Corporate Inversion Transactions: IRS Announces Intent to Issue Regulations Under Section 367 Directed at Certain TransactionsSullivan & Cromwell LLP - April 28, 2014
On April 25, 2014, the IRS issued Notice 2014-32 (the “Notice”), stating that the IRS and Treasury Department will issue regulations (the “Regulations”), to be effective immediately, targeting certain transactions that the IRS believes to be contrary to the policy underlying Section 367 which imposes tax on shareholders of a US target that is acquired by a foreign acquirer (i.e., becomes “inverted”) where transferring US shareholders own more than 50% of the combined entity. The Notice is aimed at inversion transactions that were structured to avoid such shareholder-level gain recognition. As a result, inversion transactions in which the former US shareholders of the acquired US corporation end up with more than 50% of the foreign acquirer will likely be taxable transactions to the former shareholders of the US corporation (and an excise tax may also apply to certain previously deferred equity compensation payable to senior executives and directors).
In the Notice, the IRS describes a transaction (the “Transaction”) where (1) a foreign corporate parent (“FP”) forms a domestic subsidiary (“USS”) that generates a small amount of earnings and profits, (2) USS acquires stock of FP in exchange for a note, and (3) USS exchanges the acquired FP stock for all the stock of a domestic target corporation (“UST”) in a tax-free triangular reorganization which results in the former US holders of UST stock acquiring a majority of FP’s stock. The Notice states that the IRS has become aware that taxpayers have designed the Transaction in a way to take the position that (i) no gain is recognized by the former US holders of UST stock on the exchange of their UST stock for FP stock and (ii) only a small amount of US withholding tax is due on USS’s deemed distribution to FP. The Notice states that the IRS and Treasury disagree with the interpretations of existing regulations underlying such intended treatment and that the Regulations will provide several important modifications and additions to the existing regulations, as discussed below.
The Notice provides that the Regulations will be effective for transactions completed on or after April 25, 2014, but generally carves out transactions that are completed pursuant to a binding agreement entered into prior to such date. The Notice states that no inference is intended regarding the treatment of the Transaction, and states that the IRS may challenge such transactions under current law.