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IRS Issues Additional Anti-Inversion Guidance
Practical Law Legal Update w-000-9980 (Approx. 4 pages)
IRS Issues Additional Anti-Inversion Guidance
by Practical Law Corporate & Securities
| Published on 24 Nov 2015 • USA (National/Federal) |
The Treasury Department and IRS released additional anti-inversion guidance which mainly applies to transactions occurring on or after November 19, 2015.
On November 19, 2015, the Treasury Department and the IRS released IRS Notice 2015-79 (the Notice) which announces Treasury regulations that they intend to issue to:
- Make it more difficult for US companies to invert.
- Reduce the tax benefits of inversions.
The Notice also makes some corrections to last year's action on inversions, IRS Notice 2014-52 (see Legal Update, IRS Issues New Anti-Inversion Rules). The Notice is mostly prospective and generally applies to transactions occurring on or after November 19, 2015.
IRC Section 7874 was enacted to prevent a corporate group with a US parent from restructuring so that a foreign corporation in a jurisdiction with more favorable tax rules becomes the parent of the group (referred to as an inversion). If the former stockholders of the US company own at least 80% of the new foreign parent, IRC Section 7874 disregards the inversion transaction and treats the new foreign parent as a US corporation for US federal income tax purposes unless 25% or more of the new group's business activity is in the home country of the new foreign parent (the substantial business activities exception). If the former stockholders own at least 60% but less than 80% of the new foreign parent, IRC Section 7874 respects the new foreign parent for US tax purposes but certain limits are placed on the US company's use of its tax attributes (unless the substantial business activities exception is met).
The new regulations will make it more difficult for US companies to invert by:
- Strengthening the requirement that the former owners of a US company own less than 80% of the new combined entity. Specifically, the Notice:
- limits the ability of US companies to combine with foreign entities when the new foreign parent is located in a "third country" (for example, when a US company and Dutch company complete an inversion in which the new parent is a tax-resident in Ireland). In certain cases when the foreign parent is a tax resident of a third country, stock of the foreign parent issued to the stockholders of the existing foreign corporation is disregarded for purposes of the ownership requirement. This new rule will prevent US companies from cherry-picking a tax-friendly country to locate their tax residence; and
- limits the ability of US companies to inflate the new foreign parent corporation's size to avoid the 80-percent rule (referred to as the anti-stuffing rules). The Notice clarifies that the anti-stuffing rules apply to any assets acquired with a principal purpose of avoiding the 80-percent rule, regardless of whether the assets are passive assets.
- Strengthening the substantial business activities exception. Under current law, a US company can successfully invert if, after the transaction, at least 25% of the combined group's business activity is in the foreign country where the new foreign parent is created or organized, regardless of whether the new foreign parent is a tax resident of that foreign country. The Notice provides that the combined group cannot satisfy the substantial business activities exception unless the new foreign parent is a tax resident in the foreign country where it is created or organized.
These new rules apply to transactions completed on or after November 19, 2015.
The new regulations will also reduce the tax benefits of inversions by preventing inverted companies from transferring foreign operations "out from under" the US tax net without paying current US tax. Specifically, the Notice:
- Expands the scope of inversion gain for which current US tax must be paid to include certain taxable deemed dividends recognized by an inverted company. This rule applies to dividends attributable to passive income recognized by a controlled foreign corporation (CFC) when the CFC transfers foreign operations to the new foreign parent.
- Requires that all built-in gain in CFC stock be recognized when the CFC is restructured, without regard to the amount of deferred earnings.
These new rules apply to transactions occurring on or after November 19, 2015 but only if the inversion is completed on or after September 22, 2014.
The Notice also makes some corrections to last year's action on inversions in IRS Notice 2014-52. In particular, the Notice corrects the rules that:
- Limit the ability of companies to count passive assets that are not part of the entity's daily business functions to inflate the new foreign parent's size and evade the 80-percent rule (commonly referred to as using a "cash box"). The correction provides that assets used in an active insurance business will not be treated as passive assets.
- Prevent US companies from reducing their size by making extraordinary dividends to evade the ownership requirement. The correction provides that this rule will not apply when a foreign corporation acquires a US company in an all-cash or mostly cash acquisition.
Taxpayers can elect to apply these corrections to acquisitions completed before November 19, 2015.
The Notice states that the Treasury Department and the IRS expect to issue additional guidance to further limit inversion transactions that are contrary to the purposes of IRC Section 7874 and the benefits of post-inversion tax avoidance transactions. In particular, the Treasury Department and the IRS are considering guidance to address strategies that avoid US tax on US operations by shifting or "stripping" US-source earnings to lower-tax jurisdictions, including through intercompany debt.