Businesses commonly develop some form of intangible property (IP). IP could be legally registered – like patents, copyrights or trademarks – or not registered and somewhat amorphous in nature, such as manufacturing know-how, marketing intangibles, workforce-in-place, goodwill and going concern value. The location of IP for a company operating in multiple countries can materially impact its tax costs and overall risk.

US multinational businesses often decide whether to 'outbound' US-based IP to a foreign jurisdiction, or 'inbound' foreign-based IP to the US, or just leave the IP in place. Sometimes tax considerations are equally important to business or legal concerns that drive these decisions. Tax consequences related to IP tend to follow the entity (or entities) owning the IP or that have property interests in the IP, such as those held by a licensee.

At the front end, when IP is being developed, the owner (or owners) typically claim deductions for the research and development (R&D) costs. At the back end, when the developed IP is exploited, the 'nonroutine' or 'residual' profits are allocated to the owner (or owners) and the users of IP earn a return commensurate with the risks and rewards of their functions and activities. Currently the tax considerations for placing IP in the US versus overseas are at an all-time high level of uncertainty.

This perfect storm began with the Tax Cuts and Jobs Act of 2017 (TCJA), which ended deferral of US taxation on foreign earnings and implemented the most comprehensive tax reform for US multinational companies in 30 years. Prior to the TCJA, many multinationals had successfully moved IP ownership to foreign jurisdictions and enjoyed the benefit of deferral. Once the IP was outbound, it was cost prohibitive to return it to the US, as the IP's value would be a fully taxable dividend.

The TCJA imposed a one-time toll charge on deferred foreign earnings and a US tax going forward on foreign intangible income, known as 'GILTI'. To encourage the location of IP in the US, together with R&D and business activity giving rise to intangible income, multinationals became taxed at lower rates on income from foreign sales that is sourced in the US, known as 'FDII'. The US toll charge made it easier to inbound IP as pre-taxed property, subject to any foreign toll charge on the repatriation. Conversely, Congress imposed new barriers to making outbound IP transfers.

Post-TCJA, a difficult question for any US multinational was whether to maintain mostly an offshore IP structure and navigate the complexities of GILTI, or to maintain mostly an onshore IP structure and attempt to comply with FDII.

At first glance, the tax rates made GILTI appear more favourable than FDII, indicating that an offshore structure would be preferable. GILTI's effective US tax rate is 10.5 percent (13.125 percent after 2025), whereas FDII's effective US tax rate is 13.125 percent (16.406 percent after 2025). But GILTI has its drawbacks too.

Foreign taxes paid on GILTI receive a 20 percent haircut before they are creditable against the US GILTI tax. Excess foreign taxes, say due to foreign rates being higher than the US rate, may not be carried back or carried forward as they can be in other situations. Claiming foreign tax credits on GILTI can also cause greater exposure to TCJA's base erosion and anti-abuse tax, known as 'BEAT'. And GILTI has an unfavourable effect on multinationals with US-based net operating losses (NOLs).

On the other hand, US multinationals with an existing onshore IP structure would typically focus on benefitting from FDII. Converting to an offshore IP structure and benefitting from the GILTI regime can be cost prohibitive due to the US tax on outbound IP transfers. The FDII regime may be preferable to GILTI if the foreign country in which the multinational operates has high taxes that would not be creditable under a GILTI regime, or if the multinational has NOLs. FDII also, however, presents its own set of challenges and uncertainty: FDII is more subjective and complicated than determining GILTI, and it requires significant record keeping to qualify income as FDII.

In addition to focusing on a GILTI/offshore structure or an FDII/onshore structure, a third option is to have IP owned in a foreign subsidiary that is treated as a disregarded entity for US tax purposes, effectively an offshore structure for legal purposes but an onshore structure for tax purposes. That is, a 'branch' of the US multinational is considered the owner of the IP and thus it is taxed in the US as part of the multinational's US business.

A multinational having an offshore IP structure, and wanting to avoid the GILTI regime, could 'check the box' on the foreign subsidiary owning the IP and thereby move the IP into a branch. The US tax cost of this inbound transfer could be negligible due to TCJA changes. Losses generated by a foreign branch may be used to offset US taxes on US-source income. Branch income, however, does not enjoy the lower FDII rates, and foreign taxes on branch income are creditable only against US taxes on branch income (that is, no cross-crediting on other types of foreign income).

After the TCJA's enactment and before regulations addressed the multitude of interpretive questions, multinationals planned their affairs, including the location of IP, with both caution and uncertainty. Now, after many questions have been addressed in thousands of pages of regulations issued by the US Treasury Department, multinationals make planning decisions in a world of complexity.

Several of the Treasury's regulatory positions greatly impacted multinationals' decisions made in a pre-regulation context to either keep IP offshore in a foreign subsidiary or move it to the US or a foreign branch. For example, regulations require that an allocable portion of the US multinational's interest expense reduce the amount of its GILTI income counted for foreign tax credit purposes, which reduces the credit and can trigger US tax in excess of the 10.5 percent effective tax rate that was contemplated by Congress. This position caused an expected US tax increase on GILTI, relative to the normal 21 percent US corporate rate and the 13.125 percent FDII rate.

Some US multinationals repatriated their foreign-owned IP by converting a foreign subsidiary into a foreign branch, only to later find that regulations effectively forced an unfavourable, unexpected taxation result. Essentially there is a deemed transaction between the US group and the foreign branch, that causes a reduction in the US group's income that otherwise would be eligible for an FDII benefit, and corresponding US income to the branch for which foreign tax credits would not likely be available. Fortunately, the IRS and Treasury have listed on their Priority Guidance Plan (PGP), issued 9 September 2021, a regulations project "addressing the inbound transfer of intangible property".

US multinationals seeking to offshore IP by contribution to a foreign subsidiary must recognise gain on the transferred 'intangible property', which the TCJA defined to include goodwill, going concern value, workforce in place and any residual value associated with the transferred assets. Whether intangible assets are offshored through contributions, sales or licences, there remain questions as to the particular principles used to value the transferred assets. The TCJA provided the Treasury with regulatory authority to address certain principles. Those regulations are still in progress and listed in the PGP.

US multinationals having most of their IP value onshore, but operating in foreign jurisdictions through digital services and other consumer-facing activities, face a new Organisation for Economic Co-operation and Development (OECD) proposal for taxation in the foreign jurisdictions known as 'Pillar 1'. It is critical that this Pillar 1 tax be creditable for US tax purposes, or else these companies will be double taxed, first in the US on their GILTI and second by the foreign country on their Pillar 1 income.

Meanwhile, US multinationals have become increasingly subject to various taxes imposed by foreign countries on digital or other consumer-facing activities associated with consumers resident in the foreign country, commonly known as a digital services tax (DST). The Treasury and the IRS recently issued proposed regulations that would treat DSTs and similar taxes as non-creditable. The finalisation of those regulations is listed in the PGP. It is anticipated that DSTs will be withdrawn if Pillar 1 is ever implemented, but there is no guarantee currently.

The final area of uncertainty is the prospect of new tax legislation. During the week of 27 September 2021, the House is expected to vote on a $3.5 trillion reconciliation bill that includes $2.3 trillion in revenue raisers, mainly an increase in the corporate rate from 21 to 26.5 percent. The effective US tax rates for GILTI and FDII would increase to 16.56 percent and 20.7 percent, respectively.

In some respects, the GILTI regime would become more costly due to proposals to determine GILTI and foreign tax credits on a country-by-country basis. In other respects, certain issues that influenced decisions on where to locate IP would be changed in the taxpayer's favour, such as the elimination of interest expense apportionment to the GILTI foreign tax credit basket and the elimination of the separate foreign tax credit basket for foreign branches.

The PGP, combined with potential Pillar 1 taxes and new legislation, confirm that only time will tell how all these uncertainties eventually get resolved.

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