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

Sullivan & Cromwell LLP - November 20, 2015

On November 19, 2015, the Internal Revenue Service (the “IRS”) and the Treasury Department (the “Treasury”) issued Notice 2015-79 (the “Notice”) announcing that the Treasury and IRS intend to issue regulations that will address inversion transactions and certain post-inversion transactions, expanding on guidance previously issued in Notice 2014-52 (the “Prior Notice”).  The widely anticipated “earnings stripping” guidance (adumbrated in the Prior Notice) is absent from this Notice and continues to be pending, but in the accompanying press release the Treasury appears to indicate that it could be issued in the “coming months.”  In general, the Notice leaves the Below-60 Transactions (as defined below) unaffected, but imposes greater adverse consequences for 60-80 Transactions (as defined below).

Specifically, in limiting the ability to invert, the Notice provides that new regulations would:

  • limit the ability of a U.S. party to combine with a foreign target to invert to a third foreign jurisdiction;
  • require that the “substantial business activities” test be satisfied only if the foreign acquiring corporation is subject to tax as a resident in the applicable foreign jurisdiction; and
  • clarify that “anti-stuffing” rules will apply to any assets (including active business assets) acquired with the principal purpose of avoiding the purpose of Section 7874.

These provisions are generally applicable to transactions completed on or after November 19, 2015 (even if completed pursuant to an agreement in place prior to that date).

In reducing the potential benefits of inversion, the Notice provides that new regulations would:
  • expand the scope of “inversion gain” to include certain deemed dividends so that they cannot be offset by losses or other attributes;
  • require all net unrealized built-in gain in controlled foreign corporation (“CFC”) stock be recognized, without regard to the amount of deferred earnings, upon a restructuring of the CFC; and
  • clarify the rule issued in the Prior Notice with respect to “de-controlling” or “diluting” an expatriated entity’s CFCs in post-inversion transactions. 

These provisions are generally applicable to post-inversion transfers completed on or after November 19, 2015, where the inversion transaction is completed on or after September 22, 2014 (the date of the Prior Notice).  Inversion transactions are defined by the Notice as effectively those cross-border combinations where stockholders of the U.S. party end up holding between 60 percent and 80 percent (“60-80 Transactions”) of the combined entity.

In two taxpayer-friendly developments, the Notice:
  • clarified that an active insurance business would not be treated as creating a “cash box” under the Prior Notice; and
  • created a de minimis exception to the anti-“skinny down” rules of the Prior Notice, although stating that such an exception would only apply if the “skinny down” distributions did not have an avoidance purpose. 

These taxpayer-friendly modifications to the Prior Notice are generally applicable to transactions completed on or after November 19, 2015; however, taxpayers may elect to apply them to transactions that closed before November 19, 2015.