In summary
On May 3, the U.S. Department of the Treasury and the IRS published proposed regulations under IRC Section 367(d) that in certain cases would eliminate a disincentive for U.S. taxpayers that transfer intangible property outside the U.S. and then repatriate it by transferring it to a related U.S. person. The regulations are proposed to be effective for dispositions of intangible property occurring on or after the date final regulations are published. Comments and requests for public hearing are due on July 3, 2023.
IRC Section 367(d) generally provides that a U.S. corporation transferring intangible property to a foreign corporation in a transaction covered by IRC Section 351 or Section 361 is deemed to receive an annual contingent payment from the transferee over the useful life of the intangible property. The deemed payments are included in the U.S. transferor’s taxable income as ordinary income and are treated as royalties for purposes of determining the source of the income and for computing the U.S. transferor’s foreign tax credit limitation.
Current regulations provide that a subsequent transfer of the intangible property by the foreign transferee to a person unrelated to the initial U.S. transferor generally is treated as a disposition of the intangible property and terminates the transferor’s IRC Section 367(d) income inclusion as of the date of the disposition. In addition, the initial U.S. transferor recognizes any gain (but not loss) on the constructive sale of the intangible property on the date of the subsequent transfer, and the foreign transferee is required to make certain adjustments to related tax attributes.
However, if the intangible property is transferred to a person related to the initial U.S. transferor, the current regulations provide that the annual income inclusion under IRC Section 367(d) continues regardless of whether the related transferee is a U.S. or foreign person. Therefore, if an initial U.S. transferor transfers intangible property offshore subject to IRC Section 367(d), and the foreign transferee then transfers the intangible property to a U.S. person related to the initial U.S. transferor, the initial U.S. transferor continues to recognize deemed income with respect to the intangible property. Additionally, the related U.S. person transferee also is subject to U.S. taxation on the income generated by the intangible property. The preamble to the proposed regulations recognizes that the continued deemed income inclusion by the initial U.S. transferor could discourage the repatriation of intangible property subject to IRC Section 367(d) to a related U.S. person.
Consolidated groups have addressed the disincentive for intangible property repatriation through requests for private letter rulings to allow them to apply intercompany transaction rules under IRC Section 1502 to eliminate the overinclusion of income under the current IRC Section 367(d) regulations. The preamble to the proposed regulations states that the revisions to the current rules are intended to provide relief more broadly to U.S. related parties that are not members of the same consolidated group and to avoid the need to file a private letter ruling request to obtain relief.
The proposed regulations generally terminate application of IRC Section 367(d) income inclusion if a transferee foreign corporation transfers the intangible property to a qualified domestic person and certain reporting requirements under IRC Section 6038 are satisfied. If the conditions are met, the annual income inclusion by the initial U.S. transferor terminates as of the date of the repatriation, and the initial U.S. transferor recognizes any gain from the repatriation transaction under a new gain recognition provision.
A qualified domestic person includes the initial U.S. transferor of the intangible property, its qualified successor, and a U.S. individual or qualified corporation related to the U.S. transferor. U.S. partnerships are not treated as a qualified domestic person.
The preamble to the proposed regulations explains that potential issues related to partnership allocations and certain administrative and compliance burdens when non-U.S. partners are involved led to exclusion of U.S. partnerships from the definition of a qualified domestic person. Public comments are likely to be submitted on the exclusion of U.S. partnerships from the definition of a qualified domestic person.
Crowe observation
In the overall context of the proposed regulations, it might have been more consistent to use an aggregate approach and treat U.S. partnerships as a qualified domestic person if the partners are qualified domestic persons.
The new gain recognition rule requires an initial U.S. transferor to recognize any gain as a result of the repatriation to a qualified domestic person. The gain recognition rule operates differently based on whether the intangible property is transferred basis property (as defined in IRC Section 7701(a)(43)) by reason of the repatriation absent the application of the IRC Section 367(d) rules. If the intangible property is transferred basis property, the amount of the gain recognized by the initial U.S. transferor is the amount of any gain that would be recognized by the transferee foreign corporation on the repatriation under general subchapter C rules if the adjusted basis in the intangible property was equal to the initial U.S. transferor’s adjusted basis at the time the intangible property was originally transferred offshore. If the intangible property is not transferred basis property, the amount of any gain recognized by the initial U.S. transferor is the excess, if any, of the fair market value of the intangible property over the initial U.S. transferor’s adjusted basis at the time the intangible property was originally transferred offshore.
The proposed regulations also would require specified adjustments to the earnings and profits and gross income of the original foreign transferee that arise because of any gain that the original U.S. transferor recognizes under the gain recognition rule. Additionally, the proposed regulations describe how a qualified domestic person adjusts its basis in intangible property that it receives in the repatriation. The gain recognition rule and the adjustments generally prevent a qualified domestic person from receiving a tax-free increase to its adjusted basis in the repatriated property.
The proposed regulations also require adjustments related to the annual income inclusion, address the consequences of having multiple U.S. transferors, and provide a special rule for transactions related to the transfer of the offshored intangible property to a qualified domestic person.
The following provisions also are included in the proposed regulations:
If finalized, the proposed regulations would remove a disincentive to repatriate into the U.S. intangible property that was subject to the rules under IRC Section 367(d). However, until final regulations are published, taxpayers considering repatriation of intangible property subject to IRC Section 367(d) might want to delay repatriation or, if in a consolidated group, seek relief under a private letter ruling.
