Final § 367 Regulations Eliminate Favorable Tax Treatment of Foreign Goodwill and Going-Concern Value
In December 2016, the Internal Revenue Service (IRS) issued final regulations under § 367 that now tax the transfer of certain intangible property - foreign goodwill and going concern value - transferred from a U.S. person to a foreign corporation under a nonrecognition provision (e.g., § 351). For example, the re-structuring of foreign branch operations into a foreign corporation would be subject to these new rules. Foreign goodwill and going concern value were previously excepted from § 367 and, not surprisingly, these final regulations received significant critical feedback during their proposal phase. In its view, the IRS has taken these necessary measures in an effort to curb aggressive tax positions in this area. We encourage readers to coordinate with their tax advisors on any recent transactions involving foreign corporations because the range of potentially taxable transactions under § 367 has now widened.
In general, § 367(a) mandates immediate gain recognition on an otherwise tax-free transfer of property by a U.S. person to a foreign corporation. Property used in the active conduct of a trade or business (ATB) outside of the United States is excluded from §367(a) treatment if the property is to be used by the foreign corporation in an active trade or business abroad. However, this broad ATB exception is not applicable to certain property designated in the Internal Revenue Code (e.g., inventory, accounts receivable). Furthermore, intangible property is not subject to the rules of § 367(a), but subject to § 367(d).
Per § 367(d), the transfer of intangible property (defined under § 936(h)(3)(B)) by a U.S. transferor to a foreign corporation, in an otherwise tax-free exchange, is treated as a sale of the of the intangible and gain is recognized in the transferor’s income over the useful life of the property. Prior to the recent regulations, foreign goodwill or going concern value were treated favorably and not subject to § 367(d) treatment.
Now, with the final regulations in effect, transfers of goodwill and going concern value are no longer favorably treated and thereby potentially subject to taxation under § 367(a), which requires immediate gain recognition upon transfer, or § 367(d), which provides for gain recognition over the life of the property transferred. Thus, the incorporation of a foreign branch or the check-the-box election to change the entity classification of a branch or partnership into a foreign corporation would give rise to potentially adverse tax consequences.
The final regulations are complex and also impact other facets of § 367, such as the treatment of foreign currency in the context of the ATB exception. Accordingly, the above does not constitute a comprehensive analysis of the final regulations and readers with multinational operations are strongly encouraged to consult with their tax advisors to determine the impact of these final regulations on their specific situation. We predict this area will generate significant controversy going forward. The final regulations generally apply to transfers occurring on or after September 14, 2015, and to transfers occurring September 14, 2015, resulting from entity classification elections that were filed on or after September 14, 2015 (which resulted in constructive transfers of property under § 367).