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Proposed regulations could affect nonrecognition of transfers of property to foreign corporations

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Property transfers to foreign corpsTreasury and the IRS recently issued proposed regulations (REG-139483-13) addressing transfers made by U.S. persons of certain property, including foreign goodwill and going-concern value, to foreign corporations in nonrecognition transactions described in Section 367. The proposed regulations, if made final, would eliminate the foreign goodwill exception and limit the scope of the active trade or business exception.

Importantly, under the proposed regulations, transfers of foreign goodwill and going concern, which were generally not subject to tax previously, would be subject to either current gain recognition under Section 367(a)(1) or the tax treatment provided under Section 367(d).

Treasury and the IRS concurrently released temporary and final regulations (T.D. 9738) that clarify the coordination of the application of the arm's length standard and the best method rule under Section 482 in conjunction with other provisions of the tax code, most notably Section 367. These amendments also contain final regulations that add cross-references in the existing final regulations under Section 482 to relevant sections of these temporary regulations.

The proposed regulations acknowledge that some taxpayers broadly interpret the meaning of foreign goodwill and going-concern value, and that despite existing regulations under Section 367 defining foreign goodwill or going-concern value by reference to a business operation conducted outside of the United States, some taxpayers have asserted that they have transferred significant foreign goodwill or going-concern value when a large share of that value was associated with a business operated primarily by employees in the United States. Accordingly, Treasury determined that allowing intangible property to be transferred outbound in a tax-free manner is inconsistent with the policies of Section 367 and proposed the amendments to the regulations, discussed below.

The proposed regulations eliminate the foreign goodwill exception under Treas. Reg. Sec. 1.367(d)-1T and limit the scope of property that is eligible for the active trade or business exception generally to certain tangible property and financial assets. Consequently, under the proposed regulations, upon an outbound transfer of foreign goodwill or going-concern value, a U.S. transferor will be subject to either current gain recognition under Section 367(a)(1) or the tax treatment provided under Section 367(d) (e.g., over time).

In addition, the proposed regulations eliminate the existing rule under Treas. Reg. Sec. 1.367(d)-1T(c)(3) that limits the useful life of intangible property to 20 years. Proposed Treas. Reg. Sec. 1.367(d)-1(c)(3) provides that the useful life of intangible property is the entire period during which the exploitation of the intangible property is reasonably anticipated to occur, as of the time of transfer.

Under existing regulations, all property is eligible for the active trade or business exception, unless specifically excluded. To limit the scope of this exception, the proposed regulations provide that only specifically listed types of property are “eligible” for the active trade or business exception. The proposed regulations do not retain the category for intangible property. Nevertheless, for “eligible” property to satisfy the active trade or business exception, it must also be considered transferred for use in the active conduct of a trade or business outside of the United States.

If finalized, the proposed regulations will generally apply to transfers occurring on or after Sept. 14, 2015, and also to transfers occurring before that date that are the result of entity classification elections. However, the removal of the exception for certain property denominated in a foreign currency currently provided in Treas. Reg. Sec. 1.367(a)-5T(d)(2) will apply to transfers occurring on or after the date that the proposed regulations are made final, and also to transfers occurring before that date resulting from entity classification elections.

The preamble to the temporary and final regulations highlights the government’s concerns regarding situations in which controlled groups evaluate economically integrated transactions on a separate basis in a manner that results in a misapplication of the best method rule and fails to reflect an arm's length result. For example, for purposes of Section 482, taxpayers may have asserted that interrelated transactions should be separately evaluated simply because different statutes or regulations apply to the transactions (e.g., where Section 367 applies to one transaction and the general recognition rules of the tax code apply to another related transaction). Accordingly, the temporary regulations were released to clarify the coordination of the application of Section 482 to various code and regulatory provisions.

To clarify the coordination of the interrelated code sections and regulatory provisions, the temporary regulations included three modifications to the current rules:
  • Added a new rule that provides that arm’s length compensation must be consistent with, and must account for all of, the value provided between the parties in a controlled transaction, without regard to the form or character of the transaction. See Treas. Reg. Sec. 1.482-1T(f)(2)(i)(A).
  • Clarified existing rules by adding a new clause that states that the aggregation principle also applies for purposes of an analysis under multiple provisions of the code or regulations, elaborating that consideration of the combined effect of two or more transactions may be appropriate to determine whether the overall compensation is consistent with the value provided, including any synergies among items and services provided. This new clause however, does not retain a statement included in Treas. Reg. Sec. 1.482-1(f)(2)(i)(A) that transactions generally will be aggregated only when they involve related products or services, as defined in Treas. Reg. Sec. 1.6038A-3(c)(7)(vii), which the preamble noted may create unintended potential to be misconstrued by taxpayers as limiting the aggregation analysis pursuant to the best method rule. See Treas. Reg. Sec. 1.482-1T(f)(2)(i)(B).
  • Provided that a coordinated best method analysis and evaluation of the transactions may be necessary to ensure that the overall value provided (including any synergies) is properly taken into account. See Treas. Reg. Sec. 1.482-1T(f)(2)(i)(C).

It is important to note that the preamble to the final and temporary regulations states that the regulations are intended to be a clarification of current law and may challenge transactions entered into prior to the issuance of these temporary regulations under currently applicable law. The temporary and final regulations apply to taxable years ending on or after Sept. 14, 2015.

The proposed regulations, if made final, may significantly impact certain transactions entered into after the effective date, which involve outbound transfers of foreign goodwill and going concern. When released the proposed regulations received significant scrutiny from commentators and industry experts, who have been asserting the rules may not be consistent with legislative history. Accordingly, taxpayers considering transactions affected by the proposed regulations should carefully review these rules and closely monitor the developments of the proposed regulations.

Contact Fred Murray

T +1 202 861 4141

E fred.murray@us.gt.com


Cory Perry
T +1 202-521-1509
E cory.perry@us.gt.com

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