Treasury and the IRS issue notice of new regulations to stop inversions
TAX ALERT |
On Sept. 22, 2014, the Treasury and the IRS released Notice 2014-52, outlining their intent to issue new regulations targeted at reducing the tax benefits of corporate tax inversions. The Treasury intends to "significantly diminish the ability of inverted companies to escape U.S. taxation." The regulations, while not yet issued, will apply to inversion transactions completed on or after Sept. 22, 2014. Given the recent controversy over several high-profile corporate inversions, the Treasury's action had been anticipated.
A corporate inversion is a transaction in which a U.S.-based corporation restructures its ownership in such a way that a foreign entity becomes the parent and U.S. taxes on foreign earnings can be avoided. Currently, such inverted companies are subjected to potential adverse tax consequences if, after the transaction: 1) less than 25 percent of the new multi-national's business activities occur in the country of the new foreign parent, and 2) the former shareholders of the old U.S. corporation own at least 60 percent of the shares in the new foreign parent on account of their former U.S. ownership. If former U.S. shareholder ownership is 80 percent or greater, the new foreign parent is treated as a U.S. corporation for U.S. federal income tax purposes, thereby eliminating any potential tax benefit. However, if the ownership falls within the range of 60 to 80 percent, the transaction is generally respected for U.S. federal income tax purposes, but several potentially adverse tax consequences may occur.
Scope of future regulations
Notice 2014-52 focuses on those transactions falling within the 60 to 80 percent U.S. shareholder ownership threshold that are perceived as abusive. Specifically, the notice describes regulations that will address several perceived abuses.
Repatriations of offshore earnings
The Treasury intends to write regulations to limit the new foreign parent's ability to access the accumulated earnings of prior U.S.-controlled foreign corporations (CFCs). Under current law, U.S. companies owe tax on the profits of their CFCs upon repatriation of those profits to the U.S. parent as a dividend. If a CFC makes a loan to, or invests in the stock of, a U.S. person, the tax law treats the U.S. parent as if it received a dividend from the CFC. However, loans from or equity investments from a CFC to a foreign parent do not result in a U.S. income inclusion. Notice 2014-52 would eliminate any benefit from these "hopscotch" transactions and would provide that such loans or equity investments to a foreign parent will trigger an income inclusion to the former U.S. shareholders. This rule represents a broad expansion of existing anti-deferral tax policy because hopscotch transactions do not put cash into the U.S.
Dilution of ownership to eliminate CFC status
In some cases post-inversion, the new foreign group may seek to integrate its foreign operations with the CFCs owned by related U.S. companies. This integration may require the foreign companies to invest in the CFCs, which may result in a loss of CFC status. This would allow the foreign parent to distribute the earnings of the CFCs directly to the foreign parent without triggering U.S. tax. Notice 2014-52 addresses this situation by treating an investment by the foreign parent in a CFC as an investment in the former U.S. parent.
Transactions designed to skirt current law ownership threshold
As set forth above, whether the current law governing inversions applies to a transaction depends in part on whether former U.S. shareholders have a sufficient level of ownership in the new foreign parent. Under current law, the IRS may disregard certain transactions designed to avoid the ownership thresholds that trigger adverse consequences under the inversion rules. For example, under current law, the IRS may disregard certain stock issued in an initial public offering or in certain private placements. The regulations announced in Notice 2014-52 would expand this rule to exclude stock attributable to certain passive assets, with certain exceptions for banks and other financial institutions. This rule could significantly affect normal non-tax merger and acquisition activity. For example, a foreign acquirer will need to closely monitor and project the value of its passive assets at the time of closing to ensure that the transaction will not qualify as an inversion. Companies with significant amounts of cash could be adversely affected by these rules because a significant portion of their stock could be treated as attributable to passive assets, which could increase the likelihood that the transaction would qualify as an inversion.
Notice 2014-52 would also address so-called "skinny down" transactions in which the U.S. target distributes a portion of its assets (including via a spin-off) to avoid the inversion ownership thresholds. The rules announced in Notice 2014-52 would increase the value of a U.S. corporation by the amount of "non-ordinary course distributions." However, this rule does not apply to the foreign parent in a potential inversion transaction, which could produce unexpected results. Finally, the regulations will inhibit "spinversions" in which assets of a U.S. company are contributed to a foreign subsidiary and spun-off as part of the inversion.
As previously mentioned, the notice provides that all anticipated regulations will generally apply to inversions that close on or after Sept. 22, 2014. Additionally, the notice states that the Treasury and the IRS expect to issue additional guidance to further limit inversion transactions that are contrary to the purposes of section 7874. In particular, the Treasury and the IRS are considering whether to issue guidance on earnings stripping transactions.