Corp X, a domestic corporation, receives $150,000 under a contract for services performed concurrently in the United States and in several foreign countries by numerous Corp X employees. Each employee performs services exclusively in one jurisdiction, and the compensation must be sourced between U.S. and foreign labor under Treas. Reg. § 1.861-4(b)(1)(ii).
Although the number of employees — and the hours they spend — performing the contract within the United States equals the number performing it abroad (250 hours, or 50% of time, on each side), the U.S. employees are paid more because of the more sophisticated nature of the services they perform. The U.S. payroll cost for the contract is $20,000 out of a total contract payroll cost of $30,000, while the foreign payroll cost is $10,000.
Under these facts, a determination based upon relative payroll costs — rather than time — is the basis that most correctly reflects the proper source of the income. Accordingly, of the $150,000 included in Corp X's gross income, $100,000 ($150,000 × $20,000/$30,000) is attributable to labor performed within the United States and $50,000 ($150,000 × $10,000/$30,000) is attributable to labor performed without the United States.
Compensation for services is sourced where the labor is performed, and the taxpayer must use the basis that most correctly reflects the proper source of the income under the facts and circumstances.
Here an even 50/50 split of hours did not control; relative payroll cost ($20,000 vs. $10,000) better reflected the value of the work, so it governed the split.
$150,000 × $20,000/$30,000 = $100,000 U.S.-source; $150,000 × $10,000/$30,000 = $50,000 foreign-source.
The U.S./foreign source split of Corp X's compensation drives foreign tax credit limitation, withholding, and effectively connected income analysis for the income earned under the contract.
