On September 22, 2014, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) issued Notice 2014-52, “Rules Regarding Inversions and Related Transactions” (“Notice”) in the wake of the recent wave of inversions. In a previous article, we covered the new regulations to be issued regarding Internal Revenue Code (“IRC”) Section 956 so-called “Hopscotch loans” and related transactions. In this article, we will examine the new Treasury and IRS regulations to be issued to address transactions to de-control or significantly dilute controlled foreign corporations (“CFCs’”) under Notice Section 3.02.
This article is intended to provide explanatory material regarding the new inversion regulations as they relate to IRC Section Sections 954, 964, and 367 de-control aspects; the article does not convey legal or tax advice. Please contact the experienced international tax law practice of Sherayzen Law Office, Ltd. for questions about your tax and legal needs.
Transactions to De-Control or Significantly Dilute CFCs
In general, foreign subsidiaries of acquired U.S. corporations will continue to hold CFC status following most expatriation transactions; such status makes these CFCs subject to U.S. taxation under the IRC subpart F provisions. Prior to the Notice, however, companies could structure inversions so that the newly-formed foreign parent would purchase sufficient stock in order to remove control (or “de-control”) of an expatriated foreign subsidiary away from the former U.S. parent company so that the foreign subsidiary would no longer be treated as a CFC.
By ceasing to be a CFC, as noted in the Notice, companies could thus “Avoid the imposition of U.S. income tax, so as to avoid U.S. tax on the CFC’s pre-inversion earnings and profits. For example, after an inversion transaction, a foreign acquiring corporation could issue a note or transfer property to an expatriated foreign subsidiary in exchange for stock representing at least 50 percent of the voting power and value of the expatriated foreign subsidiary. The expatriated foreign subsidiary would stop being a CFC, and the U.S. shareholders would no longer be subject to subpart F of the Code with respect to the expatriated foreign subsidiary…” Such an effect could also be achieved if the foreign acquiring corporation acquired enough stock to substantially dilute a U.S. shareholder’s ownership of the CFC; U.S. taxation of the CFC’s pre-inversion earnings and profits could be avoided if the CFC later redeemed on a non-pro rata basis, its stock held by the foreign acquiring corporation. (The Notice also provides other similar examples of pre-Notice tax avoidance strategies).
Regulations to Address Transactions to De-Control or Significantly Dilute CFCs
In response to the concerns addressed in the previous paragraphs, under Notice Section 3.02, Treasury and the IRS will issue regulations under IRC Section 7701(l) to “Recharacterize certain transactions that facilitate the avoidance of U.S. tax on the expatriated foreign subsidiary’s pre-inversion earnings and profits”, and they also intend to issue new regulations to modify the application of IRC Section 367(b) in order to require, “[I]ncome inclusion in certain nonrecognition transactions that dilute a U.S. shareholder’s ownership of a CFC.”
Under IRC Section 7701(l), Treasury and the IRS intend to issue regulations providing that a “specified transaction” will be recharacterized under the procedures of the Notice. A specified transaction is defined to be a, “[T]ransaction in which stock in an expatriated foreign subsidiary… is transferred (including by issuance) to a ‘specified related person.’” A specified person is defined to mean a, “[N]on-CFC foreign related person… a U.S. partnership that has one or more partners that if completed during is a non-CFC foreign related person, or a U.S. trust that has one or more beneficiaries that is a non-CFC foreign related person.”
Under the Notice, “if an expatriated foreign subsidiary issues specified stock to a specified related person, the specified transaction will be recharacterized as follows: (i) the property transferred by the specified related person to acquire the specified stock (transferred property) will be treated as having been transferred by the specified related person to the section 958(a) U.S. shareholder(s) of the expatriated foreign subsidiary in exchange for instruments deemed issued by the section 958(a) U.S. shareholder(s) (deemed instrument(s)); and (ii) the transferred property or proportionate share thereof will be treated as having been contributed by the section 958(a) U.S. shareholder(s) (through intervening entities, if any, in exchange for equity in such entities) to the expatriated foreign subsidiary in exchange for stock in the expatriated foreign subsidiary.” (See Notice for further information).
Further, under IRC Section 367(b), Treasury and the IRS also intend to amend the section’s regulations, in general, to require that “an exchanging shareholder described in §1.367(b)-4(b)(1)(i)(A) will be required to include in income as a deemed dividend the section 1248 amount attributable to the stock of an expatriated foreign subsidiary exchanged in a “specified exchange”. A specified exchange is defined to mean an exchange “in which a shareholder of an expatriated foreign subsidiary exchanges stock in the expatriated foreign subsidiary for stock in another foreign corporation pursuant to a transaction described in §1.367(b)-4(a).” Exceptions may be applicable in certain cases under the Notice. (See Notice for more details).
Effective Date for Notice Section 3.02(e)
The effective dates of Notice Section 3.02(e) will apply to specified transactions and specified exchanges (see definitions above) completed on, or after, September 22, 2014 (but only if the inversion transaction is completed on, or after, September 22, 2014). The Notice is currently in the comment period.
With the new Treasury and IRS Notice, the need for successful international tax and legal planning will only increase. If you need legal and tax assistance, please contact Attorney Eugene Sherayzen at Sherayzen Law Office, Ltd. for questions about your tax and legal needs.