IRS releases audit guidelines on transfers of intangibles

IRS releases audit guidelines on transfers of intangiblesThe IRS recently issued two international practice network (IPN) practice units outlining guidance to examiners involving the licensing of intangibles and the transfer of intangibles offshore. In the first practice unit, IRS agents are instructed to examine whether a controlled foreign corporation (CFC) paid an appropriate arm’s-length amount to its U.S. parent for the use of licensed property owned by the parent, and, in the second, agents are advised to look at how taxpayers try to avoid Section 367(d) when they move intangibles offshore, particularly to lower-tax jurisdictions.

The first practice unit (ISO/9411.02_03 2013) focuses on the transfer of intangible property (IP) from a U.S. parent to a foreign subsidiary by license. The practice unit highlights that licenses of IP from a U.S. person to a related foreign subsidiary are subject to transfer pricing rules that require the consideration for licensing to be arm’s-length.

IRS examiners are instructed to look at a CFC’s use of licensed IP owned by a U.S. parent and consider whether the CFC paid an arm’s-length amount to the parent for the use of the IP. A variety of methods that may be used to determine arm’s-length consideration are discussed in Treas. Reg. Sec. 1.482-4.

If a foreign subsidiary compensates a U.S. parent at lower than an arm’s-length consideration, IRS agents should allocate income between the parties under Section 482, so that the U.S. parent reports the correct taxable income. Finally, the practice unit advises agents to consider making a referral for economic assistance if the case potentially involves significant valuation adjustment.

The second practice unit (ISO/ 9411.02_03(2013), highlights a strategy that taxpayers may use to try to reduce or eliminate the federal tax consequences under Section 367(d) when transferring IP offshore to a jurisdiction that imposes little, if any, tax burden on the income from the transferred IP. The practice unit also details audit techniques that may be used when auditing the issues presented with this transaction.

To reduce its effective tax rate for financial statement purposes, a U.S. taxpayer may transfer intangible assets offshore though a Section 351 or Section 361 intangible transfer, which generally triggers a deemed sale of the IP in exchange for a continuing deemed annual royalty under Section 367(d). If the foreign corporation disposes of the property to an unrelated party, the U.S. transferor must recognize gain equal to the difference between the fair market value and its adjusted basis.

The IRS instructs agents to reference Section 482 in determining the appropriate charge for the deemed royalties, including both the arm’s-length and commensurate-with-income standards.  

Some aspects of the practice unit may change because of recently proposed regulations under Sections 482 and 367(d).

Please contact David Bowen or Cory Perry for more information.

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