Proposed regulations under IRC Section 367 represent a major change in the treatment of an outbound transfer of foreign goodwill and going concern value. If finalized, the regulations will subject to tax outbound transfers of foreign goodwill and going concern value that occur after Sept. 14, 2015.
When a U.S. taxpayer transfers assets to a foreign corporation in an otherwise tax-free transaction, IRC Section 367 treats the transfer as a taxable event unless an exception applies. Section 367(a)(3) provides such an exception when the property being transferred is used in the active conduct of a trade or business outside the U.S. Special rules also are provided under Section 367(d), which provides that if a U.S. taxpayer transfers intangible property to a foreign corporation as described under Section 936(h)(3)(B) it will be deemed to have done so in exchange for an annual royalty commensurate with the income generated by the transferred intangible. Taxpayers generally have taken the position that foreign goodwill and going concern value are not intangible property under 936(h)(3)(B) for purposes of Section 367(d). In fact, Treasury Regulation 1.367(d)-1T(b) specifically excludes these items from 367(d).
Through the proposed regulations, Treasury is suggesting three fundamental changes that would limit a taxpayer’s ability to claim the active trade or business exception. The first change made by the proposed regulations removes the language that excludes foreign goodwill and going concern from Section 367(d). Second, the proposed regulations limit the types of property eligible for the 367(a)(3) active trade or business exception by specifically providing the types of assets covered by the exception. Notably absent from the list of qualifying assets is foreign goodwill and going concern. The third change allows the U.S. transferor to decide if the transfer of foreign goodwill or going concern, or any other intangible property, will be taxed under section 367(a) or section 367(d). If 367(a) treatment is elected, the taxpayer will be subject to a one-time gain at the time of contribution. If 367(d) treatment is elected, the taxpayer will be subject to annual income inclusions for the useful life of the property, which represents another significant policy change. The current regulations under 367(d) limit the period of recognition to the lesser of the useful life of the property or 20 years. The proposed regulations eliminate the 20-year limit, effectively making the income stream indefinite. There also are proposed conforming regulations that require taxpayers to disclose the treatment elected as either 367(a)(1) or 367(d).
Although the regulations only are proposed and currently are not required to be followed, if the regulations are adopted as currently written, a simple branch incorporation occurring after Sept. 14, 2015, may subject the taxpayer to significant tax expense related to the foreign goodwill and going concern value. Taxpayers should consider the implications of the proposed regulations on any proposed check-the-box elections and Section 351 contributions.