Notice 2015-79: New Anti-Inversion Guidance

By Natallia Shapel, CPA, MBA, MST, New York City

Editor: Kevin D. Anderson, CPA, J.D.

On Nov. 19, 2015, the IRS issued its latest inversion guidance in Notice 2015-79, which introduces new restrictions on corporate inversions and post-inversion restructuring transactions.

A corporate inversion is a transaction that results in the replacement of a U.S. parent of a multinational group with a foreign parent. The anti-inversion rules fall under Secs. 7874 and 367.

Sec. 7874 applies to a transaction completed after March 4, 2003, if under a plan or series of related transactions:

  1. A foreign corporation acquires (directly or indirectly) substantially all of the properties of a domestic corporation (or substantially all of the properties constituting a trade or business of a domestic partnership);
  2. The shareholders (or partners) of the domestic corporation (or partnership) hold at least 60% of the vote or value of the foreign corporation by reason of holding stock in the domestic corporation (or interest in the partnership); and
  3. The foreign corporation, considered together with all companies connected to it by a chain of greater than 50% ownership (i.e., the expanded affiliated group, or EAG), does not conduct substantial business activities in its country of incorporation compared with the EAG's total worldwide business activities.

If an inversion transaction meets all of the above tests, the foreign acquiring corporation is treated as a surrogate foreign corporation with respect to the expatriated domestic corporation or partnership. The tax treatment of the surrogate foreign corporation varies, depending on the level of shareholder continuity. If the owners of the former domestic entity own, by vote or value, 80% or more of the surrogate foreign corporation following the inversion, the foreign corporation is treated as a domestic corporation for all purposes of the Code and for all U.S. treaty purposes. If the ownership by former shareholders of the inverted corporation is less than 80% but is at least 60%, the surrogate foreign corporation is treated as a foreign corporation. However, the expatriated entity is denied the use of its tax attributes (e.g., net operating losses (NOLs) or certain credits) to offset the inversion gain for the succeeding 10-year period, and other adverse implications can apply (e.g., the Sec. 4985 excise tax on the value of certain stock-based compensation held by certain corporate insiders).

Additionally, if the foreign parent is respected as a foreign corporation under Sec. 7874, then Sec. 367 needs to be considered. Generally, Sec. 367 triggers U.S. income tax at the corporate and/or shareholder level upon transfer of the former U.S. parent's stock or assets to the new foreign parent.

Details: Notice 2015-79

The notice generally addresses transactions structured to avoid the application of Secs. 367 and 7874. Specifically, it provides guidance to (1) limit the ability of domestic corporations or partnerships to effectuate an inversion transaction; (2) limit the tax benefits of certain post-inversion restructuring transactions used by inverted companies to access overseas earnings without triggering U.S. tax; and (3) clarify or correct certain aspects of Notice 2014-52, the previously issued anti-inversion notice.

Rules Limiting the Ability to Effectuate an Inversion Transaction

Substantial business activities test tightened: Notice 2015-79 provides that the substantial business activities test can be met only if the new foreign parent of the inverted U.S. group is a tax resident in the country of the new foreign parent's incorporation. In contrast, the statute (Sec. 7874(a)(2)(B)(iii)) only requires the new foreign parent to be created or organized in the country with substantial business activities. As the statute currently provides, there is no requirement for the foreign parent to also be taxed in that country as a resident (e.g., on a worldwide basis) (Sec. 7874(a)(2)(B)(iii)). The IRS is concerned that a U.S. parented group could invert by using a foreign parent that is incorporated in a relevant jurisdiction (i.e., a jurisdiction with substantial business activities) but is not subject to tax in that jurisdiction by virtue of being managed and controlled elsewhere.

Another example of the perceived abuse results from disparate entity classification rules in the United States and the relevant foreign country. Specifically, the foreign acquiring corporation may be treated as a corporation for U.S. tax purposes under the U.S. entity classification rules, but as a fiscally transparent entity under the tax law of the relevant foreign country. In that case, the foreign acquiring corporation would not be subject to tax as a resident of the relevant foreign country. The notice states that allowing the substantial business activities exception to apply in those circumstances is contrary to the policy underlying the substantial business activities test.

Third-country limitation: The notice limits the ability of U.S. companies to merge with an existing foreign target under a new foreign parent residing in a "third country." Specifically, the notice provides that, when a third-country jurisdiction (i.e., other than the United States and the foreign target's jurisdiction) is the location of the new foreign parent, certain stock of the foreign parent issued to the shareholders of the existing foreign target will be disregarded in determining the ownership percentage of the former shareholders of the domestic corporation, thereby raising the ownership attributable to the former shareholders of the U.S. entity, possibly above the 80% threshold.

The notice provides four complex requirements in evaluating the applicability of this provision. Notably, one of these requirements looks to whether the domestic entity shareholders' ownership percentage in the new foreign parent is, without regard to the new rule, at least 60% but less than 80%. If the 60% ownership threshold is not reached, the "third country" limitation may not apply. Thus, in a situation where the U.S. group and the foreign target group are relatively close in size, the stock of a "third country" foreign parent may not be disregarded in measuring the 80% continuity interest by the domestic entity's former shareholders.

Clarification of the anti-stuffing rule: The anti-stuffing rules (which prevent companies from inflating the size of the new foreign parent by transferring certain assets to it) are clarified under the notice to apply to any assets (whether or not passive) acquired for a principal purpose of avoiding Sec. 7874.

Rules Limiting the Benefits of Post-Inversion Transactions

Expand the definition of the inversion gain: Under current law, an inverted U.S. company cannot use its tax attributes (e.g., NOLs and certain credits) to reduce the U.S. income tax on inversion gain. The definition of inversion gain is expanded under the notice to include income or gain recognized on certain indirect property transfers or licenses, e.g., deemed dividends attributable to gain a controlled foreign corporation (CFC) has recognized on a transfer of its assets to the new foreign parent. The IRS was concerned that, although the income or gain recognized by a CFC may be taxable to the expatriated domestic entity under the subpart F provisions, the expatriated entity could—in the absence of the new rule—use its tax attributes to reduce or eliminate the U.S. tax on the income or gain. The notice also provides that if foreign partnerships that are foreign related persons with respect to the expatriated entity license property, a partner of the partnership will be treated as having transferred or licensed its proportionate share of the property for purposes of determining inversion gain.

Built-in gain trigger: Regs. Sec. 1.367(b)-4(b) currently requires the former U.S. parent transferring stock of its CFC subsidiaries in an exchange subject to Sec. 367(b) to include in income as a deemed dividend certain undistributed earnings of the CFC (i.e., a Sec. 1248 amount) if the transfer results in either a loss of CFC status of the transferred foreign corporation or a loss of Sec. 1248 shareholder status of the U.S. parent. Because the current regulations limit the income recognition to a Sec. 1248 amount, the IRS is concerned that certain nonrecognition transactions may allow the U.S. shareholder to avoid U.S. tax on unrealized appreciation in property held by the expatriated foreign subsidiary at the time of the transaction while, at the same time, diluting the U.S. shareholder's ownership interest in that subsidiary, a result that the IRS feels is inappropriate.

To prevent this avoidance of tax, the IRS stated that it would instead be appropriate to require the U.S. shareholder to recognize all of the built-in gain inherent in the transferred stock (regardless of the amount of the CFC's undistributed earnings). Accordingly, the IRS intends to amend the regulations under Sec. 367(b) to provide that, if an exchanging shareholder would be required under the rules in Notice 2014-52 to include in income as a deemed dividend the Sec. 1248 amount (if any) with respect to stock of an expatriated foreign subsidiary, the exchanging shareholder also must recognize all realized gain with respect to that stock, after taking into account any increase in basis resulting from a deemed dividend with respect to the exchange under Regs. Sec. 1.367(b)-2(e)(3)(ii).

Additional Corrections and Clarifications of Notice 2014-52

"Cash box" rule: The cash box rule, set forth in Notice 2014-52, is corrected under the new notice. Notice 2014-52 announced that the IRS intended to issue regulations under Sec. 7874(c)(6) that will exclude from the denominator of the ownership fraction certain stock of a foreign acquiring corporation that is attributable to passive assets. Notice 2014-52 did not exclude property that gives rise to income described in Sec. 1297(b)(2)(B) (passive foreign investment company insurance exception) from the general definition of passive assets. Notice 2015-79 changes this rule, providing that in the intended regulations, property that gives rise to income described in Sec. 1297(b)(2)(B) is excluded from the general definition but subject to the special rule for substitute property. This correction is intended to ensure that assets used in an active insurance business are not treated as passive assets.

Non-ordinary course distributions—addition of a de minimis exception: The notice also corrects the rule that disregards certain preinversion non-ordinary course distributions for purposes of the 80% stock ownership requirement. For the de minimis exception to the non-ordinary course rule to apply, the ownership percentage must be less than 5% (by vote and value) after the acquisition and all transactions related to the acquisition are completed, and former shareholders or former partners of the domestic entity must own in aggregate less than 5% (by vote and value) of the stock of (or a partnership interest in) any member of the EAG that includes the foreign acquiring corporation. Thus, under this exception, the non-ordinary course distribution rule will not apply when a foreign corporation acquires a U.S. company in an all-cash or mostly cash acquisition and the former shareholders of the domestic entity retain only a small interest in the foreign acquiring corporation.

Clarifying change to small dilution exception: Notice 2014-52 announced that the IRS intended to issue regulations that will recharacterize certain post-inversion transactions that result in decontrol or a significant dilution of a U.S. shareholder's ownership of a CFC that is an expatriated foreign subsidiary. In determining whether a significant dilution occurred, some taxpayers were comparing the value of stock of an expatriated subsidiary owned by a U.S. shareholder before and after the specified transaction, rather than percentages of stock owned (by value), which the IRS stated was inconsistent with the purpose of the small dilution exception and the relevant rules and example in Notice 2014-52. Therefore, the new regulations will clarify the application of the small dilution exception by substituting the phrase "the percentage of stock (by value)" for the phrase "the amount of stock (by value)."

Earnings Stripping

Notably, Notice 2015-79 does not include earnings-stripping guidance. However, the notice stated that the IRS continues to consider guidance to address strategies that avoid U.S. tax on U.S. operations by shifting or "stripping" U.S.-source earnings to lower-tax jurisdictions, including through intercompany debt, and reiterated the request made in Notice 2014-52 for comments on these issues. (For more on earnings stripping, see "Earnings Stripping: Effective Tax Strategy to Repatriate Earnings in a Global Economy.")

Effective Dates

The notice provides that the regulations incorporating its provisions would generally apply to transactions completed on or after Nov. 19, 2015. The regulations expanding the definition of inversion gains will apply to transfers or licenses of property occurring on or after Nov. 19, 2015, but only if the inversion transaction was completed on or after Sept. 22, 2014. The regulations requiring the recognition of built-in gain will apply to specified exchanges occurring on or after Nov. 19, 2015, but only if the inversion transaction was completed on or after Sept. 22, 2014. The regulations incorporating the clarifying changes to the small dilution exception will apply to specified transactions and exchanges completed on or after Nov. 19, 2015, but only if the inversion transaction was completed on or after Sept. 22, 2014.


Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Washington.

For additional information about these items, contact Mr. Anderson at 202-644-5413 or

Unless otherwise noted, contributors are members of or associated with BDO USA LLP.

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