IRS Tax Regulations

Transfer of Intangibles to Foreign Corporations IRS Regulations

Final IRS Regulations on Transfers of Intangibles to Foreign Corporations

On December 16, 2016, the Internal Revenue Service (IRS) published final regulations regarding transfers of intangible assets, including goodwill and going concern value, by U.S. persons to foreign corporations. These new regulations modify regulations under Internal Revenue Code (IRC) §§367(a) and (d) to ensure that the transfer of foreign goodwill or going concern value by a U.S. person to a foreign corporation will be subject to either current gain recognition under IRC §367(a) or the tax treatment provided under IRC §367(d). This article will begin by explaining the basic provisions of IRC §§367(a) and (d). The article will next discuss why the IRS promulgated the new regulations and then explain the final regulations.

Provisions of IRC §§ 367(a) and 367(d)

In general, under IRC §367(a) a U.S. person (which can be a corporation) immediately recognizes gain upon the transfer of business property to a foreign corporation in an exchange described in the non-recognition provisions of IRC §§332, 351, 354, 356, or 361. Section 367(a) provides an exception to the general rule for transfers of certain property used in the active conduct of a trade or business (henceforth known as the “ATB exception”). The ATB exception, unless otherwise modified by regulation, does not apply to the following types of assets: (1) inventory and copyrights or any other property described in IRC §§1221(a)(1) and (3); (2) accounts receivable or similar property; (3) foreign currency or other property denominated in a foreign currency; (4) intangible property described in §936(h)(3)(B) (henceforth known as “§936 intangibles”); and (5) property that the transferor leases unless the transferee was the lessee at the transfer date. Section 936 intangibles include but are not limited to patents, copyrights, trademarks, trade names, franchises, contracts, technical data, or any similar item with “substantial value independent of the services of any individual.”

IRS Tax RegulationsIRC §367(d) generally, applies to transfers of §936 intangible property by a U.S. person to a foreign corporation in a transaction described in IRC §§351 for 361. Section 367(d) treats the U.S. person as having sold the §936 intangible in exchange for payments contingent upon the productivity, use, or disposition of the §936 intangible. Specifically, the statute treats the U.S. person as receiving payments that reasonably reflect what it would have received annually over the useful life of the §936 intangible, or at the time the §936 intangible was sold following the transfer. Further, the amounts taken into account under §367(d) must be commensurate with the income attributable to the §936 intangible.

Example: A 90% U.S. shareholder transfers a patent to ABC Ltd., a foreign corporation. The patent should generate $500,000 in royalty income evenly over its remaining five-year five year term. The U.S. person will therefore report $90,000 in royalty income per year (the $500,000 of royalty income divided by five years multiplied by the 90% ownership stake).

Reasons for Regulatory Changes

Congress amended IRC §367 in 1984. The legislative history indicates that the House Ways and Means Committee contemplated “that, ordinarily, no gain will be recognized on the transfer of goodwill and going concern value for use in an active trade or business.” Additionally, the Committee noted that it did not “anticipate that the transfer of goodwill or going concern value developed by a foreign branch to a newly organized foreign corporation” would lead to the “abuse of the U.S. tax system.”

Although the legislative history remains instructive, Congress nevertheless did grant the IRS the regulatory authority to require income recognition in cases of outbound transfers that have the potential for tax avoidance. It also allowed the IRS to determine the property eligible for the ATB exception. Subsequent to the enactment of the amendment taxpayers developed tax avoidance strategies relating to outbound transfers of intangible property. The IRS responded to these subsequent developments with the release of these final regulations.

Final Regulations

The specific provisions of the final regulations regarding transfers of intangibles by U.S. persons to foreign corporations are as follows:

  • Limitation on the scope of ATB exception under IRC §367(a): The regulations provide a list of property eligible for the ATB exception that includes tangible property, working interests in oil and gas property, and certain financial assets unless listed in one of the four ineligible types of intangible property (the former regulation only listed ineligible property).
  • Elimination of exception from IRC §367(d) for transfers of foreign goodwill and going concern value: Prior regulations provided exceptions for foreign goodwill and going concern value. The final regulations remove the exceptions.
  • Election of 20-year useful life under IRC §367(d): The new regulations allow a taxpayer to elect a 20-year useful for intangible property with an indefinite life or whose expected life exceeds 20 years.
  • Foreign currency and the ATB exception under IRC §367(a): The ATB exception does not apply to transfers of property that produce a foreign currency gain or loss when the transaction is denominated in a nonfunctional currency.

The final regulations apply to transfers occurring on or after September 14, 2015. For more information on these regulations and how they affect your unique situation please contact a tax professional.

About The Author

Daniel Quintana

Daniel Quintana of Kurtz & Company, P.C. in Dallas Texas.