If a sale is made in the United States involving goods which are at the time stored in a foreign-trade zone, and the goods were not produced, manufactured, or processed abroad by the foreign seller, the entire profit from the sale would constitute income derived from sources within the United States, and would be subject to the United States Federal income taxation. If the goods were manufactured abroad by the foreign seller the profits from such sale would constitute income derived from sources partly within and partly without the United States. In the latter case, the portion of the profit attributable to United States sources (determined in accordance with apportionment rules provided for in the United States Federal tax regulations) would be subject to the United States Federal income taxation.

"Permanent Establishment" 2 and Its Effect

Consideration should also be given to the provisions of the income tax convention or treaty between the United States and a third country, under which special treatment is accorded to business enterprises of each country. Under the provisions of that treaty, a foreign enterprise is not subject to United States Federal income taxation in respect of its industrial or commercial profits derived from sources within the United States unless it is engaged in trade or business in the United States through a "permanent establishment" (as defined in the tax convention) situated in the United States. If it is so engaged, United States tax may be imposed upon the entire income of such enterprise from sources within the United States. The term "foreign enterprise" means an industrial or commercial enterprise or undertaking carried on by a resident of a third country.

The rules for determining what constitutes income derived from sources within or without the United States are not changed by this tax convention.

As above indicated, if the sale does not take place in the United States, the profit therefrom is not subject to United States Federal income taxation even though the seller has a permanent establishment in the United States. And, too, the profit from sales made by a foreign enterprise would not be subject to United States Federal taxation, even though the property interest in the goods passed from the seller to the buyer in the United States, if the foreign enterprise does not otherwise have a permanent establishment in the United States. But,

A typical definition of the term "permanent establishment" is found in Article II, U. S.-U. K. income tax treaty, which is as follows: "The term 'permanent establishment' when used with respect to an enterprise of one of the Contracting Parties means a branch, management, factory or other fixed place of business, but does not include an agency unless the agent has, and habitually exercises, a general authority to negotiate and conclude contracts on behalf of such enterprise or has a stock of merchandise from which he regularly fills orders on its behalf. An enterprise of one of the Contracting Parties shall not be deemed to have a permanent establishment in the territory of the other Contracting Party merely because it carries on business dealings in the territory of such other Contracting Party through a bona fide commission agent, broker or custodian acting in the ordinary course of his business as such. The fact that an enterprise of one of the Contracting Parties maintains in the territory of the other Contracting Party a fixed place of business exclusively for the purchase of goods or merchandise shall not of itself constitute such fixed place of business a permanent establishment of such enterprise. The fact that a corporation of one Contracting Party has a subsidiary corporation which is a corporation of the other Contracting Party or which is engaged in trade or business in the territory of such other Contracting Party (whether through a permanent establishment or otherwise) shall not of itself constitute that subsidiary corporation a permanent establishment of its parent corporation."

if apart from such sales within the United States, the foreign enterprise has a permanent establishment in the United States, then the profits from those sales would (under the terms of the income tax convention) not be exempt from United States Federal income taxation. (As noted above, the treaty exemption from Federal taxation of industrial or commercial profits derived from sources within the United States is inapplicable if the enterprise deriving such profits has a permanent establishment in the United States.)

Without attempting to discuss in detail the different fact situations which may or may not constitute having a permanent establishment in the United States, within the meaning of the income tax convention, it may be noted that the presence in the United States of an executive of a foreign enterprise who has the power to bind such enterprise constitutes a permanent establishment of the enterprise in the United States under the provisions of the income tax convention. However, it should be borne in mind that the use of a commission agent as the medium of sale on the United States market does not of itself constitute a permanent establishment within the United States. It, therefore, follows that the enterprise of a foreign country which has a tax convention with the United States can thus market its products in the United States without incurring United States Federal income tax on the profit thus realized.

It also should be emphasized that whether the storage of goods in a foreign-trade zone for purpose of sale in the United States would of itself be regarded as the maintenance of a permanent establishment in the United States would depend upon the particular circumstances involved. It would appear that the consistent storage-that is, regularly storing goods-in a foreign-trade zone would probably constitute maintenance of a permanent establishment.

Applicability of U. S. Patent Laws to U. S. Foreign-Trade Zones

There is no mention of the patent laws in the Foreign-Trade Zones Act (Title 19 of the U. S. Code, sections 81a-81u), which is the basic legislation governing the establishment and operation of zones. The subject is also not specifically treated or mentioned in the United States patent laws, and the Department of Commerce is not aware of any court decisions which deal with this matter. It, nevertheless, would appear, in the light of the following, that the patent laws do, if otherwise applicable, cover operations within the foreign-trade zones.

The Foreign-Trade Zones Act specifically excepts merchandise within the zones from the United States customs laws. The act, however, does not contain any exception concerning other United States laws. The position of the Board in this respect has been that all laws of the United States apply to and within the foreign-trade zones except that, to the extent provided in the Foreign-Trade Zones Act, the United States customs laws do not apply to merchandise brought into the zone.

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With respect to the patent laws themselves (Title 35, U. S. Code), the territorial coverage of patent rights does not specifically exclude foreign-trade zones. On the other hand, the laws do contain a specific exception covering temporary presence in the United States which is limited to use of inventions in foreign vessels, aircraft, or vehicles temporarily or accidentally in the United States. Section 154 provides that a patent grants "the right to exclude others from making, using or selling the invention throughout the United States ***" And, Section 271 (a) states that, except as otherwise provided in Title 35, "whoever without authority makes, uses or sells any patented invention, within the United States during the term of the patent therefor, infringes the patent."

Section 272 contains the only relevant exception to the infringement rule; it provides that the use of any invention in any vessel, aircraft, or vehicle of any country which affords similar privileges to United States vessels, aircraft, or vehicles, entering the United States temporarily or accidentally, shall not constitute infringement of any patent, if the invention is used exclusively for the needs of the vessel, aircraft, or vehicle and is not sold in or used for the manufacture of anything to be sold in or exported from the United States.

Foreign Trade Zones Act

As Amended

Foreign-Trade Zones Act, Public Law 397, 73d Congress, approved June 18, 1934 (48 Stat. 998-1003; 19 U. S. C. 81a-81u), as amended by Public Law 566, 81st Congress, approved June 17, 1950.

AN ACT

To provide for the establishment, operation, and maintenance of foreign-trade zones in ports of entry of the United States, to expedite and encourage foreign commerce, and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, That when used in this act

(a) The term "Secretary" means the Secretary of Commerce;

(b) The term "Board" means the Board which is hereby established to carry out the provisions of this act. The Board shall consist of the Secretary of Commerce, who shall be chairman and executive officer of the Board, the Secretary of the Treasury, and the Secretary of the Army;

(c) The term "State" includes any State, the District of Columbia, Alaska, Hawaii, and Puerto Rico;

(d) The term "corporation" means a public corporation and a private corporation, as defined in this act;

(e) The term "public corporation" means a State, political subdivision thereof, a municipality, a public agency of a State, political subdivision thereof, or municipality, or a corporate municipal instrumentality of one or more States;

(f) The term "private corporation" means any corporation (other than a public corporation) which is organized for the purpose of establishing, operating, and maintaining a foreign-trade zone and which is chartered under special act enacted after the date of enactment of this act of the State or States within which it is to operate such zone;

(g) The term "applicant" means a corporation applying for the right to establish, operate, and maintain a foreign-trade zone;

(h) The term "grantee" means a corporation to which the privilege of establishing, operating, and maintaining a foreign-trade zone has been granted;

(i) The term "zone" means a "foreign-trade zone" as provided in this act.

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Sec. 2. (a) The Board is hereby authorized, subject to the conditions and restrictions of this act and of the rules and regulations made thereunder, upon application as hereinafter provided, to grant to corporations the privilege of establishing, operating, and maintaining foreign-trade zones in or adjacent to ports of entry under the jurisdiction of the United States.

(b) Each port of entry shall be entitled to at least one zone, but when a port of entry is located within the confines of more than one State such port of entry shall be entitled to a zone in each of such States, and when two cities separated by water are embraced in one port of entry, a zone may be authorized in each of said cities or in territory adjacent thereto. Zones in addition to those to which a port of entry is entitled shall be authorized only if the Board finds that existing or authorized zones will not adequately serve the convenience of commerce.

(c) In granting applications preference shall be given to public corporations.

(d) In case of any State in which harbor facilities of any port of entry are owned and controlled by the State and in which State harbor facilities of any other port of entry are owned and controlled by a municipality, the Board shall not grant an application by any public corporation for the establishment of any zone in such State, unless such application has been authorized by an act of the legislature of such State (enacted after the date of enactment of this act).

Sec. 3. Foreign and domestic merchandise of every description, except such as is prohibited by law, may, without being subject to the customs laws of the United States, except as otherwise provided in this Act, be brought into a zone and may be stored, sold, exhibited, broken up, repacked, assembled, distributed, sorted, graded, cleaned, mixed with foreign or domestic merchandise, or otherwise manipulated, or be manufactured except as otherwise provided in this Act, and be exported, destroyed, or sent into customs territory of the United States therefrom, in the original package or otherwise: but when foreign merchandise is so sent from a zone into customs territory of the United States it shall be subject to the laws and regulations of the United States affecting imported merchandise: Provided, That whenever the privilege shall be requested and there has been no manipulation or manufacture effecting a change in tariff classification, the collector of customs shall take under supervision any lot or part of a lot of foreign merchandise in a zone, cause it to be appraised and taxes determined and duties liquidated thereon. Merchandise so taken under supervision may be stored, manipulated, or manufactured under the supervision and regulations prescribed by the Secretary of the Treasury, and whether mixed or manufactured with domestic merchandise or not may, under regulations prescribed by the Secretary of the Treasury, be exported or destroyed, or may be sent into customs territory upon the payment of such liquidated duties and determined taxes thereon. If merchandise so taken under supervision has been manipulated or manufactured, such duties and taxes shall be payable on the quantity of such foreign merchandise used in the manipulation or manufacture of the entered article. Allowance shall be made for recoverable and irrecoverable waste; and if recoverable waste is sent into customs territory, it shall be dutiable and taxable in its condition and