Planning Ideals for the Modern Day International Corporate Merger or Reorganization

By Anthony Diosdi

There are many good business reasons for corporate mergers or reorganization in the international context. Such transactions are commonly referred to as corporate “reorganizations,” “spin-offs,” “split-ups,” or “split-offs.” Generally, corporate mergers and corporate reorganizations are governed by Internal Revenue Code Sections 351, 368 and 355. The main benefit of meeting the requirements of Internal Revenue Code Sections 351, 368 and 355 in the domestic context, is that corporate mergers and reorganizations can be accomplished on a tax-free basis. A corporate merger or reorganization in the case of a multinational group raises difficult issues because Internal Revenue Code Sections 367 and 7874 (the inversion rules). This article discusses planning ideals to mitigate the impact of Section 367 in the context of a cross-border merger or reorganization. This article will discuss planning concepts for cross-border corporate mergers or reorganizations involving U.S. shareholders and foreign corporations. The concepts discussed in this article do not apply to international corporate mergers or reorganizations involving U.S. shareholders holding interests in foreign corporations that are not controlled foreign corporations or CFCs.

Corporate Reorganizations

The Internal Revenue Code provides for nonrecognition of gain or loss realized in connection with a number of corporate organizational changes. Reorganizations are defined in Section 368(a)(1), include statutory mergers and consolidations, acquisitions by one corporation of the stock or assets of another corporation, recapitalizations, changes in form or place of organization. If the transaction qualifies as a reorganization, neither gain nor loss will be recognized by the corporation or corporations involved or by the shareholders who may exchange their stock for stock or by certain security holders who may exchange their securities for other security holders who may exchange their securities for other securities of the party to the reorganization.

The basic types of reorganizations are:

Type A reorganization- in the context of international corporate acquisitions, Type A reorganizations often take the form of forward triangular mergers, in which the acquired corporation is merged into a subsidiary of the acquiring corporation.

Type B reorganization- in a Type B reorganization, one corporation acquires another corporation solely for all or part of its voting stock or voting stock of its parent corporation.

Type C reorganization- in a Type C reorganization, substantially all of the assets of a corporation are acquired by another corporation in exchange for part or all of the latter’s voting stock or the voting stock of its parent’s corporation, followed by the liquidation of the acquired corporation.

Type D reorganization- in a Type D reorganization allows certain distributions by one corporation (the “distributing corporation”) to its shareholders stock or securities in another corporation corporation (the “controlled corporation”) to be tax-free to the shareholders, and also be tax-free to the distributing corporation.

Type E reorganization- Type E reorganization involves the recapitalization of a corporation.

Type F reorganization- a Type F reorganization involves “a mere change in identity, or place of organization of one corporation, however effected.” See IRC Section 368(a)(1)(F). The major tax advantage to classification as a Type F reorganization is a preferential set of rules that will apply after the reorganization regarding loss carryovers. For example, after a Type F reorganization, in many cases, the new corporation has an opportunity to use net operating losses of an old corporation against its income.

Type G reorganization- a Type G reorganization involves the transfer by a corporation of part or all of its assets to another corporation in a Title 11 or similar bankruptcy proceeding.

Corporate Divisions

Corporate divisions typically follow one of two patterns. The first is a stand-alone Section 355 distribution whereby a distributing corporation simply distributes the stock of a subsidiary to its shareholders. More commonly, a corporation reorganizes its affairs by contributing the assets and stock to a newly-formed formed entity.

Not surprisingly, satisfying the elements of tax-free corporate reorganization or division can be extremely complicated. Section 367 of the Internal Revenue Code adds an additional layer of complexity that must be considered in the context of cross-border corporate reorganizations and split-ups. Internal Revenue Code Section 367 has provided the mechanism for protecting the U.S. taxing jurisdiction in transactions involving transfers by U.S. taxpayers of appreciated property in exchange for stock when one or more foreign corporations are involved. Section 367 will be discussed in more detail below.

Introduction to Internal Revenue Code Section 367(a)

Internal Revenue Code Section 367(a) requires a U.S. person transferring appreciated property to a foreign corporation to recognize a gain on the transfer. The transaction subject to Section 367(a) that is most commonly encountered is probably a transfer of property to a foreign corporation in exchange for its stock under Internal Revenue Code Section 351. Section 367(a) provides a general rule of taxability with respect to outbound transfers of property in exchange for other property in transactions described in Section 332, 351, 354, 356 or 361 by stating that a foreign corporation will not be considered a corporation that could qualify for nonrecognition of gain under one of the enumerated provisions of the Internal Revenue Code.

Section 367(a) imposes a toll charge tax on the income realized on transfers of certain tainted assets. Categories of tainted assets under Section 367(a) include: 1) property relating to inventory and certain intellectual property; 2) installment obligations, accounts receivable or similar property; 3) property with respect to which the transferor is a lessor at the time of the transfer, unless the transferee was the lessee; 4) foreign currency and other property denominated in foreign currency; and depreciable property to the extent that gain reflects depreciation deductions that have been taken against U.S.-source income.

Other transactions that less obviously involve outbound transfers of property are also subject to Section 367(a). These include the acquisition of the stock or assets of a U.S. corporation in exchange for stock of a foreign corporation in a reorganization described in Section 368(a) is normally within the scope of Section 367(a). Triangular Type A mergers, whether in the form of a forward triangular merger described in Section 368(a)(2)(E), in which the shareholder of the acquired U.S. corporation exchange their stock in the U.S. corporation for stock in a foreign corporation, are treated as an indirect transfer of stock by the U.S. shareholder to the foreign corporation. The same analysis applies to a triangular Type B reorganization in which a U.S. person transfers stock in the acquired U.S. corporation to a U.S. subsidiary of the foreign corporation in exchange for stock of the foreign corporation. A U.S. shareholder is also deemed to make a transfer of stock of a U.S. corporation if substantially all of its assets are acquired by a U.S. subsidiary of a foreign corporation in exchange for stock of the foreign corporation in a Type C reorganization and the U.S. acquired corporation is then liquidated.

Introduction to Internal Revenue Code Section 367(b)

Section 367(b) and its regulations apply to outbound transfers not covered under Section 367(a). Specifically, in the case of any exchange described in Section 332, 351, 354, 356 or 361 in connection with which there is no outbound transfer subject to Section 367(a)(1), a foreign corporation will be considered to be a corporation. T.D. 8862, 200-1 C.B. 466-67, describe the policy of Section 367(b) as follows:

The principal purpose of Section 367(b) is to prevent the avoidance of U.S. tax that can arise when the Subchapter C provisions apply to transactions involving foreign corporations. The potential for tax avoidance arises because of differences between the manner in which the United States taxes foreign corporations and their sharehol;ders and the manner in which the United States taxes domestic corporations and their U.S. shareholders.

The Subchapter C provisions generally have been drafted to apply to domestic corporations and U.S. shareholders, and thus do not fully take into account the cross-border aspects of U.S. taxation (such as deferral, foreign tax credits, and Section 1248). Section 367(b) was enacted to help ensure that international tax considerations in the Internal Revenue Code are adequately addressed when the Subchapter C provisions apply to an exchange involving a foreign corporation. Because determining the proper interaction of the Internal Revenue Code’s international and Subchapter C provisions apply to an exchange involving a foreign corporation. Because determining the proper interaction of the Internal Revenue Code’s international and Subchapter C provisions is “necessarily highly technical,” Congress granted the [Treasury and the Internal Revenue Service or “IRS”] broad regulatory authority to provide the “necessary or appropriate” rules, rather than enacting a complex statutory regime. * * * See T.D. 8862, 2000-1 C.B. 466, 466-67.

The regulations issued under Section 367(b) are highly complex and target cross-border mergers and reorganizations that would otherwise be tax-free. In particular, the regulations promulgated under Section 367(b) target Section 1248. Internal Revenue Code Section 1248 recharacterizes otherwise capital gain on the sale or disposition of stock in a CFC into ordinary income to the extent of the earnings and profits of the CFC. The Section 367(b) regulations require current taxation as an ordinary income deemed dividend of amounts of earnings of a CFC that might otherwise escape U.S. taxation and permit deferral of U.S. tax on amounts of income or gain associated with a CFC.

In general, if a U.S. shareholder of a CFC exchanges, in a non-outbound transaction, shares of that corporation for shares of another CFC as to which the shareholder is also a U.S. shareholder, as defined in Section 1248(a)(2), gain recognition may potentially be deferred until the disposition of the stock. See Treas. Reg. Section 1.367(b)-4(b). On the other hand, if the exchanging shareholder was a U.S. shareholder of a CFC of the stock exchanged, but not a U.S. shareholder of the transferred corporation, the U.S. shareholder may be required to pay Section 1248 liability.

Concurrent Application of Section 367(a) and (b)

Section 367 of the Internal Revenue Code was originally aimed at preventing tax-free transfers by U.S. taxpayers of appreciated property to foreign corporations that could sell the property free of U.S. tax. The reach of this provision has been broadened over the years to apply to a broad spectrum of transactions involving transfers both into and out of the United States. Today, Internal Revenue Code Section 367(a) provides a general rule of taxability with respect to outbound transfers of property in exchange for other property in a corporate reorganizations and split-ups. The character and source of gain produced by Section 367 is determined as if the transferor had sold the property to the transferred in a taxable transaction. Under the pre-2018 rules, Section 367(a) required taxpayers to recognize gain on outbound transfers unless: 1) the transfer qualified for an active trade or business exception, or 2) the assets consisted of stock or securities of a foreign corporation and the U.S. transferor entered into a gain-recognition agreement to preserve gain. In the Tax Cuts and Jobs Act, Congress eliminated the active trade or business exception. This means that it is no longer to incorporate a foreign branch for purposes of a tax-free cross-border reorganization. The only exception to Section 367(a) that now remains for purposes of tax-free cross-border merger or reorganization is to transfer stock to a foreign corporation by virtue of a gain-recognition agreement.

Planning Opportunities Utilizing a Gain Recognition Agreement

Transfers by a U.S. person of stock or securities of a U.S. corporation to a foreign corporation are generally taxable under Section 367, unless an exception is available. One such exception is the execution of a closing agreement between the IRS and the U.S. transferor under which the transferor must agree to recognize taxable gain on the transferee corporation’s later disposition of the transferred stock or securities (a “gain-recognition agreement”). According to Treasury Regulation Section 1.367(a)-3(b)(1), if a U.S. person is a percent or more shareholder of the vote or value of the transferred foreign corporation immediately after the transfer and files a gain recognition agreement, the gain recognition provisions of Section 367(a) is not triggered.

A gain-recognition agreement is an agreement to which the U.S. transferor agrees to recognize gain if the transferred foreign corporation disposes of the transferred stock or securities during the term of the gain recognition and pay interest on any additional tax owing if a “triggering event” occurs. A “triggering event” typically takes place when a foreign corporation disposes of the untaxed U.S. property.  In most cases, a gain recognition agreement term is 60 months following the end of the taxable year in which the initial transfer is made. This means, in certain cases, with a properly drafted gain-recognition agreement, the adverse tax federal income consequences associated with a cross-border merger or reorganization involving a U.S. corporation can be deferred up to five years, interest-free.

Dissecting the Contents of a Gain Recognition Agreement

If a U.S. person is a five percent or more shareholder with respect to the stock of a transferee foreign corporation, the shareholder may be eligible to file a gain recognition agreement to avoid immediate gain recognition under Section 367(a)(1). A gain recognition agreement may be very valuable to eliminate (or defer) the tax consequences associated with the outbound transfer of stock transfers in cross-border merger or reorganization. The rules governing gain recognition agreements are highly complex. The regulations contain very specific rules as to what needs to be in a gain recognition agreement. We will next discuss the specific contents that must be included in a gain recognition agreement in order to be recognized by the IRS.

1. The Gain Recognition Agreement Must be Properly Titled.

A gain recognition agreement must specifically state that it is a gain recognition agreement in accordance with Treasury Regulation Section 1.367(a)-8.

2. The Gain Recognition Agreement Must Provide a Description of the Transferred Stock or Securities and Other Information

A gain recognition agreement must adequately describe the stock or securities being transferred through the agreement. In order to satisfy the conditions and requirements of Treasury Regulation 1.367(a)-8(c)(3), the gain recognition agreement should provide provide the following:

(A) A calculation of the amount of the built-in gain (i.e., the fair market value of the stock or securities over the tax basis) in the transferred stock or securities that are subject to the gain recognition agreement, reflecting the basis and fair market value on the date of the initial transfer;

(B)  A description of the shares transfer agreement used to transfer the stock or securities;

(C) The amount of any gain recognized by the U.S. transferor on the initial transferor of stock or securities;

(D) The percentage (by vote and value) that the transferred stock (if any) represents of the total stock outstanding of the transferred corporation on the date of the initial transfer.

3. Identifying Information of the Transferring Corporation

The gain recognition agreement should state the name, address, place of incorporation, and the taxpayer identification number (if any) of the transferred corporation shares or securities.

4. The Acquisition Date

The gain recognition agreement should state the date on which the U.S. transferor acquired the transferred stock or securities.

5. Information Regarding the Transferee Foreign Corporation

The gain recognition agreement should state the name, address, and place of incorporation of the transferred foreign corporation, and a description of the stock or securities received by the U.S. transferor in the initial transfer, including the percentage of stock (by vote and value) of the transferred foreign corporation received in such exchange.

6. A Statement that the Conditions of Internal Revenue Code Section 367(a)(5) and its Regulations Have Been Satisfied

The gain recognition agreement should include a statement that the initial transfer described in Treasury Regulation Section 1.367(a)-3(e), a statement that the conditions of Internal Revenue Code Section 367(a)(5) and any regulations under that section have been satisfied, and a description of any adjustments to the basis of the stock received in the transaction or other adjustments made pursuant to Section 367(a)(5) and any regulations under that section.

7. A Statement Describing the Application of Section 7874 to the Transaction

Transfers of stock or securities of U.S. corporations may constitute a “corporate inversion” or “corporate expatriation” discussed in Section 7874 of the Internal Revenue Code. According to the provisions of Section 7874, if the shareholders of the U.S. parent company receive 80 percent or more of a new foreign parent’s stock, the new foreign parent is deemed an inverted corporation and taxed as a U.S. corporation. If at least 60 percent but less than 80 percent of the new foreign parent’s stock is acquired by the shareholders of the U.S. parent, the foreign parent will be treated as a “surrogate foreign corporation,” resulting in “inversion gain” being recognized by an “expatriated entity” in the expatriation transaction from the transfer of stock is fully taxable without offset by credits, losses or other tax attributes, and for the following ten years the expatriated entity’s gain on transfers (excluding sales of inventory in the ordinary course of business) or licenses to a “foreign related person.” The anti-inversion rules do not apply in cases where: 1) the transferred is a foreign partnership; 2) less than substantially all the assets are transferred; or 3) substantial activities are conducted in the country where the new holding company is located.

If the transferred corporation is domestic, a statement describing the application of Section 7874 to the transaction should be included in the gain recognition agreement and that the requirements of Treasury Regulation Section 1.367(a)-3(c)(1) are satisfied should be included in the agreement. It should be understood that a gain recognition agreement only applies to avoid immediate gain recognized under Section 367(a)(1). A gain recognition agreement will not likely avoid adverse tax consequences as the result of a “corporate inversion” or “corporate expatriation.” Proper planning should take into consideration Section 7874 and a statement should be attached to the gain recognition agreement discussing the application of Section 7874 to the applicable cross-border transaction.

8. Statement Regarding Section 1248 of the Internal Revenue Code

If the transferred corporation is foreign, a statement should be included in the gain recognition agreement indicating whether the U.S. transferor was a Section 1248 shareholder (as defined in Treasury Regulation Section 1.367(b)-2(b)) of the transferred corporation immediately before the initial transfer, and whether the U.S. transferor is a Section 1248 shareholder with respect to the transferred foreign corporation immediately after the initial transfer, and whether any reporting requirements or other rules contained in the regulations under Section 367(b) are applicable, and, if so whether they have been satisfied.

As discussed above, a gain recognition agreement only applies to transfers discussed under Section 367(a). A gain recognition agreement does not avoid immediate gain recognition under the provisions of Section 367(b) and its basic trust to implement taxation under Section 1248 in transactions that would otherwise be exempt from tax under a tax free-exchange provision. In order to satisfy the gain recognition rules, the gain recognition agreement should indicate whether the U.S. transferor was a Section 1248 shareholder. A Section 1248 shareholder is any U.S. person that satisfies the ownership requirements of Section 1248(a)(2) or (c)(2) with respect to a foreign corporation. To qualify as a Section 1248 shareholder, a U.S. person must own, directly or indirectly under Section 958 principles, 10 percent or more of the combined voting power of all classes of stock entitled to vote of such foreign corporation. To determine whether this circumstance applies, it is necessary to consider whether the relevant Section 1248 shareholder status exists immediately before the cross-border reorganization.

For example, when a CFC distribution in a Type D reorganization, the results depend upon whether a distributee shareholder’s “post distribution amount” in the distributing corporation and the controlled corporation is less than its “predistribution amount” in either corporation. The predistribution amount is the distributee’s Section 1248 amount immediately before the distribution , and the post distribution amount is the distributee’s shareholder’s Section 1248 amount immediately after the transaction. A distributee shareholder’s Section 1248 amount is the lesser of the built-in gain in the stock of the corporation or its total earnings and profits. Both before and after the reorganization, the Section 1248 amount is computed separately for the distributee’s interest in the distributing group (the distributing corporation and corporations it controls) and the controlled group (the controlled corporation whose stock is distributed and corporations it controls).

A careful analysis should be done to determine if the U.S. person is a Section 1248 shareholder and if so, the gain recognition agreement should provide a detailed analysis of the 1248 gain both before and after the cross-border merger or reorganization.

9. Statement Discussed Whether the Initial Transfer Involves a Partnership

If the initial transfer involves a transfer by a partnership, the gain recognition agreement should include a complete description of the transfer, including a description of the partners in the partnership.

10. Statement Regarding Property Other Than Transferred Stock or Securities

If the transaction involves the transfer of property other than the transfer of stock or securities and the transaction is subject to the indirect stock transfer rules of Section 1.367(a)-3(d), the gain recognition agreement should include a statement indicating whether:

(A) The reporting requirements under Section 6038B have been satisfied with respect to the transfer of such property;

(B) Whether gain was recognized under Section 367(a)(1);

(C) Whether Section 367(d) applied to the transfer of such property (Section 367(d) will be discussed in more detail below);

11. Statement Regarding Compliance with all Terms and Conditions of Treasury Regulations 1.367(a)-8

A gain recognition agreement must include a statement in which the U.S. transferor agrees to comply with all the conditions and requirements of Treasury Regulation Section 1.367(a)-8, including to recognize gain under the gain recognition agreement in accordance with Treasury Regulation Section 1.367(a)-8(c)(1)(i) to extend the period of limitations on the assessment of tax.

12. Statement that Arrangements Have Been Made that the U.S. Transferor is Informed of Triggering Events

The gain recognition agreement must include a statement that the U.S. transferor is informed of any events that affect the gain recognition agreement, including triggering events or other gain recognition events.

13. Statement Regarding “New Gain Recognition Agreement”

The gain recognition agreement provide a description of the event (such as a triggering event) and the applicable exception, if any, that gave rise to a new gain recognition agreement (such as a triggering event exception), including the date of the event and name, address, and taxpayer identification number (if any) of each person that is a party to the event.

14. Election

The gain recognition agreement should state if the U.S. transferor elects or does not elect to include income in any gain recognition agreement during the year during which a gain recognition event occurs.

Statement Describing Any Disposition of Assets of the Transferred Corporation

The gain recognition should include a statement describing any description of assets of the transferred corporation during such taxable years other than in the ordinary course of business. 

Special Rules for Intangibles

As discussed above, a gain recognition agreement provides relief from immediate gain recognition under Section 367(a)(1). Section 367(d) provides special rules for the transfer of intangibles to foreign corporations. Thus, cross-border mergers and reorganizations present special problems if the transferring corporation wishes to transfer intangibles to a foreign corporation. Gain recognition agreements cannot likely be utilized to avoid recognition under Section 367(d).

In order to better understand Section 367(d) and planning opportunities built into the Internal Revenue Code, it is important to understand the history of Section 367(d). Prior to 1984, U.S. corporations would develop intangibles and deduct the costs associated with developing the intangible against its U.S.-source income. U.S. corporations would then often transfer intangibles to a foreign corporation tax-free. Even if a toll-charge was imposed at the time of transfer, the tax would not necessarily adequately compensate the government. Thus, Internal Revenue Code Sections 367(d) and 482 were enacted. 

Under Section 367(d), defined in Section 936(h)(3)(B) intangibles are treated as a special class of a tainted asset. Section 936(h)(3)(B) defines the term “intangible property” to include a patent, invention, formula, process, design, process, know-how, copyright, literary, musical, artistic composition, trademark, trade name, brand name, franchise license, contract, method, program, system, procedure, campaign, survey, study, forecast, estimate, customer list, technical data, goodwill, going concern value, or workplace.

In every case involving the transfer of such assets in a transaction falling within Section 351 or 361, the transferor will be treated as having sold the property in exchange for payments that are contingent on the productivity, use or exchange for payments that are contingent on the productivity, use or disposition of such property. These imputed or constructive royalty payments must reflect the amounts that would have been received annually in the form of such payments over the useful life of such property. See IRC Section 367(d)(2)(A)(ii)(I). These imputed or constructive royalty payments must reasonably reflect the amounts that would have been received annually in the form of such payments over the useful life of such property. Internal Revenue Code Section 367(d) provides that in the case of intangible property in a Section 351 or 361 exchange, the royalty income with respect to such transfer is to be commensurate with the income attributable to the intangible. This means that the constructive royalty is calculated in an amount that represents an arm’s length charge for the use of the property under the regulations of Section 482. Under certain circumstances, a U.S. transferor may transfer intangibles to a foreign corporation taxed entirely at the time of transfer as a taxable sale if certain circumstances are satisfied.

In the context of a cross-border merger or reorganization, the transferor of intangible property to a foreign corporation will be treated as having sold “intangible property” discussed above in exchange for payments that are contingent on the productivity, use or disposition of such property. Section 367(d) provides that in the case of any transfer of intangible property, the transferor corporation must recognize royalty income with respect to such transfer to be commensurate with the income attributable to the property. This means a constructive royalty must be calculated in an amount that represents an arm’s length charge for the use of the intangible property (as per the regulations under Section 482 of the Internal Revenue Code).

An example as to how Section 367(d) operates in a typical cross-border reorganization is discussed below.

DC, a U.S. corporation, owns all of the stock of FS, a foreign corporation. (FS is a controlled corporation (within the meaning of Section 957(a)). DC incurs and deducts under Internal Revenue Code Section 162 and 174 various expenses relating to the development of a patented invention. After completing development of the patented invention, DC transfers the patent to FS in a transaction that, in the absence of Internal Revenue Code Section 367(d), would qualify for nonrecognition treatment under the Internal Revenue Code. FS will use the patent in its trade or business. Section 367(d) will treat DC as having sold the property to FS in exchange for payments that are contingent on the productivity, use or disposition of the patent. These constructive royalty payments are calculated in an amount which reflects an arm’s length charge for the use of the patent.

FDII Planning

In certain cases, the foreign-dervived intangible income or FDII may provide relief from the provisions of Section 367(d). FDII is a type of income that when earned by a domestic corporation (taxed under the Subchapter C provisions of the Internal Revenue Code) is entitled to a deduction equal to 37.5 percent of the FDII.  Because the U.S. federal corporate tax rate is 21 percent, FDII income is subject to an effective tax rate of only 13.125 percent (or lower).

Consider the following example. A U.S. corporation based in California develops apps for the streaming of audio or video. The U.S. corporation may sell or lease the apps to non-U.S. customers and recognize a U.S. federal tax rate at a rate of only 13.125 percent. Similar tax benefits can apply in a multitude of industries. The low tax rates associated with FDII associated with a U.S. corporation’s sale or lease of property or license of intellectual property to non-U.S. entities could be considered as a part of a greater planning option in the context of a cross-border merger or reorganization. Below, this article explains the general framework of FDII. The determination of FDII is a mechanical calculation that rewards a corporation that has minimal investment in tangible assets. The determination of FDII is a mechanical calculation.

First, a corporation’s gross income is determined. The gross income is reduced by certain items of income including subpart F income, dividends received from a CFC and income received from foreign branches. This amount is reduced by deductions allocable to such income. This product is called the deduction eligible income. Second, the income foreign portion of FDII must be determined. This amount includes any income derived from the sale of property to any foreign person for foreign use. The definition of the term “sale” includes leases, licenses, exchanges, or other dispositions. The definition of “foreign use” includes “any use, consumption, or disposition which is not in the United States.” The gross foreign sales and income is reduced by expenses properly allocated to such income. This is known as foreign-derived deductible eligible income. Finally, a corporation’s deemed intangible income must be determined. The deemed intangible income is the excess (if any) of the corporation’s deduction eligible income over 10 percent of its qualified business asset investment or QBAI. QBAI is the average of a corporation’s adjusted bases in depreciable tangible property used in its trade or business to generate deduction eligible income. U.S. tax on FDII may be reduced further with foreign tax credits.

The FDII deduction discussed above is potentially available to every U.S. corporation that exports property to a person or entity located outside the United States. It is important to note that income eligible for FDII benefits includes, but is not limited to licenses, royalties or other types of income that are generally thought of as income that are generally thought of as income generated from intangibles.

Conclusion

Section 367 imposes a toll charge tax on the income realized on the transfer of certain tainted assets. Acquisition of the stock or assets of a U.S. corporation in exchange for stock of a foreign corporation in a merger or reorganization described in Section 368 is normally within the scope of Section 367. In certain cases, a gain recognition agreement can be utilized to mitigate the immediate income tax consequences of Section 367. Even if a gain recognition agreement can be utilized to mitigate the immediate gain recognition associated with Section 367, U.S. shareholders may also be subject to provisions of Section 1248 and 7874. These code provisions should also be taken into consideration in any cross-border merger or reorganization planning. In cases involving U.S. corporations that export property or services to persons or entities located outside the United States, cross-border merger or reorganization planning should take into consideration the FDII deduction.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals. He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.