Citing aggressive taxpayer positions, recently proposed regulations do away with the foreign goodwill exception to gain or income recognition for outbound transfers under Section 367. The rules also restrict the type of property eligible for the active business exception.

Reasons for Change

Per the preamble, taxpayers interpret Section 367 and the regulations in one of two ways when claiming favorable treatment of foreign goodwill and going concern value. One interpretation argues that goodwill and going concern value are not IP within the meaning of Section 936(h)(3)(B) and thus not subject to Section 367(d), but may qualify for the active business exception. The other view argues that goodwill and going concern value are within the scope of Section 936(h)(3)(B) IP, but the foreign goodwill exception applies.

Under either view, taxpayers attempt to avoid gain and income recognition by asserting that “an inappropriately large share” of the value of transferred property is foreign goodwill or going concern value. Temporary regulations under Section 482, issued contemporaneously with the proposed regulations, look to rein in “aggressive” transfer pricing positions.

2015 Proposed Regulations

The proposed regulations eliminate the foreign goodwill exception of Section 1.367(d)-1T. Section 367(d) would apply to any outbound transfer of IP, without exception. Proposed Section 1.367(a)-1(d)(5) modifies the definition of IP for Section 367 purposes in a way that both removes the foreign goodwill exception and allows a U.S. transferor to apply Section 367(d) to an outbound transfer that would otherwise be subject to Section 367(a), depending on the taxpayer’s interpretation of Section 936(h)(3)(B). The modified definition includes property described in Section 936(h)(3)(B) or property to which a U.S. transferor applies Section 367(d) (rather than Section 367(a)).

The proposed rules also drop the existing rule that limits the useful life of IP to 20 years because IRS and Treasury believe that the limitation may prevent full income recognition for property with a longer useful life. Instead, proposed Section 1.367(d)-1(c)(3) provides that the useful life is the entire period over which exploitation of the IP is reasonably anticipated, determined as of the time of transfer. Importantly, exploitation includes use of the IP in research and development.

To thwart incentives to undervalue Section 367(d) IP further, the proposed rules limit the type of property eligible for the active business exception to tangible property, including working interests in oil and gas, and certain financial assets. Four types of property in the existing regulations remain ineligible for the active business exception: inventory, receivables, foreign currency and certain leased tangible property. The ineligibility of IP in the existing regulations goes away. Thus, an outbound transfer of any IP, including foreign goodwill or going concern value, will be subject to gain recognition under Section 367(a) or deemed income inclusions under Section 367(d).