United States: New Temporary Regulations Introduce A Welcome De Minimis Rollover-Shareholder Exception To US Anti-Inversion Rules

On January 16, 2014, the Treasury Department and the Internal Revenue Service released new temporary regulations on one aspect of corporate inversions under Section 7874 (the "Regulations") that altered and clarified the "Exclusion Rule" first announced by the IRS in Notice 2009-78 (the "Notice").1The Exclusion Rule had the potential of causing transactions that were primarily cash acquisitions to be subject to the inversion rules and causing a foreign acquiring corporation to be deemed a US corporation. The new Exclusion Rule, while in some ways broader than the Notice's version, does contain a welcome de minimis exception. The de minimis exception will make it easier for a foreign corporate acquiror to acquire a US corporation or US partnership for cash consideration while allowing management or other shareholders to roll-over into an equity interest in the foreign corporate acquiror without causing the foreign corporate acquiror to be deemed a US corporation.


Under Section 7874, a foreign corporation may be treated as a US corporation for US federal income tax purposes even though the foreign corporation is organized under the laws of a foreign jurisdiction. In the case of an "inversion" of a US corporation, Section 7874 may apply to a foreign corporation that acquires "substantially all" of the properties of the US corporation (including indirectly through a stock acquisition) if shareholders of the US corporation exchange, or are deemed to exchange, their interests in the US corporation for sufficient stock in the foreign corporation. Specifically, Section 7874(b) will apply to an inversion transaction to treat a foreign corporation as a US corporation for US federal income tax purposes if, pursuant to a plan or a series of related transactions: (i) the foreign corporation directly or indirectly acquires substantially all of the properties held directly or indirectly by the US corporation, (ii) after the acquisition at least 80 percent of the stock of the foreign corporation (by vote or by value) is held, or deemed held, by former shareholders of the US corporation by reason of the former shareholders holding stock in the US corporation and (iii) after the acquisition, the expanded affiliated group that includes the foreign corporation does not have substantial business activities in the foreign country in which the foreign corporation is created or organized, when compared to the total business activities of the expanded affiliated group.2 For purposes of measuring the ownership by former shareholders of the US corporation, an option on the stock of an acquiring foreign corporation will be treated as stock of the corporation, with a value equal to the holder's claim on the equity of the corporation.3 If an inversion meets the three conditions above, or would meet those conditions but for the fact that less than 80 percent, but at least 60 percent, of the stock of the foreign corporation is held, or deemed held, by former shareholders of the US corporation by reason of the former shareholders holding stock in the US corporation, then the income and gain recognized by the US corporation in connection with the inversion (including certain licensing transactions) is subject to US federal income tax regardless of whether any deductions (such as NOL carryovers) or current year losses would otherwise be available to be used by the US corporation to offset such income or gain. Similar rules apply to a foreign acquiring corporation that acquires substantially all of the assets of a trade or business of a US partnership and the income or gain recognized by partners in the partnership in connection with the inversion.

Public Offering Rule

Under Section 7874(c)(2)(B), stock of the foreign acquiring corporation that is sold in a "public offering" related to the inversion is not taken into account for purposes of calculating the ownership fraction that is held, or deemed held, by former shareholders of the US corporation by reason of the former shareholders holding stock in the US corporation (the "ownership fraction"). The effect of this rule is that public offerings are not treated as diluting continuing former shareholder ownership for purposes of the 80 percent test or the 60 percent test. The Code does not provide a definition of "public offering" for these purposes.

The statutory public offering rule created uncertainty as to the scope of "public offering" and whether it included private placements or non-SEC registered public offerings as well as other issues.

Notice 2009-78

In Notice 2009-78, the Treasury Department stated its intention to alter the statutory public offering rule by essentially doing away with the "public offering" criterion and introducing a new rule (the Exclusion Rule). The Notice provided that, under guidance that would apply to transactions that occur on or after September 17, 2009, the issuance of stock of a foreign corporation for cash or other "nonqualified property"4 in any transaction that is related to the acquisition of substantially all of the properties of a US corporation is not to be taken into account for the purpose of determining the ownership fraction.

The Notice created issues in M&A deals in which a foreign corporation acquired a US corporation for cash consideration but the foreign corporation wanted management or other shareholders to receive stock of the foreign corporation (or acquisition vehicle). This is common where the acquiror wants to retain the US corporation's management and motivate them by providing them rollover equity. The Exclusion Rule set forth in the Notice could cause Section 7874 to apply to acquisitions that are, in substance, sales of a US business for cash with little continuity of ownership by the historic owners of the US corporation. For example, assume a foreign acquiror formed a new foreign company (to which it contributed cash) in order to acquire a US target and wanted to give management 10% of the new foreign company's stock in exchange for their shares in the target company. The Exclusion Rule in the Notice would have resulted in the ownership fraction being 100% because the foreign acquiror received new foreign company stock in exchange for cash. The Exclusion Rule in the Notice would have caused this result even if only one target shareholder received a single share of stock in the new foreign company. This also would have been the result irrespective of whether the exchange of new foreign company stock for US target stock was tax-free or taxable.

New Section 7874 Treasury Regulations

The Regulations set forth a modified version of the Exclusion Rule. The Regulations describe all situations in which stock will be excluded from the denominator of the ownership fraction under Section 7874(c)(2)(B). The Regulations expand the definition of nonqualified property to include certain obligations and exclude from the ownership fraction (i) stock of the foreign acquiring corporation transferred to any person (including the acquired US corporation) in exchange for property to the extent, pursuant to the same plan, the stock is later transferred in exchange for the satisfaction or the assumption of an obligation associated with the property exchanged and (ii) any stock of the foreign corporation transferred in exchange for nonqualified property by any person (including unrelated persons) in connection with the potential inversion transaction, but, in each case, only to the extent such transfers increase the fair market value of the assets or decrease the amount of liabilities of the foreign corporation.5

The Preamble of the Regulations indicates that the Treasury Department considered comments on the Notice recommending that Section 7874 should not apply to acquisitions of a domestic entity by a foreign corporation in exchange for mostly, but not exclusively, cash. The Treasury Department did not adopt those recommendations in general.

However, the Regulations provide an exception from the Exclusion Rule when the former owners of the US corporation own a de minimis equity interest in the foreign corporation after the acquisition. This exception applies if, (i) the ownership fraction determined without regard to the Exclusion Rule is less than five percent (by vote and value), (ii) after the acquisition and all transactions related to the acquisition, former shareholders of the US corporation, in the aggregate, own directly or indirectly, less than five percent (by vote and value) of the stock of any member of the expanded affiliated group that includes the foreign corporation, and (iii) stock of the foreign corporation which would otherwise be excluded from the denominator was not transferred in a transaction related to the acquisition with a principal purpose of avoiding the purposes of Section 7874.6 In the example above, the foreign acquiring corporation would not be taxed as a US corporation if management received no more than 4.9% of the stock of the new foreign company.

The 5 percent threshold provides some relief as compared to the Notice, but because the threshold is still relatively low, the new Exclusion Rule may still cause Section 7874 to apply to transactions the predominant effect of which is not an inversion, but rather that of a sale or joint venture, due to the magnitude of the change in share ownership of the acquired US corporation.

The Regulations' changes to the Exclusion Rule are generally applicable to transactions completed on or after January 16, 2014. A taxpayer can elect to apply all of the Regulations retroactively, including the de minimis exception described above, to acquisitions completed on or after September 17, 2009, so long as the taxpayer applies the Regulations consistently to all such acquisitions.

If you wish to receive more information on cross-border mergers and acquisitions generally or the Section 7874 regulations, you may contact your regular Shearman & Sterling contact person or any contact person listed in this publication.


1 Notice 2009-78, 2009-40 I.R.B. 452 (September 17, 2009). Unless otherwise noted, all section references herein are to the Internal Revenue Code of 1986, as amended (the "Code").

2 See also, Section 7874(a)(2)(B). The term "expanded affiliated group" means an affiliated group as defined in Section 1504(a) but without regard to Section 1504(b)(3), except that Section 1504(a) shall be applied by substituting "more than 50 percent" for "at least 80 percent" each place it appears. Section 7874(c)(1). In general, the an expanded affiliated group will have "substantial business activities" if least 25 percent of the expanded affiliated group's employees (by number and compensation), business assets and business income are located or derived in the foreign country in which the foreign corporation is created or organized. See Treas. Reg. §1.7874-3T(b).

3 Treas. Reg. §1.7874-2(h)(1).

4 Nonqualified property, for these purposes, included: (i) cash and cash equivalents; (ii) marketable securities as defined in Section 453(f)(2), but, in the case of stock of a member of the expanded affiliated group that, after the acquisition, includes the foreign acquiring corporation, only if a principal purpose of issuing the stock of the foreign acquiring corporation in exchange for such stock was the avoidance of the purposes of Section 7874; and (iii) any other property acquired in a transaction with a principal purpose of avoiding the purposes of Section 7874.

5 Treas. Reg. §1.7874-4T(c).

6 Treas. Reg. §1.7874-4T(d)

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 Mondaq.com.

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

Similar Articles
Relevancy Powered by MondaqAI
Shearman & Sterling LLP
Davies Ward Phillips & Vineberg
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Shearman & Sterling LLP
Davies Ward Phillips & Vineberg
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

Mondaq.com (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 www.mondaq.com

To Use Mondaq.com 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