outbound transfers & section 367...– section 91(a) relies on the same definition of...
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OUTBOUND TRANSFERS & SECTION 367
A LOOK AT KEY CHANGES
AFTER TAX REFORM
OR
CAN I STILL CHECK THE
BOX ON MY FOREIGN
BRANCH?
MAY 2018
velaw.com
SECTION 367(a) ISSUES
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GENERAL RULESSECTION 367(a) ISSUES
• As a result of the CTB election, US Parent is treated as
contributing all of the assets and liabilities of Foreign Branch
to a new foreign corporation.
• This would generally be a section 351 transaction, subject
to section 367. Section 367(a) generally provides that for
purposes of determining the extent to which gain is
recognized in connection with any outbound transfer under
sections 332, 351, 354, 356, or 361, the transferee foreign
corporation is not considered to be a “corporation.”
• As a result, US Parent would generally recognize any gain
on the outbound transfer of the property.
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes
Foreign
Branch
US Parent
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ACTIVE TRADE OR BUSINESS EXCEPTION BEFORE TAX REFORMSECTION 367(a) ISSUES
Foreign
Branch
US Parent
• If Foreign Branch operates an active trade or business
outside of the United States, prior to tax reform, certain of its
assets would generally be eligible for the exception to the
general gain recognition rule under section 367(a)(3)(A).
– Property was generally eligible for the active trade or business
exception unless specifically excluded.
– Specifically excluded property included inventory and copyrights,
installment obligations, accounts receivable, foreign currency,
intangible property under section 936(h)(3)(B), and certain leased
property.
• Under proposed regulations issued in 2015 and final
regulations issued in 2016, the Treasury limited this
exception by providing an exclusive list of property eligible
for the exception.
– Eligible property was defined to mean tangible property, working
interests in oil and gas property, and certain financial assets (cash
equivalents, securities, commodities positions, and notional
principal contracts).
– Eligible property excluded, however, inventory, installment
obligations, accounts receivable, certain property giving rise to
section 988 transactions, and certain leased property.
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch operates an active trade or
business
Active Trade or
Business
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NO ACTIVE TRADE OR BUSINESS EXCEPTION AFTER TAX REFORMSECTION 367(a) ISSUES
Foreign
Branch
US Parent
• Tax reform eliminated the active trade or business
exception.
• Therefore, as a general matter, outbound transfers of
tangible property are now subject to tax under section 367.
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch operates an active trade or
business
Active Trade or
Business
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BRANCH LOSS RECAPTURE BEFORE TAX REFORMSECTION 367(a) ISSUES
Foreign
Branch
US Parent
• If Foreign Branch’s business has generated losses, it may
have to recapture such losses, even if the assets
transferred would otherwise qualify for the active trade or
business exception.
• The branch loss recapture rule under former section
367(a)(3)(C) generally required the US transferor to include
in income an amount equal the lesser of:
– The aggregate amount of gain realized with respect to the
transferred foreign branch assets, or
– The sum of any branch losses that were deductible by the US
transferor, minus the following amounts:
o any taxable income of the branch incurred in taxable years
after the year of the loss through the year of the transfer, and
o any amount recognized under the overall foreign loss rules
under section 904(f).
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch operates an active trade or
business
Active Trade or
Business
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BRANCH LOSS RECAPTURE AFTER TAX REFORM – NEW SECTION 91SECTION 367(a) ISSUES
Foreign
Branch
US Parent
• Under new section 91, if US Parent is required to include
the “transferred loss amount” with respect to Foreign
Branch.
– Section 91(a) relies on the same definition of “branch” as applied
for former section 367(a)(3)(C).
– It applies to transfers to a “specified 10-percent owned foreign
corporation,” i.e., generally any foreign corporation with respect to
which a US corporate transferor is a United States shareholder
after the transfer. This is the same definition that applies for
purposes of the dividends received deduction under new section
245A.
• Any gain taken into account under section 91(a) is treated
as US-source income.
• The gain results in basis adjustments to the stock of the
foreign corporation in the US transferor’s hands and the
assets transferred in the foreign corporation’s hands.Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch operates an active trade or
business
Active Trade or
Business
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BRANCH LOSS RECAPTURE AFTER TAX REFORM – NEW SECTION 91SECTION 367(a) ISSUES
Foreign
Branch
US Parent
• The “transferred loss amount” generally equals:
– the sum of all losses incurred after December 31, 2017 and before
the transfer that were deductible by the transferor,
– minus the following amounts:
o any taxable income of the branch incurred in taxable years
after the year of the loss through the year of the transfer,
o any amount recognized under the overall foreign loss rules
under section 904(f), and
o except to the extent taken into account under section 904(f),
any gain recognized on the transfer. Under a transition rule,
this amount is reduced by the amount of gain which would be
recognized under section 367(a)(3)(C) with respect to losses
incurred before January 1, 2018.
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch operates an active trade or
business
Active Trade or
Business
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BRANCH LOSS RECAPTURE AFTER TAX REFORM – NEW SECTION 91SECTION 367(a) ISSUES
• Before tax reform, the built-in gain on the transfer of trade or business assets was generally not
recognized, but the loss deduction was recaptured to the extent of that gain.
• Under the new law, the built-in gain is recognized, and the loss is not recaptured to the extent of the
gain recognized.
EXAMPLE
– There is $100 of built-in gain in tangible assets used in Foreign Branch’s active trade or business (assume all of its
assets are eligible for the active trade or business exception under prior law)
– Foreign Branch has $75 of losses from 2017 and $150 of losses from 2018, and no income
OLD Rule –
367(a)(3)(C)
NEW Rule –
Section 91
Gain recognized on transfer of trade or business assets - 0 - $100
Total branch losses $225
Post-2017 losses $150
Less: gain recognized on transfer, as reduced by pre-2018
losses under transition rule
($100 - $75) =
($25)
Branch Loss Recapture $100 $125
Total Amount Recognized upon CTB Election $100 $225
SECTION 367(d) ISSUES
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GENERAL RULESSECTION 367(d) ISSUES
Foreign
Branch
US Parent
• If Foreign Branch has intangible property, section 367(d)
generally applies in lieu of section 367(a).
– “Intangible property” is defined by reference to section 936(h)(3)(B).
Before tax reform, this meant:
o a patent, invention, formula, process, design, pattern or know-how,
o copyright, literary, musical or artistic composition,
o trademark, trade name, or brand name,
o franchise, license, or contract,
o method, program, system, procedure, campaign, survey, study, forecast,
estimate, customer list, or technical data, or
o any similar item which has substantial value independent of the services of
any individual.
• Under section 367(d), US Parent would generally be treated
as having sold the intangible property in exchange for
payments that are contingent upon the productivity, use, or
disposition of the property over the useful life of the
property.
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch has foreign IP
IP
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FORMER FOREIGN GOODWILL EXCEPTIONSECTION 367(d) ISSUES
Foreign
Branch
US Parent
• Before new regulations were finalized in 2016, the
regulations generally provided that section 367(d) applies to
the transfer of any intangible property, but not to the transfer
of foreign goodwill or going concern value.
– For this purpose, the following definition in section 1.367(a)-
1T(d)(5)(iii) applied:
Foreign goodwill or going concern value is the residual value of a
business operation conducted outside of the United States after all
other tangible and intangible assets have been identified and
valued. For purposes of section 367 and regulations thereunder
the value of the right to use a corporate name in a foreign country
shall be treated as foreign goodwill or going concern value.
• Taxpayers could take the position that either:
– Foreign goodwill and going concern value were not section
936(h)(3)(B) intangible property, so section 367(d) did not apply,
and section 367(a) did not apply because such property was thus
also eligible for the active trade or business exception; or
– Foreign goodwill and going concern value were section
936(h)(3)(B) intangible property, and thus section 367(d) and not
section 367(a) applied, but such property was eligible for the
foreign goodwill exception from section 367(d).
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch has goodwill
Goodwill
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FORMER FOREIGN GOODWILL EXCEPTIONSECTION 367(d) ISSUES
Foreign
Branch
US Parent
• Treasury issued proposed regulations in 2015 and final
regulations in 2016 that eliminated the foreign goodwill
exception and, as discussed above, limited the scope of
property that is eligible for the active trade or business
exception generally to certain tangible property and financial
assets.
– The revised definition of intangible property under the final
regulations provides that “’intangible property’ means either
property described in section 936(h)(3)(B) or property to which a
U.S. person applies section 367(d) pursuant to paragraph (b)(5) of
this section, but does not include property described in section
1221(a)(3) or a working interest in oil and gas property.
– U.S. transferors were permitted to elect for intangible property not
described in section 936(h)(3)(B) (or property with respect to which
the application of section 936(h)(3)(B) was unclear and unsettled,
such as goodwill and going concern value) to be taxed under
either section 367(a) or 367(d).
• Accordingly, upon an outbound transfer of foreign goodwill
or going concern value, a US Parent would be subject to
either current gain recognition under section 367(a)(1) or
the tax treatment provided under section 367(d).
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch has goodwill
Goodwill
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FORMER FOREIGN GOODWILL EXCEPTIONSECTION 367(d) ISSUES
Foreign
Branch
US Parent
• However, noting that commenters on the regulations had
cited legislative history that contemplated active business
exceptions, the Treasury subsequently announced in 2017
work on expanding the scope of the active trade or business
exception to include outbound transfers of foreign goodwill
and going-concern “under circumstances with limited
potential for abuse and administrative difficulties, including
those involving valuation.”
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch has goodwill
Goodwill
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TRANSFERS OF INTANGIBLES AFTER TAX REFORMSECTION 367(d) ISSUES
Foreign
Branch
US Parent
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch has goodwill and foreign IP
Goodwill
+ IP
• Intangible property subject to section 367(d) now explicitly
includes foreign goodwill and going-concern value and also
an expanded catch-all provision. Now set forth in section
367(d)(4), such property includes:
– goodwill, going concern value, or workforce in place
(including its composition and terms and conditions
(contractual or otherwise) of its employment) or
– other item the value or potential value of which is not
attributable to tangible property or the services of any
individual.
• The amendment also removed the flush language of former
section 936(h)(3)(B), which had previously limited that
section to intangibles with substantial value independent of
the services of any individuals.
• The Conference Report notes that the change was intended
to address “recurring definitional and methodological issues”
under both sections 367(d) and 482.
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GENERAL RULESSECTIONS 367(d) & 482
Foreign
Branch
US Parent
• Deemed royalty income from a transferred intangible under
section 367(d) must be “commensurate with the income
attributable to the intangible.”
– The temporary regulations under section 367(d) provide that the
deemed royalty income must be in an amount that “represents an
appropriate arms-length charge for the use of the property” as
“determined in accordance with the provisions of section 482 and
regulations thereunder.”
• Likewise, section 482 provides that any transfer or license
of intangible property between controlled entities must be
“commensurate with the income attributable to the
intangible.”
– Section 367(d) does not apply to an actual sale or license of an
intangible by a US person to a foreign corporation.
– Section 482 only applies to all transfers of rights to use intangible
assets between controlled entities, while section 367(d) applies to
a transfer of property subject to section 351 or section 361.Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch has goodwill and foreign IP
Goodwill
+ IP
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AFTER TAX REFORMSECTIONS 367(d) & 482
Foreign
Branch
US Parent
• After tax reform, the IRS has more leeway and authority in
valuing the outbound transfer of intangibles.
• New section 367(d)(2)(D) and new language added to the
end of section 482 both provide that the IRS can, if it
determines it to be the “most reliable means of valuation of
such transfers”:
– require the valuation of transfers of intangible property, including
intangible property transferred with other property or services, on
an aggregate basis, or
– require the valuation of such a transfer on the basis of the realistic
alternatives to such a transfer.
• The Conference Report indicates that the provisions are not
intended to “modify the basic approach of the existing
transfer pricing rules with regard to income from intangible
property” but that they do grant authority under section 367
to use aggregate basis valuation and the realistic alternative
principle.
– The existing section 482 regulations provide that transactions may
be aggregated in “appropriate circumstances,” and that the arm’s
length determination can take into account “alternatives available
to the taxpayer.”
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch has goodwill and foreign IP
Goodwill
+ IP
SECTION 367 & FDII
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AFTER TAX REFORMSECTION 367 & FDII
Foreign
Branch
US Parent
• New section 250 generally provides for a 37.5 percent
deduction that would reduce the effective rate of tax to
13.125 percent on “foreign-derived intangible income.”
• For FDII to apply, income has to qualify as “foreign-derived
deduction eligible income” (“FDDEI”), which arises when:
– property is sold to a foreign person for foreign use, or
– services are provided to any person, or with respect to property,
not located in the United States.
• Because a “sale” for this purpose includes any “lease,
license, exchange, or other disposition,” it is possible that
gain or inclusions resulting under section 367 from
outbound transfers may be considered FDII.
– FDII can still apply if income is derived through a transaction with a
related foreign party, as would likely be the case in a section
367(a) or (d) transfer. There are, however, heightened standards
for establishing “foreign use” for related party sales.Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch has goodwill and foreign IP
Goodwill
+ IP
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AFTER TAX REFORMSECTION 367(d) & FDII
Foreign
Branch
US Parent
• However, to qualify for FDII, the income cannot be “foreign
branch income,” as defined under new section 904(d)(2)(J).
– Under section 904(d)(2)(J), foreign branch income is “business
profits” that are attributable to one or more qualified business units
in one or more foreign countries.
– It is not clear what the scope of “business profits” will be – e.g.,
whether business profits are limited to ordinary course income or
gain derived by the branch, or whether they include gain from a
disposition of the entire branch.
Foreign Branch elects to be treated
as a corporation for US federal
income tax purposes; Foreign
Branch has goodwill and foreign IP
Goodwill
+ IP
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There may be future guidance or other information that modifies the foregoing discussion. Further, the foregoing
discussion is not intended to constitute formal tax advice by Vinson & Elkins. We have necessarily simplified our
consideration of the applicable provisions and limited our consideration of potential issues. Accordingly, any definitive
advice can only be provided by fully considering the specific facts applicable to a given structure, transaction, or
situation, as well as the full range of potentially applicable U.S. federal income tax authorities.
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The hallmark of Vinson & Elkins’ International Tax practice is the ability to handle the complexities of internationaltaxation in a practical, commercial manner. We represent foreign and domestic clients across a broad range ofindustries, including energy, finance, technology, and real estate. Our team has broad tax structuring and litigationexperience in key areas of international tax, transfer pricing, corporate reorganizations, and partnership law.Whether structuring new “inbound” or “outbound” investments or advising on the U.S. or UK tax aspects of cross-border transactions, we are equipped to handle the most sophisticated transactions. With V&E’s decades ofexperience handling matters around the globe, we are able to provide creative and practical solutions to emerginginternational tax issues.
V&E's services encompass a broad spectrum of international tax planning, including:
• Formations of new financing and ownership structures
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• Expansions into new markets
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• Transfer pricing planning and implementation
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