What Is Section 367(d)? Deemed Royalty, Sales, and Form 926

Section 367(d) of the Internal Revenue Code stops a U.S. person from moving intangible property to a foreign corporation tax-free. When the transfer would otherwise qualify for non-recognition under Section 351 or Section 361, this provision overrides that result and treats the U.S. transferor as if the foreign corporation had licensed the intangible back and were paying an annual royalty for it. Those deemed royalty payments continue over the useful life of the property, and the amount is adjusted each year to track the income the intangible actually generates abroad.¹ No cash needs to change hands for the tax liability to accrue.

When the Rule Is Triggered

Two conditions have to line up. First, a U.S. person, meaning a U.S. citizen, resident alien, domestic corporation, or domestic partnership, transfers intangible property to a foreign corporation, which is any entity not created or organized under U.S. law. Second, the transfer happens in an exchange that would otherwise qualify for non-recognition treatment under Section 351 (a contribution to a controlled corporation) or Section 361 (a corporate reorganization).¹

A plain sale or license of intangible property to a foreign corporation is not what this provision reaches. Those are already taxable events. Section 367(d) is aimed at the specific situation where valuable intellectual property could otherwise be shifted offshore under cover of a tax-free exchange.

What Counts as Intangible Property

The definition is broad. After the 2018 technical corrections to the Tax Cuts and Jobs Act, it sits directly in Section 367(d)(4) rather than pointing to the old Section 936(h)(3)(B) definition.¹ The listed categories include:

Patents, inventions, formulas, processes, designs, and know-how
Copyrights and creative works
Trademarks, trade names, and brand names
Franchises, licenses, and contracts
Methods, programs, systems, procedures, surveys, studies, forecasts, customer lists, and technical data
Goodwill, going concern value, and workforce in place
A catch-all for any other item whose value is not attributable to tangible property or individual services

The inclusion of goodwill and going concern value is a significant change from earlier practice. Before the TCJA, goodwill and going concern value developed by a foreign branch could sit outside Section 367(d) and fall under the more favorable rules of Section 367(a). That carve-out is gone. Those assets now travel with the full deemed royalty regime when moved offshore.

The classification is fixed at the moment of the initial transfer. A copyrighted article, meaning the physical copy of a film or recording, is not the same as the copyright itself. Moving the underlying copyright triggers Section 367(d); shipping physical media does not.

How the Deemed Royalty Works

The U.S. transferor includes an amount in gross income each year as if the foreign corporation were making contingent payments for use of the intangible. The number is not locked in at the date of transfer. Section 367(d)(2)(A) requires that the deemed payments be “commensurate with the income attributable to the intangible.”¹ If the foreign subsidiary’s profits from a transferred process climb, the inclusion climbs with them. If the intangible’s value erodes, the inclusion drops. An initial valuation can be overridden by later performance.

Deemed payments continue over the useful life of the transferred property. The regulations reference a 20-year window for evaluating whether the commensurate-with-income standard has been met, and the IRS can look at income generated beyond that period when making its assessment.² For intangibles with indefinite useful lives, the obligation can run for decades.

Character of the Inclusion

Any amount recognized under Section 367(d) is ordinary income.¹ For foreign tax credit limitation purposes under Section 904(d), it is treated as a royalty. Because no actual foreign tax is paid by the U.S. transferor on the deemed payment, the ability to offset U.S. tax with foreign tax credits is limited.

Effect on the Foreign Corporation

The deemed royalty reduces the earnings and profits of the foreign corporation, the same way an actual royalty payment would.¹ That flows through to subpart F income, GILTI tested income under Section 951A, and dividend characterization. Keeping the annual amount current with the commensurate-with-income standard requires ongoing transfer pricing documentation and continuous monitoring of the foreign corporation’s results.

What Happens on a Later Sale

The annual regime keeps running until either the intangible itself or the stock of the foreign corporation changes hands. At that point, an immediate gain recognition event replaces the ongoing inclusions.

Foreign Corporation Sells the Intangible

If the foreign corporation sells the transferred intangible to an unrelated party, the U.S. transferor recognizes gain equal to the difference between the intangible’s fair market value at the time of the sale and its adjusted basis, which is typically zero because the original transfer was a non-recognition event. The gain is ordinary, consistent with the deemed royalty character, and it replaces all future annual inclusions.²

A related-party sale by the foreign corporation is treated differently. The deemed royalty regime continues, with the related recipient stepping into the shoes of the transferee foreign corporation for ongoing adjustments and accounts receivable.² The IRS can still test the terms of that transfer under the commensurate-with-income standard.

U.S. Transferor Sells the Foreign Corporation Stock

When the U.S. transferor sells the stock of the foreign corporation, the regulations treat the transferor as if the intangible itself had been disposed of. Gain is calculated using the intangible’s fair market value at the time of the stock sale and recognized as ordinary income, regardless of whether the stock sale would otherwise have produced capital gain. The transferor’s basis in the stock is stepped up by the gain recognized, so the same economic value is not taxed twice. A partial stock sale triggers only a proportionate acceleration; the annual regime continues for the remainder.

The Gain Recognition Election

Treasury Regulation Section 1.367(d)-1T(g)(2) offers a narrow alternative. A qualifying U.S. transferor can elect to recognize gain in the year of the transfer instead of taking on annual deemed royalty inclusions.³ The gain equals fair market value minus adjusted basis and is treated as ordinary income from U.S. sources.

Eligibility is limited to two situations:

Government compulsion. The transfer is legally required by the foreign government as a condition of doing business there, or is compelled by a genuine threat of immediate expropriation.
A qualifying joint venture capitalization. The intangible is transferred within three months of the foreign corporation’s formation as part of its original capitalization, the U.S. transferor owns between 40 and 60 percent of the total voting power and value, unrelated foreign persons own at least 40 percent, and intangible property makes up at least 50 percent of the fair market value of the property the U.S. person transfers.³

These conditions are more restrictive than they look. A U.S. company contributing a patent to its wholly owned foreign subsidiary does not qualify, because the ownership band tops out at 60 percent. The election is built for forced transfers and genuine joint ventures with real foreign participation.

A taxpayer who makes the election pays tax on the upfront gain, and the foreign corporation takes a stepped-up basis in the intangible equal to fair market value. The election has to be made by notifying the IRS in accordance with the Section 6038B reporting requirements and including the recognized gain on a timely filed return for the year of the transfer.³ Missing that window locks the transferor into the deemed royalty regime by default.

When available, the election can be strategically useful. It removes years of transfer pricing documentation and annual recalculations, and it can absorb expiring net operating losses that would otherwise go unused. The tradeoff is the immediate tax hit and the U.S.-source character of the gain, which restricts the use of foreign tax credits against it.

Form 926 and the Penalty for Failing to Report

A U.S. person who transfers property to a foreign corporation in an exchange described in Section 6038B has to report the transfer on Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation.⁴ The requirement applies whether the transfer falls under Section 367(d) or Section 367(a). Limited exceptions for certain small shareholders and specific reorganization types are laid out in the Form 926 instructions.⁵

The penalty for failing to file is 10 percent of the fair market value of the transferred property at the time of the exchange. It is capped at $100,000 per exchange unless the failure was due to intentional disregard, in which case the cap disappears.⁶ On a $5 million transfer, the default penalty caps at $100,000; intentional disregard exposes the transferor to the full $500,000.

The penalty does not apply where the taxpayer shows reasonable cause and the absence of willful neglect. That usually requires evidence of an honest mistake despite good-faith efforts to comply.

A separate 40 percent penalty can apply to any underpayment attributable to an undisclosed foreign financial asset understatement.⁴ For high-value intellectual property, the overlapping penalty regimes make timely, accurate reporting the first thing to get right when Section 367(d) is in play.

1
Office of the Law Revision Counsel. 26 USC 367 Foreign Corporations
2
eCFR. 26 CFR 1.367(d)-1 Transfers of Intangible Property to Foreign Corporations Subject to Section 367(d)
3
eCFR. 26 CFR 1.367(d)-1T Transfers of Intangible Property to Foreign Corporations Subject to Section 367(d)
4
Internal Revenue Service. Form 926 Filing Requirement for US Transferors of Property to a Foreign Corporation
5
Internal Revenue Service. Instructions for Form 926 Return by a US Transferor of Property to a Foreign Corporation
6
Office of the Law Revision Counsel. 26 USC 6038B Notice of Certain Transfers to Foreign Persons