The IRS has issued temporary (T.D. 9654) and proposed (REG-121534-12) regulations providing guidance on the identification of certain stock of a foreign corporation that is disregarded in calculating ownership of the foreign corporation for purposes of determining whether it is a surrogate foreign corporation under the inversion rules of Section 7874. Section 7874 generally applies to inversion transactions whereby a foreign corporation directly or indirectly acquires substantially all of the properties held by a U.S. corporation (and, in some cases, the trade or business of a domestic partnership). In such cases, the U.S. federal tax treatment of the foreign acquirer will be determined based on a number of tests, including the percentage (vote or value) that the shareholders in the U.S. corporation hold in the foreign acquiring corporation following the acquisition (the ownership fraction).
The final and temporary regulations clarify and expand the guidance in Notice 2009-78, which said the IRS would issue regulations to provide that stock of a foreign acquiring corporation issued in exchange for "nonqualified property" in a transaction related to the acquisition is not taken into account for purposes of the ownership fraction under Section 7874. Notice 2009-78 had defined nonqualified property as cash or cash equivalents, certain marketable securities and any other property acquired in a transaction with a principal purpose of avoiding the purposes of Section 7874. The new regulations expand this definition of nonqualified property to include certain disqualified obligations. They also contain a new de minimis exception where a foreign acquirer will generally not be subject to the provisions of Section 7874 if certain former owners of a U.S. corporation own less than 5% (by vote and value) of the foreign acquirer following the transaction.
Importantly, the final and temporary regulations apply to acquisitions completed on or after Sept. 17, 2009, to the extent these regulations incorporate rules contained in Notice 2009-78. Other rules included in the new regulations but not addressed by Notice 2009-78 apply to acquisitions that are completed on or after Jan. 17, 2014. Taxpayers may also elect to apply the rules under the new regulations to acquisitions completed on or after Sept. 17, 2009, but before Jan. 17, 2014, if the taxpayer applies those paragraphs consistently to all acquisitions completed before such date.
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