US State Income Tax Digest - June 2025
Highlighting significant income and business tax developments
Final regulations address Section 367(d) treatment of repatriation of intangible property
October 2024
In brief
What happened?
Treasury and the IRS on October 9 released final regulations under Section 367(d) that address repatriation of intangible property (IP) from a foreign corporation to certain US persons. Section 367(d) applies when a US person (a ‘US transferor’) transfers IP described in Section 367(d)(4) to a foreign corporation (‘transferee foreign corporation’) in a Section 351 or 361 exchange. The final regulations address the consequences that arise when the transferee foreign corporation subsequently transfers the intangibles to a US person, including when the US transferor would recognize gain upon the repatriation and when the paradigm under Section 367(d) requiring annual income inclusions over the useful life of the intangibles (‘Section 367(d) inclusions’) should terminate. The final regulations follow proposed regulations published on May 3, 2023, with minimal changes.
Why is it relevant?
In light of the tax benefits of FDII and aggressive foreign transfer pricing audits, several companies are considering repatriating their IP to the United States. These regulations provide a method for doing so without suffering potential double taxation under Section 367(d).
Background
The final regulations under Section 367(d) are based on proposed rules published on May 3, 2023. See PwC’s Insight on the proposed regulations. In general, those regulations eliminated Section 367(d) inclusions after a repatriation of previously outbounded IP, provided that certain requirements were satisfied. Comments submitted on the proposed regulations included suggested modifications to the scope of a US person who could receive IP (a ‘qualified domestic person’), adjustments to a qualified domestic person’s adjusted basis in repatriated IP, clarifications on the required adjustments related to an annual Section 367(d) inclusion, changes to the proposed regulations to accommodate repatriations preceded by certain transfers of IP between related foreign corporations, and clarifications of the reporting and relief provisions. Nearly all of these comments were rejected by the IRS and Treasury, who cited administrative burden and compliance as a rationale.
Qualified domestic person
The regulations use the term ‘qualified domestic person’ to describe the type of person that can receive IP from a foreign corporation that results in the cessation of Section 367(d) inclusions to the US transferor. The final regulations adopt the proposed regulation’s definition of a ‘qualified domestic person’ without change. A ‘qualified domestic person’ for purposes of terminating the Section 367(d) regime is defined by reference to an 'initial US transferor’ of the IP, a ‘qualified successor’ to the US transferor, or a US person that is either an individual or 'qualified corporation' related to either the initial US transferor or qualified successor.
Observation: The final regulations exclude certain entities, such as a regulated investment company, a real estate investment trust, a DISC, or an S corporation from being considered a qualified domestic person. Partnerships are not considered qualified domestic persons for the purpose of terminating Section 367(d) provisions, even if all of the partnership’s owners would be qualified domestic persons. The preamble notes that these exclusions are intended to ensure that the income generated by the repatriated IP is subject to current US tax and there are some theoretical instances in which these entities could have owners that are not subject to US tax. For example, an S corporation, which generally can only have US individuals as shareholders, can be owned by an employee stock ownership plan that may not be subject to tax with respect to its distributable share of the S corporation’s income. While some comments requested inclusion of partnerships and S corporations and provided detailed suggestions for how to accommodate the government’s concerns about IP income not being subject to US tax, the final regulations did not adopt these suggestions due to concerns over administrability and compliance issues.
Adjusted basis in repatriated IP and amount of gain recognized by US transferor
The final regulations adopt the proposed regulations’ guidance on adjusted basis in repatriated IP without change.
Under the final regulations, a qualified domestic person’s adjusted basis in IP that qualifies as transferred basis property due to the repatriation will equal the lesser of (1) the US transferor's former adjusted basis in the IP or (2) the transferee foreign corporation's adjusted basis in that IP immediately before the repatriation, increased by the greater of (x) the amount of gain recognized by the US transferor upon the repatriation under the final Section 367(d) regulations (if any) or (y) the amount of gain recognized by the transferee foreign corporation upon the repatriation (if any). If the IP does not qualify as transferred basis property by reason of the repatriation, a qualified domestic person's adjusted basis in the IP will equal the fair market value of the IP as of the repatriation date.
In addition, a US transferor must recognize gain in connection with a repatriation transaction to a qualified domestic person. The gain recognized is the amount of gain the transferee foreign corporation would recognize if its adjusted basis in the IP were equal to the US transferor’s original basis (if the IP is transferred basis property), or the excess, if any, of the fair market value of the IP on the date of the subsequent disposition over the US transferor’s adjusted basis in IP (if the IP is not transferred basis property by reason of the subsequent disposition).
Observation: The rules described above may result in over taxation of IP because a foreign corporation can have a higher basis in IP than the initial US transferor. This can occur, for example, where a foreign corporation has transferred the IP to a related foreign corporation in a taxable transaction or where the transferee foreign corporation has capitalized expenses into the basis of the IP. Nevertheless, Treasury and the IRS declined to address these issues, which implicate broader issues under Section 367(d) that are beyond the scope of the regulations.
Deductions allocated to all gross income
The final regulations adopt the proposed regulations’ approach that the deemed annual payment under Section 367(d) by the transferee foreign corporation is treated as an allowable deduction that must be allocated and apportioned to the transferee foreign corporation’s classes of gross income in accordance with Reg. 1.882-4(b)(1), 1.954-1(c), and 1.960-1(c) and (d) (as applicable). Thus, under the final regulations, payments may be allocated and apportioned to any class (or classes) of gross income, as appropriate, for various purposes of the Code rather than solely to gross subpart F and tested income.
Observation: Comments suggested that Section 162 should be added the list of deductions to clarify that IP that is transferred to a US person that is not a qualified domestic person may still give rise to deductions that correspond to the Section 367(d) inclusion recognized by the US transferor. Treasury and the IRS rejected this comment based on their view that the final regulations are the exclusive means by which a Section 367(d) inclusion can be terminated. This explanation could leave taxpayers with the risk of significant double taxation in a number of circumstances. For example, if an S corporation (which is not a qualified domestic person) transfers IP to a foreign corporation, which thereafter repatriates the IP back to the S corporation, S corporation will continue to have a Section 367(d) inclusion with respect to the IP but will not be able to claim an offsetting deduction under Section 162. In effect, therefore, the regulations could penalize the repatriation of IP in certain circumstances and may encourage certain US transferors to keep IP offshore.
Multiple transfers before repatriation
The final regulations do not adopt suggested changes to the proposed regulations to accommodate repatriations preceded by certain transfers of IP subject to Section 367(d) between related foreign corporations. One comment provided an example that highlighted that it may be possible to recognize income under both Sections 951A and 367(d) with respect to the same property in some fact patterns where separate transactions occur in separate foreign corporations, even though that result would not occur in cases where the property is not transferred among multiple foreign corporations.
Observation: Treasury and the IRS noted that coordinating potential disparities between income recognition under Section 367(d) as compared to other generally applicable provisions of the Code, and potential disparities in tax basis for purposes of Section 367(d) as compared to adjusted basis for other purposes, is beyond the scope of these regulations.
Transfers of IP involving a foreign branch
The final regulations address the interaction between the Section 367(d) rules and the foreign tax credit rules under Section 904(d). Specifically, the final regulations state that the repatriation of IP does not affect the application of foreign branch income rules under Reg. 1.904-4(f)(2)(vi)(D). Each transfer of IP must be considered independently from any other preceding or subsequent transfer of the IP, ensuring that foreign branches continue to recognize the appropriate amount of income attributable to the transferred IP.
Observation: Treasury and the IRS declined to adopt multiple comments relating to these rules, including requests that the proposed regulations be finalized without finalizing the proposed Section 904(d) foreign branch income rules.
Information reporting
The final regulations impose additional information reporting requirements as a condition for terminating the application of Section 367(d) with respect to repatriated IP. If the US transferor fails to meet provided reporting requirements, the final regulations provide for continued application of the Section 367(d) regime, meaning that the US transferor must continue to include annual amounts in income. However, relief is available for taxpayers that promptly correct any reporting failures and provide a reasonable explanation for the failure. The relief for a failure to comply is conditioned upon the US transferor timely filing one or more amended returns for the tax year in which the subsequent transfer occurred and succeeding years, and, if the US transferor is under examination when an amended return is filed, providing a copy of the amended return(s) to the IRS personnel conducting the examination (if applicable).
Observation: The emphasis on reporting reflects the IRS’s concern about potential non-compliance and abuse of the repatriation rules. Treasury and the IRS will consider prescribing a particular form as part of future guidance for reporting with respect to Section 367(d) generally.
Clarification to Example 3
Treasury also clarified the facts of Prop. Reg. 1.367(d)-1(f)(6)(ii)(C) (Example 3), which illustrates the determination of a qualified domestic person’s adjusted basis in IP under the proposed regulations. The final regulations clarify that the transferee foreign corporation (TFC)’s earnings and profits and gross income arising by reason of the repatriation are reduced by the amount of gain recognized by USP under Prop. Reg. 1.367(d)-1(f)(4)(i)(A).
Applicability dates
The final regulations apply to subsequent transfers of IP occurring on or after October 10, 2024, the date of publication in the Federal Register. However, taxpayers that repatriated IP before this date are still subject to the previous Section 367(d) rules.
Observation: Comments had requested that the regulations apply retroactively, particularly for transactions that occurred after the proposed regulations were issued in May 2023. However, Treasury and the IRS declined this request, citing concerns about administrative complexity and the potential for inconsistent treatment of taxpayers.
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