Constructive Distribution to Foreign Sub Results in Gain Recognition Under Sec. 367

(Parker Tax Publishing February 2022)

The Tax Court held that, in order for the nonrecognition rules Code Secs. 354, 356, and 361 to apply to a reorganization described in Code Sec. 368(a)(1)(F), the transaction, however actually effected, is treated as involving (1) a 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 (2) 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 the constructive distribution by a Delaware limited liability company (LLC) that occurred as part of a reorganization was a "disposition" within the meaning of Code Sec. 367(d)(2)(A)(ii)(II) which required the LLC to recognize gain. TBL Licensing LLC f.k.a. The Timberland Company v. Comm'r, 158 T.C. No. 1 (2022).

Background

Through its subsidiaries, VF Corp. (VF) designs, manufactures, and sells apparel and footwear under brands such as Lee, Wrangler, Nautica, Vans, and North Face. Before it was acquired by a subsidiary of VF in 2011, the business of Timberland Co. involved the design, development, manufacture, marketing, and sale of footwear, apparel, and accessories under its own brand and others, such as SmartWool. In 2011, the VF and Timberland businesses were combined by means of a merger of Timberland and TBL International Properties, LLC (International Properties). In the merger, the former Timberland shareholders received cash in exchange for their Timberland stock.

In August of 2011, VF organized International Properties as a limited liability company (LLC) under Delaware law. International Properties was a disregarded entity from the time of its formation. TBL Licensing LLC is also a Delaware LLC whose sole member interest was owned by International Properties. TBL Licensing was treated as a corporation for U.S. federal income tax purposes. Before the merger in which International Properties acquired Timberland, VF transferred its membership interest in International Properties to VF Enterprises S.a.r.l. (VF Enterprises), an indirect foreign subsidiary of VF. In a post-acquisition restructuring, TBL Licensing came to own Timberland's intangible property, including trademarks, foreign workforce, and foreign customer relationships.

On September 22, 2011, after the close of the merger by which International Properties acquired the Timberland stock and after TBL Licensing had acquired Timberland's intangible property, VF Enterprises contributed to TBL Investment Holdings GmbH (TBL GmbH), a Swiss corporation, the sole member interest in International Properties. About a week later, TBL Licensing elected under Reg. Sec. 301.7701-3(c)(1)(i) to be disregarded as an entity separate from its owner, effective September 24, 2011.

On the Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, included with its federal income tax return for the tax year ended September 23, 2011, TBL Licensing reported that the trademarks it acquired from Timberland had a fair market value of $1,274,100,000. In a 2015 notice, the IRS advised TBL Licensing that it had determined a deficiency of $504,691,690 in the income tax of the affiliated group of corporations, of which TBL Licensing had been the common parent, for the group's tax year ending September 23, 2011.

The parties stipulated that Lee Bell, Inc. (Lee Bell), an indirect domestic subsidiary of VF and indirect parent of VF Enterprises, reported income under Code Sec. 367(d)(2)(A)(ii)(I) in specified amounts for the tax years 2011 through 2017. The inclusions in Lee Bell's income related to TBL Licensing's constructive transfer of intangible property to TBL GmbH. The parties also stipulated that Lee Bell never owned the intangible property that TBL Licensing constructively transferred to TBL GmbH.

TBL Licensing challenged the tax deficiency and took its case to the Tax Court. The issue for the court to decide was whether TBL Licensing was required to recognize ordinary income under Code Sec. 367(d)(2)(A)(ii)(II) as a result of a constructive transfer of intangible property to TBL GmbH and, if so, whether, in determining the amount of that income, the property should be treated, as a matter of law, as having a useful life limited to 20 years. Each party moved for summary judgment.

Analysis

The Tax Court held that, in order for the operative nonrecognition rules Code Secs. 354, 356, and 361 to apply to a reorganization described in Code Sec. 368(a)(1)(F), the transaction, however actually effected, should be treated as involving (1) a 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 (2) the old corporation's distribution to its shareholders of the stock of the new corporation in cancellation of their stock in the old corporation. Thus, the court concluded that VF Enterprises' transfer to TBL GmbH of the sole member interest in International Properties and TBL Licensing's election to be disregarded as an entity separate from TBL GmbH effected a reorganization described in Code Sec. 368(a)(1)(F).

The court held that, as part of that reorganization, TBL Licensing should be treated as (1) having transferred its intangible and other properties to TBL GmbH in exchange for TBL GmbH stock and (2) as having distributed that TBL GmbH stock to VF Enterprises in cancellation of the stock VF Enterprises had been treated as holding in TBL Licensing during the time that TBL Licensing was classified as a corporation for federal tax purposes.

The Tax Court further held that the constructive distribution by TBL Licensing to VF Enterprises of TBL GmbH stock that occurred as part of the reorganization by which TBL GmbH acquired TBL Licensing was a "disposition" within the meaning of Code Sec. 367(d)(2)(A)(ii)(II). The court found that TBL Licensing's constructive distribution of TBL GmbH stock to VF Enterprises necessarily followed the constructive transfer of intangible property by TBL Licensing to TBL GmbH that occurred as part of the reorganization; consequently, in the absence of a provision in the regulations to the contrary, TBL Licensing was required to recognize gain in the intangible property under Code Sec. 367(d)(2)(A)(ii)(II).

Finally, the Tax Court concluded that the fair market value of transferred intangible property, for the purpose of determining gain that must be recognized under Code Sec. 367(d)(2)(A)(ii)(II), should be determined on the basis of the property's entire expected useful life, without regard to the 20-year limit imposed, for some purposes, by Reg. Sec. 1.367(d)-1T(c)(3).

For a discussion of the rules under Code Sec. 367(d) for transfers of intangibles to foreign corporations, see Parker Tax ¶47,450.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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