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Reporting Cross-Border Transfers and Reorganizations on IRS Form 926

Reporting Cross-Border Transfers and Reorganizations on IRS Form 926

By Anthony Diosdi


If a U.S. corporation is liquidated and its assets are distributed to foreign shareholders, U.S. tax will be imposed on the gain realized by the distributing corporation except to the extent that a tax-free-exchange provision provides otherwise. Likewise, if the stock or assets of a corporation are acquired by a foreign corporation in exchange for stock of the foreign corporation, or if, conversely, a foreign corporation is acquired for stock of a U.S. corporation, gain realized by U.S. shareholders and the U.S. corporation will also be subject to tax, except to the extent that the gain is sheltered by a tax-free-exchange provision. Even an acquisition of one foreign corporation by another foreign corporation involving U.S. shareholders who exchange their stock in the acquired corporation for stock in the acquiring corporation may be subject to U.S. tax unless the transaction qualifies as a tax-free exchange. Similarly, if a foreign corporation engages in a recapitalization or a reincorporation, U.S. shareholders who exchange their original stock or securities of the foreign corporation for new stock or securities will be taxed on any gain realized, except to the extent that a nonrecognition provision applies.

To assist the Internal Revenue Service (“IRS”) better police cross-border corporate reorganizations, divisions, and liquidations, the IRS requires any U.S. person (the term “U.S. person” means: a citizen or resident of the United States, a domestic partnership, a domestic corporation, or U.S. trust) who transfers property to a foreign corporation must attach Form 926 entitled “Return by Transferor of Property to a Foreign Corporation” to its tax return for the year of the transfer. This reporting requirement applies to outbound transfers of both tangible and intangible property. This article discusses Form 926 and is designed to supplement the instructions promulgated by the IRS.

Penalties for Non-Compliance

The penalty for failure to timely file a Form 926 with the IRS equals 10 percent of the fair market value of the property transferred to the foreign corporation. However, the penalty does not apply if the U.S. person can show that the failure to comply was due to reasonable cause and not due to willful neglect. The penalty is limited to $100,000 unless the failure to comply was due to intentional disregard. In addition, a 40 percent penalty may be imposed on any underpayment resulting from an undisclosed foreign financial asset understatement.

Overview

This article will review and analyze the IRS Form 926 in detail in the context of cross-border transfers and reorganizations.This article is designed to be a supplement to the directions promulgated by the IRS for Form 926.

Part I. U.S. Transferor Information

Part I of Form 926 is entitled “U.S. Transferor Information.”  This subsection of Form 926 asks the preparer to provide basic information regarding transferees of property being transferred to a foreign corporation.

Question 1.

Question 1 asks the preparer if the transferee is a specified 10 percent owned foreign corporation that is not a controlled corporation.

A specified 10 percent owned foreign corporation is defined in Section 245A(b)(1) as any foreign corporation with respect to which any domestic corporation is a U.S. shareholder. A controlled foreign corporation is defined in Section 957(a) as any foreign corporation if, on any day during the tax year of such foreign corporation, U.S. shareholders own (within the meaning of Section 958(a), or are considered to own by applying the rules of ownership of Section 958(b), more than 50 percent of 1) the total combined voting power of all classes of stock of such corporation entitled to vote, or 2) the total value of the stock of such corporation.

The preparer should check the “Yes” box on line 1 if the transfer is a specified 10 percent owned foreign corporation.

Question 2.

Question 2 asks if the transferor was a corporation and if so, to complete Questions 2a and 2b.

Question 2a.

If the preparer answered “Yes” to Question 2a and the asset is stock, Section 367(a)(4) may require basis adjustments. (Section 367(a)(5), redesignated Section 367(a)(4) by the Tax Cuts and Jobs Act discusses cases of an exchange of property described in Section 361(a) or (b)). If the preparer answered “No” to Question 2a and the asset is a tangible asset, the transfer is taxable under Sections 367(a)(1) and (a)(4). If the asset transferred is an intangible asset, see section 367(d) and its regulations (Under Section 367, as a general rule, a disposition of intangible property to a foreign corporation will accelerate gain recognition). If a preparer answered “No” to question 2a: If the U.S. transferor is owned directly by more than five domestic corporations immediately before the reorganization, but some combination of five or fewer domestic corporations controls the U.S. transferor, the U.S. transferor must designate the five or fewer domestic corporations that comprise the control group. The preparer must list these designated corporations on Form 926, line 2b.


Question 2b.
Question 2b asks the preparer if the transferor remains in existence after the transfer. If the transferor went out of existence pursuant to the transfer (for example, as in a reorganization described in section 368(a)(1)(C)), the preparer must list the controlling shareholders and their identifying numbers.

Question 2c.

Question 2c asks the preparer if the transferor was a member of an affiliated group filing a consolidated return. Under Section 1501 of the Internal Revenue Code and regulations issued pursuant to Section 1502, a U.S. corporation is permitted to file a consolidated tax return with other U.S. corporations in an affiliated group. An affiliated group consists, broadly speaking, of one or more chains of U.S. corporations connected by stock ownership (excluding certain preferred stock) of at least 80 percent of the vote and value with a common U.S. parent. See IRC Section 1504. If the transferee of property was a member of an affiliated group, but not the parent corporation, the preparer should list the name and EIN of the parent corporation and file Form 926 with the parent corporation’s consolidated return.

Question 2d.

Question 2d asks the preparer if basis adjustments under Section 367(a)(4) have been made. If the answer to line 2d is “Yes,” and if the asset is transferred in an exchange described in section 361(a) or (b), attach the following: 1) A statement that the conditions set forth in the second sentence of section 367(a)(4) and any regulations under that section have been satisfied and 2) An explanation of any basis or other adjustments made pursuant to Section 367(a)(4) and any regulations thereunder.

 
Question 3.

Question 3 asks if the transferor was a partner in a partnership that was the actual transferor (but not treated as such under Section 367) to complete questions 3a and 3d.

Congress has provided the Treasury and the IRS expanded regulatory authority to treat transfers of property to foreign corporations by U.S. persons as paid-in surplus or contributions to capital as fair market sales and require gain recognition on such sales. See IRC Section 367(f). In addition, Section 721(c) provides regulatory authority to require gain recognition on a transfer by a U.S. person of appreciated property to a partnership in the situation where the gain when recognized by the partnership would be allocable to a foreign partner.

Question 3a.

Question 3a asks the preparer to list the name of the partnership and its EIN number in which a U.S. person made a transfer of property.

Question 3b.

Question 3b asks if the partner picked up its pro rata share of gain on the transfer of partnership assets. If the partner picked up its share of gain on the transfer of partnership assets, the preparer should check the “Yes” box.

Question 3c.

Question 3c asks if the partner is disposing of its entire interest in the partnership. A U.S. person’s proportionate share of partnership property shall be determined under the rules and principles of sections 701 through 761 and the regulations thereunder. See Temporary Regulations section 1.367(a)-1T(c)(3). If the partner is disposing of its entire interest in the partnership, the preparer should check the “Yes” box.

Question 3d.

Question 3d asks if the partner is disposing of an interest in a limited partnership that is regularly traded on an established market. For the definition of “regularly traded on an established securities market,” See Temporary Regulations section 1.367(a)-1T(c)(3)(ii)(D). If the answer to Question 3d is “Yes,” the rules of Temporary Regulations section 1.367(a)-1T(c)(3)(ii)(C) apply.

Part II Transferee Foreign Corporation Information

Part II is used to disclose information regarding transferee foreign corporations.


Question 5a.

Question 5a asks the preparer to provide the identifying number of the transferred foreign corporation.

Question 5b.

Question 5b asks the preparer to provide a reference ID number for the foreign transferee foreign corporation. A reference ID number is required on line 5b only in cases where no EIN was entered on line 5a for the transferee foreign corporation. However, filers are permitted to enter both an EIN and a reference ID number. If applicable, enter on line 5b the reference ID number (defined below) you have assigned to the transferee foreign corporation. A “reference ID number” is a number established by or on behalf of the U.S. transferor identified at the top of page 1 of the form that is assigned to the transferee foreign corporation with respect to which Form 926 reporting is required. These numbers are used to uniquely identify the transferee foreign corporation in order to keep track of the entity from tax year to tax year. The reference ID number must meet the requirements set forth below. Because reference ID numbers are established by or on behalf of the U.S. person filing Form 926, there is no need to apply to the IRS to request a reference ID number or for permission to use these numbers. In general, the reference ID number assigned to a transferee foreign corporation on Form 926 has relevance only to Form 926 and should not be used with respect to the transferee foreign corporation on other IRS forms. The reference ID number must be alphanumeric (defined below) and no special characters or spaces are permitted. The length of a given reference ID number is limited to 50 characters.

For these purposes, the term “alphanumeric” means the entry can be alphabetical, numeric, or any combination of the two.

The same reference ID number must be used consistently from tax year to tax year with respect to a given transferee foreign corporation. If for any reason a reference ID number falls out of use (for example, the transferee foreign corporation no longer exists due to disposition or liquidation), the reference ID number used for that transferee foreign corporation cannot be used again for another transferee foreign corporation for purposes of Form 926 reporting.

There are some situations that warrant correlation of a new reference ID number with a previous reference ID number when assigning a new reference ID number to a transferee foreign corporation. For example: 1) In the case of a merger or acquisition, a Form 926 filer must use a reference ID number which correlates the previous reference ID number with the new reference ID number assigned to the transferee foreign corporation; or 2) In the case of an entity classification election that is made on behalf of a transferee foreign corporation on Form 8832, Regulations Section 301.6109-1(b)(2)(v) requires the transferee foreign corporation to have an EIN for this election. For the first year that Form 926 is filed after an entity classification election is made on behalf of the transferee foreign corporation on Form 8832, the preparer must enter the new EIN on line 5a and the old reference ID number on line 5b. In subsequent years, the Form 926 filer may continue to enter both the EIN and the reference ID number, but must enter at least the EIN on line 5a.

In the case of a merger or acquisition, the preparer must correlate the reference ID numbers as follows: New reference ID number [space] Old reference ID number. If there is more than one old reference ID number, you must enter a space between each such number. As indicated above, the length of a given reference ID number is limited to 50 characters and each number must be alphanumeric with no special characters. This correlation requirement applies only to the first year the new reference ID number is used.

Question 6.

Question 6 requires that the preparer enter the address of the foreign transferee foreign corporation.

Question 7.

For Question 7, the preparer must enter the two-letter country code (from the list at IRS.gov/countrycodes) of the transferee foreign corporation’s country of incorporation or organization.

Question 8.

For Question 8, the preparer must list the entity classification (for example, partnership, corporation, etc.) of the transferee foreign corporation under the laws of the country of incorporation or organization.

Question 9.

For Question 9, the preparer must state whether the transferee foreign corporation was a controlled foreign corporation under Section 957(a). Under Section 957(a) a “controlled foreign corporation” or “CFC” as a foreign corporation of which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned, directly, indirectly or constructively under the Section 958 ownership rules, by “U.S. shareholders” on any day during the foreign corporation’s tax year. Section 951(b) defines a “U.S. shareholder as a U.S. citizen, resident alien, corporation, partnership, trust or estate, owning directly, indirectly or constructively under the ownership rules of Section 958, ten percent or more of the total combined voting power of all classes of stock of a foreign corporation. If the transferred foreign corporation is a CFC, the preparer should check the “Yes” box.

Part III. Information Regarding Transfer of Property

Information in Part III is reported in three sections to the IRS. Collectively, the three sections capture information with regard to all of the properties transferred. The properties covered by each section, respectively, are:

1) Cash (“Section A”),

2) Other property (other than intangible property subject to section 367(d)) (“Section B”), and

3) Intangible property subject to section 367(d) (“Section C”).

Section A

Section A captures information regarding cash. A preparer must disclose both domestic and foreign currency in Schedule A. 


Line 10.

If cash was the only property transferred, the preparer should skip the remainder of Part III and proceed to Part IV of Form 926.

Section B- Other Property (other than intangible property subject to Section 367(d))

Section B captures information regarding property (other than cash and intangible property subject to Section 367(d)) that is subject to full gain recognition under the general rule of Section 367(a)(1). 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 Code sections. The exchange will be tax-free only to the extent specifically provided in the Internal Revenue Code and its regulations.The principal purpose of Section 367(a) is to prevent the avoidance of U.S. tax that can arise when the Subchapter C provisions (i.e. Type A, Type B, or Type C tax-free mergers) apply to transactions involving foreign corporations.

Section 367(a) imposes a tax on the income realized on the transfer of assets to a foreign corporation. Categories of assets under Section 367(a) subject to recognition include: 1) property described in Section 1221(a)(1) or 1221(a)(3) – relating to inventory and certain narrowly defined intellectual property (e.g., a copyright held by the creator of work); 2) installment obligations, accounts receivable or similar property to the extent that the taxpayer has not previously included the principal amount in income; 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 (e.g., installment obligations, accounts receivable and other obligations calling for payment in foreign currency); and 5) depreciable property to the extent that gain reflects depreciation deductions that have been taken against U.S.-source income. Recapture gain is required to be recognized as ordinary income on the transfer of depreciable property used in the United States (whether or not it is thereafter used in an active business abroad) to the extent that depreciation deductions previously claimed by the taxpayer with respect to the transferred property would be recaptured if the property were sold. 

Although the regulations that have been issued under Section 367 are highly complex, their basic thrust is to implement taxation under Section 1248 in transactions that would otherwise be exempt from tax under a tax-free-exchange provision. The purpose of Section 1248 is to prevent a U.S. shareholder from realizing the accumulated earnings of a CFC by selling its stock or liquidating at capital gains rates. The Section 367(b) regulations require current taxation as an ordinary income deemed dividend of amounts of earnings a CFC may otherwise escape.

For Section B, the preparer must list property (other than intangible property) such as stock and securities, inventory, other property (not listed under another category), and property with built-in loss that is subject to the provisions of Section 367(a).

In order to complete Schedule B, the preparer must provide information regarding the following assets transferred to a foreign corporation:

Stock and securities- For column (a), the preparer must state the date of transfer of the stocks or securities. In column (b), the preparer states the class or type of stock and the name of the issuing corporation. For the remaining columns, the preparer must state the fair market value of the stocks on the date of transfer, the cost basis of the stock, and the gain recognized on the transfer.

Inventory- the regulations under Section 367(a) provide that inventory is subject to Section 367(a) toll charge upon its transfer to a foreign corporation. As with stocks and securities, the preparer must state the date of transfer, description of property, fair market value on date of exchange, cost basis, and gain recognition on Schedule B.

Other Property (not listed under another category)- for this category, the preparer should list narrowly defined intellectual property (e.g., a copyright held by a creator of work), installment obligations, accounts receivable, foreign currency and other property denominated in foreign currency (this is not an exhaustive list). The preparer will also need to state the date of transfer, description of property, fair market value on date of exchange, cost basis, and gain recognition on Schedule B.

Finally the “property with built-in loss” refers to depreciable property to the extent that depreciation deductions have been taken against U.S.- source income. The preparer will also need to state the date of transfer, description of property, fair market value on date of exchange, cost basis, and gain recognition on Schedule B. In addition, the preparer will need to state the loss that is realized but not recognized for each asset transferred.

Question 11.

Question 11 asks the preparer if the transfer stock or securities subject to Section 367(a) was the subject of a gain recognition agreement filed with the IRS.

A gain recognition agreement is an agreement to which a U.S. transferor agrees to recognize gain if the transferee foreign corporation disposes of the transferred stock or securities during the term of the gain recognition agreement and to pay interest on any additional tax owing if a so-called “triggering event” occurs. A gain recognition agreement is typically 60 months.

If the transferor of stock or securities subject to Section 367(a) entered into a gain recognition agreement with the IRS, the preparer should check the “Yes” box.

Question 12a.


Question 12a asks the preparer if any assets of a foreign branch (including a branch that is a foreign disregarded entity) transferred to a foreign corporation.

The preparer should “Yes” to line 12a if any of the property transferred to a foreign corporation consisted of assets of a foreign branch. Checking “Yes” to Question 12a will likely result in the branch loss recapture rules being triggered. Under the branch loss recapture rules, a U.S. person that transfers part or all of the assets of a foreign branch to a foreign corporation in a Section 367(a)(1) exchange must recognize as recapture gain certain of the previously deducted cumulative losses of the branch. A foreign branch is defined for this purpose as an integral business operation carried on by a U.S. person outside the United States. 

Question 12b

Question 12b asks if the transferor domestic corporation substantially transferred substantially all of the assets of a foreign branch to a 10 percent owned foreign corporation.

If a domestic corporation substantially transferred all the assets from a foreign branch to a 10 percent owned corporation. The term “10-percent owned foreign corporation” means any foreign corporation with respect to which any domestic corporation is a United States shareholder with respect to such corporation. If such a transfer was made, the preparer should check the “Yes” box.

Question 12c

Question 12c asks the preparer if immediately after the transfer, was the domestic corporation a U.S. shareholder with respect to the transferee foreign corporation. If immediately after the transfer, a domestic corporation was a U.S. shareholder with respect to the transferee foreign corporation, the preparer should check the “Yes” box.

Question 12b

For Question 12b, the preparer should enter the income from Section 91. Under Internal Revenue Code Section 91, if a domestic corporation transfers substantially all of the assets of a foreign branch (within the meaning of Section 367(a)(3)(C)), to a specified 10 percent owned foreign corporation (as defined in Section 245A) with respect to which it is a United States shareholder after such transfer, such domestic corporation shall include in gross income for the taxable year which includes such transfer an amount equal to the transferred loss amount with respect to such transfer. For purposes of Section 91, the term “transferred loss amount” means, with respect to any transfer of substantially all of the assets of a foreign branch, the excess (if any) of: 1) the sum of losses which were incurred by the foreign branch after December 31, 2017 and before the transfer, and with respect to which a deduction was allowed to the taxpayer; over 2) the sum of any taxable income of such branch for a taxable year after the taxable year in which the loss was incurred and through the close of the taxable year of the transfer; and 2) any amount which is recognized under Section 904(f)(3) on account of the transfer. See IRC Section 91(b)

Under Section 91, the U.S. transferor must include in gross income an amount equal to the transferred loss amount, if any, as defined in Section 91(b) upon a transfer of substantially all of the assets of a foreign branch (including a foreign branch that is a foreign disregarded entity) to a foreign corporation. The transferred loss amount may be reduced (but not below zero) by the amount of gain recognized on account of the transfer, other than the amounts recognized under section 904(f)(3), if any. Enter the amount of the transferred loss amount included in gross income as a positive number on line 4. If the amount is equal to or less than zero, enter zero and no transferred loss amount is required to be recognized by the U.S. transferor on the transfer under Section 91. The transferred loss amount should be entered on line 12b.

Questions 12b–d. If the answer to lines 12b and 12c is “Yes,” the following information should be provided to the IRS: 1) Describe the foreign branch whose property is transferred; 2) Describe the property of the foreign branch, including its adjusted basis and fair market value; 3) Set forth a detailed calculation of the transferred loss amount. Provide, on a year-by-year basis, amounts of the losses generated by such foreign branch after December 31, 2017, as well as any income amounts generated after such loss year; 4) Provide the amount, if any, recognized under Section 904(f)(3) on account of the transfer; 5) Set forth a detailed summary of the gain (other than the section 91 transferred loss amount) recognized by the transferor, including any section 367(a)(1) gain recognized on the transfer of property. See IRC Section 91(c). 6) Set forth a calculation of the net sum of the previously deducted losses incurred by such foreign branch for tax years before January 1, 2018, that would have been recaptured under Section 367(a)(3)(C), as determined without regard to the repeal of the section 367(a)(3) active trade or business exception. See IRC Section 14102(d)(4).

Question 13.

Question 13 asks the preparer if there was property transferred in Section 367(d)(4). Section 367(d)(4) property is defined as the following: A) parent, invention, formula, process, design, pattern, or know-how; B) copyright, literary, musical, or artistic composition; C) trademark, trade name, or brand name; D) franchise, license, or contract; E) method, program, system, procedure, campaign, survey, study, forecast, estimate, estimate, customer list, or technical data; F) goodwill, going concern value, or workforce in place (including its composition and terms and conditions (contractual or otherwise) of its employment); or G) other item the value or potential value of which is not attributable to tangible property or services of any individual.

Section C- Intangible Property Subject to Section 367(d)

Section C captures information regarding transfers of intangible property subject to Section 367(d).

The preparer should list the type of property described in Section 367(d)(4) in Section C transferred to a foreign corporation.

The preparer will also need to complete columns (a) through (f) for each identified transferred Section 367(d)(4) intangible. In general, the following instructions apply to columns (a) through (f).

For column (a), the preparer should enter the date of transfer. This should be the first date on which title to, possession of, or rights to the use of the property passed for U.S. income tax purposes. See Temp. Reg. Section 1.6038B-1T(b)(4) for additional information.

For column (b), the preparer should enter a description of property transferred. The preparer should provide a separate description for each identified intangible, including each identified (i) patent, invention, formula, process, design, pattern, or know-how; (ii) copyright, literary, musical, or artistic composition; (iii) trademark, trade name, or brand name; (iv) franchise, license, or contract; (v) method, program, system, procedure, campaign, survey, study, forecast, estimate, customer list, or technical data; (vi) any goodwill, going concern value, or workforce in place (including its composition and terms and conditions (contractual or otherwise) of its employment); or (vii) any other item the value or potential value of which is not attributable to tangible property or the services of any individual.

The preparer should also provide a brief explanation of how the taxpayer determined the arm’s length price on the date of transfer for each intangible.


For column (c), the preparer should enter the useful life for each intangible. The useful life of intangible property is defined under Treasury Regulations Section 1.367(d)-1(c)(3)(i). If the useful life of intangible property is indefinite, enter “indefinite.”

For column (d), the preparer should enter the arm’s length price on the date of transfer. Generally, if a U.S. person transfers intangible property subject to Section 367(d), such person shall, over the useful life of the property, annually include in gross income an amount that represents an appropriate arm’s length charge for use of the property. The appropriate charge is determined in accordance with the provisions of section 482 and the regulations thereunder. See Temp. Reg. Section 1.367(d)-1T(c)(1). For each intangible the preparer should report in Section C the arm’s length price on the date of transfer.

For column (e), the preparer should enter the adjusted basis in the property transferred on the date of the transfer. See IRC Sections 1011 through 1016.

Column (f) is to report the income inclusion for the year of transfer. A U.S. person who transfers property subject to Section 367(d) is treated as having sold such property in exchange for payments which are contingent upon the productivity, use, or disposition of such property and receiving amounts annually over the useful life of the property that represent an appropriate arm’s length charge for use of the property. For each intangible transferred, enter the amount included in income under Section 367(d) on the income tax return for the year of the transfer. If the amount reported in column (d) as the arm’s length price for intangible property is an allocation of an amount determined based on an aggregate analysis, enter the inclusion amount in column (f) that corresponds to the allocated amount reported in column (d). If no amount is included, enter “0.” The preparer should include in the amount entered in column (f) gain recognized as a result of making an election to treat a transfer of certain intangible property as a sale under Temporary Regulations Section 1.367(d)-1T(g)(2).

Question 14a.

Question 14a asks if the transferor transferred any intangible property that, at the time of transfer, hads a useful life reasonably anticipated to exceed 20 years. If the transferor transferred any intangible property that at the time of transfer had a useful life reasonably anticipated to exceed 20 years, the preparer should check “Yes” in box 14a.

Question 14b.

Question 14b asks if at the time of transfer if the property had an indefinite useful life. If so, the preparer should check “Yes.”

Question 14c.

Question 14c asks if the transferor chooses to apply a 20-year inclusion period. In cases where the useful life of the transferred intangible property is indefinite or reasonably anticipated to be more than 20 years, a taxpayer may, instead of including amounts in income during the entire useful life of the intangible property, choose in the year of transfer to increase annual inclusions during the 20-year period beginning with the first year in which the U.S. transferor takes into account income pursuant to Section 367(d), to reflect amounts that, but for the choice to increase annual inclusions, would have been required to be included following the end of the 20-year period. To apply this 20-year inclusion period, a taxpayer must attach a statement titled “Application of the 20-year Inclusion Period to Section 367(d) Transfer” to a timely filed original federal income tax return (including extensions) for the year of the transfer. See Regulations Section 1.367(d)-1(c)(3)(ii). If the answer to line 14c is “Yes,” see the Line 14c and Line 14d instructions below for information that must be included in the Supplemental Part III Information Required To Be Reported section at the end of Part III of the form.

If the answer to the line 14c question is “Yes,” the preparer should describe the property for which the transferor chose to apply the 20-year inclusion period. See Treas. Reg. Sections 1.6038B-1(d)(1)(iv) and 1.367(d)-1(c)(3)(ii).


Question 14d.

If the answer to Question 14c was “Yes,” the preparer should enter the total estimated income or cost reduction attributable to the intangible property or properties.

Question 15.

Question 15 asks if there was any intangible property transferred considered or anticipated to be a platform contribution under Treas. Reg. Section 1.482-7(c)(1).

In order to answer this question, it is important to understand the Section 482 regulations on point. In part, the current regulations for Section 482 were enacted to target the avoidance of taxes on the exploitation by foreign affiliates of technology developed in the United States. In the case of any transfer (or license) of intangible property, the income with respect to such transfer or license. This provision, which has come to be called the “super-royalty” provision.

In order to implement the super-royalty provision, the royalty or other consideration payable by the transferee of intangible property rights to its commonly controlled owner is subject to periodic review and adjustments by the IRS. The purpose is to ensure that the consideration paid over time remains commensurate with the income produced by the intangible in the hands of the transferee. Under Treas. Reg. Section 1.482-7, an arrangement called cost sharing is provided as a basic alternative to arm’s length royalty arrangements between related parties with respect to intangibles. In general, a cost sharing arrangement is an agreement between two or more persons to share the costs and risks of research and development as they are incurred in exchange for a specified interest in any intangible property that is developed. Because each participant receives rights to any intangibles developed under the arrangement, no royalties are payable by the participants for exploiting their rights to such intangibles.

Cost sharing arrangements obviate the uncertainties of attempting to fix arm’s length royalties for intangibles that are inherently difficult, if not impossible, to value with confidence. The Conference Committee Report to the 1986 Tax Act states that, while Congress intends to permit cost sharing arrangements, it expects them to produce results consistent with the purpose of the commensurate-with-income standards in Section 482- i.e., that the actual economic activity undertaken by each.” See H.R. Conf. Rep. No. 841, 99th Cong., 2nd Sess II-638 (1986). The regulations provide that no reallocation under Section 482 will generally be made with respect to a “qualified cost sharing arrangement” except for assuring that the parties to the arrangement bear shares of the costs of developing the intangible property equal to their shares of reasonably anticipated benefits.

Certain requirements must be met if the cost sharing agreement is to be treated as “qualified.” The agreement must be in writing and must reflect a sharing of the costs of developing intangibles based upon the participants’ respective shares of anticipated benefits from exploiting them. It must provide for adjustments to account for changes in economic conditions, business and practices and the ongoing development of intangibles.

In the context of cost sharing agreements agreements, Treasury Regulation Section 1.482-7(c)(1) defines a platform contribution to be “any resource, capability, or right that a controlled participant has developed, maintained, or acquired externally to the intangible development activity that is reasonably anticipated to contributed to developing cost sharing intangibles.

If there was any intangible property transferred or anticipated to be transferred during the reporting period or a platform contribution defined in Treas. Section 1.482-7(c)(1) during the reporting period, the prepared should check “Yes” for question 15.

Supplemental Part III Information Regarding Transfer of Property

Internal Revenue Code Section 6038B requires notice to be provided to the IRS when certain transfers to foreign persons take place. The information that is required to be provided to the IRS is generally described in Section 6038B(a)(1)(A). In order to comply with Section 6038B, the following information should be provided to the IRS:

1) A general description of the transfer and any wider transaction of which it forms a part, including a chronology of the transfers involved and an identification of the other parties to the transaction to the extent known. See Temp. Reg. Section 1.6038B-1T(c)(2)(ii).

2) A description of the consideration received by the U.S. person making the transfer. The description should identify: i) The property comprising the consideration and the total fair market value of the items; and ii) In the case of stock or securities, the class, type, amount, and characteristics of the interest received. See Temp. Treas. Reg. Sections 1.6038B-1T(c)(3) and 1.6038B-1T(d)(1)(iii).

All property being transferred to a foreign person should be stated on Supplemental Part III.  

Part IV— Additional Information Regarding Transfer of Property


Question 16.

For Question 16, the preparer should state the transferor’s interest in the transferee foreign corporation before and after the transfer.

Question 17.

For Question 17, the preparer should state the type of nonrecognition transfer that gave rise to the reporting obligation (for example, section 332, 351, 354, 356, or 361).

Question 18a

If gain recognition was required under Section 904(f)(3) with respect to any transfer reported in Part III,  the preparer should attach a statement identifying the transfer and the amount of the transfer.

For purposes of Section 904(f), any taxpayer that sustains an overall loss on the disposition of property predominantly used without the United States trade or business. 


Question 18b.

If gain is recognized under Section 904(f)(5)(F) with respect to any transfer reported in Part III,  the preparer should attach a statement identifying the transfer and the amount of the transfer.

Section 904(f)(5)(F) is defined as the amount of any separate limitation loss for any taxable year allocated against any separate limitation income for such taxable year.

Question 18c.

For Question 18c, the preparer must state if there is a recapture under Section 1503(d).

In order to answer question 18c, the preparer must understand the rules governing dual consolidated losses. Opportunities for tax savings through international tax arbitrage can arise when there are inconsistencies between the rules in two relevant countries for determining the residence of corporations. For example, a corporation organized in the United States is treated as a U.S. resident, subject to U.S. tax on its worldwide net income with losses whenever incurred being deductible. Under Section 1501 of the Internal Revenue Code, a U.S. corporation is permitted to file a consolidated tax return with other U.S. corporations in an affiliated group. An affiliated group consists of one or more chains of U.S. corporations connected by stock ownership (in some cases excluding preferred stock) of at least 80 percent of the vote and value with a common parent. If two or more U.S. corporations are members of an affiliated group that files a consolidated return, the losses of any one of the group generally may offset tax on the income of another member of the group.

Inconsistencies arise because some other countries use criteria other than place of incorporation to determine whether a corporation is a domestic resident for their tax purposes. For example, countries, such as the United Kingdom and Australia, treat a corporation as a domestic resident if it is managed or controlled there, regardless of where the corporation is incorporated. If a corporation is a resident under this test, it will typically be taxed by the country of residence on its worldwide net income with losses wherever incurred being deductible. If certain conditions are met, these countries allow losses of a resident corporation to reduce or eliminate tax on income of other commonly controlled domestic corporations. See generally Staff of Joint Comm. on Tax’n, 100th Cong., 1st Sess., General Explanations of the Tax Reform Act of 1986, at 1063 (1987).

Because of the application of differing criteria for determining corporate residence it is possible for a U.S. corporation to incorporate a foreign subsidiary under the laws of a foreign country that determines the residence of a corporation not on the basis that it is incorporated there but on the basis of where the corporation’s management or control is located. If the foreign corporation’s top management is located in the United States, the corporation might be exempt from income tax in the United States and in the country in which it is incorporated.

A dual resident corporation is frequently the U.S. parent corporation of one affiliated group of corporations in the United States and another affiliated group in the foreign country that also treats the group as a taxable resident. Such a dual resident corporation might find opportunities to engage in “double-dipping” with respect to losses and expense items that may be deducted under the tax laws of both the United States and the foreign country concerned.

To deal with the double-dip international tax arbitrage opportunities for dual resident corporations, Congress enacted Internal Revenue Code Section 1503(d). Section 1503(d) provides that the dual consolidated loss of a dual resident corporation for any tax year cannot reduce the taxable income of any other U.S. member of the affiliated group for that or any other tax year. A dual consolidated loss is defined essentially as a net operating loss of a U.S. corporation that is taxed by a foreign country on its worldwide income or on a residence basis. See IRC Section 1503(d)(2)(A). The Staff of the Joint Committee describes Section 1503(d) as follows:

Section 1503 provides that if a U.S. corporation is subject to a foreign country’s tax on worldwide income, or on a residence basis as opposed to a source basis, any net operating loss it incurs cannot reduce the taxable income of any other member of a U.S. affiliated group for that or any other taxable year. (A net operating loss of such a corporation is referred to as a “dual consolidated loss”). A company may be subject to foreign tax on a residence basis because its place of effective management is in a foreign country or for other reasons. Where a U.S. corporation is subject to foreign tax on a residence basis, then, under Section 1503, for U.S. purposes, its loss will be available to offset income of that corporation in other years, but not income of another U.S. corporation. See Taxation of International Transactions, Thomson West (2006), Charles H. Gustafson, Robert J. Peroni, and Richard Crawford Pugh.

Congress did not perceive any relevant distinction between a deduction that arises on account of interest expense and one that arises on account of some other expense, or between a deduction for a payment to a related party and one for a payment to an unrelated party. Therefore, the provision applies to any dual consolidated loss regardless of the type of deductions that caused it. Since the enactment of Section 1503(d), the Department of Treasury has issued a number of regulations, which have been updated over the years. The regulations state the general principle that a dual consolidated loss cannot offset the taxable income of any U.S. affiliate for the tax year of the loss or any other tax year. The same limitation on loss use applies to a separate unit of a U.S. corporation as if the separate unit were the corporation’s wholly owned subsidiary. See Treas. Reg. Section 1.1503-2(b)(1). “Separate unit” for purposes of Section 1503(d) includes a foreign branch, a partnership interest, a trust interest and an interest in a hybrid entity treated as a corporation under foreign law. See Treas. Reg. Section 1.1503-2(c)(i).

The dual consolidated loss limitations is illustrated in the regulations under Section 1505(b) in the following examples:

Example 1. X, a member of a consolidated group, conducts business through a branch in Country Y. Under Country Y’s income tax laws, the branch is taxed as a permanent establishment and its losses may be used under the Country Y form of consolidation to offset the income of Z, a Country Y affiliate of X. In Year 1, the branch of X incurs an overall loss that would be treated as a net operating loss if the branch were a separate domestic corporation. Under paragraph (c)(3) of Treas. Reg. Section 1.1503-2, the branch of X is treated as a separate domestic corporation and a dual resident corporation. Thus, under paragraph (c)(5), its loss constitutes a dual consolidated loss. Unless X qualifies for an exception under paragraph (g) of this section, paragraph (b) of this section precludes the use of the branch’s loss to offset any income of X not derived from the branch operations or any income of a domestic affiliate of X.

Example 2. X is classified as a partnership for U.S. income tax purposes. A, B, and C are the sole partners of X. A and B are domestic corporations and C is a Country Y corporation. For U.S. income tax purposes, each partner has an equal interest in each item of partnership profit or loss. Under Country Y’s law, X is classified as a corporation and its income and losses may be used under the Country Y form of consolidation to offset the income of companies that are affiliates of X. Under paragraph (c)(3) and (4) of this section, the partnership interests held by A and B are treated as separate domestic corporations and as dual resident corporations. Unless an exception under paragraph (g) of this section applies, losses allocated to A and B can only be used to offset profits of X allocated to A and B, respectively.

See Treas. Reg. Section 1.1503-2(b)(4), Exs. 1, 3.

For question 10a, the preparer must state if the foreign foreign branch or disregarded entity is not a separate unit subject to the dual consolidated loss rules.

For question 18c, the preparer must state if there was a dual consolidated loss that needs to be recaptured.

Question 18d.

Question 18d asks the preparer if there was any exchange gain under Section 987. In order for the preparer to answer this question, it is necessary for the preparer to understand Section 987. This Internal Revenue Code Section prescribes the rule for dealing with a foreign branch that is a QBU using a foreign functional currency. The basic approach is to determine profit or loss of the foreign branch for the tax year in its functional currency and then to translate the profit or loss at the “appropriate exchange rate,” The appropriate exchange rate is the average exchange rate for the tax year. See IRC Section 989(b)(4).

To determine the profit or loss of the branch, the branch preparers a profit and loss statement from the branch’s books and records, makes adjustments necessary to conform the statement to U.S. tax principles (called the “adjusted statement” in the proposed regulations) and translates the amount shown on the adjusted statement into U.S. dollars at the average exchange rate for the tax year. The branch must translate any amount shown on the adjusted statement attributable to actual dividends or deemed dividends under Section 1248 into U.S. dollars at the spot rate when the amount is included in income. When there is a remittance from the foreign branch to the U.S. parent entity (or another QBU having a different functional currency), the entity recognizes gain or loss to the extent that the dollar value of the foreign currency at the time of its remittance differs from its dollar value when earned.

The Treas. Reg. Section 1.987-2 provides a number of examples for determining the tax consequences of remittances from QBUs:

Example 1. X owns Business A and Business B, both of which are Section 987 QBUs of X. X owns equipment in Business A and is reflected on the books and records of Business A. Because Business A has excess manufacturing capacity and X intends to expand the manufacturing capacity of Business B, the equipment formerly used in Business A is transferred to Business B for use by Business B. As a result, the equipment is removed from the books and records of Business A and is recorded on the books and records of Business B.

The transfer of the equipment from the books and records of Business A to the books and records of Business B is not regarded for Federal income tax purposes (because it is an inter branch transaction), and therefore it is a disregarded transaction. Therefore, for purposes of Section 987, the Business A Section 987 QBU is treated as transferring the equipment to X, and X is subsequently treated as transferring the equipment to Business B Section 987 QBU. These transfers are taken into account in determining the amount of any remittance for the taxable year.

Example 2. X owns all of the interests in DE1 and DE2. DE1 and DE2 own Business A and Business B, respectively, both of which are Section 987 QBUs of X. DE1 owns equipment that is used in Business A and is reflected on the books and records of Business A. For business reasons, DE1 sells a portion of the equipment used in Business A to DE2 in exchange for a fair market value amount of Japanese yen. The yen used by DE2 to acquire the equipment was generated by Business B and was reflected on Business B’s books and records. Following the sale, the yen and the equipment will be used in Business A and Business B, respectively. As a result of such sale, the equipment is removed from the books and records of Business A and is recorded on the books and records of Business B. Similarly, as a result of the sale, the yen is removed from the books and records of Business B and is recorded on the books and records of Business A.

The sale of equipment between DE1 and DE2 is a transaction that is not regarded for Federal income tax purposes (because it is an interbranch transaction). Therefore the transaction is a disregarded transaction. As a result, the sale does not give rise to an item of income, gain, deduction, or loss for purposes of determining Section 987 taxable income. However, the yen and equipment exchange by DE1 and DE2 in connection with the sale must be taken into account as a disregarded transaction. As a result of the disregarded transaction, the equipment ceases to be reflected on the books and records of Business A and becomes reflected on the books and records of Business B. Therefore, the Business A Section 987 QBU is treated as transferring the equipment to X, and X is subsequently treated as transferring such equipment to the Business B section 987 QBU. Additionally, as a result of the disregarded transaction, the yen currency ceases to be reflected on the books and records of Business B and becomes reflected on the books and records of Business A. Therefore, the Business B section 987 QBU is treated as transferring the yen to X, and X is subsequently treated as transferring such yen from X to the Business A Section 987 QBU. The transfers among Business A, Business B and X are taken into account in determining the amount of any remittance for the taxable year.  


Question 19.

Question 19 asks the preparer if this transfer resulted from a change in entity classification (a deemed transfer resulting from a classification change on Form 8832, Entity Classification Election, or a termination of a section 1504(d) election), check the “Yes” box. If the transfer was an actual transfer of property to a foreign corporation, check the “No” box.


Question 20.

For question 20a, the preparer should check the “Yes” box on line 20a if the domestic corporation (domestic liquidating corporation) made a distribution of property in complete liquidation under section 332 to a foreign corporation that meets the stock ownership requirements of section 332(b) with respect to stock in the domestic liquidating corporation.

If the answer to line 20a is “Yes,” complete lines 20b and 20c and provide the following information in the Supplemental Part III Information Required To Be Reported section. Preface this supplemental information on the form with the heading “Section 367(e)(2) Information.”

1) A description, including the adjusted tax basis and fair market value, of all property distributed by the distributing corporation (regardless of whether the distribution of the property qualifies for nonrecognition treatment).

2) If the answer to line 20c is “Yes,” an identification of the items of property for which nonrecognition treatment is claimed under Regulations section 1.367(e)-2(b)(2)(ii) or (iii), as applicable.

For question 20b, if the answer to line 20a is “Yes,” enter the total amount of gain or loss recognized according to Regulations Section 1.367(e)-(2)(b). Under Section 367(e)(2), the U.S. person transferring property to a foreign corporation may not recognize loss in excess of gain on the distribution. If realized losses exceed recognized losses on transferred property, the loss is recognized on a pro rata basis and used to offset recognized gain on other transferred property in the category of assets (that is, capital or ordinary), but not below zero. The preparer should enter the net amount on line 20b.

For question 20c, if the answer to line 20c is “Yes,” the preparer should review Regulations Section 1.367(e)-2(b)(2)(i) for further guidance on the conditions for nonrecognition for distributions of certain qualifying property and additional reporting documentation that is required. Distributions of section 367(d)(4) intangible property do not qualify for nonrecognition and thus are subject to gain recognition.


For Question 21, the preparer should check “Yes” to line 21 if the transferor is a domestic corporation that makes a section 355 distribution (or so much of Section 356 as relates to Section 355) of stock in a foreign controlled corporation to a foreign corporation. Section 367(e)(1) and Regulations Section 1.367(e)-1 require the distributing domestic corporation to recognize gain (not loss) on the distribution. See Regulations section 1.367(e)-1(b) for the computation of recognized gain.


Conclusion

The IRS Form 926 is an incredibly complicated return. It is extremely important to work with an international tax attorney to ensure accurate preparation of your Form 8858. Having the wrong professional complete your Form 926 can result in significant penalties. We have substantial experience advising U.S. persons investing abroad of their compliance obligations. We have provided assistance to many accounting and law firms (both large and small) in all areas of international taxation.

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 also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. 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.

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