U.S. Sandwich Structures in the International Inbound Context

By Mitchell Weiss, J.D., Chicago, IL, and Jeremy Hagee, J.D., LL.M., Chicago, IL

Editor: Jon Almeras, J.D., LL.M.

Foreign Income & Taxpayers

When a foreign multinational operates in the United States through a U.S. group that has underlying foreign operations—known as a “U.S. sandwich structure”—repatriating the U.S. group’s foreign earnings often results in tax inefficiencies. This is because the after-tax foreign earnings may be subject to multiple layers of income and withholding tax as the earnings are repatriated up the ownership chain from the foreign operating entities (the controlled foreign corporations, or CFCs) to the U.S. group and then to the foreign parent. U.S. sandwich structures are also operationally inefficient, as the interposition of the U.S. group may prevent the foreign parent from achieving cost savings and business synergies by eliminating redundant sales and administrative functions, consolidating plants, and cross-selling products and services among the various operating units.

Out-from-Under Planning Techniques

To eliminate, or at least mitigate these inefficiencies, foreign multinationals frequently restructure their U.S. group such that the income of the underlying CFCs inures to the foreign parent or is otherwise earned outside the U.S. tax net. In the past, this restructuring, sometimes referred to as “out-from-under” planning, often was ac complished through a parent-subsidiary stock sale, whereby a foreign holding company of the CFCs would check the box on the CFCs and sell them to the foreign parent in exchange for stock of the U.S. parent. Sec. 304(a)(2) treats the stock sale as a dividend-equivalent redemption of the U.S. parent’s stock. For foreign tax purposes, the disposition of the U.S. parent stock may be largely tax free, due to a basis offset and, in certain countries, any resulting gain may be largely exempt from local country tax.

Before the change in law discussed below, the dividend-equivalent redemption amount was treated for U.S. tax purposes as a dividend, first to the extent of the earnings and profits (E&P) of the acquiring foreign holding company and then to the extent of the E&P of the U.S. parent. This transaction removed the CFCs out from under the U.S. tax net. It also resulted in the E&P of the CFCs “hopscotching” around the U.S. group, as the redemption amount was treated as foreign-source dividend income for U.S. tax purposes and thus not subject to U.S. withholding tax. Checking the box on the CFCs before the disposition would reduce the amount of any subpart F inclusion to the U.S. group, and if the value of the CFCs exceeded the E&P of the acquiring foreign holding company, the acquisition of the “hook” stock in the U.S. parent would not trigger an income inclusion under Sec. 956.

To combat perceived abuses in this area, Congress amended Sec. 304(b) on August 10, 2010, as part of the Education Jobs and Medicaid Assistance Act of 2010, P.L. 111-226. This new provision, Sec. 304(b)(5)(B), provides that, in the case of a stock acquisition by a foreign corporation, the E&P of the foreign acquiring company is not taken into account in determining the dividend-equivalent amount if more than 50% of the dividends arising from the stock purchase would have been neither (1) subject to U.S. income tax in the year of the transaction nor (2) included in the E&P of a CFC. When this provision applies, the E&P of the foreign acquiring company is not eliminated, and thus the hook stock in the U.S. parent may result in an income inclusion under Sec. 956.

This legislation significantly changed the means by which foreign multinationals can reduce the potential adverse tax consequences of a restructuring while still resolving business inefficiencies associated with their U.S. sandwich structures. Numerous out-from-under planning techniques are still available, one of which is discussed below.

Preferred Stock Freeze

The “preferred stock freeze” is not new but, in light of the amendment to Sec. 304(b)(5), has been in vogue lately. Rather than completely removing the CFCs’ earnings from the U.S. tax net, this tax planning technique limits the U.S. group’s foreign earnings to an interest-like yield. The earnings in excess of this interest-like yield inure to the foreign parent or another foreign affiliate that is subject to a lower effective tax rate.

There are numerous ways of structuring a preferred stock freeze, each having its own advantages and disadvantages depending on the group’s organizational structure, the E&P and other tax attributes of the group, and the value of the CFCs relative to the other foreign entities involved in the restructuring. While the structuring alternatives vary, the overriding business objectives are often the same: To integrate the group’s operations, eliminate the number of redundant legal entities, and create a more efficient repatriation structure. Accomplishing these business objectives in a tax-free manner often presents a number of technical challenges, some of which are discussed below.

Structuring considerations: The U.S. group and the foreign parent could form a new foreign holding company that would acquire the CFCs and other foreign operating entities from the U.S. group and the foreign parent, respectively. Assuming the foreign holding company is a CFC, and the U.S. group enters into a five-year gain recognition agreement, the transfer of the CFCs should qualify for nonrecognition treatment under Sec. 351. This planning technique is effective because the ownership split is structured in a way that maintains the controlled foreign corporation status of the CFCs that were transferred to the foreign holding company. Hence, the transaction avoids triggering a deemed dividend to the U.S. group under Sec. 367(b). Rather, the CFCs’ E&P remains within the transferred CFCs or within the foreign holding company.

Depending on the tax profiles involved, it may be more advisable to structure the transfer of the CFCs as a B reorganization or as a D reorganization by checking the box on the CFCs after the transfer or actually liquidating the CFCs into the foreign holding company. A preexisting foreign subsidiary of the foreign parent also could be used as the foreign holding company. This, however, may make it more difficult to satisfy the 80% control requirement for nonrecognition treatment under Sec. 351.

To satisfy this control requirement, stock previously owned by a transferor is taken into account unless the stock received by such transferor for the additional property transferred is of a relatively small value when compared to the value of the stock previously owned by the transferor. Other structuring alternatives, therefore, may need to be considered if an existing operating entity must be used as the holding company and the foreign parent is unable to transfer more than a token amount of property. For example, nonrecognition treatment still may be possible if the restructuring is ef fected through a D reorganization. Alternatively, the foreign parent could transfer the preexisting operating entity down below an existing CFC that would serve as the foreign holding company.

None of the structuring alternatives discussed above would freeze the value of the U.S. group’s interest in the CFCs if the U.S. group receives common shares in the foreign holding company. This is because the common shares would appreciate in value as the combined business operation appreciates in value. A freeze may be beneficial to the U.S. group in that the U.S. group would have less risk if the value of the investment decreases. To achieve the freeze, the U.S. group could receive preferred shares in the foreign holding company or recapitalize its common shares into preferred shares. If a recapitalization is required, it is likely that the transaction would qualify as an E reorganization, if an existing CFC is used as the foreign holding company.

The preferred shares must be structured in a manner that avoids the application of Sec. 351(g). Otherwise, the nonqualified preferred shares received by the U.S. group in the exchange will be treated as boot and result in the taxable disposition of the CFCs. To avoid application of Sec. 351(g), the preferred shares should not carry a redemption right or obligation that may be exercised within 20 years, and the coupon rate should not be tied to an interest rate or equivalent index, among other criteria.

Depending on the anticipated exit strategy, it also may be advisable to ensure that the preferred shares are not classified as Sec. 306 stock. Were that the case, the amount realized on certain dispositions of the preferred shares would be characterized as ordinary income to the extent the U.S. group would have received a dividend had it received cash, rather than the preferred shares, when the CFCs were transferred to the foreign holding company. Such ordinary income would not carry with it any Sec. 902 indirect foreign tax credits, and any loss realized on the preferred shares would not be recognized. Accordingly, in certain circumstances, the sale of Sec. 306 stock could result in ordinary income inclusion, without the benefit of any Sec. 902 indirect foreign tax credits, even though the shares were actually sold at a loss.

Subpart F considerations: If properly structured, the preferred shares will limit the U.S. group’s interest in the foreign holding company to a fixed, market-based return on the preferred shares, thereby capping the amount of the foreign holding company’s earnings (including the income from the underlying CFCs) that is subject to U.S. tax. The earnings in excess of the coupon rate on the preferred shares, including any subpart F income, will inure to the benefit of the common shares held by the foreign parent. As a trade-off for capping the amount of income subject to the U.S. tax net, the U.S. group will be taxed on a current basis each year as the dividends are paid on the preferred shares. Such dividends, however, will include a gross-up for the portion of the foreign taxes paid on the underlying income, and thus the Sec. 902 foreign tax credits associated with the preferred dividends may further mitigate the U.S. group’s tax exposure on the foreign holding company’s earnings.


In the international inbound context, U.S. sandwich structures make it challenging to integrate operations, exploit synergies, and efficiently repatriate the earnings of the foreign operating entities to the foreign parent. Despite the recent addition of Sec. 304(b)(5)(B) to the Code, effective planning techniques still remain for dismantling these sandwich structures in a tax-efficient manner. The technical path, however, is challenging, and many traps lie in wait. Careful tax planning is therefore an essential ingredient in restructuring a foreign multinational’s U.S. sandwich structure in a way that accommodates its business objectives.

The authors would like to thank Robert Stricof, the leader of Deloitte Tax LLP’s Global U.S. Investment Services group, and Robert Rothenberg from Deloitte Tax LLP’s Washington National Office for their helpful comments on this item.


Jon Almeras is a tax manager with Deloitte Tax LLP in Washington, DC.

For additional information about these items, contact Mr. Almeras at (202) 758-1437 or jalmeras@deloitte.com.

Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP.

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