Treasury and IRS Propose Regulations to Eliminate Tax-Free Outbound Transfer of Foreign Goodwill

International Tax Alert
09.21.15

On Monday, September 14, 2015, the Treasury Department (Treasury) and the Internal Revenue Service (IRS) released proposed regulations that would eliminate the favorable treatment under section 367 of the outbound transfer of active trade or business assets other than certain fixed and financial assets. As a result, in a significant departure from longstanding policy, any built-in gain attributable to foreign goodwill and going concern value will be subject to tax. A U.S. transferor of foreign goodwill or going concern value would be subject to either deemed royalty treatment under section 367(d) or current gain recognition under section 367(a). If the proposed regulations are finalized, the rules generally would be effective for transfers occurring on or after September 14, 2015, the date the proposed regulations were promulgated. Accordingly, taxpayers must consider the proposed regulations when evaluating the tax consequences of certain outbound transactions, such as the incorporation of foreign branch operations. The comment period runs until December 15, 2015, and the IRS requests comments on all aspects of the proposed regulations, especially on whether a "limited exception" to the proposed elimination of the goodwill exception should be provided in final regulations.

On September 14, Treasury and the IRS also released temporary regulations clarifying the interaction of section 482's best method rule and the arm's length standard with other Code provisions. In addition, the temporary regulations address the aggregation of multiple transactions to determine whether the overall consideration is consistent with the value provided, including any synergies between items.

Current Law

Section 367(a) provides rules for the taxation of outbound transfers of property by U.S. persons to foreign corporate transferees in transactions that would otherwise qualify for nonrecognition treatment. In general, section 367(a)(1) suspends the nonrecognition of gain on transfers to foreign corporations, subject to several exceptions. Under the active trade or business exception in section 367(a)(3), except as provided in regulations, if an asset is transferred to a foreign corporation for use by that corporation in the active conduct of a trade or business outside of the United States, then section 367(a)(1) does not apply, and the normal nonrecognition rules apply. All property is eligible for the active trade or business exception unless the property is specifically excluded. Certain intangible property is not eligible for the active trade or business exception and is instead subject to taxation under section 367(d).

Section 367(d) imposes U.S. tax on certain outbound transfers of intangible property by treating the U.S. transferor as if it sold the intangible property in exchange for annual payments contingent upon the productivity, use or disposition of the property, with the amount of this deemed royalty commensurate with the income attributable to the intangible. Section 367(d) defines intangible property by reference to the list of property in section 936(h)(3)(B). The current regulations (first promulgated in 1986) exclude the transfer of foreign goodwill or going concern value from the application of section 367(d), based on the legislative history of section 367(d). For these purposes, foreign goodwill and going concern value equal the residual value of a foreign business operation after all other tangible and intangible assets have been valued. As a consequence of the regulatory exclusion, a U.S. person that transfers assets to a foreign corporate transferee may achieve nonrecognition treatment for built-in gain attributable to foreign goodwill and going concern value.

Perceived Taxpayer Abuses of Current Regulatory Exception

According to the preamble of the proposed regulations, Treasury and the IRS have observed that certain taxpayers are "asserting that an inappropriately large share (in many cases, the majority) of the value of the property transferred [in outbound transactions] is foreign goodwill or going concern value that is eligible for favorable treatment under section 367." Specifically, certain taxpayers minimize the value of intangible property for which a deemed inclusion is required under section 367(d), "in a manner contrary to section 482," which, in turn, maximizes the residual value attributable to foreign goodwill and going concern value. Treasury and the IRS note that some taxpayers are interpreting foreign goodwill and going concern value in an excessively expansive fashion. For example, some taxpayers have asserted that value created through customer-facing activities occurring within the United States is foreign goodwill or going concern value.

Proposed Treatment of Foreign Goodwill and Going Concern Value

The proposed regulations remove the clause in Treas. Reg. § 1.367(d)-1T(b) that excludes foreign goodwill and going concern value from the application of section 367(d). Accordingly, to the extent foreign goodwill and going concern value is intangible property, its outbound transfer would therefore result in deemed royalty payments to the U.S. transferor under section 367(d).

Turning the current law approach on its head, the proposed regulations provide an exclusive list of property eligible for the active trade or business exception.1 Eligible property includes tangible property, working interests in oil and gas property and certain financial interests, with certain specific exclusions consistent with the current regulations (e.g., inventory). Foreign goodwill and going concern value is not included in the list of eligible property, and therefore cannot qualify for the active trade or business exception. Assuming that foreign goodwill and going concern value is not intangible property, its outbound transfer would therefore result in gain recognition to the U.S. transferor under section 367(a).

The proposed regulations expressly allow the U.S. transferor of foreign goodwill and going concern value to elect between gain recognition under section 367(a) or deemed royalty treatment under section 367(d). Specifically, a U.S. transferor may apply section 367(d) to a transfer of foreign goodwill and going concern value that would otherwise be subject to section 367(a). The preamble states that the proposed regulations purposely do not address whether foreign goodwill and going concern value is section 936(h)(3)(B) intangible property.

Additional Elements of Proposed Regulations

The proposed regulations would also eliminate the existing rule that limits the useful life of intangible property to 20 years and would instead provide that the useful life equals the entire period during which exploitation of the intangible property is expected to occur, as reasonably anticipated at the time of transfer. The preamble indicates that "useful life" would be determined "[c]onsistent with the guidance for cost-sharing arrangements" in the regulations under Treas. Reg. § 1.482-7. This proposal reflects an effort by Treasury and the IRS to conform all rules involving transfers of intangible property to recent guidance in the cost sharing context. The positions pursued by the IRS in this arena have been the subject of significant and ongoing controversy. See, e.g., Veritas Software Corp. v. Commissioner, 133 T.C. 297 (2009); nonacq., action on dec., 2010-05, at nn.3-4, (Nov. 12, 2010).

In addition, the proposed regulations eliminate the application of the active trade or business exception to property denominated in foreign currency that is acquired in the course of the business of the U.S. transferor that will be carried on by the transferee corporation. To promote accessibility, the proposed regulations consolidate the exceptions to the active trade or business exception into a single section. The proposed regulations leave at least one housekeeping item unaddressed. The proposed regulations do not modify the outdated regulation (Treas. Reg. § 1.367(d)-1T(c)(1)) requiring amounts included in income under section 367(d) to be treated as U.S. source, even though section 367(d) was amended in 1997 to source such amounts in the same manner as if the transferor sold the intangible property in exchange for contingent payments.

General Observations

If adopted, the proposed regulations would mark a substantial departure from established policy and would conflict with congressional intent as expressed in the legislative history to section 367(d). In 1984, Congress amended section 367(d) to provide an exception to the rule permitting a tax-free incorporation of a foreign active trade or business due to "specific and unique" problems associated with intangibles.2 In particular, Congress targeted "U.S. persons who take advantage of tax incentives for research" and then "transfer the fruits of research (intangibles) to foreign corporations that may use the intangibles free of any U.S. tax."3 This mismatch concern trumped the more general policy permitting a tax-free incorporation of a foreign active trade or business as an extension of the nonrecognition rules applicable in the domestic context. Congress did not view foreign goodwill and going concern value as giving rise to the mismatch of expenses and income that arose when certain types of intangible property were transferred outside of the United States, and therefore indicated that foreign goodwill and going concern value should be treated like other foreign active trade or business assets.4

The preamble to the proposed regulations acknowledges that Congress expected that regulations would prevent recognition of gain on the transfer of foreign goodwill or going concern value, but rejects the presumption on which this expectation was formed: "that the transfer of foreign goodwill or going concern value developed by a foreign branch to a foreign corporation was unlikely to result in abuse of the U.S. tax system." Given the ongoing "challenges in administering the transfer pricing rules," Treasury and the IRS concluded that any attempt to provide favorable treatment for the transfer of foreign goodwill "would be impractical to administer." In other words, because it has been difficult to differentiate between built-in gain attributable to section 936(h)(3)(B) intangible property (which is subject to tax under section 367(d)) and built-in gain attributable to foreign goodwill and going concern value (which historically has been accorded nonrecognition treatment), Treasury and the IRS have concluded that built-in gain attributable to both categories of property should be taxed. In effect, the proposed regulations would significantly broaden the application of section 367(a)(1) to avoid administrative challenges under the transfer pricing rules.


For further discussion of the history of the rules governing outbound transfers and the establishment of the exception for foreign goodwill and going concern value, see Layla J. Asali and Rocco V. Femia, Section 367(d), Intangibles, and Base Erosion: A Reassessment, Tax Management Memorandum (May 20, 2013).

1. The approach of the proposed regulations does not depend on the characterization of foreign goodwill and going concern value as "intangible property." Many taxpayers and commentators have taken the position that foreign goodwill and going concern value is not intangible property within the meaning of section 936(h)(3)(B), and therefore that it may be transferred tax-free to the extent the conditions of the active trade or business exception are met.

2. H.R. Rep. No. 98-432, Vol. II, at 1316 (Mar. 5, 1984).

3. Id. at 1322.

4. Id. at 1320.


For additional information, please contact any of the following lawyers:

Layla J. Asali, lasali@milchev.com, 202-626-5866

Rocco V. Femia, rfemia@milchev.com, 202-626-5823

Jeffrey M. Tebbs

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