On May 2, 2023, the Treasury Department and IRS released a new set of proposed regulations (the “Proposed Regulations”) which, under certain circumstances, would eliminate the annual income inclusion required under Section 367(d)[1] when intangible property (“IP”) is repatriated to certain U.S. persons. Taxpayers may be interested in returning IP to the U.S. for a variety of reasons, including taking advantage of the Section 250 deduction for “Foreign Derived Intangible Income” or for other commercial reasons. The Proposed Regulations address a disincentive for taxpayers to repatriate IP to the United States due to “excessive” U.S taxation under current rules.

Section 367(d) Background

Congress enacted Section 367(d) to address the concern that U.S. companies were transferring IP to low-taxed jurisdictions to defer U.S tax on the profits generated by the intangible assets after having used deductions incurred in connection with the research and development of such IP to offset U.S. income. Section 367(d) addresses this concern by treating a U.S. person that transfers IP to a foreign corporation (referred to herein as the “original U.S. transferor”) as having sold the IP in exchange for payments contingent on the productivity, use, or disposition of the IP over the useful life of the IP. In practice, the original U.S. transferor is required to include in income annually over the useful life of the IP an arm’s length amount commensurate to income attributable to the IP.

The Section 367(d) regulations also address subsequent transfers of IP by the foreign transferee corporation (or shares of the transferee foreign corporation received by the original U.S. transferor in exchange for the IP). The tax consequences of such transfers depend on whether the subsequent transferee is related to the original U.S. transferor. If the foreign transferee corporation subsequently transfers the IP to an unrelated person, the U.S. transferor recognizes a lump-sum gain equal to the excess of the fair market value of the IP at the time of the disposition over the tax basis in the IP at the time of the original outbound transfer. In contrast, under current law, when IP is transferred to a related person, it would usually require the original U.S. transferor to continue including the Section 367(d) amount annually in income, even if the IP was repatriated back to the original US transferor or an affiliate.

Existing regulations did not adequately address a situation in which the foreign transferee corporation subsequently repatriates the IP to the original U.S. transferor (or a related person). Thus, this type of repatriation potentially would result in the U.S. transferor continuing to recognize the royalty-like inclusion amount despite (i) the IP having returned to the U.S. transferor (or a related party); and (ii) that U.S. person being subject to any income associated with the IP. The Proposed Regulations address this potential double inclusion of income and the disincentive it creates to repatriate IP.

Proposed Regulations

To address the disincentive, the Proposed Regulations would terminate the annual inclusion requirement under Section 367(d) if the following requirements are met:

  1. A transferee foreign corporation repatriates IP to a “qualified domestic person,” and;
  2. The original U.S. transferor complies with the required reporting requirements under Section 6038B.

The Proposed Regulations define a “qualified domestic person” to include:

  1. The original U.S. transferor of the IP;
  2. A successor U.S. transferor that is subject to tax in the U.S.; or
  3. An individual or a qualified corporation that is related to the U.S. transferor or successor U.S. transferor, with certain exceptions for tax exempt persons including RICs, REITs, and DISCs.

If the transferee foreign corporation repatriates IP to a qualified domestic person and the reporting requirements are met, the original U.S. transferor (or successor U.S. transferor) is required to include in income a partial annual inclusion attributable to the portion of the taxable year prior to the repatriation but can then cease the annual Section 367(d) inclusion.

The Proposed Regulations also provide guidance for situations in which gain might be recognized by the original or successor U.S. transferor on repatriation. These rules depend on the form of the transaction and whether the repatriated IP is considered “transferred basis property” within the meaning of Section 7701(a)(43).  Generally, the rules provide that the amount of gain the U.S. transferor will recognize is the amount of the gain the transferee foreign corporation would recognize, if any, under subchapter C rules if its adjusted basis in the IP were equal to the U.S. transferor’s former adjusted basis in that property. Thus, the U.S. transferor would not recognize gain in the case of a repatriation occurring through a nonrecognition transaction in which no gain or loss otherwise is recognized by the transferee foreign corporation (e.g., a liquidation of the transferee foreign corporation into its U.S. parent corporation that qualifies for nonrecognition treatment under Sections 332 and 337). Alternatively, if the repatriated IP is not transferred basis property (e.g., the transferee foreign corporation repatriates the IP to the U.S. transferor in a taxable distribution described in Section 311(b)), the amount of gain recognized by the original U.S. transferor (or successor US transferor) would equal the excess of the fair market value of the IP at the time of repatriation over the original U.S. transferor’s basis in the intangible at the time of the IP’s outbound transfer.

The Proposed Regulations also provide guidance on determining the qualified domestic person’s basis in the IP, corresponding adjustments to the transferee foreign corporation’s E&P, and a variety of other related provisions.

Conclusion

If finalized, the Proposed Regulations would provide favorable results for certain taxpayers because Section 367(d) would cease to apply with regard to IP repatriated to the U.S. Thus, the Proposed Regulations would alleviate the disincentive to repatriate IP. However, the regulations are proposed to apply only to IP repatriations occurring on or after publication of final regulations. Comments on the Proposed Regulations must be submitted by July 3, 2023.

Please contact a Leo Berwick team member to discuss planning surrounding repatriation of IP or any other tax matter.

[1] Unless otherwise noted, all “Section” references are to the Internal Revenue Code of 1986, as amended