What should a technology or software start-up or mid-sized corporation evaluate when considering the offshore transfer of its Intellectual Property (‘IP’)? The answer is complex given the myriad of reasons for initiating such a transfer. But, the answer is relatively straightforward in terms of the ‘consequences’ of such a transfer.

IP management can help determine what assets should be transferred and ‘how’ they should be conveyed, along with all of the enabling ‘know-how’. But the financial bottom line should squarely focus on the taxation implications: transfers of intangible property to a foreign corporation *

The transferring U.S. entity will be ‘deemed’ as receiving annual payments contingent on productivity or use of the transferred property (over the useful life of the property, irrespective of whether or not those payments are received by the receiving U.S. entity). Interestingly, there are additional rules that will apply wherein there is a subsequent (direct or indirect) disposition those assets. Of note, those ‘deemed’ annual license payments remain in effect as long as the transfer is to a related entity, e.g., affiliate, while taxation on the gain will result in immediate income recognition, if the transfer is to an unrelated entity.

Finally, there are also special rules providing for an ‘election’ to treat certain IP transfers as sales at fair market value, versus the standard ‘useful life-contingent payments’. If the transfer (sale) is to a related commonly controlled entity then the IRS requires the remuneration to be the same as that of an unrelated/uncontrolled transaction. Thus, the ‘arm’s length price must be adhered to, including the general terms and conditions, and if different, then reflected in that adjusted price.

So, what is the consequence if the price is not ‘arm’s length’, e.g., much lower than would be received on the open market?
The IRS, as well as the foreign jurisdiction receiving the assets, can ‘impute’ the price differential as deemed income.
This common controlled situation is governed by the IRS’ rules for Transfer Pricing. (Section 482) The key is to ensure that the price charged is similar to that which would be selected between unrelated parties. It is important to be able to apply such arm’s length analysis and prepare accompanying documentation (contemporaneous) supporting the transaction.**

*These transfers include those in the context of those in a ‘non-recognition’ (i.e., not taxable) transaction of
‘contributing’ the IP in exchange for stock in the foreign stock entity.
**The Lilley Law Firm is dedicated to an interdisciplinary approach to providing practical business solutions to IP
acquisition, assessment, management, commercialization, and taxation.