Deemed royalty excluded after intangible returned to U.S. group

Plain-English summary

A U.S. consolidated group had previously transferred intangible property abroad in a section 368 reorganization, creating annual deemed royalty income under section 367(d). It proposed moving the property into a new U.S. corporation and bringing that corporation into the consolidated group through a series of contributions and distributions. Conditioned on a closing agreement, the IRS ruled that the remaining deemed royalty would be excluded from the parent's gross income under the consolidated-return intercompany rules. The deemed payment and receipt would not create the listed stock-basis or earnings-and-profits adjustments, and section 1504(a)(3) would not prevent the new corporation from joining the group. The IRS did not rule that the proposed distributions and reorganization qualified under sections 355 and 368.

Ruling snapshot

• Question: How would the section 367(d) deemed royalty be treated after the intangible property returned to a corporation in the U.S. consolidated group?
• Outcome: approved, subject to a closing agreement, with the remaining deemed royalty excluded and the corporation eligible to join the group
• Key authorities: IRC §§ 367(d) and 1504(a)(3); Treas. Reg. §§ 1.1502-13(c), 1.1502-32, and 1.1502-33

Full text (IRS public release)

Internal Revenue Service                                          Department of the Treasury
                                                                  Washington, DC 20224

Number: 201936004                                                 Third Party Communication: None
Release Date: 9/6/2019                                            Date of Communication: Not Applicable
Index Number: 367.30-00, 1502.13-00,
              1502.00-00, 1502.32-00,                             Person To Contact:
              1502.33-00                                          -------------, ID No. ----------------
                                                                  Telephone Number:
----------------                                                  --------------------
------------------------------------                              Refer Reply To:
----------------------------                                      CC:CORP:4
-----------------------------                                     PLR-122149-18
---------------------------------------------                     Date: June 5, 2019




Legend

Parent                              =         ----------------------------------
--------------------------------------------------------------------------
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LLC 1                               =            ------------------------------------
                                                -----------------------------------------------
                                                ------------------------

LLC 2                               =         -----------------------
--------------------------------------------------------------------------------------------
-------------------------------------------------------------------

Sub 1                               =         -------------------------------------------------
--------------------------------------------------------------------------
-------------------------------------------------------------------

Sub 2                               =         --------------------------------------
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-------------------------------------------------------------------

FSub 1                              =         ------------------------------------------------------
-----------------------------------------------------------------------------------------------
-------------------------------------------------------------------

FSub 2                              =         ----------------------
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PLR-122149-18                                               2


-------------------------------------------------------------------
Controlled                          =         -----------------------------------------------------------------------
                                             ------------------------------------------------------------------------
                                             -----------------------
-------------------------------------------------------------------

State A                             =        ---------

State B                             =        ------------

Country A                           =        ----------------------

Country B                           =        ---------------

Year                                =        -------

Date 1                              =        --------------------------

Date 2                              =        -------

Intangible Property                 =        ------------------------------------------------------------------------
                                             ------------------------------------------------------------------------
                                             ----------------------------------------------------------------------


Dear ---------------:

This letter ruling responds to your authorized representative’s letter dated July 11, 2018
and supplemental dated May 6, 2019, requesting rulings under Section 1504 and Treas.
Reg. § 1.1502-13. The material information submitted in the request is summarized
below.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.


                                                       FACTS

Parent, a State A corporation, is the parent of a worldwide group of corporations and the
common parent of a consolidated group (within the meaning of Treas. Reg. § 1.1502-
1(h)) (the “Parent Group”). Parent owns all the interests in LLC 1, a State B limited
PLR-122149-18                                 3


liability company treated as a disregarded entity, and all of the common stock of Sub 1,
a State A corporation. Sub 1 owns all of the stock of Sub 2, a State B corporation. Sub
2 owns, through two Country A entities treated as disregarded entities, all of the stock of
FSub 1, a Country A entity treated as a corporation. FSub 1 owns, indirectly through a
Country A entity treated as a disregarded entity, all the stock of FSub 2, a Country B
corporation. FSub 2 owns all of the interests in LLC 2, a State B limited liability
company treated as a disregarded entity. On Date 1, FSub 2 formed Controlled, a State
B corporation.

Pursuant to a prior restructuring following an acquisition of an unrelated public company
in Year, Parent caused LLC 2, which held the rights to the Intangible Property, to be
transferred to FSub 2 in a transaction that was intended to qualify as a § 368(a)(1)(D)
reorganization (the “Outbound Transfer”). Section 367(d) applied to the Outbound
Transfer of the Intangible Property and resulted in a stream of deemed annual
payments by FSub 2 to Parent (the “Deemed Royalty”).

                              PROPOSED TRANSACTION

Parent proposes to engage in the following Proposed Transactions in Date 2:

(i) FSub 2, through LLC 2, will transfer the Intangible Property to Controlled (the
“Contribution”).

(ii) Parent will transfer all of its interests in LLC 1 to Controlled in exchange for
Controlled voting stock representing 20% or less of the total combined voting power
of all Controlled voting stock.

(iii) FSub 2 will distribute all of its Controlled stock (representing at least 80% of the
total combined voting power of all Controlled voting stock) up the ownership chain to
FSub 1 (the “First Distribution”).

(iv) FSub 1 will distribute all of its Controlled stock (representing at least 80% of the
total combined voting power of all Controlled voting stock) up the ownership chain to
Sub 2 (the “Second Distribution”).

(v) Parent will transfer all of its Controlled stock to Sub 1 in exchange for additional
Sub 1 stock.

(vi) Sub 1 will contribute all of its Controlled stock to Sub 2.

After Step (vi), the Intangible Property will be held by Controlled as a member of
Parent's U.S. consolidated group.
PLR-122149-18                                4



                                 STATEMENT OF LAW

Section 1.367(d)-1T(c)(2) provides that when the recipient of a deemed payment under
§ 367(d) includes the deemed payment into income, the payor reduces its earnings and
profits by the amount of the deemed payment. However, the payor is allowed no other
adjustments to its earnings and profits, basis, or gross income.

Section 1.1502-13(c)(6) provides that under § 1.1502-13(c)(1)(i), S’s intercompany item
might be redetermined to be excluded from gross income or treated as a noncapital,
nondeductible amount. However, S’s intercompany income or gain is redetermined to
be excluded from gross income only to the extent §§ 1.1502-13(c)(6)(ii)(A), (B), (C), or
(D) applies.

Section 1.1502-13(c)(6)(ii)(D) provides that, under certain circumstances, the
Commissioner may determine that treating S’s intercompany item as excluded from
gross income is consistent with the purposes of § 1.1502-13 and other applicable
provisions of the Internal Revenue Code, regulations, and published guidance. One
such circumstance may occur if the corresponding item relevant to that intercompany
item of income is permanently disallowed.


                                 REPRESENTATIONS

Parent has made the following representations with respect to this letter ruling:

   (a) Following the proposed transactions, Controlled will join Parent’s U.S.
       consolidated group and will join in the filing of the Parent Group’s consolidated
       tax return.

   (b) The Contribution together with the First Distribution is intended to qualify under
       § 368(a)(1)(D) and § 355.

   (c) The Second Distribution is intended to qualify under § 355.

                                        RULINGS

Based solely on the information and representations made, and conditioned upon the
execution of a closing agreement, we rule as follows:

   (1) The Deemed Royalty is redetermined to be excluded from gross income under
       Treas. Reg. § 1.1502-13(c)(6)(ii)(D). Accordingly, the Deemed Royalty is
       redetermined to be excluded from Parent’s gross income for each of the Parent
PLR-122149-18                                 5


      Group’s consolidated return years for the remaining useful life of the Intangible
      Property.

   (2) For purposes of determining the effect of the Deemed Royalty, under Treas. Reg.
       § 1.1502-13(c)(1):

          a. Parent’s intercompany item from the deemed receipt of the Deemed
             Royalty will not be: (i) taxable income, (ii) tax exempt income, or (iii) a
             distribution with respect to stock, within the meaning of Treas. Reg.
             § 1.1502-32(b)(2); or taken into account for purposes of earnings and
             profits under Treas. Reg. § 1.1502-33;

          b. Controlled’s corresponding item from the deemed payment of the Deemed
             Royalty will not be: a non-capital, non-deductible amount, within the
             meaning of Treas. Reg. § 1.1502-32(b)(2); or taken into account for
             purposes of earnings and profits under Treas. Reg. § 1.1502-33; and

          c. The Deemed Royalty will not be subject to Treas. Reg. § 1.367(d)-
             1T(g)(1).

   (3) Section 1504(a)(3) will not prevent Controlled from being eligible to be included
       in the Parent Group’s consolidated U.S. federal income tax return immediately on
       completion of Step (iv) of the Proposed Transactions.

                                CLOSING AGREEMENT

We will, accordingly, approve a closing agreement with the taxpayer with respect to
those issues affecting its tax liability on the basis set forth above. The necessary
closing agreement for Parent has been prepared in triplicate and is enclosed. In
pursuance of our practice with respect to such agreements, the agreement contains a
stipulation to the effect that any change or modification of applicable statutes enacted
subsequent to the date of this agreement and made applicable to the taxable period
involved will render the agreement ineffective to the extent that it is dependent upon
such statutes.

                                        CAVEATS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of the proposed transaction under any provision of the Code and
regulations or the tax treatment of any condition existing at the time of, or effects
resulting from, the proposed transaction that is not specifically covered by the above
rulings. Specifically, we express no opinion on whether the Proposed Transaction
qualifies under §§ 368(a)(1)(D) and 355. In addition, we express no opinion with
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respect to the application of § 1.1502-13(c)(6)(ii)(D) to items subject to any other
provision of the Code and regulations.


                              PROCEDURAL STATEMENTS

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                       Sincerely,



                                       William W. Burhop
                                       Senior Technician Reviewer, Branch 5
                                       Office of Associate Chief Counsel
                                       (Corporate)