Gregg D. Lemein and John D. McDonald are Partners in the Chicago office of Baker & McKenzie, LLP. Stewart R. Lipeles is a Partner in the Palo Alto office of Baker & McKenzie. Baker & McKenzie, LLP is a member of Baker & McKenzie International, a Swiss Verein.
A foreign corporation generally will not be subject to U.S. federal income tax unless it is engaged in a U.S. trade or business. When a foreign corporation is engaged in a U.S. trade or business, the U.S. federal income tax is generally limited to the U.S.–source income. This column addresses the interplay of these rules and how they may be managed to reduce the risk of U.S. federal income tax.
A foreign corporation will not be subject to direct U.S. taxation unless it is “engaged in a trade or Business” in the United States. The Code does not define the phrase “trade or business.” The cases suggest that business activity will not constitute a U.S. trade or business unless they are considerable, continuous and regular. Unfortunately, the cases are old, ambiguous and involve fact patterns that generally are not directly applicable to the typical U.S. multinational. Despite the considerable, continuous and regular language, some of the cases find that lower levels of activity satisfy the standard, and the IRS has taken the position in published rulings that entering a racehorse in a single race amounts to a trade or business. Indeed, the IRS’s position, whether or not correct, seems to be that activities beyond mere passive receipt of income, if conducted in the United States, are sufficient to constitute a “trade or business” in the United States. Accordingly, when there are U.S. activities, attempting to avoid the possibility that a U.S. trade or business may exist, by itself, generally is not the most prudent approach.
When a corporation is engaged in a U.S. trade or business, it is subject to U.S. tax, at the regular graduated U.S. tax rates, on its net taxable income that is "effectively connected" with the conduct of the U.S. trade or business. In most cases, the branch profits tax also applies. The branch profits tax is the analog to the dividend withholding tax and in most respects equalizes the treatment of branches and corporations. Foreign corporations that are engaged in a U.S. trade or business are required to file U.S. tax returns on Form 1120-F and information reporting on Form 5472. If such a tax payer fails to file the tax return, the consequences can be disastrous. Among other things, all deductions, other than costs of goods sold, may be disallowed in determining taxable income. In addition, interest will be imposed on the understatement and there is the potential for penalties. As a consequence of these rules, some foreign companies that do not believe that they are engaged in U.S. trade or business nevertheless file "protective" tax returns. Filing a return should at least ensure that the taxpayer is entitled to deductions other than cost of goods sold.
Foreign-source income, however, generally is not effectively connected with a U.S. trade or business, making the source rules a critical backstop to U.S. taxation. "Fixed or determinable income (i.e., income such as dividends, interest, rents and royalties) and capital gains are treated as effectively connected with a U.S. trade or business under a two-prong test that looks to how closely the income is connected with the business as a factual matter. Under the first prong of this test, income that is derived from assets used or held for use in a U.S. trade or business is effectively connected with the business. Under the second prong of this test, income is effectively connected if the activities of the trade or business are a material factor in generating the income.
These rules ignore the largest and most important category of business income: income from the sale of inventory. Code Sec. 864(c)(3) governs income from the sale of inventory, along with all other forms of income (i.e., all income that is not fixed or determinable or capital gains is governed by this section). Under Code Sec. 864(c)(3), all other U.S.-source income is automatically treated as effectively connected. This rule is sometimes referred to as force of attraction.
These rules produce stark results and can be illustrated with the following example. Assume that a weaver in India, Mr. Dilip, sells his rugs to U.S. persons over the internet. Assume further that Mr. Dilip arranges for UPS to deliver the rugs and holds title to the rugs until they reach the U.S. customers in the United States. If all of Mr. Dilip's activities are in India,he would not be engaged in a U.S. trade or business,even though his income from sales to U.S. customers would be U.S. source under the title passage rules. If Mr. Dilip, however, travels to San Francisco to teach a two-day seminar on weaving, earns $3,001 from these personal services and remains in the United States for 91 days, he would automatically be treated as engaged in a U.S. trade or business,  and all of his income from the sale of rugs to U.S. customers would automatically be treated as effectively connected with this business and subject to U.S. federal income tax at graduated rates. This column discusses these critically important, and sometimes convoluted, sourcing rules.
With an arguably low and somewhat ambiguous standard on what constitutes a U.S. trade or business and the force of attraction rule for income from the sale of inventory, the source rules are a critical defense to U.S. taxation in numerous cases. In certain cases, however, income that would otherwise be treated as foreign source is recharacterized as U.S. source and taxed as effectively connected income.
It is also important to note that the U.S. trade or business standard of taxability is only applicable for purposes of U.S. federal income tax. A different standard is applied in the context of whether an individual state will be permitted to impose tax on a foreign corporation. In the state tax framework, the U.S. Constitution limits a state's authority to tax to circumstances in which there is "substantial nexus" with a state. The substantial nexus test has been interpreted to mean that an entity must have an actual "physical presence" in a state to be taxable in such state. Thus, where an entity has even one employee," regardless of the activities of that employee, or an office in a state, sufficient "physical presence" will generally exist to create substantial nexus. Generally, the substantial nexus standard imposes a lower threshold for taxability than the U.S. trade or business standard. As such, it is entirely possible that a foreign corporation that is not subject to U.S. federal income tax will nevertheless be subject to tax in an individual state. Once an entity is taxable in a state, its income will generally be apportioned to such state based on a formula that attempts to measure its property, payroll and sales in the state. Application of these apportionment rules will likely produce a different result than those achieved under the federal sourcing rules. Importantly, categorizing income as foreign source income will have no impact on whether it may be apportioned to a given state.
Sales of Inventory and Title Passage
There is something generally intuitive about most of the source rules. With the exception of U.S. persons that earn over 80 percent of their income from an active foreign business, interest is generally sourced to the residence or country of incorporation of the person paying the interest. Similarly, dividends are generally sourced to the country of incorporation of the company paying the dividend, rents and royalties are generally sourced to the place where the tangible or intangible property is used, and income from personal services is generally sourced to the location where the services are performed.
At least for us, the rules for sourcing income from the sale of inventory tend to be less intuitive. With, respect to inventory that is purchased rather than self manufactured, the code merely provides that gains from the purchase of inventory outside of the United States and its sale in the United States are U.S.source. Similarly, gains from the purchase of inventory within the United States and its sale outsideof the United States are foreign source. This statutory language by itself does not answer the question because it does not indicate how taxpayers are to determine the place of sale. Should you look to the place the sale is negotiated, where the contract is concluded or where the goods are delivered? The courts and the IRS have settled this issue with a simple rule. The place of sale is where title passes. This rule is highly favorable for most taxpayers because taxpayers can determine the place where title passes by contract. If the parties contractually agree that title passes outside of the United States, then it does, even if they negotiated and signed the contract within the United States. This rule has been strictly followed,even when it is disadvantageous to the IRS.
The rules for inventory that the taxpayer produces and sells are more complex and we will not try to address all of their nuances in this article. First, the taxpayer must segregate the sales proceeds into two categories; income from the production activity and income from the sales activity. There are three methods for segregating the income between production and sales. The primary method, which applies by default in the absence of an affirmative election, is the 50/50 method. This method does exactly what it sounds like it will: It apportions 50 percent of the income to the production activity and 50 percent of the income to the sales activity. Returning to our example of Mr. Dilip, assume he produces the rugs in India, his cost of goods sold on a rug is $40 and he sells the rug in the United States for $100. The gross income of $60 ($100 - $40) would be apportioned $30 to the production outside of the United States and $30 to the sale within the United States. Alternatively, the taxpayer can sometimes elect to divide income between production and sales activities under the independent factory price method. This method can only be used if the taxpayer regularly sells part of its output directly to independent distributors in a way that fairly reflects the income from the production activity. Finally, if the taxpayer obtains permission from the IRS, it can allocate income between production and sales activities based on its own books and records. Among other things, to use this method the taxpayer must establish that the tax considerations do not impact the books and records.
Once the taxpayer has divided the income between production and sales, it must source each piece. The production income is sourced to the place where the production assets are located. If the taxpayer's production assets are in different locations, which may happen with products that are manufactured in stages, the production income is allocated between locations based on the average adjusted basis of the assets in the various locations. The sales income is sourced to the place of sale.  Accordingly,the title passage rule controls.
Application of General Rules to the Typical Multinational
The typical multinational with subsidiaries in each of its operating jurisdictions will not have an issue under these rules. Take the case of a non-U.S. multinational with a U.S. sales subsidiary. The separate subsidiary should be respected pursuant to Moline Properties, Inc. As long as the group's U.S.activities are limited to the activities of its subsidiary, it should not be engaged in a U.S. trade or business. Even if it is, provided that title to the goods passes outside of the United States (and subject to the U.S.office rules discussed below that could resource the income), the income would generally be foreign source and thus it still would not be subject to U.S. federal income tax. Similarly, a U.S. multinational with foreign subsidiaries generally need not be concerned that its control or supervision of the subsidiaries would cause the subsidiaries to be engaged in a U.S. trade or business.
The risk arises when the U.S. activities, especially the sales activities, of the foreign company are conducted by or through a U.S. affiliate or other U.S. operations. Consider for instance the case of a foreign company that is just developing internationally and does not have sales persons on the ground in the United States. Instead, its executives regularly travel to the United States to negotiate and conclude contracts with U.S. customers. Given the arguably low and ambiguous standard for a U.S. trade or business, the foreign corporation could well be engaged in a U.S. trade or business. In this regard, we note that dependent agents with contract concluding authority may give rise to a permanent establishment under the OECD model treaty and most U.S. treaties.
Consider further the case of a U.S. multinational that sells its products to foreign customers through a base company. Assume that the base company buys product from related and unrelated manufacturers and resells the product. More importantly, assume that the base company has no sales or marketing employees whatsoever and that all of the sales and marketing activities are performed by employees of the U.S. parent that negotiate and conclude the contracts in the United States on behalf of the base company. Again, there may be a risk that the base company is engaged in a U.S. trade or business due to the activities conducted in the United States.
In either of the cases set forth above where there may be possible exposure to U.S. federal income tax, the taxpayer may seek protection from U.S. federal income tax under one of the bilateral income tax treaties that the United States has executed. The possible treaty defenses to U.S. federal income tax are beyond the scope of this column. Alternatively, the taxpayer may seek protection from U.S. taxation under the sourcing provisions of domestic law. As discussed above, as long as title to the goods passes outside of the United States, there would be no exposure under the general rules. Unfortunately, as discussed below, income that would otherwise be treated as foreign source may be recharacterized as U.S. source if there is a U.S. office or other fixed place of business that materially contributes to the sale.
Impact of a U.S. Office
If a foreign person has a U.S. office or other fixed place of business within the United States ("U.S. Office"), and the foreign source income is attributable to the U.S. Office, the income will generally be recharacterized as U.S. source and treated as effectively connected with the U.S. trade or business. Under the Code, for purposes of determining whether there is a U.S. office, the activities of independent agents are ignored. Agents that are not independent will still be ignored unless the agent (1) has authority to conclude contracts in the name of the foreign person and regularly exercises this authority, or (2) has a stock of merchandise from which the agent regularly fills orders. For purposes of this rule, an agent will be considered to regularly exercise such authority only if the authority is exercised "with some frequency over a continuous period of time." "Regularity" is not evidenced by "occasional or incidental activity." Furthermore, regularity would not be found where the agent's authority to negotiate and conclude contracts is limited only to "unusual cases." 
We are focusing on agents here, because if there is a risk, it is usually due to agents. In particular, the risk is that a U.S. affiliate is treated as an agent with contract concluding authority and gives rise to a U.S. Office. If employees of a U.S. affiliate that are located in the U.S. negotiate and conclude the sales contracts, such a risk may well exist.
Based on the literal language of Code Sec. 864(c)(5)(A), however, a foreign person that may be engaged in a U.S. trade or business through its U.S. agents should not be considered to have a "U.S. office" as a result of the negotiations and contract concluding activities of such agents, provided the agents do not have a stock of goods and do not regularly exercise authority to negotiate and conclude contracts in the name of the foreign person.
The regulations do not provide any threshold levels for "frequency" and "continuity." If the-number of transactions that include direct involvement by the personnel of the U.S. affiliate is relatively small, this may suggest that these sales are not frequent or continuous. However, more important to the "frequent and continuous" analysis is the pattern in which the contract negotiations and contract concluding authority is exercised. For instance, a sale once a week or once a month in which the U.S. affiliate exercises contract negotiating or concluding authority is more likely to be a problem. Conversely, any direct involvement by a U.S. affiliate in the negotiating and contract concluding process in exceptional situations should not be considered the exercise of contract concluding authority by the U.S. Office on a regular basis. This rule should provide some additional leeway for U.S. multinationals to become involved in contract negotiations by their foreign subsidiaries in unusual cases that may arise from time to time.
Aside from the sales activities discussed above (e.g., negotiating and concluding sales contracts), the other activities that a U.S. affiliate may perform for foreign affiliates generally should not give rise to a U.S. Office. Reg. §1.864-7(c) provides that policy-level management activities (including the holding of the board of directors meetings of foreign affiliates in the United States) and the exercise of general supervision and control over the policies of subsidiaries should not cause the subsidiaries to be considered to have a U.S. Office if the management of day-to-day operations of the subsidiaries' trade or business is conducted from outside the United States. Thus, the fact that the U.S. parent sets policy guidelines for customer deals should not be an issue. Similarly, the U.S. parent should be able to exercise general supervision and control over the policies of its subsidiaries without any exposure. The fact that foreign subsidiaries of a U.S. parent hold board of directors meetings in the United States also should not cause the subsidiaries to have a U.S. Office if the day-to-day operations are conducted primarily by the subsidiary outside of the United States. Providing general administrative and treasury services, along with general guidance to the field for unusual deals does not involve contracting activities at all, and as such are not relevant to the question of whether a foreign corporation has a U.S. Office. To the extent that treasury functions involve some contracting activities, those activities would be analyzed in the same manner as other contracting activities discussed below.
"Attributable" to U.S. Office
If a foreign company has a U.S. Office, subject to the "foreign material participation" exception discussed below, Code Sec. 864(c)(5)(B) provides that income shall not be considered "attributable" to the U.S. Office unless the following two requirements both are satisfied:
The U.S. Office is a "material factor" in the production of such income The U.S. Office regularly carries on activities of the type from which such income is derived.
Reg. §1.864-6(b)(1) provides that the activities of the U.S. Office shall not be considered to be a "material factor" in the realization of the income "unless they provide a significant contribution to, by being an essential economic element in, the realization of the income."
Reg. §1.864-6(b)(2)(iii), which applies specifically to income from sales of goods, provides that a U.S. Office shall be considered to be a "material factor" in the realization of income from sales of goods if it "actively participates in soliciting the order, negotiating the contract of sale, or performing other significant services necessary for the consummation of the sale which are not the subject of a separate agreement between the seller and the buyer."  This language indicates that the key activities are those relating directly to the arranging and closing of sales to customer. The legislative history sheds further light on the underlying intent by using the language "actively participates in soliciting, negotiating or performing other activities required to arrange for such a sale.” Based upon this language, participating in negotiations in unusual cases and directly contacting existing customers, at sites within the United States, in furtherance of marketing, engineering, consulting and business development efforts would seem to constitute "material factors" in the realization of income from sales of goods.
Conversely, the regulations specifically provide that making the sale subject to final approval by a U.S. Office does not mean that the U.S. Office materially participated in the sale. Similarly, holding the property in the United States and distributing it from a U.S. Office does not cause the U.S. Office to be a material factor in the realization of the income.
Displaying goods in the United States and performing clerical work are also blessed as activities that do not taint the income. Importantly, for businesses that lease or license property, developing, creating and adding substantial value to property in the United States are all activities that do not cause the U.S. Office to be a material factor in the income. Accordingly, entertainment, gaming, software and other companies that may from time to time lease or license intellectual property can do so within the United States without any fear that these rules subsequently cause unexpected issues.
Foreign Material Participation
Even if a foreign corporation is treated as having a U.S. Office, and the sales income of the foreign affiliates is treated as "attributable" to this U.S. Office, it should be possible for the foreign corporation that sells the inventory outside of the United States to avoid U.S. federal income tax if the foreign corporation materially participates in the sale. Code Sec. 865(e)(2)(B) provides that if inventory is sold for use, disposition or consumption outside the United States and an office or other fixed place of business outside of the United States materially participates in the sale, then the activities of any U.S. office will be disregarded.
"Foreign material participation" is defined under Reg. §1.864-6(b)(3)(i) as active participation in soliciting orders, negotiating contracts of sale, or performing other significant services necessary for the consummation of the sale that are not the subject of a separate agreement between the seller and the buyer. The activities identified above are not cumulative. Accordingly, the performance of one of the activities should suffice to achieve foreign office material participation. This standard is generally the same as the standard for determining whether a U.S. Office materially participates in the sale. Accordingly, making the sale subject to final approval by a foreign office does not mean that the foreign office materially participated in the sale. Similarly, holding the property outside of the United States and distributing it from a foreign office does not cause the foreign office tobe a material factor in the realization of the income: Merely displaying goods in a foreign office also does not help.
As discussed above, a dependent agent in the U.S. that has, and regularly exercises, contract concluding authority, may give rise to a U.S. Office. Similarly, a foreign person selling inventory outside of the United States may materially participate in the sale through dependent agents outside of the United States that have, and regularly exercise, contract concluding authority on behalf of a foreign person. Accordingly, a sales representative with contract concluding authority may satisfy the foreign material participation standard on behalf of a foreign corporation, even if the sales representative with contract concluding authority or a commissionaire is respected as a separate corporation for U.S. federal income tax purposes. Similarly, one could argue that a commissionaire, which concludes contracts in its own name but on behalf of the principal may possibly satisfy the standard. In this regard, we note that the regulation refers to an agent that concludes contracts in the name of the principal. Strictly speaking, since a commissionaire generally acts on an undisclosed basis, generally it does not execute contracts in the name of the principal. One would have to argue that executing contracts on behalf of the principal is nevertheless sufficient.
In any event, relying on agents to satisfy the foreign material participation standard has dangers of its own. After all, independence is in the eye of the beholder. The regulations specifically recognize that related parties can be independent for this purpose. They further suggest that in cases where an agent acts exclusively on behalf of a particular seller, this fact suggests that the agent is not independent. Accordingly, while the taxpayer might argue that the agent is dependent, the IRS would be free to take a contrary view more importantly, for non-U.S. tax purposes, it generally is not advisable to admit that a foreign entity is a dependent agent with contract concluding authority. As noted above, most treaties include a clause that provides that a dependent agent with contract concluding authority gives rise to a permanent establishment. The very facts used to argue that the foreign company satisfies the foreign material participation standard for U.S. tax purposes could be used against the taxpayer to establish that the taxpayer has a permanent establishment for foreign tax purposes.
Discussing this standard in general terms is helpful, but now you may be asking yourself, as a practical matter, what is sufficient to have foreign material participation. Consider the following fact pattern. Initially there is a sales person that identifies the customer, solicits the sale and provides promotional marketing materials. This sales person has no authority to negotiate the terms of the sale or to accept orders. When the customer has questions about how the product operates, the sales-person involves a technical engineer that knows how the product operates and how the customer can most efficiently install, operate and maintain the product. The technical engineer answers questions and helps the customer determine exactly which products out of a product line are most suitable for the customer's needs. When the customer expresses interest; the salesperson refers the customer to a sales manager that negotiates the contract and reaches a tentative agreement. Assume further than a general manager finally meets with the customer and concludes the transaction. All of these individuals should be treated as materially participating in the sale. If the foreign company that sells the product employs even one of them, and title to the goods passes outside of the United States, then the income will be foreign source and thus not subject to U.S. federal income tax, even if all of the other relevant activities take place in the United States. In short, it does not matter how many people interact with the customer; any one of them can constitute material participation as long as his or her activity is important to the sale. If there are 10 such individuals, and the foreign company selling the product employs one of these persons, that should be sufficient. Moreover, assuming the expense is material, the very fact that the multinational incurs the expense suggests that the activity is material to the sale.
Review of Sourcing Rule for Inventory and Planning Ideas
In general, the sales income is sourced to the place where title passes. The parties have the power to specify this location via contract. For goods that the taxpayer produces and sells, generally 50 percent of the income is sourced to the place of manufacture and 50 percent of the income is sourced to the place of sale. Foreign-source income will be recharacterized as U.S. source if (1) the taxpayer has a U.S. office or other fixed place of business, and (2) the U.S. office or other fixed place of business materially contributes to the income. With respect to safes of inventory outside of the United States, however, the activities of a U.S. office will be disregarded if the seller has a foreign office that also materially contributes to the sale.
As discussed above, these rules generally will not result in U.S. taxation for the typical non-U.S. multi-national that has some U.S. operations. When there is a risk, the multinational should consider filing a protective return to mitigate some of the more draconian results that may arise if the IRS concludes that a foreign company is engaged in a U.S. trade or business.
In addition, if there is a risk, most treaties will only allow the U.S. to impose tax on the income if there is a permanent establishment. Subject to the relevant limitation of benefits clause, obtaining treaty relief may be as simple as forming the seller in a treaty jurisdiction or making the company resident in a treaty jurisdiction for foreign tax purposes. In many countries, a company can become a resident, even if it has few operations in the country, if it is managed and controlled in the country. While management and control is a somewhat fuzzy standard, depending on the activities of the company it may be as simple as holding board meetings in the country and signing the principal agreements in the country. In cases that are close to the fine, it may be possible to obtain a local ruling confirming that the company is a resident. Indeed, if the matter is important, we would assume that most taxpayers would pursue a ruling if one is available.
In the event that treaty relief applies, most treaties limit the potential U.S. tax to the amounts properly attributable to the permanent establishment. While the typical treaty does not define the amount attributable to the permanent establishment, it is generally recognized that this amount should be determined under arm's-length principles similar to those found in Code Sec. 482. The critical imponderable in the treaty analysis is how to allocate the intangibles. Given that the OECD is currently reviewing how to allocate intangible income in this context, taxpayers may wish to obtain further comfort.
At least for sales of inventory to foreign customers, the foreign material participation defense is an effective option. Any employee that is materially involved in the sales process has the potential to be considered as materially participating in the sale. Moreover, through the magic of the check-the-box rules, the selling company need not directly employ the person or persons relied upon for foreign material participation. Instead, the persons providing the material participation could be employees of another foreign entity that is a disregardedbranch of the seller for U.S. federal income tax purposes. Under the check-the-box rules, if the foreign entity is disregarded for U.S. federal income tax purposes, then the company that owns the disregarded entity will be treated as the employer for U.S. tax purposes.
The authors gratefully acknowledge the comments on state tax issues provided by Kim Reeder (Baker & McKenzie, Palo Alto office).
 R.E. Amos Pinchot, CA-2,40-2 ustc ¶ 9592, 113 F2d 718; J.C. Lewenhaupt, 20TC 151, Dec. 19,606 (1953), aff'd, CA-9, 55-1 USTC ¶9339, 221 F2d 227; De Amodio, 34 TC 894, Dec. 24,315 (1 960), aff'd, CA-3, 62-1 ustc ¶9283, 299 F2d 623.
 Rev. Rul. 58-63, 1958-1 CB 624, amplified by Rev. Rul. 60-249, 1960-2 CB 264.
 GCM 18835, 1937-1 CB 141.
 Code Sec. 882 (a)(1). This column does not address the fixed or determinable annual or periodic income ("FDAF"') rules under Code Sec. 881. Under the FDAP rules, certain categories of U.S. source income (including interest and royalties) of a foreign corporation are subject to U.S. withholding tax even in the absence of a trade or business in the United States.
 Code Sec. 884. For countries that had executed a bilateral income tax treaty with the United States prior to the imposition of the branch profits tax, the regulations provide that the tax shall not apply until a new treaty allowing for the tax is in place. See Reg. §1.884-1 (g)(3).
 Code Sec. 6012; Reg. §1.601 2-2(g)(l).
 Code Sec. 6038C(a)(2). The taxpayer must also maintain certain records. See Code Secs. 6038C(b)(1) and 6038A(b)
 See, e.g., InverWorld, 71 TCM 3231, Dec. 51,428(M), TC Memo. 1996-301 (1966); compare Swallows Holding, Ltd., 126 TC -, No. 6, Dec. 56,417 (Jan. 26, 2006) (taxpayer not precluded from deducting expenses where it filed returns after the due dates for those returns but before the IRS contacted it regarding an audit; the timely filing requirement in the regulations under Code Sec. 882(c)(2) is invalid because it is inconsistent with a plain reading of Code Sec. 882(c)(2)).
 See, e.g., Code Sec. 6651 (failure to file penalty of five percent of the net amount of tax required to shown on the tax return for each month that the return is late, up to a maximum of 25 percent). This penalty does not apply if the failure to file is due to reasonable cause and not willful neglect.
 The only downside of filing such a "protective" tax return is the "red flag" effect it may have. In our experience, the filing of a protective return has not had this effect.
 See code Sec. 864(c)(2) and (3) (only treating U.S.-source income as effectively connected and therefore subject to U.S. tax at graduated rates); see also Code Sec. 864(c)(4)(A) (providing that foreign source income will not be treated as effectively connected), but compare Code Sec. 864(c)(4)(B) (discussed below, which may recharacterize certain foreign source income as U.S. source).
 Code Sec. 864(c)(2)(A).
 Code Sec. 864(c)(2)(B).
 Code Sec. 864(b).
 The "substantial nexus" limitation is imposed by the Commerce Clause of the U.S. Constitution. See Complete Auto Transit v. Brady, SCt, 430 US 274,97 SCt 1076 (1977). Protections are also available under the Due Process Clause; however, the threshold for establishing nexus under the Due Process Clause is very low. For Due Process Clause purposes, the requirement may be satisfied with a minimal showing of "some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax." Miller Bros. Co. v. Maryland, SCt, 347 US 340,344-45,74 SCt 535 (1954). That is, the relevant question is whether "the state has given anything for which it can ask return." Wisconsin v. J.C. Penney Co., SCt, 311 US 435,61 SCt 246 (1940).
 See Quill Corp. v. North Dakota, SCt, 504 US 298, 112 SCt 1904 (1992).
 Standard Pressed Steel Co. v. Dept. of Revenue, SCt, 41 9 US 560,95 SCt 706 (1975).
 National Geographic Society v. California Board of Equalization, SCt, 430 US 551,97 SCt 1386 (1977).
 It should be noted that Quill, the key U.S. Supreme Court case that defines substantial nexus, was decided in the context of a seller's obligation to collect state salesluse tax. However, it is only logical that this standard-or a higher standard-be used in determining whether a corporation has nexus for purposes of the imposition of a direct income or franchise tax. That is because the imposition of tax is more burdensome on an entity than the burden to collect a use tax owed by someone else because while both present similar administrative complexities, actually paying a tax also has a direct and material economic cost.
 Note that there has been a trend in recent years toward giving greater weight in the apportionment formula to sales made in a state. In fact, certain states base their entire apportionment formula on the extent of sales made into the state.
 Identifying the specific state sourcing rules that would apply to a foreign corporation and would require an analysis of the rules of each state in which the corporation would be doing business. Such an analysis is beyond the scope of this column.
 Code Sec. 861 (a)(1) (general rule for U.S. source interest); Code Sec. 861 (c) (for taxpayers with over 80 percent of gross income from an active foreign business); Code Sec. 862 (a)(1) (foreign-source interest).
 Code Sec. 861 (a)(2) (U.S.-source dividends); Code Sec. 862 (a)(2) (foreign-source dividends). There are exceptions to the general rule covering, for instance, Code Sec. 936 companies and foreign companies with a significant amount of income that is effectively connected with a U.S. trade or business. As with the general rule, these exceptions tend to be intuitive.
 Code Sec. 861 (a)(4). (U.S.-source rents and royalties); Code Sec. 862 (a)(4) (foreign source rents and royalties).
 Code Sec. 861 (a)(3) (U.S.-source personal services); Code Sec. 862 (a)(3) (foreign source personal services).
 Code Sec. 861 (a)(6).
 Code Sec. 862 (a)(6).
 I . Balanovski, CA-2, 56-2 ustc ¶ 9832, 236 F2d 298; American Food Products, 28 TC 14, Dec. 22,326 (1957); Reg. §1.861 -7(c).
 See, e.g., Pfaudler Inter-American, CA-2, 64-1 ustc ¶9405, 330 F2d 471; Liggett Group, 58TCM 11 67, Dec. 46,32O(M), TC Memo. 1990-18.
 Reg. §1.863-3(c)(1).
 Reg. §1.863-3(c).
 Reg. §1.863-3(b)(1)(ii).
 Reg. §1.863-3(b)(2).
 Reg. §1.863-3(b)(3).
 Reg. §1.863-3(c)(1 )(ii)(A).
 Reg. §1.863-3(c)(2).
 Moline Properties, Inc., SCt, 43-1 USTC ¶9464,319 US 436,63 SCt 11 32. See also T.M. Britt (CA-5, 70-1 USTC ¶9400,431 F2d 227. 1970) (business activities, including execution of notes and mortgages, sufficient to treat corporation as a separate taxable entity); Indiana Pub. Sent. Corp., CA-7,97-1 USTC ¶50,474,115 F3d 506 (foreign finance subsidiary not disregarded, and financing transactions were not conduit loans); J. Ogiony, (CA-2, 80-1 ustc ¶9265, 61 7 F2d 1 4, cert. denied, 449 US 900 (1980) (corporate entities not dummies even though they only entered into financing transactions); P. Taylor, CA-1, 71 -2 ustc ¶9521, 445 F2d 455) (borrowing, opening bank accounts, etc., sufficient to avoid sham status); P.R. Bass, 50 TC 595, Dec. 29,055 (1968) (CFC held viable entity, even though organized to reduce taxes under U.S.-Swiss income tax treaty); Rev. Rul. 77-240, 1977-2 CB 369; Rev. Rul. 73-39, 1973-1 CB 467.
 See article 5.5 of the OECD model treaty ("where a person--other than an agent of independent status to whom paragraph 6 applies-is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment ..." ).
 Code Sec. 864 (c)(4)(8).
 Code Sec. 864 (c)(5)(A); Reg. §1.864- 7(d)(1)(i).
 Reg. §1.864-7(d)(3)(ii).
 See Reg. §1 364-7(c) (management activity). See also Reg. §1.864-7(g), Example (1): “S, a foreign corporation, is engaged in the business of buying and selling tangible personal property. S is a wholly owned subsidiary of P, a domestic corporation engaged in the business of buying and selling similar property, which has an office in the United States. Officers of P are generally responsible for the policies followed by S and are directors of S, but S has an independent group of officers, none of whom are regularly employed in the United States. In addition to this group of officers, S has a chief executive officer, D, who is also an officer of P but who is permanently stationed outside the United States. The day to- day conduct of S's business is handled by D and the other officers of such corporation, but they regularly confer with the officers of P and on occasion temporarily visit P's offices in the United States, at which time they continue to conduct the business of S. S does not have an office or other fixed place of business in the United States for purposes of this section."
 By way of illustration, this regulation provides that "meetings in the United States of the board of directors of a foreign corporation do not themselves constitute a material factor in the realization of income." It would appear that even though the board of directors meetings are important to the overall business they are not directly related to the realization of the income.
 Note that this regulation also provides that a U.S. Office will be considered a "material factor" in the realization of income "from a sale made as a result of a sales order received in such office . . . except where the sales order is received unsolicited and that office ... is not held out to potential customers as the place to which such sales orders should be sent." See Reg. §1.864-6(b)(2)(iii).
 Foreign Investors Tax Act of 1966 (P.L. 89-809) (reprinted at 1966-2 CB 967, 1013).
 Reg. §1.864-6(b)(2)(iii).
 Reg. §1 ,864-6(b)(2)(i).
 Reg. §1.864-6(b)(3)(i).
 Reg. §1.864-7(a)(l )(i); Reg. §1.864-7(d)(1).
 Reg. §1.864-7(d)(l)(i).
 Reg. §1 364-7(d)(3).
 See Reg. §301.7701-2 et seq.