By Joseph B. Darby III and Murat Usta
People fall in love, and so do tax jurisdictions. People tend to fall in love with each other. Tax jurisdictions tend to fall in love with their tax revenues.
People, as well as tax jurisdictions, can also have a falling out. When the break up involves people, it is not only hard to do, but often very expensive. The break-up process is called "divorce" and its most costly consequence is called "alimony." In the cynical words of one divorce attorney, "Marriage is grand, but divorce is about 500 grand."
In the case of a corporate taxpayer and its tax jurisdiction, breaking up is sometimes even harder to do than it is for people. It can also be astonishingly expensive. The break-up process is called "exiting" the tax jurisdiction or "inverting" the corporate taxpayer, and its most painful consequence is the assessment of special "exit taxes." There are a wide variety of taxes that can be triggered by the departure of a corporation from its historic jurisdiction (including the transfer by a corporation of valuable assets from the jurisdiction while the corporation remains technically in place). For purposes of this article, this panoply of exit or transfer taxes are referred to (somewhat sardonically) as "alimony taxes."
In this post-modern world, divorce rates have soared and so have the types of corporate transfers that trigger alimony taxes. Breaking up may be hard to do, but it is also an inceasingly common experience. In this context, at least for the corporate taxpayer, a cautionary tale can be drawn from the world of people once in love: Sometimes it pays not to get married in the first place.
The purpose of this article is to examine how various businesses can take practical steps to address corporate alimony taxes, focusing on the United States. We will first review the most important alimony taxes imposed by the U.S., then offer some basic thoughts and strategies on how to anticipate and plan for an early, or at least a less expensive, exit. After all, few wealthy individuals these days enter into marriage without at least considering a prenuptial agreement. Any corporation with a valuable or promising business model—especially if it is based on intangible property or intellectual property—should at the very least do some "pre-nuptial" tax planning before entering into (and consummating) a domestic relationship with a specific tax jurisdiction.
The Scoop on Alimony Taxes
Jurisdictions compete to attract both new and existing businesses, a phenomenon called "charter competition."1 In a world of national tax systems that have significant disparities in tax rates,2 businesses naturally want to exploit such differences by locating and conducting business activities, when feasible, in the jurisdiction that imposes the lowest tax cost.
Not every business decision, of course, is driven solely by taxes. Multinational corporations may decide to move their manufacturing and labor-related activities to countries where the labor costs are low, while keeping their R&D in countries with highly skilled personnel. These business objectives may very well result in a migration of jobs and capital to other countries with lower tax rates and/or favorable tax incentives. Inevitably, countries (like the U.S.) experiencing an outflow of business operations tend to feel like they are being deprived of their "rightful" revenue base and respond by enacting "exit tax" laws, anti-inversion laws, or other types of alimony taxes. The most prominent U.S. alimony taxes will be discussed in a moment, but first we will address the tax phenomenon of the "accidental marriage."
Oops! The Accidental Marriage
A popular and often hysterically funny plot in Hollywood movies involves the "accidental marriage," where a male movie character goes to Las Vegas, drinks to excess, and wakes up the next day with no memory of the previous evening, but wearing a wedding ring identical to that of the female stranger in bed next to him. Oops! Don’t you hate when that happens?
Needless to say, no well-managed company should ever end up "accidentally married" to the wrong tax jurisdiction. However, plenty of companies choose to invest and develop valuable property, particularly intellectual property, in the jurisdiction where it is most convenient to produce it, not necessarily the jurisdiction where they want the property to be located and taxed once the creation process is completed. In some respects, choosing a jurisdiction solely because it is a convenient place to create the intellectual property is somewhat "accidental," but to be frank is probably located somewhere between "inattentive" and "knuckleheaded" and, when the company is later socked with exorbitant and unnecessary tax bills, may verge on "inexcusable."
The simple solution is to do what everyone should do before a marriage, which is to make a clear-eyed and sober evaluation of the consequences before entering into the arrangement. In the world of marriage, this is called a pre-nuptial agreement. In the world of corporations, it is called effective tax planning.
Alimony Taxes in the United States
There are a variety of ways to get out of a house, out of a marriage, or out of a tax jurisdiction. In the case of a house, you can walk out the front door, walk out the back door, or climb out the window. Similarly, a corporation seeking to leave a tax jurisdiction has a variety of choices as to its method of egress. However, the Internal Revenue Code offers an impressive array of mechanisms designed to block—or at least tax—most of the common exit strategies.
The "Hotel California" Approach to Taxation—Welcome to Section 7874
The 1990s and early 2000s witnessed a number of prominent "inversion transactions," where U.S. corporations decided to "invert" their structure and become subsidiaries of foreign holding corporations to achieve a lower global effective tax rate.3 In response to this perceived trend, Congress enacted Section 78744 under the American Jobs Creation Act of 2004, to stop or at least inhibit inversion transactions.
Section 7874 is an anti-inversion5 statute that is intended to apply to an expatriated U.S. entity that meets the definition of a "surrogate foreign corporation" (or person related to such entity). A surrogate foreign corporation is a foreign corporation that satisfies the following three requirements:6
1. the foreign corporation acquires substantially all of the properties held directly or indirectly by a domestic corporation (or that constitute the trade or business of a domestic partnership) (Acquisition Test);
2. after the acquisition, at least 60 percent of the stock (by vote or value) of the foreign corporation is held by the former shareholders of the domestic corporation or partners in the partnership by reason of holding interest in the domestic corporation or partnership (Ownership Test); and
3. the expanded affiliated group (EAG) (determined by using the greater-than-50-percent common ownership test under Section 1504(a) for the acquiring foreign-incorporated entity or any affiliated company7) does not have substantial business activities in the foreign country where it is incorporated compared to the total worldwide business activities of the EAG (Substantial Business Activities Test).
Under the Ownership Test, Section 7874 applies a two-tier approach: (1) an 80 percent inversion (pure inversion), where the original shareholders of the U.S. corporation continue to own 80 percent or more of the "new" foreign corporation; and (2) a 60 percent inversion (limited inversion), where there is 60 percent or more, but less than 80 percent, continuity of the original shareholders. Under an 80 percent inversion, Section 7874 treats the foreign parent as a domestic corporation subject to full U.S. taxation.8 Under the 60 percent inversion, the foreign corporation is respected as a foreign taxpayer, but any "inversion gain" recognized by the expatriating corporation over the next 10 years is fully taxable by the U.S.9
"Inversion gain" includes not only the income or gain recognized by reason of the transfer of stock or other properties to a related person during the applicable 10-year period, but also includes any income triggered by the acquisition, such as income received or accrued by reason of a license as part of the acquisition, or a license to a foreign related person.10 Also, inversion gain cannot be reduced or offset by existing NOLs or foreign tax credits of the inverting U.S. corporate group.11 This determination and reporting of the "inversion gain" for 10 years following the expatriation event obviously creates considerable compliance burdens.
In short, the U.S. government has created an anti-inversion system that is significantly more onerous than a traditional "exit tax," which at least has the virtue that it is paid only once while exiting the jurisdiction. Instead Section 7874 mandates substantial trailing or on-going payment obligations.
Section 7874 Limitation
Section 7874 does not apply in situations where the former U.S.-parent group historically had business activities in the foreign country of the new parent corporation. Determining whether an EAG has substantial business activities in the acquiring corporation’s home country requires a facts-and-circumstances determination.12 The 2006 temporary regulations provide a non-exclusive list of factors to be considered for this purpose.13 These regulations also (briefly) included an alternative substantial business activities safe harbor test.14 Under this 2006 safe-harbor test, the EAG would be considered to have substantial business activities in the foreign acquiring corporation’s country of incorporation if the EAG:
1. has at least 10 percent of its employees (by headcount and compensation) based in the foreign country;
2. has at least 10 percent of the group assets (including intangibles), by value, located in the foreign country; and
3. during a 12-month testing period, has at least 10 percent of the group sales made in the foreign country.
However, the IRS was concerned that the 10 percent safe harbor provided by the 2006 temporary regulations could apply to certain transactions in a way that was inconsistent with the purposes of Section 7874, and so the 2009 temporary regulations eliminated this safe-harbor test and and also eliminated the examples illustrating the facts-and-circumstances determination with respect to the substantial-business-activities exception. Needless to say, eliminating the safe harbor test creates greater uncertainty about when an inversion transaction will come within the still-existing exception for substantial foreign business activities.
Turning to the practical effects of Section 7874 on business planning, the provision sends the all-too-clear message to domestic U.S. taxpayers that "you can check out anytime you like but you can never leave." It is the "Welcome to the Hotel California" approach to taxation. The provision implicitly suggests to U.S. taxpayers that they may be better off incorporating start-up businesses in another jurisdiction, and it implicitly warns foreign investors to be careful about incorporating businesses in the U.S.
In short, if you expect to get divorced one day, then definitely don’t get married, because the alimony tax under Section 7874 can be brutally expensive.
"Sophie’s Choice": Trying to Save the (IP) Children
If a U.S. corporation cannot gracefully exit from U.S. tax jurisdiction—and Section 7874 makes for a very expensive divorce—one logical alternative may be to try to at least send the valuable IP abroad, to stay with the proverbial Dutch Uncle. Intangible property can generally be transferred to a related foreign person through one of four mechanisms: (1) a sale; (2) a license; (3) a capital contribution; or (4) a reorganization (e.g., a merger with and into a foreign corporation).
However, the Code is active and vigilant in preventing exactly these types of transfers from occurring except as fully taxable transactions at fair market value. Intangible property transfers (including licenses) out of the United States are restricted by two main roadblocks: Section 367(d) and Section 482. Section 367(d) generally applies to a transfer of intangible property by a U.S. person to a foreign corporation that qualifies under Section 351 (incorporation transfer) or Section 361 (reorganization transfer)15 or to a capital contribution to an 80 percent-controlled foreign corporation.16 By contrast, Section 482 applies in the case of a sale or license of intangible property to a related foreign corporation.17 Therefore, the form of the transaction dictates which Code section applies.
Sections 367(d) and 482 both specifically mandate a commensurate-with-income standard to value the intangibles transferred, and they both look at Section 936(h)(3)(B) for the definition of intangible property. Accordingly, when transferring intangibles, corporations need, first, to identify whether those intangibles fit into the definition of Section 936(h)(3)(B)18 and, second, to value those intangibles under the commensurate-with-income standard.
Transfers of Assets under Section 367(a) versus under Section 367(d)
Section 367 is designed to override the "normal" tax-free treatment under Section 351 (capital contributions) and Section 361 (reorganizations) when a U.S. person transfers property to a foreign corporation instead of a domestic corporation. With regard to tangible property transfers, Section 367(a) treats a foreign corporation as "not a corporation" within the meaning of Section 351, which results in immediate recognition of gain by the transferor, but only gain, and realized losses remain unrecognized.19 This gain is limited to the amount of gain that would have been recognized had the appreciated property been disposed of in a taxable sale at fair market value.20 Section 367(a)(3)(A) provides an important exception that allows for the tax-free transfer of tangible property if such tangible property is subsequently used by a foreign corporation in the "active" conduct of a foreign trade or business.21 However, these provisions are not applicable to transfers of certain intangible property.22
With respect to specified intangible property transfers, Section 367(d) generally does not require immediate recognition of gain23 (in contrast to Section 367(a)), but instead requires the transferor to recognize income periodically as if receiving payments contingent upon the productivity, use, or disposition of the intangible property.24 Section 367(d) re-characterizes the transfer of intangible assets by a U.S. person to a foreign corporation in connection with any exchange described in Sections 351 or 361 as a taxable sale of the intangible asset in exchange for a stream of contingent payments, the amount and calculation of which is astonishingly vague and poorly defined. Section 367(d) does specify that the payment amounts are supposed to be "commensurate with the income attributable to the intangible," and shall be treated as ordinary income.25 However, as a practical matter, the transaction is not really treated as a "sale" of property—for example, there is no apparent recovery of tax basis in the transferred intangible asset—and the payment stream is all ordinary income and is sourced to the U.S.26
Section 367(d) justifies its taxation of the outbound transfer of intangible property based on the assumption that the U.S. transferor would have the power to compel payments by the foreign transferee. However, Section 367(d) treats the U.S. transferor as having income even when the transferor has no power to compel payments and even if the transferor does not control the foreign transferee or never receives any payments for the intangible property.27
The imputed payment regime under Section 367(d) continues throughout the useful life of the intangible asset, which is the entire period during which the asset has value, but is subject to a limitation of 20 years.28 Moreover, Section 367(d) makes this particularly unattractive as a mechanism for transferring intangible assets because the imputed payments are deemed to be U.S. source income,29 and this limits the ability of the U.S. transferor to claim or utilize foreign tax credits.
The Obama Administration has proposed to further limit the shifting of income through intangible property transfers.30 As is discussed in the article, "The IRS Gets Jealous: Oh, Ruby, Don’t Take Your Love to Town or Your Intangibles Out of the Country," (Practical International Tax Strategies, May 15, 2010, p. 2) the U.S. government is not satisfied with the Section 367(d) "commensurate with income" standard as a proper barrier against shifting of income through intangible property transfers.31 Accordingly, the proposal’s stated intent is to "clarify" (broaden) the definition of "intangible" to include workforce in place, goodwill, and going concern value. However, rather than clarifying the current law, this proposal’s true effect is to dramatically expand Section 367(d) and place goodwill and going concern value—normally the core value of a modern trade or business—under vague and ominous rules. As a result, the class of assets subject to Section 367(d) would be broadened substantially, and in some cases almost the entire aggregate fair value of a business would be subject to Section 367(d).32Sales and Licenses of IP under Section 482
Given the extremely adverse tax consequences that appear to apply under Section 367(d), U.S. persons invariably explore the alternative of a taxable license or sale transaction in lieu of a tax-free transaction under Section 351 or Section 361. As noted above, Section 367(d) does not apply to a bona fide sale or a license. However, if a cross-border transaction involves a related party, the IRS will scrutinize the transaction carefully under Section 482 to ensure that the consideration paid reflects fair market value.
A comprehensive discussion of Section 482 is beyond the scope of this article, but the basic principles of Section 482 applicable to this area are relatively simple to summarize: A U.S. person generally must transfer property in a sale to a related foreign person at a price equal to the fair market value, or arm’s length price, of the property (i.e., the price at which the property would change hands in a transaction between unrelated persons). Analogously, under a licensing arrangement, the parties are required to enter into a formal agreement in which the royalty rate is the same as that which a third party would charge, given the nature of the technology itself and the terms of the transfer.
In general, Section 482 is an economist’s paradise and a taxpayer’s nightmare. The IRS exhaustively investigates the economic relationship between related parties, and then determines the arm’s length price in a particular transaction. Section 482 applies explicitly to transfers and licenses of intangible assets.33 Arm’s length consideration for intangible property transferred for commercial exploitation, via an outright sale or by licensing, is determined using one of four methods prescribed under the regulations: (1) the Comparable Uncontrolled Transaction Method (CUT); (2) the Comparable Profits Method (CPM); (3) the Profit Split Method; and (4) unspecified methods.34 The choice of methods is governed by the "best method rule" (i.e., the method that produces the most reliable results under the prevailing circumstances35). A taxpayer is required to maintain extensive documentation to support its transfer pricing methodology and can be subject to severe penalties for noncompliance.
A cost-sharing arrangement is a somewhat different animal, in which pre-existing intellectual property is transferred expressly for research purposes, as distinct from commercial exploitation purposes. Under the cost-sharing provisions, addressed in greater detail below, one is required to value pre-existing intangible assets (or "platform contributions") using a different set of methodologies (e.g., the Income Method, the Market Capitalization Method, the Acquisition Price Method, etc.).
Cost-Sharing Arrangements
Until recently, perhaps the most popular means of "transferring" intangible assets out of the United States has been through the use of a cost-sharing arrangement (CSA) permitted by the applicable regulations.36 Under a CSA, two or more related parties (one or more based in the U.S. and one or more based in a foreign jurisdiction) agree in writing to contribute jointly to the costs of developing the intangible asset in proportion to their shares of reasonably anticipated benefits from the asset that is developed.37
The cost-sharing arrangement first gained popularity after the enactment in 1984 of Section 367(d), which, as mentioned above, made it virtually impossible to transfer intangible assets to a related foreign entity on a tax-free basis. On December 20, 1995, the IRS issued (temporarily) final cost-sharing regulations,38 which required "buy-in" payments when a controlled participant owned pre-existing intangible assets and contributed these assets to the cost-sharing arrangement for research purposes. Other controlled participants were required to pay an arm’s-length charge for these rights.39 However, over time, the IRS became increasingly concerned that pre-existing intangible assets were being significantly undervalued by taxpayers seeking to transfer such assets offshore for much less than arm’s length consideration.40 To address this concern, in August 2005, Treasury issued "the 2005 Proposed Regulations,"41 which were both more complex and substantially more restrictive than the 1995 Regulations.
The 2005 Proposed Regulations adopted the "investor model" to address contributions of pre-existing intangible assets to a CSA. In order to determine arm’s length buy-in payments under the investor model, each controlled participant is viewed "as making an aggregate investment . . . for purposes of achieving an anticipated return [purportedly] appropriate to the risks of the cost sharing arrangement over the term of the development and exploitation of the intangibles resulting from the arrangement."42 In January 2009, Treasury issued "the 2009 Temporary Regulations," which replaced the 1995 Final Regulations and the 2005 Proposed Regulations in their entirety, effective January 5, 2009.43 The 2009 Temporary Regulations incorporate the "investor model" introduced in the 2005 Proposed Regulations. They also radically modify the rules governing "buy-in" payments (now referred to as "Platform Contribution Transactions," or PCTs), relative to the 1995 Regulations.44
Under the 2009 Temporary Regulations, an arrangement must satisfy certain substantive45 and administrative requirements46 in order to be considered as a CSA. One minor change from the 1995 Final Regulations is the substantive requirement that interests must be divided on a non-overlapping basis.47 The 2009 Temporary Regulations expressly authorize a division based on territorial interests; however, unlike the 2005 Proposed Regulations, the 2009 Temporary Regulations also permit divisions based on field of use or any other basis that meets the requirements of Reg. §1.482-7T((b)(4)(iv).48
More broadly, the 2009 Temporary Regulations attempt to make cost-sharing no more attractive, from a tax planning standpoint, than a simple licensing arrangement. As a practical matter, cost-sharing is vastly less attractive than licensing in most cases, because the IRS’s method of choice under the 2009 Temporary Regulations, the Income Method, often produces very large buy-in fees based largely on guesswork. The calculation of such a fee requires that taxpayers (a) develop detailed projections of each cost-sharing participant’s operating results over the life of the platform contribution, generally assumed by the IRS to be infinite, and (b) determine a reasonable risk-adjusted discount rate. Moreover, if the participants’ results turn out to be less favorable than the projected results, the original buy-in fee will generally stand. Conversely, under Section 482’s "commensurate with income" requirement, the IRS has the authority, and the motivation, to retroactively adjust the buy-in fee if cost-sharing participants’ actual and projected results diverge in the reverse direction. (According to the preamble to the 2009 Temporary Regulations, the periodic adjustment provisions are applicable to all PCTs, including those that are not Section 936(h)(3)(B) intangibles, even though the Section 936(h)(3)(B) definition is already quite broad.49)
As a result of these regulatory developments, it has become increasingly difficult to find a suitable means of migrating intellectual property out of the United States at anything less than devastating alimony tax costs.50 Stated differently, the CSA has become a notably less effective tool for moving IP from the United States to a foreign jurisdiction since the enactment of the 2009 Temporary Regulations.
Practical Tax Strategies
As described above, the rules governing U.S. alimony taxes are well-known, even if they are complex and at times maddeningly vague. The ultimate issue is to offer sensible advice and practical tax strategies to deal with these complex and often-Draconian rules. The following are some suggestions on how best to anticipate and deal with alimony taxes:
1. Don’t get married. In other words, don’t put your company or your IP into a high tax jurisdiction in the first place. This seems like a simple observation, but in fact it is a compellingly powerful statement. Alimony taxes can trap unwary parties in the short term, but in the long term such taxes should encourage corporate suitors to be skittish and to avoid coming into the wrong taxing jurisdiction in the first place.
One of the most famous moments in the history of tax legislation occurred when Robert Perlman, former vice president of taxes at Intel Corporation, testified to the Senate Finance Committee in 1999 about the effects of U.S. tax laws: "If Intel were to be founded today, I would strongly advise that the parent company be incorporated outside the United States."51 At the time his comment drew indignation and created a major furor in the U.S. Congress; today, it mere smacks of candor and common sense.
Significantly, some important American companies, including Accenture and Seagate Technologies, made the astute decision to incorporate abroad from the onset, and thus avoided the U.S. exit tax regime.52 Good news travels fast—and so will new IP start-up companies.
2. Get out while the getting is good. For companies that are already in the United States, the door has been closing quickly and ominously. In 2010, the Obama Administration, in the annual "Green Book," proposed to make it even more difficult to move assets (especially IP assets), once created, reasonably and cost effectively out of the United States.53 Therefore, there are two related strategies. First, go now because later is likely to be even worse. Second, to the extent new IP is being created, create it offshore.
3. Turn your money into offshore IP. A critical insight about intellectual property is that you can always convert cash into IP with an offshore situs, simply by sending the money on a foreign holiday and then spending it "offshore" to pay the people who have the brains to create valuable IP. In fact, money can almost always be changed, practically like a currency-conversion transaction, into valuable intellectual property. Granted you have the risk that your research does not pan out or does not produce the quality and value that you expected, but that is true of all research projects. Spend lots of money on lots of research projects, and on average you will come up with lots of pretty good (and sometimes incredibly valuable) intangible assets.
Money can always be moved offshore, absent currency restrictions or repatriation limitations. Those kinds of controls are episodically put in place by desperate political regimes, but money at the moment can still flow relatively freely around the world. In other words, money can boldly go (like the Starship Enterprise) where intellectual property cannot.
The obvious idea, therefore, is to put the money where you want the IP to be, and then use the money to create the IP in the right location. For example, a Bermuda corporation, following funding, can contract with talent and resources in the United States to create the "next generation" of IP. The "gestalt" value, meaning the genius or inspiration value of the intellectual property, will be transferred offshore, all for a "cost-plus" pricing regime. In effect, if you pay people their hourly wage, you get to keep all the benefits of their labor, even if their labor creates assets dramatically more valuable than the compensation amount. There are arm's-length pricing issues under Section 482 when the company is essentially paying itself to do the research for an offshore entity, but even this problem can be avoided by the simple expediency of contracting always with unrelated third parties. Move money offshore, contract with somebody to create valuable IP, and "Voila!" you have property located where it is not subject to alimony taxes.
In summary, international tax law is the new marriage: Your tax jurisdiction expects to tax you, in sickness and in health, for as long as it can—and then hopes to collect alimony taxes if you decide to seek a divorce. This article suggests the wisdom of picking your tax marriage partners carefully, and then entering the relationship with your eyes wide open. The old canard suggested that people marry the first time for love and the second time for money, but in the case of international taxation, all tax jurisdictions are intent on getting married for the second time. It is okay to love your tax jurisdiction—marriage can be a genuinely good thing—but you want to be sure to consider a pre-nup before you tie the knot.
___________
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
• patents, inventions, formulae, designs, patterns, know-how
• copyrights, literary, musical or artistic compositions
• trademarks, trade names, or brand names
• franchises, licenses, or contracts
• methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data
• any similar item
Under current provisions, Section 367(d) does not apply to the transfer of foreign goodwill, or going concern value. Reg. §1.367(d)-1T(b).
19
20
21
22
23
• a U.S. person transfers the assets of a foreign branch with previously deducted losses [Temp. Reg. §1.367(a)-6T(c)(4): This regulation looks at the gain realized based on the fair market value of the intangible property on the date of the transfer]; or
• a U.S. person that incurred an "overall foreign loss" transfers the intangible property used outside of the U.S. [Section 904(f)(3)].
Under both of the cases above, the income required to be reported under Section 367(d) is reduced by the immediately recognized gain [Temp. Reg. §1.367(d)-1T(g)(3)].
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
• CSTs.
• PCTs.
• Divisional Interests.
Each controlled participant must receive a non-overlapping interest in the cost shared intangibles without further obligation to compensate another controlled participant for such interest (other than those required by CSTs and PCTs). All controlled participants must commit to, and in fact, engage in platform contributions transactions (PCTs) to the extent that there are platform contributions pursuant to paragraph (c) of this section. In a PCT, each other controlled participant (PCT Payor) is obligated to, and must in fact, make arm's length payments (PCT Payments) to each controlled participant (PCT Payee) that provides a platform contribution. All controlled participants must commit to, and in fact, engage in cost-sharing transactions. In CSTs, the controlled participants make payments to each other (CST Payments) as appropriate, so that in each taxable year each controlled participant's intangible development cost (IDC) share is in proportion to its respective reasonably anticipated benefit (RAB) share;
46
47
48
49
50
51
52
53
54
See Beeton, Clayson, and Forsyth, IP in Transfer Pricing Planning, Transfer Pricing International Journal (April 2010).See "The IRS Gets Jealous: Oh, Ruby, Don’t Take Your Love to Town or Your Intangibles Out of the Country," Practical International Tax Strategies, May 15, 2010.Elizabeth Chorvat, You Can’t Take It With You: Behavioral Finance and Corporate Expatriations, 37 U.C. DAVIS L. REV. 453, 456 n.7 (2003).International Tax Issues Relating to Globalization: Hearing Before the S. Comm. on Finance, 106th Cong. 1 (1999) (statement of Robert Perlman, Vice President of Taxes of Intel Corporation).See Reg. §§1.482-7T(d)(1), (k)(1)(ii) and 1.482-7A(b)(3), (4)(ii) (requiring a qualified cost-sharing arrangement to include a provision mandating adjustments to a participant's share of development costs to account for, among other things, changes in economic conditions).T.D. 9441, Reg. §1.482-7T(i)(6).Reg. §1.482-7T(b)(4)(ii), (iii) and (iv). Reg. §1.482-7(b)(1)(iii).Reg. §§1.482-7T(b)(2) and 1.482-7T(k).Reg. §1.482-7T(b)(1): The substantive requirements are that: Reg. §§1.482-7T(a)(2) and -7T(b)(1)(ii). See generally the discussion in Charles Cope and Thomas Zollo, Changes to the Unites States Cost Sharing Arrangements, Transfer Pricing International Journal (January 2009).T.D. 9441, 74 Fed. Reg. 340 (1/5/09); REG-144615-02, 74 Fed. Reg. 236 (1/5/09). The 2009 Temporary Regulations apply to new CSAs and to previously qualified CSAs that were in existence on January 5, 2009. However, the temporary regulations’ impact on existing CSAs should be minor as long as there is no "material change" in the scope of the CSA after January 5, 2009 and the written contract evidencing the CSA is amended by July 6, 2009 to conform with Reg. §1.482-7T, and the activities of the controlled participants "substantially comply" with the new requirements under Reg. §1.482-7T as modified for existing CSAs. See Reg. §1.482-7T(m); Neal M. Kochman, Parsing the Temporary Cost Sharing Regulations, 38 TM International Journal 555 (2009).See Preamble to 2005 Proposed Regulations REG-144615-02, 70 Fed. Reg. 51116 (8/29/05): "In this regard, valuations are not appropriate if an investor would not undertake to invest in the arrangement because its total anticipated return is less than the total anticipated return that could have been achieved through an alternative investment that is realistically available to it."REG-144615-02, 70 Fed. Reg. 51116 (8/29/05).See Preamble to 2005 Proposed Regulations REG-144615-02, 70 Fed. Reg. 51116 (8/29/05); See also Neal M. Kochman, Parsing the Temporary Cost Sharing Regulations, 38 TM International Journal 555, fn. 5 (2009) citing four cases involving buy-in issues that have been either docketed in the Tax Court or decided by the Tax Court: Veritas Software Corp. v. Comr., 133 T.C. 297 (2009) (nonacquiescence by Comissioner, AOD 2010-49); Xilinx Inc. v. Comr., 125 T.C. 37 (2005) (affirmed by Xilinx Inc. v. Comr., 598 F.3d 1191 (2010)); Medtronic Inc. v. Comr., T.C. No. 17488-08 (7/15/08); and First Data Corp. v. Comr., T.C. No. 7042-09 (3/20/09).Reg. §1.482-7(g)(2) (1995). See also footnote 44.T.D. 8632, 1996-1 C.B. 85.Reg. §1.482-7A(a)(1); Reg. §1.482-7T(b)(1).Reg. §1.482-7A (applicable before January 5, 2009) and Reg.§1.482-7T (applicable on and after January 5, 2009).Reg. §1.482-1(c)(1). Reg. §1.482-4(a).Reg. §1.482-4.Thomas M. Zollo, Clarification or Modification? The Tax Treatment of the Outbound Transfer of Goodwill, Going Concern Value, and Workforce in Place to a Foreign Corporation, 39 TM International Journal 71, 11 (2010); See Green Book at p. 32. See "The IRS Gets Jealous: Oh, Ruby, Don’t Take Your Love to Town or Your Intangibles Out of the Country," Practical International Tax Strategies, May 15, 2010.See U.S. Department of Treasury, General Explanations of the Administration's Fiscal Year 2010 Revenue Proposals, at p. 32 (May 2009) (Green Book).See Reg. §1.367(d)-IT(c)(1).See Reg. §1.367(d)-1T(c)(3).Temp. Reg. §1.367(d)-1T(a) states that the U.S. person receives payments for tax purposes "regardless of whether such payments are in fact made by the transferee."Reg. §1.367(d)-1T(c)(1).Section 367d)(2)(A)(Last sentence); Section 367(d)(2)(C).Section 367(d)(2)(A).The immediate recognition of gain under Section 367(d) may happen if: Section 367(d)(1)(A); Section 367(a)(3)(B)(iv). Tangible property and also goodwill transferred under the "active" business rule can trigger gain to the extent of previously deducted branch losses.Reg. §1.367(a)-1T(b)(3)(i).Reg. §1.367(a)-1T(b)(1). Special rules apply to the outbound transfer of shares which is beyond the scope of this article.For these purposes, the term "intangible property" is defined in Section 936(h)(3)(B), and includes the following property, if such property has substantial value independent of services:Temp. Reg. §1.367(d)-1T(g)(4)(i). However, if the purported sale or license were a "sham," then Section 367(d) would still apply to that transaction. Temp. Reg. §1.367(d)-1T(g)(4)(ii).Section 367(c)(2).Section 367(d)(1).Former Reg. §1.7874-2T(d)(2).Reg. §1.7874-2T(g)(3). The factors to be considered include: the historical presence in the foreign country, the level of property and services and sales in the foreign country, managerial activities by employees based in the foreign country, the level of ownership by investors in the foreign country, and whether business activities within the foreign country are material to the achievement of the overall business objectives of the EAG. Reg. §1.7874-2T(d)(1).See T.D. 9238, 2006-6 I.R.B. 408, stated "income or gain required to be recognized by the expatriated entity … cannot be offset by net operating losses or credits (other than credits allowed under Section 901). .Section 7874(d)(2).Section 7874(a), 7874(d).Section 7874(b).Section 7874(c)(1).Section 7874(a)(2)(B). Inversions are largely paper transactions where a U.S. corporation first creates a subsidiary in a foreign country. Corporate ownership is then "inverted" by turning the foreign subsidiary into the parent company in an effort to avoid U.S. taxation on income earned abroad. See Michael J. Graetz, Foundations of International Income Taxation, 113, Foundation Press (2003).26 USC Title 26—Internal Revenue Code (IRC). Unless otherwise noted, all Section references refer to the United States Internal Revenue Code of 1986, as amended (the "Code") and the regulations promulgated thereunder (the "Treasury Regulations" or "Reg."). See Notice 94-46, which was a reaction to the Helen of Troy Corporation’s inversion into a Bermuda parent. The first wave of inversions took place around 1994, and at that time companies were somewhat restrained in implementing inversion transactions because they did not want to subject their shareholders to taxation under existing Section 367 rules. However, around 2001, the shareholder level tax imposed by Section 367 was perceived as less of an impediment because "many shareholders were likely either (1) U.S. individuals not having meaningful (if any) gains in their shares, or (2) non-individuals with little tax sensitivity to a mark-to-market event." See Tretiak and Jackman, Cross-Border Business Combinations, Int’l Tax Journal, 7; fn. 4 (2009).The United States currently has one of the highest statutory corporate tax rates in the world. 