IRS Notice 2015-79 represents the latest attack on corporate inversion transactions. According to the Notice, the IRS intends to issue regulations designed to make it more difficult for U.S. companies to invert and to limit the tax benefits of this strategy.
Companies in the United States that have significant foreign-source income have used inversions to reduce the U.S. tax burden on that income. Essentially, an inversion involves moving a corporation’s tax residence from the United States to a foreign country, typically by having a foreign corporation acquire its operations.
A bit of history
In 2004, lawmakers enacted Internal Revenue Code Section 7874 in an effort to thwart the use of corporate inversions for tax avoidance. Generally, under Sec. 7874 and related regs, a foreign corporation that acquires substantially all of a U.S. corporation’s assets will be treated as a U.S. corporation for U.S. federal income tax purposes if the corporation’s former shareholders own at least 80% of the new foreign parent. If the former shareholders own at least 60%, but less than 80%, of the foreign parent, the tax code respects the new structure but limits the U.S. company’s use of certain tax attributes, such as net operating losses and foreign tax credits.
The rules don’t apply if at least 25% of the new group’s business activities (as defined in the regs) occur in the new foreign parent’s home country. This is known as the “substantial business activities exception.”
New regs make needed changes
The regs announced in the Notice would attack inversions in several ways, such as providing that the substantial business activities exception is satisfied only if the foreign parent is a tax resident of the country in which those activities take place. So, for example, the exception wouldn’t apply to an inversion involving a foreign parent whose business activities are centered in a high-tax country but whose tax residence is in a low-tax country.
It would also limit the ability of U.S. companies to obtain tax benefits by merging with a corporation in one foreign jurisdiction but organizing the new parent corporation in another foreign jurisdiction.
The “anti-stuffing” rules limit the ability of a U.S. company to avoid the 80% ownership threshold by inflating the size of the new foreign parent, typically by issuing additional stock in exchange for “nonqualified property,” such as cash or marketable securities.
The bottom line
The Notice clarifies that the rules above apply to any assets (even active business assets) acquired principally for purposes of avoiding Sec. 7874. The Notice also outlines several regs that would reduce the potential tax benefits of an inversion. If you have questions, contact your financial advisor.