Corporate inversions and the affiliate-owned stock rule.

Author:Karges, Martin H.

The IRS and Treasury issued temporary (TD 9238) and proposed regulations (REG-143244-05) to clarify when and how stock held by members of an expanded affiliated group (EAG) should be disregarded for purposes of corporate inversions under Sec. 7874.

Inversions--General Principles

In accordance with Sec. 7874(a) (2)(B), a corporate inversion may generally occur when three requirements are met:

  1. A foreign corporation acquires directly or indirectly substantially all of the properties of a domestic corporation (or the trade or business of a domestic partnership);

  2. After the acquisition, at least 60% of such foreign corporation's stock (determined by vote or value) is held by former shareholders of the domestic corporation (or former partners of the domestic partnership); and

  3. After the acquisition, the EAG (which includes the foreign acquirer) does not have substantial business activities in the acquirer's country of incorporation.

As a result of such an "inversion," the foreign acquiring company becomes a "surrogate foreign corporation" with respect to the domestic corporation or partnership as the expatriated entity. The tax treatment of the surrogate foreign corporation varies, depending on the level of shareholder continuity. If the percentage of stock (by vote or value) in the surrogate foreign corporation held by former shareholders is 60% or more (but less than 80%), the entity is treated as a foreign corporation, but any applicable corporate-level income or gain that requires recognition by the expatriated entity (Secs. 311(b), 304, 1248, etc.), or any income or gain recognized by reason of the transfer or license of property other than inventory or similar property, cannot he offset by the expatriated entity's net operating losses or credits. The treatment of the expatriated entity will apply for a 10-year period following the completion of the acquisition. Perhaps more significantly, when the former shareholders or partners of the domestic entity hold at least 80% of the foreign surrogate corporation, that foreign corporation will be treated as a domestic corporation for all Sec. 7874(b) purposes.

Disregard of Stock Held by EAG Members

Two categories of stock have to be disregarded for purposes of determining the 60% and 80% stock ownership test: (1) stock of the foreign corporation which is sold in a public offering and (2) stock held by EAG members. The EAG is defined by reference to Sec. 1504(a), except it includes foreign...

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