The Treasury issued the new Notice 2015-79 to beef up the anti-inversion section 7874. It contains three rules applicable to deals closing after the Notice and two rules that are retroactive to the 2014 Notice’s effective date. Those two rules increase the potential taxability of post-inversion restructurings. The three prospective rules are the most surprising and potentially harmful to taxpayers seeking to invert. They all relate to the use of holding company structures, which are common in cross border tax planning.
Holding company structure rules:
- If the foreign acquiring corporation (FA) is a new foreign corporation created to acquire both a foreign target (FT) and the domestic inverting corporation (domestic target or DT), then FA should be a tax resident of same country in which FT originally had its tax residence. Being a tax resident means that country considers the corporation to be domiciled in it for its tax purposes. If FT moves to a different country in anticipation of the inversion, the shift will be ignored for this purpose. If FA is not resident in the same country as FT, the FA stock issued in exchange for FT will be disregarded for purposes of the 80% test of section 7874, if FA is a surrogate foreign corporation for purposes of section 7874, which means at least 60% of the stock of FA was issued to the DT shareholders in exchange for their DT stock. If this rule applies it is likely that section 7874 will apply to defeat the inversion (make FA domestic).
- The justification for this rule is that using a third country holding company implies that there was not a business purpose for joining with FT, but rather a purpose to take advantage of the other country’s tax and treaty rules.
- Solution: If a new foreign holding company is to be put over FT, make sure it is a tax resident in the same country in which FT has its tax residence.
- The principal purpose of putting FT into a FA holding company cannot be section 7874 avoidance. If it is, the FA stock issued for FT will be ignored in determining both the 60% and 80% fractions, likely meaning that section 7874 will apply to defeat the inversion.
- Solution: The best solution is to have a good business purpose for the combination. But if concerned, don’t transfer FT to FA but rather transfer stock of DT to FT for FT stock.
- The 25% substantial business activities exception to the application of section 7874 requires that the 25% activities must occur in the country in which FA is chartered. The new Notice requires that that country must also be its tax residence for purpose of that country’s tax laws. This exception is rarely applicable now.
- Solution: Satisfy that country’s residence requirement.
