Questions have arisen in practice around the tax accounting considerations for intra-entity intellectual property migration arrangements. Question TX 2-2 addresses different considerations when intellectual property is sold within the consolidated group for cash versus an installment note.
Question TX 2-2
When internally-generated intellectual property (IP) is sold to another member of the same consolidated group, are there any distinctions between a sale for cash versus a sale for an installment note?
Yes. Depending on whether the sale is for cash or an installment note, the implications could be different. Consider an example in which a US parent transfers IP with a zero book basis to a foreign subsidiary.
For both the sale for cash and the sale for an installment note, the consolidated reporting entity would be required to recognize the deferred tax asset in the foreign subsidiary for the book/tax basis difference.
If the sale is for cash, the consolidated reporting entity would recognize tax expense on the sale of the IP. If the sale is for an installment note, there are two acceptable views when recording the tax effects to the US parent in relation to the future taxes that will be paid as the intra-entity installment note is collected.
Under the first view, no temporary difference remains in the consolidated balance sheet since the installment note payable and receivable are eliminated in consolidation. A deferred tax liability would not be recognized under this view.
Under the second view, a fixed and unavoidable obligation to pay taxes over the period of the installment note exists and, therefore, a deferred tax liability should remain in the consolidated balance sheet.
The approach a reporting entity selects is an accounting policy election that should be applied consistently.
Question TX 2-3 addresses accounting for transactions in which the total consideration received is partially dependent on future events.
Question TX 2-3
How should companies account for transactions in which the total consideration received is partially dependent on future events?
A reporting entity may transfer an asset from one jurisdiction (that of the seller) to another jurisdiction (that of the buyer) for an amount based on the asset’s future productivity in the buyer’s jurisdiction. In this instance, the seller’s tax consequences are tied to revenues generated in the future and are therefore contingent.
One common contingent payment transaction is known for US tax purposes as a “367(d) transaction,” which occurs when a US corporation transfers IP to a foreign corporation in exchange for shares of stock of the foreign corporation. For US tax purposes, the transaction is deemed to be a sale of property in exchange for payments (considered to be annual royalties) that are contingent upon the future revenues generated from the IP. This deemed royalty is based upon a predetermined royalty rate and is included as taxable income in future periods.
In many jurisdictions, notwithstanding the deferred taxation of this transaction in the US, the IP will have an established tax basis at the time of transfer. Therefore, deferred taxes would need to be recorded in the buyer’s jurisdiction if the buyer’s tax basis is different than the consolidated book basis and will result in a future deductible amount.
For 367(d) transactions, the prevailing view is that since there is no book versus tax basis difference in the consolidated balance sheet, no deferred tax liability would be recorded. This view would result in recognition of only the foreign deferred tax basis difference that arises upon the transfer. No US tax expense would be recognized at the time of transfer; rather, the US current tax provision would reflect the effects of the deemed royalties in future periods as they are included in taxable income.
Based on discussion with the SEC staff, we understand that the staff would accept not recognizing a deferred tax liability in the US. A registrant that is considering recognizing a deferred tax liability (similar to that described under the installment sale scenario in Question TX 2-2) is encouraged to consult with the SEC staff prior to electing this approach.
We believe that a similar approach would apply to other intra-entity transfers in which there may be contingent elements, similar to 367(d) transactions.
Question TX 2-4
If a US company transfers acquired IP that has an associated deferred tax liability (dating back to the IP’s acquisition) to a reporting entity in another country through a 367(d) transaction, does the deferred tax liability remain with the transferor upon transfer?
We believe that the US company transferring the acquired IP should retain the associated deferred tax liability. This is because even though the IP is no longer resident in the US, the tax consequences from recovering the IP will still occur in the US, only now in the form of future royalties. Companies should monitor for specific events (e.g., impairments, acquisitions) that may change the book value of the IP and therefore have an impact on the measurement of the associated deferred tax liability.