United States: IRS And Treasury Issue More Guidance On "Inversion" Transactions

The Treasury Department and the Internal Revenue Service have issued additional guidance about so-called "inversion" transactions. Generally, an inversion transaction results where a U.S. corporation ("U.S. Target") is acquired by a non-U.S. corporation ("Non-U.S. Acquirer"), but with the U.S. Target's historic shareholders continuing as significant equityholders of the Non-U.S. Acquirer after closing. The U.S. federal income tax consequences of inversion transactions vary based on a number of factors, including the extent of the U.S. Target shareholder's continuing equity stake, but in the broadest possible sense, an inversion can have the result of reducing the U.S. Target's gross income subject to U.S. corporate tax post-inversion. These transactions are not new – a number of statutory provisions have been enacted by the U.S. Congress (notably, Sections 367 and 7874), and various regulatory projects and other administrative guidance have been issued by the Treasury Department and I.R.S. to address these transactions since the early 1990s. However, notwithstanding the government's efforts, inversion transactions continue.

The latest round of guidance is Notice 2015-79 (the "2015 Notice," issued November 20, 2015), expanding on the inversion guidance in Notice 2014-52 (the "2014 Notice"). The principal purpose of the 2015 Notice, like the 2014 Notice, is the announcement of future proposed regulations broadly intended both to make inversions harder to accomplish in a tax-preferred manner and to restrict the benefits of certain U.S. post-inversion structuring transactions. These future proposed regulations will have effective dates that are designed to foreclose immediately, as a practical matter, the future use of the structures and techniques described.

Future Proposed Regulations

The 2015 Notice continues their approach from the 2014 Notice of announcing the content of future regulations in general terms through administrative releases, and that those future regulations that will be effective for transactions closing on or after the date of the Notice (or, in certain cases, effective as of the date of the 2014 Notice), regardless of the manner in which any potential ambiguities of the Notice might be resolved. The most important provisions to be included in the future proposed regulations announced are:

  • The exception to the inversion statute available where the Non-U.S. Acquirer has "substantial business activities" in its home jurisdiction will be limited to situations where the Non-U.S. Acquirer is a tax resident of the country where the substantial business activities occur (applying U.S. tax standards for determining residence). This is intended to prevent the Non-U.S. Acquirer from not being subject to tax as a resident where the "substantial business activities" occur, whether by application of local law treating the Non-U.S. Acquirer as tax resident elsewhere or the U.S. "check-the-box" rules creating a "reverse-hybrid" entity.
  • Potential inversion structures where a U.S. Target and a non-U.S. corporation combine under a newly formed Non-U.S. Acquirer organized in a third country essentially will be eliminated unless the "substantial business activities" test is met in the third country, to prevent the use of the third country company for no business purposes other than tax.
  • The "anti-stuffing" rules, preventing inflation of the size of the Non-U.S. Acquirer, will be clarified to include all assets (not just cash and other passive assets) acquired for the purpose of avoiding the application of the 80% post-acquisition U.S. Target shareholder ownership threshold.
  • The Notice expands the recognition of "inversion gain" post-inversion in various situations in which the U.S. Target attempts to move assets or income to foreign jurisdictions. Under Section 7874, where the U.S. Target's shareholders end up with at least 60% but less than 80% of the Non-U.S. Acquirer's equity post-inversion, income treated as "inversion gain" is subject to current U.S. tax, generally without reduction for losses or other tax attributes. The 2015 Notice announces future regulations will expand the inversion gain rules as follows, to be effective as of September 22, 2014 (the date of the 2014 Notice).

    • Inversion gain will expand to include income from an indirect transfer or license of property, including "Subpart F income" of a controlled foreign corporation (CFC), which would generally capture deemed dividend income to a CFC's U.S. shareholders not otherwise within the scope of inversion gain.
    • All of the built-in gain in that CFC's stock will be taxed immediately – not just the portion otherwise treated as effectively a dividend to the U.S. target – where a U.S. Target's CFC subsidiary is sold or exchanged to the Non-U.S. Acquirer or other foreign affiliate.

The 2015 Notice states that more rules are forthcoming, including rules addressing "earnings stripping" through the use of intercompany debt, and possibly other post-inversion matters, and reiterates the 2014 Notice request for comments on this issue.

IRS And Treasury Issue More Guidance On "Inversion" Transactions

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.

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