The purpose of section 367(b) in the context of an inbound section 332 liquidation or section 368 reorganization (inbound asset transfer) is to ensure that the domestic acquiring corporation (or domestic shareholder of the domestic acquiring corporation in the case of certain inbound reorganizations) does not get the benefit of the tax attributes of the foreign acquired corporation (e.g., transferred asset basis) without US taxation of the earnings that gave rise to those attributes. Thus, under Treas. Reg. § 1.367(b)-3, the domestic acquiring corporation in an inbound liquidation, or a domestic shareholder of the domestic acquiring corporation in the case of certain inbound reorganizations, is generally required to include in gross income as a deemed dividend the “all earnings and profits amount” with respect to the foreign acquired corporation.
Prior to the enactment of tax reform, the required inclusion of the all earnings and profits amount made many inbound asset transfers cost prohibitive because the deemed dividend would be fully taxable in the United States. Like many things, that landscape has changed due to tax reform, particularly (i) the imposition of a one-time toll charge on deferred foreign income under section 965; (ii) the imposition of a minimum residual US tax on above-routine earnings of a controlled foreign corporation, referred to as global intangible low-taxed income (GILTI); and (iii) the introduction of a participation exemption regime under section 245A have significantly altered section 367(b)’s operation in the context of inbound asset transfers.
Specifically, the all earnings and profits amount of a foreign corporation excludes, among other things, previously taxed income. Since in many cases section 965 will have converted all of a foreign corporation’s accumulated pre-tax reform earnings into previously taxed income, such earnings will not be taxed under Treas. Reg. § 1.367(b)-3 upon an inbound asset transfer. Further, for tax years following the section 965 inclusion year, a foreign corporation’s all earnings and profits amount will typically be limited to non-Subpart F and non-GILTI earnings. Although these earnings will still be included in the gross income of the domestic acquiring corporation as a deemed dividend, the domestic acquiring corporation may be entitled to a full deduction with respect to such a deemed dividend under new section 245A (provided the threshold holding period and other requirements are satisfied). Thus, post-tax reform, the only portion of the earnings of a foreign corporation potentially taxable on an inbound asset transfer under section 367(b) would be those earnings which were neither subject to the toll charge nor previously taxed under Subpart F or GILTI and which do not qualify for the participation exemption under section 245A (e.g., if the inbound asset transfer occurs before the required holding period under sections 245A and 246(c) is satisfied). Consequently, an inbound asset transfer that was cost-prohibitive prior to tax reform may now potentially be undertaken with minimal or no US taxation.
In addition, inbound asset transfers generally may qualify as tax-free transactions under regular subchapter C principles, such as the rules applicable to tax-free liquidations or tax-free reorganizations. As a result, inbound asset transfers may be a particularly attractive avenue for taxpayers looking to repatriate intellectual property or other property to the United States without recognizing built-in gain in the property, as would occur if property were merely distributed to a US shareholder in a section 301 distribution (and such gain may give rise to subpart F income or “tested income” for purposes of the GILTI provisions).
Taxpayers will, of course, need to examine the full gamut of potential US federal income tax considerations in evaluating a potential inbound asset transfer. For example, if the acquired foreign corporation operates a business directly or owns a foreign disregarded entity, a foreign branch of a domestic corporation would generally be created, the taxes of which would fall under the new foreign branch income basket for foreign tax credit purposes. Also, while a taxpayer may be entitled to a full deduction under new section 245A on the deemed dividend of the all earnings and profits amount upon an inbound asset transfer, gain may nevertheless be recognized if the dividend qualifies as extraordinary under section 1059, the stock has not been held by the domestic corporation for more than two years, and the basis adjustments required under that section exceed available basis. In addition, bringing assets inbound to the US tax net, even if achieved on a tax-free basis, may be a more difficult decision to reverse going forward; changes under tax reform to section 367(a) and section 367(d) make taking assets outbound from a US person to a foreign corporation more costly. On the other hand, bringing valuable assets into the United States may have material—and complex—impact on a company’s GILTI, foreign-derived intangible income, and base erosion anti-abuse tax calculations, all of which need to be modeled in analyzing a potential inbound asset transfer.