Treasury Department and IRS Issue Long-Awaited Inversion Guidance
On September 22, 2014, the U.S. Treasury Department and the IRS issued long-awaited inversion guidance in the form of Notice 2014-52. The Notice sets forth rules that are generally effective for acquisitions completed on or after September 22, 2014, and will be included in regulations that will be issued in the future. The new rules address two aspects of inversion transactions. First, they increase the likelihood that the inversion ownership tests under section 7874 of the Internal Revenue Code will be met (the 60 percent and 80 percent tests). Second, they limit the tax benefits of certain types of post-inversion planning.
Changes to the earnings stripping rules (which provide inverted U.S. target corporations an immediate tax benefit) are conspicuously absent from the Notice. However, the Notice indicates that Treasury and the IRS are considering (and request comments on) guidance to address strategies that shift U.S.-source earnings to lower-tax jurisdictions. Descriptions of the new rules are set forth below.
Increased Likelihood that Ownership Tests are Satisfied
Under section 7874, a foreign acquiring corporation is treated as a U.S. corporation for U.S. tax purposes (meaning that the foreign corporation is taxed by the U.S. on its worldwide income) if it acquires substantially all of the stock (or property) of a U.S. target corporation and the shareholders of the U.S. target corporation (or the U.S. target corporation) receive at least 80 percent of the foreign acquiror stock in the exchange. A lesser tax impact results if the U.S. target corporation's shareholders (or the U.S. target corporation) receive at least 60 percent, but less than 80 percent, of the foreign acquiror stock in the exchange. The Notice describes three new rules that increase the likelihood that the 60 percent and 80 percent ownership tests will be met. These changes will be effective for acquisitions that close on or after September 22, 2014.
- For the purposes of the ownership tests, a portion of the stock of a foreign acquiror is excluded from the denominator if more than 50 percent of the assets owned by the foreign acquiror's expanded affiliated group ("EAG") (not including the U.S. target corporation and its subsidiaries) are passive assets, which is determined on a consolidated balance sheet basis. An EAG is a group of corporations linked by more than 50 percent ownership.
- Non-ordinary course distributions (including redemption distributions) by the U.S. target during the 36-month period preceding the inversion transaction are disregarded in applying the ownership tests.
- Under the current section 7874 regulations, stock of the foreign acquiror that is held by members of its EAG is generally disregarded in applying the ownership tests. The Notice changes this rule for certain multi-step transactions where a U.S. parent transfers its U.S. subsidiary to a foreign subsidiary and then distributes the stock of the foreign subsidiary to its shareholders (a so-called "spinversion"), subjecting the U.S. parent's ownership of foreign subsidiary stock to the ownership tests.
Each of these changes increases the percentage of foreign acquiror stock held by the shareholders of the U.S. target corporation (or the U.S. target corporation) under the inversion ownership tests, thus increasing the likelihood that the acquisition will be subject to the inversion rules.
Limitations on Inversion Benefits
The Notice also includes three new rules that affect the benefits of post-inversion planning. The first two rules would apply to acquisitions completed on or after September 22, 2014, but only if the shareholders of the U.S. target corporation (or the U.S. target corporation) receive at least 60 percent, but less than 80 percent, of the foreign acquiror stock in an inversion that closes on or after September 22, 2014. The third rule applies to acquisitions completed on or after September 22, 2014, whether or not there has been an inversion:
- The Code subjects foreign corporations controlled by U.S. shareholders ("CFCs") to current U.S. taxation on their investments in U.S. property, including loans to their U.S. affiliates. However, "hopscotch" loans from a CFC to its U.S. shareholder's foreign parent following an inversion (bypassing the CFC's direct U.S. parent) were not subject to this rule. The Notice creates a new rule whereby stock and obligations of the new foreign parent (and of related non-CFC foreign affiliates) that are acquired at any time during the 10-year period following the inversion by a CFC of an inverted company are treated as investments in U.S. property.
- Under new rules to be issued under section 7701(l), when a CFC of the U.S. target is "de-controlled" in a transaction that involves a related foreign affiliate and does not otherwise give rise to the inclusion by the U.S. target of the untaxed earnings of the CFC, the event will be recharacterized as an issuance of an instrument by the U.S. target to the related foreign affiliate, and any distributions made by the de-controlled CFC to the related foreign affiliate will instead be treated as made by the CFC to the U.S. target, and then by the U.S. target to the related foreign affiliate.
- Under the current section 304 regulations, in some situations, a foreign parent could transfer stock of its U.S. subsidiary to the U.S. subsidiary's CFC in exchange for cash or property tax-free, thus permitting the foreign parent to access the CFC's earnings without subjecting them to U.S. tax. The Notice prevents the foreign parent from accessing the earnings of the CFC in such a transaction, causing the CFC to retain its earnings for possible future taxable distributions to the U.S. subsidiary.
For further information, please contact your principal Firm representative or one of the lawyers listed below. General email messages may be sent to our "Contact Us" form, which can be found at www.jonesday.com.
Raymond J. Wiacek
Robert A. Profusek
Lester W. Droller
Andrew M. Eisenberg
Andrew M. Levine
Edward T. Kennedy
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