In recent years, the legislative, judicial, and executive branches have all attempted to clarify the meaning of "intangible property" under Sec. 367, which has guided U.S. multinational businesses seeking to defer realized gains on transfers of high-value intangible assets to foreign-based corporations. Several judicial decisions, including Veritas Software Corp., (1) have raised questions about whether the definition of intangible property under Sec. 367(d) covers foreign goodwill, going concern value, or the value of workforce in place. President Barack Obamas administration has consistently challenged what it perceives as an abuse-prone definition of intangible property, through both the IRS and the language of the president's proposed fiscal-year budgets. As such, the president's budget requests since 2009 have proposed legislative changes that seek to clarify the definition of intangible property.
To address perceived tax avoidance practices, Treasury and the IRS issued proposed regulations (REG-139483-13) under Sec. 367 on Sept. 14, 2015, that modify and clarify the application of Sec. 367(a) and Sec. 367(d) to outbound transfers of certain intangible property. The proposed changes in the outbound transfer rules will have far-reaching consequences for transfers of foreign goodwill, going concern value, and workforce in place, and are likely to affect commercial decisions of a broad array of multinational businesses. This article updates CPAs about the changes in tax treatment of outbound transfers of goodwill or going concern value so that they may help their clients in planning these transfers of intangible assets. This article explores (1) the definition of intangible property; (2) the controversy over the definition of intangibles; and (3) the proposed changes in REG-139483-13 and key recent developments that could impact the proposed regulations as they become final.
The Definition of Intangible Property
It is not clear whether the general definition of intangible property under Sec. 936(h)(3)(B) and the tax treatment of international transfers of those assets under Sec. 367 includes goodwill, going concern value, or workforce in place. Of course, corporate taxpayers have pushed for tax deferral on the value of outbound transfers of these intangibles for many years. Conversely, the IRS has asserted that goodwill, going concern value, or workforce in place is not intangible property within the meaning of Sec. 936(h)(3)(B) and, consequently, foreign transfers of such intangibles are ineligible for tax deferral. They do not fall within the statutory exception and are taxable under Sec. 367, the IRS contends. The Obama administration has consistently sought to broaden the definition of intangible property through the president's proposed fiscal-year budgets. The latest instance can be seen in the administrations international tax proposals in the fiscal year 2017 budget, (2) which directly addresses the current controversy over the definition of intangible property under Sec. 936(h)(3)(B).
Sec. 367(a) taxes realized gains on outbound transfers of business property to a foreign corporation if the transfer is related to certain corporate nonrecognition exchanges, including those covered by Sec. 332, 351, 354, 356, or 361, unless an exception applies. (3) One of the exceptions is when a foreign corporation uses transferred property in the active conduct of a trade or business outside the United States (ATB exception). (4) However, the ATB exception does not apply to certain assets, such as copyrights, inventory, accounts receivable, and "intangible property" within the meaning of Sec. 936(h)(3)(B). The transfer of these properties outside the United States triggers immediate gain (but not loss) recognition on realized gains (see the exhibit on p. 39). (5) The following scenario illustrates the application of the Sec. 367(a)(1) exception.
Example 1: ABC Corp., a U.S. corporation, incorporates its Singaporean operations in its affiliate XYZ Corp. to engage in business activities in Singapore. ABC Corp. transfers to its XYZ affiliate equipment with a tax basis of $4,000 and a fair market value (FMV) of $9,000 (resulting in a realized gain of $5,000), inventory with a tax basis of $1,000 and an FMV of $3,000 (resulting in a realized gain of $2,000), and accounts receivable with a tax basis of $2,500 and an FMV of $3,000 (resulting in a realized gain of $500).
While the total realized gain of $7,500 ($5,000 + $2,000 + $500) is deferred under Sec. 351, the gain would still be potentially taxable under Sec. 367 because these assets were transferred outside the United States. Because the assets are used in the active conduct of business in Singapore, the gain on the equipment would be deferred by operation of the ATB exception. Notwithstanding the Sec. 367(a) (1) exception for property used in the active conduct of a trade or business, however, ABC Corp. must recognize the realized gains attributable to inventory and accounts receivable because these assets are explicitly excluded from the ATB exception.
Unlike the situation for tangible personal property, foreign transfers of intangibles come within the purview of Sec. 936(h)(3)(B), and realized gains are tax deferred to the extent such transactions are contributions of capital under Sec. 351 or part of a corporate reorganization in connection with Sec. 361. The rationale is that the aforementioned contributions of intangibles in exchange for stock are covered by the special rules for transferring intangibles in Sec. 367(d) rather than Sec. 367(a). Foreign transfers of intangibles under Sec. 367(d) are treated as sales of such intangibles in exchange for payments that are contingent on the productivity, use, or disposition of the property. (6) Taxpayers are then considered as receiving royalty amounts annually that would have been reasonably received, and they are taxed on the deemed annual royalty receipts during the assumed useful life of the intangible asset. (7) These deemed...