26 CFR 1.861-18 - Classification of, and source of gross income from, digital content transactions.

Regulations last checked for updates: May 01, 2025

Title 26 - Internal Revenue last revised: Feb 28, 2025

View all text of Part 1 [§ 1.851-1 - § 1.907(f)-1]

§ 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 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 § 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) Transfers involving copyright rights and copyrighted articles—(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) Copyright rights. The copyright rights referred to in paragraph (c)(1) of this section are as follows—

(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) Further classification of transfers involving copyright rights and copyrighted articles—(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 § 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 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) Rules of operation—(1) Term applied to transaction by parties. Neither the form adopted by the parties to a transaction, nor the classification of the transaction under copyright law, shall be determinative. Therefore, for example, if there is a transfer of a computer program on a single disk for a one-time payment with restrictions on transfer and reverse engineering, which the parties characterize as a license (including, but not limited to, agreements commonly referred to as shrink-wrap licenses), application of the rules of paragraphs (c) and (f) of this section may nevertheless result in the transaction being classified as the sale of a copyrighted article.

(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) To the public—(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. * * *

(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. 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.

(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.

(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 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.

(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 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.

(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 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 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.

(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 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 § 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.

(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 (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 § 1.861-19. See § 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.

(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 § 1.861-19. See § 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) 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 § 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 § 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 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 § 1.861-19 to the early application years;

(ii) This section and § 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 § 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.

[T.D. 8785, 63 FR 52977, Oct. 2, 1998; 63 FR 64868, Nov. 24, 1998, as amended by T.D. 9870, 84 FR 33692, July 15, 2019; T.D. 10022, 90 FR 2988, Jan. 14, 2025]

authority: 26 U.S.C. 7805,unless

source: T.D. 6500, 25 FR 11910, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, unless otherwise noted.

cite as: 26 CFR 1.861-18