Over the years there has been a number of high profile corporate inversions. However, recent tax law changes have significantly reduced the incentive for U.S. corporations to invert. Despite the reduced incentive for U.S. corporations to expatriate from the United States, in certain cases, particularly when the U.S. corporation is wholly owned by foreign investors, there may be a number of strong incentives for a U.S. corporation to expatriate to a foreign jurisdiction. This article discusses how the anti-inversion rules tax corporate expatriations. For more information in regards to how the U.S. taxes individuals that wish to expatriate from the United States, please find a link to our blog “Thinking About Renouncing Your Citizenship if Your Presidential Candidate Does Not Win the Election? Here is What You Need to Know About the Expatriation Tax.
What are the Anti-Inversion Rules?
The anti-inversion rules primarily target corporate inversions, where a U.S. corporation becomes a subsidiary of a foreign corporation to reduce its U.S. tax burden. Section 7874 of the Internal Revenue Code was enacted to nullify the tax benefits of a corporate inversion. As indicated above, the inversion exit tax for corporations is not a single, straightforward tax calculation. Rather, the tax implications of an inversion is determined by the percentage of ownership of the original U.S. shareholders of the expatriating corporation that becomes a shareholder in a newly formed foreign corporation after the inversion transaction:
The anti-inversion rules apply if the shareholders of the former U.S. corporation own 80 percent or more by vote or value of the shares of the foreign entity as a result of the inversion transaction and both 1) the U.S. corporation either becomes a subsidiary of a foreign corporation or transfers substantially all of its properties to a foreign corporation and 2) the newly formed foreign company does not have substantial business activities in the foreign corporation’s country of incorporation compared to the total worldwide business activities of the newly formed foreign corporation. If these tests are satisfied, the newly formed foreign company will still be treated as a U.S. corporation for U.S. tax purposes and the new foreign company will continue to be subject to U.S. taxation on its worldwide income.
Below, please see Illustration 1 which discusses how the anti-inversion rules apply when former U.S. shareholders of an inverted U.S. corporation own at least 80 percent (by vote or value) of the shares of the newly foreign company.
Illustration 1.
Tech Co, a publicly held U.S. C corporation, owns Foreign Sub, a controlled foreign corporation. Cayman Co, a foreign corporation incorporated in the Cayman Islands, is formed and Cayman Co forms a U.S. acquisition corporation, U.S. Acquisition Co. In a transaction designed to what would otherwise be a tax-free forward triangular reorganization under Section 368(a)(2)(D) of the Internal Revenue Code, Tech Co’s shareholders receive 100 percent of the shares of Cayman Co as Tech Co mergers into U.S. Acquisition Co. The resulting structure has the former Tech Co shareholders now owning all the shares of Cayman Co and U.S. Acquisition Co which holds the operating business of the former U.S. Tech Co. The new foreign structure also owns Foreign Sub.
Under the anti-inversion rules, the former Tech Co shareholders own 80 percent or more of Cayman Co and both 1) Tech Co shareholders own 80 percent or more of Cayman Co and 2) the group of Cayman Co, U.S. Acquisition Co, and Foreign Sub do not have substantial business activities in Cayman Co’s country of incorporation compared to its total worldwide business activities of the group. As a result, Cayman Co is treated as if it were a U.S. corporation for U.S. federal tax purposes.
If U.S. shareholders own at least 60 percent (but less than 80 percent), by vote or value of the newly formed foreign company, the anti-inversion rules that govern the transaction are different. In such a situation, the foreign corporation is respected as a foreign entity for U.S. tax purposes, but the expatriating U.S. corporation must recognize an “inversion gain” (income or gain from the transfer of assets or property to foreign affiliates as part of the inversion). In these situations, any applicable gain may not be offset by any net operating losses or foreign tax credits for tax years following the inversion transaction.
Below, please see Illustration 2 which discusses how the anti-inversion rules apply when former U.S. shareholders of an inverted U.S. corporation own at least 60 percent (but less than 80 percent), by vote or value of a newly formed foreign corporation.
Illustration 2.
Tech Co, a publicly held U.S. C corporation, owns Foreign Sub, a controlled foreign corporation. Cayman Co, a foreign corporation incorporated in the Cayman Islands, is formed and Cayman Co forms a U.S. acquisition corporation, U.S. Acquisition Co. In a transaction designed to what would otherwise be a tax-free forward triangular reorganization under Section 368(a)(2)(D) of the Internal Revenue Code, Tech Co’s shareholders receive 60 percent of the shares of Cayman Co as Tech Co merges into U.S. Acquisition Co. The resulting structure has the former Tech Co shareholders now owning all the shares of Cayman Co and U.S. Acquisition Co which holds the operating business of the former U.S. Tech Co. The new foreign structure also owns Foreign Sub.
Under the anti-inversion rules, in this example, Tech Co will recognize taxable gain on the distribution of all its assets (including the Foreign Sub’s assets) to Cayman Co. The taxable gain is subject to the standard U.S. corporate rate which is currently 21 percent.
The former shareholders of Tech Co will also realize a tax to the extent that the fair market value of the Cayman Co shares received exceeds their basis in their former Tech Co shares. See IRC Section 367(a). In addition, because the former Tech Co shareholders own at least 60 percent (but less than 80 percent) of the shares of Cayman Co, any taxable gain realized for U.S. tax purposes under the anti-inversion rules may not be reduced with foreign tax credits or net operating losses over the next 10 years. Furthermore, there is a separate consequence for certain executives and directors is a 15% excise tax on the value of their stock options and stock-based compensation at the time of the inversion.
Conclusion
The tax laws regarding transfers of stock or securities of a U.S. corporation to a foreign corporation, discussed above, reflect, in part, concerns that the Internal Revenue Service (“IRS”) has regarding so-called “corporate inversion” or “corporate expatriation” transactions in which U.S. corporations reorganizes into a foreign corporation or becomes a subsidiary of a foreign corporation. This article is intended to provide the reader with a basic understanding as to how the anti-inversion rules are applied. It should be evident from this article that this is an extremely complex subject. It is important to note that this area is constantly subject to new development and changes, as Congress continually entertains new tax laws, the Treasury promulgates new regulations, and federal courts issue new opinions that impact the subject matter discussed in this article. As a result, it is crucial that a qualified international tax attorney be involved in the planning of a corporate expatriation at the early stages of planning.
Anthony Diosdi is an international tax attorney at Diosdi & Liu, LLP. Anthony has advised various Fortune 500 companies and large privately held businesses in their cross-border tax planning. Anthony is the author of a number of published articles addressing cross-border taxation. Anthony also frequently provides continuing educational programs regarding various international tax topics.
Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.
Written By Anthony Diosdi
Anthony Diosdi focuses his practice on international inbound and outbound tax planning for high net worth individuals, multinational companies, and a number of Fortune 500 companies.
