Intellectual Property Transfers Under Corporate Tax Free Exchange Rules
Corporate tax free exchanges of intellectual property require full ownership transfer under section 351 to avoid immediate ordinary income taxation.
control test section 368
Meaning
Statutory standard that determines whether a corporate reorganization qualifies for deferred tax treatment. Under the Internal Revenue Code, the control test section 368 requires the transferor group to possess at least eighty percent of the total combined voting power of all classes of stock entitled to vote. It also requires ownership of at least eighty percent of the total number of shares of all other classes of stock of the corporation.
Statutory Requirement
Corporate transactions must satisfy this specific ownership level immediately after the exchange to defer tax liabilities. If the transferor group fails to meet the control test section 368, the transaction is treated as a taxable exchange of assets for shares. This failure triggers immediate tax liabilities for the founders on any appreciation of the contributed assets.
Ownership Threshold
Measurement of control rests on the direct holding of equity rather than indirect economic interests. The control test section 368 applies to the combined holdings of all persons who transfer property to the corporation as part of a coordinated plan. Shares held by existing shareholders who do not contribute property are generally excluded from this calculation.
Founders must coordinate their asset transfers to occur concurrently to ensure their combined holdings meet the eighty percent requirement.
Transactional Impact
Capital structures must be designed with these statutory limits in mind to prevent inadvertent taxable events. Under the control test section 368, the introduction of third-party investors who receive shares in exchange for cash can disqualify the transaction if it is integrated into the initial formation plan. This risk makes the timing of subsequent funding rounds a critical legal consideration for new entities.