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covenant not to compete constitutes foreign source income for
purposes of computing petitioner's foreign tax credit limitation
pursuant to section 904(a).
Finally, petitioner incurred $107,491 of expenses in
connection with the sale to Duskin but did not allocate any
portion of the expenses to the sale of the covenant not to
compete. At trial, Mr. Schaefer testified that "It was my
conclusion that we were selling assets, trademarks, good will,
and selling expenses should be allocated to those * * * assets
being sold. The covenant not to compete is--I equate to kind of
a performance contract. We weren't selling anything; therefore,
selling expenses should not be allocated to it." On brief,
respondent argues that to the extent a portion of the sale price
is allocated to the covenant and treated as foreign source
income, a pro rata share of the selling expenses must necessarily
be allocated to the covenant, thus reducing petitioner's foreign
source income. See sec. 862(b).
Section 1.861-8(b)(1), Income Tax Regs., provides that
deductions are allocated to the class of gross income to which
they are definitely related. Section 1.861-8(b)(2), Income Tax
Regs., provides that a deduction is "definitely related" to a
class of gross income "if it is incurred as a result of, or
incident to, an activity or in connection with property from
which such class of gross income is derived." Accordingly, we
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