On May 2, 2023, the Internal Revenue Service (IRS) issued proposed regulations (REG-124064) under Section 367(d) that address repatriations of intangible property to the United States. The proposed regulations terminate the application of Section 367(d)’s annual inclusion if the transferee foreign corporation repatriates the intangible property to a qualified domestic person.
BACKGROUND: SECTION 367(D)
Section 367(d) generally addresses outbound transfers of intangible property to a foreign corporation. It treats a US transferor that transfers intangible property subject to Section 367(d) as having sold the intangible property in exchange for payments that are contingent on the productivity, use or disposition of the intangible property.
The US transferor is treated as receiving amounts that reasonably reflect the amounts that would have been received annually in the form of such payments over the useful life of the intangible property or, in the case of a direct or indirect disposition of the intangible property following the transfer, at the time of the disposition. The earnings and profits of the transferee foreign corporation are reduced by the amount of the Section 367(d) inclusion, and the deemed payment is an expense that reduces the transferee foreign corporation’s subpart F income and tested income.
Section 367(d) regulations provide special “subsequent transfer” rules that apply if the US transferor transfers the stock of the transferee foreign corporation or the transferee foreign corporation transfers the intangible property. These rules depend on whether the transfer is to a US or a foreign person and whether it is to a related or an unrelated person. If the transferee foreign corporation stock or the intangible property is transferred to an unrelated person, the transfer generally is treated as a disposition of the intangible property that triggers a lump sum Section 367(d) inclusion. If the transferee foreign corporation stock is transferred to a related US person, the related US person begins taking into account a proportionate share of the annual Section 367(d) inclusion. If the intangible property is transferred to a related person (either US or foreign), the Section 367(d) inclusions continue, and the recipient of the intangible property is treated as the transferee foreign corporation.
PROPOSED REGULATIONS: REPATRIATIONS OF 367(D) INTANGIBLE PROPERTY
Under existing Section 367(d) regulations, a taxpayer who repatriates to the United States intangible property that was previously transferred outbound subject to Section 367(d) (for example, in order to take advantage of the lower tax rate for foreign-derived intangible income) faces the possibility that Section 367(d) could continue to apply. Because the existing regulations do not distinguish between subsequent transfers of intangible property made to a related US or foreign person, there are concerns that in some cases a US transferor may be required to continue recognizing an annual inclusion (potentially without an offsetting deduction) even if the subsequent transfer is to a related US person who will recognize the income derived from the intangible property.
The proposed regulations provide clarity for taxpayers who repatriate to the United States intangible property that was previously transferred outbound in a Section 367(d) transaction. In particular, the regulations terminate the application of Section 367(d) if the transferee foreign corporation repatriates the intangible property to a qualified domestic person and the domestic person satisfies certain reporting requirements.
The proposed regulations require the US transferor of the intangible property to recognize gain in certain circumstances. There are different gain recognition rules depending on whether the intangible property is a transferred basis property (i.e., property in which the US transferee’s basis is determined by reference to the transferor foreign corporation’s basis in the property, as would be the case if the intangible property were repatriated in a nonrecognition transaction).
If the intangible property is a transferred basis property, the transferor foreign corporation recognizes gain (if any) it would recognize under Subchapter C rules. The amount of gain recognized could be zero (for example, if the repatriation transaction is a Section 332 liquidation) or positive (for example, if the repatriation transaction is a Section 351(b) transaction). The US transferee receives the intangible property with a basis equal to the basis the original US transferor of the property had immediately prior to the original outbound transfer (or, if lower, the basis the transferee foreign corporation had in the property), plus the amount of gain recognized on the repatriation.
If the intangible property is not a transferred basis property (for example, because the intangible property is repatriated in a sale or in a distribution to which Section 311(b) applies), the original US transferor of the intangible property recognizes gain equal to the excess of the fair market value of the intangible property at the time of the repatriation over the original US transferor’s adjusted basis in the property at the time of the original outbound transfer. The US transferee receives the intangible property on a fair market value basis.
Special rules apply if the intangible property is transferred in two or more related transactions or if there were multiple original US transferors.
The proposed regulations reduce the transferee foreign corporation’s earnings and profits (but not below zero) by the gain the US transferor recognizes under the gain recognition rule. The US transferor can receive from the transferee foreign corporation an amount equal to the gain recognized without any further tax consequences under an accounts receivable mechanism provided by current regulations.
Many taxpayers have made prepayments of Section 367(d) amounts. The proposed regulations do not provide specific rules to account for Section 367(d) prepayments in the original outbound intangible property transfer. Accordingly, it appears that the same mechanisms apply without regard to whether there was a prepayment in the original outbound transaction. Failure to account for prepayments creates a possibility that Section 367(d) inclusions taken into account by the original US transferor (including due to the prepayment) may exceed the deductions allowed to the transferee foreign corporation.
PROPOSED REGULATIONS: OTHER ISSUES
The proposed regulations address a few other issues besides repatriations of intangible property to the United States. For one, they clarify that the transferee foreign corporation’s earnings and profits reduction must be allocated and apportioned to classes of gross income under the applicable rules under Sections 882, 954 and 960 rather than solely being allocated to subpart F income or tested income.
The proposed regulations also provide that the subsequent transfer rules, including the repatriation rules described in the proposed regulations, do not apply for purposes of determining the amount of foreign branch income under Section 904. Accordingly, if there were a transfer of intangible property that reallocated income between the foreign branch income category and the general category for purposes of the Section 904 foreign tax credit limitation and that intangible property was further transferred, the subsequent transfer would not cause the reattribution of income for Section 904 purposes to cease.
In the preamble, the IRS acknowledges that there is uncertainty regarding the treatment of adjusted basis in intangible property subject to Section 367(d). For example, there may be uncertainty regarding the basis of intangible property transferred outbound in a transaction to which Section 367(d) applied and gain is recognized (e.g., due to the presence of boot in the original transaction). The proposed regulations do not address this issue but indicate that it will be addressed in future rulemaking.
The rules in the proposed regulations will be effective for transfers of intangible property occurring on or after the date the IRS finalizes the proposed regulations. The proposed regulations do not include a provision allowing taxpayers to rely on them before final regulations are issued, but government officials have indicated that they would consider more flexible approaches in the final regulations.
The proposed regulations respond to concerns that there could be excessive taxation on repatriations of intangible property to the United States. The proposed regulations terminate the application of Section 367(d) if intangible property is transferred to a qualified domestic person, subject to reporting requirements being satisfied. Overall, the proposed regulations provide welcome clarity to repatriations of intangible property and ensure that taxpayers are not subject to excessive taxation.