outbound transfers & section 367...– section 91(a) relies on the same definition of...

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

Confidential and Proprietary ©2018 Vinson & Elkins LLP velaw.com 3

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


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.



income tax purposes; Foreign

Branch operates an active trade or

business

Active Trade or

Business


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.





business

Active Trade or

Business


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).





business

Active Trade or

Business


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




business

Active Trade or

Business



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.





business

Active Trade or

Business



• 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


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.




Branch has foreign IP

IP


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).




Branch has goodwill

Goodwill



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).




Branch has goodwill

Goodwill



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.”




Branch has goodwill

Goodwill


TRANSFERS OF INTANGIBLES AFTER TAX REFORMSECTION 367(d) ISSUES

Foreign

Branch

US Parent




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.


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




Goodwill

+ IP


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.”





Goodwill

+ IP

SECTION 367 & FDII


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




Goodwill

+ IP


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.





Goodwill

+ IP


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.


VINSON & ELKINS’ INTERNATIONAL TAX PRACTICE

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

• Strategic international tax planning and restructuring

• Cross-border mergers and acquisitions and public offerings

• Expansions into new markets

• Cross-border commercial transactions

• Transfer pricing planning and implementation

DAVID COLE

+1.713.758.2543

[email protected]

JASON MCINTOSH

+1.713.758.2524

[email protected]

DAVID PECK

+1.214.220.7937

[email protected]

NATAN LEYVA

+1.202.639.6793

[email protected]

GEORGE GERACHIS

+1.713.758.1056

[email protected]

Key Contacts

Nationally Recognized in International Tax

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