The contract in this case was executed pursuant to a project agreement between an agency of the United States and the foreign government which provided that a civil service expert would be recruited and employed under an individual contract with the foreign government to serve as a staff adviser to an official of the foreign government. The project was financed through a contribution of 40 dollars from the U.S. agency and a contribution of 16 dollars from the foreign government. Under the terms of the employment contract between the United States citizen and the foreign government, the United States citizen was paid a salary of 14x dollars a year and related emoluments, including transportation expenses for himself and his dependents, leave benefits, housing accommodations, medical and dental care, and a bonus on termination of his services. The foreign government paid him from its own funds a salary of 4x dollars a year, the basic rate for a special official of the foreign government. The difference between that paid for a special official and the salary stipulated in the contract was paid by the foreign government out of the funds contributed by the U.S. agency under the project agreement. However, the U.S. agency incurred no obligation to pay any part of the salary stipulated in the contract and would not have paid any part of it if the foreign government had failed to live up to its agreement. The taxpayer was required to pay all taxes and fees imposed by the laws of the foreign country. The contract provided that the first six months should be a probationary period. Either party could terminate the contract by giving one month's notice. The foreign government could, for cause, terminate the contract with or without 30 days' notice, in which event the employee could be subject to loss of entitlement to transportation expenses back to the United States and loss of the right to all or part of the bonus payable on termination of his services. The interpretation of the provisions of the contract was to be based on the laws of the foreign country. Section 911 of the Code provides, in part, as follows: (a) GENERAL RULE.-The following items shall not be included in gross income and shall be exempt from taxation under this subtitle: (2) PRESENCE IN FOREIGN COUNTRY FOR 17 MONTHS.-In the case of an individual citizen of the United States who during any period of 18 consecutive months is present in a foreign country or countries during at least 510 full days in such period, amounts received from sources without the United States (except amounts paid by the United States or any agency thereof) which constitute earned income attributable to services performed during such 18-month period. The amount excluded under this paragraph for any taxable year shall be computed by applying the special rules contained in subsection (c). * * *. The facts in this case are distinguishable from those in Commissioner v. Eldon E. Wolfe, et ux., U.S. Court of Appeals, District of Columbia Circuit, 361 F. 2d 62 (1966), reversing 43 T.C. 572 (1965), certiorari denied, 385 U.S. 838 (1966). The Wolfe case involved an employee of the U.S. Bureau of Public Roads who was assigned to work on a highway project of the Government of Iran, which had entered into a credit agreement with the Export-Import Bank in Washington under which the proceeds of a loan to Iran were to be used exclusively to finance the road project. The court of appeals held that the amounts he received as salary were "amounts paid by the United States or an agency thereof." This decision was based on the following salient features: The taxpayer was an employee of the United States, maintaining unique status as such and receiving unique benefits as such; the United States had the primary and sole obligation to pay his salary, and his rights were only against the United States; and a U.S. agency actually executed and delivered the salary checks to him. The court further noted that the taxpayer was exempt from all income taxes, duties, fees and customs charges of Iran; that he received a 10percent increment over his base salary as a foreign post differential; and that there were financial burdens on the U.S. Government which were not compensable by Iran. The facts in this case show that the taxpayer was an employee of the foreign government with respect to services performed under the contract. That government exercised complete control over him in the performance of such services, and the U.S. agency exercised no control over the employee. The foreign government had the primary and sole obligation to pay his salary. The project agreement is merely a grant on the part of the U.S. agency to enable the foreign government to hire experts at the rate of compensation which they would receive for similar services performed in this country. The taxpayer was subject to all taxes and fees imposed by the laws of the foreign country. Under these circumstances, the compensation received by the United States citizen for advisory services performed in the foreign country is not an amount paid by the United States or any agency thereof within the meaning of section 911 (a) (2) of the Code. Therefore, such compensation is excludable from the gross income of the taxpayer, to the extent provided by section 911 (c) (1) of the Code, if he otherwise meets the requirements for exemption under section 911 (a) (2) of the Code. (Also 1.911-1.) (Also Section 702; 1.702-1.) Rev. Rul. 67-158 A taxpayer, a United States citizen, is a resident partner in charge of a foreign branch of a United States partnership and the partnership agreement does not provide that he is to receive his share of partnership income from a specific source. Held, only that portion of his distributive share of partnership income which the partnership's earned income from foreign sources bears to its total earned income is earned income "from sources without the United States" for the purpose of exemption from Federal income tax under section 911(a) of the Internal Revenue Code of 1954. Another partnership is engaged, in the United States and abroad, in a business in which both personal services and capital are material income-producing factors. The partnership agreement provides that a partner assigned to a foreign branch is to receive his entire distributive share of partnership income only from the profits of the foreign branch with which he is associated. The principal purpose of such provision is not the avoidance or evasion of any tax imposed by subtitle A of the Code. Held, that partner's entire distributive share of partnership income is considered income from sources without the United States, and a reasonable allowance as compensation for personal services rendered by the taxpayer, not in excess of 30 percent of his distributive share of the net profits, is "earned income" from sources without the United States for purposes of section 911 (b) of the Code. Advice has been requested with respect to the nature of the taxpayers' distributive shares of partnership income received under the circumstances described below." Situation (1). Taxpayer A, a citizen of the United States and general partner in an accounting firm, rendered his personal services during a period of several consecutive years within X, a foreign country, as resident partner in charge of the X office of the partnership. He qualified as a "bona fide resident of a foreign country" within the meaning of section 911(a) of the Internal Revenue Code of 1954 for the entire period. The partnership is a firm of certified public accountants with offices in the major cities of the United States and in a number of foreign countries. The income of the partnership is derived from sources within and without the United States. The partnership agreement provides that the interest of each member of the firm in the firm capital and in its net profits and his obligations to meet its net losses, if any, shall be proportionate to his contribution to the firm capital. The partnership agreement does not provide that any part of taxpayer's distributive share of net partnership income is to be charged to the profits of the foreign office, nor does it provide for guaranteed payments to any partner. In each of the years, taxpayer received his distributive share of the net partnership income in accordance with the terms of the partnership agreement. Situation (2). Taxpayer B is a citizen of the United States and a general partner in a firm engaged in the general brokerage and investment banking business conducted at its principal office in New York and other cities throughout the United States and the world. He is in charge of the partnership branch office in Y, a foreign country, and qualifies as a bona fide resident of Y within the meaning of section 911 (a) of the Code for all the years herein involved. The partnership agreement provides that each general partner shall be paid an annual salary at a rate fixed by the Executive Committee, and that he shall share in the net profits or losses of the partnership (computed after deducting salaries paid to the partners) in accordance with his percentage interest as fixed by the partnership agreement. The agreement provides that the salary of a general partner assigned to a foreign branch of the partnership shall be paid only out of the profits of the branch to which he is assigned. Under the terms of the agreement, such a partner may share only in the profits of the branch with which he is associated, even though his maximum share may be measured by a percentage of the net profits of the partnership derived from all sources. Furthermore, the sum of the salary and the share of partnership net profits paid or allocated to a partner residing in a foreign country for any year may not exceed the profits attributable to his foreign branch for that year. If this limitation should, for any year, reduce the salary paid or net profits allocable to a partner, the resulting deficit shall be paid or allocated to him in a succeeding year, to the extent that the profits of his foreign branch for the succeeding year are sufficient to permit this action. Since the amount of the socalled "salary" payments is determined with reference to partnership income, these payments are distributive share income to the recipient rather than guaranteed payments within the scope of section 707 (c) of the Code. Section 911 (a) (1) of the Code provides that a United States citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year is exempt from United States income tax upon amounts received from sources without the United States (except amounts paid by the United States or any agency thereof) which constitute earned income attributable to services performed during such uninterrupted period. Section 702 (a) of the Code provides that each partner in a partnership "shall take into account separately his distributive share" of a number of specified items including "(8) other items of income, gain, loss, deduction, or credit, to the extent provided by regulations prescribed by the Secretary or his delegate." Section 702 (b) of the Code states that the character of any item of income, gain, loss, deduction, or credit included in a partner's distributive share under paragraphs (1) through (8) of subsection (a) shall be determined as if such item were realized directly from the source from which realized by the partnership. See also section 1.702-1(b) of the Income Tax Regulations. Section 1.702-1 (a) (8) (ii) of the regulations provides, in part, that under section 911 (a) of the Code, if any partner is a bona fide resident. of a foreign country who may exclude from his gross income the part of his distributive share which qualifies as earned income as defined in section 911 (b) of the Code, the earned income of the partnership for all partners must be separately stated. Section 911(b) of the Code defines the term "earned income" to mean wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered. However, if a taxpayer is engaged in a trade or business in which both personal services and capital are material income-producing factors, "earned income" is a reasonable allowance as compensation for services rendered by the taxpayer, limited under section 911 (b) of the Code, to not more than 30 percent of his share of the net profits of the trade or business. The earned income of a partnership is an item of income included in section 702 (a) (8) of the Code. Under section 702(b) of the Code and section 1.702-1 (b) of the regulations, the character of a partner's distributive share of an item of partnership income is to be determined "as if such item were realized directly from the source from which realized by the partnership." Capital is not a material income-producing factor in an accounting partnership, as referred to in Situation (1). Therefore, each partner's distributive share of that portion of partnership income representing compensation for services rendered by the partnership is "earned income." See section 1.911-1 (a) (4) of the regulations. However, under section 702 (b) of the Code and section 1.702-1 (b) of the regulations, regardless of where the individual partner works, his earned partnership income is considered to be from foreign sources only to the extent of his proportionate share of the total earned income of the partnership which is derived from such sources. See Craik v. United States, 31 F. Supp. 132 (1940). Accordingly, taxpayer A's distributive share of the partnership earned income in Situation (1) is earned income "from sources without the United States" for the purpose of section 911 (a) of the Code, only in the ratio that the earned income of the partnership from foreign sources bears to its total earned income. In Situation (2), taxpayer B is a member of an investment and banking partnership in which both personal services and capital are material income-producing factors. Since the partnership agreement provides that taxpayer's distributive share is to be paid and distributed, only to the extent that the profits of the foreign branch are sufficient therefor, his entire distributive share of partnership income is considered income from foreign sources, if the principal purpose of such provision is not the avoidance or evasion of any tax imposed by Subtitle A of the Code. See section 704 (b) (2) of the Code. In the event that the principal purpose of the provision is not such avoidance or evasion, then a reasonable allowance as compensation for personal services rendered by the taxpayer, not in excess of 30 percent of his distributive share of the net profits of the trade or business, is considered earned income from sources without the United States for purposes of section 911 (b) of the Code. Subpart F.-Controlled Foreign Corporations SECTION 956.-INVESTMENT OF EARNINGS IN 26 CFR 1.956-2: Definition of United States property. Rev. Rul. 67-130 Section 956(b) (1) (A) of the Internal Revenue Code of 1954 and section 1.956-2(a) (1) (i) of the Income Tax Regulations define one class of United States property as "tangible property located in the United States." Held, such classification does not include property which is in transit from a foreign point of origin to a foreign destination and which is being transshipped through, or temporarily stored under customs bond in the United States. SUBCHAPTER 0.—GAIN OR LOSS ON DISPOSITION OF PROPERTY PART L-DETERMINATION OF AMOUNT OF AND RECOGNITION Of gain or lOSS SECTION 1001.-DETERMINATION OF AMOUNT OF AND 26 CFR 1.1001-1: Computation of gain or loss. Rev. Rul. 67-66 Gain or loss from the exchange of vessels pursuant to section 510(i) of the Merchant Marine Act of 1936, 46 U.S.C. 1160, as amended by Public Law 86-575, 74 Stat. 312, and Public Law 89-254, 79 Stat. 980, is recognized under section 1002 of the Internal Revenue Code of 1954. |