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CCA 201106007 - Investments in U.S. Property - Intangibles

2011-02-14

In a recently released IRS Chief Counsel Memorandum (CCA 201106007), the IRS addressed whether the sale of software products by a controlled foreign corporation (CFC) to U.S. end-user customers gave rise to an investment in U.S. property for purposes of Code § 956(c)(1)(D).

The IRS concluded that the sale of the software products by the CFC to U.S. end-user customers did not constitute an investment in U.S. property for purposes of Code § 956(c)(1)(D).  However, the memorandum continued, indicating that other related transactions between the CFC and its U.S. parent may constitute an investment in U.S. property under Code § 956.

Under the facts of the memorandum, the taxpayer (“Taxpayer”), a U.S. entity, was a distributor of information technology products and services.  Taxpayer developed software in the United States pursuant to a cost sharing agreement (CSA) with its wholly-owned foreign subsidiary (“Sub”).  Sub was a CFC as defined in Code § 957.  Pursuant to the CSA, Sub acquired the rights to exploit copyrights in the U.S.  When Taxpayer completed development of a software product intended for sale to end-user customers, a final version of the software code was transferred to a “gold master” disk and sent to Sub.  Sub then reproduced and sold copies of the software to end-user customers in the United States.

The definition of “United States property” for purposes of Code § 956(c)(1)(D) includes any right to use intangible property in the U.S. that is acquired or developed by a CFC for use in the U.S.  Under the statute, the relevant consideration is whether the intangible property acquired or developed by a CFC is a right to use property in the U.S.  Whether such right has been acquired or developed for use in the U.S. is to be determined based on all the facts and circumstances of the case. Treas. Reg. § 1.956- 2(a)(iv)(d).  U.S. property is defined in relation to whether a CFC develops intangible property intended for use in the U.S. or acquires the right to use intangible property in the U.S., and it is not defined not in relation to whether such right is actually exercised.  Accordingly, an investment in U.S. property arises upon the acquisition or development of rights to use intangible property in the U.S., not upon the actual use of that intangible property in the U.S.

The CCA held that Sub made an investment in U.S. property under Code § 956 when it acquired or developed the rights to use copyright rights in the U.S. pursuant to the CSA.  However, the actual sales of the computer software copies from Sub to end-user customers in the U.S. did not in themselves give rise to an investment in U.S. property within the meaning of Code § 956(c)(1)(D).  Furthermore, the actual transfer of copies of the software by Sub to the end-user U.S. customers did not affect the calculation of the inclusion amount, if any, under Code § 956 attributable to Sub’s original investment in U.S. property, because Sub did not acquire or develop additional rights (or relinquish any rights) to use the software in the U.S. merely as a result of the sale of copies to a U.S. person.

Although Sub made an investment in U.S. property when it acquired or developed the rights to use copyright rights in the U.S. pursuant to the CSA, the amount of the investment in U.S. property depended on Sub’s adjusted basis in the copyright rights.  If Sub’s costs of acquiring and developing the copyright rights were deductible and in fact deducted, Sub may have had a $0 basis in the U.S. property.

Tags: 956 Investments in U.S. Property