IRS issues regs. on sec. 7874 expatriated entities.

AuthorNevius, Alistair M.

The IRS issued temporary regulations on June 7 governing whether a foreign corporation has "substantial business activities" in the foreign country in which, or under the law of which, the corporation is created or organized, compared to the total business activities of the expanded affiliated group (T.D. 9592). At the same time, it issued final regulations explaining when a foreign corporation is treated as a "surrogate foreign corporation" under Sec. 7874(a)(2)(B) (T.D. 9591). Sec. 7874 is intended to prevent abusive corporate inversion transactions.

Sec. 7874(a) imposes a tax on the inversion gain of an "expatriated entity." Inversion gain generally is income or gain recognized from the transfer by the expatriated entity of stock or other property in an acquisition described in Sec. 7874(a)(2)(B)(i).

An expatriated entity is a domestic corporation or partnership with respect to which a foreign corporation is a "surrogate foreign corporation" and any U.S. person who is related to such a domestic corporation or partnership (Sec. 7874(a)(2)(A)). A surrogate foreign corporation is a foreign corporation that acquires substantially all the properties held by a domestic corporation (or constituting a domestic partnership's trade or business) and, after the acquisition, at least 60% of the entity's stock is held by former shareholders of the domestic corporation (or former partners of the domestic partnership), and the expanded affiliated group that includes the entity does not have substantial business activities in the foreign country in which (or under the law of which) the entity is created or organized (Sec. 7874(a)(2)(B)).

To determine whether a foreign corporation has substantial business activities in a foreign country and thus is not a surrogate foreign corporation, in the new temporary regulations, the IRS applies a bright-line rule (replacing a facts-and-circumstances test in earlier temporary regulations). Under the temporary regulations, an expanded affiliated group will have substantial business activities in the foreign country only if at least 25% of the group employees, group assets, and group income are located or derived in the...

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