Menu
Tax Notes logo

Firm Focuses on Transitory Ownership in Proposed FTC Regs

FEB. 1, 2019

Firm Focuses on Transitory Ownership in Proposed FTC Regs

DATED FEB. 1, 2019
DOCUMENT ATTRIBUTES

February 1, 2019

CC:PA:LPD:PR (REG–105600–18)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Comments on Prop. § 1.904-4(f)(2)(vi)(D) in REG–105600–18

Dear Sirs or Madams:

We write to comment on Prop. § 1.904-4(f)(2)(vi)(D). This clause requires that non-passive category gross income attributable to a foreign branch (or its owner) be adjusted to reflect disregarded transactions in which § 367(d)(4) intangible property (“IP”) is transferred to or from the foreign branch. We believe this rule should be clarified to exclude a branch's transitory ownership of IP repatriated to the U.S., and should have an effective date delayed so it applies only to disregarded transactions occurring after publication of the final regulations.

Many companies repatriated IP to the U.S. to reduce foreign taxes and address BEPS concerns by aligning IP profits with U.S. DEMPE functions. While these companies considered it preferable for income from the IP to be taxed at the higher FDII rate rather than the GILTI rate to reduce foreign taxes and address BEPS concerns, they did not expect such income to be attributable to (and taxed in) the foreign branch income basket. Rather, their expectation was consistent with the tax treatment afforded by the residence foreign country of the branch, which respects the IP transfer and no longer taxes profits generated by the IP.

The stated purpose of the proposed regulation is to guard against “non-economic reallocations of gross income attributable to the foreign branch category.” There is no non-economic reallocation of gross income attributable to the foreign branch income category in the situation of transitory ownership of the IP by a branch — e.g., if a CFC makes a check-the-box election and the resulting branch contemporaneously distributes IP to its owner. The CFC simply repatriated IP to the U.S., consistent with Congress' goal in enacting the FDII deduction. Many U.S. companies perform a majority of DEMPE functions in the U.S., so repatriating IP to the U.S. is also a sensible response to the OECD BEPS initiative to align taxation of IP profits with DEMPE functions.

We recommend the following clarification to Prop. § 1.904-4(f)(2)(vi)(D) to exclude transfers of IP from a CFC to a U.S. corporation if the IP is transitorily owned by a branch:

(D) Certain transfers of intangible property. For purposes of applying this paragraph (f)(2)(vi), the amount of gross income attributable to a foreign branch (and the amount of gross income attributable to its foreign branch owner) that is not passive category income must be adjusted under the principles of paragraph (f)(2)(vi)(B) of this section to reflect all transactions that are disregarded for Federal income tax purposes in which property described in section 367(d)(4) is transferred to or from a foreign branch, whether or not a disregarded payment is made in connection with the transfer. Transitory ownership by a foreign branch that neither enhances nor exploits the section 367(d)(4) property will not be considered a transfer for purposes of this paragraph (f)(2)(vi)(D). In determining the amount of gross income that is attributable to a foreign branch that must be adjusted by reason of this paragraph (f)(2)(vi)(D), the principles of sections 367(d) and 482 apply. For example, if a foreign branch owner transfers property described in section 367(d)(4), the principles of section 367(d) are applied by treating the foreign branch as a separate corporation to which the property is transferred in exchange for stock of the corporation in a transaction described in section 351.

The treatment could also be clarified in examples:

Prop. § 1.904-4(f)(4)(iv) Example 4. Certain transfers of intangible property:

(A) Facts. P, a domestic corporation, owns FDE, a disregarded entity that is a foreign branch within the meaning of paragraph (f)(3)(iii) of this section. FDE develops and exploits property described in section 367(d)(4), which FDE transfers to P for exploitation by P.

(B) Analysis. Under § 1.904-4(f)(2)(vi)(D), the gross income attributable to FDE must be adjusted upward and the gross income attributable to P must be adjusted downward annually, under section 482 principles by treating FDE as a separate corporation from which the property is transferred.

Prop. § 1.904-4(f)(4)(v) Example 5. Certain transfers of intangible property:

(A) Facts. P, a domestic corporation, owns CFC1, a controlled foreign corporation. CFC1 develops and exploits property described in section 367(d)(4). In order to repatriate the intangible property to the US, P makes an election for CFC1 to be treated as a disregarded entity. The day after the effective date of such election, CFC1, which has become a FDE, distributes the IP to P.

(B) Analysis. Because the ownership of the IP by FDE is transitory and the IP was neither enhanced nor exploited by FDE, no gross income is adjusted under § 1.904-4(f)(2)(vi)(D) because of the transfer.

The disregarded IP transfer could have been avoided if the taxpayer was aware of the treatment in Prop. § 1.904-4(f)(2)(vi)(D). For example, the taxpayer could have adopted a formal plan of liquidation, distributed the IP (a regarded transfer), and then checked the box on the CFC. There would have been no disregarded transfer from a foreign branch and Prop. § 1.904-4(f)(2)(vi)(D) would not apply. We submit that the form of an IP repatriation transaction should not produce different results in this context. To prevent what we think is an unduly harsh retroactive application of this rule, we recommend the effective date of Prop. § 1.904-4(f)(2)(vi)(D) be delayed so it applies only to disregarded transactions occurring after publication of the final regulations. Taxpayers with advance knowledge of the treatment in Prop. § 1.904-4(f)(2)(vi)(D) could then plan their transactions appropriately.

Thank you for considering these two recommendations.

Sincerely,

Rod Donnelly
Partner

Bart Bassett
Partner

Morgan, Lewis & Bockius LLP
Palo Alto, CA

DOCUMENT ATTRIBUTES
Copy RID