Tax-Free Acquisitions of U.S. Companies Considerations

Expenditures by foreign direct investors to acquire U.S. businesses totaled $232.2 billion in 2025, according to preliminary statistics released by the Bureau of Economic Analysis. Expenditures increased $76.8 billion, or 49.5 percent, from 2024 levels. Many of the foreign acquisitions of U.S. companies were done through tax-free reverse or forward triangular mergers and acquisitions. In order for such a merger or acquisition to be done tax-free for U.S. tax purposes, three sets of U.S. tax rules must be considered when planning an acquisition of a U.S. corporation by a foreign corporation. To be tax-free for U.S. federal income tax purposes, an acquisition of a U.S. corporation by a foreign corporation must satisfy the following: 1) Section 367 regulations, 2) Section 368 reorganization / Section 351 rules, and 3) the anti-inversion rules of Section 7874. This article discusses these three requirements.

The “Helen of Troy” Regulations of Section 367

When appreciated property, such as equipment or intangible property rights is transferred to a foreign corporation, gain will often be realized by the U.S. person. This gain will be recognized and subject to U.S. federal tax unless one of the tax-free-exchange provisions of the Internal Revenue Code applies. Thus, if a U.S. company is liquidated and its assets are distributed to foreign shareholders, U.S. tax will be imposed on the gain realized by the distributing company except to the extent that a tax-free-exchange provision provides otherwise.

Section 367 was enacted to prevent tax-free transfers by U.S. taxpayers of appreciated property to foreign corporations that could then sell the property free of U.S. tax. Section 367 stands sentinel to ensure that (with certain exceptions) a U.S. tax liability (sometimes called a “toll charge”) is imposed when property with untaxed appreciation is transferred beyond U.S. taxing jurisdiction. It generally accomplishes this objective by treating the foreign transferred corporation as not qualifying as a “corporation” for purposes of certain tax-free-exchange provisions. As discussed in more detail below, to avoid the Section 367 “toll charge,” the transaction must satisfy five key conditions:

1. U.S. transferors of U.S. target stock can avoid immediate tax if they receive 50% or less of the total voting power and value of the foreign acquiring stock;
2. The U.S. persons cannot own more than 50% of the foreign acquirer in total immediately after the transfer;
3. Section 367 includes several requirements, including a requirement that the foreign acquiror must have been engaged in an active trade or business outside the U.S. continuously for the entire 36-month pre-closing period. The regulations under Section 367 provide that “[i]n general, a trade or business is a specific unified group activities that constitute (or could constitute) an independent economic enterprise carried on for profit. The group of activities must ordinarily include the collection of income and the payment of expenses.”
4. If U.S. shareholders receive between 50% and 80% of the foreign acquirer, they may sometimes execute a formal gain recognition agreement (“GRA”) to defer gain, agreeing to retroactively pay tax if the foreign buyer disposes of stock within a statutory timeframe. Through a GRA, shareholders agree to recognize taxable gain realized, but not recognized, on the transaction before the 5th full taxable year following the transaction.
5. The IRS may, in limited circumstances, issue a Private Letter Ruling (“PLR”) to permit a transaction to qualify as tax-free under Section 367 even if it does not fully the greater equity value and active trade or business requirement, provided the transaction meets all the other Section 367 requirements. The IRS has issued the following PFRs under its substantial compliance authority, including:

PLR 201935004, PLR 201141011/201141012, PLR 200913008, PLR 200709054, PLR 9849014, PLR 199903048, PLR 199929039, PLR 200440009, & PLR 200536017

Section 351 Considerations

When property is transferred to a corporation in exchange for stock, recognition of gain or loss is governed by Section 351 and, if gain on a transfer to a foreign corporation is involved, Section 367 may reclassify the transaction. Under Section 351, no gain or loss is recognized 1) if property is transferred to a U.S. corporation by one or more persons solely in exchange for stock in the corporation and 2) if immediately after the exchange such person or persons are in control of the corporation. “Control” for this purpose means ownership of at least 80 percent of the total combined power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of each other class of stock. Section 351 thus may come into play whenever property with a value greater or less than its basis is transferred to a newly formed corporation by the initial subscribers to its stock. It may also operate to prevent recognition of gain or loss when such property is transferred to an existing corporation. However, as discussed above, where a transfer of property to a foreign corporation in exchange for its stock is involved, the nonrecognition of gain under Section 351 will apply only to the extent provided in Section 367.

Section 368 Reorganizations

The Internal Revenue Code provides for nonrecognition of gain or loss realized in connection with a number of corporate organizational changes. The basic types of reorganization found in Section 368 of the Internal Revenue Code are:

• Type A reorganization. In a Type A reorganization, the assets and liabilities of a target corporation are transferred to an acquiring corporation in a statutory merger or consolidation, and the target corporation is dissolved. The consideration received by the target’s shareholders is determined by the merger agreement. Internal Revenue Code Section 368(a)(1)(A) does not expressly limit the permissible consideration in a merger or consolidation. The IRS requires that at least 50% of the consideration paid must consist of stock. In the context of international corporate acquisitions, tax-free mergers may take the form of forward triangular mergers, in which the acquired corporation is merged into a subsidiary of the acquiring corporation.
• Type B reorganization. A Type B reorganization takes place when a purchaser acquires the stock of a target corporation solely in exchange for the purchaser’s voting stock, provided that the purchaser is in “control” of the target immediately after the acquisition. See IRC Section 368(a)(1)(B). For this purpose, “control” is ownership of 80% or more of the target’s voting power and 80% or more of the total shares of each class of the target’s nonvoting stock.
• Type C reorganization. A Type C reorganization generally takes place when the purchaser acquires substantially all of the target’s assets solely in exchange for the purchaser’s voting stock (or voting stock of the purchaser’s parent).
• Type D reorganization. A Type D reorganization takes place when there is a transfer by a corporation of part or all of its assets to another corporation if immediately after the transfer the transferor and/or its shareholders are in control of the transferee corporation and if the stock of the transferred corporation are distributed in a transaction qualifying under Section 354, 355, or 356.
• Type E reorganization. A Type E reorganization is recapitalization of a corporation.
• Type F reorganization. A Type F reorganization is a mere change in identity, form, or place of organization of one corporation, however effected.
• Type G reorganization. A Type G reorganization is a transfer by one corporation of all or part of its assets to another corporation in a bankruptcy or similar proceeding.

In order for a tax-free acquisition of a U.S. company by a foreign corporation to take place, the acquisition transaction must satisfy one of the Section 368 tax-free reorganizations discussed above. A significant portion of acquisitions of U.S. companies by foreign corporations are done through Type A forward triangular mergers. From the time it was authorized as a tax-free reorganization, the forward triangular merger has become one of the most widely used acquisition techniques. Section 368(a)(2)(D) permits a subsidiary (“S”) to acquire a target (“T”) in a statutory merger, using purchaser’s (“P”) stock as consideration, provided that: (1) S acquires “substantially all” of the properties of T; (2) no stock of S is used in the transaction; and (3) the transaction would have qualified as a Type A reorganization if T had merged directly into P. Since a significant portion of the acquisition of U.S. companies are done through Type A reorganizations, this article will focus on Type A tax-free reorganizations.

Type A Reorganization

Description of the Basic Type A Reorganization

The Type A reorganization is defined in the Internal Revenue Code as a statutory merger or consolidation. For this purpose, “statutory” refers to a merger or consolidation pursuant to local corporate law. Under a typical state merger statute, the assets and liabilities of the target corporation are transferred to the acquiring corporation without the need for deeds or bills of sale, and the target dissolves by operation of law. See, e.g., 8 Del.Code Section 251. The consideration received by the target’s shareholders is specified in a formal agreement of merger between the two companies. The shareholders may receive stock or debt instruments of the acquiring corporation, cash or a combination of all three. A consolidation involves a similar transfer of the assets and liabilities of two corporations to a newly created entity followed by the dissolution of the transferor corporations, and the shareholders of the transferors become shareholders of the new entity by operation of law.

The Internal Revenue Code is strangely silent as to the permissible consideration in a Type A reorganization. To fill the gap and preserve the integrity of the nonrecognition scheme, courts developed the continuity of proprietary interest and continuity of business enterprise requirements. Section 368(a)(1)(A) does not expressly limit the permissible consideration in a merger or consolidation. It is settled, however, that a transaction will not qualify as a Type A reorganization continuity of proprietary interest (“COI”) requirement is met. See Southwest Natural Gas Co. v. Commissioner, 189 F.2d 332 (5th Cir. 1951). The test focuses on the quality of consideration received by the target’s shareholders (stock maintains continuity, debt or cash does not) and the percentage (by value) of equity consideration received by the target’s shareholders as a group relative to the total consideration paid by the purchaser in the reorganization. For ruling purposes, the IRS requires that at least 50% of the consideration paid by the purchaser to the target’s shareholders must consist of the purchaser’s stock, which may be common or preferred and need not be voting stock. Rev.Proc. 77-37, 1977-2 C.B. 578; Prop. Reg. Section 1.368-2(e)(3) Example 1. Some older cases have held that COI is met by lesser percentages. See, e.g., John A. Nelson Co. v. Helvering, 296 U.S. 374, 56 S.Ct. 273 (1935) (38% preferred stock sufficient). The test is even satisfied if some of target’s shareholders receive only cash or purchaser’s debt as long as the target shareholders as a group maintain COI. See Rev.Rul. 66-224, 1966-2 C.B. 114.

A target’s shareholders have never been required to maintain continuity of interest in the purchasing corporation for any particular period of time after a Type A reorganization. But in determining if the COI has been met, the IRS historically has considered sales and other dispositions of stock occurring subsequent to a merger which are part of the overall “plan.” See Rev.Proc. 77-37, 1977-2 C.B. 568. Thus, if a former target shareholder sold stock of the purchasing corporation pursuant to a contractual obligation prior to a merger, the merger and sale could be classified as one integrated transaction that may fail the COI test.

Continuity of Shareholder Proprietary Interest Requirement

Case law holds that future rights to receive stock generally are not treated as “boot” and, instead, are treated as “stock equivalents” for COI purposes if the rights exist for a valid business purpose and represent only rights to additional stock and nothing more. Consistent with case law, the IRS has provided in Revenue Procedure 84-42, 1984‍-‍1 C.B. 521, something akin to a non-exclusive “safe harbor” for this treatment. Under the procedure, rights to receive contingent stock in the future are stock equivalents (and not boot) for COI purposes if:

1. All the stock will be issued within 5 years;
2. There is a valid business reason for not issuing all the stock immediately;
3. The maximum number of shares which may be issued in the exchange is stated;
4. At least 50 percent of the maximum number of shares of each class of stock which may be issued is issued in the initial distribution;
5. The rights to receive stock cannot be assigned or transferred;
6. Such rights can give rise to the receipt only of additional stock of the corporation making the underlying distribution;
7. The stock issuance will not be triggered by an event the occurrence or nonoccurrence of which is within the control of shareholders;
8. The stock issuance will not be triggered by the payment of additional tax or reduction in tax paid as a result of an IRS audit of the shareholders or the corporation; and
9. The mechanism for the calculation of the additional stock to be issued is objective and readily ascertainable.

The IRS, however, has not provided guidance either in Revenue Procedure 84-42 or, as far as we can tell, anywhere else on how one actually performs a COI determination with contingent consideration. In this absence, many practitioners have apparently developed and applied to their transactions a “rule of thumb” described in a report issued by the NYC Bar Association in 2010. This rule involves calculating the present values of the respective stock and non-stock components of the consideration that would be paid post-closing to selling stockholders, and including these present values in the overall COI determination. For this purpose, the future amounts are discounted to the closing date using an applicable federal interest rate.

Transaction Exchange

If structured as a forward triangular merger that qualifies as a tax-free (or, more accurately, tax-deferred) reorganization under Section 368(a)(1)(A) and (a)(2)(D) of the Internal Revenue Code, the transaction may in part be tax-free. In a cross-border forward triangular Type A reorganization involving the acquisition of a U.S. corporation, the foreign acquiring corporation will establish a U.S. subsidiary or Acquisition Sub (typically a Delaware C-corporation) to acquire the assets of the U.S. target. The same requirements and standards imposed on Type A reorganizations discussed above will apply. However, the foreign purchaser’s corporate stock will be utilized to acquire the U.S. target corporation. If the rules governing a Type A reorganization are followed, the domestic target corporation, the Acquisition Sub, or the foreign purchaser will recognize gain or loss on this exchange. However, the U.S. shareholders of the selling corporation will recognize taxable gain on any cash payments received in connection with the acquisition transaction.

Sometimes a U.S. target’s assets consist of intangible property and/or goodwill. If so, this may trigger Section 367(d). Internal Revenue Code Section 367(d) denies the non-recognition (i.e., tax-deferred) treatment afforded under Internal Revenue Code Sections 351 or 361 if a U.S. person transfers intangible property to a foreign corporation. Under Section 367(d), the U.S. transferor is treated as having sold the intangible property to the foreign corporation in return for annual royalty payments received over the property’s useful life. These royalty payments would be classified as ordinary income and would be taxed to the U.S. transferor at ordinary, rather than capital gain, rates.

Internal Revenue Code Section 367(d) provides that it applies to transfers of intangible property where the transferee is a foreign corporation. Given this wording, it should follow that Section 367(d) does not apply if the transferee is incorporated in one of the U.S. states. Specifically, Section 367(d) should not apply to the second exchange of the forward triangular merger if Acquisition Sub is a U.S. corporation. It bears noting, however, that there is no guidance or commentary confirming this interpretation of Section 367(d)’s plain language. Namely, structuring a forward triangular merger to use a U.S. acquisition subsidiary would indeed cause the transfer of intangible property to fall outside the scope of Section 367(d).

If Section 367(d) does not apply, the general provisions of Section 367(a) apply instead. Like Internal Revenue Code Section 367(d), Section 367(a) also denies non-recognition treatment to outbound transfers of property by U.S. persons to foreign corporations. However, unlike Section 367(d), Internal Revenue Code Section 367(a) includes provisions, referred to as “indirect stock transfer rules,” that treat a transfer of property to a U.S. subsidiary owned by a foreign corporation as an indirect transfer of stock to that parent foreign corporation. These rules allow Section 367(a) to apply to a transaction when it otherwise would not.

Here, Section 367(a)’s indirect stock transfer rule would treat the transfer of the U.S. target’s assets to a so-called acquisition subsidiary and ultimately to the foreign purchaser as an indirect transfer of stock or assets.  As a result, the transaction would fail to qualify as a tax-free reorganization under Internal Revenue Code Section 368(a)(1)(A) and (a)(2)(D) and would be taxable. Section 367 will typically treat a statutory merger as a sale of the domestic corporation’s assets (and liabilities) to the Acquisition Sub (held by foreign acquiring corporation) as a taxable transaction.

Nevertheless, Section 367(a) of the Internal Revenue Code provides for a “limited interest exception” pursuant to which non-recognition treatment may still be obtained, but only if the requirements in Treasury Regulation 1.367(a)-3(c) are met. Included among these requirements are the following:

1. If the Seller owns at least 5% (by either vote or value) of the acquiror’s total outstanding stock immediately after closing, the Seller must execute a five-year GRA with the IRS meeting the requirements of Treasury Regulation 1.367(a)-8.
2. The Seller, who is a U.S. person, must not own more than 50% (by vote or value) of the acquiring foreign corporation’s total outstanding stock immediately after closing.
3. The foreign acquiring corporation must be engaged in an active trade or business outside the United States for the entire 36-month period immediately before closing.
4. At closing, neither the selling corporation nor buying corporation may not have an intention to substantially dispose of or discontinue such trade or business.
5. The purchasing foreign corporation’s fair market value must equal or exceed the fair market value of the domestic corporation.

Transaction Requirements

As a forward triangular merger, the transaction must satisfy the following requirements:

1. The statutory merger of the domestic acquired company into Acquisition Sub must be effected pursuant to the merger statute (or statutes) under applicable local law.
2. By operation of law under the merger statute (or statutes), the assets of the domestic acquired corporation must become those of the acquisition subsidiaries, and the acquired domestic corporation must cease to exist as a separate legal entity.
3. All parties to the transaction must adopt a plan of reorganization (“Plan or Reorg”) setting forth, among other things, the specific transfers to occur on the closing date.  Plans of Reorganization often take the form of a master agreement that is executed by all parties before the closing date.
4. The transaction must meet the continuity of business enterprise requirements. Thus, the purchasing foreign corporation must either i) continue to hold the U.S. companies historic business or ii) use a significant portion of the domestic acquired corporation’s historic business assets in its business.
5. The transaction must be entered into for a legitimate business purpose and not to avoid tax.

Type A Reverse Triangular Mergers

Section 368(a)(2)(E) also permits a “reverse triangular merger” to qualify as a Type A reorganization. In the reverse triangular merger, the purchasing corporation’s subsidiary is merged directly into the target corporation so that the target corporation survives the mergers and the acquiring subsidiary corporation disappears. In other words, the target shareholders exchange their target stock for the purchasing corporation stock. As in a forward triangular merger, the basic merger of a subsidiary corporation into the target corporation must qualify as a Type A merger. In addition, a reverse merger will qualify as a tax-free reorganization if: 1) the surviving target corporation holds substantially all of the properties formerly held by both the target and subsidiary corporation, and 2) the former target corporation shareholders exchange stock constituting “control” (measured by the 80 percent test discussed in Section 368(c)(1) of the Internal Revenue Code).

Section 368(c) of the Internal Revenue Code defines “control” as the ownership of stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote, and at least 80% of the total number of shares of all other classes of stock in the corporation.

As for tax consequences, the shareholders of the target corporation exchanging target stock for the purchasing corporation stock in the reverse triangular merger may be entitled to nonrecognition of tax pursuant Section 354 of the Internal Revenue Code. Section 354 of the Internal Revenue Code deals with the nonrecognition of gain or loss in certain corporate reorganizations when stock or securities are exchanged. Specifically, Section 354 states that no gain or loss is recognized if shareholders or security holders exchange their stock or securities for stock or securities in a corporation that is a party to the reorganization.

An example of an outbound cross-border reverse triangular reorganization is as follows:

Assume that foreign corporation wishes to acquire a U.S. Target’s business. In order to acquire the U.S. Target, the foreign corporation may form a wholly-owned subsidiary, U.S. Acquiror, as an acquisition vehicle. Next assume that the U.S. Acquiror merges into U.S. Target, with U.S. Target’s shareholder receiving Foreign Parent shares as the merger consideration and the U.S. Target survives. This merger should qualify as a reverse triangular reorganization. See Temp Reg. Section 1.367(a)-3(d)(1)(ii); Treas. Reg. Section 1.368-2(b)(1)(iii)(Ex. 13). However, the U.S. Target’s U.S. shareholders will recognize taxable gain unless the limited-interest exception discussed below applied.

Here, Section 367(a)’s indirect stock transfer rule a reverse triangular merger transaction would fail to qualify as a tax-free reorganization under Internal Revenue Code Section 368(a)(1)(A) and (a)(2)(D) and would be taxable. Section 367 will typically treat a statutory merger as a sale of the domestic corporation’s assets (and liabilities) to the Acquisition Sub (held by foreign acquiring corporation) as a taxable transaction.

Nevertheless, Section 367(a) of the Internal Revenue Code provides for a “limited interest exception” pursuant to which non-recognition treatment may still be obtained, but only if the requirements in Treasury Regulation 1.367(a)-3(c) are met as discussed above.

Inversions

Anytime a U.S. company is acquired by a foreign corporation, the anti-inversion rules must be considered. A tax-free acquisition of a U.S. company will only be respected if it avoids Section 7874 of the Internal Revenue Code. Section 7874 was enacted to nullify the tax benefits of a corporate inversion. 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.

Under the regulation of Section 7874, a foreign corporation will be treated as having “substantial business activities” in the foreign country in which it is legally organized only if it satisfies each prong of the following three part test:

1. Employee Threshold: At least 25% of the group’s total assets must be located in that foreign country.
2. Asset Threshold: At least 25% of the group’s total gross income must be derived from transactions in the ordinary course of business with unrelated customers in that foreign country.
3. Tax Residency: The foreign acquiring corporation must be a tax resident of that same foreign country (provided the country imposes a corporate income tax).

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.

Serial Inverter Rule

The Section 7874 regulations contain a “Serial Inversion Rule.” This rule modifies the computation of ownership fraction in cases where the foreign acquiring corporation has made prior, albeit unrelated, acquisitions of other U.S. entities. The “Serial Inversion Rule” is located in Treasury Regulation Section 1.7874-2(e). The regulation limits a single foreign corporation from serving as the counter-party to a series of increasingly larger acquisitions of U.S. companies during a 3-year look-back or testing period.

The “Serial Inverter Rule” was determined to be invalidly issued under the Administrative Procedure Act in Chamber of Commerce of the United States of America v. IRS, No. 1:16-cv-00944 (W.D. Tax. 2017). Notwithstanding the Chamber of Commerce, the Serial Inverter Rule must be taken into consideration in all cases involving the acquisition of a U.S. company by a foreign corporation.

Non-Ordinary Course Distributions Rule

The regulations under Section 7874 contains a rule designed to identify non-ordinary course distributions that could be used to reduce the equity of a potentially inverting U.S. corporation to manipulate the anti-inversion rules of Sections 7874 and 367. The application of this rule must be considered by any U.S. corporation that may be acquired by a foreign corporation. Typically, the relative ownership interests between the shareholders of a U.S. corporation and the foreign corporation immediately after an inversion transaction determines the applicability of the tax rules governing inversions. For example, Section 7874(c)(4) provides that a transfer of property or liabilities will be disregarded for purposes of the ownership test of such transfer as part of a plan of which the principal purpose is to avoid the purpose of Section 7874. The IRS also issued regulations which state that all distributions made by the U.S. corporation or its predecessor during three consecutive 12-month periods prior to the acquisition in excess of 110% of the average annual distributions during the three-year period preceding the acquisition are classified as non-ordinary course of distributions and are excluded from the numerator and the denominator in computing the ownership fraction. See Temp. Reg. Section 1.7874-10.

The term “distribution” is defined expansively to include (i) distributions of cash and property regardless of whether it is taxable or tax-free, (ii) distributions of money provided by the U.S. corporation for share buy backs (or other distributions in redemption of its stock) and (iii) transfers of money (or other property) made to shareholders of the U.S. corporation made in connection with an inversion to the extent the money (or other property) is provided (directly or indirectly) by the U.S. corporation.

Conclusion

This article is intended to provide the reader with a basic understanding of the basic planning considerations of the acquisition of U.S. companies by foreign corporations. It should be evident from this article that this is a relatively complex subject. In addition, it is important to note that this area is constantly subject to new developments and changes. As a result, it is crucial that any organization considering a cross-border reorganization consult with a qualified international tax attorney. We have advised a significant number of entities, law firms, and accounting firms regarding the U.S. tax implications of cross-border reorganizations.

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 a frequent author and speaker on 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.