Specifically Unspecific: Inversion Aversion and IRS Treas. Notice - - PDF document

Specifically Unspecific: Inversion Aversion and IRS Treas. Notice 14-52

By: Paul Determan, Michael Steffany & Jason Jointer

What is an Inversion?

• U.S.-based multinational changes its corporate structure,

via merger, so that the new foreign corporation replaces the U.S. Target Co.

• Target Co. changes its country of residence
• Usually in low or no tax jurisdiction

US Target Co. Foreign Parent (X) US Target Co. US SH US SH Foreign Corp (X) F SH

Assets/Stock

F SH

Q: Why Corporations Invert

• U.S. tax policies create an incentive to shift ownership

away from U.S. based companies

Putting it all Together A: To gain access to foreign earnings and reduce U.S. earnings

Inversion Arguments

Inversion Activity

• The statutory framework has existed for years
• Increase in frequency, size and visibility

IRS and Treas. Action

• Incremental changes to deter inversions techniques when

they see a flare up in activity benefitting corporations

• The Notice is the most recent example of this behavior.

Notice 14-52

Inversions

http://nexusnow.info/forum/showthread.php?9084- Whack-A-Mole

Early Inversion Activity

• Naked inversion- U.S. parent corporation inverts into its own

foreign subsidiary

• Many of these inversions lacked clear business purpose and

primarily motivated by tax avoidance

• Substantially the same owners

Inversion without ownership or control limits Determined to be tax abusive

• Led to the enactment of anti-inversion rules under § 7874

§ 7874

• Restricts the tax benefits of an inversion
• When the owners of the new company are not substantially

different from the owners of the original company.

• Requires the ownership of the new foreign parent to be in a

range of 60% to 80% by the former domestic shareholders

• Allows for a safe harbor for substantial business activities

Substantial Business Activities

• Safe harbor from § 7874 anti-inversion

provisions

• If the affiliated group’s post-​merger activities are

at least 25 percent in each category: employees, assets, and income

• These activities must be located or derived in

the foreign jurisdiction where foreign parent is incorporated.

Ownership Thresholds

Does not deter inversions, corporations are willing to accept penalties

§ 367- Anti-inversion penalties

• Shareholders are taxed on inversion gain
• Target Co.’s taxable income cannot be less than the

inversion gain until 10 yrs. after the inversion

• Inversion cannot be offset by NOLs, FTCs or other tax

attributes

• Doesn’t discourage inversions
• Corporations wait till the 10 years lapses

IRS & Treasury’s Intentions

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IRS Notice 2014-52

• Treasury and IRS intend to issue regulations

addressing inversions and post-inversion transactions.

• The notice describes the substance of these future

regulations.

• However: the Treasury and IRS expect to issue

additional guidance to further limit inversions and specifically will address earnings stripping.

• Both the described and undescribed future guidance

applies to companies that complete inversion on or after September 22, 2014.

Example Described Regulation

SECTION 3. REGULATIONS TO ADDRESS POST- INVERSION TAX AVOIDANCE TRANSACTIONS .01 Regulations to Address Acquisitions of Obligations and Stock that Avoid Section 956

• (a) Section 956 Background

Section 957(a) defines a CFC as a foreign corporation with respect to which more than 50 percent of the total combined voting power of all classes of stock entitled to vote or the total value of the stock of the corporation is owned (directly, indirectly, or constructively) by United States shareholders (U.S. shareholders). Section 951(b) defines a U.S. shareholder as a U.S. person that owns (directly, indirectly,

• r constructively) 10 percent or more of the total combined

voting power of all classes of stock entitled to vote of the foreign corporation.

Future Earnings Stripping Regulation Description:

”The Treasury Department and IRS expect to issue additional guidance to further limit inversion transactions contrary to the purpose of section 7874 and the benefits of post-inversion tax avoidance transactions. In particular

the IRS and Treasury Department are 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. Comments are requested

regarding the approaches such guidance should take.”

Notice’s Inversion Ownership Threshold Proposed Regulations

• Future regulations will limit the ability of U.S. Corporations to

meet the ownership threshold required by:

• Limiting a U.S. Corporation’s ability to invert with a

foreign corporation that has subsantial passive or liquid

• assets. In many cases, stock attributed to such assets will

not impact the ownership fraction.

• Limiting a U.S. Corporation’s ability to meet the ownership

tests by making “skinny down” distributions.

• Limiting a U.S. Corporations ability to take advantage of

the internal group restructuring exception.

Notice’s CFC Earnings Access Proposed Regulations

• Future regulations will provide that for 10 years after inversion,

the new foreign parent’s ability to access CFC earnings will be limited:

• New Foreign Parent cannot access earnings of CFC’s via a

“hopscotch” loan.

• New Foreign Parent cannot access earnings of CFC’s via a

“de-controlling” transaction.

• New Foreign Parent cannot receive U.S. tax free transfers
• f property or cash from a CFC via certain section 304

transfers.

Post-Notice Effect on Inversions

ENDED:

• AbbieVie/Shire: abandoned on October 20. The

cancellation resulted in a (deductible!) $1.635 billion break up fee paid by AbbieVie.

• Salix Pharmaceuticals and Cosmo: abandoned on

October 3. NEW PARTNER:

• Auxilium/QLT abandoned
• Auxilium has made a deal to be acquired by Endo
• Chiquita/Fyffes abandoned
• Chiquita/Cutrale-Safra are in discussions for inversion to

Brazil.

Post Notice Effect on Inversions

RESTRUCTURED:

• Medtronic/Covidien: restructured deal with new

financing terms specifically to mitigate the effects of the Notice

• Mylan/Abbott Laboratories: restructured deal, and

“announced adjustments” to their deal on October 22 NEW INVERSIONS:

• Civeo Corp. of Texas announced on Sept. 29 it would be

“redomiciling” in Canada

• Steris Corp. of Ohio announced on October 13 it would

acquire Synergy Health Plc, and invert to the UK.

Potential Challenges to Notice 14-52

• Authority to issue Regs.
• Judicial review and deference given to the Regs.
• Effective date of the Regs.

Service and Treasury Authority

• The Notice proposes substantial regulations on a variety of

statutes, most notably IRC 956, 7701, 304, and 7874

• Each of these statutes has a specific grant from Congress to

issue subsequent regulations. Specifically 956(e), 7701(l), 304(c), and 7874(g)

• The Service will argue that these are full legislative regulations

and should likewise be given full deference by the Court.

Weight of Proposed Regs.

• Because there is a Congressional grant to write regs. under

these statutes, the Regs. will likely be afforded a great deal

• f deference by the Courts.
• Typically Courts grant legislative regs. Chevron deference.

Meaning that the agency’s interpretation will be respected as long as it is based on a permissible construction of the

• statute. ( Chevron U.S.A., Inc. v. Natural Resources

Defense Council, Inc. 467 U.S. 837 (1984)

Weight of Proposed Regs.

• However there is a long history of Courts respecting

transactions with reasonable business purposes and the same could happen here.

• Additionally the argument may be made that because of

the nature of the proposals the Secretary is going further than the Congressional grant to interpreting existing statues and write regs. and is effectively creating new law thus exercising a power not reserved for the executive.

Effective Date of Regs.

26 U.S. Code § 7805 - Rules and regulations

• (b) Retroactivity of regulations
• (1) In general
• Except as otherwise provided in this subsection, no

temporary, proposed, or final regulation relating to the internal revenue laws shall apply to any taxable period ending before the earliest of the following dates:

• (C) The date on which any notice substantially describing

the expected contents of any temporary, proposed, or final regulation is issued to the public.

• Two further exceptions for retroactivity are carved out within IRC 7805
• 7805(b)(6) Congressional authorization

The limitation of paragraph (1) may be superseded by a legislative grant from Congress authorizing the Secretary to prescribe the effective date with respect to any regulation.

• There is no such grant related to Earnings Stripping mentioned in the

Notice.

• 7805(b)(3) Prevention of abuse

The Secretary may provide that any regulation may take effect or apply retroactively to prevent abuse.

• While the IRS may issue retroactive regs. to prevent abuse, Congress has

neither defined the term nor given anyone else power to do the same.

Effective Date of Regs.

Effective Date of Regs.

• The Notice makes clear that the regulations will have an

effective date that relates back to the date of the Notice

• IRC 7805(b)(1)(c) allows for regulations to date back to

the date of a notice that substantially describes the expected contents of the future regulations.

• Here the notice discusses changes to 956, 7701, 304, and

7874 at length.

• It is likely the regs. will be allowed to relate back to the

date of the notice.

End Result of Regs.

• The proposed changes the Notice details are likely

authorized by the specific Congressional grant contained in statute.

• Their effective date is also likely to be upheld as to the

date of the Notice as it describes the proposals in detail.

• While the changes to statute are likely authorized,

whether they are upheld in Court is a different issue.

• Attacking them will take a plaintiff willing to litigate

whether they are a reasonable interpretation of statute and whether they are in effect creating new law.

Earnings Stripping

• In contrast to the verbosity with which the Notice 14-52

discusses the proposed regulations, Section 5 of the Notice merely makes mention of the desire to take further action on earnings stripping.

Example Described Regulation:

SECTION 3. REGULATIONS TO ADDRESS POST-INVERSION TAX AVOIDANCE TRANSACTIONS .01 Regulations to Address Acquisitions of Obligations and Stock that Avoid Section 956

• (a) Section 956 Background

Section 957(a) defines a CFC as a foreign corporation with respect to which more than 50 percent of the total combined voting power of all classes of stock entitled to vote or the total value

• f the stock of the corporation is owned (directly,

indirectly, or constructively) by United States

Future Earnings Stripping Regulation Description:

”The Treasury Department and IRS expect to issue additional guidance to further limit inversion transactions contrary to the purpose of section 7874 and the benefits of post-inversion tax avoidance transactions. In particular

the IRS and Treasury Department are 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. Comments are requested

regarding the approaches such guidance should take.”

Authority to Issue Regs. on Earnings Stripping

• Unlike the proposed regs. no specific statute relating to

earnings stripping activity is mentioned in the Notice.

• As such the Notice does not point to any specific

Congressional grant of authority to issue regulations on the subject.

Weight Given to Earnings Stripping Action

• Because the Notice doesn’t mention any proposed

changes, it is difficult to determine what weight they will be given.

• The weight that these regulations will be given depends

upon the statutory language that they are tied to and whether it grants the Secretary Congressional Authority to issue Regs.

• However they too will have to be a reasonable

interpretation of statute and pass any challenges presented by litigation.

Effective Date of Earnings Stripping Action.

• Section 5 of the notice indicates that future action on

earning stripping and the use of intercompany debt is going to be forthcoming, and that any future regulation in the arena will be prospective but will relate back to the date of the notice for companies that have inverted on or after 9/22/14 (date of the notice).

• However the Notice does not “substantially describe” the

contents of future regs. on earnings stripping.

• Retroactivity is the exception to the normal rule making

process of the IRS, and is generally disfavored.

• To the extent that the Notice is attempting to relate future

regulation on earnings stripping back to the date of the notice the IRS will likely be unsuccessful based on 7805(b)(1)(c) given that the Notice does not describe the contents of future changes at all.

• Further the Notice does not point to any legislative grant to

write regs. on Earnings Stripping, which renders 7805(b) (6) inapplicable.

Effective Date of Earnings Stripping Action.

Effective Date of Earnings Stripping Action.

• Congress has not defined abuse nor have they given the

Secretary that authority to create one. Absent a clear finding that earnings stripping is abusive this likely renders the Services efforts to relate back based on 7805(b)(3) ineffective.

• Further Courts have be hesitant to hold retroactive regs. as

valid in many instances and largely respect transactions with legitimate business purposes.

Cases that have denied Relation back

• Murfam Farms, LLC v. United States, 88 Fed. Cl. 516

(2009) (regulation 1.752-6 (basis reduction for transfers of contingent obligations to partnership) cannot be applied retroactively b/c of limitation in 7805) (also speaks to three step process, one retroactivity is generally barred absent an exception, reg is not a valid interp. Under Chevron, reg failed notice and comment under APA)

• Stobie Creek Invs., LLC v. United States, 82 Fed. Cl. at

667–671 (regulation 1.752-6 cannot be applied retroactively); exceeded scope of specific authorization granted IRS under applicable law. fact that taxpayers may have had notice via Notice 2000-44, 2000-2 CB 255 didn't

• therwise justify retroactive reg application

• IRS may have difficulty with implementing the proposed

changes and face litigation based on the possible impermissible creation of new law rather than the creation

• f regs. Additionally Courts may find that certain

transactions have valid business purposes and choose not to adhere to the new regs.

• As it relates to earnings stripping there is no legislative

grant, abuse is not defined, and the notice inadequately describes the activity for purposes of relating back.

Future of Notice 14-52