United States: Outbound Acquisitions:Holding Companies Of Europe – A Guide For Tax Planning, Or A Road Map For Difficulty?

Last Updated: August 23 2017
Article by Stanley C. Ruchelman

INTRODUCTION

In General

When a U.S. company acquires foreign targets, the use of a holding company structure abroad may provide certain global tax benefits. The emphasis is on "global" because standard U.S. benefits such as deferral of income while funds remain offshore may not be available without further planning once a holding company realizes dividends and capital gains. In addition, the operative term is "may provide" because of steps that have been taken by the Organization for Economic Cooperation and Development ("O.E.C.D."), the European Commission, and the European Parliament to impede tax planning opportunities that have been available to multinational groups for many years.

If we assume the income of each foreign target consists of manufacturing and sales activities that take place in a single foreign country, no U.S. tax will be imposed until the profits of the target are distributed in the form of a dividend or the shares of the target are sold. This is known as "deferral" of tax. Once dividends are distributed, U.S. tax may be due whether the profits are distributed directly to the U.S. parent company or to a holding company created under the laws of a different foreign jurisdiction. Without advance planning to take advantage of the entity characterization rules known as "check-the-box," the dividends paid by the manufacturing company will be taxable in the U.S.1 If paid to a holding company that is a controlled foreign corporation ("C.F.C.") for U.S. income tax purposes, the dividend income in the hands of the holding company will be viewed to be an item of Foreign Personal Holding Company Income, which generally will be taxed to the U.S. parent company or any other person that is treated as a "U.S. Shareholder" under Subpart F of the Internal Revenue Code.2

Benefits Of Holding Companies

Nonetheless, the use of a holding company can provide valuable tax-saving opportunities when profits of the target company are distributed. Historically, the use of a holding company could reduce foreign withholding taxes claimed as foreign tax credits by the U.S. parent. This could be achieved through an income tax treaty, or in the case of operations in the E.U., through the Parent-Subsidiary Directive (the "P.S.D."). This can result in substantial savings if the operating and tax costs of maintaining the holding company are significantly less than the withholding taxes being saved.

However, as will be described below, the E.U. has taken steps to modify the P.S.D. so that it does not apply when the parent is in turn owned by a company based outside the E.U. and the structure is viewed to be abusive. In addition, all of the European countries discussed in this paper signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the "Multilateral Instrument") on June 7, 2017. Once the Multilateral Instrument comes into force in a particular European jurisdiction, it will take effect on the first day of the following calendar year or taxable period. Under Article 7 ("Prevention of Treaty Abuse") of the M.L.I. benefits enjoyed by a European holding company in connection with dividends paid by a European operating company may be limited when

it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.3

It remains to be seen how this provision will play out for holding companies that are used to channel dividends to U.S. parent companies. Presumably, where the holding company conducts active headquarters operations through its own staff of employees and executives, treaty abuse may be a conclusion that is difficult to reach.

Although the foreign tax credit is often described as a "dollar-for-dollar reduction of U.S. tax" when foreign taxes are paid or deemed to be paid by a U.S. parent company, the reality is quite different. Only taxes that are imposed on items of "foreign-source taxable income" may be claimed as a credit.4 This rule, known as "the foreign tax credit limitation," is intended to prevent foreign income taxes from being claimed as a credit against U.S. tax on U.S. taxable income. The U.S., as with most countries that eliminate double taxation through a credit system, maintains that it has primary tax jurisdiction over domestic taxable income. It also prevents so-called "cross crediting," under which high taxes on operating income may be used to offset U.S. tax on lightly-taxed investment income. For many years, the foreign tax credit limitation was applied separately with regard to eight different categories of baskets of income designed to prevent the absorption of excess foreign tax credits by low-tax foreign-source income. In substance, this eviscerated the benefit of the foreign tax credit when looked at on an overall basis. The problem has since eased because the number of foreign tax credit baskets has been reduced from eight to two: passive and general.

The benefit of the foreign tax credit is reduced for dividends received from foreign corporations that, in the hands of the recipient, benefit from reduced rates of tax in the U.S. A portion of foreign dividends received by U.S. individuals that qualify for the 0%, 15%, or 20% tax rate under Code §1(h)(11)(B)(i) are removed from the numerator and denominator of the foreign tax credit limitation to reflect the reduced tax rate.5 This treatment reduces the foreign tax credit limitation when a U.S.-resident individual receives both qualifying dividends from a foreign corporation and other items of foreign-source income within the same basket that are subject to ordinary tax rates.

As a result, a U.S.-based group must determine the portion of its overall taxable income that is derived from foreign sources, the portion derived in each "foreign tax credit basket," and the portion derived from sources in the U.S. This is not an easy task, and in some respects, the rules do not achieve an equitable result from management's viewpoint.

Allocation And Apportionment Regulations And Self-Help Options

U.S. income tax regulations require expenses of the U.S. parent company to be allocated and apportioned to all income, including foreign dividend income.6 The allocation and apportionment procedures set forth in the regulations are exhaustive and tend to maximize the apportionment of expenses to foreign-source income. For example, all interest expense of the U.S. parent corporation and the U.S. members of its affiliated group must be allocated and apportioned under a set of rules that allocates interest expense on an asset-based basis to all income of the group.7 Direct tracing of interest expense to income derived from a particular asset is permitted in only limited circumstances8 involving qualified nonrecourse indebtedness,9 certain integrated financial transactions,10 and certain related C.F.C. indebtedness.11 Research and development expenses, stewardship expenses, charitable deductions, and state franchise taxes also must be allocated and apportioned. These rules tend to reduce the amount of foreign-source taxable income in a particular category and may even eliminate that category altogether. The problem is worsened by carryovers of an overall foreign loss account.12 This is an "off-book" account that arises when expenses incurred in a particular prior year are allocable and apportionable to foreign-source income and those expenses exceed the amount of foreign-source gross income of the year. Where that occurs, the loss is carried over to future years and reduces the foreign-source taxable income of the subsequent year when computing the foreign tax credit limitation.

The pressure that has been placed on full use of the foreign tax credit by a U.S.-based group has resulted in several public companies undergoing inversion transactions. In these transactions, shares of the U.S. parent company that are held by the public are exchanged for comparable shares of a newly-formed offshore company to which foreign subsidiaries are eventually transferred. While the share exchange and the transfer of assets may be taxable events, the identity of the shareholder group (i.e., foreign persons or pension plans) or the market value of the shares (i.e., shares trading at relatively low values) may eliminate actual tax exposure in the U.S. Thereafter, the foreign subsidiaries are owned directly or indirectly by a foreign parent corporation organized in a tax-favored jurisdiction and the foreign tax credit problems disappear.

Anti-Inversion Rules

This form of "self-help" is no longer easily available as a result of the anti-inversion rules of Code §7874. In some circumstances, Code §7874 imposes tax on inversion gains that cannot be reduced by credits or net operating loss carryforwards. In other circumstances, Code §7874 treats the foreign corporation as if it were a U.S. corporation. In Notice 2014-52, the I.R.S. described regulations it intends to issue that will address transactions structured to avoid the purposes of Code §§7874 (involving inversion transactions), 367 (involving reorganizations or spin-offs), and 956 (investments in U.S. property by a C.F.C.):

  • Regarding Code §7874, the regulations will disregard certain stock of a foreign acquiring corporation that holds a significant amount of passive assets. The potential abuse is that because the passive assets reflect an asset-stuffing transaction in the acquiring company, it has the effect of avoiding the triggers for the application of the anti-inversion provisions.
  • Also regarding Code §7874, the regulations will provide guidance on the treatment of certain transfers of stock of a foreign acquiring corporation through a spin-off or otherwise that occur after an acquisition.
  • Regarding Code §§7874 and 367, the regulations will provide guidance for disregarding certain distributions that are not made in the ordinary course of businesses. Again, because the potential abuse is that the distribution reduces the assets in the U.S. entity, it has the effect of avoiding the triggers for the application of the anti-inversion provisions.
  • Regarding Code §956, the regulations will prevent the avoidance of the investment in U.S. property rules when a C.F.C. acquires obligations of or equity investments in the new foreign parent corporation or certain foreign affiliates.
  • Regarding Code §956, the regulations will target the investment of pre-inversion earnings and profits of a C.F.C. through a post-inversion transaction that terminates the C.F.C. status of foreign subsidiaries or that substantially dilutes a U.S. shareholder's interest in those earnings and profits.

Finally, regarding Code §956, the regulations will limit the ability of a group to

remove untaxed foreign earnings and profits of C.F.C.'s through related-party stock sales subject to Code §304 (which converts a stock sale of controlled stock into a dividend payment).

In 2016, the Treasury Department adopted updates to the U.S. Model Income Tax Convention (the "2016 U.S. Model"), which serves as the basic document that the U.S. submits when negotiating an income tax treaty. The draft provisions propose, inter alia, to reduce the tax benefits that may be enjoyed by an expatriated group by imposing full withholding taxes on key payments such as dividends,13 interest,14 and royalties15 made to connected persons that are residents of a treaty country by "expatriated entities" as defined under the Internal Revenue Code. This lasts for ten years and goes to the heart of the bargain between the U.S. and its treaty partners, because the full withholding tax reduces the tax in the country of the recipient.

In Notice 2015-79, the I.R.S. outlined forthcoming guidance on corporate inversions in response to perceived abuse. The abusive plans and the I.R.S. responses include the following:

  • Manipulating Substantial Activity Rules: The I.R.S. is aware of transactions in which a taxpayer asserts that the expanded affiliated group ("E.A.G.") has substantial business activities in the relevant foreign country, but the foreign acquiring corporation is not subject to income taxation in the relevant foreign country as a resident. According to the I.R.S., this is abusive.
  • Third Country Transactions: The I.R.S. is aware that certain acquisitions in which a domestic entity combines with an existing foreign corporation are structured by establishing a new foreign parent corporation with a tax residence that is different from that of the existing foreign corporation. In these transactions, the stock or assets of the existing foreign corporation are acquired by the new third-country parent and the U.S. shareholder group owns less than 80% of the parent in the third country. The I.R.S. is concerned that a decision to locate the tax residence of a new foreign parent corporation outside of both the United States and the jurisdiction in which the existing foreign corporation is tax resident generally is driven by abusive tax planning.
  • Disregard of Stock Transferred in Exchange for Nonqualified Property: Stock of the foreign acquiring corporation that is sold in a public offering related to the acquisition is excluded from the denominator of the ownership fraction. Disqualified stock includes stock of the foreign acquiring corporation that is transferred in exchange for "nonqualified property." Nonqualified property includes (i) cash or cash equivalents, (ii) marketable securities, (iii) certain obligations, and (iv) any other property acquired with a principal purpose of avoiding the anti-inversion rules. The I.R.S. is concerned that some taxpayers are narrowly interpreting the definition of avoidance property, contending that it is limited to stock that is used to transfer indirectly specified nonqualified property to the foreign acquiring corporation.
  • Post-Acquisition Transactions: The I.R.S. is concerned that certain indirect transfers of stock or other property by an expatriated entity, rather than direct transfers by the expatriated entity itself, have the effect of removing foreign operations from the U.S.'s taxing jurisdiction. This is because under current law, the income from these indirect transfers is not inversion gain. Consequently, attributes can be used to reduce the tax.
  • Code §1248 Toll Charges: Current §367(b) regulations require a shareholder that exchanges stock in a transaction which results in a loss of C.F.C. status and future exposure under Code §1248 to include the Code §1248 amount in its income as a deemed dividend. The I.R.S. is concerned that the toll charge is not a sufficient deterrent.

On April 4, 2016, the Treasury Department issued a third round of new rules under Code §7874 aimed at halting the wave of inversions that have allowed U.S.-owned multinational groups to restructure their global organization in order to lower U.S. taxes. The Treasury sought to close down a planning strategy used by some foreign companies in which multiple acquisitions of unrelated U.S. target corporations are made over time. This strategy allowed the foreign companies to avoid the application of §7874, since each acquisition was analyzed on its own.16 The prevention of this strategy is accomplished under a multiple domestic entity acquisition rule set forth in Treas. Reg. §1.7874-8T.17

The Treasury was concerned that certain taxpayers were targeting foreign corporations with a value that was attributable to substantial passive assets rather than business assets. Treas. Reg. §1.7874-7T incorporates a rule that identifies certain foreign corporation stock which has substantial value and is attributable to passive assets. When triggered, this rule will skew the ownership fraction in the direction of the former shareholders of the domestic acquired corporation so that Code §7874 may apply.

A so-called "anti-skinnying" rule of the First Notice would disregard any non-ordinary course distribution ("N.O.C.D.") made by the domestic entity during the 36-month period ending on the acquisition date.18

Other rules apply Code §§956, 367, and 304 in a manner that imposes tax on typical transactions that occur after an inversion.

To view the full article click here

Footnotes

1 Treas. Reg. §301.7701-3(a). If an election is made for a wholly-owned subsidiary, the subsidiary is viewed to be a branch of its parent corporation. Intra-company distributions of cash are not characterized as Foreign Personal Holding Company Income, discussed later in the text.

2 There are exceptions to the general characterization of a dividend as an item of Foreign Personal Holding Company Income that might apply. One relates to dividends received from a related person which (i) is a corporation created or organized under the laws of the same foreign country as the recipient C.F.C., and (ii) has a substantial part of its assets used in its trade or business located in that foreign country. See Code §954(c)(3)(A)(i). For a temporary period of time, a look-through rule is provided in Code §954(c)(6), under which dividends received by a C.F.C. from a related C.F.C. are treated as active income rather than Foreign Personal Holding Company Income to the extent that the earnings of the entity making the payment are attributable to active income. This provision is regularly adopted for two-year periods after which it must be re-enacted. The latest version was terminated at the conclusion of 2014.

3 Paragraph 1 of Article 7 of the Multilateral Instrument.

4 Code §904(a).

5 See Code §§1(h)(11)(C)(iv) and 904(b)(2)(B).

6 See Treas. Reg. §§1.861-8 through 17.

7 Treas. Reg. §1.861-9T(f)(1) and (g).

8 Treas. Reg. §1.861-10T(a).

9 Treas. Reg. §1.861-10T(b).

10 Treas. Reg. §1.861-10T(c).

11 Treas. Reg. §1.861-10T(e).

12 Code §904(f).

13 Paragraph 5 of Article 10 (Dividends) of the 2016 U.S. Model.

14 Id., ¶2(d) of Article 11 (Interest).

15 Id., ¶2 of Article 12 (Royalties).

16 T.D. 9761, Explanation of Provisions, I(B)(3). (April 8, 2016); Treas. Reg. §1.7874-12T(a)(17).

17 Treas. Reg. §1.7874-8T(b).

18 Treas. Reg. §1.7874-7T(h). Because it is a temporary regulation, this regulation expires in three years.

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.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
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
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
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.

Disclaimer

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.

General

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