury Department and the
IRS are issuing a companion notice of proposed rulemaking addressing
the source of income from cloud transactions concurrent with these
final regulations. Therefore, to avoid potentially inconsistent
inferences, the final regulations remove both Examples 4 and 5 of Sec.
1.937-3(e).
V. Comments Outside the Scope of This Treasury Decision
The preamble to Treasury Decision 8785, which promulgated Sec.
1.861-18 in 1998, stated that the Treasury Department and the IRS were
considering whether to issue guidance regarding whether transactions in
copyrighted articles are transactions in tangible property, and whether
transactions in copyright rights are transactions in intangible
property, in each case for purposes of section 482. The proposed
regulations did not contain further guidance on this topic.
One comment to the proposed regulations recommended that the
Treasury Department and the IRS reconsider this matter and issue
guidance on this topic because the characterization of a transfer of
digital content as tangible or intangible property is important for
purposes of sections 250, 367(d), and 482. The Treasury Department and
IRS have determined that guidance on whether the categories of
transactions in Sec. 1.861-18 are considered tangible or intangible
property for purposes of such Code sections is outside the scope of
these regulations.
One comment suggested that section 904 should be amended as it
relates to certain sales income earned by U.S. residents to prevent
``cross-crediting'' of high-taxed income and zero- or low-taxed income
within the same foreign tax credit basket under section 904(d)(1). The
comment noted that such ``cross-crediting'' results in the U.S.
partially or fully bearing the cost of the high tax rates in some
foreign jurisdictions because a credit related to the high-taxed income
may offset U.S. tax on the income from low-tax jurisdictions.
Amendments to section 904 are outside the scope of this Treasury
Decision.
Two comments suggested changes to the regulations under section 250
pertaining to foreign-derived intangible income (FDII). One comment
requested that the Treasury Department and the IRS introduce a rule
under Sec. 1.250(b)-4 stating that intangible property used in
providing a service that is a cloud transaction within the meaning of
Sec. 1.861-19 is, for purposes of section 250, used at the location of
the employees engaged in, and tangible property used in, providing the
cloud transaction service. That comment also suggested adding a de
minimis rule under Sec. 1.250(b)-4 providing that any de minimis use
of intangible property is disregarded in a cloud transaction. A second
comment noted that the characterization of a cloud transaction would
impact whether income is eligible for the FDII deduction because there
are different rules for establishing ``foreign use'' for services and
lease transactions. That comment also suggested that the ``foreign
use'' rule for intangible property should replicate the rule governing
foreign use of general property. These comments are outside the scope
of this Treasury Decision, but were considered in finalizing the
section 250 regulations. See T.D. 9901 (85 FR 43042, July 15, 2020).
VI. Final Regulations Apply Only for Certain International Provisions
of the Code
Section 1.861-18, as in effect before this Treasury decision,
applied only to certain listed international provisions of the Code.
When Sec. 1.861-18 was promulgated in 1998, the preamble stated that
the Treasury Department and the IRS were considering whether the
principles of Sec. 1.861-18 should apply to other provisions of the
Code. The proposed regulations retained the scope of Sec. 1.861-18 by
applying only to certain listed international provisions of the Code,
although additional sections of the Code were added to the scope of the
proposed regulations due to changes in law between 1998 and the date of
the proposed regulations. Proposed Sec. 1.861-19 would also apply only
to the same listed international provisions of the Code.
The Treasury Department and the IRS received comments recommending
expanding the scope of the final regulations to apply for all purposes
of the Code, particularly with respect to Sec. 1.861-18 for which all
comments received on this topic recommended expansion to all purposes
of the Code. Multiple comments expressed that the framework of the
proposed regulations provides sensible rules and certainty with respect
to transactions involving digital content. One comment also expressed
concern that limiting the scope of the final regulations to only
international provisions of the Code could lead to the same transaction
being characterized differently depending on which Code section was
applied. Another comment expressed the belief that both taxpayers and
the IRS will utilize the guidance in the final regulations by analogy
even if the final regulations apply only to international provisions of
the Code, and that it would be better to make it clear that the final
regulations apply to all provisions of the Code so that taxpayers and
the IRS will not have to go through the rigors of trying to convince
the other party that the final regulations are relevant in a particular
case.
Unlike Sec. 1.861-18, some comments recommended that Sec. 1.861-
19 not be applied beyond the scope provided in the proposed
regulations. These comments expressed concern that the
[[Page 2987]]
preamble to Sec. 1.861-19 referenced section 7701(e) (pertaining to
the treatment of certain contracts as leases rather than service
contracts), and recommended against any guidance providing that section
7701(e) could apply throughout the Code, including Subchapter M. One
comment explained that the extent to which the provision of services
affects the definition of ``rents from real property'' for real estate
investment trust purposes is addressed not only in Subchapter M and the
regulations thereunder, but also in numerous items of IRS sub-
regulatory guidance and private letter rulings specifically
interpreting Subchapter M. The comments recommended adding an explicit
disclaimer in the preamble and the text of the final regulations that
any purported interpretation and application of section 7701(e)
principles in the final regulations do not apply outside the intended
scope of the final regulations, and therefore do not apply to lease-
versus-service determinations under other provisions of chapter 1 of
the Code. As discussed under Part III.A of this Summary of Comments and
Explanation of Revisions, the final regulations treat all cloud
transactions as the provision of services, and accordingly remove the
section 7701(e) factors from the regulatory text.
More broadly, the Treasury Department and the IRS continue to study
issues related to applying the final regulations to all provisions of
the Code. Concurrently with the issuance of the final regulations, the
Treasury Department and the IRS are issuing a Notice (Notice 2025-6)
requesting comments regarding issues to consider in deciding whether to
apply the characterization rules in Sec. Sec. 1.861-18 and 1.861-19,
as amended and added, respectively, by the final regulations to all
provisions of the Code.
VII. Change in Method of Accounting
The proposed regulations would treat a change in method of
accounting that a taxpayer made in order to comply with the proposed
regulations as a change initiated by the taxpayer. Accordingly, the
change in method of accounting would have to be implemented under the
rules of Sec. 1.446-1(e) and the applicable administrative procedures
that govern voluntary changes in method of accounting under section
446(e).
Two comments suggested that if a taxpayer must change its method of
accounting in order to comply with the final regulations, then such
change should be eligible for automatic consent.
The final regulations do not adopt these comments. The Treasury
Department and the IRS generally do not anticipate taxpayers needing to
change methods of accounting as a result of the final regulations.
Additionally, in light of the aforementioned Notice requesting comments
on applying the characterization rules in Sec. Sec. 1.861-18 and
1.861-19, as amended and added, respectively, by the final regulations
for all purposes of the Code, the Treasury Department and IRS have
determined that it is important to ensure that any accounting method
changes due to these regulations are consistent with the appropriate
treatment of the transactions at issue under all appropriate Code or
regulation sections.
VIII. Applicability Date
The proposed regulations were proposed to apply to transactions
entered into pursuant to contracts entered into in taxable years
beginning on or after the date of publication of final regulations.
Comments recommended the final regulations apply to transactions
entered into in taxable years beginning on or after the date that final
regulations are published, regardless of the date of the contracts
pursuant to which such transactions were entered into. One comment
noted that it would be difficult to trace particular transactions to
contracts that were entered into in taxable years that begin on or
after the date of publication of final regulations. Other comments
noted that the proposed applicability date may result in different
rules applying to similar transactions of the same taxpayer long after
these regulations are finalized.
One comment suggested allowing taxpayers to elect application of
the final regulations to taxable years ending after the date of
publication of the proposed regulations. Another comment recommended
that taxpayers be allowed to elect to apply the final regulations to
transactions taking place before the effective date of the final
regulations.
In response to these comments, the final regulations generally
apply to taxable years beginning on or after the date of publication of
this Treasury decision in the Federal Register. However, taxpayers may
elect to apply all of the rules of the final regulations to taxable
years beginning on or after August 14, 2019 and all subsequent taxable
years as long as all related persons (within the meaning of sections
267(b) and 707(b)) also apply all of the rules of the final regulations
to taxable years beginning on or after August 14, 2019 and all
subsequent taxable years, the period of limitations on assessment for
each taxable year of the taxpayer and all related parties (within the
meaning of sections 267(b) and 707(b)) is open under section 6501, and
the taxpayer would not be required under this section to change its
method of accounting as a result of such election.
Special Analyses
I. Regulatory Planning and Review--Economic Analysis
Pursuant to the Memorandum of Agreement, Review of Treasury
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory
actions issued by the IRS are not subject to the requirements of
section 6 of Executive Order 12866, as amended. Therefore, a regulatory
impact assessment is not required.
II. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) (PRA)
generally requires that a Federal agency obtain the approval of the
Office of Management and Budget (OMB) before collecting information
from the public, whether such collection of information is mandatory,
voluntary, or required to obtain or retain a benefit. An agency may not
conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a valid control number
assigned by the Office of Management and Budget.
The collections of information in these final regulations contain
reporting and recordkeeping requirements that are necessary to ensure
the correct classification of digital content transactions and cloud
transactions. The collections will be used by the IRS for tax
compliance purposes.
The final regulation mentions a reporting requirement where a
taxpayer may be required to change its method of accounting. For PRA
purposes, Form 3115, Application for Change in Accounting Method, is
already approved by OMB under Control Numbers 1545-0047 for tax-exempt
entities, 1545-0074 for individuals, 1545-0123 for business filers and
1545-0092 for trust and estate filers.
The recordkeeping requirements include that entities keep records
of their transactions to substantiate the transaction classification.
These recordkeeping requirements are considered general tax records
under Sec. 1.6001-1(e). For PRA purposes, general tax records are
already approved by OMB under 1545-0047 for tax-exempt entities, 1545-
0074 for individuals, 1545-0123 for business filers and 1545-0092 for
trust and estate filers.
[[Page 2988]]
These final regulations are not creating new information
collections or changing information collections already approved by
OMB.
III. Regulatory Flexibility Act
The Regulatory Flexibility Act requires consideration of the
regulatory impact on small businesses. It is hereby certified that
these final regulations will not have a significant economic impact on
a substantial number of small entities within the meaning of section
601(6) of the Regulatory Flexibility Act (5 U.S.C. chapter 6).
Although data are not readily available to estimate the number of
small entities that would be affected by the final regulations, the
Treasury Department and the IRS project that any economic impact of the
regulations would be minimal for businesses regardless of size. These
final regulations generally provide clarification of definitions
regarding how transactions are classified, and thus are not expected to
have an impact on burden for large or small businesses. The Treasury
Department and the IRS project that any economic impact would be small
because current industry practice is generally consistent with the
principles underlying the final regulations.
IV. Section 7805(f)
Pursuant to section 7805(f) of the Code, the proposed regulations
(REG-130700-14) preceding these final regulations were submitted to the
Chief Counsel for Advocacy of the Small Business Administration for
comment on the impact on small businesses and no comments were
received.
V. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 requires
that agencies assess anticipated costs and benefits and take certain
other actions before issuing a final rule that includes any Federal
mandate that may result in expenditures in any one year by a State,
local, or Tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. The final regulations do not include any Federal mandate
that may result in expenditures by State, local, or Tribal governments,
or by the private sector in excess of that threshold.
VI. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on State and local
governments, and is not required by statutes, or preempts State law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive order. The final regulations do not have
federalism implications, do not impose substantial direct compliance
costs on State and local governments, and do not preempt State law
within the meaning of the Executive order.
Drafting Information
The principal authors of these final regulations are Christopher E.
Fulle and Michelle L. Ng of the Office of the Associate Chief Counsel
(International). However, other personnel from the Treasury Department
and the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, the Treasury Department and the IRS amend 26 CFR part
1 as follows:
PART 1--INCOME TAXES
0
Paragraph 1.The authority citation for part 1 continues to read in part
as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.861-7 is amended by revising paragraph (c) to read as
follows:
Sec. 1.861-7 Sale of personal property.
* * * * *
(c) Country in which sold. For purposes of part I (section 861 and
following), subchapter N, chapter 1 of the Code, and the regulations
thereunder, a sale of personal property is consummated at the time
when, and the place where, the rights, title, and interest of the
seller in the property are transferred to the buyer. Where bare legal
title is retained by the seller, the sale shall be deemed to have
occurred at the time and place of passage to the buyer of beneficial
ownership and the risk of loss. However, in any case in which the sales
transaction is arranged in a particular manner for the primary purpose
of tax avoidance, the foregoing rules will not be applied. In such
cases, all factors of the transaction, such as negotiations, the
execution of the agreement, the location of the property, and the place
of payment, will be considered, and the sale will be treated as having
been consummated at the place where the substance of the sale occurred.
For determining the place of sale of copyrighted articles transferred
through an electronic medium, see Sec. 1.861-18(f)(2)(ii).
* * * * *
0
Par. 3. Section 1.861-18 is amended by:
0
a. Revising the section heading;
0
b. Revising paragraphs (a), (b), (c)(1), (c)(2)(i) through (iv),
(c)(3), (d), (e), (f)(1) through (3), (g)(2), (g)(3)(i) and (ii), and
(h) through (j); and
0
c. Removing paragraph (k).
The revisions read as follows:
Sec. 1.861-18 Classification of, and source of gross income from,
digital content transactions.
(a) General--(1) Scope. This section provides rules for classifying
digital content transactions (as defined in paragraph (b)(1) of this
section) for purposes of subchapter N of chapter 1 of the Internal
Revenue Code, sections 59A, 245A, 250, 267A, 367, 404A, 482, 679,
1059A, chapters 3 and 4, sections 842 and 845 (to the extent involving
a foreign person), and transfers to foreign trusts not covered by
section 679.
(2) Digital content--(i) Digital content defined. For purposes of
this section, digital content means a computer program or any other
content, such as books, movies, and music, in digital format that is--
(A) Protected by copyright law; or
(B) Not protected by copyright law solely--
(1) Due to the passage of time; or
(2) Because the creator dedicated the content to the public domain.
(ii) Computer program defined. For purposes of this section, a
computer program is a set of statements or instructions to be used
directly or indirectly in a computer in order to bring about a certain
result and includes any media, user manuals, documentation, data base,
or similar item if the media, user manuals, documentation, data base,
or other similar item is incidental to the operation of the computer
program.
(b) Categories of transactions--(1) General. A transaction that
constitutes a transfer of digital content, or the provision of services
or of know-how with respect to digital content (each a digital content
transaction), is treated as being solely one of the following--
(i) A transfer of a copyright right in the digital content;
(ii) A transfer of a copy of the digital content (a copyrighted
article);
(iii) The provision of services for the development or modification
of the digital content; or
(iv) The provision of know-how relating to development of digital
content.
(2) Transaction with multiple elements. Taking into account the
[[Page 2989]]
overall transaction and the surrounding facts and circumstances, a
transaction that has multiple elements, one or more of which would be a
digital content transaction if considered separately, is classified in
its entirety as a digital content transaction under one of the
categories described in paragraph (b)(1) of this section if the
predominant character of the transaction is described in one of the
categories in that paragraph.
(3) Determination of predominant character--(i) General rule. For
purposes of paragraph (b)(2) of this section and Sec. 1.861-19(c)(2),
the predominant character of a transaction is determined by
ascertaining the primary benefit or value received by the customer in
the transaction.
(ii) Special rule. If the primary benefit or value received by the
customer in the transaction is not reasonably ascertainable, the
predominant character of a transaction is instead determined by
ascertaining the primary benefit or value received by a typical
customer in a substantially similar transaction as determined under
paragraphs (b)(3)(ii)(A) and (B) of this section.
(A) The primary benefit or value received by a typical customer is
determined by data on how a typical customer uses or accesses the
digital content. See paragraph (h)(17) of this section (Example 17).
(B) If data described in paragraph (b)(3)(ii)(A) of this section is
not available, then the predominant character of a transaction subject
to the special rule in paragraph (b)(3)(ii) of this section is
determined by examining other factors that are indicative of the
primary benefit or value received by a typical customer, including the
following--
(1) How the transferor or provider markets the transaction;
(2) The relative development costs to the transferor or provider of
each element of the transaction; and
(3) The relative price paid in an uncontrolled transaction for one
or more elements compared to the total contract price of the
transaction in question.
(iii) Identification and development of data. A transferor or
provider must use reasonable efforts to identify the data specified in
paragraphs (b)(3)(i) and (ii)(A) of this section, or if necessary, to
apply the factors relevant to paragraph (b)(3)(ii)(B) of this section.
However, a transferor or provider is not required to develop any of the
data specified in those paragraphs that it does not develop in the
course of business.
(c) * * *
(1) Transfers involving transfers of copyright rights. A digital
content transaction involves a transfer of a copyright right if, as a
result of the transaction, a person acquires one or more of the rights
described in paragraphs (c)(2)(i) through (iv) of this section.
(2) * * *
(i) The right to make copies of the digital content for purposes of
distribution to the public by sale or other transfer of ownership, or
by rental, lease or lending;
(ii) The right to prepare derivative digital content based upon the
digital content;
(iii) The right to make a public performance of digital content,
other than a right to publicly perform digital content for the purpose
of advertising the sale of the digital content performed; or
(iv) The right to publicly display digital content, other than a
right to publicly display digital content for the purpose of
advertising the sale of the digital content displayed.
(3) Copyrighted articles. A copyrighted article includes a copy of
digital content from which the work can be perceived, reproduced, or
otherwise communicated, either directly or with the aid of a machine or
device. The copy of the digital content may be fixed in any medium.
(d) Provision of services. The determination of whether a
transaction involving newly developed or modified digital content
involves the provision of services described in paragraph (b)(1) of
this section is based on all the facts and circumstances of the
transaction, including, as appropriate, the intent of the parties (as
evidenced by their agreement and conduct) as to which party is to own
the copyright rights in the digital content and how the risks of loss
are allocated between the parties. See paragraph (h)(15) of this
section (Example 15).
(e) Provision of know-how. The provision of information with
respect to digital content involves the provision of know-how for
purposes of this section only if the information is--
(1) Information relating to the development of digital content;
(2) Furnished under conditions preventing unauthorized disclosure,
specifically contracted for between the parties; and
(3) Considered property subject to trade secret protection.
(f) * * *
(1) Transfers of copyright rights. The determination of whether a
transfer of a copyright right is a sale or exchange of property is made
on the basis of whether, taking into account all facts and
circumstances, there has been a transfer of all substantial rights in
the copyright. A transfer of a copyright right that does not constitute
a sale or exchange because not all substantial rights have been
transferred will be classified as a license. For this purpose, the
principles of sections 1222 and 1235 apply. Income derived from the
sale or exchange of a copyright right will be sourced under section
865(a), (c), (d), (e), or (h), as appropriate. Income derived from the
licensing of a copyright right will be sourced under section 861(a)(4)
or 862(a)(4), as appropriate.
(2) Transfers of copyrighted articles--(i) Classification. The
determination of whether a transfer of a copyrighted article is a sale
or exchange is made on the basis of whether, taking into account all
facts and circumstances, the benefits and burdens of ownership have
been transferred. A transfer of a copyrighted article that does not
constitute a sale or exchange because insufficient benefits and burdens
of ownership of the copyrighted article have been transferred, such
that a person other than the transferee is properly treated as the
owner of the copyrighted article, will be classified as a lease.
(ii) Source. Income from transactions that are classified as sales
or exchanges of copyrighted articles will be sourced under section
861(a)(6), 862(a)(6), 863, or 865(a), (b), (c), or (e), as appropriate.
When a copyrighted article is sold and transferred through an
electronic medium, the sale is deemed to have occurred at the location
of the billing address of the purchaser for purposes of Sec. 1.861-
7(c). However, in any case in which the sales transaction is arranged
in a particular manner for a principal purpose of tax avoidance, the
foregoing rules will not be applied. In such a case, all of the facts
and circumstances relevant to the transaction, such as the place where
the copyrighted article will be used, the place where negotiations and
the execution of the agreement occurred, and the terms of the
agreement, will be considered, and the sale will be treated as having
occurred where the substance of the sale occurred. Income derived from
leasing a copyrighted article will be sourced under section 861(a)(4)
or 862(a)(4), as appropriate.
(3) Special circumstances of digital content. In connection with
determinations under this paragraph (f), consideration must be given as
appropriate to the special characteristics of digital content in
transactions that take advantage of these characteristics (such as the
ability to make perfect
[[Page 2990]]
copies at minimal cost). For example, a transaction in which a person
acquires a copy of digital content on a disk subject to a requirement
that the disk be destroyed after a specified period is generally the
equivalent of a transaction subject to a requirement that the disk be
returned after such period. Similarly, a transaction in which the
digital content deactivates itself after a specified period is
generally the equivalent of a transaction subject to a requirement that
the disk be returned after a specified period.
(g) * * *
(2) Means of transfer not to be taken into account. The rules of
this section shall be applied irrespective of the physical or
electronic or other medium used to effectuate a digital content
transaction.
(3) * * *
(i) In general. For purposes of paragraph (c)(2)(i) of this
section, a transferee of digital content shall not be considered to
have the right to distribute copies of the digital content to the
public if it is permitted to distribute copies of the digital content
to only either a related person, or to identified persons who may be
identified by either name or by legal relationship to the original
transferee. For purposes of this subparagraph, a related person is a
person who bears a relationship to the transferee specified in section
267(b)(3), (10), (11), or (12), or section 707(b)(1)(B). In applying
section 267(b), 267(f), 707(b)(1)(B), or 1563(a), ``10 percent'' shall
be substituted for ``50 percent.''
(ii) Use by individuals. The number of employees of a transferee of
digital content who are permitted to use the digital content in
connection with their employment is not relevant for purposes of this
paragraph (g)(3). In addition, the number of individuals with a
contractual agreement to provide services to the transferee of digital
content who are permitted to use the digital content in connection with
the performance of those services is not relevant for purposes of this
paragraph (g)(3).
(h) Examples. The examples in this paragraph (h) illustrate the
provisions of this section. Unless otherwise specified, assume that
Corp A is a domestic corporation, the digital content described in each
example does not contain any online functionality, and all facts in
each example occur as part of a single transaction.
(1) Example 1: Sale of a computer program on a disk--(i) Facts.
Corp A owns the copyright in a computer program, Program X. It copies
Program X onto disks. The disks are placed in boxes covered with a
wrapper on which is printed what is generally referred to as a shrink-
wrap license. The license is stated to be perpetual. Under the license
no reverse engineering, decompilation, or disassembly of the computer
program is permitted. The transferee receives, first, the right to use
the program on two of its own computers (for example, a laptop and a
desktop) provided that only one copy is in use at any one time, and
second, the right to make one copy of the program on each machine as an
essential step in the utilization of the program. The transferee is
permitted by the shrink-wrap license to sell the copy so long as it
destroys any other copies it has made and imposes the same terms and
conditions of the license on the purchaser of its copy. These disks are
made available for sale to the general public in Country Z. In return
for valuable consideration, P, a Country Z resident, receives one such
disk.
(ii) Analysis. (A) Under paragraph (b)(1) of this section, the
transfer of a disk containing a copy of Program X from Corp A to P is a
digital content transaction with one element, which is the transfer of
a copy of Program X. Therefore, the transaction is treated solely as a
transfer of a copyrighted article under paragraph (b)(1)(ii) of this
section. Under paragraph (g)(1) of this section, the label license is
not determinative.
(B) Taking into account all of the facts and circumstances, P is
properly treated as the owner of a copyrighted article. Therefore,
under paragraph (f)(2) of this section, there has been a sale of a
copyrighted article rather than the grant of a lease.
(2) Example 2: Sale of a computer program via download from the
internet--(i) Facts. The facts are the same as those in paragraph
(h)(1) of this section (Example 1), except that instead of selling
disks, Corp A decides to make Program X available, for a fee, on a
World Wide Web home page on the internet. P, the Country Z resident, in
return for payment made to Corp A, downloads Program X (via modem) onto
the hard drive of his computer. As part of the electronic
communication, P signifies his assent to a license agreement with terms
identical to those in Example 1, except that in this case P may make a
back-up copy of the program on to a disk.
(ii) Analysis. (A) Under paragraph (b)(1) of this section, the
digital transfer of a copy of Program X from Corp A to P is a digital
content transaction with one element, which is the transfer of a copy
of Program X. Therefore, the transaction is treated solely as a
transfer of a copyrighted article under paragraph (b)(1)(ii) of this
section. Although P did not buy a physical copy of the disk with the
program on it, paragraph (g)(2) of this section provides that the means
of transferring the program is irrelevant.
(B) As in paragraph (h)(1) of this section (Example 1), P is
properly treated as the owner of a copyrighted article. Therefore,
under paragraph (f)(2) of this section, there has been a sale of a
copyrighted article rather than the grant of a lease.
(3) Example 3: Lease of a computer program with requirement to
return disk--(i) Facts. The facts are the same as those in paragraph
(h)(1) of this section (Example 1), except that Corp A only allows P,
the Country Z resident, to use Program X for one week. At the end of
that week, P must return the disk with Program X on it to Corp A. P
must also destroy any copies made of Program X. If P wishes to use
Program X for a further period he must enter into a new agreement to
use the program for an additional charge.
(ii) Analysis. (A) Under paragraph (b)(1) of this section, the
transfer of a disk with a copy of Program X from Corp A to P is a
digital content transaction with one element, which is the transfer of
a copy of Program X. Therefore, the transaction is treated solely as a
transfer of a copyrighted article under paragraph (b)(1)(ii) of this
section.
(B) Taking into account all of the facts and circumstances, P is
not properly treated as the owner of a copyrighted article. Therefore,
under paragraph (f)(2) of this section, there has been a lease of a
copyrighted article rather than a sale. Taking into account the special
characteristics of digital content as provided in paragraph (f)(3) of
this section, the result would be the same if P were required to
destroy the disk at the end of the one-week period instead of returning
it since Corp A can make additional copies of the program at minimal
cost.
(4) Example 4: Lease of a computer program with electronic lock--
(i) Facts. * * *
(ii) Analysis. (A) Under paragraph (b)(1) of this section, the
digital transfer of a copy of Program X from Corp A to P is a digital
content transaction with one element, which is the transfer of a copy
of Program X. Therefore, the transaction is treated solely as a
transfer of a copyrighted article under paragraph (b)(1)(ii) of this
section.
(B) As in paragraph (h)(3) of this section (Example 3), P is not
properly treated as the owner of a copyrighted article. Therefore,
under paragraph (f)(2) of this section, there has been a lease of a
copyrighted article rather than a sale.
[[Page 2991]]
While P does retain Program X on its computer at the end of the one-
week period, as a legal matter P no longer has the right to use the
program (without further payment) and, indeed, cannot use the program
without the electronic key. Functionally, Program X is no longer on the
hard drive of P's computer. Instead, the hard drive contains only a
series of numbers which no longer perform the function of Program X.
Although in Example 3, P was required to physically return the disk,
taking into account the special characteristics of digital content as
provided in paragraph (f)(3) of this section, the result in this
paragraph (h)(4) (Example 4) is the same as in Example 3.
(5) Example 5: Sale of copyright rights to a computer program--(i)
Facts. Corp A transfers a disk containing Program X to Corp B, a
Country Z corporation, and grants Corp B an exclusive license for the
remaining term of the copyright to copy and distribute an unlimited
number of copies of Program X in the geographic area of Country Z,
prepare derivative works based upon Program X, make public performances
of Program X, and publicly display Program X. Corp B will pay Corp A a
royalty of $y a year for three years, which is the expected period
during which Program X will have commercially exploitable value (a
period shorter than the copyright term). Corp A has ascertained that
the primary benefit or value from the transaction to Corp B is derived
from the four legal rights obtained in Program X from Corp A and not
from the receipt of a copy of Program X. The transfer of a copy of
Program X is merely the means by which Corp A provides Corp B access to
Program X in order to exercise its copyright rights.
(ii) Analysis. (A) The transaction between Corp A and Corp B has
multiple elements. One element is the transfer of a disk with a copy of
Program X, which would be a digital content transaction described under
paragraph (b)(1)(ii) of this section (transfer of a copyrighted
article) if considered separately. Another element is the grant of the
right to make an unlimited number of copies of Program X and distribute
those copies to the public, the right to prepare derivative works based
upon Program X, the right to make public performances of Program X, and
the right to publicly display Program X, which would be described under
paragraphs (b)(1)(i) and (c)(2) of this section (transfer of a
copyright right) if considered separately.
(B) Because the transaction has multiple elements, one or more of
which would be a digital content transaction if considered separately,
paragraph (b)(2) of this section provides that the transaction is
classified within a single category under paragraph (b)(1) of this
section if its predominant character is described in that paragraph.
Pursuant to paragraph (b)(3)(i) of this section, the predominant
character of the transaction is based on the primary benefit or value
of the transaction to the customer, if it is reasonably ascertainable.
The predominant character of this transaction is therefore the transfer
of copyright rights because the primary benefit or value received by
Corp B from the transaction is the ability to exercise the copyright
rights described in paragraph (c)(2) of this section. Therefore, this
transaction is classified solely as a transfer of copyright rights
described in paragraph (b)(1)(i) of this section.
(C) Applying the all substantial rights test under paragraph (f)(1)
of this section, Corp A will be treated as having sold copyright rights
to Corp B. Corp B has acquired all of the copyright rights in Program
X, has received the right to use them exclusively within Country Z, and
has received the rights for the remaining life of the copyright in
Program X. The fact the payments cease before the copyright term
expires is not controlling. Under paragraph (g)(1) of this section, the
fact that the agreement is labelled a license is not controlling nor is
the fact that Corp A receives a sum labelled a royalty. (The result in
this case would be the same if the copy of Program X to be used for the
purposes of reproduction were transmitted electronically to Corp B, as
a result of the application of the rule of paragraph (g)(2) of this
section.)
(6) Example 6: License of copyright right to make copies of a
computer program and distribute to the public--(i) Facts. Corp A
transfers a disk containing Program X to Corp B, a Country Z
corporation, and grants Corp B the non-exclusive right to reproduce and
distribute for sale to the public an unlimited number of disks
containing Program X at its factory in Country Z in return for a
payment related to the number of disks copied and sold. The term of the
agreement is two years, which is less than the remaining life of the
copyright. Corp A has ascertained that the primary benefit or value
from the transaction to Corp B is derived from the right to reproduce
and distribute Program X and not from the receipt of a copy of Program
X. The transfer of a copy of Program X is merely the means by which
Corp A provides Corp B access to Program X in order to exercise its
copyright rights.
(ii) Analysis. (A) The transaction between Corp A and Corp B has
multiple elements. One element is the transfer of a disk with a copy of
Program X, which would be described under paragraph (b)(1)(ii) of this
section (transfer of a copyrighted article) if considered separately.
Another element is the grant of the right to reproduce and distribute
for sale to the public an unlimited number of disks containing Program
X, which would be described under paragraphs (b)(1)(i) and (c)(2)(i) of
this section (transfer of a copyright right) if considered separately.
(B) Because the transaction has multiple elements, one or more of
which would be a digital content transaction if considered separately,
paragraph (b)(2) of this section provides that the transaction is
classified within a single category under paragraph (b)(1) of this
section if its predominant character is described in that paragraph.
Pursuant to paragraph (b)(3) of this section, the predominant character
of the transaction is based on the primary benefit or value of the
transaction to the customer, if it is reasonably ascertainable. The
predominant character of this transaction is therefore the transfer of
a copyright right because the primary benefit or value received by Corp
B is the right to reproduce and distribute for sale to the public
copies of Program X. Therefore, this transaction is classified solely
as a transfer of copyright rights described in paragraph (b)(1)(i) of
this section.
(C) Taking into account all of the facts and circumstances, there
has been a license of Program X to Corp B. Under paragraph (f)(1) of
this section, there has not been a transfer of all substantial rights
in the copyright to Program X because Corp A has the right to enter
into other licenses with respect to the copyright of Program X,
including licenses in Country Z (or even to sell that copyright,
subject to Corp B's interest). Corp B has acquired no right itself to
license the copyright rights in Program X. Finally, the term of the
license is for less than the remaining life of the copyright in Program
X.
(7) Example 7: Sale of disks containing copies of a computer
program to a distributor--(i) Facts. Corp C, a distributor, enters into
an agreement with Corp A to purchase as many copies of Program X on
disk as it may from time-to-time request. Corp C will then sell these
disks to retailers. The disks are shipped in boxes covered by shrink-
wrap licenses (identical to the license described in paragraph (h)(1)
of this section (Example 1)).
(ii) Analysis. (A) Under paragraph (b)(1) of this section, the
transfers of
[[Page 2992]]
disks with copies of Program X from Corp A to Corp C are digital
content transactions with one element, which is the transfer of copies
of Program X. Therefore, the transactions are classified solely as the
transfer of copyrighted articles under paragraph (b)(1)(ii) of this
section. The use of the term license is not dispositive under paragraph
(g)(1) of this section.
(B) Taking into account all of the facts and circumstances, Corp C
is properly treated as the owner of copyrighted articles. Therefore,
under paragraph (f)(2) of this section, there has been a sale of
copyrighted articles.
(8) Example 8: License to a computer manufacturer of copyright
rights to make and load copies of a computer program onto the hard
drive of computers--(i) Facts. Corp A transfers a disk containing
Program X to Corp D, a foreign corporation engaged in the manufacture
and sale of personal computers in Country Z. Corp A grants Corp D the
non-exclusive right to copy Program X onto the hard drive of an
unlimited number of computers, which Corp D manufactures, and to
distribute those copies (on the hard drive) to the public. The term of
the agreement is two years, which is less than the remaining life of
the copyright in Program X. Corp D pays Corp A an amount based on the
number of copies of Program X it loads on to computers. Corp A has
ascertained that the primary benefit or value from the transaction to
Corp D is the ability to copy and distribute Program X onto computers
manufactured by Corp D, not from the receipt of a copy of Program X.
The transfer of a copy of Program X is merely the means by which Corp A
provides Corp D access to Program X in order to exercise its right to
make and distribute copies.
(ii) Analysis. (A) The transaction between Corp A and Corp D has
multiple elements. One element is the transfer of a disk with a copy of
Program X, which would be described in paragraph (b)(1)(ii) of this
section (transfer of a copyrighted article) if considered separately.
Another element is the grant of the non-exclusive right to copy Program
X onto the hard drive of an unlimited number of computers and
distribute those copies (on the hard drive) to the public, which would
be described in paragraphs (b)(1)(i) and (c)(2)(i) of this section
(transfer of a copyright right) if considered separately.
(B) Because the transaction has multiple elements, one or more of
which would be a digital content transaction if considered separately,
paragraph (b)(2) of this section provides that the transaction is
classified within a single category under paragraph (b)(1) of this
section if its predominant character is described in that paragraph.
Pursuant to paragraph (b)(3) of this section, the predominant character
of the transaction is based on the primary benefit or value of the
transaction to the customer, if it is reasonably ascertainable. The
predominant character of this transaction is therefore the transfer of
copyright rights because the primary benefit or value received by Corp
D is the right to copy Program X onto the hard drive of an unlimited
number of computers and sell those copies (on the hard drive) to the
public. Therefore, this transaction is classified solely as a transfer
of copyright rights described in paragraph (b)(1)(i) of this section.
(C) Taking into account all of the facts and circumstances, there
has been a license of Program X to Corp D. Under paragraph (f)(1) of
this section, there has not been a transfer of all substantial rights
in the copyright to Program X because Corp A has the right to enter
into other licenses with respect to the copyright of Program X,
including licenses in Country Z (or even to sell that copyright,
subject to Corp D's interest). Corp D has acquired no right itself to
license the copyright rights in Program X. Finally, the term of the
license is for less than the remaining life of the copyright in Program
X. The result would be the same if Corp D included with the computers
it sells a copy of Program X on a disk.
(9) Example 9: Sale of disks containing a copy of computer program
to a computer manufacturer--(i) Facts. The facts are the same as those
in paragraph (h)(8) of this section (Example 8), except that Corp D,
the Country Z corporation, receives physical disks. The disks are
shipped in boxes covered by shrink-wrap licenses (identical to the
licenses described in paragraph (h)(1) of this section (Example 1)).
The terms of these licenses do not permit Corp D to make additional
copies of Program X. Corp D uses each individual disk only once to load
a single copy of Program X onto each separate computer. Corp D
transfers the disk with the computer when it is sold.
(ii) Analysis. (A) Under paragraph (b)(1) of this section, the
transfers of disks with copies of Program X from Corp A to Corp D are
digital content transactions with one element, which is the transfer of
copies of Program X. Therefore, the transaction is classified solely as
the transfer of copyrighted articles under paragraph (b)(1)(ii) of this
section. Corp D acquires the disks without the right to reproduce and
distribute publicly further copies of Program X.
(B) Taking into account all of the facts and circumstances, Corp D
is properly treated as the owner of copyrighted articles. Therefore,
under paragraph (f)(2) of this section, the transaction is classified
as the sale of a copyrighted article. The result would be the same if
Corp D used a single physical disk to copy Program X onto each
computer, and transferred an unopened box containing Program X with
each computer, if Corp D were not permitted to copy Program X onto more
computers than the number of individual copies purchased.
(10) Example 10: Sale of a computer program with right to load onto
multiple employee workstations--(i) Facts. Corp A transfers a disk
containing Program X to Corp E and grants Corp E the right to load
Program X onto 50 individual workstations for use only by Corp E
employees at one location in return for a one-time per-user fee
(generally referred to as a site license or enterprise license). If
additional workstations are subsequently introduced, Program X may be
loaded onto those machines for additional one-time per-user fees. The
license which grants the rights to operate Program X on 50 workstations
also prohibits Corp E from selling the disk (or any of the 50 copies)
or reverse engineering the program. The term of the license is stated
to be perpetual.
(ii) Analysis. (A) It must be determined whether the transfer from
Corp A to Corp E of a disk containing a copy of Program X and the right
to load Program X onto 50 individual workstations is a transaction with
multiple elements. There is at least one element, which is the transfer
of a disk containing a copy of Program X, which either is a digital
content transaction under paragraph (b)(1) of this section or would be
a digital content transaction if considered separately. If there is no
additional element, then the transaction is classified as a transfer of
a copyrighted article pursuant to paragraph (b)(1)(ii) of this section.
If there is a second element, then paragraph (b)(2) of this section
applies and the transaction is classified within a single category
under paragraph (b)(1) of this section if its predominant character is
described in that paragraph. The grant of a right to copy,
unaccompanied by the right to distribute those copies to the public, is
not the transfer of a copyright right described in paragraph (c)(2) of
this section. Therefore, there is no second element in this transaction
and it is classified solely as the transfer of
[[Page 2993]]
copyrighted articles (50 copies of Program X).
(B) Taking into account all of the facts and circumstances, Corp E
is properly treated as the owner of copyrighted articles. Therefore,
under paragraph (f)(2) of this section, there has been a sale of
copyrighted articles rather than the grant of a lease. Notwithstanding
the restriction on sale, other factors such as, for example, the risk
of loss and the right to use the copies in perpetuity outweigh, in this
case, the restrictions placed on the right of alienation.
(C) The result would be the same if Corp E were permitted to copy
Program X onto an unlimited number of workstations used by employees of
either Corp E or other persons that had a relationship to Corp E
specified in paragraph (g)(3) of this section.
(11) Example 11: Sale of a computer program with right to make
available to multiple employees via local area network--(i) Facts. The
facts are the same as those in paragraph (h)(10) of this section
(Example 10), except that Corp E, the Country Z corporation, acquires
the right to make Program X available to workstation users who are Corp
E employees by way of a local area network (LAN). The number of users
that can use Program X on the LAN at any one time is limited to 50.
Corp E pays a one-time fee for the right to have up to 50 employees use
the program at the same time.
(ii) Analysis. Under paragraph (g)(2) of this section the mode of
utilization is irrelevant. Therefore, as in paragraph (h)(10) of this
section (Example 10), this is a digital content transaction with a
single element that is classified as the transfer of a copyrighted
article pursuant to paragraph (b)(1)(ii) of this section. Under the
benefits and burdens test of paragraph (f)(2) of this section, this
transaction is a sale of copyrighted articles. The result would be the
same if an unlimited number of Corp E employees were permitted to use
Program X on the LAN or if Corp E were permitted to copy Program X onto
LANs maintained by persons that had a relationship to Corp E specified
in paragraph (g)(3) of this section.
(12) Example 12: Lease of a computer program with right to receive
upgrades and technical support services--(i) Facts. The facts are the
same as in paragraph (h)(11) of this section (Example 11), except that
instead of paying a one-time fee, Corp E pays a monthly fee to Corp A
calculated with reference to the permitted maximum number of users
(which can be changed) and the computing power of Corp E's server. In
return for this monthly fee, Corp E receives the right to receive
upgrades of Program X when they become available. The agreement may be
terminated by either party at the end of any month. When the disk
containing the upgrade is received, Corp E must return the disk
containing the earlier version of Program X to Corp A. If the contract
is terminated, Corp E must delete (or otherwise destroy) all copies
made of the current version of Program X. The agreement also requires
Corp A to provide technical support in the form of troubleshooting and
configuration assistance to Corp E, but the agreement does not allocate
the monthly fee between the right to use Program X, the right to
receive upgrades of Program X, and the technical support services. The
amount of technical support that Corp A will provide to Corp E is not
foreseeable when the contract is entered into but is expected to be
minimal. Corp A has ascertained that the primary benefit or value to
Corp E from the transaction is the right to use Program X on the LAN
(without the ability to exercise any of the rights described in
paragraphs (c)(2)(i) through (iv) of this section), not the receipt of
technical support services with respect to Program X.
(ii) Analysis. (A) The transaction between Corp A and Corp E has
multiple elements. One element is the transfer of a disk with a copy of
Program X, which would be described in paragraph (b)(1)(ii) of this
section (transfer of a copyrighted article) if considered separately.
Another element is the provision of technical support services, which
are not services for the development or modification of Program X
described in paragraph (d) of this section because Corp E has received
no copyright rights with respect to Program X. Thus, the technical
support services would not be described in any of the categories in
paragraph (b)(1) of this section if considered separately.
(B) Because the transaction has multiple elements, one or more of
which would be a digital content transaction if considered separately,
paragraph (b)(2) of this section provides that the transaction is
classified within a single category under paragraph (b)(1) of this
section if its predominant character is described in that paragraph.
Pursuant to paragraph (b)(3) of this section, the predominant character
of the transaction is based on the primary benefit or value of the
transaction to the customer. The predominant character of this
transaction is therefore the transfer of a copyrighted article because
the primary benefit or value received by Corp E is the right to use
Program X. Accordingly, this transaction is classified solely as a
transfer of a copyrighted article described in paragraph (b)(1)(ii) of
this section.
(C) Taking into account all facts and circumstances, under the
benefits and burdens test Corp E is not properly treated as the owner
of the copyrighted article. Corp E does not receive the right to use
Program X in perpetuity, but only for so long as it continues to make
payments. Corp E does not have the right to purchase Program X on
advantageous (or, indeed, any) terms once a certain amount of money has
been paid to Corp A or a certain period has elapsed (which might
indicate a sale). Once the agreement is terminated, Corp E will no
longer possess any copies of Program X, current or superseded.
Therefore, under paragraph (f)(2) of this section there has been a
lease of a copyrighted article.
(13) Example 13: Sale of a computer program along with right to
receive upgrades--(i) Facts. The facts are the same as those in
paragraph (h)(12) of this section (Example 12), except that, while Corp
E must return copies of Program X as new upgrades are received, if the
agreement terminates, Corp E may keep the latest version of Program X
(although Corp E is still prohibited from selling or otherwise
transferring any copy of Program X).
(ii) Analysis. For the reasons stated in paragraph (h)(10)(ii)(B)
of this section (Example 10), the transfer of the program will be
treated as a sale of a copyrighted article rather than as a lease.
(14) Example 14: Sale of a modified computer program--(i) Facts.
Corp G enters into a contract with Corp A for Corp A to modify Program
X so that it can be used at Corp G's facility in Country Z. Under the
contract, Corp G is to acquire one copy of the program on a disk and
the right to use the program on 5,000 workstations. The contract
requires Corp A to rewrite elements of Program X so that it will
conform to Country Z accounting standards and states that Corp A
retains all copyright rights in the modified Program X. The agreement
between Corp A and Corp G is otherwise identical as to rights and
payment terms as the agreement described in paragraph (h)(10) of this
section (Example 10).
(ii) Analysis. (A) It must be determined whether the transfer of
disks with modified copies of Program X from Corp A to Corp G is a
transaction with multiple elements. There is at least one element, the
transfer of copies of Program X, which either is a digital content
transaction under paragraph (b)(1) of this section or would be a
digital content transaction if considered separately. If there is no
additional
[[Page 2994]]
element, then the transaction is classified as a transfer of a
copyrighted article pursuant to paragraph (b)(1)(ii) of this section.
If there is a second element, then paragraph (b)(2) of this section
applies and the transaction is classified within a single category
under paragraph (b)(1) of this section if its predominant character is
described in that paragraph. Pursuant to paragraph (d) of this section,
the modifications made by Corp A before transferring Program X to Corp
G do not constitute the provision of services for the development or
modification of digital content because Corp A retains all copyright
rights with respect to the modified software. Therefore, there is no
second element in this transaction and it is classified solely as the
transfer of copyrighted articles.
(B) Taking into account all facts and circumstances, Corp G is
properly treated as the owner of copyrighted articles. Therefore, under
paragraph (f)(2) of this section, there has been the sale of a
copyrighted article rather than the grant of a lease.
(15) Example 15: Provision of services for development of a
computer program--(i) Facts. Corp H enters into a license agreement for
a new computer program. Program Q is to be written by Corp A. Corp A
and Corp H agree that Corp A is writing Program Q for Corp H and that,
when Program Q is completed, the copyright in Program Q will belong to
Corp H. Corp H gives instructions to Corp A programmers regarding
program specifications. Corp H agrees to pay Corp A a fixed monthly sum
during development of the program. If Corp H is dissatisfied with the
development of the program, it may cancel the contract at the end of
any month. In the event of termination, Corp A will retain all
payments, while any procedures, techniques or copyrightable interests
will be the property of Corp H. All of the payments are labelled
royalties. There is no provision in the agreement for any continuing
relationship between Corp A and Corp H, such as the furnishing of
updates of the program, after completion of the modification work.
(ii) Analysis. Under paragraph (b)(1) of this section, the
provision of computer program development services by Corp A to Corp H
is a digital content transaction with one element, which is the
provision of services for the development or modification of digital
content. Under paragraph (d) of this section, the transaction between
Corp A and Corp H involves the provision of services for the
development of a computer program because Corp H bears all of the risks
of loss associated with the development of Program Q and is the owner
of all copyright rights in Program Q. Taking into account all of the
facts and circumstances, Corp A is treated as providing services to
Corp H described in paragraph (b)(1)(iii) of this section. Under
paragraph (g)(1) of this section, the fact that the agreement is
labelled a license is not controlling (nor is the fact that Corp A
receives a sum labelled a royalty).
(16) Example 16: Provision of know-how by computer programmers--(i)
Facts. Corp A and Corp I, a Country Z corporation, agree that a
development engineer employed by Corp A will travel to Country Z to
provide know-how relating to certain techniques not generally known to
computer programmers, which will enable Corp I to more efficiently
create computer programs. These techniques represent the product of
experience gained by Corp A from working on many computer programming
projects, and are furnished to Corp I under nondisclosure conditions.
Such information is property subject to trade secret protection.
(ii) Analysis. The provision of know-how with respect to computer
programming techniques by Corp A's development engineer to Corp I is
described in paragraph (e) of this section. Therefore, the transaction
is a digital content transaction with one element, which is the
provision of know-how. The transaction is classified solely as the
provision of know-how pursuant to paragraph (b)(1)(iv) of this section.
(17) Example 17: Sale of development program in transaction with
multiple elements--(i) Facts. Corp A transfers a disk containing
Program Y to Corp E in exchange for a single fixed payment. Program Y
is a computer program development program, which is used to create
other computer programs, consisting of several components, including
libraries of reusable software components that serve as general
building blocks in new software applications. Because a computer
program created with the use of Program Y will not operate unless the
libraries are also present, the license agreement between Corp A and
Corp E grants Corp E the right to distribute copies of the libraries
with any program developed using Program Y. The license agreement is
otherwise identical to the license agreement in paragraph (h)(1) of
this section (Example 1). Corp A cannot reasonably ascertain the
primary benefit or value of the transaction to Corp E. A customer like
Corp E derives two benefits from this or a substantially similar
transaction, the first of which is the ability to use Program Y to
develop new software and the second of which is the right to utilize
the libraries and reusable software components in Program Y in
distributed programs. Corp A possesses data arising from market
research and customer surveys indicating that customers utilize Program
Y primarily for its computer program development features and do not
make significant use of the libraries of reusable software components.
The libraries and reusable software components are not significant
components of any overall new program created by using Program Y.
(ii) Analysis. (A) The transaction between Corp A and Corp E has
multiple elements. One element is the transfer of a disk with a copy of
Program Y, which would be described in paragraph (b)(1)(ii) of this
section (transfer of a copyrighted article) if considered separately.
Another element is the grant of the right to distribute copies of the
libraries of reusable software components with any program developed
using Program Y, which would be described in paragraphs (b)(1)(i) and
(c)(2)(i) of this section (transfer of a copyright right) if considered
separately.
(B) Because the transaction has multiple elements, one or more of
which would be a digital content transaction if considered separately,
paragraph (b)(2) of this section provides that the transaction is
classified within a single category under paragraph (b)(1) of this
section if its predominant character is described in that paragraph.
Pursuant to paragraph (b)(3)(i) of this section, the predominant
character of a transaction is generally based on the primary benefit or
value of the transaction to the customer. If the primary benefit or
value is not reasonably ascertainable, paragraph (b)(3)(ii) of this
section provides that the predominant character of a transaction may be
determined based on the primary benefit or value to a typical customer
of a substantially similar transaction. This primary benefit or value
to a typical customer can be identified through actual data about use
or access pursuant to paragraph (b)(3)(ii)(A) of this section, or if
that data is not available, by other evidence indicative of the primary
benefit or value to a typical customer pursuant to paragraph
(b)(3)(ii)(B) of this section. Although there are two benefits in this
type of transaction, Corp A possesses data indicating that a typical
customer primarily uses Program Y because of its computer program
development features, rather than the right to
[[Page 2995]]
distribute reusable components. This is reinforced by the fact that
programs created using Program Y do not contain libraries of reusable
software components as significant components. These facts indicate
that the primary benefit or value to a typical customer arises from the
ability to use Program Y, rather than the right to distribute reusable
components. Therefore, the predominant character of this transaction is
the transfer of a copy of Program Y, and this transaction is thus
classified solely as the transfer of a copyrighted article described in
paragraph (b)(1)(ii) of this section.
(C) Taking into account all the facts and circumstances, Corp E is
properly treated as the owner of a copyrighted article. Therefore,
under paragraph (f)(2) of this section, there has been the sale of a
copyrighted article rather than the grant of a lease.
(18) Example 18: Sale of a computer program with right to make
modifications--(i) Facts. Corp A transfers a disk containing Program X
to Corp E. The disk contains both the object code and the source code
to Program X, and the license agreement grants Corp E the right to
modify the source code to correct minor errors and make minor
adaptations to Program X so it will function on Corp E's computer; as
well as the right to recompile the modified source code. The license
does not grant Corp E the right to distribute the modified Program X to
the public. The license is otherwise identical to the license agreement
in paragraph (h)(1) of this section (Example 1). Corp A has ascertained
that the primary benefit or value received by Corp E from the
transaction is the core functionality of Program X rather than the
limited rights to modify the source code.
(ii) Analysis. (A) The transaction between Corp A and Corp E has
multiple elements. One element is the transfer of a disk with a copy of
Program X, which would be described in paragraph (b)(1)(ii) of this
section (transfer of a copyrighted article) if considered separately.
Another element is the grant of the right to modify the source code to
Program X and recompile the modified source code to create new code to
correct minor errors, and to make minor adaptations to Program X, which
would be described in paragraphs (b)(1)(i) and (c)(2)(ii) of this
section (transfer of a copyright right) if considered separately.
(B) Because the transaction has multiple elements, one or more of
which would be a digital content transaction if considered separately,
paragraph (b)(2) of this section provides that the transaction is
classified within a single category under the categories described
under paragraph (b)(1) of this section if its predominant character is
described in that paragraph. Pursuant to paragraph (b)(3) of this
section, the predominant character of the transaction is based on the
primary benefit or value of the transaction to the customer, if it is
reasonably ascertainable. Since the primary benefit or value received
by Corp E is the core functionality of Program X, rather than the
limited rights to modify the source code, the predominant character of
this transaction is the transfer of a copyrighted article. Therefore,
this transaction is classified solely as a transfer of a copyrighted
article under paragraph (b)(1)(ii) of this section.
(C) Taking into account all the facts and circumstances, Corp E is
properly treated as the owner of a copyrighted article. Therefore,
under paragraph (f)(2) of this section, there has been the sale of a
copyrighted article rather than the grant of a lease.
(19) Example 19: License to website operator to make and sell
copies of electronic books via download--(i) Facts. Corp A operates a
website that offers electronic books for download onto customers'
computers or other electronic devices. The books offered are protected
by copyright law. In a transaction between Corp A and a content owner,
Corp A receives from the content owner a digital master copy of a book,
which Corp A downloads onto its server. Corp A receives the non-
exclusive right to reproduce an unlimited number of copies of the book
for purposes of distribution and sale to the public. Corp A pays the
content owner a specified amount for each copy sold to a customer. Corp
A may not transfer any of the rights it receives from the content
owner. The term of the agreement Corp A has with the content owner is
shorter than the remaining life of the copyright. The content owner has
ascertained that the primary benefit or value Corp A receives in the
transaction is the right to reproduce and distribute an unlimited
number of copies of the book and not the transfer of a copy of the
book. In a separate transaction, Corp A charges a customer a fixed fee
for each book purchased. When purchasing a book from Corp A on Corp A's
website, the customer must acknowledge the terms of a license agreement
with the content owner that states that the customer may download and
view the electronic book in perpetuity but may not reproduce,
distribute, or sell copies of it. Once the customer downloads the book
from Corp A's server onto a device, the customer may access and view
the book from that device, which does not need to be connected to the
internet for the customer to view the book. The customer owes no
additional payment to Corp A for the ability to view the book in the
future.
(ii) Analysis. (A) Notwithstanding the license agreement between
each customer and the content owner granting the customer rights to use
the book, the relevant transactions are the transfer of a master copy
of the book along with the grant from the content owners to Corp A of
the right to reproduce and sell to the public copies of the books, and
the transfers of copies of the books by Corp A to customers. Although
the content owner is identified as a party to the license agreement
memorializing the customer's rights with respect to the book, each
customer obtains those rights directly from Corp A, not from the
content owner. Under paragraph (b)(1) of this section, the download of
a copy of a book by a customer is a digital content transaction with
one element, which is the transfer of a digital copy of a book.
Therefore, the transaction is treated solely as a transfer of a
copyrighted article under paragraph (b)(1)(ii) of this section. Under
the benefits and burdens test of paragraph (f)(2) of this section, the
transaction is classified as a sale and not a lease, because the
customer receives the right to view the book in perpetuity on its
device.
(B) The transaction between the content owner and Corp A has
multiple elements. One element is the transfer of a master copy of the
book, which would be described in paragraph (b)(1)(ii) of this section
(transfer of a copyrighted article) if considered separately. Another
element is the grant of the right to reproduce and sell an unlimited
number of copies to customers, which would be described in paragraphs
(b)(1)(i) and (c)(2)(i) of this section (transfer of a copyright right)
if considered separately. Because the transaction has multiple
elements, one or more of which would be a digital content transaction
if considered separately, paragraph (b)(2) of this section provides
that the transaction is classified within a single category under the
categories described under paragraph (b)(1) of this section if its
predominant character is described in that paragraph. Pursuant to
paragraph (b)(3) of this section, the predominant character of the
transaction is based on the primary benefit or value of the transaction
to the customer, if it is reasonably ascertainable. Since the primary
benefit or value Corp A receives in the transaction is the right to
reproduce and distribute an unlimited
[[Page 2996]]
number of copies, the predominant character of this transaction is the
transfer of a copyright right. Therefore, this transaction is
classified solely as a transfer of copyright rights described in
paragraph (b)(1)(i) of this section.
(C) Taking into account all of the facts and circumstances, there
has been a license of books to Corp A. Under paragraph (f)(1) of this
section, there has not been a transfer of all substantial rights in the
copyright rights to the books because each content owner has the right
to enter into other licenses with respect to the copyright of their
book. Corp A has acquired no right itself to license the copyrights in
the books. Finally, the terms of the licenses are for less than the
remaining lives of the copyrights in the books.
(20) Example 20: internet platform operator as agent for
application developers--(i) Facts. Corp A operates a platform on the
internet that offers applications for download onto a customer's mobile
phone. Under general tax principles, Corp A and an application
developer establish an agency relationship whereby Corp A acts as the
agent to offer the application for sale to customers on behalf of the
application developer. The applications are protected by copyright law.
Under the agreement between Corp A and the application developer, Corp
A agrees to provide the application developer with platform and agency
services to facilitate the sale of the application to customers. Corp A
also provides the application developer with hosting services to host
the application on Corp A's servers for download by the customers. Corp
A receives a digital master copy of the application along with a non-
exclusive right to make copies of the application and allow customers
to download copies of the application from Corp A's platform. Corp A
has ascertained that the primary benefit or value from the transaction
received by the application developer is the platform and agency
services that Corp A provides. Corp A receives the right to make copies
of the application merely to perform its activities as an agent on
behalf of the application developer. When purchasing an application on
Corp A's platform, the customer must acknowledge the terms of a license
agreement with the application developer that states that the customer
may use the application but may not reproduce or distribute copies of
it. In addition, the agreement provides that the customer may download
the application onto only one mobile phone at a time. A customer does
not need to be connected to the internet to access the application. The
customer owes no additional payment to Corp A or the application
developer for the ability to use the application in perpetuity. Corp A
retains a fixed percentage of each purchase price of the application
and remits the remaining balance to the application developer.
(ii) Analysis. (A) The transaction between Corp A and the
application developer has multiple elements. One element is the
transfer of a master copy of an application by the application
developer to Corp A, which would be described in paragraph (b)(1)(ii)
of this section (transfer of a copyrighted article) if considered
separately. Another element is the transfer of the right to make and
distribute copies of the application by the application developer to
Corp A, which would be described in paragraphs (b)(1)(i) and (c)(2) of
this section (transfer of a copyright right) if considered separately.
A third element is the platform and agency services provided by Corp A
to the application developer, which would not be described in this
section if considered separately. A fourth element is the hosting
services provided by Corp A to the application developer, which would
be described in Sec. 1.861-19 if considered separately. Under the
facts and circumstances, although Corp A receives a copy of the
application and the right to make and distribute copies of the
application, Corp A receives this copy and right merely to facilitate
the sale of applications on behalf of the application developer.
(B) Because the transaction has multiple elements, one or more of
which would be a digital content transaction if considered separately,
paragraph (b)(2) of this section provides that the transaction is
classified within a single category under the categories described
under paragraph (b)(1) of this section if its predominant character is
described in that paragraph. Pursuant to paragraph (b)(3) of this
section, the predominant character of the transaction is based on the
primary benefit or value of the transaction to the customer, if it is
reasonably ascertainable. Since the primary benefit or value the
application developer receives in the transaction is the platform and
agency services, the predominant character of this transaction is the
platform and agency services and not a digital content transaction nor
a cloud transaction.
(C) The transfer of a copy of an application from the application
developer to a customer is a digital content transaction with one
element, which is the transfer of a copy of a digital program.
Therefore, the transaction is treated solely as a transfer of a
copyrighted article under paragraph (b)(1)(ii) of this section. Under
the benefits and burdens test of paragraph (f)(2) of this section, this
transaction is a sale of a copyrighted article because a customer has
the right to use the application in perpetuity.
(21) Example 21: Movies and TV shows available for stream, rent, or
purchase--(i) Facts. Corp A offers a catalog of movies and TV shows,
all of which are subject to copyright protection. Corp A gives
customers several options for viewing the content, each of which has a
separate price. A ``streaming'' option allows a customer to view the
video, which is hosted on Corp A's servers, while connected to the
internet for as many times as the customer wants during a limited
period. A ``rent'' option allows a customer to download the video to
its computer or other electronic device (which does not need to be
connected to the internet for viewing) and watch the video as many
times as the customer wants for a limited period, after which an
electronic lock is activated and the customer may no longer view the
content. A ``purchase'' option allows a customer to download the video
and view it as many times as the customer chooses with no end date.
Under all three options, the customer may view the video but may not
reproduce or distribute copies of it, prepare derivative works based on
it, or publicly display it.
(ii) Analysis. (A) With respect to the ``rent'' option, under
paragraph (b)(1) of this section the download of a video by a customer
is a digital content transaction with one element, which is the
transfer of a copy of the video. Therefore, the transaction is treated
solely as the transfer of a copyrighted article under paragraph
(b)(1)(ii) of this section. Although a customer will retain a copy of
the content at the end of the payment term, the customer cannot access
the content after the electronic lock is activated. The activation of
the electronic lock is the equivalent of having to return the copy.
Therefore, the transaction is classified as a lease of a copyrighted
article under paragraph (f)(2) of this section because the customer's
right to view the videos is for a limited period.
(B) With respect to the ``purchase'' option, under paragraph (b)(1)
of this section the download of a video by a customer is a digital
content transaction with one element, which is the transfer of a copy
of the video. Therefore, the transaction is treated solely as the
transfer of a copyrighted article under paragraph (b)(1)(ii) of this
section. The transaction is classified as a sale of a copyrighted
article under paragraph
[[Page 2997]]
(f)(2) of this section because the customer receives the right to view
the videos in perpetuity.
(C) With respect to the ``streaming'' option, the transaction is
Corp A's grant of the right to its customers to view the movies or
shows while connected to the internet for a limited period. There is no
transfer of any copyright rights described in paragraph (c)(2) of this
section. There is also no transfer of a copyrighted article because the
content is not downloaded by a customer, but rather, is accessed
through an on-demand network. The transaction also does not constitute
the provision of services for the development of digital content or the
provision of know-how under paragraph (b)(1) of this section.
Therefore, the transaction is not a digital content transaction
described in paragraph (b)(1) of this section. Instead, the transaction
is a cloud transaction that is classified under Sec. 1.861-19. See
Sec. 1.861-19(b).
(22) Example 22: Website offering third-party videos via stream--
(i) Facts. Corp A operates a website that allows customers to stream
videos that third-party content creators upload to Corp A's website.
Corp A has advertising contracts with third-party advertisers pursuant
to which Corp A earns advertising revenue when a customer views a
video. Customers can either stream videos for free with advertisements
or can pay a subscription fee to stream videos without advertisements.
Under the contract between Corp A and content creators, content
creators retain all ownership rights in their videos and must own or
have the necessary rights to publish their videos. The contract also
states that content creators grant Corp A a non-exclusive license to
use, reproduce, distribute, and display their videos in connection with
Corp A's website, and grant customers a non-exclusive license to view
the videos. These licenses terminate within a commercially reasonable
time after a content creator removes or deletes a video from Corp A's
website. Content creators have ascertained that the primary benefit or
value Corp A receives from transactions with content creators is the
right to use, reproduce, distribute, and display their videos. Corp A
pays content creators a percentage of advertising revenue generated
from the videos and a percentage of subscription fees.
(ii) Analysis. (A) The transaction between Corp A and the content
creators has multiple elements. One element is the uploading of a video
by a content creator, which would be described in paragraph (b)(1)(ii)
of this section (transfer of a copyrighted article) if considered
separately. Another element is the grant by content creators to Corp A
of the right to use, reproduce, distribute, and display their videos,
which would be described in paragraph (b)(1)(i) of this section
(transfer of a copyright right) if considered separately. Content
creators are not providing content development services to Corp A under
paragraph (d) of this section because content creators own the
copyright rights in the videos.
(B) Because the transaction has multiple elements, one or more of
which would be a digital content transaction if considered separately,
paragraph (b)(2) of this section provides that the transaction is
classified within a single category under the categories described
under paragraph (b)(1) of this section if its predominant character is
described in that paragraph. Pursuant to paragraph (b)(3) of this
section, the predominant character of the transaction is based on the
primary benefit or value of the transaction to the customer. The
predominant character of the transaction is therefore the transfer of
copyright rights because the primary benefit or value received by Corp
A is the right to use, reproduce, distribute, and display videos.
Accordingly, this transaction is characterized solely as a transfer of
a copyright right as described in paragraphs (b)(1)(i) of this section.
(C) Taking into account all of the facts and circumstances, there
has been a license of videos to Corp A. Under paragraph (f)(1) of this
section, there has not been a transfer of all substantial rights in the
copyright rights to the videos because each content owner has the right
to enter into other licenses with respect to the copyright of their
videos. Corp A has acquired no right itself to license the copyrights
in the videos. Finally, the terms of the licenses are for less than the
remaining lives of the copyrights in the videos.
(D) For both the free streaming and subscription streaming
transactions between Corp A and customers, there is no transfer of any
copyright rights described in paragraph (c)(2) of this section. There
is also no transfer of a copyrighted article, because the content is
not downloaded by a customer, but rather is accessed through an on-
demand network. The transactions also do not constitute the provision
of services for the development of digital content or the provision of
know-how under paragraph (b)(1) of this section. Therefore, paragraph
(b)(1) of this section does not apply to such transactions. Instead,
both transactions are cloud transactions that are classified under
Sec. 1.861-19. See Sec. 1.861-19(b).
(23) Example 23: Sale of computer programs electronically through a
reseller--(i) Facts. Corp A owns the copyright to software (Program S).
Corp A hosts Program S on its servers. Corp A grants Corp B, a foreign
corporation wholly owned by Corp A, the right to distribute copies of
Program S (without the right to reproduce copies of Program S) to Corp
B's customers that are located in Corp B's country. Under the agreement
between Corp A and Corp B, Corp B pays Corp A a fixed fee for each copy
of Program S that Corp A delivers to a customer. In separate
transactions, customers pay Corp B for the right to receive digital
copies of Program S that they may then use in perpetuity without
further payment. Corp B is responsible for managing the purchase/sale
interaction with Corp B's customers, including invoicing and
collections. Corp A is responsible for creating and delivering the
digital copies of Program S to Corp B's customers from Corp A's
servers. Corp B does not perform any functions to provide access to
Program S.
(ii) Analysis. (A) Although there is a single contract between Corp
A and Corp B that grants a legal right to Corp B with respect to
Program S, that right (the right to distribute) is not a copyright
right described in paragraphs (b)(1)(i) and (c)(2) of this section.
Instead, the transactions between Corp A and Corp B and then Corp B and
its customers are functionally and economically equivalent to back-to-
back transfers of copyrighted articles. The transfers are only
superficially different from those described in paragraph (h)(24) of
this section (Example 24) where the reseller acquires product keys and
sells them on to customers. Therefore, each sale of a copy of Program S
by Corp B to a customer should be viewed as a transfer of a copyrighted
article from Corp A to Corp B and then from Corp B to the customer.
(B) The transaction between Corp A and Corp B is a digital content
transaction with a single element that is classified as a transfer of a
copyrighted article described in paragraph (b)(1)(ii) of this section.
There are no additional elements because Corp B's receipt of the right
to distribute copies of Program S (without the right to make copies) is
not a copyright right described in paragraph (c)(2) of this section.
Under the benefits and burdens test of paragraph (f)(2) of this
section, the transfer is classified as the sale of a copyrighted
article.
(C) The transaction between Corp B and a customer is a digital
content transaction with a single element that is classified as a
transfer of a copyrighted article described in paragraph (b)(1)(ii)
[[Page 2998]]
of this section. Under the benefits and burdens test of paragraph
(f)(2) of this section, this transaction is a sale of a copyrighted
article because the customer has the right to use the application in
perpetuity.
(24) Example 24: Sale of video games with online and offline
functionality through retailers using digital keys--(i) Facts. Corp A
owns the copyright in a computer program (Program Y). Corp A creates
digital keys that allow for the download of one copy of Program Y from
Corp A's website. Corp A sells these digital keys to retailers for a
one-time fee per key, and the retailers do not use Program Y, but
instead sell them in separate transactions to customers for a one-time
fee per key. Corp A ascertains that the primary benefit or value to
retailers from the purchase of digital keys from Corp A is the right to
further transfer the digital keys to customers. The retailers cannot
reasonably ascertain the primary benefit or value that their specific
customers derive from Program Y, nor is there data available to the
retailers about how their customers typically use Program Y. Program Y
is a video game that contains online and offline features, both of
which can be played without paying an additional game-specific cost
after paying the one-time fee to purchase a key. The offline feature is
comprised of a single-player story that does not require any internet
connection to play. The online feature is comprised of the ability to
play competitive matches against other players that are hosted on
servers owned by Corp A. The competitive matches require an ongoing
connection to the internet to play. Neither the customers nor the
retailer receives any copyright rights described in paragraph (c)(2) of
this section with respect to Program Y. Customers can use Program Y in
perpetuity. Program Y is primarily marketed as a single-player game in
television and online advertising, with only brief mentions of the
multiplayer mode in print advertising. The development cost for Program
Y was allocated 40% to developing the single-player content, 20% to
developing the multiplayer content, and 40% to developing content that
is used by both types of content (e.g., cost of developing the game
engine).
(ii) Analysis. (A) The transaction between Corp A and a retailer
has multiple elements. One element is the transfer of a key with the
right to download a copy of Program Y for use to play the offline
story, which would be a digital content transaction described in
paragraph (b)(1)(ii) of this section (transfer of a copyrighted
article) if considered separately. Another element is the transfer of
the same key with a copy of Program Y providing on-demand network
access to digital content in the form of competitive multiplayer
functionality, which would be a cloud transaction described in Sec.
1.861-19(b) if considered separately.
(B) Because the transaction has multiple elements, one of which
would be a digital content transaction if considered separately and one
of which would be a cloud transaction if considered separately,
paragraph (b)(2) of this section provides that the transaction is
classified within a single category under paragraph (b)(1) of this
section if its predominant character is described in that paragraph, or
the transaction is classified solely as a cloud transaction if its
predominant character is a cloud transaction pursuant to Sec. 1.861-
19(c)(2). Pursuant to paragraph (b)(3)(i) of this section, the
predominant character of the transaction is based on the primary
benefit or value of the transaction to the customer, if it is
reasonably ascertainable. The predominant character of this transaction
is therefore the transfer of copyrighted articles because the primary
benefit or value received by a retailer is the right to further
transfer the same copyrighted articles to customers in the form of
digital keys. The retailers do not have any intent to utilize the cloud
functionality of the digital keys, although they do have the right to
do so. Therefore, this transaction is classified solely as a transfer
of copyrighted articles described in paragraph (b)(1)(ii) of this
section.
(C) Under the benefits and burdens test of paragraph (f)(2) of this
section, the transfer between Corp A and a retailer is classified as
the sale of a copyrighted article because the retailer has the right to
use, or sell, Program Y in perpetuity without further payment.
(D) The transfer of a key (with the right to download a copy of
Program Y) by a retailer to a customer also contains the same two
elements as each transaction between Corp A and a retailer. However, a
retailer cannot reasonably ascertain the primary benefit or value
derived by a specific customer from Program Y. In such situations,
paragraph (b)(3)(ii) of this section provides that the predominant
character of a transaction may be determined based on the primary
benefit or value to a typical customer of a substantially similar
transaction. This primary benefit or value to a typical customer can be
identified through actual data about use or access pursuant to
paragraph (b)(3)(ii)(A) of this section, or if that data is not
available, by using other evidence indicative of the primary benefit or
value to a typical customer pursuant to paragraph (b)(3)(ii)(B) of this
section. Because the retailers do not have available data about how
customers use Program Y, they may use the marketing with respect to
Program Y to determine that its predominant character is that of a
transfer of a copyrighted article described in paragraph (b)(1)(ii) of
this section. The relative development costs of the offline and online
components of the game could also be used if they are known to a
retailer. Therefore, the transfer between a retailer and a customer of
a digital key containing the right to download a copy of Program Y is
classified solely as a transfer of a copyrighted article.
(E) Under the benefits and burdens test of paragraph (f)(2) of this
section, the transfer between a retailer and a customer is classified
as the sale of a copyrighted article because the customer has the right
to use Program Y in perpetuity without further payment.
(25) Example 25: Source of income from the sale of a copyrighted
article transferred through an electronic medium--(i) Facts. Corp A is
the parent company of a world-wide group of affiliated companies. Corp
B is a foreign corporation wholly owned by Corp A. In the ordinary
course of business, Corp B acts as a procurement hub for Corp A's
affiliated companies. In this role, Corp B regularly purchases products
that will be distributed amongst Corp A's affiliated companies to be
used by them in their respective businesses. Corp B purchases digital
copies of a computer program (Program Y) from Corp C, an unrelated
company. Corp B may use Program Y in perpetuity without further
payment. Corp B receives no copyright rights in Program Y. Corp B does
not use Program Y, and instead distributes all of its copies of Program
Y to various affiliates. Corp C sources income from the sale of Program
Y using sections 861(a)(6) and 862(a)(6).
(ii) Analysis. (A) Under paragraph (b)(1) of this section, the
transfer of Program Y from Corp C to Corp B is a digital content
transaction with one element, which is the transfer of a copy of
Program Y. Therefore, the transaction is treated solely as transfers of
a copyrighted articles under paragraph (b)(1)(ii) of this section.
Taking into account all of the facts and circumstances, there have been
sales of copies of Program Y to Corp B under paragraph (f)(2) of this
section.
(B) Income from the sale of Program Y by Corp C is sourced pursuant
to sections 861(a)(6) and 862(a)(6) to the place where the sale
occurred. Pursuant to paragraph (f)(2)(ii) of this section, a transfer
of a copyrighted article through
[[Page 2999]]
an electronic medium is treated as occurring at the billing address of
the purchaser, in this case Corp B, unless the sales transaction is
arranged for a principal purpose of tax avoidance. In this case, the
sale is treated as occurring at the billing address of Corp B, and Corp
C's income is foreign source, even though Corp B will not use Program
Y, because Corp B regularly purchases products that will be distributed
amongst its affiliates to be used in their respective businesses, and
therefore there is no evidence that Corp B was used by Corp A to
purchase Program Y with a principal purpose of tax avoidance.
(26) Example 26: Application of anti-abuse rule for sale of a
copyrighted article transferred through an electronic medium--(i)
Facts. Corp A is the parent company of a world-wide group of affiliated
companies. Corp B is a foreign affiliate of Corp A. In the ordinary
course of business, Corp B does not act as a procurement hub regularly
purchasing products for use by Corp A's affiliated companies. Corp A
negotiates an agreement with Corp C, an unrelated company, to purchase
digital copies of a computer program (Program Y) for use in Corp A's
business. The agreement grants Corp A the right to use Program Y in
perpetuity for a one-time payment. Corp C requests that Corp B be the
purchaser of the copies of Program Y even though Corp B will not use
Program Y and is not otherwise involved in the transaction between Corp
A and Corp C for a principal purpose of tax avoidance. Corp A agrees,
and Corp B purchases the copies of Program Y and subsequently
distributes them to Corp A. Corp C sources income from the sale of
Program Y using sections 861(a)(6) and 862(a)(6).
(ii) Analysis. (A) Under paragraph (b)(1) of this section, the
transfer of Program Y from Corp C to Corp B is a digital content
transaction with one element, which is the transfer of a copy of
Program Y. Therefore, the transaction is classified solely as a
transfer of a copyrighted article under paragraph (b)(1)(ii) of this
section. Taking into account all of the facts and circumstances, there
have been sales of copies of Program Y to Corp B under paragraph (f)(2)
of this section.
(B) Income from the sale of Program Y by Corp C is sourced pursuant
to sections 861(a)(6) and 862(a)(6) to the place where the sale
occurred. Pursuant to paragraph (f)(2)(ii) of this section, a transfer
of a copyrighted article through an electronic medium is treated as
occurring at the billing address of the purchaser, in this case Corp B,
unless the sales transaction is arranged for a principal purpose of tax
avoidance. In this case, Corp B does not regularly purchase products
that will be used by other companies within Corp A's group of
affiliated companies, and Corp B was instead used as the purchaser of
Program Y on behalf of Corp A with a principal purpose of tax
avoidance. Therefore, the place where the sale occurred must be
determined based on all relevant facts and circumstances. Corp A
negotiated the purchase, and the software will be used by Corp A in its
business. As a result, under paragraph (f)(2)(ii) of this section, the
sale is treated as occurring at the location of Corp A and the income
derived by Corp C from the sale is U.S. source.
(C) The same result would apply if, instead of using Corp B for the
purchase, Corp A made the purchase but rented a P.O. Box outside the
United States to serve as the billing address for the transaction with
a principal purpose of tax avoidance.
(i) Applicability date--(1) In general. This section applies to
taxable years beginning on or after January 14, 2025.
(2) Early application. A taxpayer can apply this section to taxable
years beginning on or after August 14, 2019 and all subsequent taxable
years not described in paragraph (i)(1) of this section (early
application years) if--
(i) The taxpayer also applies Sec. 1.861-19 to the early
application years;
(ii) This section and Sec. 1.861-19 are applied to the early
application years by all persons related to the taxpayer (within the
meaning of sections 267(b) and 707(b));
(iii) The period of limitations on assessment for each early
application year of the taxpayer and all related parties (within the
meaning of sections 267(b) and 707(b)) is open under section 6501; and
(iv) The taxpayer would not be required under this section to
change its method of accounting as a result of such election.
(j) Change in method of accounting required by this section. In
order to comply with this section, a taxpayer may be required to change
its method of accounting. If so required, the taxpayer must secure the
consent of the Commissioner in accordance with the requirements of
Sec. 1.446-1(e) and the applicable administrative procedures for
obtaining the Commissioner's consent under section 446(e) for voluntary
changes in methods of accounting.
0
Par. 4 Section 1.861-19 is added to read as follows:
Sec. 1.861-19 Classification of cloud transactions.
(a) In general. This section provides rules for classifying cloud
transactions (as defined in paragraph (b) of this section). The rules
of this section apply for purposes of Internal Revenue Code sections
59A, 245A, 250, 267A, 367, 404A, 482, 679, and 1059A; subchapter N of
chapter 1; chapters 3 and 4; and sections 842 and 845 (to the extent
involving a foreign person), and apply with respect to transfers to
foreign trusts not covered by section 679.
(b) Cloud transaction defined. A cloud transaction is a transaction
through which a person obtains on-demand network access to computer
hardware, digital content (as defined in Sec. 1.861-18(a)(2)), or
other similar resources. 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.
(c) Classification of cloud transactions--(1) In general. A cloud
transaction is classified as the provision of services.
(2) Transaction with multiple elements. Taking into account the
overall transaction and the surrounding facts and circumstances, a
transaction that has multiple elements, one or more of which would be a
cloud transaction if considered separately, is classified in its
entirety as a cloud transaction if the predominant character of the
transaction as determined under Sec. 1.861-18(b)(3) is a cloud
transaction.
(d) Examples. The examples in this paragraph (d) illustrate the
provisions of this section. Unless otherwise specified, assume that
Corp A is a domestic corporation, no rights described in Sec. 1.861-
18(c)(2) (copyright rights) are transferred as part of the transactions
described, and all facts in each example occur as part of a single
transaction.
(1) Example 1: Computing capacity--(i) Facts. Corp A operates data
centers on its premises in various locations. Corp A provides Corp B
computing capacity on Corp A's servers in exchange for a monthly fee
based on the amount of computing power made available to Corp B. Corp B
provides its own software to run on Corp A's servers.
(ii) Analysis. The provision of on-demand network computing
capacity by Corp A to Corp B is a cloud transaction with one element.
Therefore, the transaction is treated solely as a cloud transaction
under paragraph (b) of this section and is classified as the provision
of services under paragraph (c)(1) of this section.
[[Page 3000]]
(2) Example 2: Computing capacity on dedicated on-premises
servers--(i) Facts. The facts are the same as in paragraph (d)(1)(i) of
this section (the facts in Example 1), except that, in order to offer
more security to Corp B, Corp A provides Corp B computing capacity
exclusively through designated servers, which are owned and operated by
Corp A and located at Corp B's facilities. Corp A agrees not to use the
designated server for any other customer for the duration of its
arrangement with Corp B. Although the server is located at Corp B's
facilities, Corp B accesses the server through Corp A's network and the
monthly fee is based on the amount of computing power made available to
Corp B.
(ii) Analysis. As in paragraph (d)(1) of this section (Example 1),
the transaction between Corp A and Corp B is the provision of on-demand
network computing capacity and is therefore a cloud transaction with
one element. Therefore, the transaction is treated solely as a cloud
transaction under paragraph (b) of this section and is classified as
the provision of services under paragraph (c)(1) of this section. If
the transaction between Corp A and Corp B involved only the provision
of a server by Corp A for use by Corp B, and not on-demand network
access to computing capacity, the transaction would not be a cloud
transaction and this section would not apply.
(3) Example 3: Access to software development platform and website
hosting--(i) Facts. Corp A provides Corp B a software platform that
Corp B uses to develop and deploy websites with a range of features,
including blogs, message boards, and other collaborative knowledge
bases. The software development platform consists of an operating
system, web server software, scripting languages, libraries, tools, and
back-end relational database software and allows Corp B to use in its
websites certain visual elements subject to copyrights held by Corp A.
The software development platform is hosted on servers owned by Corp A
and located at Corp A's facilities. Corp B's finished websites are also
hosted on Corp A's servers. Corp B accesses the software development
platform via a standard web browser. Corp B has no ability to alter the
software code. A small amount of copyrighted scripting code is
downloaded onto Corp B's computers to facilitate secure logins and
access to the software development platform. All other functions of the
software development platform execute on Corp A's servers, and no
portion of the core software code is ever downloaded by Corp B or Corp
B's customers. Corp A has ascertained that the primary benefit or value
to Corp B from the transaction is the right to use the software
development platform. Corp B pays Corp A a monthly fee for the platform
and website hosting.
(ii) Analysis. (A) There is one transaction with multiple elements
between Corp A and Corp B. One element is Corp A's provision to Corp B
of on-demand network access to the software platform, which would be a
cloud transaction described in paragraph (b) of this section if
considered separately. Another element is Corp A's hosting of Corp B's
finished websites, which would be a cloud transaction described in
paragraph (b) of this section if considered separately. A third element
is the grant by Corp A to Corp B of the right to use in Corp B's
websites certain visual elements subject to copyrights held by Corp A,
which would be a transfer of copyright rights under Sec. 1.861-
18(b)(1)(i) if considered separately. A fourth element is the download
of scripting code by Corp B, which would be a transfer of a copyrighted
article under Sec. 1.861-18(b)(1)(ii) if considered separately.
(B) Because the transaction has multiple elements, one or more of
which would be a cloud transaction if considered separately, paragraph
(c)(2) of this section provides that the transaction is classified as a
cloud transaction if its predominant character is a cloud transaction.
Pursuant to Sec. 1.861-18(b)(3), the predominant character of the
transaction is based on the primary benefit or value of the transaction
to the customer, if it is reasonably ascertainable. The predominant
character of this transaction is therefore a cloud transaction because
the primary benefit or value received by Corp B is the right to use the
software development platform. Accordingly, this transaction is
classified solely as a cloud transaction described in paragraph (b) of
this section and is classified as the provision of services under
paragraph (c)(1) of this section.
(4) Example 4: Access to online software via an application--(i)
Facts. Corp A provides Corp B word processing, spreadsheet, and
presentation software and allows employees of Corp B to access the
software over the internet through a web browser or an application
(``app'') that can be downloaded from Corp A's servers onto a computer
or mobile device. Corp B's employees usually download Corp A's app onto
their mobile devices. To access the full functionality of the app, the
device must be connected to the internet. Only a limited number of
features on the app are available without an internet connection. Corp
B has no ability to alter the software code. The software is hosted on
servers owned by Corp A and located at Corp A's facilities and is used
concurrently by other Corp A customers in addition to Corp B. Corp B
pays a monthly fee based on the number of employees with access to the
software. Users have the option to save files either online using the
storage provided by Corp B, or offline on their own hard drives. Corp
B's employees can also download updates to the app as part of the
monthly fee arrangement. Upon termination of the arrangement, Corp A
activates an electronic lock preventing Corp B's employees from further
utilizing the app, and Corp B's employees are no longer able to access
the software via a web browser. Corp A has ascertained that the primary
benefit or value to Corp B from the transaction is the right to access
Corp A's software over the internet, whether via web browser or after
downloading the app.
(ii) Analysis. (A) There is one transaction with multiple elements
between Corp A and Corp B. One element is Corp A's provision to Corp B
of on-demand network access to Corp A's computer hardware and software
resources for the purpose of fully utilizing Corp A's software, which
would be a cloud transaction described in paragraph (b) of this section
if considered separately. Another element is the download of Corp A's
app by Corp B employees, which would be a transfer of a copyrighted
article under Sec. 1.861-18(b)(1)(ii) if considered separately.
(B) Because the transaction has multiple elements, one or more of
which would be a cloud transaction if considered separately, paragraph
(c)(2) of this section provides that the transaction is classified as a
cloud transaction if its predominant character is a cloud transaction.
Pursuant to Sec. 1.861-18(b)(3), the predominant character of the
transaction is based on the primary benefit or value of the transaction
to the customer, if it is reasonably ascertainable. The predominant
character of this transaction is therefore a cloud transaction because
the primary benefit or value received by Corp B is the right to access
Corp A's software over the internet. Accordingly, this transaction is
classified solely as a cloud transaction described in paragraph (b) of
this section and is classified as the provision of services under
paragraph (c)(1) of this section.
(5) Example 5: Access to offline software with limited online
functions--
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(i) Facts. Corp A provides Corp B word processing, spreadsheet, and
presentation software that is functionally similar to the software in
paragraph (d)(4) of this section (Example 4). The software is made
available for access over the internet but only to download the
software from servers owned by Corp A onto a computer or mobile device
in the form of an app. The downloaded software contains all the core
functions of the software. Employees of Corp B can use the software on
their computers or mobile devices regardless of whether their computer
or mobile device is online. When online, the software provides a few
ancillary functions that are not available offline, such as access to
document templates and data collection for diagnosing problems with the
software. Whether working online or offline, Corp B employees can store
their files only on their own computer or mobile device, and not on
Corp A's data storage servers. Corp B's employees can also download
updates to the software as part of the monthly fee arrangement. Upon
termination of the arrangement, an electronic lock is activated so that
the software can no longer be accessed. Corp A has ascertained that the
primary benefit or value to Corp B from the transaction is the right to
download and use Corp A's software offline.
(ii) Analysis. (A) The transaction between Corp A and Corp B
contains multiple elements. One element is the transfer of a copy of
Corp A's software via download, which would be a transfer of a
copyrighted article described under Sec. 1.861-18(b)(1)(ii) if
considered separately. Another element is the provision of online
ancillary functionality of the software, which would be a cloud
transaction described in paragraph (b) of this section if considered
separately.
(B) Because the transaction has multiple elements, one or more of
which would be a cloud transaction if considered separately, paragraph
(c)(2) of this section provides that the transaction is classified as a
cloud transaction if its predominant character is a cloud transaction.
Pursuant to Sec. 1.861-18(b)(3), the predominant character of the
transaction is based on the primary benefit or value of the transaction
to the customer, if it is reasonably ascertainable. The predominant
character of this transaction is therefore the transfer of a
copyrighted article because the primary benefit or value received by
Corp B is the right to download and use Corp A's software offline.
Accordingly, this transaction is classified solely as a transfer of a
copyrighted article described in Sec. 1.861-18(b)(1)(ii). The
provision of the software constitutes a lease of a copyrighted article
under Sec. 1.861-18 because access to the app is terminated when the
monthly fee is no longer paid, even though Corp B employees retain the
locked files on their devices. See Sec. 1.861-18(h)(4).
(6) Example 6: Data storage, separate from access to offline
software--(i) Facts. The facts are the same as in paragraph (d)(5)(i)
of this section (the facts in Example 5), except that Corp A also
provides on-demand network data storage to Corp B on Corp A's servers
in exchange for a monthly fee based on the amount of data storage used
by Corp B. Under the data storage terms, Corp B employees may store
files created by Corp B employees using Corp A's software or other
software. Although Corp A's word processing software is compatible with
Corp A's data storage systems, the core functionality of Corp A's
software is not dependent on Corp B's purchase of the storage plan.
Corp A's provision of software and data storage capacity constitute
separate transactions.
(ii) Analysis. (A) As explained in paragraph (d)(5)(ii) of this
section, Corp B's download of fully functional software, along with on-
demand network access to certain limited online features, does not
constitute a cloud transaction, but rather constitutes a lease of a
copyrighted article under Sec. 1.861-18.
(B) The provision of on-demand network data storage by Corp A to
Corp B is a cloud transaction with one element. Therefore, the
transaction is treated solely as a cloud transaction under paragraph
(b) of this section and is classified as the provision of services
under paragraph (c)(1) of this section.
(7) Example 7: Streaming and temporary download of digital content
using third-party servers--(i) Facts. Corp A offers via stream or
temporary download digital content in the form of videos and music to
customers from servers located in data centers owned and operated by
Data Center Operator. Each customer uses a computer or other electronic
device to access unlimited streaming or temporary downloads of video
and music in exchange for payment of a flat monthly fee to Corp A. The
customer may select from among the available content the particular
video or song to be streamed or downloaded. Corp A continually updates
its content catalog, replacing content with higher quality versions and
adding new content at no additional charge to the customer. It also
provides additional functionality such as various methods of filtering
and sorting the library, a watchlist, and recommendations based on a
customer's preferences. Content that is streamed to the customer is not
stored locally on the customer's computer or other electronic device
and therefore can be played only while the customer's computer or other
electronic device is connected to the internet. Content that is
temporarily downloaded is stored on the customer's computer or other
electronic device for 1 week and therefore can be played while the
customer's computer or other electronic device is not connected to the
internet. Corp A cannot reasonably ascertain the primary benefit or
value that its specific customers derive from accessing Corp A's
catalog of digital content. Data collected by Corp A indicates that the
vast majority of customers stream digital content rather than
temporarily download the content. Corp A pays Data Center Operator a
fee based on the amount of data storage used and computing power made
available in connection with Corp A's content offerings.
(ii) Analysis. (A) The provision of data storage and computing
power by Data Center Operator to Corp A is a cloud transaction with one
element. Therefore, the transaction is treated solely as a cloud
transaction under paragraph (b) of this section, and is classified as
the provision of services under paragraph (c)(1) of this section.
(B) A transaction between Corp A and a customer has two elements.
One element is streaming access to a curated and routinely updated
library of digital content, which would be a cloud transaction
described in paragraph (b) of this section if considered separately.
Another element is the transfer of a copy of digital content via
temporary download, which would be a transfer of a copyrighted article
under Sec. 1.861-18(b)(1)(ii) if considered separately.
(C) Because the transaction has multiple elements, one or more of
which would be a cloud transaction if considered separately, paragraph
(c)(2) of this section provides that the transaction is classified as a
cloud transaction if its predominant character is a cloud transaction.
Pursuant to Sec. 1.861-18(b)(3), the predominant character of the
transaction is based on the primary benefit or value of the transaction
to the customer if it is reasonably ascertainable. However, Corp A
cannot reasonably ascertain the primary benefit or value derived by a
specific customer from Corp A's offering. In such situations, Sec.
1.861-18(b)(3)(ii) provides that the predominant character of a
transaction may be determined based on the
[[Page 3002]]
primary benefit or value to a typical customer of a substantially
similar transaction. This primary benefit or value to a typical
customer can be identified through actual data about use or access
pursuant to Sec. 1.861-18(b)(3)(ii)(A), or if that data is not
available, by using other evidence indicative of the primary benefit or
value to a typical customer pursuant to Sec. 1.861-18(b)(3)(ii)(B).
Because Corp A has data that shows the typical customer streams digital
content rather than temporarily downloading it, the primary benefit or
value received by a typical customer is streaming access to digital
content. Therefore, the predominant character of the transaction is a
cloud transaction. Under paragraph (c)(1) of this section, the cloud
transaction is classified as the provision of services.
(8) Example 8: Access to online database--(i) Facts. Corp A offers
an online database of industry-specific materials. Customers access the
materials through Corp A's website, which aggregates and organizes
information topically and hosts a proprietary search engine. Corp A
hosts the website and database on its own servers and provides multiple
customers access to the website and database concurrently. Most
materials in Corp A's database are publicly available by other means,
but Corp A's website offers an efficient way to locate and obtain the
information on demand. Certain materials in Corp A's database
constitute digital content within the meaning of Sec. 1.861-18(a)(2),
and Corp A pays the copyright owners a license fee for using them. Each
customer may download any of the materials to its own computer and keep
such materials without further payment. The customer pays Corp A a fee
based on the number of searches or the amount of time spent on the
website, and such fee is not dependent on the amount of materials the
customer downloads. The fee that the customer pays is substantially
higher than the stand-alone charge for accessing the same digital
content outside of Corp A's system. Corp A cannot reasonably ascertain
the primary benefit or value that a specific customer derives from
accessing Corp A's database. Corp A does not have data indicating
whether the typical customer downloads materials from the database.
Corp A markets its website and online database as user-friendly and an
efficient way to find relevant materials because of its proprietary
search engine. Developing the proprietary search engine was the largest
cost Corp A incurred in creating its website and online database.
(ii) Analysis. (A) The transaction between Corp A and a customer
has multiple elements. One element is Corp A's provision to a customer
of access to Corp A's website and online database, which is a cloud
transaction described in paragraph (b) of this section if considered
separately. Another element is the transfer of digital content via
download, which is the transfer of a copyrighted article under Sec.
1.861-18 if considered separately.
(B) Because the transaction has multiple elements, one or more of
which would be a cloud transaction if considered separately, paragraph
(c)(2) of this section provides that the transaction is classified as a
cloud transaction if its predominant character is a cloud transaction.
Pursuant to Sec. 1.861-18(b)(3), the predominant character of the
transaction is based on the primary benefit or value of the transaction
to the customer, if it is reasonably ascertainable. However, Corp A
cannot reasonably ascertain the primary benefit or value derived by a
specific customer from access to Corp A's database. In such situations,
Sec. 1.861-18(b)(3)(ii) provides that the predominant character of a
transaction may be determined based on the primary benefit or value to
a typical customer of a substantially similar transaction. This primary
benefit or value to a typical customer can be identified through actual
data about use or access pursuant to Sec. 1.861-18(b)(3)(ii)(A), or if
that data is not available, by using other evidence indicative of the
primary benefit or value to a typical customer pursuant to Sec. 1.861-
18(b)(3)(ii)(B). That Corp A focuses on its proprietary search engine
when marketing its website and database, as well as the facts that the
search engine was the most expensive cost incurred by Corp A in
creating its website and database, and that customers pay a
substantially higher fee to access Corp A's system than they would
otherwise pay to access the content outside of Corp A's system,
indicates that the primary benefit or value received by a typical
customer is the right to use the search engine. Therefore, under
paragraph (c)(2) of this section, the predominant character of the
transaction between Corp A and a customer is a cloud transaction. Under
paragraph (c)(1) of this section the cloud transaction is classified as
the provision of services.
(9) Example 9: Temporary or perpetual access to a single movie via
stream or download--(i) Facts. Corp A hosts movies on its website and
allows customers to view a single movie for a limited period or
perpetually for a one-time fee, with perpetual viewing rights costing a
higher fee. Corp A does not charge customers a separate fee for access
to the website. In addition, Corp A's website provides recommendations
for movies based on a customer's search for a particular title and/or
the customer's purchase history. Customers have no ability to alter the
servers, website, or movies available on the website. The movies in
Corp A's database constitute digital content within the meaning of
Sec. 1.861-18(a)(2), and Corp A pays the copyright owners a license
fee for using them. Corp A allows customers to view the movies by
either streaming the movies from Corp A's servers, or by downloading
the movies onto the customer's computer or other electronic device. The
file size of movies offered by Corp A is generally large and so
customers may be expected to download movies only in certain situations
such as when traveling without internet access. Upon the expiration of
the rental period, customers will no longer have access to stream the
movies, and any movie that was downloaded onto a customer's computer or
other electronic device will auto-delete from the customer's computer
or other electronic device. Whether a customer chooses to view the
movie via stream or download, Corp A charges the same one-time fee.
Corp A cannot reasonably ascertain the primary benefit or value that a
specific customer derives from accessing Corp A's website. Corp A
maintains aggregate data on whether a given movie is viewed via stream
or download, and this data shows that most movies are viewed by
streaming, even in the case where a customer pays for the right to view
a movie in perpetuity.
(ii) Analysis. (A) A transaction between Corp A and a customer
contains multiple elements. One element is Corp A's provision to a
customer of access to Corp A's website in order to view a movie via
stream, which is a cloud transaction described in paragraph (b) of this
section if considered separately. Another element is Corp A's provision
to a customer of access to Corp A's website in order to download a
movie, which is the transfer of a copyrighted article under Sec.
1.861-18 if considered separately.
(B) Because the transaction has multiple elements, one or more of
which would be a cloud transaction if considered separately, paragraph
(c)(2) of this section provides that the transaction is classified as a
cloud transaction if its predominant character is a cloud transaction.
Pursuant to Sec. 1.861-18(b)(3), the predominant character of the
transaction is based on
[[Page 3003]]
the primary benefit or value of the transaction to the customer, if it
is reasonably ascertainable. However, Corp A cannot reasonably
ascertain the primary benefit or value derived by a specific customer
from access to Corp A's database. In such situations, Sec. 1.861-
18(b)(3)(ii) provides that the predominant character of a transaction
may be determined based on the primary benefit or value to a typical
customer of a substantially similar transaction. This primary benefit
or value to a typical customer can be identified through actual data
about use or access pursuant to Sec. 1.861-18(b)(3)(ii)(A), or if that
data is not available, by using other evidence indicative of the
primary benefit or value to a typical customer pursuant to Sec. 1.861-
18(b)(3)(ii)(B). Corp A has data that shows that the typical customer
views movies by streaming rather than download. Accordingly, under
paragraph (c)(2) of this section, the predominant character of the
transaction is a cloud transaction because the primary benefit or value
a typical customer receives is access to stream movies on Corp A's
website. Under paragraph (c)(1) of this section, the cloud transaction
is classified as the provision of services.
(10) Example 10: Reseller of software as a service--(i) Facts. Corp
A owns the copyright to software (Program S). Corp A hosts Program S on
its servers. Customers access Program S only through an internet
connection. Corp A grants Corp B, a foreign corporation wholly owned by
Corp A, the right to sell access to Program S to Corp B's customers
that are located in Corp B's country. Corp B is responsible for
managing the purchase/sale interaction with Corp B's customers,
including invoicing and collections. Corp A is responsible for
providing customers with access to Program S. Corp B does not perform
any functions to provide access to Program S.
(ii) Analysis. (A) The transaction between Corp A and Corp B is
treated as Corp A providing on-demand access to Program S to Corp B
even though Corp B resells that access. This transaction is a cloud
transaction with one element. Under paragraph (c)(1) of this section,
the cloud transaction is classified as the provision of services. The
transaction
[…truncated; see source link]Indexed from Federal Register on January 14, 2025.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.