Final regulations retroactively affect nonrecognition on outbound transfers of foreign goodwill

Tax Hot TopicsThe Treasury Department and the IRS recently issued final regulations relating to certain transfers of property by U.S. persons to foreign corporations (T.D. 9803). These final regulations generally adopt proposed regulations (REG–139483–13) issued in 2015, as well as portions of temporary regulations (T.D. 8087) issued in 1986.  The final regulations eliminate the so-called “foreign goodwill exception” and limit the scope of the active trade or business exception relating to certain transfers of property by U.S. persons to foreign corporations.  

The regulations primarily affect domestic corporations that transfer property to foreign corporations in certain outbound nonrecognition exchanges. The final regulations eliminate favorable treatment for foreign goodwill and going concern value. First, the regulations remove the foreign goodwill exception that provides that foreign goodwill and going concern value is not subject to Section 367(d). Second, the regulations narrow the scope of property that is eligible for the active trade or business exception under Section 367(a)(3).  

Consequently, 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) (i.e., a deemed royalty).

Under the 1986 temporary regulations, all property was eligible for the active trade or business exception, unless the property was specifically excluded. To limit the scope of this exception, the final regulations provide that only specifically listed types of property are “eligible” for the active trade or business exception, and do not retain the category for intangible property. The scope of “eligible” property was also limited to exclude certain property denominated in foreign currency. 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

The final regulations also modify the proposed rule limiting the useful life of intangible property to 20 years. The final regulations provide that the useful life of intangible property is the entire period during which the exploitation of the intangible property is reasonably anticipated to affect the determination of taxable income, as of the time of transfer. In response to comments received on the 20-year period, the final regulations include an option whereby taxpayers may, in lieu of including amounts during the entire useful life of the intangible property, choose in the year of transfer to increase annual inclusions taken into account during the 20-year period (i.e., all anticipated inclusions are allocated over a 20-year period as opposed to the useful life).

The final regulations also modify the valuation rules under Treas. Reg. Sec. 1.367(a)-1T to better coordinate the regulations under Sections 367 and 482.

The final regulations apply retroactively to transfers occurring on or after Sept. 14, 2015 (the effective date included in the proposed regulations), and also to transfers occurring before Sept. 14, 2015, resulting from entity classification elections filed on or after Sept. 14, 2015.

Read Grant Thornton LLP’s previous coverage on the proposed regulations here.

Contact David Sites
Partner, Washington National Tax Office
+1 202 861 4104

Cory Perry
Experience Manager, Washington National Tax Office
+1 202 521 1509

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