The Treasury and the IRS have announced that they will be taking targeted action against corporations employing a technique known as a tax inversion in order to avoid taxation, and have issued a fact sheet and a Notice in that respect.
What happens with an inversion, is a U.S.-based multinational corporation restructures so that the U.S. parent is replaced by a foreign corporation, in order to avoid paying U.S. taxes. The administration is seeking to reduce the incentives to invert, as well as to make it more difficult to accomplish an inversion.
Inversions should be distinguished from genuine cross-border mergers, which benefit the U.S. economy. The most recent action by the IRS and Treasury eliminates certain techniques used by inverted companies in order to gain tax-free access to the deferred earnings of a foreign subsidiary. This will significantly diminish the ability of inverted companies to escape U.S. taxation. As a result, for many corporations considering mergers, inversions will no longer make economic sense.
The IRS in its releases discusses the definition of a corporate inversion. The actions described in the notice include the following:
(1) Prevent inverted companies from accessing a foreign subsidiary’s earnings while deferring U.S. tax through the use of creative loans, known as “hopscotch loans” (Code Sec. 956(e)). This will involve
(i) preventing the avoidance of Code Sec. 956 through post-inversion acquisitions by controlled foreign corporations (CFCs) of obligations of (or equity investments in) the new foreign parent corporation or certain foreign affiliates;
(ii) preventing the avoidance of U.S. tax on pre-inversion earnings and profits of CFCs through post-inversion transactions that otherwise would terminate the CFC status of foreign subsidiaries or substantially dilute the U.S. shareholders’ interest in those earnings and profits; and
(iii) limiting the ability to remove untaxed foreign earnings and profits of CFCs through related party stock sales subject to Code Sec. 304.
(2) Prevent inverted companies from restructuring a foreign subsidiary in order to access the subsidiary’s earnings tax free (Code Sec. 7701(l));
(3) Close a loophole to prevent inverted companies from transferring case or property from a CFC to a new parent to completely avoid U.S. tax (Code Sec. 304(b)(5)(B)); and
(4) Make it more difficult for U.S. entities to invert by strengthening the requirement that the former owners of the U.S. entity own less than 80 percent of the new combined entity (Code Secs. 367 and 7874). This will be accomplished by disregarding certain stock of a foreign acquiring corporation that holds a significant amount of passive assets, by disregarding certain non-ordinary course distributions, and by providing guidance on the treatment of certain transfers of stock of a foreign acquiring corporation (through a spin-off or otherwise) that occur after an acquisition.
The notice gives details on the planned actions, as well as examples of relevant transactions. In general, the regulations described in the notice will apply to acquisitions or transfers of stock completed on or after September 22, 2014. Treasury and the IRS have requested comments on the notice.
Jack Lew’s Comments
During a September 19 meeting with Australian Treasurer Joe Hockey at the G-20 Summit in Australia, Treasury Secretary Jack Lew said that America needs comprehensive tax reform with anti-inversion provisions to close loopholes and make its tax system more competitive. “While that will take time, I have been urging Congress to enact legislation to address the problem of inversions,” Lew said. “And as I have said before, we at Treasury are preparing to take administrative action, but Congress will still need to act.”
Lew also saluted the work being done at the G-20 to combat tax evasion and tax avoidance by multinational corporations.
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