There are some important U.S. international tax considerations to be aware of when a U.S. person transfers intangible property outside the United States. When a U.S. person contributes intangible property to a foreign corporation as a capital contribution in exchange for stock, a taxable event will generally occur for U.S. federal income tax purposes. The U.S. transferor is considered to have taxable income from a deemed sale of the intangible property in the form of annual deemed payments based on the productivity or use of the property for the lesser of the useful life of the property or 20 years.
This requirement is based on Section 367(d) of the U.S. Internal Revenue Code. For purposes of this rule, the definition of intangibles is provided under Section 936(h)(3)(B) to include patents, copyrights, trademarks, franchises, licenses, contracts and customer lists which have substantial value independent of the services of any individual.
Where the U.S. transferor is a parent or subsidiary of the transferee foreign corporation, Section 482 transfer pricing rules require that the deemed annual payments must be based on the arm’s length standard between uncontrolled taxpayers. This means that the U.S. transferor’s annual deemed payments from the deemed sale of the intangible property must be determined by the amount of income that is expected to be produced from the intangible property. The same rules also apply to a transfer of intangible property in an outbound corporate reorganization transaction that otherwise would be a nontaxable merger or acquisition.
A U.S. person also may consider structuring an offshore transfer of intangible property to a foreign company as a sale. In the case of a sale, the U.S. transferor is subject to U.S. taxation on the difference between the cost basis and the sale price of the intangible property. The source (U.S. or foreign source) and the character of the income (ordinary or capital gain) could vary depending on the situation and the terms of the sale.
Another way to transfer intangible property offshore is through a licensing agreement. In the case of a transaction between related parties such as a U.S. parent and a foreign subsidiary, the royalty for the use of the intangible property must be based on the Section 482 arm’s length standard. If the U.S. company is paying a royalty to a foreign company for the use of the intangible property in the United States, the royalty payment is subject to 30% U.S. nonresident tax withholding unless the royalty income is considered to be effectively connected with the foreign company’s U.S. trade or business.
Even though cost-sharing arrangements between related U.S. and foreign companies is an area where the IRS is currently increasing its scrutiny, they could also provide an opportunity for the cross-border co-development of intangible property.