Company Seeks Goodwill Exception for Some Branch Incorporations

Amex is a global services company with four operating segments: US Card Services, International Card Services, Global Commercial Services, and Global Network and Merchant Services. Amex's principal products and services are charge and credit payment card products and travel-related services offered to consumers and businesses around the world. Amex, like all multinational U.S.-based financial institutions, is facing a challenging and evolving regulatory landscape globally, at the same time that the payment services business is evolving, and these are two factors that drive us to examine the potential reorganization of some of our existing branches as corporations. The regulatory landscape facing financial services entities outside the U.S. continues to evolve, and the pace and scope of regulatory change has increased since the 2008 financial crisis. In some circumstances, changes in the regulatory environment, including suggestions that we simplify our organizational structure and new requirements being imposed by local regulators relating to regulatory capital, are putting pressure on financial services businesses such as ours to reorganize our branches as corporations. In other cases, as the payment services business evolves, it potentially makes good business sense to move from an older branch operating model to a subsidiary model.

The Proposed Regulations make sweeping changes, and they are naturally of concern to us as we consider reorganizations in order to address changes in the regulatory and business environment. We believe, therefore, that Goodwill should be treated as eligible property for purposes of the ATB exception in non-abusive Branch Incorporations. This submission outlines an approach for identifying such non-abusive cases as those in which the foreign branch (i) is a bona fide financial services branch, (ii) has been in operation for a number of years; and (iii) is customer-facing in the foreign country.

It is our understanding that key motivations for the Proposed Regulations include addressing situations in which it is difficult to draw clear lines between separately identifiable intangibles and Goodwill and also to determine the value of such Goodwill. This letter proposes a framework for identifying and valuing Goodwill when treated as eligible property for the ATB exception where certain requirements are satisfied.

Amex is primarily regulated by the Board of Governors of the Federal Reserve ("Federal Reserve"), and American Express Company is both a bank holding company under the Bank Holding Company Act of 1956 as well as a financial holding company. As a global financial institution, many aspects of Amex's activities are subject to rigorous regulation that affects banks and the payments industry in the United States and many other countries in which our charge and credit cards are used and where we conduct banking, card, and payment network activities. The regulation of Amex's activities varies by line of business and jurisdiction, and the regulatory environment around the world continues to evolve and increase the requirements on the conduct of Amex's business.

Amex's organizational structure includes over 30 foreign branches owned by U.S. entities. Amex has traditionally chosen to organize in branch form to improve capital efficiency and streamline corporate governance. There is generally no need to infuse capital into a branch. Instead, net income or expense can be settled to or from the parent entity on a monthly basis, and debt utilized to finance the branch operations can be incurred locally or by the parent or another affiliate. Amex has historically used this model for its foreign operations in very large markets (Australia, Japan, Singapore, Hong Kong, and most of Europe). Typically, Amex has operated through foreign subsidiaries only where there is a specific local requirement to do so (for example, in Canada, France, the UK, Taiwan, and Thailand).

Amex has also chosen to organize certain foreign operations in branches in order to streamline corporate governance. Governance related to branches is less complex and more efficient, requiring less corporate infrastructure, such as a board of directors, officers, and separate meeting minutes.

Historically, Amex's decision to organize as a branch or subsidiary has been driven by considerations of capital efficiency, corporate governance, and other aspects of the local business and regulatory environment. The same business considerations drive the decision to convert an existing branch into a subsidiary. For example, the electronic payment business, which includes the card business, is evolving rapidly. New and innovative players are continuously entering the market, making the industry much more competitive and forcing us to consider changing some of our business practices and operating models, which may necessitate reorganizing certain long-standing operations. This competition and increased regulation requires successful participants to evolve and innovate to remain competitive. This evolution requires companies to rethink how they operate, which often involves internal business combinations that could include operations currently conducted in branch form.

According to the preamble to the Proposed Regulations, the Treasury Department and the IRS excluded Goodwill from eligible property based on certain perceived abuses and problems with administering the current Section 367(a) and (d) rules. The preamble specifically noted issues that the government has seen under current law: taxpayers attributing foreign business value to foreign Goodwill despite significant contributions by employees (including through customer-facing activities) in the United States;² the manner in which Goodwill is valued;³ and the ability of the IRS to continue to properly administer transfer pricing rules where there is favorable treatment for Goodwill but not for other intangibles.⁴

The activities of the employees of our foreign branches give rise to significant customer relationships and Goodwill. Many of these branches have been in operation for decades, keeping separate books and records and being subject to local regulation. There is no doubt, therefore, that these branches have significant substance and that their business is driven by local employees and interactions with local customers. For example, our Global Network Services ("GNS") business has established several card-issuing and/or merchant-acquiring arrangements with banks and other institutions in countries around the world. GNS is built around partnerships with financial institutions that issue Amex-branded cards that are accepted on the Amex network. Local Amex branches invite financial institutions to issue cards with the Amex logo and also to act as merchant acquirers on the Amex network. Local GNS affiliates identify, pursue, and close transactions with banks, and they advise their customers on how to run a profitable card business. Significant value is generated by the efforts of local employees, including developing products tailored to the local market and establishing local relationships with clients.

Furthermore, Amex's branches do not fit the factual paradigm of U.S.-developed intangibles being transferred offshore after U.S. deductions have been taken on the development of nascent intellectual property prior to maturity. Instead, Amex's foreign branches incur expenses that are closely related to the generation of income that is taxable currently in the United States. The intangibles transferred to Amex's foreign branches upon incorporation are generally limited to goodwill and going concern value generated by the branch itself over many years. Incorporations of these branches are in line with Congress's expectation that transfers of foreign goodwill and going concern value are unlikely to result in tax abuse.⁶

Our proposal would define a branch as an "eligible financial services branch" if the following requirements are met:

Further, Congress believed that "no gain will be recognized on the transfer of goodwill or going concern value for use in an active trade or business" of a foreign corporation.⁸ This sentiment was particularly relevant to the "transfer of goodwill or going concern value developed by a foreign branch to a newly organized foreign corporation," as such a transfer was not viewed to be an abuse of the U.S. tax system.⁹

The requirements suggested above seek to ensure that the foreign branch is a true operating financial services branch and has operated as such over a five-year period. In addition, financial services activities are not the type of activities that result in U.S. deductions for the development of nascent intellectual property that can be transferred to a foreign branch shortly before reaching its profit potential. Rather, foreign financial services branches' creation of intangibles other than foreign goodwill and going concern value (such as customer lists) is very limited and tends to be closely related to the generation of income that is currently taxable in the United States. The legislative history of Section 367(d) indicates that incorporations of such branches were not the abuse targeted by the statute.

Step 3 above should use typical arm's length approaches to value the hot intangibles, such as the income approach, the market (or comparables) approach, or the cost approach. A cost-based approach is generally appropriate for intangible assets used primarily as business operating intangibles (rather than as intangibles for license or sale to customers), and we would expect the cost-based approach to be appropriate for most hot intangibles used by financial services entities that undergo a Branch Incorporation.

We believe a cost-based approach focusing on sales, general, and administrative expenses ("SG&A") would be a reliable way to value each of the hot intangibles used by a financial services branch. Specifically, expenses associated with developing each hot intangible would be the basis to apply a cost-based approach. The annual costs incurred should be capitalized over the useful life of the specific hot intangible, which can be characterized as the total cost to develop the intangible.¹³

The Proposed Regulations express Treasury's concern that taxpayers artificially limit the value of hot intangibles by analyzing them on an item-by-item basis or by failing to perform "a full factual and functional analysis of the business in which the intangible property is employed." Therefore, we propose allocating an additional profit element to the hot intangibles in recognition of the branch income derived from their exploitation over time. The capitalized value of each hot intangible should be marked up by a return on investment factor (for example, based on the company's average internal hurdle rate) in order to reach an arm's length price for that hot intangible.¹⁴ The sum of the capitalized costs of all the hot intangibles plus the profit element markup is the total fair market value of the hot intangibles and would be taxable under Section 367(d).

The remaining value should be allocated to foreign goodwill and going concern value.¹⁵ This proposed method is consistent with the regulatory definition of "foreign goodwill or going concern value" as "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."¹⁶

² "[S]ome taxpayers have asserted that they have transferred significant foreign goodwill or going concern value when a large share of that value was associated with a business operated primarily by employees in the United States, where the business simply earned income remotely from foreign customers. In addition, some taxpayers take the position that value created through customer-facing activities occurring within the United States is foreign goodwill or going concern value."

³ "Specifically, the Treasury Department and the IRS are aware that some taxpayers value the property transferred in a manner contrary to section 482 in order to minimize the value of the property transferred that they identify as section 936(h)(3)(B) intangible property for which a deemed income inclusion is required under section 367(d) and to maximize the value of the property transferred that they identify as exempt from current tax. For example, some taxpayers (i) use valuation methods that value items of intangible property on an item-by-item basis, when valuing the items on an aggregate basis would achieve a more reliable result under the arm's length standard of the section 482 regulations, or (ii) do not properly perform a full factual and functional analysis of the business in which the intangible property is employed."

⁴ "The Treasury Department and the IRS ultimately determined, however, that such an approach would be impractical to administer. In particular, while the temporary regulations under section 482 that are published in the Rules and Regulations section of this issue of the Federal Register clarify the proper application of section 482 in important respects, there will continue to be challenges in administering the transfer pricing rules whenever the transfer of different types of intangible property gives rise to significantly different tax consequences."

⁵ S. Rep. No 169, 98th Cong., 2d Sess., at 360 (1984); H.R. Rep. No. 432, 98th Cong., 2d Sess., at 1317 (1984).

⁶See U.K. Rep. No. 432, 98th Cong., 2d Sess. (1984) ("The committee does not anticipate that the transfer of goodwill or going concern value developed by a foreign branch to a newly organized foreign corporation will result in abuse of the U.S. tax system.").

⁷ S. Rep. No 169, 98th Cong., 2d Sess., at 360 (1984); H.R. Rep. No. 432, 98th Cong,, 2d Sess., at 1315 (1984).

⁸ S. Rep. No. 169, 98th Cong., 2d Sess., at 364; H.R. Rep. No. 432, 98th Cong., 2d Sess., at 1319 (1984).

⁹ S. Rep. No. 169, 98th Cong., 2d Sess., at 362; H.R. Rep. No. 432, 98th Cong., 2d Sess., at 1317 (1984).

¹⁰ Overall branch value should be determined under all the facts and circumstances, generally using an income approach or a multiple-of-earnings approach.

¹¹ This could be the value reported for regulatory purposes.

¹² In other words, the hot intangibles would not be valued in isolation -- their contribution to the overall branch value would be taken into account. In the context of a cost-based approach, the contribution will be based on the return on investments the company typically seeks for undertaking in-house projects, which may be represented by the company's hurdle rate.

¹³ For example, if the annual costs allocated to the branch for IT platform operating intangibles is $20 million on an annual basis and the useful life of the IT platform operating intangibles is seven years, the total costs of the operating intangibles would be approximately seven multiplied by $20 million, which equals $140 million.

¹⁴ In the example described in the footnote above, the total costs of $140 million should be marked up. If the hurdle rate for the group that the branch was part of was 20%, then the markup would be 20% of $140 million or $28 million. The total value of the intangible would be $140 million plus the profit element of $28 million for a total value of this particular hot intangible of $168 million.

¹⁵ The remaining value is equal to the overall branch value (as determined in step 1) minus the value of all tangible and financial assets (as determined in step 2) minus the value of all hot intangibles (as determined instep 3).

¹⁶See Treas. Reg. § 1.367(a)-1T(d)(5)(iii).