New US tax rules aim to shut down certain outbound asset reorganisations
In Notice 2012-39, the US Internal Revenue Service (IRS) issued rules to govern certain outbound asset reorganisations involving the transfer of intangibles under US tax Code Sec. 367(d) occurring on or after July 13th, 2012, and that will apply instead of existing US Treasury regulations (Temp. Regs. Secs. 1.367(d)-1T(c), (d), (e), and (g)). The IRS intends to issue regulations incorporating the guidance in the notice.
Under Sec. 367(d)(2)(A), the US person transferring intangible property in an exchange described in Sec. 351 or 361 is treated as having sold the property in exchange for payments that are contingent upon the productivity, use or disposition of the property. The transferor is treated as receiving amounts that reasonably reflect the amounts that would have been received: (1) annually in the form of payments over the useful life of the property, or (2) if the property is disposed of (indirectly or directly) after the transfer, at the time of the disposition. An indirect disposition of the intangible property following the transfer includes a disposition of the transferor’s interest in the transferee corporation.
The rules in the notice are intended to stop certain transactions that taxpayers are engaging in under Sec. 367(d)(2) and Temp. Regs. Sec. 1.367(d)-1T to repatriate earnings from foreign corporations without the appropriate recognition of income – transactions that the IRS says, “raise significant policy concerns.”
An example of such a transaction involves a US parent corporation that holds all the stock in its US subsidiary, which in turn holds a patent with a tax basis of zero. The subsidiary transfers the patent to a foreign corporation wholly owned by its parent in exchange for $100 cash, then distributes the cash to its parent and liquidates.
According to the IRS, the taxpayer takes the position that neither of the US corporations recognises gain on the receipt of the cash, and the parent also applies the existing rule under Temp. Regs. Sec. 1.367(d)-1T(c)(1) to include these amounts in income over time and establish a receivable from the foreign corporation. This transaction results in a repatriation of more than $100 ($100 at reorganisation and then through repayment of the receivable), but income is only recognised in the amount of the inclusions over time.
The notice states that regulations to be issued will ensure that, for all outbound Sec. 367(d) transfers, the total income to be taken into account is either included in income by the US transferor in the year of the reorganisation or, where appropriate, over time by one or more qualified successors. The rules included in the notice explain when income must be included in the year of the reorganisation or over time and how to determine the amount that the transferor or qualified successor must include in income in the required period. The notice also contains an example illustrating the application of the rules.
—Sally P. Schreiber (sschreiber@aicpa.org) is a CGMA Magazine senior editor.