Anti-Inversion Notice Issued: IRS and Treasury Issue Guidance Intended to Reduce the Tax Benefits of Inversion Transactions

Sullivan & Cromwell LLP - September 24, 2014

On September 22, 2014, the Internal Revenue Service (the “IRS”) and the Treasury Department (the “Treasury”) issued Notice 2014-52 (the “Notice”) announcing that the Treasury and the IRS intend to issue regulations that will address inversion transactions and certain post-inversion transactions that the IRS and the Treasury characterize as tax avoidance transactions. According to the Treasury, the forthcoming regulations are intended to reduce the potential tax savings that could be extracted from inversion transactions and generally tighten the rules on cross-border mergers. The Notice is generally applicable to acquisitions completed on or after September 22, 2014 (even if completed pursuant to an agreement in place prior to that date), and to certain transactions completed on or after that date where the inversion transaction is also completed on or after that date.

The Notice describes regulations the IRS and Treasury intend to issue with respect to two categories:

  • Limiting for ten years after the inversion the new foreign parent’s ability to access earnings of controlled foreign corporations (“CFC”) by:
  • Preventing inverted companies from accessing earnings of existing CFCs using “hopscotch” transfers or using “de-controlling” transactions.
  • Preventing tax-free transfers of property or cash from a CFC to the new foreign parent in certain Section 304 transactions.
  • Limiting the ability of U.S. corporations to satisfy the ownership threshold necessary for an expatriation to be respected by:
  • Limiting the ability of a U.S. corporation to invert with a foreign corporation that has substantial liquid assets (e.g., so-called “cash boxes”).
  • Limiting the ability of U.S. corporations to satisfy the various ownership tests by making “skinny-down” distributions (including a per se test for Section 7874 and an anti-“skinny-down” rule for Section 367).
  • Limiting the ability of U.S. corporations to take advantage of the internal group restructuring exception to engage in what the IRS calls “spinversions”.

The Notice is generally targeted at “inversion transactions,” defined by the Notice as effectively those cross-border combinations where stock holders of the U.S. party end up holding between 60 percent and 80 percent of the combined entity, with some exceptions noted below. The scope of the Notice could make “mergers of equals” relatively more attractive.

The Notice does not change the 80 percent ownership threshold required for an “inverted corporation” not to be treated as a domestic corporation, does not modify the “substantial business activities” exception, and does not specifically address “earnings stripping” through additional leverage. However, the IRS and Treasury reserved further action on the last point, and specifically stated their expectation that, “to the extent any tax avoidance guidance applies only to inverted groups, such guidance will apply to groups that complete inversion transactions on or after September 22, 2014.”