Last month, the First Circuit Court of Appeals affirmed the Tax Court’s decision in TBL Licensing LLC v. Commissioner holding that a reorganization resulting in the outbound transfer of intangible property (IP) led to immediate recognition of the gain in the transferred IP under section 367(d). See No. 22-1783 (1st Cir. Sept. 8, 2023), aff’g 158 T.C. No. 1 (2022). The dispute in TBL Licensing arose in connection with a restructuring that took place after the 2011 merger of VF Corporation (VF) and The Timberland Company (Timberland). Roughly $1.5 billion of Timberland’s value was attributable to its IP. After the merger, TBL Licensing LLC (TBL), a domestic corporation for federal income tax purposes and an indirect wholly owned subsidiary of VF, owned the Timberland IP. The transaction at issue here was an F reorganization, which the parties agreed involved a transfer of the Timberland IP to a related foreign corporation and thus that section 367(d) applied. But the parties disagreed over the timing of the recognition of the gain attributable to the Timberland IP. The taxpayer reported annual income inclusions pursuant to the generally applicable rule in section 367(d), whereas the IRS took the position that the F reorganization included a “disposition” of the Timberland IP that triggered full gain recognition. The Tax Court and the First Circuit agreed with the IRS. The F reorganization involved two steps: (1) a transfer by TBL of the Timberland IP to a related foreign corporation in exchange for stock and (2) a distribution by TBL of the foreign transferee stock to TBL’s shareholder. Based largely on its construction of the statutory text, the First Circuit affirmed the Tax Court’s conclusion that the second step constituted a “disposition” of the Timberland IP, which followed the transfer of the IP (i.e., step one). As such, section 367(d)(2)(A)(ii)(II) applied and required the taxpayer to recognize the entire unrecognized gain in the Timberland IP at the time of the “disposition.”
We also saw developments in transfer pricing last month. The IRS filed a notice of appeal to the Eighth Circuit of the Tax Court’s decision in the long-running dispute between the IRS and Medtronic. In August 2022, the Tax Court issued its second opinion in Medtronic, Inc. v. Commissioner, holding that the IRS’s comparable profits method was not the best method to determine the arm’s length royalty owed under intercompany licenses between the U.S. parent of the Medtronic group and its Puerto Rican affiliate (see prior coverage here). Instead, the Tax Court endorsed a novel multi-step unspecified method to allocate profits between the U.S. and Puerto Rican affiliates. In June 2023, the Tax Court entered its decision in the case determining the deficiencies due from Medtronic as a result of the court’s opinion, which started the 90-day period to file a notice of appeal.
Finally, on September 8, 2023, the taxpayer filed a brief in the DC Circuit Court of Appeals appealing the Tax Court’s decision in Rawat v. Commissioner, T.C. Memo 2023-14. As we previously reported, the Tax Court held in Rawat that when a partner sells an interest in a partnership with “hot assets” – unrealized receivables or inventory items – and recognizes gain that is treated as ordinary income under section 751(a), the source of that gain is determined as if the partner sold the hot assets directly. The taxpayer in Rawat, a nonresident alien, argues in her brief that the Tax Court erred in interpreting section 751(a) to “adopt a ‘disaggregation’ theory of partnerships” pursuant to which she was “deemed” to sell inventory rather than a partnership interest. As a result, she argues, she should not be subject to U.S. tax on the portion of gain from the sale of her partnership interest attributable to inventory of the underlying partnership.