Often the best way to defend a tax position is to see the train before it gets to the station.
On Friday, the Internal Revenue Service issued Notice 2012–39, which addresses certain transactions that allow a U.S. taxpayer to repatriate foreign income in a tax efficient manner by using low basis domestic intangibles and the corporate reorganization rules. The Notice announced that the IRS will be issuing new regulations, with an effective date of July 13, 2012, to prevent these transactions. In the meantime, taxpayers are expected to follow the guidance in the Notice to report income from transactions that might be described in the Notice.
Notice 2012–39 describes the primary transaction of concern as follows:
USP, a domestic corporation, owns 100 percent of the stock of UST, a domestic corporation. USP’s basis in its UST stock equals its value of $100x. UST’s sole asset is a patent with a tax basis of zero. UST has no liabilities. USP also owns 100 percent of the stock of TFC, a foreign corporation. UST transfers the patent to TFC in exchange for $100x of cash and, in connection with the transfer, UST distributes the $100x of cash to USP and liquidates.
The taxpayer takes the position that neither USP nor UST recognizes gain or dividend income on the receipt of the $100x of cash. USP then applies the section 367(d) regulations to include amounts in gross income under §1.367(d)-1T(c)(1) in subsequent years. USP also applies the 367(d) regulations to establish a receivable from TFC in the amount of USP’s aggregate income inclusion. USP takes the position that TFC’s repayment of the receivable does not give rise to income (notwithstanding the prior receipt of $100x in connection with the reorganization). Accordingly, under these positions, the transactions have resulted in a repatriation in excess of $100x ($100x at the time of the reorganization and then through repayment of the receivable in the amount of USP’s income inclusions over time) while only recognizing income in the amount of the inclusions over time.
The Notice also notes that the transaction can be accomplished through the foreign subsidiary’s assumption of liabilities belonging to the domestic corporation. Another variation on the theme occurs when a controlled foreign corporation (CFC) uses deferred earnings to acquire the stock of a domestic corporation from an unrelated party for cash, followed by an outbound asset reorganization of the domestic corporation, avoiding income inclusion under section 956.
Given the IRS’s “significant policy concerns” about these transactions, this Notice should be taken as a warning for taxpayers who may have engaged in these transactions in recent years – expect the issue to be challenged under examination. Those companies may want to revisit their financial accounting reserve for these items and prepare for the controversy coming up around the bend.
Read the notice here:
IRS Notice 2012-39