In Chief Counsel Advice (CCA), IRS has concluded that the sale of software products by a controlled foreign corporation (CFC) to U.S. end-user customers did not constitute an investment in U.S. property.
Basically, under the overly complicated CFC rules, foreign business income is not taxed to the US until it is repatriated (brought into the US). This would include cash, loans or investments in US property. This means that we can establish foreign subsidiaries (or other business interests) to distribute our software products without immediately triggering US income tax.
Here are the facts of the case which you may find interesting:
Taxpayer, a U.S. entity, was a distributor of information technology products and services. Taxpayer developed software in the U.S. under a cost sharing agreement (CSA) with its wholly-owned foreign subsidiary, Sub, a CFC. Under the CSA, Sub acquired the rights to exploit copyrights in the U.S. When Taxpayer had 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 U.S.
Conclusion of the case:
The CCA concluded that the sale of software products by Sub to end-user customers in the U.S. did not constitute an investment in U.S. property. Sub made an investment in U.S. property when it acquired or developed the rights to use copyright rights in the U.S. under 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. The CCA noted that both the Code and regs define U.S. property 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.—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.
This is an extremely complicated area of tax law, so please proceed cautiously. However, there are significant benefits if the transaction is properly structured. Please do not hesitate to contact us to discuss how to structure these types of transaction to minimize the impact of US income tax.