Having had a few days to ruminate, I have some further thoughts on the President's tax proposal on transfer of intangible assets (see earlier posting). Looking over the proposals in more detail, it became clear that it contain three separate proposals: an expansion of the definition of intangibles; dealing with the issue of transfer of multiple intangible properties; and, a valuation issue.
Let me deal with them in reverse order. The last proposal calls for the valuation of the intangible "at its highest and best use, as it would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts." In other words, a market transaction. Generally, there are three accepted methods of valuation: the market approach, the cost approach, and the income approach. Under current law, the income approach is used -- specifically Section 367(d)(2)(A) of the Internal Revenue Code requires the treating the transaction as "receiving amounts which reasonably reflect the amounts which would have been received annually in the form of such payments over the useful life of such property."
If this provision becomes law, it will be interesting to see how it is implemented. It will have to be based on the use of comparable sales - which will make it interesting to define the comps.
On this, let me propose a slightly different idea. In Medieval Denmark, the King levied tolls on ships passing through the Øresund (the channel connecting the Baltic and the North Sea between the modern border of Denmark and Sweden). Tolls were collected at Elsinore (better known in literature as Hamlet's castle). The method of valuation was a simple self-declaration. But the King reserved the right to purchase any and all of the cargo at the stated valuation. Such methods of market checks on self-valuation are rare, but not unheard of. (For a discussion of this method of self-valuation see Sound taxation? On the use of self-declared value). Such a method may not be practical when assessing the valuation of intangible for international transfer pricing tax purposes -- but it is worth further exploration.
The second proposal goes to the power of the IRS Commissioner under Section 482 to place his/her own value on a transfer whenever "necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses." The proposal would allow the Commissioner to value the intangible on an aggregate basis. This appears to go after the well-know issue that portfolios on intangibles are more valuable than the individual items taken separately. This issue is also tied to the market valuation issue -- as the current rules of using income appear to require tying the income to each specific intangible.
The last proposal is the most interesting. It would expand the definition of intangibles include workforce in place, goodwill and going concern value. It is also, at least to me, attacking a very different issue than the other two. Those three intangibles are essentially "whole-enterprise" assets. They can not be split off from the enterprise. As such, they are generally not transferred from entity to another as individual components like a patent or a trademark could be.
Thus, the issue of international transfer pricing is different in this case. It is about transferring control of the enterprise to a foreign owner. This is a slightly different "loophole" the IRS has been going after. Beginning 2007, the IRS has defined workforce in place as an intangible asset for purposes of what is called Section 936 Exit Strategies (see Industry Director Directive on Section 936 Exit Strategies # 1 and Industry Director Directive on Section 936 Exit Strategies # 2). These are specific transactions having to do with the restructuring of companies who had gained tax credits for operating in Puerto Rico as those credits have been phased out. The classification of workforce in place as an intangible asset made such a transfer a taxable event. Not surprisingly, this is view as a very controversial move. (For more information see the KPMG write up The Transfer of Workforce in Place to a Foreign Corporation.) It appears that this latest proposal is an extension of that same principle -- that all asset transfers should be subject to taxation -- to all transactions.
As such, this may the politically most difficult - but the least directly tied to the issue of the transfer of intangibles to tax havens. We will see how the politics of the various proposals plays out.
Leave a comment