Immediate Taxation of Intangible Property Transfers Under Outbound, Type F Reorganizations
Through recent Legal Advice Issued by Field Attorneys (“LAFA 20152104F“), the IRS affirmed the applicability of Code § 367(d) to the transfer of intangible property (“IP”) when occurring as part of outbound type F reorganizations as defined under Code § 368(a)(1)(F). The transferor of the IP was deemed to have made an indirect disposition that triggered the recognition of a lump-sum gain under Code § 367(d)(2)(A)(ii)(II) upon liquidation of the transferor. The gain was calculated using a value for the IP on the date of the deemed indirect disposition.
Code § 368(a)(1)(F)
Code § 368(a)(1)(F) defines type F reorganizations as those in which only a “mere change in identity, form or place of organization of one corporation, however effected” occurs. When a U.S. corporation uses a type F reorganization to become a foreign corporation, the reorganization is referred to as an outbound, type F reorganization.
Regulation § 1.367(a)-1T(f) defines three steps that are deemed to occur under outbound, type F reorganizations. They are as follows:
- A domestic corporation (the U.S. transferor) transfers assets to a foreign corporation (the foreign acquiror) in exchange for stock or securities of the foreign acquirer and the assumption of the transferor’s liabilities by the foreign acquiror. The assets that are transferred may include IP. The exchange occurs pursuant to § 361(a) and; consequently, no recognition of gain or loss occurs due to the exchange.
- The stock or securities of the foreign acquirer that are received by the transferor are distributed to the shareholders of the U.S. transferor.
- The U.S. transferor’s shareholders transfer their stock and securities in the U.S. transferor to the U.S. transferor.
As a result of steps two and three above, the domestic corporation ceases to exist. Its operations continue under the foreign acquirer.
Code § 367
Code § 367 governs the transfer of property from the United States to a foreign acquirer and code § 367(d) specifies special rules that relate to the transfer of intangibles. These rules are designed to prevent the tax-free transfer abroad of intangible property that would have otherwise generated U.S. tax and that may have been developed using U.S. tax incentives for research. The intangible property covered under § 367(d) is defined by Code § 936(h)(3)(B) and includes patents, inventions, processes, know-how, copyrights, trademarks, franchises, licenses, contracts, customer lists, technical data or similar items.
According to Code § 367(d)(2)(A)(ii)(I), the transfer abroad of intangible property by a U.S. person will be considered to have been sold in exchange for an annual stream of payments that are based upon the productivity, use or disposition of the intangible property. The annual stream of payments is considered to occur over the useful life of the transferred property. However, according to Code § 367(d)(2)(A)(ii)(II) if the foreign transferor disposes, directly or indirectly, the intangible property after its transfer by the U.S. transferor, then the transferor is required to recognize a lump-sum gain at the time of the disposition based on the value of the IP at the time of the disposition and that value must reflect the income attributable to the intangible.
LAFA 20152104F
LAFA 20152104F pertains to an outbound, type F reorganization. The shareholder of the U.S. transferor is a foreign person and the shareholder is not related to the U.S. transferor.
In the LAFA, the IRS notes that in an outbound, type F reorganization, the U.S. transferor liquidates upon distribution of its stock and securities in the foreign acquiror to its shareholders in exchange for their stock in the U.S. transferor. As the U.S. transferor no longer exists, the U.S. transferor does not have the ability to collect a future stream of deemed royalty payments subject to U.S. tax. Consequently, the Service concludes, that the outbound, type F reorganization creates an indirect disposition of the intangible property by the foreign acquirer and that the indirect disposition results in a taxable lump-sum payment to the U.S transferor. The tax liability pertains to the year in which the U.S. transferor ceases to exist.
If you have any questions the tax implications of cross-border corporate actions, please contact a Withum professional, a member of our International Services Group or email us at [email protected].
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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
