On Wednesday, October 9, 2024, the Treasury Department and the Internal Revenue Service (“IRS”) released final regulations (TD 9994), confirming that the application of section 367(d) to intangible property (“IP”)—e.g., patents, copyrights, trademarks, licenses, etc.—is terminated when the IP is repatriated to the United States (“U.S.”) under certain circumstances. 

Overview of Section 367(d)

In general, section 367(d) and the corresponding Treasury Regulations seek to prevent domestic corporations from shifting income-generating IP offshore in tax-free transactions.  Specifically, section 367(d)(1) provides that, if a U.S. person (“U.S. transferor”) transfers any IP to a foreign corporation in a tax-free exchange (e.g., section 351 or section 361), then the transferred IP is subject to section 367(d).  Under section 367(d)(2)(A), if a U.S. transferor transfers IP subject to section 367(d), then the U.S. transferor is treated as having sold the IP in exchange for payments that the U.S. transferor would have otherwise received annually over the useful life of the IP.  These annual amounts that the U.S. transferor is treated as having received are defined as “section 367(d) inclusions.”  The foreign corporation also must make a corresponding adjustment to its earnings and profits (“E&P”), reducing it by the amount of the deemed payment (i.e., the section 367(d) inclusion) to the U.S. transferor. 

If the U.S. transferor subsequently transfers the stock of the foreign corporation it received in exchange for the IP or if the foreign corporation transfers the IP, the application of the section 367(d) regulations changes depending on whether the transferee in the subsequent transfer is a U.S. person or a foreign person and whether the transferee is a related or unrelated person to the U.S. transferor.  The prior regulations did not distinguish between subsequent transfers made to a related U.S. or foreign person, which would result in different tax consequences. 

For example, if a U.S. transferor transferred the stock of the foreign corporation to a related U.S. person, the transfer would not be treated as a disposition of the IP (i.e., an event that would not accelerate a lump-sum section 367(d) inclusion) and the related U.S. person would be required to include a proportionate share of the annual section 367(d) inclusion as income.  If the U.S. transferor would have transferred the stock of the foreign corporation to an unrelated person, the transfer would be treated as a disposition of the IP (i.e., an event that would accelerate a lump-sum section 367(d) inclusion) and the U.S. transferor would be required to recognize gain as if the U.S. transferor had sold the IP itself to an unrelated person.  By contrast, if the foreign corporation were to transfer the IP to a related person (U.S. or foreign), the subsequent transfer would constitute a direct disposition of the IP but would not accelerate a lump-sum section 367(d) inclusion for the U.S. transferor.  Only if the foreign corporation were to transfer the IP to an unrelated person would the U.S. transferor be required to recognize gain. 

The prior regulations did not allow for the application of section 367(d) (i.e., the annual section 367(d) inclusion) to be turned off when the IP was transferred or “repatriated” to a related U.S. person that was subject to U.S. taxation on income earned from the IP, thereby collectively subjecting the U.S. transferor and the related U.S. person to excessive U.S. taxes.

Proposed Regulations

On May 3, 2023, the Treasury Department and the IRS published a notice of proposed rulemaking (REG-124064-19), which sought to address issues involving the repatriation of IP.  Specifically, the proposed regulations clarified that section 367(d) did not apply when: (1) a foreign corporation repatriates IP subject to section 367(d) to a qualified domestic person and satisfies certain reporting requirements; and (2) the U.S. transferor includes in gross income a partial annual inclusion attributable to the duration of its taxable year in which the foreign corporation held the IP. 

The proposed regulations defined a “qualified domestic person” as: (1) the U.S. transferor that initially transferred the IP that is subsequently repatriated (the “initial U.S. transferor”); (2) a qualified successor to the U.S. transferor (“qualified successor”); or (3) a U.S. person or qualified corporation related to the initial U.S. transferor or qualified successor.  The proposed regulations also included various rules on whether the repatriation would require: (1) the qualified domestic person to adjust its basis in the repatriated IP; (2) the U.S. transferor to recognize gain; and (3) the foreign corporation to reduce its E&P.

The proposed regulations also set forth certain reporting requirements for companies to provide information about the subsequent transfer of intangibles and the qualified domestic person.  The proposed regulations provided that failure to provide this information would result in continued section 367(d) annual inclusions.

Final Regulations

Following the notice of proposed rulemaking, the Treasury Department and the IRS received five comments that they addressed in the final regulations.  Among other things, these comments suggested that the term “qualified domestic person” also include partnerships and S corporations and suggested various limitations that would prevent taxpayers from taking advantage of certain structural changes post-repatriation from frustrating the purpose of the proposed regulations.  The final regulations declined to adopt these comments, however, stating that the various issues and potential solutions were discussed in the preamble to the proposed regulations or the proposed regulations themselves and that the “approach outlined in the proposed regulations continues to strike the appropriate balance between implementing the general purpose and scope of the proposed regulations.” 

The final regulations also declined to address other comments regarding, for example, the treatment of adjusted basis in certain situations when IP is repatriated, as they “implicate[] broader issues under section 367(d) and, as such, [are] beyond the scope of this rulemaking.”  The final regulations did, however, elaborate on an example from the proposed regulations dealing with adjusted basis.  The final regulations also clarified certain reporting requirements and requirements for relief in the event that a taxpayer fails to report.

In sum, the final regulations largely retained the proposed regulations except for a few minor modifications.  The final regulations further declined to apply the rules set forth therein retroactively, instead electing to have them apply on or after the date that the final regulations are published in the Federal Register—i.e., repatriations of IP occurring on or after October 10, 2024.

Reflections

The final regulations are a welcome step towards encouraging multinational corporations to repatriate their IP.  Indeed, these regulations provide additional information for multinational corporations to consider when deciding whether they should repatriate their IP.  With the influx of funding from the Inflation Reduction Act, the IRS is only going to continue allocating more resources to its already aggressive transfer pricing audits.  The final regulations may allow multinational corporations to potentially mitigate their audit risk by repatriating their IP without subjecting themselves to excessive taxation under the prior section 367(d) regulatory regime.  However, the final regulations did not address some questions, such as interim foreign-to-foreign transfers of IP and basis adjustments.  Overall, taxpayers should analyze their own particular facts before moving forward with an IP repatriation.