The IRS and Treasury have issued Notice 2015-79, 2015 IRB LEXIS 583 (Nov. 19, 2015), announcing the government’s intention to issue additional regulations targeting corporate inversion transactions. The initial announcement of the government’s plan to issue regulations addressing inversion transactions was in Notice 2014-52, 2014 IRB LEXIS 576, issued in September 2014, and the new notice follows-up on the guidance provided in that prior notice. In particular, Notice 2015-79 contains guidance aimed at (1) corporate inversion transactions that are contrary to the purposes of IRC Section 7874, and also at (2) the benefits of post-inversion tax avoidance transactions.
Inversion Transactions Avoiding the Purposes of IRC Section 7874. Section 2 of the notice describes coming regulations that will address transactions structured to avoid the purposes of Section 7874. The notice states that the regulations will require the foreign acquiring corporation to be subject to tax as a resident of the relevant foreign country in order to have substantial business activities in that country. The notice states that the regulations will also disregard certain stock of the foreign acquiring corporation in "third-country" transactions. The notice further states the regulations will also clarify the definition of nonqualified property for purposes of disregarding certain stock of the foreign acquiring corporation. [Notice 2015-79, 2015 IRB LEXIS 583 ].
Substantial Business Activities of a Foreign Acquiring Corporation. The notice states that coming regulations under Section 7874 will provide that an expanded affiliated group or “EAG” (which includes the foreign acquiring corporation) “cannot have substantial business activities in the relevant foreign country when compared to the EAG’s total business activities unless the foreign acquiring corporation is subject to tax as a resident of the relevant foreign country.” [Notice 2015-79, § 2.02(a)].
Third-Country Transactions. The notice states that new regulations to be issued under IRC Section 7874(c)(6), (g) will address certain acquisitions where a domestic corporation combines with an existing foreign corporation and where the new foreign parent corporation for the combined group has a different tax residence than the existing foreign corporation and has a tax residence in a third country. The notice states that the new regulations will address these third-country transactions by “disregarding certain stock of a foreign acquiring corporation that is issued to the shareholders of the existing foreign corporation for purposes of determining whether the 80-percent threshold is met.” [Notice 2015-79, § 2.02(b)].
Definition of Nonqualified Property for Purposes of Disregarding Certain Stock of Foreign Acquiring Corporation. The notice expresses the Treasury and Service’s concern that taxpayers may be interpreting the definition of avoidance property too narrowly. Accordingly, the notice states that regulations will be issued that clarify Temporary Regulations Section 1.7874-4T to state that “avoidance property means any property (other than specified nonqualified property) acquired with a principal purpose of avoiding the purposes of Section 7874, regardless of whether the transaction involves an indirect transfer of specified nonqualified property.” [Notice 2015-79, § 2.03(b)].
Post-Inversion Tax Avoidance Transactions. Section 3 of the notice describes coming regulations that will address certain post-inversion tax avoidance transactions. The notice states that the regulations will define inversion gain for Section 7874 purposes to include certain income or gain recognized by an expatriated entity from an indirect transfer or license of property. The notice also states that the regulations will provide for aggregate treatment of certain transfers or licenses of property by foreign partnerships for purposes of determining inversion gain. The notice also states that the new regulations will require an exchanging shareholder to recognize all of the gain realized upon an exchange of stock of a controlled foreign corporation (CFC), regardless of the amount of the undistributed earnings and profits of the CFC, under certain circumstances, namely, if the transaction results in the termination of the foreign subsidiary’s status as a CFC or the substantial dilution of U.S. shareholder’s interest in the CFC. [Notice 2015-79, 2015 IRB LEXIS 583 ].
Definition of Inversion Gain. The notice expresses the Treasury and Service’s concern that certain of an expatriate entity’s indirect transfers of stock or other property (rather than an expatriated entity’s direct transfers) may result in the removal of foreign operations from U.S. taxing jurisdiction while avoiding current U.S. taxation. Notice 2015-79, § 3.01(b). Consequently, the notice states that regulations will be issued under IRC Section 7874(g) that will provide that:
“. . . inversion gain includes income or gain recognized by an expatriated entity from an indirect transfer or license of property, such as an expatriated entity's Section 951(a)(1)(A) gross income inclusions taken into account during the applicable period that are attributable to a transfer of stock or other properties or a license of property, either (i) as part of the acquisition, or (ii) after such acquisition if the transfer or license is to a specified related person. However, clause (ii) of the preceding sentence will not apply to property described in Section 1221(a)(1) in the hands of the CFC.” [Notice 2015-79, § 3.01(b)].
The notice further states that, with respect to transactions by a partnership, coming regulations will provide that “ . . . if a partnership that is a foreign related person transfers or licenses property, a partner of the partnership shall be treated as having transferred or licensed its proportionate share of that property . . . for purposes of determining inversion gain.” [Notice 2015-79, § 3.01(b)].
Stock Exchanges of an Expatriated Foreign Subsidiary. The notice expresses the Treasury and Service’s concern that “certain nonrecognition transactions that dilute a U.S. shareholder's ownership of an expatriated foreign subsidiary may allow the U.S. shareholder to avoid U.S. tax on unrealized appreciation in property held by the expatriated foreign subsidiary at the time of the exchange.” [Notice 2015-79, § 3.03(b)]. Accordingly, the notice announces that the Treasury and Service will amend the regulations under IRC Section 367(b) to provide that:
“. . . if an exchanging shareholder would be required under the rules announced in section 3.02 (e) (ii) of Notice 2014-52 to include in income as a deemed dividend the Section 1248 amount (if any) with respect to stock of an expatriated foreign subsidiary, the exchanging shareholder also must recognize all realized gain with respect to such stock, after taking into account any increase in basis resulting from a deemed dividend with respect to the exchange provided in § 1.367(b)-2(e)(3)(ii).” [Notice 2015-79, § 3.03(b)].
Corrections and Clarifications. In addition to announcing additional regulations to address inversion transactions that are contrary to the purposes of IRC Section 7874 and also the benefits of post-inversion tax avoidance transactions, the notice also announces, in Section 4, corrections and clarifications that the Treasury and Service plan to make in regards to certain rules described in Notice 2014-52.
Conclusion. Notice 2015-79 evidences the Treasury and Service’s continued concerns about corporate inversion transactions, and provides some of the additional guidance promised by the federal government after the issuance of Notice 2014-52 last fall. Uncertainty still remains as to other issues not addressed in either of the notices, most notably, the lack of guidance as to “earnings stripping” transactions. However, the Treasury has promised such guidance is on the way and not too far away. [See “Treasury Announces Additional Actions to Reduce Tax Benefits of Corporate Inversions (Nov 19, 2015),” available at https://www.treasury.gov/press-center/press-releases/Pages/jl0282.aspx]. In the meantime, the additional guidance provided in Notice 2015-79 helps clarify the rules of the game, so to speak, with respect to corporate inversion transactions, as we wait for the issuance of the proposed regulations in the coming months.
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