Country / Language

Proposed Regulation Addresses Outbound Transfers of Foreign Goodwill


10/2/15

Synopsis

U.S. taxpayers who may be contemplating outbound transfers of property should be aware of newly proposed Treasury regulations related to Internal Revenue Code Sections 367(a) and (d).  Prior to September 14, 2015, a U.S. company could transfer an active trade or business to a foreign corporation (most often by incorporating a foreign branch operation) and taxable gain would not be triggered on the transfer of foreign going concern or good will. This will no longer be the case.

Issue

Background
Section 367(d) applies to an outbound transfer of intangible property but current regulations specifically except foreign goodwill and going concern value from its scope. Similarly, the active trade or business exception (ATB exception) potentially excludes from section 367(a) outbound transfer of property used in a taxpayer’s active trade or business, including foreign goodwill and going concern value. In the past, taxpayers have relied on a combination of the foreign going concern/goodwill exception, and/or the ATB exception, to transfer outbound their foreign goodwill and going concern value tax-free. These transactions have generally hinged on the taxpayer’s interpretation of what constitutes a section 936(h)(3)(B) intangible. Treasury’s proposed regulations aim to put an end to this practice.

Proposed changes
On September 16, 2015, Treasury issued new proposed regulations (i) eliminating the foreign going concern/goodwill exception and (ii) limiting the scope of the ATB exception. Going forward, the ATB exception will only apply to tangible property, working interests in oil and gas property, and certain financial assets. Moreover, without the foreign goodwill exception, outbound transfer of foreign goodwill and going concern value will potentially be subject to section 367(d). Notwithstanding taxpayers’ interpretation of 936(h)(3)(B), proposed regulations offer to allow taxpayers the choice of applying section 367(d) to transfers of property that otherwise would fall under section 367(a).

Taxpayers should reevaluate the business case for these transfers and submit comments to the Treasury on its proposed changes.

The regulations are proposed to apply to actual transfers beginning September 14, 2015 and to transfers resulting from entity classification elections filed on or after September 14, 2015. Taxpayers should reevaluate the business case for these transfers in the event these proposals become final regulations.  At the same time, taxpayers should also actively comment on these potential changes.  The Treasury is requesting comments on whether it should make certain narrow exceptions for cases where there is limited potential for abuse.

What does CohnReznick think?
CohnReznick generally advises clients who set up foreign branch operations to license in intangible property that is of a type that is typically subject to licensing between unrelated parties (e.g., trademarks, trade names, patents, know-how, etc.). Most countries will allow a deduction for reasonable license and royalty payments. Thus, income associated with this type of IP is subject to a single level of income tax, that being by the U.S.
Conversely, foreign going concern and goodwill is part and parcel of a foreign branch operation, and it is impossible (or virtually impossible) to license this IP and obtain a local country tax deduction. Thus, the imposition of a U.S. actual payment or income imputation will result in economic double taxation unless the subject taxpayer has an unusual amount of excess U.S. foreign tax credit capacity. 

Specific identification of intangibles, including but not limited to marketing intangibles, may provide a mechanism to carve out some income from foreign going concern and goodwill and allocate such income to the marketing intangible which is a part of a company’s IP.

Taxpayers considering an outbound transfer that includes foreign goodwill or going concern value should reevaluate the business case for these transfers in the event that these proposed regulations become final. In the meantime, taxpayers should also actively comment on these proposed changes and suggest cases in which a limited exception should apply.

Further, taxpayers who contemplate setting up a foreign operation must factor in the very real possibility that they will no longer be able to convert these operations to foreign corporations without an additional toll charge for foreign going concern and goodwill. As noted above, this change will almost certainly cause some element of economic double taxation on foreign corporations’ income.

Contact

For more information, please contact James Wall, Principal and International Tax Practice Leader, at 646-254-7460 or james.wall@cohnreznick.com.

To learn more about CohnReznick’s International Tax Practice, please visit our website.


Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. 

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