US international M&A tax developments
There has been a large number of US developments in the M&A area, particularly due to a series of regulations and other guidance issued by the Obama Administration in its final two months in office. Jim Fuller and David Forst of Fenwick & West explore what these developments mean for taxpayers.
Section 385 regulations
Section 385 regulations, which affect the tax treatment of corporate debt, were finalised. The regulations reserve all aspects of their application to foreign debt issuers. Thus, they do not apply in an outbound context, such as when a US parent company makes a loan to its foreign subsidiary. However, the rules still apply in an inbound context.
The blacklisted transaction rules under the final regulations follow the pattern set forth in the proposed regulations. The general rule and funding rule both remain in place essentially as proposed. However, the final regulations add a number of new exceptions and expand some of the existing exceptions to the application of the per se funding rule.
Under the general rule, unless an exception applies, a covered debt instrument is treated as stock to the extent it is issued by a covered member to a member of the covered member's expanded group in one or more of the following transactions:
In a distribution;
In exchange for expanded group stock, other than in an exempt exchange; or
In exchange for property in an asset reorganisation, but only to the extent that, pursuant to the plan of reorganisation, a shareholder in the transferor corporation that is a member of the issuer's expanded group immediately before the reorganisation receives the covered debt instrument with respect to its stock in the transferor corporation.
The funding rule is intended to serve as a backstop, to prevent expanded group members from achieving the same result indirectly as could be achieved directly with a general rule transaction. Under the funding rule, unless an exception applies, a covered debt instrument is treated as stock to the extent it is issued by a covered member (the funded member) to a member of the funded member's expanded group in exchange for property, pursuant to a per se rule or a principal purpose rule. A covered debt instrument is treated as funding any one or more of the following blacklisted distribution or acquisition transactions.
A distribution of property by the funded member to a member of the funded member's expanded group, other than in an exempt distribution of stock pursuant to an asset reorganisation that is permitted to be received without the recognition of gain or income under § 354(a)(1) or 355(a)(1) or, when § 356 applies, that is not treated as "other property" or money described in § 356;
An acquisition of expanded group stock, other than in an exempt exchange, by the funded member from a member of the funded member's expanded group in exchange for property other than expanded group stock; or
An acquisition of property by the funded member in an asset reorganisation, but only to the extent that, pursuant to the plan of reorganisation, a shareholder in the transferor corporation that is a member of the funded member's expanded group immediately before the reorganisation receives other property or money within the meaning of § 356 with respect to its stock in the transferor corporation.
A few other changes from the proposed regulations are that the E&P exception is expanded to include all of an issuer's E&P accumulated after the proposed regulations were issued (April 4 2016) and while it was a member of the same expanded group. The "cliff effect" of the $50 million threshold exception is removed. Taxpayers can exclude the first $50 million of debt that otherwise would be recharacterised under the blacklisted transaction rules. The 90-day delay in implementation of the blacklisted transaction rules is expanded so that any debt instrument that is subject to recharacterisation but that is issued on or before January 19 2017 – the date 90 days after publication of the final regulations in the Federal Register – will not be recharacterised until January 20 2017.
Section 901(m) regulations
Section 901(m) provides that in the case of a covered asset acquisition (CAA), the disqualified portion of any foreign tax determined with respect to the income or gain attributable to relevant foreign assets (RFAs) will not be taken into account in determining the relevant foreign tax credit. Instead, the disqualified portion of any foreign income tax (the disqualified tax amount) is permitted as a deduction. A CAA is a qualified stock purchase as defined in § 338; (2) any transaction that is treated as an acquisition of assets for U.S. income tax purposes and as the acquisition of stock of a corporation (or is disregarded) for purposes of foreign income tax; (3) any acquisition of an interest in a partnership that has an election in effect under § 754 (§ 743(b) CAAs); and (4) to the extent provided by the IRS, any similar transaction.
The new regulations identify the assets that are RFAs with respect to a CAA. An asset is subject to a CAA, if, for example:
1) In the case of a qualified stock purchase to which § 338 applies, new target is treated as purchasing the asset from old target;
2) In the case of a taxable acquisition of a disregarded entity that is treated as an acquisition of stock for foreign income tax purposes, the asset is owned by the disregarded entity at the time of the purchase and therefore the buyer is treated as purchasing the asset from the seller; and
3) In the case of a § 743(b) CAA, the asset is attributable to the partnership interest transferred in the § 743(b) CAA.
Other portions of the regulations provide rules for determining the basis difference with respect to an RFA, taking into account basis difference under the applicable cost recovery method or as a result of a disposition of an RFA, and successor rules for applying § 901(m) to subsequent transfers of RFAs that have basis difference that has not yet been fully taken into account.
Section 367(d) regulations
Treasury and the IRS finalised without any substantive changes the § 367 regulations that significantly (1) narrow the active foreign trade or business exception and (2) change the rules governing the outbound transfer of intangibles in particular regarding foreign goodwill and going concern value. The final regulations also retain the proposed regulation's effective date so that the new rules apply to transfers on or after September 14 2015.
In the preamble to the final regulations, Treasury and the IRS discussed and rejected virtually every taxpayer comment or suggestion regarding the proposed regulations. Of course, Treasury and the IRS needed to go to Congress to make changes of this magnitude. Unfortunately, there will now be a period of substantial uncertainty until these regulations are withdrawn or the courts address them.
As with the proposed regulations, the regulations eliminate the favorable treatment for foreign goodwill and going concern value by narrowing the scope of the active trade or business exception under § 367(a)(3) and eliminate the exception under Temp. Treas. Reg. § 1.367(d)-1T(b) that provided that foreign goodwill and going concern value are not subject to § 367(d);
The regulations also remove the 20-year limitation on useful life for purposes of § 367(d).
Killer B notice
Notice 2016-73 announced that the Treasury and the IRS intend to issue regulations under § 367 to modify the so-called "Killer B" anti-repatriation rules relating to the treatment of certain triangular reorganisations involving one or more foreign corporations. The Notice also announced that the Treasury and the IRS intend to issue § 367 regulations to modify the amount of an income inclusion required certain inbound non-recognition transactions (the 'all E&P' amount).
The notice is highly technical, and is generally intended to target transactions designed to repatriate earnings and profits of foreign corporations without incurring US tax via the § 367(a)/§ 367(b) priority rule.
F reorganisation regulations
The IRS published final regulations regarding F reorganisations. F reorganisations under § 368(a)(1)(F) involve a "mere change" in the identity, form, or place of organisation of one corporation. F reorganisations can be wholly domestic, wholly foreign, or cross border.
The new regulations adopt regulations that were proposed in 2004. They also include rules on outbound F reorganisations (domestic transferor corporation and foreign acquiror corporation) by adopting, without substantive change, proposed regulations that were issued in 1990. These regulations, adopted as § 367 regulations, were previously in effect as temporary regulations.
The final regulations generally adopt the regulations proposed in 2004, but with certain changes. The preamble states that like the 2004 proposed regulations, the final regulations are based on the premise that it is appropriate to treat the resulting corporation in an F reorganisation as the functional equivalent of the transferor corporation and to give its corporate enterprise roughly the same freedom of action as would be accorded a corporation that remains within its original corporate shell.
Under the final regulations, six requirements apply. Four of the six requirements are generally adopted from the 2004 proposed regulations. First, all the stock of the resulting corporation, including stock issued before the transfer, would have had to be issued in respect of stock of the transferor corporation. Second, a change in the ownership of the corporation in the transaction would not have been allowed, except for a change that had no effect other than that of a redemption of less than all of the shares of the corporation. Third, the transferor corporation would have had to completely liquidate in the transaction, although it did not need to legally dissolve. Fourth, the resulting corporation would not have been allowed to hold any property or possess any tax attributes immediately before the transfer, other than a nominal amount of assets to facilitate its organisation or to preserve its existence.
The fifth and sixth requirements address comments received with respect to the proposed regulations regarding "overlap transactions," for example, transactions involving the transferor corporation's transfer of its assets to a potential successor corporation other than the resulting corporation in a transaction that could also qualify for non-recognition treatment under a different provision of the Code.
Under the fifth requirement, immediately after the F reorganisation, no corporation other than a resulting corporation may hold property that was held by the transferor corporation immediately before the F reorganisation if the other corporation would, as a result, succeed to and take into account the items of the transferor corporation described in § 381(c) (corporate attributes in a reorganisation).
The sixth requirement is that immediately after the F reorganisation, the resulting corporation may not hold property acquired from a corporation other than a transferor corporation if the resulting corporation would, as a result, succeed to and take into account the items of the other corporation described in § 381(c).
The 2004 proposed regulations also contained an independently important rule: an F reorganisation may be a step, or series of steps, before, within, or after other transactions that effect more than a mere change, even if the resulting corporation has only a transitory existence following the mere change. In some cases, an F reorganisation sets the stage for later transactions by alleviating non-tax impediments to a transfer of assets. In other cases, prior transactions may tailor the assets and shareholders of the transferor corporation before the commencement of the F reorganisation.
Treasury and the IRS concluded that step transaction principles generally should not apply to recharacterise the F reorganisation in such a situation because F reorganisations involve only one corporation and do not resemble sales of assets.
However, the preamble states that notwithstanding this rule, in a cross-border context, related events preceding or following an F reorganisation may be related to the tax consequences under certain international provisions that apply to F reorganisations. For example, such events may be relevant for purposes of applying certain rules under § 7874 (inversions) and for purposes of determining whether stock of the resulting corporation should be treated as stock of a controlled foreign corporation for purposes of § 367(b).
The final regulations also adopt a provision of the 2004 proposed regulations that the qualification of a reorganisation as an F reorganisation would not alter the treatment of other related transactions. For example, if an F reorganisation is part of a plan that includes a subsequent merger involving the resulting corporation, the qualification of the F reorganisation as such will not alter the tax consequences of the subsequent merger.
The IRS issued final and temporary inversion regulations that adopted the rules of Notices 2014-52 and 2015-27 as regulations. As a general matter these regulations simply incorporate the previous notices into a regulatory format. The new regulations, also attack serial inversion acquisitions, something that was not covered in the previous notices.
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Jim Fuller is a partner in the tax group at Fenwick & West in Mountain View, California. He is one of the world's top 25 tax advisers, according to Euromoney. Fuller is described as one of the three "most highly regarded" US tax practitioners in Law Business Research's Who's Who Legal (2016), and is the only US tax adviser to receive a coveted Chambers 'star performer' rating (higher than first tier) in Chambers USA (2016).
Fuller and his firm have served as counsel in more than 150 large-corporate IRS Appeals proceedings and more than 70 federal tax court cases. Seven Fenwick tax partners appear in International Tax Review's Tax Controversy Leaders Guide. Fenwick has been named US (or Americas) Tax Litigation Firm of the Year three times at ITR's annual Americas Awards Dinners.
Two of our tax partners were shortlisted by Euromoney at its Women in Business Law Awards dinners in the America's Leading Lawyer for Tax Dispute Resolution category. One is a two-time winner of the award.
Much of our tax dispute resolution work has involved transfer pricing. Fenwick & West is first tier in ITR's World Transfer Pricing (2016). Five Fenwick tax partners have appeared in Euromoney's World's Leading Transfer Pricing Advisers. Transfer pricing cases in which we have been involved include: Apple Computer, Xilinx, DHL, and LimitedBrands, among others. The vast majority of our transfer pricing cases have been resolved in Appeals, some on a 'no change' basis.
Other cases in which we've represented clients in federal tax litigation matters include those that involved Sanofi, CBS, Analog Devices, Dover, Chrysler, Textron, Johnson Controls, Del Commercial, Illinois Tool Works, VF, S.C. Johnson, Intel, CMI Int'l, Laidlaw, Hitachi, Union Bank, GM Trading, and others.
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David Forst is the practice group leader of the tax group of Fenwick & West. He is included in Euromoney's Guide to the World's Leading Tax Advisers. He is also included in Law and Business Research's International Who's Who of Corporate Tax Lawyers (for the last six years). David was named one of the top tax advisers in the western US by International Tax Review, is listed in Chambers USA America's Leading Lawyers for Business (2011-2016), and has been named a Northern California Super Lawyer in Tax by San Francisco Magazine.
David's practice focuses on international corporate and partnership taxation. He is a lecturer at Stanford Law School on international taxation. He is an editor of and regular contributor to the Journal of Taxation, where his publications have included articles on international joint ventures, international tax aspects of M&A, the dual consolidated loss regulations, and foreign currency issues. He is a regular contributor to the Journal of Passthrough Entities, where he writes a column on international issues. David is a frequent chair and speaker at tax conferences, including the NYU Tax Institute, the Tax Executives Institute, and the International Fiscal Association.
David graduated with an AB, cum laude, Phi Beta Kappa, from Princeton University's Woodrow Wilson School of Public and International Affairs, and received his JD, with distinction, from Stanford Law School.