International Tax Alert – December 2016

Posted on: December 22nd, 2016 by BDO USA Tax Publications Feed

Final Regulations for Certain Transfers of Property to Foreign Corporations


Summary

The Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “Service”) have issued Final Regulations relating to certain transfers of property by U.S. persons to foreign corporations.  The Final Regulations affect U.S. persons that transfer certain property, including foreign goodwill and going concern value, to foreign corporations in non-recognition transactions described in Internal Revenue Code (“IRC”) Section 367.  


Background

IRC Section 367(a) requires, in certain situations, U.S. persons to recognize gain on certain transfers of property to foreign corporations in certain non-recognition exchanges.  IRC Section 367(a)(3) provides an exception to the general recognition rule of IRC Section 367(a) for certain types of property that is used by the foreign transferee corporation in the active conduct of a foreign trade or business (“ATB exception”).  If a U.S. person makes a Section 351 or 361 transfer of intangible property described in Section 936(h)(3)(B) (“Section 936 intangibles”) to a foreign corporation, the application of Section 367(d) will need to be considered.  Section 367(d)(1) generally provides that, except as provided in regulations, if a U.S. person transfers any intangible property, within the meaning of Section 936(h)(3)(B), to a foreign corporation in an exchange described in Section 351 or 361, Section 367(d) (and not Section 367(a)) applies to such transfer.  Section 367(d)(2)(A) provides further that a U.S. transferor that transfers intangible property subject to Section 367(d) is treated as having sold the property in exchange for payments that are contingent on the productivity, use, or disposition of the property.  Specifically, the U.S. transferor is treated as receiving amounts that reasonably reflect the amounts that would have been received annually in the form of such payments over the useful life of such property, or in the case of a disposition following such transfer (direct or indirect), at the time of the disposition[1]
 
On May 16, 1986, Temporary Regulations under IRC Sections 367 and 6038B were published. On September 16, 2015, Proposed Regulations under these sections were published. The Proposed Regulations generally provided five substantive changes from the 1986 Temporary Regulations:
 
  1. Eliminating the favorable treatment for foreign goodwill and going concern value by narrowing the scope of the active trade or business exception under IRC Section 367(a)(3) (“ATB exception”) and eliminating the exception under Temporary Regulation Section 1.367(d)-1T(b) that provided that foreign goodwill and going concern value was not subject to IRC Section 367(d);
  2. Allowing taxpayers to apply IRC Section 367(d) to certain property that otherwise would be subject to IRC Section 367(a);
  3. Removing the twenty-year limitation on useful life for purposes of Section 367(d) under Temporary Regulation Section 1.367(d)-1T(c)(3);
  4. Removing the exception under Temporary Regulation Section 1.367(d)-5T(d)(2) that permitted certain property denominated in foreign currency to qualify for the ATB exception; and
  5. Changing the valuation rules under Temporary Regulation Section 1.367(d)-1T to better coordinate the regulations under IRC Sections 367 and 482 (including Temporary Regulations under IRC Section 482 issued with the Proposed Regulations (see Temporary Regulation Section 1.482-1T(f)(2)(i)).
 
Specifically, with regard to the ATB exception, the Proposed Regulations revised the categories of property that are eligible for the ATB exception so that foreign goodwill and going concern value cannot qualify for the exception. Under the 1986 Temporary Regulations, all property was eligible for the ATB exception, subject only to five narrowly tailored exceptions. In addition to limiting the scope of the ATB exception, the Proposed Regulations also implemented changes to the ATB exception that were intended to consolidate various provisions and update the 1986 Temporary Regulations in response to subsequent changes to the Code.
 
The Final Regulations generally finalize the Proposed Regulations, as well as portions of the 1986 Temporary Regulations, as amended by T.D. 9803.  The preamble to the Final Regulations states that, although minor wording changes have been made to certain aspects of those portions of the 1986 Temporary Regulations, the Final Regulations are not intended to be interpreted as making substantive changes to those regulations.  The Treasury Decision also withdraws certain Temporary Regulations.
 

Final Regulations

The preamble to the Final Regulations discusses various comments received in response to the Proposed Regulations along with Treasury’s and the Service’s responses to such comments. Certain key items from the preamble are discussed below.
 
  1. Foreign Goodwill and Going Concern Value
Several comments to the Proposed Regulations asserted that eliminating the favorable treatment of foreign goodwill and going concern value would be an invalid exercise of regulatory authority under IRC Section 367.

In particular, one comment asserted that the ATB exception must apply to transfers of foreign goodwill and going concern value, because (i) foreign goodwill and going concern value is not a Section 936 intangible, and so is subject to Section 367(a) rather than Section 367(d), and (ii) the legislative history indicates that Congress expected that the transfer of such value should be tax-free. The comment further asserted that, because goodwill and going concern value is inextricably linked to the conduct of an active trade or business, the ATB exception necessarily encompasses such transfers.  Other comments asserted that finalizing the Proposed Regulations would represent an unreasonable exercise of regulatory authority because the Proposed Regulations eliminated the favorable treatment of all transfers of purported foreign goodwill and going concern value, rather than just those transfers that Treasury and the Service determine are abusive.
 
In addition, several comments asserted that the Proposed Regulations were inconsistent with Congressional intent and cited statements from the legislative history to Section 367, such as the following:
 
The committee does not anticipate that the transfer of goodwill or going concern value developed by a foreign branch to a newly organized foreign corporation will result in abuse of the U.S. tax system. . . . The committee contemplates that the transfer of goodwill or going concern value developed by a foreign branch will be treated under [the exception for transfers of property for use in the active conduct of a foreign trade or business] rather than a separate rule applicable to intangibles.[2]

In response to these comments, the preamble notes that IRC Section 367 generally provides for income recognition on transfers of property to a foreign corporation in certain transactions that otherwise would qualify for non-recognition.  While IRC Section 367(a)(3)(A) includes a broad exception to this general rule for property used in the active conduct of a trade or business outside of the United States, grants of rulemaking authority in IRC Sections 367(a)(3)(A) and (B) authorize the Secretary to exercise administrative discretion in determining the property to which non-recognition treatment applies under the ATB exception.  In addition, the preamble notes that IRC Section 367(d) reflects a clear policy that income generally should be recognized with respect to transfers of Section 936 intangibles.  The 1984 legislative history to IRC Section 367 explains that Congress intended for the Secretary to use his “regulatory authority to provide for recognition in cases of transfers involving the potential of tax avoidance.”[3]  The preamble further provides that Treasury and the Service have determined that the Proposed Regulations and the Final Regulations are consistent with that intention and the authority granted to the Secretary under IRC Section 367, based on the fact that the statute does not refer to foreign goodwill and going concern value and the determination that, as described in the preamble to the Proposed Regulations, the favorable treatment of foreign goodwill and going concern value contravenes the policy that income generally should be recognized with respect to transfers of Section 936 intangibles.

The preamble also discusses subsequent changes to the regulatory, statutory and market context in which the 1984 legislative history was drafted (e.g., the fact that before 1993, goodwill and going concern value was not amortizable, the increase in relative importance of intangibles in the economy and in the profitability of business, the enactment of the “check-the-box” regulations and Subpart F “look-thru” rule in IRC Section 9654(c)(6), issuance of temporary regulations related to cost sharing arrangements, etc.), in order to reconcile the statements in the 1984 legislative history expressing the expectation that an exception for foreign goodwill and going concern value would not result in abuse with the Service’s contrary experience administering the statute during the intervening years.

Several comments to the Proposed Regulations requested certain exceptions be included for outbound transfers of foreign goodwill and going concern but the Final Regulations do not adopt any such exceptions.
In addition, several comments requested that Treasury and the Service address whether goodwill and going concern value should be characterized as a Section 936 intangible, and thus subject to Section 367(d), or instead as property subject to Section 367(a). Comments also requested that the regulations provide certainty to taxpayers that have taken the position that goodwill and going concern value is not described in Section 936(h)(3)(B) by providing that such taxpayers will be permitted to treat goodwill and going concern value as property subject to Section 367(a) rather than Section 367(d).

In response to these comments, the preamble notes that Treasury and the Service believe that it is appropriate to retain the approach provided in the Proposed Regulations, which allows taxpayers to apply Section 367(d) to certain property that otherwise would be taxed under Section 367(a) but which continues to require taxpayers to apply Section 367(d) to all property described in Section 936(h)(3)(B). Because the identification of items that are neither explicitly listed in Section 936(h)(3)(B)(i) through (v) nor explicitly listed as potentially qualifying for the ATB exception generally will require a case-by-case functional and factual analysis, the Final Regulations do not address the characterization of such items as similar items (within the meaning of Section 936(h)(3)(B)(vi)) or as something else.  In general, the preamble notes that the potential rules under Section 367 for identifying and valuing transferred property are beyond the scope of the Final Regulations.
 
  1. Useful life of Property
The Proposed Regulations eliminated the 20-year limitation on useful life for intangible property subject to Section 367(d) that was included in Temporary Regulation Section 1.367(d)-1T(c)(3), because of Treasury and Service concerns that the limitation results in less than all of the income attributable to transferred intangible property being taken into account by the U.S. transferor.

The Final Regulations modify the Proposed Regulations by providing that in cases where the useful life of the transferred property is indefinite or is reasonably anticipated to exceed twenty years, taxpayers may, in the year of transfer, choose to take into account Section 367(d) inclusions only during the 20-year period beginning with the first year in which the U.S transferor takes into account income pursuant to Section 367(d).  However, the preamble notes that Treasury and the Service have determined that this optional limitation should not affect the present value of all amounts included by the taxpayer under Section 367(d).  Accordingly, the Final Regulations specifically require a taxpayer that chooses to limit Section 367(d) inclusions to a 20-year period to include, during that period, amounts that reasonably reflect amounts that, in the absence of the limitation, would be required to be included over the useful life of the transferred property following the end of the 20-year period.

In addition, the Final Regulations provide that, if a taxpayer chooses to limit inclusions under Section 367(d) to a 20-year period, no adjustments will be made for taxable years beginning after the conclusion of the 20-year period.  Thus, after the statute of limitations expires for taxable years during the 20-year period, a taxpayer will have no further Section 367(d) inclusions as a result of the Commissioner’s examination of taxable years that begin after the end of the 20- year period. However, the preamble notes that, consistent with the commensurate-with-income principle, for purposes of determining whether income inclusions during the 20-year period are commensurate with the income attributable to the transferred property, and whether adjustments should be made for taxable years during that period while the statute of limitations for such taxable years is open, the Commissioner may take into account information with respect to taxable years after that period, such as the income attributable to the transferred property during those later years.

Also, the Final Regulations revise the definition of useful life to provide that useful life includes the entire period during which exploitation of the transferred intangible property is reasonably anticipated to affect the determination of taxable income, in order to appropriately account for the fact that exploitation of intangible property can result in both revenue increases and cost decreases.
 
  1. Qualification of property denominated in foreign currency for the ATB Exception
Although Section 367(a)(3)(B)(iii) provides that the ATB exception does not apply, and therefore that Section 367(a)(1) applies, to foreign currency or other property denominated in foreign currency, current Temporary Regulation Section 1.367(a)-5T(d)(2) generally provided that Section 367(a)(1) nonetheless did not apply to certain transfers of property denominated in the currency of the country in which the transferee foreign corporation is organized.  The Proposed Regulations eliminated this regulatory exception from the general rule in Section 367(a)(3)(B)(iii) that turns off the ATB exception for such property.

The Final Regulations, which corresponds to existing Temporary Regulation Section 1.367(a)-5T(d)(2), reflects amendments that increase consistency with the rules in Sections 987 and 988. In particular, the terms “foreign currency” and “property denominated in foreign currency” are no longer used.  Rather, Proposed Regulation Section 1.367(a)-2(c)(3) is revised to refer to nonfunctional currency and other property that gives rise to a Section 988 transaction of the taxpayer described in Section 988(c)(1)(B), or that would give rise to such a Section 988 transaction if it were acquired, accrued, or entered into directly by the taxpayer.  The preamble notes that these modifications do not substantially change the scope of property subject to the rule at Temporary Regulation Section 1.367(a)-5T(d)(2).
 
  1. Other Issues
The preamble notes that Treasury and the Service generally agree that additional guidance under Sections 367(a) and (d) is desirable and would benefit both taxpayers and the government including guidance on issues such as (i) the valuation of intangibles subject to Section 367(d) and the forms that deemed payments should take, including guidance providing parity with the Section 482 form-of-payment rules; (ii) whether a receivable is created upon an audit-related adjustment; (iii) the tax basis consequences under Section 367(d), including how Section 367(d) applies to intangibles subject to the Section 197 anti-churning rules; (iv) coordination of the general rules and disposition rules in Section 367(d); (v) issues raised in connection with Notice 2012-39; (vi) the definition of “property” for purposes of Section 367; and (vii) the subsequent transfer rules under the ATB exception.  Unfortunately, the preamble simply states that these issues are beyond the scope of this project.
 
  1. Applicability Dates
The Final Regulations generally apply to transfers occurring on or after September 14, 2015, the date the Proposed Regulations were filed with the Federal Register, and to transfers occurring before September 14, 2015, resulting from entity classification elections that are filed on or after September 14, 2015.
For dates of applicability to these regulations, see Treasury Regulation Sections 1.367(a)-1(g)(5), 1.367(a)-2(k), 1.367(a)-4(b) and 1.367(a)-6(j); 1.367(d)-1(j) and 1.6038B-1(g)(7).


BDO Insights

BDO can assist our clients with understanding the complexities of the Final Regulations. Companies should take particular note of the applicability dates and review how these rules can apply to both planned and completed outbound transfers to foreign corporations.
 

For more information, please contact one of the following practice leaders:
 
Robert Pedersen
Partner and International Tax Practice Leader
         Chip Morgan        Partner 

 
Joe Calianno
Partner and International Tax Technical Practice Leader 
  Brad Rode
Partner 
 

 
William F. Roth III
Partner, National Tax Office
  Jerry Seade
Principal 

 
Scott Hendon
Partner 
  Monika Loving
Partner 

 
Annie Lee
Partner
  Sean Dokko
Senior Manager 

 

[1] Prior to the changes discussed in this Alert, Temporary Regulation Section 1.367(d)-1T(b) generally provided that IRC Section 367(d) and Temporary Regulation Section 1.367(d)-1T did not apply to the transfer of foreign goodwill or going-concern value, as defined in Temporary Regulation Section 1.367(a)-1T(d)(5)(iii).  For the application of the rules under Section 367(d), see Treasury Regulation Section 1.367(d)-1 and Temporary Regulation Section 1.367(d)-1T.
[2] H.R. Rep. No. 98-432, pt. 2, at 1317-19 (1984).
[3] S. Rep. No. 98-169, at 364 (1984) (emphasis added).

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