EXHIBIT 3. Case 2:16-cv PP Filed 09/30/16 Page 1 of 18 Document 16-3
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1 EXHIBIT 3 Case 2:16-cv PP Filed 09/30/16 Page 1 of 18 Document 16-3
2 UNITED STATES DISTRICT COURT EASTERN DISTRICT OF WISCONSIN Arlene D. Gumm, et al. on behalf of themselves and all other similarly situated stockholders of Johnson Controls, Inc. v. Alex A. Molinaroli, et al. Case No. 16-cv-1093PP DECLARATION OF ADAM H. ROSENZWEIG I. Background and Qualifications 1. My name is Adam H. Rosenzweig and I am a Professor of Law and Vice Dean for Academic Affairs at Washington University in Saint Louis School of Law. I joined the faculty of Washington University in 2007 as an Associate Professor of Law, was promoted to Professor of Law in 2012, and was appointed as Vice Dean for Academic Affairs in In addition, I served as a Visiting Associate Professor at the University of Texas School of Law in and as a Visiting Assistant Professor of Law at Northwestern University Law School from I graduated with a JD from Georgetown University Law Center in 1998 and received a LLM in Taxation from New York University School of Law in Prior to entering academia, I was employed as an Associate Attorney at Simpson, Thacher & Bartlett LLP in New York specializing in Federal Income Taxation and from I served as law clerk to the Honorable James L. Dennis of the United States Court of Appeals for the Fifth Circuit. My C.V. is attached as Exhibit My expertise is in the field of US Federal Income Taxation with an emphasis on International Taxation and Business. I regularly teach courses in Federal Income Tax, International Tax, Partnership Tax, and International Business Transactions, and I am the coauthor of a casebook on Federal Income Taxation published by Aspen Law & Business. I have 1 Case 2:16-cv PP Filed 09/30/16 Page 2 of 18 Document 16-3
3 published extensively on the issue of international taxation generally and corporate inversions in particular. My articles have been published in law reviews such as Florida State Law Review, the Wisconsin Law Review and the William & Mary Law Review, in peer-reviewed journals such as the Journal of Empirical Legal Studies, and in tax specialty journals such as the Virginia Tax Review, the Florida Tax Review, Tax Notes Magazine and Tax Notes International. In addition, I am regularly invited to speak on the topics of corporate and international taxation at profession meetings such as the American Bar Association and the International Fiscal Association and serve on the Academic Advisory Board of the US Branch of the International Fiscal Association. 3. I have been asked by class counsel to discuss the potential tax strategies available to US domestic corporations to engage in so-called inversions and to explain the relative costs and benefits of each strategy to the corporation and its shareholders. As I explain below, based on my research of the relevant law and understanding of similar transactions, I believe that Johnson Controls, Inc. ( JCI ) had a number of alternative structures available to it to engage in a corporate inversion, each of which would have had differing tax impacts on the corporation and its shareholders. In particular, I believe that alternative structures were available to JCI that would permit JCI to engage in a corporate inversion that would minimize the adverse tax consequences to certain minority shareholders of JCI. My compensation for this matter has been $500 per hour plus expenses. II. Case Background 4. This lawsuit is a class action complaint against certain senior executive officers and the members of the Board of Directors of Johnson Controls, Inc. ( JCI ), JCI, and Tyco International plc ( Tyco, whose name is to be changed to Johnson Controls plc ( JCplc )) for 2 Case 2:16-cv PP Filed 09/30/16 Page 3 of 18 Document 16-3
4 violations of 14(a) and 20 of the Securities Exchange Act of 1934, and Rule 14a-9 thereunder, and for breaching their fiduciary duties (or for aiding and abetting the same) in connection with JCI s proposed merger with Tyco to engage in a reincorporation in Ireland to reduce its taxes. JCI and Tyco have entered into an Agreement and Plan of Merger, dated as of January 24, 2016 (the Merger Agreement ), pursuant to which JCI will be merged with a subsidiary of the smaller Tyco. The class action contends that, by entering into the proposed merger, the Officers and Directors of JCI have failed to disclose material facts and have breached their fiduciary duties of due care, disclosure, good faith, loyalty, and fair dealing that they owe to JCI s minority taxpaying shareholders and to all JCI public shareholders. By engaging in the merger and reincorporating in Ireland, JCI claims it will, among other things, reduce the top marginal tax rate on its foreign earnings from the US corporate tax rate of 35% to the lower corporate tax rate of 12.5% applied by Ireland. The class action plaintiffs challenge the structure of the deal to achieve these tax benefits for JCI at the expense of JCI s minority taxpaying shareholders and to avoid the inversion-related adverse tax consequences under 4985 and 7874 of the Internal Revenue Code ( IRC ) at the expense of JCI public shareholders. 5. Plaintiffs have now moved the court for injunctive relief to prevent the closing of the proposed merger as structured and to provide additional disclosures or, alternatively, for damages arising from the breach of fiduciary duties arising from structuring the transaction as a corporate inversion. III. JCI s Options relating to the Taxation of the Tyco Acquisition 6. Plaintiffs contend that the structure chosen by JCI to engage in the corporate inversion merger with Tyco was chosen to benefit JCI and JCplc, in the form of lower US and worldwide corporate taxes, and the officers or directors of JCI, by avoiding certain anti-inversion 3 Case 2:16-cv PP Filed 09/30/16 Page 4 of 18 Document 16-3
5 excise taxes, at the expense of JCI public shareholders and in particular certain minority individual taxpaying shareholders ( JCI Minority Shareholders ). 7. The proposed merger is currently structured as an acquisition by Tyco of JCI, although JCI is larger than Tyco and will pay approximately $16.5 billion for Tyco. Current JCI shareholders will own 56% of JCplc and receive aggregate cash of $3.86 billion, while current Tyco shareholders will own 44% of JCplc. Complaint at 2. JCplc will maintain Tyco s Irish legal domicile with its global headquarters in Ireland, while it will keep its primary operational headquarters in Milwaukee. Complaint at The transaction will value Tyco at $34.88 per share, a 13% premium to Tyco shareholders based on 30-day volume-weighted average prices and an 11% premium based on Tyco s share price as of January 22, JCI shareholders will be entitled to receive in exchange for each share of JCI common stock one ordinary share of JCplc or cash of $34.88 up to an aggregate of $3.86 billion; Tyco shareholders will receive for each ordinary share of Tyco of an ordinary share of JCplc. Complaint at IRC 11 (in conjunction with other provisions of the Internal Revenue Code) imposes a US federal income tax on the worldwide income of domestic corporations. IRC 7701(a)(4) defines a domestic corporation as a corporation formed or organized under the laws of the United States, any State thereof, or the District of Columbia, and IRC 7701(a)(5) defines a foreign corporation as a corporation that is not domestic. 10. Prior to the enactment of IRC 7874 in 2004, pursuant to the definitions in IRC 7701, a corporation could transform its status from domestic to foreign, and thus no longer be subject to US federal income taxation on its worldwide income, by changing its legal place of 4 Case 2:16-cv PP Filed 09/30/16 Page 5 of 18 Document 16-3
6 incorporation, through a merger or otherwise. Starting in the 1990s, corporations began doing so through so-called inversion transactions. These transactions were referred to as inversions because, to avoid the application of other rules discussed below, they were typically structured such that a newly-formed foreign corporate subsidiary, wholly-owned by the domestic corporation, would invert and become the new publicly-traded parent corporation owning the former domestic parent corporation as a subsidiary. The following diagram depicts the most general forms of corporate organization before and after giving effect to an inversion: Before Inversion Domestic Parent Corporation After Inversion Foreign Parent Corporation Foreign Subsidiary Domestic Subsidiary 11. Under IRC 1001, if a domestic corporation sells or exchanges its assets the corporation realizes and recognizes gain subject to taxation under IRC 11. By contrast, since the corporation is treated as a taxpayer separate from its shareholders (see Moline Properties v. Commissioner, 319 U.S. 436 (1943)), sales of stock by shareholders of a corporation are typically not treated as the realization of gain by the corporation. Such sales of stock by shareholders are typically treated as realization of gain or loss by the shareholder under IRC 1001 (see Cottage Savings Association v. Commissioner, 499 U.S. 554 (1991)). 12. IRC 368 defines certain corporate mergers and acquisitions as reorganizations for purposes of the US federal income tax laws. IRC 361 provides that gain realized by a corporation upon the exchange of its assets for stock of another corporation in a reorganization 5 Case 2:16-cv PP Filed 09/30/16 Page 6 of 18 Document 16-3
7 under IRC 368 will not be recognized for purposes of IRC 1001(c), and thus would not be subject to tax. 1 Similarly, IRC 354 provides that shareholders receiving stock in a corporate reorganization would not recognize any gain realized in the exchange and thus also would not be subject to tax. In short, the tax law permits corporations to engage in certain mergers and acquisitions tax-free to the extent that stock is used as consideration. 13. IRC 367 provides the Secretary of Treasury (and its delegates) to promulgate regulations that turn off the tax-free reorganization rules for certain acquisitions involving foreign corporations. In particular, IRC 367(a) provides authority to promulgate regulations with respect to acquisitions of domestic corporations by foreign corporations, and IRC 367(b) provides authority to promulgate regulations applicable to other transactions with similar effects to those under IRC 367(a). 14. Prior to enactment of IRC 7874, to engage in corporate inversions, publiclytraded domestic corporations would form a new, wholly-owned foreign corporate subsidiary that would acquire all of the stock of the domestic corporation in exchange for the stock of the foreign corporation. For example, such a transaction was undertaken by Helen of Troy, Inc. in This would result in the foreign corporation becoming the publicly-traded parent and the former domestic parent corporation becoming a subsidiary of the foreign corporation. See 10 supra. These inversion transactions were structured so as to be treated as an exchange of stockfor-stock that meets the definition of a reorganization under IRC 368(a)(1)(B) (a B Reorg ). Since the exchange is solely stock-for-stock at the shareholder level, the domestic corporation would not realize any gain. Since the transaction met the definition of a B Reorg, shareholders 1 Generally, tax liability is only imposed on gains that are both realized and recognized for tax purposes. IRC 61(a), Case 2:16-cv PP Filed 09/30/16 Page 7 of 18 Document 16-3
8 would realize gain on the exchange of shares but would not recognize any of the gain realized in the transaction under IRC 354 and, thus, would not be subject to tax. See 12 supra. 15. In response to these so-called naked inversions, such as the one undertaken by Helen of Troy, Inc., the Department of Treasury ( DOT ) promulgated Treas. Reg (a)-3 pursuant to its authority under IRC 367(a) (the HOT Regs ). Under the HOT Regs, IRC 354 would no longer apply to stock-for-stock reorganizations between domestic corporations and foreign corporations in which shareholders of the domestic corporation own at least 50 percent of the combined company after the merger. Consequently, shareholders of the domestic corporation would be required to recognize gain realized under IRC 1001 in the transaction as if they had sold their stock for its fair market value on the date of the transaction and, thus, would be subject to tax. 16. In general, the intent of the HOT Regs was to create an adversity of interests between the corporation, which would not be taxable, and shareholders, who would be taxable, in an inversion transaction. Notwithstanding the HOT Regs, however, companies continued to engage in inversion transactions after their promulgation. For example, in 1999 Tyco, Inc. engaged in a corporate inversion transaction to move from the United States to Bermuda. 17. Under IRC 61(a)(3), gross income includes gains from property. Under IRC 1001(a), a taxpayer recognizes gain on the sale or exchange of property in an amount equal to the excess of the amount realized over the adjusted basis of that property. In general, under IRC 1001(b), the amount realized is defined as the amount of cash plus the fair market value of property received in the sale or exchange. Adjusted basis is determined under IRC 1011 and Under these rules, for property such as corporate stock the adjusted basis is typically equal to the amount paid for the stock. Under IRC 63, taxable income is defined as gross income 7 Case 2:16-cv PP Filed 09/30/16 Page 8 of 18 Document 16-3
9 less certain deductions. In general, individuals are subject to tax on taxable income under IRC 1 and corporations are subject to tax on taxable income under IRC While the HOT Regs result in the recognition of gain under IRC 1001 that is included in gross income under IRC 61 for all shareholders of an inverting corporation, the actual tax liability incurred by any particular shareholder depends on the particular tax attributes of that shareholder. For example, as a general matter tax-exempt entities would not pay tax on gain recognized with respect to corporate stock held as an investment. Similarly, individuals generally would not pay tax on gain recognized with respect to stock owned through tax-deferred accounts such as an IRA, 401(k), or 403(b) account. 19. In response to the perceived abuse of inversion transactions and the ineffectiveness of the HOT Regs in deterring their use, Congress enacted IRC 7874 in IRC 7874 provides certain rules intended to reduce the tax benefits available in a corporate inversion to an expatriated entity as defined in IRC IRC 7874(a)(2)(A) defines an expatriated entity as a domestic corporation acquired by a surrogate foreign corporation and IRC 7874(a)(2)(B) defines a surrogate foreign corporation as a foreign corporation that acquires substantially all of the assets of a domestic corporation (including by a merger with, or the acquisition of the outstanding stock of, the domestic corporation) and, after the acquisition, at least 60 percent of the stock (by vote or value) of the entity is held by former shareholders of the domestic corporation. If a transaction meets these definitions, certain U.S. federal income tax consequences apply. In particular, under IRC 7874(a)(2)(C), as opposed to the general rule of IRC 7701(a)(5), the company must have substantial business activities in the foreign country to be treated as foreign for U.S. federal income tax purposes. Further, under IRC 7874(b), if at least 80 percent of the stock of the combined entity is held by former shareholders of the 8 Case 2:16-cv PP Filed 09/30/16 Page 9 of 18 Document 16-3
10 domestic corporation, the combined company is treated as a domestic corporation regardless of its place of legal incorporation. Taken together, IRC 7874 denies the ability of domestic corporations to engage in naked inversions but permits inversions under certain circumstances undertaken as mergers with foreign corporations with substantial business assets and value. 20. At the same time, Congress enacted IRC 4985 which imposes an excise tax on certain officers and directors of an expatriated entity as defined under IRC 7874(a)(2). The excise tax is equal to the capital gains tax rate applied to the equity compensation held by those officers and directors over the one-year period straddling the date of the inversion. 21. Separately, in 2006 DOT announced that it would promulgate regulations under IRC 367(b) to prevent corporations from using a B Reorg to engage in a different perceived abusive transaction, typically referred to as Killer B transactions. In general, Killer B transactions were being utilized by domestic corporations with foreign subsidiaries to repatriate the foreign earnings of such subsidiaries without incurring a current US federal income tax liability. For example, assume a U.S. corporation owns 100% of the stock of a Dutch corporation. In general, the active earnings of the Dutch corporation are not taxable to the US parent corporation unless and until paid as a dividend. Conversely, almost any use of the cash at the Dutch subsidiary by the U.S. parent corporation would be treated as a dividend for these purposes. As a result, cash held by the Dutch corporation is often referred to as trapped outside the United States in the sense that it cannot be accessed by the US parent corporation without paying a U.S. tax on those earnings. Corporate taxpayers were utilizing Killer B transactions to permit the U.S. parent corporation effectively to access the cash held by its foreign subsidiaries without incurring a current U.S. tax liability by doing so as part of a tax-free B Reorg. Under Treas. Reg (b)-10 (the Killer B Regs ), DOT provided that a B Reorg 9 Case 2:16-cv PP Filed 09/30/16 Page 10 of 18 Document 16-3
11 undertaken in such a manner would be treated as if the domestic corporation had repatriated the earnings of the foreign subsidiary in a fully taxable transaction. With respect to the hypothetical, the Killer B Regs would effectively treat a B Reorg undertaken in this manner as a taxable dividend from the Dutch subsidiary to its US parent corporation. 22. Despite the fact that the HOT Regs and the Killer B Regs were intended to address different perceived abuses, DOT recognized that both regulations could apply to a single transaction because both transactions happened to utilize a B Reorg to achieve their goals. For this reason, Treas. Reg (b)-10 originally provided for an overlap rule in which only the rule resulting in a greater amount of total income (whether or not subject to tax) would apply to a transaction subject to both rules. 23. In Notice , the DOT and Internal Revenue Service ( IRS ) announced that they were aware of transactions in which corporations were intentionally structuring their transactions to fall under the Killer B Regs solely to avoid the application of the HOT Regs under the overlap rule. More specifically, a domestic corporation could prevent shareholders from recognizing taxable gain under the HOT Regs by choosing to have the corporation recognize income under the Killer B Regs. 2 Under the overlap rule in place at the time, this would only be possible if the corporation would recognize more income under the Killer B Regs than gain that the shareholders would recognize under the HOT Regs. Due to an unanticipated 2 See, e.g., Endo International Limited, Amendment No. 1 to Form S-4 Registration Statement under the Securities Act of 1933, pp. 7, 21-22, 37, , at: _52 [visited 8/25/2016]; Liberty Global Corporation Limited, Amendment No. 3 to Form S-4 Registration Statement under the Securities Act of 1933, pp , 47, , at: _68 [visited 8/25/2016]. 10 Case 2:16-cv PP Filed 09/30/16 Page 11 of 18 Document 16-3
12 interaction of a number of technical rules, however, such corporations were able to satisfy this requirement without actually incurring a significant tax liability under the Killer B Regs. 3 In Notice , the DOT and IRS announced that the overlap rule would be changed to apply the rule that resulted in the higher amount of income actually subject to tax, as opposed to total income whether or not subject to tax. 4 In doing so, the DOT and IRS effectively conceded that taxpayers were permitted to choose whether to apply the HOT Regs or the Killer B Regs to an inversion transaction by adopting different structures. 24. In 2014 and 2015, the DOT and IRS issued a series of Notices attacking perceived abuses of IRC 7874 and related anti-inversion rules. For the most part, these rules addressed two areas of concern. First, these rules addressed transactions in which taxpayers attempted to manipulate the ownership of stock to avoid the application of the 60 percent or 80 percent thresholds in IRC Second, these rules addressed perceived structural abuses being used by inverted companies to avoid paying US federal income tax on certain foreign earnings of the company. In light of these rules, a number of domestic corporations attempted to structure inversions transactions in such a way to avoid the application of these rules. In particular, the most onerous of these rules only applied to an expatriated entity as defined under IRC 7874(a)(2). Thus, one way to avoid the application of these rules would be to structure the merger such that former shareholders of the domestic corporation own less than 60 percent of the 3 For example, distributions (including deemed distributions under the Killer B Regs) made by a corporation are treated as a taxable dividend only to the extent of the earnings and profits of the corporation. See 26 infra. 4 See fn.1 supra. 11 Case 2:16-cv PP Filed 09/30/16 Page 12 of 18 Document 16-3
13 combined company after the merger. These rules were promulgated in Proposed and Temporary Regulations in Taken together, the rules applicable to domestic corporations seeking to engage in an inversion present a number of complex alternatives. A domestic company engaging in a merger with a foreign corporation in which former shareholders of the domestic corporation will own at least 60 percent of the combined company faces a number of significant and complex anti-inversion rules. By contrast, a domestic company engaging in a merger with a foreign corporation in which former shareholders of the domestic corporation will own less than 60 percent of the combined company can avoid the application of most of these rules, including the 4985 excise tax. Even in such case, if former shareholders of the domestic corporation own at least 50 percent of the combined company, the HOT Regs would continue to apply to a traditional inversion transaction. However, a domestic corporation could choose to structure the transaction such that the Killer B Regs would apply to the corporation and the HOT Regs would no longer apply to the shareholders. 26. For transactions undertaken after Notice (and the regulations implementing it), whether a domestic corporation could choose to elect to structure an inversion to fall under the Killer B Regs rather than the HOT Regs depends on two factors: (1) the gain subject to tax by shareholders under IRC 1001 if they were to sell their stock in a fully taxable transaction ( Shareholder Gain ) and (2) the earnings and profits of the domestic corporation as defined under IRC 312 and Treas. Reg ( E&P ). Assuming that the E&P is greater than the Shareholder Gain, a domestic corporation could choose to structure an inversion transaction to be subject to the Killer B Regs and not the HOT Regs. In such a case, the 12 Case 2:16-cv PP Filed 09/30/16 Page 13 of 18 Document 16-3
14 shareholders would no longer be subject to tax in the inversion because the HOT Regs would no longer apply to disallow the application of the default B Reorg rules. 27. Taken together, a domestic corporation may undertake a corporate inversion in a number of different ways with different tax consequences for different constituencies of the corporation. These include: (1) a merger inversion subject to the HOT Regs, IRC 7874 and 4985, (2) a merger inversion subject to the HOT Regs but neither IRC 7874 or 4985, (3) a merger inversion subject to the Killer B Regs but not the HOT Regs, IRC 7874 or Under option (1), the corporation is not subject to tax but shareholders and officers and directors are subject to tax. Under option (2), neither the corporation nor the officers and directors are subject to tax but the shareholders are subject to tax. Under option (3) the corporation is subject to tax but the officers and directors and shareholders are not subject to tax. Based on the facts disclosed in the JCI/Tyco Joint Proxy Statement/Prospectus that are included as part of the S-4 Registration Statement ( S-4 ) filed with the Securities and Exchange Commission ( SEC ) on April 4, 2016, it appears that JCI could have considered each of these three options in structuring its inversion merger with Tyco. 29. JCI disclosed that the proposed merger was intentionally structured with a combination of cash and stock in such a way that would result in the tax consequences of option 5 In addition, other different alternatives options, as well as alternative structures, are potentially available to domestic corporations seeking to engage in an inversion transaction as well. One example would be a so-called Up-C Structure. As a general matter, in an Up-C Structure the companies provide shareholders an election either to receive stock in the combined company post-merger or to receive interests in a limited liability company or limited partnership that are exchangeable into stock of the publicly-traded corporation in the merger. This structure was reportedly utilized in the Burger King/Tim Hortons inversion merger to permit certain shareholders with significant built-in-gain in their stock to avoid the application of the HOT Regs. 13 Case 2:16-cv PP Filed 09/30/16 Page 14 of 18 Document 16-3
15 (2). Complaint at 12; S-4 at 39, More specifically, JCI discloses that the amount of cash and stock consideration used in the merger was calculated to ensure that former shareholders of JCI would own less than 60 percent (but more than 50 percent) of JCplc so as to prevent JCI from being treated as an expatriated entity under IRC 7874 and avoid the excise tax of IRC S-4 at 223; see also Complaint at 97-99, The S-4 discloses the general U.S. federal income tax consequences of the merger, including a statement that The receipt of combined company ordinary shares and/or cash in exchange for Johnson Controls common stock pursuant to the merger will be a taxable transaction for U.S. federal income tax purposes. S-4 at 225; see also S-4 at 17, 39. This is consistent with the assumption that the merger will be subject to the tax treatment of option (2). The S-4 does not appear to discuss the tax consequences of either option (1) or option (3), whether these alternative structures were available as an option for the merger, or that these alternative structures would result in significantly different tax consequences to JCI, its officers and directors, and the Minority JCI Shareholders. 6 Complaint at 143. By contrast, the S-4 does disclose other potential tax consequences to the JCplc, including potential limitations on related transactions and limitations on the use of JCI tax attributes. S-4 at If JCI were to use a Killer-B structure, 7 and assuming sufficient earnings and profits (as determined for U.S. income tax purposes), the 367(b) amount would be equal to the value of JCplc stock used to acquire JCI. Assuming a $38 billion value of JCplc and that JCI 6 The tax disclosure section of the S-4 excludes a number of taxpayers from the scope of the tax disclosure, including (among others) tax-exempt shareholders and shareholders holding shares through certain tax-deferred accounts. S-4 at See fn. 2 supra. 14 Case 2:16-cv PP Filed 09/30/16 Page 15 of 18 Document 16-3
16 shareholders receive 56% of JCplc in the merger, this would result in approximately $21 billion. Assuming Tyco is eligible for the US/Ireland tax treaty, the 367(b) amount would be subject to a 5% withholding tax, or approximately $1 billion. 32. Assuming JCI shareholders built-in gain on the closing date will be two-thirds of JCI s $22.7 billion market capitalization (as of January 4, 2016), JCI shareholders have a built-in gain of $15 billion. This amount is less than what appears to be JCI s 367(b) taxable income of $21 billion. Assuming an average combined federal/state capital gains tax rate of 23%, Defendants are proposing a plan that theoretically exposes JCI shareholders up to $3.5 billion (0.23 x $15 billion) in capital gains taxes so that JCI may permanently avoid paying $1 billion in U.S. income taxes. If instead JCI shareholders had built-in gain on the closing date in an amount equal to half of JCI s $22.7 billion market capitalization (as of January 4, 2016), JCI shareholders would have a built-in gain of approximately $11 billion and theoretical capital gains taxes of roughly $2.5 billion Assuming 80% of JCI shareholders are tax-indifferent, those JCI shareholders will not be required to pay tax on the 367(a) income recognized as a result of the inversion. 9 Thus, rather than incur a capital gains tax of either $3.5 billion or $2.5 billion (depending on the assumptions), the JCI shareholders would instead incur a total of either $700 million or $500 8 As a real world matter it can effectively be impossible for the corporation (or the IRS) to know the shareholder tax with certainty because that amount depends on taxpayer-specific attributes, such as the taxable status of the shareholders, the possibility the shareholder could have losses or other tax attributes to offset the gain, and the basis of the shares in the hands of the taxpayer. Thus, estimates are typically necessary at some point. 9 See n.6 supra; see also Complaint 61(a), 120, Case 2:16-cv PP Filed 09/30/16 Page 16 of 18 Document 16-3
17 million of actual taxes (20% of $3.5 billion and $2.5 billion, respectively). This amount would be borne exclusively by the JCI Minority Shareholders. 34. Taken together, given the rules applicable to corporate inversions, including IRC 367(a) and (b) and Treas. Reg (a)-3 and 1.367(b)-10, JCI can only say with certainty that its shareholders will be taxed in connection with the inversion if JCI has determined that the merger will be subject to the HOT Regs. See S-4 at 17, 39, 225. This statement can only be true to the extent that JCI either structured the transaction intentionally so as to subject the transaction to the HOT Regs, thereby subjecting its shareholders to the inversion-related taxes, as opposed to the Killer B Regs or some other alternative structure under which JCI shareholders would not be subject to tax, or did so in ignorance of whether JCI or its shareholders would be subject to the inversion-related taxes under these rules. 35. In general, after the acquisition of control of a domestic corporation by another corporation in which the corporation or shareholders will be subject to IRC 367(a), the corporation or its successor must file IRS Form 8806 within 45 days of the acquisition. Treas. Reg To comply with this rule, JCI (or JCplc) will need to determine whether the inversion is subject to IRC 367(a) within this period of time so as to determine whether to file IRS Form To avoid the imposition of penalties for substantial underpayment of tax, the position reported by a taxpayer on its tax return must be supported by substantial authority. Treas. Reg Substantial authority is less stringent than the more likely than not standard (the standard that is met when there is a greater than 50-percent likelihood of the position being upheld), but more stringent than the reasonable basis standard. Treas. Reg. 16 Case 2:16-cv PP Filed 09/30/16 Page 17 of 18 Document 16-3
18 (d)(2). So long as JCI has substantial authority to take a position on its tax return, it will not be subject to penalties for substantial understatement of tax. 37. Based on the disclosures of the structure of the inversion in the S-4, it appears that JCI intends to report the inversion as subject to IRC 367(a). However, there is a possibility that substantial authority exists for JCI to report the inversion under IRC 367(b) if certain steps were to be taken by JCI before the reporting period ended (e.g., by incorporating a dividend from JCI to JCplc into the structure). For example, authority exists supporting the proposition that a corporation may change or amend a merger structure post-closing to comply with the order of a court of competent jurisdiction. See, e.g., Rev. Rul , C.B. 181; Private Letter Ruling ; Private Letter Ruling Thus, if a court of competent jurisdiction were to require JCI and/or its successors or directors to take the steps necessary to report the inversion merger under IRC 367(b) instead of IRC 367(a) to prevent or remedy a violation of state law, it is possible that JCI would have substantial authority to do so without incurring tax penalties. I declare under penalty of perjury under the laws of the United States of America that the foregoing is true and correct. Saint Louis, MO, September 29, 2016 Adam H. Rosenzweig Professor of Law and Vice Dean for Academic Affairs Washington University in Saint Louis 17 Case 2:16-cv PP Filed 09/30/16 Page 18 of 18 Document 16-3
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