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The IRS Has Never Won a Subpart F Sales or Services Case

The IRS has never won a single litigated case arguing for foreign base company sales income (and has never litigated a foreign base company services income case). Courts have consistently rejected the government’s arguments to expansively apply the definition of Subpart F sales income in order to carry out asserted congressional intent. While the courts have acknowledged that the policies informed the rules, they have not permitted the policies to eclipse the plain language of the code, even where the taxpayer engaged in tax planning that took advantage of the rules and arguably frustrated the policies underlying the rules.

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IRS Practice Unit Advises Examiners to Use Aggregate Approach in Valuing Outbound Transfers

On January 4, 2017, the Internal Revenue Service (IRS) released a new “International Practice Unit” (IPU) on the value of intangibles in IRC Section 367(d) transactions in conjunction with cost sharing arrangements (CSA). See IPU here. The IPU notes that transferring highly valuable intangibles offshore has become a routine tax strategy for reducing a company’s effective tax rate for financial statement and tax purposes.

Typically, questions concerning the value of intangibles arise where a US taxpayer enters into a CSA with a controlled foreign corporation (CFC) in a low or no tax jurisdiction, and contributes resources, rights and capabilities (which may include IRC Section 936(h)(3)(B) intangibles) to the CSA. An arm’s length payment to the US taxpayer is then required for the contribution. Simultaneously with, or shortly before entering into a CSA, the US taxpayer transfers certain intangible property to the CFC in an IRC Section 351 or 361 transaction, which is taxable under IRC Section 367(d). Again, there is an arm’s length charge for the use of that intangible property.

Oftentimes in these transactions, the US taxpayer values the intangibles transferred in the IRC Section 367(d) transfer separately from the platform contributions, even though, the IRS says, the intangibles conveyed in both transactions will be exploited on a combined basis. Based on the aggregation principles in the IRC Section 482 regulations, the IPU warns that a non-aggregate approach may not provide an arm’s length result. Moreover, despite taxpayer arguments to the contrary, the IPU maintains that the scope of intangible property for purposes of IRC Section 367(d) is just as broad as the scope of platform contributions.

Practice Point: The IPU is a good source of information of what the IRS’s examination division will consider when auditing an outbound transfer of intangible rights for use in a CSA. If you have or intend to engage in such a transaction, you should study the IPU to ensure that you have adequately documented the arm’s length payments for the transfer.




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IRS Issues Regulations Related to CFC Loans

The Internal Revenue Service (IRS) has just released final regulations regarding the treatment of United States property held by a controlled foreign corporation (CFC) in connection with certain transactions involving partnerships. The final regulations also provide rules for determining whether a CFC is considered to derive rents and royalties in the active conduct of a trade or business for purposes of determining foreign personal holding company income, as well as rules for determining whether a CFC holds United States property as a result of certain related party factoring transactions. The new rules finalize proposed regulations, and withdraws temporary regulations, published on September 2, 2015. It also finalizes proposed regulations, and withdraws temporary regulations, published on June 14, 1988. In addition, the IRS has issued proposed regulations that provide rules regarding the determination of the amount of United States property treated as held by a CFC through a partnership. The final and proposed regulations affect United States shareholders of CFCs.

The final and proposed regulations can be found here and here.




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Subpart F: When Does a CFC Receive Substantial Assistance in Performing Services?

Income derived by a controlled foreign corporation (CFC) from performing services for an unrelated customer generally is not Subpart F income. However, if U.S. related persons furnish substantial assistance contributing to the performance of the services, under regulations, the CFC will be deemed to perform the services for a related person. In such case, the services income would be Subpart F income to the extent attributable to services performed outside the CFC’s country of organization.

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