The US Treasury Department and the Internal Revenue Service recently announced their intention to issue regulations limiting certain tax-driven inversion transactions. In these transactions, a US parent company typically becomes a subsidiary of a company seated in a jurisdiction with a lower effective corporate income tax rate. The proposed regulations tighten the '80% ownership' test, address the tax treatment of loans made by the inverted US company's foreign subsidiaries to the new foreign parent and intend to achieve policy objectives on shifting US-source income outside the US.
Since the late 1990s, US-based multinationals have been relocating their headquarters to preferred foreign jurisdictions including Ireland, the UK, Switzerland and the Netherlands in an attempt to lower their consolidated corporate tax burden. A recent increase in these 'inversion transactions' – to be distinguished from the establishment of letterbox companies – has led to extensive political debate on the need for reforming the US tax system.
In an attempt to discourage inversion transactions and to prevent the erosion of the US tax base, the US Treasury Department and the IRS have announced plans to issue regulations, including:
Tightening the Ownership Test
Current US tax law does not recognise the inversion
transaction. For US tax purposes, the new foreign parent company is
treated as a US company if the US parent's former shareholders
hold at least 80% of the foreign parent's shares and no
substantial business activities are carried out in the foreign
jurisdiction. For US tax purposes, the new foreign parent company
will then be treated as a US company.
The proposed regulations tighten the 80% ownership test by
disregarding certain non-ordinary course distributions intended to
ensure compliance with the 80%-ownership test. Non-ordinary course
distributions mean any distributions made by the US company in
excess of 110% of the average distributions during the three-year
period preceding the inversion. Furthermore, if the new foreign
parent company holds a significant amount of passive assets, such
as cash, certain shares of the foreign acquirer are disregarded in
determining the 80%-threshold.
The treatment of certain intragroup loans as taxable
dividend
The inversion transaction may enable the new foreign parent
company to access earnings and profits of the inverted US
company's foreign subsidiaries – insofar as these are
untaxed – without incurring any US tax liability. The foreign
subsidiaries could, for example, grant a loan to the new foreign
parent company. Under the proposed regulations, this type of loan
is deemed a payment of a taxable dividend to the inverted US
company if the loan is made within ten years after the inversion
transaction. The US Treasury Department and the IRS also intend to
issue regulations aimed at preventing the avoidance of US tax on
foreign subsidiaries' pre-inversion earnings and profits
through transactions that terminate the US shareholder's
control or dilute that shareholder's interest.
Guidance on the limitation of earnings stripping outside the
US
The US Treasury Department and the IRS also seek to address
post-inversion strategies that result in a reduction of the future
US tax burden by shifting or stripping US source taxable earnings
to other (lower tax) jurisdictions within the group, such as new
intragroup loans.
Since the proposed regulations have not been issued, their impact cannot yet be established. They will, however, apply retrospectively to transactions completed on or after 22 September 2014.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.