SECTION 2. BACKGROUND

.01 Repeal of Sections 1491 through 1494

Until they were repealed as part of the Taxpayer Relief Act of 1997 (the 1997 Act), sections 1491 through 1494 imposed an excise tax on certain transfers of appreciated property by a U.S. person to a foreign partnership, which generally was 35 percent of the amount of gain inherent in the property. Staff of the Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 1997, Part Two: Taxpayer Relief Act of 1997 (H.R. 2014) (Dec. 19, 1997). As the Joint Committee explained, Congress believed that the imposition of enhanced information reporting obligations (including sections 6038, 6038B, and 6046A) with respect to foreign partnerships would eliminate the need for sections 1491 through 1494. Id.

Notwithstanding these enhanced information reporting requirements, the 1997 Act granted the Secretary regulatory authority in section 721(c) to override the application of the nonrecognition provision of section 721(a) to gain realized on the transfer of property to a partnership (domestic or foreign) if the gain, when recognized, would be includible in the gross income of a person other than a U.S. person. In the 1997 Act, Congress also enacted section 367(d)(3), which provides the Secretary regulatory authority to apply the rules of section 367(d)(2) to transfers of intangible property to partnerships in circumstances consistent with the purposes of section 367(d). Id. Regulations have never been issued pursuant to section 721(c) or section 367(d)(3).

.02 Sections 367 and 721

Congress enacted section 367 (and its predecessor) in order to prevent U.S. persons from avoiding U.S. tax by transferring appreciated property to foreign corporations using nonrecognition transactions. Staff of the Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 (H.R. 4170) (Dec. 31, 1984). The outbound transfer of intangible property raises additional issues that Congress also sought to

address. Specifically, section 367(d) was enacted to prevent U.S. persons from transferring intangibles offshore in order to achieve deferral of U.S. tax on the profits generated by the intangibles. H.R. Rep. No. 98–432, at 1311–15 (1984). Under section 367(d), a U.S. person that transfers intangible property (within the meaning of section 936(h)(3)(B)) to a foreign corporation in an exchange described in section 351 or section 361 (a section 351 exchange or a section 361 exchange, respectively) is treated as having sold such property in exchange for payments that are contingent upon the productivity, use, or disposition of such property, and receiving amounts that reasonably reflect the amounts that would have been received annually in the form of such payments over the useful life of such property, or, in the case of a disposition following such transfer (whether direct or indirect), at the time of the disposition. Section 367(d)(2)(A). The amounts taken into account must be commensurate with the income attributable to the intangible. Id.

The regulations under sections 367(a) and 367(d) contain special rules for transfers to foreign corporations in a section 351 exchange or section 361 exchange under certain circumstances involving partnerships. Specifically, in the case of a transfer of property to a foreign corporation by a partnership in which a U.S. person is a partner, §§ 1.367(a)– 1T(c)(3)(i)(A) and 1.367(d)–1T(a) treat the partnership’s transfer as if the U.S. partner had transferred its proportionate share of the partnership’s assets (determined under sections 701 through 761) directly to the foreign corporation. In the case of a transfer of a partnership interest to a foreign corporation by a U.S. person, §§ 1.367(a)–1T(c)(3)(ii)(A) and 1.367(d)– 1T(a) treat the U.S. partner as if it had transferred its proportionate share of the property of the partnership (determined under sections 701 through 761) directly to the foreign corporation. In both cases, if section 367(a) requires gain recognition, the regulations provide rules for making basis adjustments to take into account the gain recognized.

Section 721(a) provides a general rule that no gain or loss is recognized to a

August 24, 2015 210 Bulletin No. 2015–34

partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership. Because section 367 only applies to the transfer of property to a foreign corporation, absent regulations under section 721(c) or section 367(d)(3), a U.S. person generally does not recognize gain on the contribution of appreciated property to a partnership with foreign partners.

.03 Section 704

Section 704(c)(1)(A) requires partnerships to allocate income, gain, loss, and deduction with respect to property contributed by a partner to the partnership so as to take into account any variation between the adjusted tax basis of the property and its fair market value at the time of contribution.

Section 1.704–3(a)(1) provides that the purpose of section 704(c) is to prevent the shifting of tax consequences among partners with respect to pre-contribution gain or loss. Section 704(c) allocations must be made using any reasonable method consistent with that purpose. § 1.704–3(a)(1). Section 1.704–3 describes three methods of making section 704(c) allocations that are generally reasonable, including the remedial allocation method. Id . Under the remedial allocation method, a partnership may eliminate distortions caused by the ceiling rule (as described in § 1.704– 3(b)(1)) by making remedial allocations of income, gain, loss, or deduction to the noncontributing partners equal to the full amount of the limitation caused by the ceiling rule, and offsetting those allocations with remedial allocations of income, gain, loss, or deduction to the contributing partner. T.D. 8585, 1995–1 C.B. 120. If a partnership’s section 704(c) allocation method is unreasonable, the Secretary can make adjustments by exercising his authority under the anti-abuse rule at § 1.704–3(a)(10); however, the IRS does not require a partnership to use the remedial allocation method. § 1.704–3(d)(5)(ii).

Section 704(a) and (b) provide that a partner’s distributive share of income, gain, loss, deduction, or credit shall be determined under the partnership agreement unless the partnership agreement does not provide rules for such allocation or the allocation does not have substantial eco

nomic effect. Section 1.704–1(b)(1)(iii) provides that an allocation that is respected under section 704(b) and the regulations promulgated thereunder may still be reallocated under other provisions, such as section 482. See also Rodebaugh v. Commissioner, T.C. Memo. 1974–36 (holding that the Commissioner could make allocations under section 482 that differed from the formula set forth in the partnership agreement), aff’d, 518 F.2d 73 (6th Cir. 1975).

.04 Sections 482 and 6662 and the Regulations Thereunder

Section 482 provides, in part, that the Secretary may make allocations between or among two or more organizations, trades, or businesses (whether or not incorporated or affiliated and whether or not organized in the United States) that are owned or controlled directly or indirectly by the same interests in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades, or businesses. Section 1.482–1(a)(2) provides that the IRS may make allocations between or among the members of a controlled group if a controlled taxpayer has not reported its true taxable income. In such a case, the IRS may allocate income, deductions, credits, allowances, basis, or any other item or element affecting taxable income.

Section 1.482–1(b)(1) provides that, in determining the true taxable income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer. A controlled transaction meets the arm’s length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm’s length result). § 1.482–1(b)(1). For purposes of section 482, § 1.482–1(i)(7) and (8) provide that controlled transactions include contributions. Section 1.482–1(c)(1) provides that the arm’s length result of a controlled transaction must be determined under the method (or application of a method) that, under the facts and circumstances, provides the most reliable measure of an arm’s length result.

Determining the degree of comparability between controlled and uncontrolled

transactions includes the following analyses: (i) a functional analysis of the economically significant activities undertaken or to be undertaken; (ii) a consideration of the resources that are employed, or to be employed, in conjunction with the activities undertaken; and (iii) a comparison of the significant contractual terms and risks of the two transactions. § 1.482–1(d)(3). The contractual terms, including the allocation of risks specified or implied by those terms, will be respected if such terms are consistent with the substance of the underlying transactions, including the actual conduct of the controlled taxpayers. § 1.482–1(d)(3)(ii)(B) and (iii)(B). In the absence of a written agreement between the controlled taxpayers or when the contractual terms are inconsistent with the substance of the underlying transaction, the IRS may impute a contractual agreement between the controlled taxpayers that is consistent with the substance of the transaction. Id.

In determining true taxable income, the combined effect of two or more separate (controlled or uncontrolled) transactions (whether before, during, or after the taxable year under review) may be considered if such transactions, taken as a whole, are so interrelated that consideration of multiple transactions is the most reliable means of determining the arm’s length consideration for the controlled transactions. § 1.482–1(f)(2)(i).

The IRS will evaluate the results of a transaction as actually structured by the taxpayer unless the terms of the transaction lack economic substance. § 1.482–1(f)(2)(ii)(A). However, the IRS may consider the alternative transactions available to the taxpayer in determining whether the terms of the controlled transaction would be acceptable to an uncontrolled taxpayer faced with the same alternatives and operating under comparable circumstances. Id. The IRS may adjust the consideration charged in the controlled transaction based on the cost or profit of an alternative as adjusted to account for material differences between the alternative and the controlled transaction, but will not restructure the transaction as if the alternative had been adopted by the taxpayer. Id.

Section 1.482–7 provides the specific methods to be used to evaluate whether a cost sharing arrangement as defined in

Bulletin No. 2015–34 211 August 24, 2015

§ 1.482–7 produces results consistent with an arm’s length result. § 1.482–1(b)(2)(i). Section 1.482–7(g)(1) provides for specified and unspecified methods for purposes of evaluating the arm’s length amount charged in a platform contribution transaction. Sections 1.482–4 and 1.482–9, as appropriate, provide specified and unspecified methods to be used to determine arm’s length results of arrangements, other than cost sharing arrangements covered by § 1.482–7, for sharing the costs and risks of developing intangibles. § 1.482–1(b)(2)(iii). These other arrangements expressly include partnerships. Id. In the case of such other arrangements, the principles, methods, comparability, and reliability considerations set forth in § 1.482–7 are relevant in determining the best method, including an unspecified method, as appropriately adjusted in light of the differences in the facts and circumstances between such arrangements and a cost sharing arrangement. §§ 1.482–4(g) and 1.482–9(m)(3).

In the case of any transfer or license of intangible property (within the meaning of section 936(h)(3)(B)), the consideration charged by the transferor with respect to such transfer or license must be commensurate with the income attributable to the intangible. Section 482 (second sentence); § 1.482–4(a) (third sentence) and (f)(2) and (6); and § 1.482–7(i)(6). If such consideration does not satisfy the commensurate with income requirement, the Commissioner may make periodic adjustments to such consideration in a subsequent taxable year without regard to whether the taxable year of the original transfer remains open for statute of limitations purposes. §§ 1.482–4(f)(2)(i) and 1.482– 7(i)(6)(i). If an intangible is transferred in a controlled transaction in exchange for annual royalty payments, the Commissioner may make periodic adjustments to such payments as necessary to ensure an arm’s length royalty amount is paid in each taxable year. § 1.482–4(f)(2)(i). If an intangible is transferred in a controlled transaction for a lump sum, § 1.482– 4(f)(6) provides that the lump sum must be commensurate with the income attributable to the intangible. Section 1.482– 4(f)(6) also explains how to determine a periodic adjustment for a particular taxable year with respect to that lump sum.

Section 6664(c) provides generally that a penalty may not be asserted under section 6662 with respect to a portion of an underpayment if it is shown that there was reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion. However, when the IRS determines that a penalty otherwise would apply as the result of a net section 482 transfer price adjustment, as defined in section 6662(e)(3), or as the result of a gross valuation misstatement, as defined in section 6662(h)(2), section 6662(e)(3)(D) provides that, for purposes of section 6664(c), the taxpayer is not treated as having reasonable cause for a portion of an underpayment attributable to a net section 482 adjustment unless the taxpayer meets the requirements of section 6662(e)(3)(B)(i), (ii), or (iii) with respect to such portion. Those requirements are further described in § 1.6662–6(d) and generally require a taxpayer to select and apply a specified or unspecified method that the taxpayer could reasonably conclude met the relevant measure of reliability set forth in § 1.6662–6(d). Those requirements also include a requirement to maintain sufficient contemporaneous documentation to establish the taxpayer’s reasonable conclusion.