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US Inbound: New Treasury regulations could affect foreign acquisitions of US corporations

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Jim Fuller


David Forst

The US Treasury Department issued new regulations under the Code section 7874 (the "anti-inversion" rules) that could affect foreign acquisitions of US corporations. Thus, although discussed in this issue's outbound column, there also are important inbound issues under the new regulations. The anti-inversion rules are intended to prevent US corporations from reorganising (inverting) as foreign parent corporations. Among other things, if at least 80% of the new foreign parent's stock is held by shareholders of the former domestic parent by reason of holding such stock, then the new foreign parent is treated as a domestic corporation.

Under Section 7874(c)(2)(B) (statutory public offering rule), stock of the foreign acquiring corporation that is sold in a public offering related to the acquisition is not taken into account for purposes of calculating the ownership percentage. The statutory public offering rule furthers the policy that Section 7874 is intended to curtail inversion transactions that "permit corporations and other entities to continue to conduct business in the same manner as they did prior to the inversion".

This rule was modified by Notice 2009-78 which provides that the issuance of stock of a foreign corporation for cash or other "non-qualified property" in any transaction (not just a public offering) that is related to the acquisition is not to be taken into account in calculating the ownership percentage.

This can present issues in a purely foreign acquisition of a US company, where, for example, the foreign company capitalises a new foreign subsidiary with cash to effect the acquisition, and executives of the US target company receive some stock of the acquiring company.

In adopting the rules announced in the Notice, the IRS made certain modifications. The new regulations institute what is termed the "exclusion rule." Under this rule, subject to a de minimis exception, "disqualified stock" is excluded from the denominator of the ownership fraction. Disqualified stock is generally stock issued for cash, marketable securities, and in a new category – an obligation owed by a member of the expanded affiliated group that includes the foreign acquiring corporation, a former shareholder or partner of the domestic entity and certain persons related to the above. The use of foreign acquirer stock in the satisfaction or assumption of an obligation of the transferor is treated similarly as if the foreign acquirer stock was received in exchange for non-qualified property. Further, disqualified stock also includes stock that the transferee subsequently exchanges for the satisfaction or assumption of a liability associated with the property exchanged.

The regulations also state that disqualified stock does not include stock transferred in an exchange that does not increase the fair market value of the net assets of the foreign acquiring corporation (with hook stock excluded from this exception).

The regulations add an important de minimis rule that can be helpful and was not provided in the Notice. This rule provides that stock is not treated as disqualified stock if the ownership percentage determined without regard to the disqualified stock rule is less than 5%, and after the acquisition and all related transactions are completed, former shareholders in the aggregate own less than 5% of the stock of any member of the expanded affiliated group that includes the foreign acquiring corporation.

This rule is intended to mitigate the effects of predominantly cash acquisitions by foreign companies of the domestic target entity effected through a cash infusion of the foreign acquirer as described above. However, the 5% could serve as a constraining limitation in certain cases, and perhaps should be higher.

Jim Fuller (jpfuller@fenwick.com)

Tel: +1 650 335 7205

David Forst (dforst@fenwick.com)

Tel: +1 650 335 7274

Fenwick & West

Website: www.fenwick.com

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