Overview
In December 2016, the US Treasury Department and the IRS issued final regulations under section 367, regarding the treatment of transfers of certain property to foreign corporations. As foreshadowed in the proposed regulations issued in September 2015, the IRS changed the law so that transfers of foreign goodwill and going concern value are taxable. The final regulations are a departure from 30 years of IRS guidance. Further, Congress itself explicitly stated when it enacted the statute that such transfers ordinarily should be tax free.
In general, section 367(a) prevents transactions involving the transfer of property from a US person to a foreign corporation from being treated as tax-free under certain nonrecognition provisions under the Internal Revenue Code (the Code). However, section 367(a)(3) provides an exception for property transferred to a foreign corporation for use by the foreign corporation in the active conduct of a trade or business outside of the United States (the ATB exception). In addition, transfers of certain intangible property generally are treated under special rules as a deemed sale of the intangible property in exchange for a continuing deemed annual royalty. Intangible property generally is not eligible for the ATB exception.
Section 367(d) was enacted by the Deficit Reduction Act of 1984 (the Act). The House committee report for the Act states that “ordinarily, no gain will be recognized on the transfer of goodwill or going concern value for use in an active trade or business.” The Joint Committee on Taxation’s explanation of the Act states that (except in the case of an incorporation of a foreign loss branch, where other rules apply) “the Congress did not believe that transfers of goodwill, going concern value, or certain marketing intangibles should be subject to tax.” Implementing this congressional intent, temporary regulations, issued in 1986 and still in effect until they were withdrawn by the final regulations, provided that the special rules of section 367(d) did not apply to foreign goodwill or going concern value (the 367(d) regulatory exception).
Some taxpayers took the position that section 367(a) and section 367(d) did not apply to transfers of foreign goodwill and going concern value, relying on the ATB exception and the 367(d) regulatory exception. However, the 2015 regulations proposed changing the treatment of foreign goodwill and going concern value by narrowing the scope of the ATB exception and eliminating the 367(d) regulatory exception. The final regulations adopted this approach and, as a result, outbound transfers of foreign goodwill and going concern value generally will be taxable.
The public filed numerous substantive comments pointing out many flaws in the proposed regulations from a legal and practical perspective. Taxpayers may pursue a court challenge under Altera, arguing that Treasury and the IRS failed to grapple adequately with those substantive comments as required by the Administrative Procedures Act.
It appears that the IRS rushed to finalize these controversial regulations before January 20, knowing that the Trump Administration would be unlikely to approve an IRS regulation increasing the tax burden on corporate taxpayers. These final 367 regs are precisely the sort of ‘midnight regulations’ that Congress and the Trump Administration have signaled will be scrutinized closely. It is reasonable to expect the new Administration's Treasury appointees will carefully consider reversing these regulations, particularly given that the regulations contradict explicit Congressional intent.
