U.S. corporations often explore using corporate inversion transactions to reduce their U.S. tax liability by relocating their tax residence to that of a smaller acquired foreign company. In response, the IRS and U.S. Department of Treasury continue their efforts to limit the effectiveness of corporate inversions in two separate actions:
- Limiting exceptions to taxing inversion transactions in final regulations issued in March of 2016
- Issuing proposed, temporary, and final regulations that stiffen the inversion rules and attempt to limit earnings stripping
In the first action, the IRS and Treasury issued final regulations in Treasury Decision 9760. The final regulations are substantially identical to temporary regulations issued in 2013 that eliminated one of three exceptions to a coordination rule. The exception that was eliminated allowed certain foreign reorganization transactions to be nontaxable. The regulations also specify that companies qualifying for one of the two remaining exceptions to the coordination rule cannot end up with an asset basis greater than the original basis.
In the second action, the IRS and Treasury issued temporary and final regulations that implement several expected rules from previously issued IRS guidance and simultaneously issued proposed regulations that limit earnings-stripping transactions. Among other items, the new proposed rules:
- Disregard stock of a U.S. company purchased by a foreign company three years prior to the signing date of the foreign company’s latest U.S. company acquisition. This change limits a foreign company’s ability to circumvent the inversion rules by acquiring multiple U.S. companies in a short period of time.
- Limit earnings stripping by targeting increases in related-party debt that does not finance new investment in the U.S. Specifically, the regulations include anti-abuse rules that would:
- Treat a debt instrument as stock if a U.S. subsidiary distributes it to a foreign parent as a dividend
- Address a “two-step” version of a dividend distribution of debt in which a U.S. subsidiary borrows cash from a related company and pays a cash dividend to its foreign parent
- Treat a debt instrument as stock if it is issued in connection with an acquisition of stock or assets of a related corporation and there are no meaningful nontax consequences
- Allow the IRS on audit to split a purported debt instrument to a related party as part debt and part stock.
- Require documentation for members of large groups so the IRS can conduct a debt versus equity analysis for related-party debt. The documentation includes a binding obligation for an issuer to repay the principal amount borrowed, creditor’s rights, a reasonable expectation of repayment, and evidence of an ongoing creditor-debtor relationship.
The IRS and Treasury have indicated they expect to move quickly to finalize the proposed and temporary regulations. In general, the regulations will not be effective for transactions on or before April 4, 2016, but taxpayers should review any prior transactions carefully as some of the temporary regulations based on prior IRS guidance may have effective dates that go back to 2014.