2015-Issue 32 – Although their efforts have been highly politicized and trumpeted in the press as of late, U.S. multinationals have for years sought and implemented various planning techniques to lower their overall corporate effective tax rate. For technology and life sciences companies (and any other company with valuable intangible assets), migration of intangible property (IP) to low-tax jurisdictions has become standard fare. Most IP migrations involve either some form of IP transfer (involving either a lump sum buy-in payment or annual deemed royalty payment commensurate with the income derived from the use of the IP) or license of IP. However, not all IP migrations are created equal, and in recent years the use of a partnership as a vehicle to migrate IP offshore has gained popularity as an alternative to these traditional methods. Why use a partnership?
Well, Congress enacted Section 367 (and its predecessor) to prevent U.S. persons from avoiding U.S. tax by transferring appreciated property, including IP to foreign corporations using non-recognition transactions. (See the Staff of the Joint Committee on Taxation’sGeneral Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 (H.R. 4170) Dec. 31, 1984.) Under Section 367(d), a U.S. person that transfers intangible property (within the meaning of Section 936(h)(3)(B)) to a foreign corporation in an exchange described in Section 351 or Section 361 (i.e., a reorganization) is treated as having sold such property in exchange for payments that are contingent upon the productivity, use or disposition of such property, and receiving amounts that reasonably reflect the amounts that would have been received annually in the form of such payments over the useful life of such property or, in the case of a disposition following such transfer (whether direct or indirect), at the time of the disposition. The amounts taken into account must be commensurate with the income attributable to the intangible. In 1997, Congress enacted Section 367(d)(3) giving Treasury the ability to provide regulations extending these rules to the transfer of intangible property to foreign partnerships; however, no regulations were issued.
In contrast, Section 721(a) provides a general rule that no gain or loss is recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership. Therefore, a U.S. corporation could transfer appreciated IP outbound to a foreign partnership in exchange for a participating preferred partnership interest without recognizing any gain upon the transfer. Although Section 721(c) gives the Secretary authority to issue regulations requiring the recognition of gain where such gain would not otherwise be includible in the income of a U.S. person, no regulations have been issued.
Therefore, absent regulations under Section 721(c) or Section 367(d)(3), a U.S. corporation could migrate IP offshore without recognizing any income or gain upfront and limit its annual inclusion of income to its preferred return and any participation feature. Sounds great, but keep reading!
Section 704(c) requires partnerships to allocate income, gain, loss and deduction with respect to property contributed by a partner so as to take into account any built-in gain that exists at the time of the contribution. The purpose of Section 704(c) is to prevent the shifting of tax consequence among partners with respect to pre-contribution gain or loss. Treas. Reg. Section 1.704-3 provides three different methods for allocating items of income, gain, loss or deduction: (i) traditional method; (ii) traditional method with curative allocations; and (iii) remedial method. With careful planning, a U.S. corporation could migrate appreciated IP to a partnership with a foreign partner (typically a controlled foreign corporation (CFC) within the meaning of Section 957 residing in a low-tax jurisdiction) and, by taking back a participating preferred equity interest and adopting the use of the traditional method, shift income derived through the use of the IP by the foreign partnership to the low-taxed CFC partner. Various anti-abuse rules within Section 704(c) give the Secretary the authority to make adjustments to the allocations and thus prevent the shifting of all income derived from the IP to the low-tax CFC partner. However, with the right facts, many U.S. corporations were able to strike the right balance of allocating income to the low-tax CFC partner under the traditional method without triggering anti-abuse rules, resulting in an overall lower cost of migrating IP when compared to a Section 367(d) transfer or IP license.
On August 6, 2015, Treasury issued Notice 2015-54 in response to IP partnerships. The Notice focuses on perceived abuses of the use of the traditional method of allocating items of income, gain, loss or deduction to foreign partners and the use of valuation techniques that are inconsistent with the arm’s-length standard set forth under Section 482. Treasury and the IRS determined such perceived abuses are most appropriately addressed through the exercise of Treasury’s regulatory authority granted in Section 721(c), as opposed to its regulatory authority under Section 367(d)(3). The Notice provides that the non-recognition provisions of Section 721(a) will continue to apply to the transfer of appreciated IP to a partnership with related foreign partners only where the remedial allocation method is used with respect to the appreciated IP transferred to the partnership.
Alvarez & Marsal Taxand Says:
So, what does Notice 2015-54 mean? In effect, the benefits of implementing an IP partnership as a preferred alternative to the more traditional Section 367(d) IP transfer or IP licensing transaction have largely evaporated. While taxpayers should continue to perform appropriate diligence and feasibility modeling to determine the best form of IP migration for their business, the use of IP partnerships has become more challenging and may not provide optimal results.
Managing Director, New York
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The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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