The IRS has issued final regulations that target tax-motivated inversion transactions and certain post-inversion tax avoidance transactions.
The IRS has issued final regulations that target tax-motivated inversion transactions and certain post-inversion tax avoidance transactions. The final regulations retain the thresholds and substantiation requirements of the 2016 final, temporary and proposed regulations (the 2016 regulations), but make limited changes to the 2016 regulations to improve clarity and reduce unnecessary complexity and burdens on taxpayers. These changes also ensure that the final regulations do not impact cross-border transactions that are economically beneficial and not tax-motivated.
Generally, in an inversion transaction, a U.S.-based multinational expatriates by changing its tax residence from the United States to another country in an effort to avoid or reduce U.S. taxes.
Subject to certain limitations, the transaction allows the inverted company to reduce future taxes on U.S.-source earnings, such as by deducting interest paid on loans from the new foreign parent. In addition to U.S. tax base erosion, inversions may have other effects on the U.S. economy, such as reduced employment when the headquarters are moved overseas.
Code Sec. 7874 limits inversions that are tax-motivated by generally targeting transactions in which the following occur:
Under (2) above, if the former shareholders of the domestic corporation hold 80 percent or more of the stock of the foreign corporation after the transaction, the foreign corporation is treated as a domestic corporation for U.S. tax purposes. If the former shareholders hold at least 60 percent but less than 80 percent of the stock of the foreign acquiring corporation after the transaction, then the transaction is respected but use of tax attributes is limited. Transactions where the former shareholders of the domestic corporation hold less than 60 percent of the stock of the foreign acquiring corporation are generally not limited. The percentage of stock is referred to as the ownership percentage, and the fraction used to calculate the ownership percentage is referred to as the ownership fraction.
The Tax Cuts and Jobs Act of 2017 (TCJA) ( P.L. 115-97) reduced, but did not completely eliminate, the incentives for tax-motivated inversions.
Similar to the 2016 regulations, the final regulations under Code Sec. 7874 provide rules for:
However, the final regulations clarify the prior rules, provide additional exceptions to their application, and reduce complexity and unnecessary burdens on taxpayers, including by providing guidance on how to apply particular mechanical rules. Specifically, the final regulations make clarifying changes to some of the stock exclusion rules: the passive assets rule, the serial acquisition rule, and the third country rule. Clarifying changes are also made to the substantial business activities test.
In addition, the final regulations add additional exceptions to the serial acquisition rule and the third country rule to narrow their scope. To reduce complexity and ambiguity, changes are made to the passive assets rule, the NOCD rule, and the rules coordinating the application of the stock exclusion rules with the EAG rules.
The final regulations further provide rules under Code Sec. 7874 and other provisions to reduce the tax benefits of certain post-inversion tax avoidance transactions. Such rules generally prevent the post-inversion dilution of U.S. shareholders’ interests in expatriated foreign subsidiaries.
The final regulations apply the passive assets rule only for purposes of determining the ownership percentage by value. The passive assets rule is also modified so that stock excluded under any of the stock exclusion rules is not taken into account. In addition, property that gives rise to stock excluded under any of the stock exclusion rules is not taken into account for purposes of this rule.
The final regulations retain the 36-month look-back period for the serial acquisition rule, but make three technical clarifications or modifications to this rule. Specifically, the final regulations:
The final regulations also:
The applicability dates of the rules in the final regulations are generally the same as the applicability dates of the rules as set forth in the 2016 regulations. However, differences between the final regulations and the 2016 regulations generally apply on a prospective basis, with an option for taxpayers to apply the differences retroactively. Since taxpayers may have relied on the 2016 regulations, the modifications to the final regulations generally apply prospectively. However, domestic entity acquisitions completed before July 12, 2018, continue to be subject to those rules as set forth in the 2016 regulations, but generally with an option for taxpayers to apply the differences retroactively.