North Face Maker, IRS Test $505 Million Multinational Tax Ruling

The owner of The North Face and Wrangler will square off against the IRS in Tuesday oral arguments over whether property the company moved overseas should be taxed based on a one-time estimate of its future value or on actual annual profits.

The US Tax Court sided with the Internal Revenue Service in 2022 when it upheld a tax bill of nearly $505 million against TBL Licensing LLC, an apparel company owned by VF Corp., whose brands include The North Face, Wrangler, Lee, Nautica, and Vans. The US Court of Appeals for the First Circuit is hearing arguments in the company’s appeal over taxes tied to VF Corp.'s combination with another apparel business, Timberland Co.

The case centers on the tax consequences of TBL Licensing’s transfer of all its property, including highly valuable intangible property developed in the US, to a foreign subsidiary through a tax code Section 361 corporate reorganization.

A basic example of a Section 361 reorganization involves two companies that are combining. First, one of the companies transfers all its property to the other in exchange for stock. Second, the stock recipient distributes the stock to its parent corporation shareholders. As a result, the companies have combined, with the shareholders of one company owning the other company.

The parties are contesting whether there is a lump-sum trigger of tax through a disposition under Section 367, which relates to the transfer of intangible property.

The IRS maintains that, under tax code Section 367(d)(2)(A)(ii)(II), a US corporation must immediately recognize the entire gain from transferring intangible property to a foreign corporation in exchange for stock if the US corporation disposes of the stock as part of the reorganization.

TBL Licensing insists that’s a misreading of the code section and that the income should instead be recognized and taxed each year, as it actually comes in.

“Statutory history, purpose, and policy confirm what statutory text and structure show: under § 367(d), the annual-payments rule applies to overseas transfers of intangible property in § 361 exchanges unless there is a disposition after the § 361 reorganization,” the company wrote in its appeal brief.

It’s unclear how many multinationals will be affected by the case, according to John P. Warner, a lawyer at Buchanan Ingersoll & Rooney PC in Washington who focuses on international and corporate tax issues. In arguing that the annual payments would continue to be taxable in the US, TBL Licensing has relied on the fact that the property-receiving foreign corporation in its arrangement is controlled by US shareholders, he said.

“There are probably a limited number of situations in which a CFC-owned U.S. subsidiary is likely to transfer all of its property to a foreign corporation, because it requires U.S. ownership of a foreign corporation that owns a U.S. corporation that transfers its assets to a foreign corporation – not the most tax-efficient structure,” Warner said in an email to Bloomberg Law.

The Tax Court’s January 2022 decision assigned the taxes against an affiliated group of corporations headed by TBL Licensing for a tax year ending in September 2011.

Competing Interpretations

In ruling on the question of when TBL Licensing had to recognize the future gain, the US Tax Court had to choose which of two provisions under Section 367(d)—Section 367(d)(2)(A)(ii)(I) or Section 367(d)(2)(A)(ii)(II)—applied. The former applies generally and compels annual gain recognition, and the latter applies when there is a disposition following the transfer, compelling immediate gain recognition in those cases.

The Tax Court said the second provision applied because the company’s constructive distribution of stock to the foreign corporation was a “disposition.”

On appeal, TBL Licensing said the Tax Court’s endorsement of the IRS’s position would subject every Section 361 exchange to the immediate-gain-recognition rule, “leaving no work for the annual-payments rule to do.” The company reasoned that every Section 361 reorganization includes a transfer of assets for stock and a distribution of that stock, so treating the distributions as dispositions would trigger lump-sum payments every time.

The company also argued that Congress preferred annual payments to a before-the-fact value estimate because they “promote accuracy and avoid valuation disputes.”

Instead, the First Circuit should hold that the annual-payments rule applies because the foreign corporation that received the intangible property hasn’t disposed of it—meaning the disposition that triggers the lump-sum-payments rule hasn’t happened, the company says.

The IRS responded that TBL Licensing’s complaints “boil down to its opinion that treating the second step of every reorganization as a potential trigger for the disposition-payment rule is ‘peculiar.’”

The agency said peculiarly worded statutes must be enforced unless they produce absurd results, adding that there’s a risk after a reorganization of no US taxpayer remaining to recognize income under an annual-payments rule.

“Therefore, it makes perfect sense that Congress would apply the disposition-payment rule to all outbound reorganizations and leave it to Treasury to carve out exceptions when the annual-payments rule could apply without risking tax avoidance,” the agency said.

The argument is before Judges William J. Kayatta Jr., Kermit V. Lipez, and Gustavo A. Gelpí.

TBL Licensing is represented by Skadden, Arps, Slate, Meagher, & Flom LLP and Fenwick & West LLP.

The case is TBL Licensing LLC v. Comm’r, 1st Cir., No. 22-1783, oral arguments 7/25/23.