Emerging issues for non-U.S. shareholders in corporate inversions.

• Author: Jones, Don

In 2004, Congress enacted Sec. 7874 in response to a number of U.S. companies that were reincorporating as foreign (i.e., non-U.S.) corporations (primarily in tax-haven jurisdictions) despite maintaining the majority of their headquarter functions in the United States. In many cases, the U.S. companies performing these "inversion transactions" had few or no business operations in the foreign country of reincorporation; the primary purpose of the transactions was to reduce their overall U.S. federal tax liability by shifting profits to low-tax foreign jurisdictions. U.S. corporations and shareholders of such corporations face potentially harsh tax consequences if they become subject to Sec. 7874.

The financial turmoil of the past few years has caused U.S. companies and foreign investors to take another look at potential Sec. 7874 issues in certain circumstances. The financial crisis has made it difficult for U.S. companies to raise much-needed capital through debt financing. Therefore, some U.S. companies are seeking access to capital by going public on Asia Pacific (ASIA-PAC) stock exchanges. There are many reasons for this trend, but the most prevalent is that countries in the ASIA-PAC region (e.g., China and Hong Kong) have weathered the recession much better than other countries. Due to these countries' better current financial condition, there may be more investors in ASIA-PAC with capital to invest in initial public offerings (IPOs) than in other markets. Another important factor is that the ASIA-PAC exchanges often have less-stringent reporting and filing requirements than more traditional exchanges such as the New York Stock Exchange or the London Stock Exchange.

U.S. companies going public on an ASIA-PAC exchange may find it easier to do so with a non-U.S. company such as a Hong Kong or a British Virgin Islands--based company. This is achieved by taking a foreign company public and at the same time causing the foreign company to acquire the stock of the U.S. company. The U.S. company's shareholders receive publicly traded stock in the newly created foreign company in exchange for their stock in the U.S. company. Post-transaction, the former investors in the U.S. company along with the new investors who purchased the IPO shares collectively own the foreign company, which in turn wholly owns the U.S. subsidiary. In this foreign IPO context, Sec. 7874 may create undesirable tax consequences for foreign investors that invest in the new...