On Dec. 15, 2016, final regulations related to certain outbound transfers of property to foreign corporations were issued under IRC Sections 367(d) and 6038B. The regulations limit the type of property that qualify for the active trade or business exception and eliminate the exception for foreign goodwill.
As a general rule, when a U.S. person transfers property to a foreign corporation in an otherwise tax-free transaction, the transferee corporation is not considered to be a corporation causing the U.S. person to recognize gain on the transfer. However, an exception provides that a U.S. person may transfer certain property that is used in an active trade or business outside the U.S. to a foreign corporation on a tax-free basis. Certain property is excluded from the active trade or business exception, however, including items such as inventory, accounts receivable, foreign currency, and intangible assets described under Section 936(h)(3)(B). Taxpayers transferring intangible assets are considered to have sold the intangible assets in exchange for payments commensurate with the income to be earned by the property over its useful life or 20 years.
Taxpayers long have taken the position that foreign goodwill and going concern are excluded from Section 936, and that position has been the general rule of taxation under the legislative history under Section 367 and the temporary regulations issued in 1986. In the fall of 2015, the IRS issued proposed regulations that, among other things, eliminated the active trade or business exception for foreign goodwill and allowed taxpayers to elect to apply the rules under Section 367(d) related to outbound transfers of intangibles, rather than be subject to current taxation on the gain under the general rule under Section 367.
The final regulations adopt the temporary regulations and remove foreign goodwill and going concern from the active trade or business exception. As a result, taxpayers may apply the general gain recognition rule under Section 367(a)(1) or apply the rules under Section 367(d) and be taxed on the gain over a period of 20 years and commensurate with the income attributed to the goodwill over its useful life, which may extend beyond 20 years. These regulations apply retroactively to transfers occurring after Sept. 14, 2015.