Regs. define disregarded stock for purposes of sec. 7874 inversion transactions.

• Author: Shapel, Natallia

On Jan. 16,2014, the IRS issued long-awaited temporary regulations (T.D. 9654) providing guidance on when foreign corporate stock is taken into account in determining whether the ownership test is satisfied for Sec. 7874. The temporary regulations also provide guidance on the effect of transfers of stock of a foreign corporation after the foreign corporation has acquired substantially all of the properties of a domestic corporation or of a trade or business of a domestic partnership. The temporary regulations replace guidance provided in Notice 2009-78, which is made obsolete.

Sec. 7874: Background

Sec. 7874 applies to a transaction completed after March 4,2003, if under a plan or series of related transactions:

* A foreign corporation acquires (directly or indirectly) substantially all of the properties of a domestic corporation (or partnership) (the acquisition test);

* The shareholders (or partners) of the domestic corporation (or partnership) acquire at least 60% of the vote or value of the foreign corporation by reason of holding stock in the domestic corporation (or interest in the partnership) (the ownership test); and

* The foreign corporation, considered together with all companies connected to it by a chain of greater than 50% ownership (i.e., the expanded affiliated group), does not conduct substantial business activities in its country of incorporation compared with the total worldwide business activities of the expanded affiliated group (the substantial activities test).

If an inversion transaction meets all the above tests, the foreign acquiring corporation is treated as a surrogate foreign corporation with respect to the expatriated domestic corporation or partnership. The tax treatment of the surrogate foreign corporation varies, depending on the level of shareholder continuity. If the owners of the inverted U.S. entity own, by vote or value, 80% or more of the surrogate foreign corporation following the inversion, the foreign corporation is treated as a domestic corporation for all purposes of the Code and for all U.S. treaty purposes. If the former shareholders' ownership of the inverted corporation is less than 80% but at least 60%, the surrogate foreign corporation is treated as a foreign corporation. However, the expatriated entity is denied the use of its tax attributes (e.g., net operating losses or credits) to offset the inversion gain and certain other income for the succeeding 10-year period.

Public Offering Rule and Notice 2009-78

In determining if...