The Tax Court in Brief February 7 – February 11, 2022
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Tax Litigation: The Week of February 7 – February 11, 2022
TBL Licensing LLC v. Comm’r, Corrected 158 T.C. 1 | February 8, 2022 | Filed January 31, 2022 | Halpern, J. | Dkt. No. 21146-15
Short Summary: This 92-page opinion case involves a $504,691,690 tax deficiency determination resulting from a business merger combination of VF Corp. (VF) and the Timberland Co. (Timberland) at the near-end of tax year 2011. The combination involved foreign and domestic entities, including corporations, a holding company, and wholly-owned subsidiaries (collectively, the Timberland Entities or Petitioner, for simplicity’s sake, except where noted otherwise herein). The transaction is summarized as follow:
- VF Enterprises, an indirect foreign subsidiary of VF, contributed to TBL GmbH, its own foreign subsidiary, the sole member interest in an entity TBL International Properties, LLC, a domestic LLC and a disregarded entity for federal income tax purposes.
- International Properties owned the sole member interest in Petitioner, TBL Licensing LLC, and Petitioner owned assets, including intangible property, that it acquired from Timberland.
- Petitioner then elected to be disregarded as an entity separate from its owner, International Properties (which, in turn, was disregarded as an entity separate from TBL GmbH). Those events did not include a transfer of intangible property, and upon the completion of those events, Petitioner continued to own the Timberland intangible property.
The primary tax-event underlying the deficiency regarded (A) the transfer and acquisition of Timberland’s intangible property – trademarks, foreign workforce, and foreign customer relationships – valued at $1,274,100,000 and (B) generally speaking, how the direct and indirect distribution and acquisition of that intangible property should be characterized for tax purposes under, primarily, 26 U.S.C. § 367(d) (Section 367(d)). The target Timberland Entity (TBL Licensing LLC) was treated as a corporation per election made pursuant to Treas. Reg. § 301.7701-3(c)(1)(i). The Timberland Entities and the Commissioner agreed that, because Timberland – at the relevant time in question was treated as a U.S. corporation – constructively transferred intangible property to a foreign corporation (TBL Licensing LLC) in a transaction that would otherwise qualify for nonrecognition treatment under Section 361(a), Section 367(d) applied to the transfer. However, the parties disagreed on the consequences of Section 367(d)’s application.
- (1) Whether Petitioner is required to recognize ordinary income under Section 367(d)(2) as a result of a constructive transfer of intangible property to a foreign holding company, and, if so, (2) whether, in determining the amount of that income, the property should be treated, as a matter of law, as having a useful life limited to 20 years.
- The constructive distribution of a foreign holding company’s stock to another related foreign entity necessarily followed the constructive transfer of intangible property that occurred as part of a reorganization described in Section 368(a)(1)(F). Thus, the U.S. transferor’s distribution of the stock of the transferee foreign corporation was a “disposition” within the meaning of Section 367(d)(2)(A)(ii)(II). The Timberland Entity in issue (Petitioner, TBL Licensing LLLC) with respect to that beneficial transfer is required to recognize gain in the intangible property “at the time of the disposition.” See 26 U.S.C. § 367(d)(2)(A)(ii)(II). No provision of the regulations allows Petitioner to avoid the recognition of gain under that statutory provision.
- Because International Properties was disregarded as an entity separate from its owner and Petitioner was, on September 22, 2011, classified as a corporation, VF Enterprises’ contribution to TBL GmbH of the sole member interest in International Properties should be treated, in the first instance, as a contribution of “stock” in Petitioner.
- The fair market value of transferred intangible property, for the purpose of determining gain that must be recognized under Section 367(d)(2)(A)(ii)(II), should be determined on the basis of the property’s entire expected useful life, without regard to any 20-year limit imposed by then-existing Temp. Treas. Reg. § 1.367(d)-1T(c)(3).
- Based on Temporary Treas. Reg. § 1.367(d)-1T(g)(5) applicable to the case, and in general application, the gain that a U.S. transferor must recognize under Section 367(d)(1) upon disposing of stock of a transferee foreign corporation to an unrelated person should take into account the actual fair market value of the transferred intangible property on the date of the disposition. That FMV should reflect the amount that an unrelated purchaser would pay for the property in an arm’s-length transaction, taking into account the entire period during which the property may be expected to have value.
Key Points of Law:
- When foreign corporations are involved, property can move in and out of the U.S. tax jurisdiction. A U.S. person who makes an “outbound” transfer of property to a foreign corporation might be required to recognize gain even if, had the transfer been made to a U.S. corporation, it would have been entitled to nonrecognition treatment. Section 367(a), which applies to outbound transfers of most types of properties, achieves that result by providing, subject to exceptions, that the foreign corporation that receives the property is not treated as a corporation.
- Outbound transfers of intangible property are not covered by section 367(a) but are instead addressed by section 367(d), which generally requires the U.S. transferor of intangible property to recognize gain in the form of ordinary income, but the timing of that income recognition varies depending on the circumstances.
- Section 367(d) applies to a transfer of intangible property by a U.S. person to a foreign corporation only if the transfer takes the form of “an exchange described in section 351 or 361.” See 26 U.S.C. § 367(d)(1)-(2). For an exchange to be described in section 351 (transfer to corporation controlled by transferor) or section 361 (nonrecognition of gain or loss to corporations; treatment of distributions), it must be a transfer of property in exchange, at least in part, for stock of the recipient. See 26 C.F.R. § 1.367(a)-1 (Transfers to foreign corporations subject to section 367(a): In general).
- When Section 367(d)(1) applies to a transfer, the U.S. person transferring the intangible property is treated as (i) having sold such property in exchange for payments which are contingent upon the productivity or use of such property, and (ii) receiving amounts which reasonably reflect the amounts which would have been (I) received annually in the form of such payments over the useful life of such property, or (II) in the case of a disposition following such transfer (whether direct or indirect), at the time of the disposition. 26 U.S.C. § 367(d)(2)(A)-(d)(2)(A)(II). Pursuant to Section 367(d)(2)(C), “any amount included in gross income by reason of this subsection shall be treated as ordinary income. For purposes of applying section 904(d) [relating to the foreign tax credit], any such amount shall be treated in the same manner as if such amount were a royalty.”
- Subclause (II) in Section 367(d)(2)(A) applies only in the event of a “disposition following [the] transfer” of intangible property. Here, the exchange of intangible property followed, if only by a moment, the distribution of stock in issue. Thus, Petitioner’s constructive disposition to the stock in question of holding company (the transferee foreign corporation and recipient of the intangible property) was a “disposition” within the meaning of Section 367(d)(2)(A)(ii)(II).
- Under Section 367(d)(2)(A)(ii)(II), a “disposition” requires the U.S. transferor of intangible property to recognize gain when it “follow[s]” the transfer. Treas. Reg. § 1.167(a)-3 allows, in certain instances, the cost of an intangible asset to be recovered over either 15 or 25 years, subject to applicable amortization beginning when the intangible asset is placed in service by the taxpayer. However, Temporary Treas. Reg. § 1.367(d)-1T(c)(3) (in effect for the tax year in issue) provided: “For purposes of this section, the useful life of intangible property is the entire period during which the property has value. However, in no event shall the useful life of an item of intangible property be considered to exceed twenty years.”
- As a general matter, an eligible entity (i.e., a “business entity” other than a state law corporation or other entity that is required to be classified as a corporation for federal tax purposes) cannot make more than one entity classification election every five years. Treas. Reg. § 301.7701-3(c)(1)(iv). That limitation does not apply to “[a]n election by newly formed eligible entity that is effective on the date of formation.”
- The Treasury Regulations provide a series of constructs to explain an entity’s change in classification for federal tax purposes. Treas. Reg. § 301.7701-3(g)(1)(iii) supplies the construct for cases in which an entity with a single owner – that had been classified as an association – elects to be disregarded. See Reg. § 301.7701-2(b)(2) (including within the definition of “corporation” any “association (as determined under § 301.7701-3)”). In that event, “the following is deemed to occur: The association distributes all of tis assets and liabilities to its single owner in liquidation of the association. Treas. Reg. § 301.7701-3(g)(1)(iii).
- Private letter rulings may not be used or cited as precedent, 26 U.S.C. § 6110(k), but they may be cited to show the practice of the Commissioner. See Dover Corp. & Subs. v. Comm’r, 122 T.C. 324, 341 n.12 (2004).
Insights: This opinion, while complex and unique, provides key insight as to how the value of intangible property must be recognized in an “outbound” transaction involving U.S. and foreign corporations, some of which are treated as disregarded entities for purposes of U.S. federal income tax purposes. In TBL, the transaction qualified as a “disposition” within the meaning of Section 367(d)(2)(A)(ii)(II), being one which requires a transfer of property in exchange, at least in part, for stock of the recipient entity. A key strategic business decision in the TBL fact pattern, and one that the court circled back to time and again, regarded the timing of when Petitioner elected to be treated as a disregarded entity. Whether or not a different election, or different timing would have benefited the Timberland Entities from a federal income tax perspective is unknown to this writer, but likely one issue of many that is under review by Timberland.