US outbound transfers to foreign corporations

Treasury and the IRS released important proposed regulations on the treatment of transfers of intangible property by US persons to foreign corporations subject to § 367(d). The proposed regulations eliminate the so-called foreign goodwill exception from the § 367(d) regulations, and limit the § 367(a) active trade or business exception to certain tangible property and financial assets. The regulations, when finalised, would have a retroactive effective date to apply to transfers occurring on or after September 14 2015, and to transfers occurring before that date which result from entity classification elections that are filed on or after that date.

The preamble states that the proposed regulations would eliminate the foreign goodwill exception under Temporary Treasury Regulation § 1.367(d)-1T and limit the scope of property that is eligible for the active foreign trade or business exception generally to certain tangible property and financial assets. Accordingly, under the proposed regulations, when there is an outbound transfer of foreign goodwill or going concern value, the US transferor will be subject to either current gain recognition under § 367(a) or the tax treatment provided under § 367(d).

This would be a major change in the law, and one that is at odds with the clear legislative history, which states that "no gain will be recognised on the transfer of goodwill and going concern value for use in an active trade or business". Note that the Obama Administration has proposed to change the law to include goodwill, going concern value and workforce-in-place in § 936(h)(3)(B). At first, the Administration's description referred to this change as a "clarification". However, in the two most recent Administration budgets, the assertion that this change would be a 'clarification' was dropped. These proposals were never enacted by Congress.

In addition, the proposed regulations eliminate the existing rule that limits the useful life of intangible property to 20 years. The preamble states that if the useful life of transferred intangible property exceeds 20 years, the limitation might result in less than all of the income attributable to the property being taken into account by the US transferor. Accordingly, proposed Treasury Regulation § 1.367(d)-1(c)(3) provides that the useful life of intangible property is the entire period during which the exploitation of the intangible is reasonably anticipated to occur, as of the time of the transfer.

The regulations under § 956 contain an anti-avoidance rule providing that a controlled foreign corporation (CFC) will be considered to hold, indirectly, investments in US property acquired by any other foreign corporation that is controlled by the CFC, if one of the principal purposes for creating, organising, or funding (through capital contributions or debt) such other foreign corporation is to avoid the application of section 956 with respect to the CFC.

The anti-avoidance rule was expanded to provide that the rule can apply when a foreign corporation controlled by a CFC is funded other than through capital contributions or debt. It was also expanded to apply to US property acquired by a partnership that is controlled by the CFC if the property would be US property if held directly by the CFC, and a principal purpose of creating, organising or funding the partnership is to avoid the application of § 956 with respect to the CFC.

Additional proposed regulations provide that for purposes of § 956, an obligation of a disregarded entity is treated as an obligation of the owner of the disregarded entity. Thus, for example, an obligation of a disregarded entity that is owned by a domestic corporation is treated as an obligation of the domestic corporation for purposes of § 956. According to the IRS, this rule follows from an application of the check-the-box rules and is therefore not a change from current law.

Proposed regulations provide that the rule treating a CFC as holding an obligation of a US person if it pledges assets in respect of, or guarantees, the obligation, should also apply in respect of partnerships in which CFCs are partners. Treasury and the IRS are considering whether to exercise the authority granted under § 956(e) to prescribe regulations as may be necessary to carry out the purposes of § 956 to allocate the amount of the obligation among the relevant CFCs so as to eliminate the potential for multiple inclusions and, instead, limit the aggregate inclusions to the unpaid principal amount of the obligation.

As a general matter no gain or loss is recognised on a transfer of property to a partnership in exchange for a partnership interest. However, § 721(c) authorises the IRS to write regulations treating certain transfers of property to a partnership with foreign partners as taxable. The IRS issued Notice 2015-54, exercising its authority under § 721(c).

These rules apply when a US person transfers property to either a domestic or foreign partnership where income or gain derived from property contributed by a US partner could be allocated to a foreign partner. The purpose of these rules, which are linked to the § 367(a) outbound transfer regime, is to impose an 'exit tax' on appreciated tangible property and intangible property (whether appreciated or not) that leaves the US taxing jurisdiction.

The regulations under § 721 would require a US partner contributing built-in gain property to a partnership (whether domestic or foreign) with a related foreign partner either immediately or periodically to take the gain into account. The regulations will do this by forcing a partner to elect the remedial allocation method under § 704(c) with respect to the built-in gain property or otherwise forgo the application of § 721(a). The new rules apply to both tangible and intangible property with a built-in gain.

In the Notice, the IRS states that it has elected to exercise its regulatory authority granted in § 721(c) to override the application of § 721(a) in certain cases where the transfer of property to a partnership (domestic or foreign) would result in built-in gain on the property being includible in the gross income of a foreign person. The Notice states that the IRS has elected not to act pursuant to § 367(d)(3) because the transactions at issue are not limited to transfers of intangible property.

The Notice states that Treasury and the IRS intend to issue regulations providing that § 721(a) will not apply when a US transferor contributes an item of § 721(c) property (or a portion thereof) to a § 721(c) partnership, unless the 'gain deferral method' (GDM) is applied with respect to such property. The portion of the Notice addressing the GDM does not apply to transactions to which § 721(a) otherwise would not apply.

The Notice defines § 721(c) property generally as any property with a 'built-in gain'. Built-in gain is the excess § 704(b) book value of the property over the contributing partner's adjusted tax basis in the property at the time of the contribution (and does not include gain created when a partnership revalues partnership property). The Notice does not state how to determine the book value of an item of property, but presumably a book value amount will be respected if it reflects amounts that would be reasonably agreed to by partners acting at arm's-length.

A '§ 721(c) partnership' is generally a partnership (domestic or foreign) if a US person contributes § 721(c) property to the partnership, and, after the contribution and any transactions related to the contribution: (i) a related foreign person is a direct or indirect partner in the partnership; and (ii) the US transferor and one or more related persons own more than 50% of the interests in the partnership's capital, profits, deductions or losses. Relatedness is defined by reference to § 267(b) or § 707(b)(1).

The GDM contains five requirements, the most notable of which is that the § 721(c) partnership must adopt the remedial allocation method described in Treasury Regulation § 1.704-3(d) for built-in gain with respect to all § 721(c) property contributed to the partnership. It effectively requires the taxpayer to elect between including its built-in gain in respect of the § 721(c) property immediately (if it does not choose the remedial method and also follow the other requirements below) or including the built-in gain in installments (by choosing the remedial method and following the other requirements of the GDM).

The Notice also states that § 482 and related penalties apply to controlled transactions involving partnerships. For example, when US and foreign persons under common control enter into a partnership, the amounts of their contributions to, and distributions from, the partnership are subject to adjustment in order to reflect arm's-length results. Partnership allocations, including allocations under § 704(c), also are subject to adjustment.

New temporary regulations provide for the coordination of § 482 with other Code and regulatory provisions, such as § 367(d). Treasury and the IRS say the consistent analysis and valuation of transactions subject to multiple Code and regulatory provisions is required under the best method rule described in Treasury Regulation § 1.482-1(c).

A new regulation provides that arm's-length compensation must be consistent with, and must account for all of, the value provided between parties in a controlled transaction, without regard to the form or character of the transaction. For this purpose, states the IRS, it is necessary to consider the entire arrangement between the parties, as determined by the contractual terms, whether written or imputed in accordance with the economic substance of the arrangement, in light of the actual conduct of the parties.

The regulations provide a number of new examples to illustrate the statement in the regulations that the combined effect of two or more separate transactions may be considered if the transactions, taken as a whole, are so interrelated that an aggregate analysis of these transactions provides the most reliable measure of an arm's-length result determined under the best method rule.

Altera Corporation v Commissioner, 145 TC No 3 (2015), is a follow-on from the Xilinx v Commissioner case, 125 TC 37 (2005), aff'd, 598 F.3d 1191 (9th Cir. 2010). In Xilinx, the Tax Court held that, under the § 1995 cost-sharing regulations, controlled entities entering into qualified cost-sharing agreements (QCSAs) need not share stock-based compensation costs because parties operating at arm's-length would not do so. In an effort to overrule Xilinx, Treasury and the IRS in 2003 issued Treasury Regulation § 1.482- 7(d)(2). The 2003 regulation requires controlled parties entering into QCSAs to share stock-based compensation costs. Altera addressed that regulation, and held that it was invalid.

The Court concluded that Treasury failed to examine the relevant data and it failed to support its belief that unrelated parties would share stock-based compensation with any evidence in the record. The Court also stated that the final rule was contrary to the evidence before Treasury when it issued the final rule.

In its continuing battle against foreign acquisitions of US companies, Treasury issued Notice 2015-79, which imposes additional restrictions on these transactions. The Notice's most significant changes are new rules that alter the computation of the relative ownership of the foreign surviving company.

One rule adjusts the ownership fraction if the foreign surviving company is tax resident in a different country from the country in which the foreign target is resident. It states that the stock of the foreign surviving company that otherwise would be included in the denominator of the ownership fraction will be excluded from the denominator to the extent the stock is held by former owners of the foreign target by reason of holding stock in the foreign target. This rule only applies if the shareholders of the US target own at least 60% of the stock of the foreign surviving corporation.

The second rule is, what the IRS terms, 'a clarification' of the rule that stock of the foreign acquirer is not counted in the denominator of the ownership fraction if it is received in exchange for 'non-qualified property'. The Notice states that non-qualified property includes property acquired with a principal purpose of avoiding the purposes of § 7874, regardless of whether the transaction involves an indirect transfer of other non-qualified property.

An additional rule provides that 'inversion gain' includes income or gain recognised by an expatriated entity from an indirect transfer or license of property, such as an expatriated entity's subpart F inclusions that are attributable to a transfer of stock or other properties or a license of property, either as part of the acquisition or after the acquisition if the transfer or license is to a related person.

David Forst Fenwick & West Silicon Valley Centre 801 California Street Mountain View, CA 94041 US Tel: +1 650 335 7254 dforst@fenwick.com www.fenwick.com David Forst is the practice group leader of the tax group of Fenwick & West where he focuses on international corporate taxation. David is included in the Legal Media Group's Guide to the World's Leading Tax Advisers, published by Euromoney. He is also in Law and Business Research's International Who's Who of Corporate and Tax Lawyers (for the last five years). David is listed in Chambers USA's America's Leading Lawyers for Business (2011-2014), and has been named a Northern California 'Super Lawyer' in tax by San Francisco Magazine. David is a lecturer at Stanford Law School on international taxation where he has taught Stanford's international tax course for a number of years. Fenwick & West has served as counsel in more than 150 large-corporate IRS Appeals proceedings and more than 70 federal tax court cases. Seven Fenwick tax partners appear in International Tax Review's Tax Controversy Leaders Guide. Fenwick was named US (or Americas) Tax Litigation Firm of the Year three times at ITR's annual America's Awards dinners. Much of our tax dispute resolution work has involved transfer pricing. Fenwick & West is first tier in ITR's World Transfer Pricing (2015). Five Fenwick tax partners have appeared in Euromoney's Guide to the World's Leading Transfer Pricing Advisers. Transfer pricing cases in which we have been involved include: Apple Computer, Xilinx, DHL, LimitedBrands, among others. The vast majority of our transfer pricing cases have been resolved in Appeals, some on a "no change" basis. Other cases in which we've represented clients in federal tax litigation matters include those that involved Sanofi, CBS, Analog Devices, Dover, Chrysler, Textron, Johnson Controls, Del Commercial, Illinois Tool Works, VF, S.C. Johnson, Intel, CMI Int'l, Laidlaw, Hitachi, Union Bank, GM Trading, and many more.

James Fuller Fenwick & West Silicon Valley Center 801 California Street Mountain View, CA 94041 US Tel: +1 650 335 7205 jpfuller@fenwick.com www.fenwick.com Jim Fuller is a partner in the tax group at Fenwick & West in Mountain View, California. He is one of the world's top 25 tax advisers, according to Euromoney. Fuller is described as one of the three "most highly regarded" US tax practitioners in Law Business Research's Who's Who Legal (2015), and is the only US tax adviser to receive a coveted Chambers 'star performer' rating (higher than first tier) in Chambers USA (2015). Fuller and his firm have served as counsel in more than 150 large-corporate IRS Appeals proceedings and more than 70 federal tax court cases. Seven Fenwick tax partners appear in International Tax Review's Tax Controversy Leaders Guide. Fenwick has been named US (or Americas) Tax Litigation Firm of the Year three times at ITR's annual Americas Awards Dinners. Two of our tax partners were shortlisted by Euromoney at its Women in Business Law Awards dinners in the America's Leading Lawyer for Tax Dispute Resolution category. One is a two-time winner of the award. Much of our tax dispute resolution work has involved transfer pricing. Fenwick & West is first tier in ITR's World Transfer Pricing (2015). Five Fenwick tax partners have appeared in Euromoney's World's Leading Transfer Pricing Advisers. Transfer pricing cases in which we have been involved include: Apple Computer, Xilinx, DHL, and LimitedBrands, among others. The vast majority of our transfer pricing cases have been resolved in Appeals, some on a 'no change' basis. Other cases in which we've represented clients in federal tax litigation matters include those that involved Sanofi, CBS, Analog Devices, Dover, Chrysler, Textron, Johnson Controls, Del Commercial, Illinois Tool Works, VF, S.C. Johnson, Intel, CMI Int'l, Laidlaw, Hitachi, Union Bank, GM Trading, and others.

Adam Halpern Fenwick & West Tel: +1 650 335 7111 ahalpern@fenwick.com www.fenwick.com Adam Halpern is a partner in the tax group at Fenwick & West. His practice focuses on the US federal income taxation of international transactions. Adam is a frequent chairman and speaker at conferences on US international income taxation, having spoken before the Tax Executives Institute, the NYU Institute on Federal Taxation, and the Council for International Tax Education, among others. He is the 2013 Distinguished Adjunct Professor at Golden Gate University's master's in taxation programme, teaching classes in US international income tax.

Andrew Kim Fenwick & West Silicon Valley Center 801 California Street Mountain View, CA 94041 US Tel: +1 650 335 7146 Email: akim@fenwick.com Website: www.fenwick.com Andrew Kim is a partner in the tax group of Fenwick & West. His practice focuses on both domestic and international corporate tax matters, with an emphasis on tax dispute matters. Andrew served as counsel in CBS Corporation v. United States in the US Court of Federal Claims, and is now serving as counsel in Analog Devices, Inc. v. Commissioner in the US Tax Court. Andrew appears in Euromoney's World's Leading Tax Advisers, International Tax Review's Tax Controversy Leaders, and Law Business Research's Who's Who Legal: Corporate Tax 2015. Andrew has significant experience in representing clients with respect to cross-border transactions, corporate restructurings, international joint ventures, transfer pricing, as well as dispute resolution matters. He has published articles on international tax issues and developments in the Journal of Taxation, International Taxation, the Euromoney Corporate Tax Handbook, and World Tax. Andrew frequently speaks on international tax issues at meetings for professional tax groups, including the Tax Executives Institute and Bloomberg BNA. Fenwick's tax practice has earned a reputation as one of the nation's leading domestic and international tax practices. Fenwick was named US (or Americas) Tax Litigation Firm of the Year three separate times by International Tax Review. Fenwick has also been recognised by International Tax Review as first tier in both its World's Leading Tax Planning Firms and World's Leading Transactional Firms surveys, and has been recognised as Americas M&A Tax Firm of the Year. Andrew received his JD, cum laude, from Harvard Law School, and BS in psychology with highest honours from the University of Illinois. Andrew is a member of the state bars of California and Illinois.