Action Expected Shortly By U.S. Treasury On Outbound Transfers As Well As Other Important Issues, Including The Branch Currency Rules

By: Jerald David August

Shortly after President Trump took the oath of office as President, on April 21, 2017, President Trump issued Executive Order 13789, a directive intended to reduce tax regulatory burdens on the IRS and Treasury.[1] The order instructed the Secretary of the Treasury to review all “significant tax regulations” issued on or after January 1, 2016 by the predecessor administration, and submit two reports, followed promptly by taking concrete action to alleviate the burdens of regulations that meet criteria outlined in the order.

Specifically, the President directed the Secretary, in consultation with the Administrator of the Office of Information and Regulatory Affairs, to submit a 60-day interim report (which it in fact complied with) in identifying regulations that (i) impose an undue financial burden on U.S. taxpayers; (ii) add undue complexity to the Federal tax laws; or (iii) exceed the statutory authority of the Internal Revenue Service (IRS). The order further instructs the Secretary to submit a final report to the President by September 18, 2017, recommending “specific actions to mitigate the burden imposed by regulations identified in the interim report.”

Deluge of Regulations Issued During Last Year of the Obama Administration

From January 1, 2016, through April 21, 2017, Treasury and the IRS issued 105 temporary, proposed, and final regulations. One set of regulations, under Section 385, the Office of Management and Budget designated as significant pursuant to Executive Order 12866. Executive Order 13789 provides, however, that in determining whether a regulation is significant for the purpose of this review, past determinations made pursuant to Executive Order 12866 were not to be considered as controlling.

Fifty-three of the 105 regulations issued during the relevant review period are minor or technical in nature and generated minimal public comment. To ensure a comprehensive review, Treasury treated the remaining 52 regulations as potentially significant and reexamined all of them for the purpose of formulating its interim report. See https://www.treasury.gov/resource-center/tax-policy/Pages/Executive-Orders.aspx. Treasury proceeded to identify regulations that meet the criteria of President Trump’s order and qualify as significant per Executive Order 13789. [2]

Within 150 days of the date of the order — by September 18, 2017,  — the Secretary of the Treasury is required to submit a report to the President that contains the Secretary’s “plan of attack” for each regulation identified in the interim report. It is unclear when that report would be made publicly available.

Based on that reexamination, Treasury has identified regulations that meet the criteria of the President's order and qualify as significant in view of the Presidential priorities for tax regulation outlined in Executive Order 13789.

Treasury Identified Regulations For Burden Reduction

Treasury concluded, in Notice 2017-38, 2017-30 I.R.B. 147, that eight regulations meet at least one of the first two criteria specified by Section 2 of Executive Order 13789. Consistent with the order, Treasury intends to propose reforms—potentially ranging from streamlining problematic rule provisions to full repeal—to mitigate the burdens of these regulations in a final report submitted to the President.

1. Proposed Regulations under Section 103 on Definition of Political Subdivision (REG-129067-15; 81 F.R. 8870)

These proposed regulations define a “political subdivision” of a State (e.g., a city or county) that is eligible to issue tax-exempt bonds for governmental purposes under Section 103 of the Internal Revenue Code. The proposed regulations require a political subdivision to possess three attributes: (i) sovereign powers; (ii) a governmental purpose; and (iii) governmental control. Commenters stated that the longstanding “sovereign powers” standard was settled law and had been endorsed by Congress, and additional limitations were unnecessary. There had been criticism of these proposed regulations in that they would disrupt the status of numerous existing entities and that it would be burdensome and costly for issuers to revise their organizational structures to meet the new requirements of the proposed regulations.

2. Temporary Regulations under Section 337(d) on Certain Transfers of Property to Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITs) (T.D. 9770; 81 F.R. 36793)

The temporary regulations amend existing rules on transfers of property by C corporations to REITs and RICs generally. In addition, the regulations provide additional guidance relating to certain newly-enacted provisions of the Protecting Americans from Tax Hikes Act of 2015, intended to prevent certain spinoff transactions involving transfers of property by C corporations to REITs from qualifying for non-recognition treatment.

3. Final Regulations under Section 7602 on the Participation of a Person Per Section 6103(n) in Issuing Summons (T.D. 9778; 81 F.R. 45409)

These final regulations provide that persons described in Section 6103(n) and Treas. Reg. § 301.6103(n)-1(a) with whom the IRS contracts for services— such as outside economists, engineers, consultants, or attorneys—may receive books, papers, records, or other data summoned by the IRS and, in the presence and under the guidance of an IRS officer or employee, participate fully in the interview of a person who the IRS has summoned as a witness to provide testimony under oath. Treasury will review these regulations as they concern the outside attorneys under contract with the IRS to participate in the taking of compulsory testimony under oath.

4. Proposed Regulations under Section 2704 on Restrictions on Liquidation of an Interest for Estate, Gift and Generation-Skipping Transfer Taxes (REG-163113-02; 81 F.R. 51413)

Section 2704(b) requires that certain non-commercial restrictions on the ability to dispose of or liquidate family-controlled entities should be disregarded in determining the fair market value of an interest in that entity for estate and gift tax purposes. Concern had been raised by professional commentators and bar groups that the proposed regulations would eliminate or restrict common discounts, such as minority discounts and discounts for lack of marketability, which would result in increased valuations and transfer tax liability that would increase financial burdens.

5. Temporary Regulations under Section 752 on Liabilities Recognized as Recourse Partnership Liabilities (T.D. 9788; 81 F.R. 69282).

This set of somewhat controversial temporary regulations generally provide: (i) rules for how liabilities are allocated under Section 752 solely for purposes of disguised sales under Section 707 of the Internal Revenue Code; and (ii) rules for determining whether “bottom-dollar payment obligations” provide the necessary “economic risk of loss” to be taken into account as a recourse liability. Commenters stated that the first rule was novel and would unduly limit the amount of partners' bases in their partnership interests for disguised sale purposes, which would negatively impact ordinary partnership transactions. Commenters were further concerned that the bottom-dollar payment obligation rules would prevent many business transactions compared to the prior regulations and suggested their removal or the development of more permissive rules.  Converting recourse debt to non-recourse debt for applying the disguised sales rules was permitting draconian in its application from prior law and ignored economic risk of loss principles.

6. Final and Temporary Regulations Defining Debt Versus Equity Under Section 385 On the Issuance of Interests in Corporations (T.D. 9790; 81 F.R. 72858)

The final and temporary regulations under Section 385 addressed the classification of related-party debt as debt or equity for federal tax purposes. The regulations are primarily comprised of (i) rules establishing minimum documentation requirements that ordinarily must be satisfied in order for purported debt among related parties to be treated as debt for federal tax purposes; and (ii) transaction rules that treat as stock certain debt instruments that are issued by a corporation to a controlling shareholder in a distribution or in another related-party transaction that achieves an economically similar result. The rules were viewed by many as overly burdensome and costly.

7. Final Regulations under Section 987 on Income and Currency Gain or Loss With Respect to a Section 987 Qualified Business Unit (T.D. 9794; 81 F.R. 88806)

These final regulations issued with respect to Section 987 provide rules for (i) translating income from branch operations conducted in a currency different from the branch owner's functional currency into the owner's functional currency, (ii) calculating foreign currency gain or loss with respect to the branch's financial assets and liabilities, and (iii) requiring recognition of foreign currency gain or loss when the branch makes a transfer of any property to its owner. As with other Obama Administration regulations during the relevant period under review, the final regulations under Section 987 were perceived to impose an undue financial burden on taxpayers because it disregarded losses calculated by the taxpayer for years prior to the transition but not previously recognized and otherwise imposes undue costs and administrative burdens on subject taxpayers.

8. Final Regulations under Section 367 on the Treatment of Certain Transfers of Property to Foreign Corporations (T.D. 9803; 81 F.R. 91012)

Section 367 requires income recognition with respect to immediate or future transfers of property (tangible and intangible) to foreign corporations, subject to certain exceptions. The newly minted final regulations eliminated the ability of taxpayers under prior regulations to transfer foreign goodwill and going concern value to a foreign corporation without immediate or future U.S. income tax. Some comments were filed that the final regulations would increase burdens by taxing transactions that were previously exempt, noting in particular that the legislative history to Section 367 contemplated an exception for outbound transfers of foreign goodwill and going concern value. 

This Blog Post: Addresses The Section 367 Regulations

Section 367(a)

Foreign business organizations generally are not subject to U.S. income (or branch) tax on foreign earnings. The presence of this limitation on the taxing powers of the U.S., for years transfers of property by U.S. persons to foreign entities would have the ability, if not limited by statutory and/or regulatory policing type rule, to promote a host of tax avoidance strategies with a projected likelihood of success, at least in various instances. Thus, for example, where a U.S. individual (citizen or resident) transferred valuable intangible property to a foreign corporation, the transfer itself may escape recognition treatment and the future exploitation of such intangibles in the form of royalties and sales proceeds would not be U.S. source income. [3] In some instances, however, the resulting foreign source income could be currently taxed under Subpart F if the CFC rules were “turned-on” or until there was a repatriation to the U.S. [4] Still, the capital contribution in would not be subject to recognition treatment.

As a general block to deny favorable treatment to a set of potential income avoidance maneuvers, Section 367(a) denies non-recognition treatment that would otherwise be applicable with respect to transfers of appreciated property by U.S. persons to foreign corporations. [5] The general rule of Section 367(a)(1) is that gain is recognized when a U.S. person transfers property to a foreign corporation in any of the following transactions:

1. A U.S. person's transfer of property to a foreign corporation in exchange for the foreign corporation's stock, where the transferor, alone or together with others making contemporaneous transfers, controls the corporation immediately after the exchange;[6] 

2. A U.S. person's exchange of stock or securities of a domestic corporation for stock or securities of a foreign corporation pursuant to a plan of reorganization; and

3. A domestic corporation's transfer of its assets to a foreign corporation in a reorganization exchange for stock or securities of the foreign corporation or in a subsidiary-to-parent liquidation.

The recognition provision contained in Section 367(a)(1) has several exceptions. First, transfers of stock or securities to a foreign corporation fall outside the scope of Section 367(a)(1). [7] Nonrecognition treatment is also provided under Section 367(a)(3) for transfers of some types of assets to be used by a transferee foreign corporation in the active conduct of a trade or business in a foreign country. Generally, the active business rule allows nonrecognition for gains not likely to be realized quickly by the transferee. A loss recapture rule, however, requires that even such gains be recognized on the incorporation of a foreign branch that has sustained losses. As a third potential exception, Section 367(a)(4) provides, subject to regulations, that a transfer by a U.S. person of an interest in a partnership to a foreign corporation for stock will be treated as a transfer to such corporation of such person’s pro rata share of the assets of the partnership.

Section 367(d) applies with respect to transfers by U.S. persons to foreign corporation of interests in copyrights, patents, and similar intangibles. The provision treats such transfers as if the property had been licensed to the foreign corporation-“licensee” for a royalty payable over the property’s economic life. The constructive payments of royalty income, which of course are subject to U.S. income tax, are adjusted periodically throughout. [8] Goodwill and going concern value were, as part of tax legislation enacted in 1984, to be treated as outside the scope of Section 367(d). Therefore, for example, the transfer of good will or going concern valued generated by a foreign branch of a U.S. person will be treated under the active trade or business exception rather than under Section 367(d).[9]

Section 367(e) and the regulations thereunder supplement
Section 367(a) by requiring gain recognition in two situations:

1. A domestic subsidiary corporation generally is required to recognize gain on distributing its assets in liquidation to a foreign parent corporation, and, a liquidating foreign subsidiary must usually recognize gain on distributing its U.S. business assets to a foreign parent corporation.

2. A domestic corporation distributing stock or securities of a controlled corporation must recognize gain with respect to any portion of the stock or securities distributed to foreign distributees.

Temporary Section 367 Regulations

In May, 1986, the Treasury and Service issued temporary and proposed regulations to Sections 367(a) and 367(d) as well as for Section 6038B. Treas. Reg. §1.367(d)-1T set forth applicable rules with respect to transfers of intangible property by U.S. persons to foreign corporations under Section 351 or Section 361. In general, Treas. Reg. § 1.367(d)-1T(a) provided that a U.S. transferor would be treated as receiving annual payments contingent on productivity or use of the transferred property over the useful life of the property (regardless of whether those payments were in fact made by the transferee). Another main feature of the temporary regulations was set forth in Treas. Reg. §1.367(d)-1T(b) which provides that Section 367(d) and Treas. Reg. §1.367(d)-1T will apply to the transfer of any intangible property. Still Section 367d) and Treas. Reg. § 1.367(d)-1T were not “turned on” with respect to apply to the transfer of goodwill and going concern value or to the transfer of other specified intangible property.

The 2015 Proposed Section 367 Regulations

Thirty years later, in September 2015, the Treasury and the IRS issued proposed regulations under Section 367. The proposed Section 367 regulations suggested five substantive changes to the temporary Section 367 regulations: (i) the elimination of favorable (active trade or business exception) with respect to foreign goodwill and going concern value; (ii) allowing taxpayers to apply Section 367(d) to some property that otherwise would be subject to section 367(a); (iii) removing the 20-year limitation period in determining the useful life of intangibles subject to the super-tax under Section 367(d); (iv) removing the exception that permits specific property denominated in foreign currency to qualify for the active trade or business exception in Section 367(a)(3); and (iv) changing the valuation rules of the temporary regulations to be consistent with applicable principles under Section 482.

The Final Section 367 Regulations

Final Section 367 regulations were issued on December 16, 2016 which generally retained the provisions under the proposed regulations. Most notably and yes unfortunately was that the final regulations eliminated the goodwill and going concern value exception as part of Section 367(a)(3).

Due to the draconian effect of removing the goodwill and going concern value rule or exception under Section 367(a)(3), it is hoped that Treasury will repeal the final Section 367 regulations or at least remove this unfortunate inclusion in the final regulations. It is time for the Treasury release a report containing necessary recommendations and reforms and issue proposed or final rule-makings on the area under study. 


[1] Executive Order 13789 § 2(a) (2017).

[2] See Executive Order 12866 § 3(f) (1993) ( “significant regulatory action” includes, inter alia, “any regulatory action that is likely to result in a rule that may ... [r]aise novel ... policy issues arising out of ... the President's priorities”). To assess “undue financial burden,” Treasury considered the degree to which the regulation at issue imposed compliance costs or resulted in tax liabilities that exceed the minimum required to achieve the relevant statutory objectives. To assess “undue complexity,” Treasury considered whether the regulation at issue imposed new substantive, computational, or other requirements not required to achieve the relevant statutory objectives, or introduced rules that added uncertainty for taxpayers.

[3] But see §§367(d), 721(d), 951-960.

[4] See, e.g.,§956 (investment of earnings in U.S. property).

[5] See generally Dolan & Jackman, U.S. Taxation of International Mergers, Acquisitions and Joint Ventures (Carswell 2004); Daub, “Section 367 Adrift: Old Statute, New Applications”, 151 Tax Notes 1207 (May 30, 2016), 151 Tax Notes 1353 (June 6, 2016); Davis, “Outbound Transfers of Tangible Property Under Section 367(a),” 23 Tax Mgmt. Int'l J. 55, 103 (1994); Hicks, Section 367

[6] The non-recognition provisions affected by this rule are the following: (i) Section 351 (no gain or loss is recognized on a transfer of property to a corporation in exchange for stock of the corporation if the transferor, alone or together with others making contemporaneous transfers, owns at least 80 percent of the corporation's stock immediately after the transfer); (ii) Section 354 (no gain or loss is recognized on exchange of stock or securities for other stock or securities pursuant to a reorganization); (iii) Section 356 (if Section 354 would apply but for receipt of other property in addition to stock, recognized gain is limited to the value of the other property, and no loss is recognized); (iv) Section 361 (corporation recognizes no gain or loss on transferring its property pursuant to a plan of reorganization in exchange for stock or securities of another corporate party to the plan). Note also that under Section 367(c)(2), a U.S. person's contribution to the capital of a foreign corporation is deemed made in exchange for stock equal in value to the contributed property if the U.S. person, alone or together with others making contemporaneous contributions, owns (actually or constructively) at least 80 percent of the foreign corporation's stock immediately after the transfer.

[7] Section 367(a)(2) provides that unless otherwise provided in regulations, Section 367(a)(1) shall not apply to the transfer of stock or securities of a foreign corporation which is a party to the exchange or the reorganization.

[8] Under the 1984 Deficit Reduction Act, Section 367(d)1) provided that if a U.S. transfer transfers intangible property per Section 936(h)(3)(B) to a foreign corporation in an exchange described in either Section 351 or Section 361, Section 367(d) would override application of those non-recognition rules.

[9] H.R. Rep. No. 98-432, at 1320 (1984).


"Disclaimer of Use and Reliance: The information contained in this blog is intended solely for informational purposes and the benefit of the readers of this blog. Accordingly, the information does not constitute the rendering of legal advice and may not be relied upon by the reader in addressing or otherwise taking a position on one or more specific tax issues or related legal matter for his or her own benefit or the for the benefit of a client or other person.” ©Jerald David August for Kostelanetz & Fink, LLP”