Historically, foreign manufacturers selling goods in the U.S., through either a domestic distributor or by transfer of title at a U.S. port, were to treat the transfer of goods as U.S. sourced income, which is more likely to be taxable by the IRS. This meant, to not have any income sourced in the U.S., foreign manufacturers needed to ensure any transfer title of goods occurred outside of the country. Recently, however, the tax code was amended so that foreign manufacturers selling their goods in the U.S. are now to treat all income as foreign sourced income, which means it is less likely to be taxed in the U.S. In short, if a foreign manufacturer sells its goods as Free on Board at a port of the U.S., the manufacturer can transfer title of the goods on U.S. soil without the income being considered U.S. sourced. This will benefit foreign manufacturers making it easier to sell goods in the U.S. and still avoid U.S. tax.
Nevertheless, sourcing the income as foreign does not guarantee it will not be taxed in the U.S. Furthermore, if no return is filed and the IRS determines there was U.S. tax, the foreign manufacturer will be taxed on GROSS income without regard to any deductions. Therefore, foreign manufacturers may choose to file a protective return. Filing a protective return provides the taxpayer, in this case a foreign manufacturer, with the ability to retain the right to file a proper return (including any applicable deductions or credits) should the IRS determine the U.S. sales are taxable. While this does alert the IRS that a foreign entity is operating within the U.S., if there is any doubt regarding the taxability it is likely worth the protection.
Overall, sourcing is just the first step in the comprehensive analysis needed to assess U.S. taxability. To determine if a foreign business is required to file a return and pay taxes, a full analysis is required to look at business activities, tax laws, and any relevant tax treaty.
