The Internal Revenue Service has issued a notice to provide guidance to multinational companies on the thorny question of transferring intangible property such as patents from a domestic corporation in the U.S. to a foreign corporation or subsidiary, noting that some repatriation transactions "raise significant policy concerns."
Notice 2012-39 addresses transactions that raise significant policy concerns involving certain transfers of intangible property by a domestic corporation to a foreign corporation in an exchange described in a Section 361exchange. The IRS and the Treasury Department plan to issue regulations that incorporate the guidance described in the notice. The regulations will apply to transfers occurring on or after July 13, 2012.
“The IRS and the Treasury Department are aware that certain taxpayers are engaging in transactions intended to repatriate earnings from foreign corporations without the appropriate recognition of income,” said the notice.
The notice takes as an example a hypothetical case involving the transfer of stock between a domestic corporation and another corporation that it wholly owns. “In one such transaction, USP, a domestic corporation, owns 100 percent of the stock of UST, a domestic corporation. USP's basis in its UST stock equals its value of $100x,” said the notice. “UST's sole asset is a patent with a tax basis of zero. UST has no liabilities. USP also owns 100 percent of the stock of TFC, a foreign corporation. UST transfers the patent to TFC in exchange for $100x of cash and, in connection with the transfer, UST distributes the $100x of cash to USP and liquidates. The taxpayer takes the position that neither USP nor UST recognizes gain or dividend income on the receipt of the $100x of cash. USP then applies the section 367(d) regulations to include amounts in gross income under Section 1.367(d)-1T(c)(1) in subsequent years. USP also applies the 367(d) regulations to establish a receivable from TFC in the amount of USP's aggregate income inclusion. USP takes the position that TFC’s repayment of the receivable does not give rise to income (notwithstanding the prior receipt of $100x in connection with the reorganization). Accordingly, under these positions, the transactions have resulted in a repatriation in excess of $100x ($100x at the time of the reorganization and then through repayment of the receivable in the amount of USP’s income inclusions over time) while only recognizing income in the amount of the inclusions over time.”
The notice goes on to describe how the IRS and the Treasury find some transactions to be dubious in nature.
“The IRS and the Treasury Department understand that other transactions may be structured to have the same or similar effect, including, for example, transactions that involve TFC’s assumption of liabilities of UST,” said the notice. “Similar results may also be achieved in cases in which a controlled foreign corporation uses deferred earnings to fund an acquisition of all or part of the stock of a domestic corporation from an unrelated party for cash, followed by an outbound asset reorganization of the domestic corporation to avoid an income inclusion under section 956. The IRS and the Treasury Department believe that these transactions raise significant policy concerns, and accordingly, intend to revise the regulations under section 367(d) in the manner described in this notice.”
The IRS and the Treasury Department said they plan to issue regulations addressing the transfer by a domestic corporation of Section 367(d) property in a Section 361 exchange to a transferee foreign corporation incorporating the rules described in this notice. The regulations will ensure that, with respect to all outbound Section 367(d) transfers, the total income to be taken into account under Section 367(d) is either included in income by the U.S. transferor in the year of the reorganization or, where appropriate, over time by one or more qualified successors.
Any income taken into account under the notice must be commensurate with the income attributable to the Section 367(d) property transferred in the outbound Section 367(d) transfer, the IRS noted.