The U.S. Tax Court has held that TBL Licensing LLC was required to recognize ordinary income when it constructively transferred intangible property to TBL Investment Holdings, a Swiss corporation. The court also determined that the property transferred shouldn’t be treated, as a matter of law, as having a useful life limited to 20 years.
Background.
In May 2015, the IRS determined a $504,691,690 deficiency in the 2011 income tax of the affiliated group of which TBL Licensing was the common parent. The deficiency arose from a post-acquisition restructuring carried out after a business combination involving VF Corp. (VF) and Timberland Co. (Timberland). Through its subsidiaries, VF designs, manufactures, and sells apparel and footwear under brands such as Lee, Wrangler, Nautica, Vans, and The North Face. Timberland’s business involves the design, development, manufacture, marketing, and sale of footwear, apparel, and accessories under its own brand and others, such as SmartWool.
Post-acquisition restructuring.
The post-acquisition restructuring transaction occurred as follows:
F1, a foreign corporation, transferred to F2, its foreign subsidiary, the sole member interest in DE, a disregarded entity for federal tax purposes. DE owned TBL Licensing LLC, a domestic limited-liability company originally treated as a corporation for federal tax purposes. TBL Licensing, which owned certain intangible property (trademarks, tradenames, etc.), then elected to be treated as a disregarded entity for federal tax purposes.
The transaction (F1’s transfer of DE to F2 and TBL Licensing’s election to be a disregarded entity) was a “reorganization” under Code Sec. 368(a)(1)(F) (“F” reorganization). As part of this reorganization, TBL Licensing constructively transferred intangible property to F2.
For tax years 2011 through 2017, US1, a domestic corporation and indirect parent of F1 and F2, included in its income “deemed annual payments” attributable to the constructive transfer of TBL’s intangible property.
Tax Court’s holding.
The Tax Court held that for the nonrecognition rules to apply to an F reorganization, the transaction is treated as involving:
- The transfer of the old corporation’s assets to the new corporation, in exchange for stock of the new corporation and the new corporation’s assumption of any liabilities of the old corporation; and
- The old corporation’s distribution to its shareholders of the stock of the new corporation in cancellation of their stock in the old corporation.
The court further held that F2’s acquisition of TBL Licensing’s stock through TBL’s constructive distribution of F2 stock to F1, which occurred as part of the reorganization, was a disposition under Code Sec. 367(d)(2)(A)(ii)(II).
TBL Licensing’s constructive distribution of F2 stock to F1 necessarily included the constructive transfer of intangible property by TBL Licensing to F2. Therefore, TBL was required to recognize gain in the intangible property under Code Sec. 367(d)(2)(A)(ii)(II).
The Tax Court didn’t find any provision in the regulations that allowed US1 to report deemed annual payments due to the constructive transfer of TBL’s intangible property, instead of TBL reporting immediate gain on the transfer as required under Code Sec. 367(d)(2)(A)(ii)(II).
After the reorganization, TBL Licensing was no longer recognized as a separate entity from DE for federal tax purposes, so it couldn’t report the “deemed annual payments” described in Code Sec. 367(d)(2)(A)(ii)(I), but US1 was neither the U.S. transferor of the intangible property (that was TBL) nor the recipient of the F2 stock (that was F1).
Finally, according to the Tax Court, the fair market value of the transferred intangible property, for purposes of determining the recognized gain, was determined using the property’s entire expected useful life, without regard to the 20-year limit imposed, for some purposes, by Temp Reg. §1.367(d)-1T(C)(3). The court found that “[a]ny implication that the useful life limitation imposed by” the temporary reg “might apply in determining the amount of gain that must be recognized would conflict with the definition of “fair market value” provided in the reg’s paragraph (g)(5).
To continue your research on exchanges considered to occur in Type F reorganizations where a domestic corporation is the transferor corporation, see FTC 2d/FIN ¶ F-6024.
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