The IRS followed up on the Treasury Department’s Monday announcement that it is cracking down on corporate tax inversions by providing more detail on how the crackdown will work (Notice 2014-52). The new rules, which will be issued as regulations, generally apply to inversion transactions occurring on or after Sept. 22, 2014. They are designed to reduce the tax benefits and therefore the incentives for inversions, in which a multinational company based in the United States replaces its U.S. parent with a foreign parent, by curtailing the ability of the inverted company to access foreign subsidiaries’ overseas earnings without paying U.S. tax.
First, the IRS announced it will issue regulations under Sec. 7874(c)(6) (which permits regulations to be issued to treat stock as not stock), providing that, if more than 50% of the gross value of all “foreign group property” constitutes “foreign group nonqualified property,” a portion of the stock of the foreign acquiring corporation will be excluded from the denominator of the ownership fraction for purposes of determining if a company is a surrogate foreign corporation. The 50% test is applied after the acquisition and all transactions related to the acquisition, if any, are completed.
Second, regulations will be issued under Secs. 7874 and 367 that are intended to prevent transactions to avoid the substantiality test that applies to certain transfers of property. Under the substantiality test, at the time of the transfer, the fair market value (FMV) of the transferee foreign corporation must be at least equal to the FMV of the U.S. target company. The transferee foreign corporation’s FMV generally does not include assets acquired outside the ordinary course of business within the 36-month period preceding the exchange if they produce, or are held for the production of, passive income or are acquired for the principal purpose of satisfying the substantiality test. Under the proposed rules, non-ordinary course distributions the domestic entity (including a predecessor) made during the 36-month period ending on the acquisition date are treated as part of a plan, a principal purpose of which is to avoid the purposes of Sec. 7874, and will be disregarded.
In another provision to make it more difficult for corporations to avoid the 80% ownership requirements in the expanded affiliated group (EAG) rules, the third change provides that, if stock described in Sec. 7874(a)(2)(B)(ii) of a foreign acquiring corporation is received by a former corporate shareholder or former corporate partner of the domestic transferring corporation, and, in a transaction related to the acquisition, the transferred stock is transferred again, the transferred stock is not treated as held by a member of the EAG for applying the EAG rules. The transferred stock is included in the numerator and the denominator of the ownership fraction.
Finally, the regulations will contain provisions to address certain tax-avoidance strategies by (1) preventing the evasion of Sec. 956 through post-inversion acquisitions by controlled foreign corporations (CFCs) of obligations of (or equity investments in) the new foreign parent corporation or certain foreign affiliates; (2) preventing the avoidance of U.S. tax on pre-inversion earnings and profits of CFCs through post-inversion transactions that otherwise would terminate the CFC status of foreign subsidiaries and/or substantially dilute the U.S. shareholders’ interest in those earnings and profits; and (3) limiting the ability to remove untaxed foreign earnings and profits of CFCs through related-party stock sales subject to Sec. 304.