A Walk Through Anti-Inversion Notice
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1 A Walk Through Anti-Inversion Notice October 31, 2014 Moderator Jason Yen, Covington & Burling LLP Panelists Taylor Kiessig, Sutherland Asbill & Brennan LLP Stephen Massed, KPMG Daniel McCall, IRS Brenda Zent, U.S. Treasury Department 1
2 Today s topics Section 7874 rules Cash box acquisitions Non-ordinary course distributions Spinversions Post-Inversion planning Hopscotch loans CC decontrol transactions Section 304(b)(5)(B) uture Effective dates Earnings stripping rules? 2
3 Themes Technical and complex rules mean that results can sometimes be counterintuitive; traps for the unwary Rules tend to favor preexisting foreign ownership over U.S. ownership 3
4 Disregarding oreign Acquiring Stock Attributable To Passive Assets 4
5 Mechanical Rules orthcoming regulations will be issued under 7874(c)(6) that will disregard a portion of oreign Acquiring stock (the Disregarded Portion ) if more than 50% of the gross value of all foreign group property ( GP ) is foreign group nonqualified property ( GNP ) 50% test is applied after the acquisition (and all related transactions) are completed. 5
6 Mechanical Rules GP All property held by the oreign Acquiring EAG after the inversion (and all related transactions) is completed, other than: GNP Property directly/indirectly acquired in the acquisition that was directly/indirectly held by Domestic Target at the time of the inversion; Stock of or a partnership interest in a oreign Acquiring EAG member; and An obligation owed by a oreign Acquiring EAG member (Latter two categories avoid double counting) All GP that is nonqualified property (within the meaning of Reg T(i)(7)) other than property that gives rise to income derived in connection with the active conduct of a banking business or the active conduct of an insurance business Anti-substitution rule taints otherwise non-gnp received in exchange for GNP in a transaction related to the acquisition 6
7 Mechanical Rules Disregarded Portion If GNP represents more than 50% of GP (i.e., GNP/GP > 50%), the Disqualified Portion must be computed Disregarded Portion = Historic oreign Acquiring Stock x GNP/GP Historic oreign Acquiring Stock is oreign Acquiring stock other than Stock received by reason of holding Domestic Target Stock Stock excluded from the ownership test under EAG Exception or Disqualified Stock rule or these purposes, neither GNP nor GP includes property received by oreign Acquiring that gives rise to Disqualified Stock Regulations will include rules addressing their interaction with the EAG Exception 7
8 Example Transaction SH 1) Transfer of for 76 shares of A stock A SH A 20 existing shares 2) Transfer of $50 for 4 shares of A stock Analysis The 4 shares of A stock issued to A Shareholders in exchange for cash is not included in the ownership test under Reg T(b) GP is equal to $300 (Cash, Asset A, and Asset B) stock is not considered GP, because it is stock of an EAG member s assets are not considered GP, because they were directly/indirectly owned by and directly/indirectly acquired by A Result SH Asset A: GNP ($150 GV) Asset B: GP ($100 GV) A SH GNP is equal to $200 (Cash and Asset A) Since GNP is 66.67% of GP ($200/$300), the Disqualified Portion must be computed (Historic A Stock x (GNP*/GP*)): Historic A Stock: 20 Shares; GNP*: 150; GP*: 250 Disqualified Portion = 20 x ($150/$250) = Shares A 24 Shares Ownership raction: Total A Shares: 100 Less: Disqualified Portion <12> Less: Disqualified Stock <4> Ownership Test Denominator 84 $50 Cash Ownership Percentage = 76/84 = 90.4% Asset A: GNP ($150 GV) Asset B: GP ($100 GV) 8
9 Disregard Domestic Target Non- Ordinary Course Distributions 9
10 Representative Transaction at Issue Skinnying Distributions 2) Distribution of C SH A SH SH 79% 21% A SH 1) Transfer of Unwanted Assets A (V $21) C A C Unwanted Assets ($10) Wanted Assets ($79) Unwanted Assets ($10) Wanted Assets ($79) 10
11 Overview or purposes of applying 7874(c)(4), non-ordinary course distributions ( NOCDs ) made by Domestic Target (including a predecessor) during the 36-month period preceding the acquisition date are disregarded for purposes of 7874 A NOCD is the excess of all distributions made during a taxable year by Domestic Target with respect to its stock (or partnership interests) over 110% of the average of such distributions during the 36-month period immediately preceding such taxable year Irrelevant whether the distribution is treated as a dividend for U.S. federal income tax purposes (e.g., a 355 distribution and a 302(a) redemption) Distribution includes any transfer of money or property to the Domestic Target equity holders made in connection with the inversion to the extent such money or property is directly or indirectly provided by Domestic Target Similar rules to those described above for purposes of applying the substantiality test of Reg (a)-3(c)(3)(iii) 11
12 Who is a Predecessor? 2) Distribution of C SH SH A SH 79% 21% 1) Transfer of S1 C A C S1 S2 S1 S1 S2 12
13 Computational Uncertainties SH SH A SH Transaction 6/30 Year 7 79% 21% A Calendar Year Taxpayer Year Date Type 7 9/30 Cash Distribution 7 3/31 Cash Distribution 6 9/30 Cash Distribution 6 3/31 Cash Distribution 5 3/31 Cash Distribution 4 12/1 Stock Repurchase 4 3/31 Cash Distribution 3 3/31 Cash Distribution 2 3/31 Cash Distribution 1 3/31 Cash Distribution Distributions within 36 months of the tested acquisition 13
14 Regulations Under Section 7874 Regarding Subsequent Transfers of Stock of the oreign Acquiring Corporation (Spinversions) 14
15 Spinversions Under existing rules, a U.S. entity may have been able to invert a portion of its operations by transferring a portion of its operations to newly formed foreign acquiring corporation (oreign Acquiring) and then spinning-off oreign Acquiring to the U.S. entity s shareholders (a Spinversion). General Rule: Stock of oreign Acquiring received by a former shareholder (or former partner) of domestic target that is subsequently transferred in a transaction related to the acquisition will not be treated as held by a member of the expanded affiliated group (EAG) for purposes of applying the EAG rules. Such oreign Acquiring stock is included in the numerator and denominator of the ownership fraction resulting in oreign Acquiring being treated as a domestic corporation. 15
16 Spinversions U.S.-Parented Group (PG) Exception: Subsequently transferred oreign Acquiring stock is treated as held by a member of the EAG for purposes of the EAG rules if: Before and after the acquisition, the transferor corporation (or its successor) is a member of the PG; and After the acquisition, both the person that holds the transferred oreign Acquiring stock after all related transfers of such stock are completed and oreign Acquiring are members of the PG. oreign-parented Group (PG) Exception: Subsequently transferred oreign Acquiring stock is treated as held by a member of the EAG for purposes of the EAG rules if: Before the acquisition, the transferor corporation and the domestic target are members of the same PG; and After the acquisition, the transferring corporation is a member of the EAG or would be a member of the EAG absent the transfer of oreign Acquiring stock by a member of the PG in a transaction related to the acquisition (taking into account all transactions related to the acquisition). Where the exceptions apply, subsequently transferred oreign Acquiring stock is excluded from the numerator of the ownership fraction, and may be excluded from the denominator of the ownership fraction. 16
17 Spinversions Example 1 Application of general rule Transaction D Shareholders Result D Shareholders (2) Distribution of A Stock (1) Transfer of Stock for 100 A shares D A * D A Other Subs Other Subs 17
18 Spinversions Alternate facts transfer of disregarded entity Transaction D Shareholders Result D Shareholders (2) Distribution of A Stock (1) Transfer of D Assets (less than sub all) for 100 A shares D A D A Other Subs Other Subs 18
19 Spinversions Example 1 (alternate facts) Application of PG exception Transaction D Shareholders Result D Shareholders (2) Distribution of A Stock (1) Transfer of Stock for 100 A shares A A Other Subs Other Subs 19
20 Spinversions Example 2 Application of PG exception Transaction A Result A (2) Distribution of A Stock T (1) Transfer of Stock for 100 A shares A A 20
21 Spinversions Example 2 (alternate facts) Application of PG exception Transaction A B Result A B (2) Distribution of A Stock T (1) Transfer of Stock for 100 A shares (3) Qualified Property for 200 A Shares 100 Shares A 200 Shares A 21
22 Spinversions Alternate facts - contribution of nonqualified property Transaction A B Result A B (2) Distribution of A Stock T (1) Transfer of Stock for 100 A shares (3) Nonqualified Property for 200 A Shares 100 Shares A * 200 Shares A 22
23 Regulations to Address Acquisitions of Obligations and Stock that Avoid Section 956 (Hopscotch Transactions) 23
24 Hopscotch Transactions Under existing rules, a new foreign parent could access the untaxed earnings and profits (E&P) of controlled foreign corporations (CCs) of an inverted U.S. entity without a current tax to the U.S. entity through such CCs making loans to the new foreign parent or acquiring stock of the new foreign parent (Hopscotch Transactions). Rule: Solely for purposes of section 956, any obligation or stock of a foreign related person other than an expatriated foreign subsidiary (such person, a non-cc foreign related person ) will be treated as United States property to the extent acquired by an expatriated foreign subsidiary during the 10-year applicable period. oreign related person A foreign person that is related to an expatriated entity, or is under common control with an expatriated entity. Expatriated foreign subsidiary A CC with respect to which an expatriated entity is a United States shareholder. Does not include a CC that is a member of the EAG immediately after the acquisition and all related transactions if the domestic entity was not a United States shareholder with respect to the CC on or before the completion date. Rules similar to the existing section 956 pledge and guarantee rules apply. 24
25 Hopscotch Transactions Example ormer A Shareholders ormer Shareholders 21% 79% A Loan Section 956 Inclusion CCs 25
26 POST-INVERSION CC DILUTION TRANSACTIONS 26
27 Two Types of Regulations 7701(l) regulations Recharacterization of certain de-control transactions 367(b) regulations Certain exchanges will require shareholder to include section 1248 amount 27
28 7701(l) Regulations
29 Representative Transaction at Issue (l) ormer A Shareholders ormer Shareholders ormer A Shareholders ormer Shareholders 21% 79% 21% 79% A A S S <50% >50% 1) De-Controlling Contribution CCs 2) Loan Subs Low Taxed E&P Low Taxed E&P 29
30 7701(l) Regulations In General Will recharacterize a specified transaction that is completed during the applicable period (as defined in 7874(d)(1)) for all purposes of the Code Specified Transaction - A transaction in which stock of an expatriated foreign subsidiary ( Specified Stock ) is transferred or issued to a specified related person Specified Related Person Any person that is (i) a Non- CC oreign Related Person, (ii) a U.S. partnership that has as its partner(s) at least one Non-CC oreign Related Person, (iii) a U.S. trust that has as its beneficiar(ies) at least one Non-CC oreign Related Person 30
31 7701(l) Regulations Recharacterization General Rule Recharacterize a specified transaction for all U.S. tax purposes as a transaction between the specified related person and the expatriated foreign subsidiary s Section 958(a) U.S. Shareholders Section 958(a) U.S. Shareholder - A U.S. shareholder (as defined by 951(b)) that (i) directly or indirectly through foreign corporations owns stock of the expatriated foreign subsidiary, and (ii) is related to (under 267(b) or 707(b)(1)) or under common 482 control with the specified related person Recharacterization: 1) The specified related person is deemed to transfer the property actually transferred in exchange for the Specified Stock to the Section 958(a) U.S. Shareholder(s) in exchange for a deemed instrument(s) (the Instrument ); 2) Section 958(a) U.S. Shareholder(s) are treated as directly (or indirectly through intervening entities, as necessary) transferring the property deemed received in exchange for the Instrument(s) to the expatriated foreign subsidiary; 3) Any payments actually made by the expatriated foreign subsidiary with respect to the Specified Stock will be deemed made to the Section 958(a) U.S. Shareholder(s); and 4) The Section 958(a) U.S. Shareholder(s) will be deemed to make corresponding payments on the Instrument(s) with the expatriated foreign subsidiary serving as the paying agent of the Section 958(a) U.S. Shareholder(s) with respect to the corresponding payments. 31
32 7701(l) Regulations Exceptions The recharacterization will not apply: ull Gain Exception - The transferor of the Specified Stock either is required to (1) recognize and include in income all the gain recognized with respect to Specified Stock (including gain recharacterized as a dividend under 964(e) or 1248(a), characterized as a dividend under 356(a)(2)), or (2) an income inclusion under Reg (b)-4 (as modified by the Notice) Ownership Retention Exception Both of the following are satisfied The expatriated foreign subsidiary is a CC immediately after the specified transaction and all related transactions, and The amount of stock (by value) in the expatriated foreign subsidiary stock (and any lower-tier expatriated foreign subsidiary) that is owned, in the aggregate, directly or indirectly by the Section 958(a) U.S. Shareholder(s) of the expatriated foreign subsidiary immediately before the specified transaction and any related transaction does not decrease by more than 10% as a result of such transactions 964(e) dividend that results from a specified transaction completed during the applicable period will not be eligible for the 954(c)(6) look-through exception 32
33 Example Transaction ormer A Shareholders 21% ormer Shareholders 79% Analysis A s acquisition of the T stock from T is a specified transaction, because stock of an expatriated foreign subsidiary was transferred (by issuance) to a specified related person (A). A 1) $10x for 60% of T vote A s acquisition of the T stock is recharacterized as follows, with the result that T continues to be a CC: 1) is treated as having issued an Instrument to A in exchange for $10x of cash T (CC) Recharacterization ormer A Shareholders ormer Shareholders 2) is treated as having contributed the $10x of cash to T in exchange for T stock. Recharacterization of subsequent T distributions actually made with respect to the Specified Stock: 21% A 79% Instrument A will be treated as distributing such property to 1) $10x for Instrument will be treated as making a matching distribution with respect to the Instrument T is treated as the paying agent of with respect to the Instrument 2) $10x for Additional T stock T (CC) 33
34 Example Transaction Recharacterization ormer A SHs ormer SHs ormer A SHs ormer SHs 21% 79% 21% 79% A 2) Property for 60% A 60% 1) T stock for 40% 40% T (CC) PRS T (CC) PRS Analysis s transfer of the T stock is a specified transaction, because stock of an expatriated foreign subsidiary was transferred to a specified related person (PRS). Under Notice , s transfer of the T stock is recharacterized as follows, with the result that T continues to be a CC: PRS is treated as having issued 40% of its capital and profits interests to in exchange for the Instrument is treated as continuing to own all of the stock of T Any distribution with respect to the T stock actually acquired by PRS will be treated as a distribution to, which, in turn, will be treated as making a matching distribution with respect to the Instrument that is treated as having issued to PRS T is treated as the paying agent of with respect to the Instrument issued by to PRS Instrument 34
35 367(b) Regulations 35
36 Representative Transaction at Issue - 367(b) ormer A Shareholders ormer Shareholders ormer A Shareholders ormer Shareholders 21% 79% 21% 79% A A S <50% 1) CCs >50% CCs S CCs 36
37 367(b) Regulations Will require an exchanging shareholder to include into income as a deemed dividend the 1248 amount attributable to the stock of an expatriated foreign subsidiary transferred in a specified exchange during the applicable period, irrespective of whether 1248 shareholder status is preserved Specified Exchange - An exchange in which a shareholder of an expatriated foreign subsidiary exchanges such subsidiary s stock for stock in another foreign corporation in a transaction described in Reg (b)-4(a) (e.g., a 351 exchange or acquisitive reorganization). Regulations, however, will include an exception similar to the Ownership Retention Exception under the forthcoming 7701(l) Regulations 37
38 Example Transaction ormer A Shareholders 21% A ormer Shareholders 79% Analysis s exchange of the T stock is a specified exchange, because exchanged stock of an expatriated foreign subsidiary (T) for stock in a foreign corporation (S) pursuant to a transaction described in Reg (b)-4(a) (i.e., B reorganization) T (CC) T Stock S Although the specified exchange is also a specified transaction because there is a transfer of T stock to a specified related person (S), the exchange is not recharacterized under the Notice s 7701(l) provisions because of the ull Gain Exception. Result ormer A Shareholders ormer Shareholders Under Reg (b)-4(b)(1)(i), as modified by the Notice, must include in income the 1248 amount with respect to the T stock exchanged, without regard to the fact that immediately after the exchange: 21% A 79% 40% S (CC) The S stock received by in the exchange is stock in a corporation that is a CC as to which is a 1248 shareholder, and T is a CC as to which is a 1248 shareholder 60% T (CC) 38
39 Interaction Between the Out-from-Under Rules Transaction Result ormer A Shareholders ormer Shareholders ormer A Shareholders ormer Shareholders 21% 79% 21% 79% A A T Sub S T (CC) T Sub T (CC) T Sub S (CC) T Sub 39
40 Regulations under Section 304 to Prevent the Removal of Untaxed oreign E&P (Section 304(b)(5)(B)) 40
41 Section 304(b)(5)(B) Under an interpretation of existing rules, the E&P of a CC of an inverted U.S. entity could be reduced, to facilitate subsequent repatriations of cash or other property of the CC, through sales by the new foreign parent of the inverted U.S. entity s stock to the CC recast under section 304. Rule: or purposes of section 304(b)(5)(B), the determination of whether more than 50% of the dividends that arise under section 304(b)(2) is subject to tax or includible in the E&P of another CC will be made taking into account only the E&P of the acquiring corporation (and excluding the E&P of the issuing corporation). If a partnership, option (or similar interest), or other arrangement, is used with a principal purpose of avoiding the application of this rule (e.g., to treat a transferor as a CC), such partnership, option (or similar interest), or other arrangement will be disregarded for purposes of applying this rule. Note that this rule applies without regard to whether an inversion transaction has occurred. 41
42 Section 304(b)(5)(B) Example 1 Section 304(b)(5)(B) applies Transaction A Result A $100x of Stock $100x $51x E&P $0 E&P S1 (CC) S1 (CC) $49x E&P $49x E&P 42
43 Section 304(b)(5)(B) Example 2 Section 304(b)(5)(B) does not apply Transaction Result A A 40% 40% 60% 60% S1 (CC) S2 Stock $100x Cash PRS S1 (CC) PRS $150x E&P $100 MV $50x E&P S2 (CC) S2 (CC) 43
44 Effective Dates and uture Guidance 44
45 uture Guidance Rules in the Notice apply to inversions/transactions effected on or after September 22, 2014 Treasury/IRS expect to issue further guidance limiting inversions and post-inversion planning, including possibly earnings stripping rules uture guidance will apply prospectively, but to the extent any tax avoidance guidance applies only to inverted groups, such guidance applies to inversions on/after September 22,
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