Treasury notice creates need for caution. The Treasury Department’s recent rules try to make tax inversions less financially attractive, so companies need to analyze whether the deals are still worth pursuing. Read more about inversions: http://gt-us.co/1oH7qCg

1. The issue of tax inversions – whereby a U.S.
corporation is replaced by a foreign corporation as the
parent company of a worldwide affiliated group of
companies – has been the focus of both legislators and
the administration. Section 7874 deals with a foreign
acquiring corporation’s treatment as a domestic
corporation if certain conditions are met.
Recently, several legislative and administration
proposals have focused on tightening the rules related
to inversions after numerous large U.S. corporations
announced they were either undertaking or were
considering undertaking inversion transactions. As
Congress debates what type of legislative action may
be appropriate, Treasury has acted to make inversions
less attractive by issuing Notice 2014-52. The notice
not only tightens the application of Section 7874 to
inversion transactions but also makes postinversion
planning more difficult.
The notice states that certain recent inversion
transactions are inconsistent with the purpose of
current law, especially sections of the code that deal
with inversion transactions, like Section 7874.
In light of concerns that “certain inversion
transactions are motivated in substantial part by the
ability to engage in certain tax avoidance transactions
after the inversion that would not be possible in the
absence of the inversion,” Treasury, in Notice 2014-
52, announced it intended to issue regulations under
Sections 304(b)(5)(B), 367, 956(e), and 7701(l) to
address postinversion transactions.
Any U.S. company considering an inversion
should carefully examine whether Treasury’s notice
substantially affects the economics of their situation.
Treasury notice creates need for caution
for companies contemplating inversions
A highly anticipated notice issued on Sept. 22 by the Treasury Department
on tax inversion transactions may adversely affect the economics of such
deals. Accordingly, parties considering such a transaction should carefully
evaluate whether Treasury’s new rules make it worth pursuing.

2. 2
Treasury notice creates need for caution for companies contemplating inversions
Furthermore, Treasury intends to issue future
administrative guidance on inversions. This could
affect other areas of international and corporate tax
law, including intragroup loans resulting in earnings
stripping under Section 163(j).
The rules described in the notice generally apply to
transactions/acquisitions closing on or after Sept.
22, 2014 (with an ability for taxpayers to apply rules
relating to subsequent transfers of stock of the foreign
acquiring corporation when a domestic entity is a
member of a foreign-parented group to acquisitions
completed before Sept. 22, 2014).
Rules under Section 7874 relating
to inversion transactions
Under Section 7874, certain adverse tax consequences
can arise if a domestic corporation expatriates to a
foreign jurisdiction, by way of acquisition by a foreign
acquiring corporation.
Section 7874 generally applies if, as a part of a plan or
series of related transactions, three tests are met:
1. Substantially all of the assets of the domestic
corporation are acquired directly or indirectly by
the foreign acquiring corporation
2. At least 60% of the foreign corporation’s stock (by
vote or value) is held by the former shareholders
of the domestic corporation, by reason of
those shareholders’ ownership in the domestic
corporation
3. After the acquisition, the expanded affiliated group
that includes the foreign acquiring corporation
does not have substantial business activities in
the jurisdiction where the foreign acquiring
corporation is created or organized
If the percentage of ownership by the former
shareholders of the domestic corporation is at least
60% but less than 80% and the other two tests are
satisfied, certain adverse tax consequences can occur. If,
however, the ownership by the former shareholders of
the domestic corporation is 80% or more and the other
two tests are satisfied, the foreign acquiring corporation
will be treated as a domestic corporation.
Section 7874 also can apply in the context of a foreign
corporation that acquires substantially all of the
properties constituting a trade or business of a domestic
partnership, assuming the ownership and substantial
business activities tests of Section 7874 are satisfied.
To tighten Section 7874, the notice disregards a
portion of the stock of a foreign acquiring corporation
that holds a significant amount of passive assets.
When rules of the notice are applied, Section 7874
would be more likely to apply to the transaction (as
well as making it more likely that the 80% threshold
to treat a foreign acquiring corporation as a domestic
corporation will apply).
Additionally, the notice contains a rule that would
prevent domestic entities from reducing their size by
making certain “non-ordinary course distributions.”
The notice provides details on this calculation. Those
so-called “skinny-down” distributions would be
disregarded for purposes of calculating the ownership
fraction under Section 7874 (thus, increasing the
interest in the foreign acquiring corporation by the
former owners of the domestic entity for purposes of
the ownership test under Section 7874).
The notice also contains a similar rule for applying
Treas. Reg. 1.367(a)-3(c) – a regulation dealing with
outbound transfers of stock and securities – for
purposes of applying the substantiality test in that
regulation (a test for determining whether the foreign
acquiring corporation is at least equal to the fair
market value of the domestic target corporation).
The notice also contains detailed rules under Section
7874 regarding how Section 7874 should be applied
when there are subsequent transfers of stock of the
foreign acquiring corporation, with specific rules aimed
at subsequent transfers involving a U.S.-parented group
and a foreign-parented group. One of the transactions
addressed by these rules would be the use of spinoffs to
effect an inversion.

3. 3
Treasury notice creates need for caution for companies contemplating inversions
‘Anti-Hopscotch’ rules
If the controlled foreign corporation (CFC) makes
a loan to its U.S. parent or acquires its U.S. parent’s
stock, holding such an obligation or stock generally
would result in an investment in U.S. property under
Section 956, with a possible income inclusion to the
U.S. parent under Section 951.
The notice addresses certain transactions in which a
CFC that is owned by an inverted U.S. company makes
a loan to or invests in stock of the ultimate foreign
parent of the group (or certain foreign-related persons).
Relying on its authority under Section 956(e), the
notice expands the definition of U.S. property in
this situation by treating a CFC as holding “U.S.
property” for purposes of Section 956. As a result,
depending on the particular facts, the inverted
domestic company could have an income inclusion
under Sections 951 and 956.
‘Decontrolling’ transactions
The notice also addresses certain types of transactions
by the foreign parent or a foreign affiliate that are
designed to “decontrol” a CFC. Treasury exercises its
authority under Section 7701(l) to pursue that action.
One type of decontrolling strategy identified is when
the new foreign parent of the group will buy enough
stock in a CFC to take control of that entity away
from the domestic company such that the foreign
corporation is no longer a CFC. The notice states that
the foreign parent would be treated as owning stock in
the U.S. parent, rather than the CFC. The CFC would
remain a CFC.
The notice also contains rules under Section 367(b)
designed to modify the application of the Section
367(b) regulations to require an income inclusion in
certain nonrecognition transactions that dilute a U.S.
shareholder’s ownership of a CFC.
Regulations to prevent removal of untaxed
foreign earnings
In some cases, taxpayers may engage in certain
transactions that could reduce the earnings and profits
(E&P) of a CFC. One example in the notice is when
after an inversion, the foreign acquiring corporation
sells a portion of the U.S. target corporation’s stock
to a wholly owned CFC of the domestic corporation.
In exchange, the foreign acquiring corporation
receives property from the CFC. Some taxpayers
have interpreted Section 304(b)(5)(B) to not apply
where more than 50% of the dividend arising upon
the application of Section 304 is sourced from the
domestic company, even though, for example,
pursuant to an income tax treaty there may be no (or
a reduced rate of) U.S. withholding tax imposed on a
dividend sourced from the domestic company. Under
this position, the dividend sourced from the E&P of
the CFC would never be subject to U.S. tax.
The notice states that regulations will provide that,
for purposes of applying 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 a CFC will be made
by taking into account only the E&P of the acquiring
corporation (and therefore excluding the E&P of the
issuing corporation).
The notice also indicates these rules will apply as a
general matter, regardless of whether an inversion
transaction has occurred.
Request for comments and future guidance
The notice says the Treasury Department expects to
issue additional guidance to further limit inversion
transactions that are contrary to the purposes of Section
7874 and the benefits of postinversion tax avoidance
transactions. In particular, Treasury is considering
guidance to address strategies that avoid U.S. tax on
U.S. operations by shifting or “stripping” U.S.-source
earnings to lower-tax jurisdictions, including through
intercompany debt. The notice indicated that future
guidance will apply prospectively; however, Treasury
expects that to the extent any tax avoidance guidance
applies only to inverted groups, such guidance will
apply to groups that completed inversion transactions
on or after Sept. 22, 2014.

4. Treasury notice creates need for caution for companies contemplating inversions
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The notice also stated that Treasury is reviewing its
tax treaty policy regarding inverted groups and the
extent to which taxpayers inappropriately obtain tax
treaty benefits that reduce U.S. withholding taxes on
U.S. source income.
The takeaway
Treasury’s actions are significant, and taxpayers and
their advisers should carefully study them. Taxpayers
considering an inversion should take into account
their own facts and circumstances and determine
whether the transaction is still worth pursuing.
Action on Capitol Hill
With Congress not returning until after the Nov.
4 elections, there can be no legislative action on
inversions in the next several weeks. It remains to be
seen whether Congress will even take up the issue when
it returns for the lame-duck session this fall.
Republicans have generally panned the approach
of administrative rulemaking by Treasury, calling for
fundamental tax reform versus stopgap measures.
Democrats, on the other hand, have supported
administrative action, though for many, tax reform
would be the ideal venue to address such transactions.
Treasury Secretary Jacob Lew agrees with that
approach and said that regulatory action can only affect
some of the economics of inversion transactions, and
that “only a change in law can shut the door, and only
tax reform can solve the problems in our tax code that
leads to inversions.”
Contact
Joe Calianno
Partner
Washington National Tax Office
Grant Thornton LLP
T +1 202 521 1505
E joe.calianno@us.gt.com
Shamik Trivedi
Manager
Washington National Tax Office
Grant Thornton LLP
T +1 202 521 1511
E shamik.trivedi@us.gt.com