United States

Proposed section 367 regulations close outbound goodwill transfer loophole

TAX ALERT  | 

On Sept. 14, 2015, the Treasury and IRS issued proposed regulations that would align the outbound transfer rules of section 367 with the transfer pricing rules of section 482 and remove interpretations that have historically allowed the transfer of high value “goodwill” abroad tax free. Taxpayer’s historic ability to broadly interpret the definition of foreign goodwill in order to receive favorable tax treatment on large swaths of value transferred to controlled foreign corporations (CFCs) has, according to the IRS and Treasury, raised “significant policy concerns” and is “inconsistent with the expectation, expressed in legislative history.” Generally, transfers of property to foreign corporations in a transaction that would otherwise receive non-recognition treatment under the Code (e.g., sections 332, 351, 361, etc.) are taxable transfers pursuant to section 367 with a few exceptions. The exception used to exclude gain on transfers of foreign goodwill is the active trade or business (ATB) exception, which generally excludes assets transferred abroad from gain recognition under section 367(a). However, there are five asset classes where gain is recognized including intangibles defined in section 936(h)(3)(B), which instead are subject to section 367(d). Because foreign goodwill does not fall within that definition, and is not otherwise identified in the other four asset classes, taxpayers have generally treated it as an asset transferred abroad for use in an ATB and therefore excluded from gain recognition.

As a result, taxpayers have had an incentive to discount the value of identified intangibles in favor of allocating value to foreign goodwill and going concern. The IRS believes this is contrary to the legislative intent. According to the IRS, Congress was of the view that little abuse of these tax code provisions would occur as U.S. companies with foreign branches would simply incorporate foreign entities with assets already in place, and recognize minimal gain on that incorporation. Instead, the IRS believes taxpayers have stretched the definition of foreign goodwill to include businesses operated primarily by U.S. employees but with foreign earnings.

In response, the proposed regulations would no longer allow foreign goodwill to move abroad in a non-recognition transaction by providing an exclusive and exhaustive list of assets that are eligible for the ATB exception. Under existing rules all assets except those listed are generally considered eligible for the ATB exception. Taxpayers would be forced to choose to classify goodwill as either a section 367(a) asset, where current inclusion of the gain is required, or as a section 367(d) intangible, where the arms-length principles of section 482 would apply and result in current inclusion over time. The regulations are generally proposed to be effective for transfers occurring on or after Sept. 14, 2015, and for transfers occurring before Sept. 14, 2015, resulting from entity classification elections on or after Sept. 14, 2015.

If finalized, the proposed regulations will significantly alter the tax position and future planning of multi-national companies by eliminating safe haven buckets of intangible assets when incorporating or transferring assets abroad. The offshoring of valuable goodwill and intellectual property would have a cost and likely slow the further offshoring efforts. When considering your structure abroad, consult your tax advisor.

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