Canada: Major U.S. Anti-Inversion Regulations Impact Canadian Companies Both In And Out Of The Inversion Sandbox

On Monday April 4, 2016, the U.S. Treasury Department released a comprehensive set of temporary regulations that are designed to stop the flow of headline-grabbing U.S. corporate expatriation transactions commonly referred to as "inversion transactions." These inversion regulations introduce certain new measures, including a rule targeted at so-called "serial" inverters, which can have a devastating tax impact on transactions within its scope.  This new provision, for example, caused the prompt derailment of Pfizer's pending $160 billion inversion transaction with Ireland-based Allergan (at a reported cost to Pfizer of $150 million in breakup fees).  These anti-inversion rules (and certain related party debt rules introduced in tandem as described below) are of particular relevance to Canadian companies for three principal reasons:

  • First, although these regulations combat inversion transactions by extending the reach of the anti-inversion rules and blunting the effectiveness of conventional post-inversion tax planning, they do not address the underlying tax fundamentals and market forces that are driving U.S. companies to seek to invert: the 35% U.S. corporate tax rate is higher than most other developed countries, and it applies to all global earnings that are repatriated to the U.S. As a result, we expect that there will continue to be strong motivation for U.S. corporations to pursue inversion-style transactions and that, given the strong economic and geographical connection between Canadian and U.S. markets, Canada will become an increasingly attractive M&A destination for these U.S. companies.
  • Second, given the extraordinarily broad reach of these anti-inversion and related-party debt rules, their impact will be felt far beyond the domain of inversion transactions.  We expect that these new rules will spill-over into mainstream cross-border M&A transactions that have no underlying "inversion" motivation and may profoundly impact these deals in ways that may not be obvious or predictable.  In particular, it seems clear that these new rules will have an important effect on the manner in which cross-border Canada-U.S. acquisition transactions are structured, diligenced and financed.
  • Third, the new regulations serve as a reminder that once a business is incorporated in U.S. corporate form, it is extraordinarily difficult to exit the U.S. tax net.  Accordingly, careful consideration should be given when starting a new business to incorporating in a jurisdiction outside of the U.S. at the outset (i.e., in Canada).

As a general matter, other than the "serial" inverter rule noted above, most of the content included in this important regulatory action is not "new" in the sense that these rules implement anti-inversion measures that had been previously announced in IRS Notices issued in 2014 and 2015.  However, these new inversion regulations were introduced in tandem with sweeping new proposed U.S. tax regulations governing related party debt arrangements.  If enacted in their current form, these new debt rules would not only be a powerful tool for the IRS in its efforts to combat inversion transactions, but given their extraordinarily broad scope, these rules would fundamentally change the manner in which Canadian corporations finance their U.S. subsidiaries with related-party cross-border debt.  To review Osler's summary of these new debt regulations, please click here.

Inversions generally

Generally, an inversion occurs when a non-U.S. company (i.e. a Canadian company) buys a U.S. company, and the shareholders of the U.S. company retain a substantial ownership in the foreign (i.e. Canadian) acquirer.  After the acquisition, the combined group arranges its affairs so that (a) a portion of revenue is earned outside of the U.S., and (b) revenue earned within the U.S. is reduced as a result of interest payments or other intercompany transfers. Under the U.S. federal tax system, U.S. companies are taxed on their worldwide income, except that active income earned in foreign subsidiaries is taxed only when brought back to the U.S.  An inversion sets the stage, structurally speaking, for a U.S. corporation to attempt to reduce its combined companies' gross U.S. tax payments on U.S. source income and avoid U.S. tax on non-U.S. source income through post-inversion restructuring and recapitalizations.  The net impact of this post-inversion tax restructuring is to dramatically reduce the effective rate of U.S. taxation borne by the inverting enterprise.  This reduction in U.S. tax burden can significantly increase the present value of a U.S. corporation's future stream of free cash flows, which serves as a powerful economic incentive to pursue this strategy.  Canada has been considered an attractive home for inverted companies because the Canadian corporate tax rate (25%) is lower than the U.S. corporate tax rate (35%), and Canada generally provides an exemption for foreign-source active business income earned in over 100 countries.

Anti-inversion regulations

The new U.S. regulations are the latest installment in a long line of regulatory actions designed to curb or kill the expatriation of U.S. corporations through inversion.  While the anti-inversion rules have become extremely complicated, their basic architecture is relatively straightforward. Specifically, when a U.S. corporation and non-U.S. corporation merge or otherwise combine in a cross-border transaction, that combination will be subject to the U.S. anti-inversion rules if the former owners of a U.S. business own, by virtue of that former ownership, at least 60% (a 60% inversion) or 80% (an 80% inversion) of a foreign acquiring company (an FAC) after the combination.  In an 80% inversion, the FAC is treated as a domestic corporation for all U.S. federal income tax purposes (which would completely frustrate the U.S. tax purposes of engaging in the transaction in the first place). In a 60% inversion, the FAC continues to be treated as a foreign corporation for tax purposes, but adverse tax consequences apply that, among other consequences, restrict the use of tax attributes to reduce U.S. taxable income of the group. Exceptions to the rules apply if the FAC, together with its affiliates, conducts substantial business activities in the country in which the FAC is created or organized.  Substantially all of the high-profile inversions that have occurred over the past four years have been transactions that are 60% inversions.

New "serial inverter" measures

As noted above, an inversion analysis starts with computing a fraction, the numerator of which is the stock in the FAC owned by such former U.S. owners, and the denominator of which is the stock of the FAC owned by all shareholders.  In an effort widely believed to have been intended to kill transactions like the Pfizer-Allergan transaction (where Allergan was only large enough to avoid the scope of certain inversion rules because of its previous combination with Actavis), the new regulations provide that if the FAC has acquired other U.S. companies within the 36 month period prior to the signing date of the U.S. acquisition (even in deals wholly unrelated to the inversion) then the value of the stock of the FAC that goes in the denominator is reduced by the value of those other deals (based on the value of the stock at the time of the subsequent acquisition), as illustrated in the following example:

Note, this example is meant to be an illustration only and is based on several assumptions regarding the share price, redemptions, and distributions of the FAC between the two testing dates.

These new measures, introduced for the first time in the April 4 temporary regulations, are generally effective as of April 4, 2016.

Confirmation and details of existing anti-inversion rules

For the most part, the anti-inversion regulations issued on April 4, 2016 do not contain new rules.  Rather, these regulations confirm and implement the anti-inversion measures that were previously announced by the IRS in Notices issued in 2014 and 2015.  See Notice 2014-52, 2014-42 IRB 712 (Sept. 23, 2014); Notice 2015-79, 2015-49 IRB 775 (Nov. 20, 2015). Most significantly, these regulations provide technical and clarifying language to implement the following previously announced rules:

  • Non-ordinary course distributions: This rule (which was included in the 2014 IRS Notice) broadens the reach of the anti-inversion rules by providing that any "non-ordinary course distributions" made by a U.S. corporation in the 3-year period prior to a potential inversion will effectively be added back to the value of the U.S. corporation for purposes of testing whether the subsequent combination transaction is treated as an inversion.  This effectively prevents pre-inversion transactions that are intended to "shrink" the size of the U.S. corporation so that its subsequent combination with a foreign merger partner does not qualify as a 60% or 80% inversion.  For purposes of these regulations, a non-ordinary course distribution is a distribution during a taxable year that is in excess of 110% of the average distributions made in previous taxable years.  Importantly, the new temporary regulations clarify that it is the value of the property distributed at the time of its distribution that is relevant for purposes of determining the hypothetical value of the U.S. corporation at the time of the potential inversion for purposes of applying this rule.  This removes some of the ambiguity that previously surrounded this rule but leaves important questions unanswered.  For example, in cases where a Canadian corporation acquires a U.S. target for consideration that includes cash and it appears that at least some portion of that cash consideration is financed from the U.S. target's balance sheet, the non-ordinary course distribution rule may potentially operate in unexpected ways to make that acquisition subject to the anti-inversion rules.  Counterintuitively, this means that even in a deal that involves a Canadian acquiring company buying a U.S. target largely for cash, an inversion analysis may be required.
  • Cash-box rule: The new regulations implement the so-called "cash box" rule that was announced by the IRS in the 2014 Notice.  Under this rule, if more than 50% of the assets of a foreign corporation (that would be a merger partner in a potential inversion transaction) are comprised of "nonqualified property" (generally, cash, cash equivalents and marketable securities) then a portion of the foreign acquiring corporation's shares will be ignored for purposes of applying the 60% or 80% inversion test when that foreign corporation acquires a U.S. company.  Broadly speaking, this rule neutralizes the ability of parties to manipulate the 60% or 80% testing fraction by "bulking up" the foreign corporation with passive, non-business assets.  This rule is particularly problematic for Canadian special purpose acquisition companies (or SPACs) that seek to acquire U.S. target corporations with consideration that includes SPAC shares.  The cash-box rule will, in many cases, cause such acquisitions to be 80% inversions, with the potentially awkward result that the SPAC would be concurrently treated as both a Canadian corporation for Canadian tax purposes and a U.S. corporation for U.S. tax purposes (by operation of the anti-inversion rules).  The Canada-U.S. Tax Treaty does little to ameliorate the tax position of a corporation that finds itself in this position, which would result in the corporation being subject to full corporate taxation in both Canada and the U.S.
  • Third-country parent rule:  The April 4 anti-inversion regulations also provide more guidance on the "third-country rule," which provides that if a foreign company and a U.S. company combine under a new foreign company that is resident in a third country, the transaction is much more likely to be an inversion.  We expect that this rule will limit the number of "destination" jurisdictions into which an inversion transaction may be successfully completed.  Merger partners will not have as much flexibility to select a desired location for the new post-merger corporation, but will instead be constrained to relocating to the jurisdiction in which the foreign merger partner is organized.  We anticipate that this rule, together with the new "serial inverter" rule, may have the result of causing U.S. corporations to look more closely at Canadian and U.K corporations as potential cross-border merger partners.   
  • Rules combatting the effectiveness of post-inversion tax planning:  The April 4 anti-inversion regulations also provide for technical implementation of a number of previously-announced measures that were designed to nullify the effectiveness of common post-inversion restructuring techniques.  In particular, these regulations combat two areas of post-inversion tax planning:

    • "Hopscotch" loans:  After an inversion transaction, an inverted U.S. corporation would frequently attempt to access previously inaccessible offshore earnings of foreign subsidiaries through the use of so-called "hopscotch" loans.  Under these loans, foreign subsidiaries of the inverted U.S. corporation would lend cash directly to the new foreign parent, effectively bypassing the U.S. corporation and avoiding the material U.S. tax cost that would arise if those amounts had instead been repatriated to the U.S. shareholders.  The rules, which were announced in 2014, frustrate this tactic by causing these loans to be subject to the U.S. subpart F anti-deferral rules which would frequently result in a significant current U.S. tax cost.
    • Decontrolling transactions:  After an inversion transaction, an inverted U.S. corporation may try to eliminate or minimize the U.S. tax cost of repatriating offshore earnings by having the new post-inversion foreign parent acquire a significant ownership interest in the inverted U.S. corporation's non-U.S. subsidiaries. These arrangements were designed to "de-control" the foreign subsidiaries from their former U.S. shareholder and thereby turn off the U.S. subpart F rules.  The new regulations implement rules that combat these arrangements by effectively deeming the U.S. corporation's ownership in these entities to not be diluted.

The parts of the new April 4 Temporary Regulations that implement the measures described above are generally effective as of the date of the IRS Notice that originally announced these measures (September 22, 2014, in the case of the 2014 IRS Notice and November 19, 2015, in the case of the 2015 IRS Notice).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions