In an attempt to curb the significant number of “inversion transactions,” the IRS has issued Notice 2014-52. An inversion, or expatriation, occurs when a U.S. company becomes a subsidiary of a foreign company usually through a merger or transfer of substantially all of its assets to a foreign company. One benefit of inversion transactions for U.S. companies is the ability to avoid U.S. tax on the earnings of the foreign subsidiaries and reduce U.S. tax by paying fees and expenses to the foreign parent. Internal Revenue Code (IRC) Section 7874 was added in 2004 to address inversion transactions. Under these rules, in addition to other criteria, if an inverted company had 80 percent or more common ownership after the transaction compared to immediately before the inversion, the inverted company is still considered to be a U.S. company and not a foreign company. If the post-inversion common ownership is between 60 percent and 80 percent, the transaction could be taxable to the shareholders, and there are limits on the ability to use certain pre-inversion attributes to reduce taxable income. However, these provisions have failed to stem the tide of inversions.
In Notice 2014-52, the IRS has indicated that it intends to issue new regulations under IRC Sections 304(b)(5)(B), 367, 956(e), 7701(l) and 7874. Treasury and the IRS have taken these steps as a result of the inability of Congress to offer a legislative solution to stop inversions. While the new regulations do not prevent inversions from occurring, they might make them less attractive and more difficult to accomplish. The regulations will apply to transactions completed on or after Sept. 22, 2014.
The new regulations under IRC Section 7874 will cause certain stock issued following an inversion to be included in the tests for common ownership, possibly expanding the application of the 80 percent or 60 percent rules. In addition, the new rules will make it more difficult for inverted companies to use “hopscotch loans,” which bypass the U.S shareholder, to access the cash of controlled foreign corporations. The new regulations also will make it more difficult to dilute the ownership of the foreign corporation so that it no longer is a controlled foreign corporation to avoid the application of the investment in U.S. property rules under IRC Section 956. The IRS also intends to issue regulations to prevent the removal of earnings and profits of controlled foreign corporations via IRC Section 304, in which certain intragroup stock sales are considered to be redemptions.
The IRS indicated it will look at additional measures to reduce the benefits of inversions. Taxpayers need to analyze the new regulations for any transactions not completed prior to Sept. 22, 2014, to determine if the anticipated benefits remain. For transactions completed prior to Sept. 22, taxpayers should be aware the IRS might challenge such transactions under applicable code provisions or judicial doctrines.