Limitations to the Non-Recognition Rules for Asset Transfers to Foreign Corporations
Are you thinking of transferring appreciated property to a foreign corporation in order to utilize the corporate “non-recognition” rules, and to possibly avoid further US taxes? You should be aware that while in certain circumstances it is feasible to transfer such property in order to properly run a business, there are many limitations placed upon the ability of US persons to do so when transfers to foreign corporations are involved. This article will briefly explain these limitations under section 367, and its subsections.
The Corporate Non-Recognition Rules
Under the IRS non-recognition rules, C corporations can generally avoid taxation on certain transfers of appreciated property when a corporation is formed (IRC section 351), reorganized (IRC sections 354, 355, or IRC 361), or liquidated (IRC section 332). These rules thus constitute an exception to the general corporate tax rule that sales or exchanges of property by taxpayers is a taxable event.
However, the corporate non-recognition rules are limited under IRC Section 367 when property is transferred by or to foreign corporations.
IRC Section 367
IRC Section 367 was enacted in order to prevent US taxpayers from avoiding US taxes by transferring assets to controlled foreign corporations when such an entity is formed, reorganized, or liquidated under the corporate non-recognition provisions. The section specifies that a foreign entity will not be considered to be a “corporation” for the purposes of IRC Sections 332, 351, 354, 356, and 361.
The following paragraphs will briefly describe some of the subsections of section 367.
IRC Section 367(a)
Section 367(a) limits the ability of US persons to transfer appreciated property (such as stock, assets, or certain other property) to foreign corporations in a corporate reorganization to avoid US taxes, and then sell the appreciated property outside of the U.S. tax jurisdiction. Unless a transferor qualifies for an exception, section 367(a) generally treats an exchange of certain property (under sections 351, 354, 356 or 361) by a U.S. person to a foreign corporation as a taxable exchange. These exchanges are commonly termed as “outbound transfers”.
The IRC generally grants an exception to outbound transfers of assets (other than stock) if the assets are to be used in the active conduct of a trade or business outside the United States.
IRC Section 367(b)
IRC section 367(b) is primarily intended to monitor the earnings and profits of a controlled foreign corporation. The subsection IRC provides that, “[I]n the case of any exchange described in IRC sections 332, 351, 354, 355, 356 or 361 in connection with which there is no transfer of property described in IRC section 367(a)(1), a foreign corporation shall be considered to be a corporation except to the extent provided in regulations prescribed by the Secretary which are necessary or appropriate to prevent the avoidance of Federal income taxes”. Additionally, there are proposed regulations under this section addressing the carryover of earnings and profits and taxes.
IRC Section 367(d)
Outbound transfers of intangible assets are covered under subsection 367(d), and not the more general subsection 367(a). Under this subsection, if a U.S. person transfers an intangible asset to a foreign corporation (in an exchange described in IRC section 351 or 361), the tax effect is to treat the intangible asset as having been exchanged for contingent (royalty) payments. The contingent payments (for a period of no more than 20 years) must be commensurate with the income attributable to the intangible transferred.
US persons subject to this subsection must report the exchange in accordance with IRC section 6038B, or be subject to penalties, as well as an extended statute of limitations under IRC section 6501(c)(8).
IRC Section 367(e)
Under Section 367(e), if a US corporation distributes the stock of a foreign corporation to a foreign person in a distribution described in IRC section 355 (“Distribution of stock and securities of a controlled corporation”), gain on the distribution will be taxable to the distributing corporation under IRC section 367(e)(1); however, the distribution of the stock of a domestic corporation by a US corporation to a foreign person under section 355 would not generally be taxable under IRC Section 367(e). The tax liability of the foreign person is unaffected by this section.
Furthermore, under IRC section 367(e)(2), if a U.S. corporation is liquidated into a foreign parent corporation under IRC section 332, the U.S. corporation will be treated as if it sold its assets in a taxable transaction (i.e. IRC section 337(a) and (b)(1) will not be applicable), except as provided by regulations.
Additional Related Reporting Requirements
It is important to remember that IRC Section 367 requires various IRS reporting requirements, collectively known as “367 Notices”. Moreover, certain outbound transfers by U.S. persons may require the filing of Form 926. Other IRS reporting requirements may apply depending on your particular fact pattern.
Contact Sherayzen Law Office for Legal Help With Transferring of Appreciated Property to Foreign Corporations
This article provides only a very general overview of the IRC Section 367; however, the subject matter is much more complex and depends on constantly changing IRS regulations. Therefore, this article does not offer legal advice and should NOT be relied upon in determining your particular tax situation.
If you (or the entities that you control or partially-own) are planning on transferring tangible and intangible property to a foreign entity, contact Sherayzen Law Office for professional legal assistance in this obscure and highly complicated international tax matter. Our experienced international tax firm will guide you through the complex web of international tax rules in order to best structure your international business and tax transactions as well as help you comply with the numerous relevant IRS reporting requirements.