US Outbound: New anti-Inversion regulations address use of disqualified stock
The US Treasury Department and Internal Revenue Service (IRS) recently released long-awaited temporary and proposed regulations addressing the use of certain "disqualified stock" in corporate inversion transactions (T.D. 9654). The new regulations generally adopt the rules previously announced in Notice 2009-78 (2009-40 IRB 452), subject to several important modifications. As general background, the Section 7874 anti-inversion rules apply if pursuant to a plan or series of related transactions:
A foreign corporation acquires (directly or indirectly) substantially all of the assets of a US corporation;
After the acquisition, at least 60% of the stock of the foreign acquiring corporation is owned by former shareholders of the US corporation by reason of their prior ownership of stock in the US corporation; and
After the acquisition, the foreign acquiring corporation's expanded affiliated group does not have substantial business activities in the foreign country in which the foreign acquiring corporation is organised.
For purposes of calculating the ownership percentage described in (ii) above, Section 7874(c)(2)(B) provides that stock of the foreign acquiring corporation that is sold in a public offering related to the acquisition is not taken into account (the statutory public offering rule). According to the preamble, this 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".
In Notice 2009-78, the IRS expanded the statutory public offering rule to provide that stock of a foreign acquiring corporation issued in exchange for certain "non-qualified property" is also not taken into account, regardless of whether such stock is issued in a public offering (for example a private placement). The Notice defined "disqualified property" to include (i) cash or cash equivalents, (ii) marketable securities, and (iii) any other property acquired with a principal purpose of avoiding the purposes of Section 7874. The Notice also provided that "marketable securities" will not include stock of a member of the foreign acquiring corporation's expanded affiliated group (including an entity that becomes a member pursuant to the same transaction as the acquisition).
One of the more significant modifications from the Notice in the temporary regulations is the expansion of the definition of "disqualified property" to include "disqualified obligations." The temporary regulations define a "disqualified obligation" as an obligation of (i) a member of the foreign acquiring corporation's expanded affiliated group, (ii) a former shareholder of the US corporation, or (iii) a person that, before or after the acquisition, is related to any person described in (i) or (ii) above.
The temporary regulations also expand the scope of the Notice to provide that stock issued by a foreign acquiring corporation in exchange for property that is not "non-qualified property" will nevertheless be ignored if such stock is subsequently exchanged for the satisfaction or assumption of an obligation associated with the transferred property.
Finally, and perhaps most importantly, the new regulations include a welcome de minimis exception providing that the disqualified stock rules described above do not apply if, without regard to those rules, the former shareholders of the US corporation own less than 5% of the foreign acquiring corporation.
The newly-issued regulations are generally effective with respect to matters covered in Notice 2009-78 for acquisitions completed on or after September 17, 2009, and are otherwise effective for acquisitions completed on or after January 16, 2014 (unless the taxpayer elects to apply the earlier date).
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