Specifically Unspecific: Inversion Aversion and IRS Treas. Notice - PDF document

Specifically Unspecific: Inversion Aversion and IRS Treas. Notice 14-52 By: Paul Determan, Michael Steffany & Jason Jointer

What is an Inversion? • U.S.-based multinational changes its corporate structure, via merger, so that the new foreign corporation replaces the U.S. Target Co. • Target Co. changes its country of residence • Usually in low or no tax jurisdiction US F SH SH US F SH SH Foreign Parent (X) US Target Foreign Assets/Stock Co. Corp (X) US Target Co.

Q: Why Corporations Invert • U.S. tax policies create an incentive to shift ownership away from U.S. based companies

Putting it all Together A: To gain access to foreign earnings and reduce U.S. earnings

Inversion Arguments

Inversion Activity • The statutory framework has existed for years • Increase in frequency, size and visibility

IRS and Treas. Action • Incremental changes to deter inversions techniques when they see a flare up in activity benefitting corporations • The Notice is the most recent example of this behavior. Notice 14-52 Inversions http://nexusnow.info/forum/showthread.php?9084- Whack-A-Mole

Early Inversion Activity • Naked inversion- U.S. parent corporation inverts into its own foreign subsidiary • Many of these inversions lacked clear business purpose and primarily motivated by tax avoidance • Substantially the same owners Inversion without ownership or control limits Determined to be tax abusive • Led to the enactment of anti-inversion rules under § 7874

§ 7874 • Restricts the tax benefits of an inversion • When the owners of the new company are not substantially different from the owners of the original company. • Requires the ownership of the new foreign parent to be in a range of 60% to 80% by the former domestic shareholders • Allows for a safe harbor for substantial business activities

Substantial Business Activities • Safe harbor from § 7874 anti-inversion provisions If the affiliated group’s post- ​ merger activities are • at least 25 percent in each category: employees, assets, and income • These activities must be located or derived in the foreign jurisdiction where foreign parent is incorporated.

Ownership Thresholds Does not deter inversions, corporations are willing to accept penalties

§ 367- Anti-inversion penalties • Shareholders are taxed on inversion gain • Target Co.’s taxable income cannot be less than the inversion gain until 10 yrs. after the inversion • Inversion cannot be offset by NOLs, FTCs or other tax attributes • Doesn’t discourage inversions • Corporations wait till the 10 years lapses

IRS & Treasury’s Intentions http://fiberplex.com/wp-content/uploads/2014/05/mallet2.jpg

IRS Notice 2014-52 Treasury and IRS intend to issue regulations • addressing inversions and post-inversion transactions. The notice describes the substance of these future • regulations. However: the Treasury and IRS expect to issue • additional guidance to further limit inversions and specifically will address earnings stripping. Both the described and undescribed future guidance • applies to companies that complete inversion on or after September 22, 2014 .

Example Described Regulation SECTION 3. REGULATIONS TO ADDRESS POST- INVERSION TAX AVOIDANCE TRANSACTIONS .01 Regulations to Address Acquisitions of Obligations and Stock that Avoid Section 956 • (a) Section 956 Background Section 957(a) defines a CFC as a foreign corporation with respect to which more than 50 percent of the total combined voting power of all classes of stock entitled to vote or the total value of the stock of the corporation is owned (directly, indirectly, or constructively) by United States shareholders (U.S. shareholders). Section 951(b) defines a U.S. shareholder as a U.S. person that owns (directly, indirectly, or constructively) 10 percent or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation.

Future Earnings Stripping Regulation Description: ”The Treasury Department and IRS expect to issue additional guidance to further limit inversion transactions contrary to the purpose of section 7874 and the benefits of post-inversion tax avoidance transactions . In particular the IRS and Treasury Department are considering guidance to address strategies that avoid U.S. tax on U.S. operations by shifting or ‘stripping’ U.S.-source earnings to lower-tax jurisdictions, including through intercompany debt. Comments are requested regarding the approaches such guidance should take.”

Notice’s Inversion Ownership Threshold Proposed Regulations Future regulations will limit the ability of U.S. Corporations to • meet the ownership threshold required by: Limiting a U.S. Corporation’s ability to invert with a • foreign corporation that has subsantial passive or liquid assets. In many cases, stock attributed to such assets will not impact the ownership fraction. Limiting a U.S. Corporation’s ability to meet the ownership • tests by making “skinny down” distributions. Limiting a U.S. Corporations ability to take advantage of • the internal group restructuring exception.

Notice’s CFC Earnings Access Proposed Regulations Future regulations will provide that for 10 years after inversion, • the new foreign parent’s ability to access CFC earnings will be limited: New Foreign Parent cannot access earnings of CFC’s via a • “hopscotch” loan. New Foreign Parent cannot access earnings of CFC’s via a • “de-controlling” transaction. New Foreign Parent cannot receive U.S. tax free transfers • of property or cash from a CFC via certain section 304 transfers.

Post-Notice Effect on Inversions ENDED: • AbbieVie/Shire: abandoned on October 20. The cancellation resulted in a (deductible!) $1.635 billion break up fee paid by AbbieVie. • Salix Pharmaceuticals and Cosmo: abandoned on October 3. NEW PARTNER: • Auxilium/QLT abandoned • Auxilium has made a deal to be acquired by Endo • Chiquita/Fyffes abandoned • Chiquita/Cutrale-Safra are in discussions for inversion to Brazil.

Post Notice Effect on Inversions RESTRUCTURED: • Medtronic/Covidien: restructured deal with new financing terms specifically to mitigate the effects of the Notice • Mylan/Abbott Laboratories : restructured deal, and “announced adjustments” to their deal on October 22 NEW INVERSIONS: • Civeo Corp . of Texas announced on Sept. 29 it would be “redomiciling” in Canada • Steris Corp . of Ohio announced on October 13 it would acquire Synergy Health Plc , and invert to the UK.

Potential Challenges to Notice 14-52 • Authority to issue Regs. • Judicial review and deference given to the Regs. • Effective date of the Regs.

Service and Treasury Authority The Notice proposes substantial regulations on a variety of • statutes, most notably IRC 956, 7701, 304, and 7874 Each of these statutes has a specific grant from Congress to • issue subsequent regulations. Specifically 956(e), 7701(l), 304(c), and 7874(g) The Service will argue that these are full legislative regulations • and should likewise be given full deference by the Court.

Weight of Proposed Regs. • Because there is a Congressional grant to write regs. under these statutes, the Regs. will likely be afforded a great deal of deference by the Courts. • Typically Courts grant legislative regs. Chevron deference. Meaning that the agency’s interpretation will be respected as long as it is based on a permissible construction of the statute. ( Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc. 467 U.S. 837 (1984)

Weight of Proposed Regs. • However there is a long history of Courts respecting transactions with reasonable business purposes and the same could happen here. • Additionally the argument may be made that because of the nature of the proposals the Secretary is going further than the Congressional grant to interpreting existing statues and write regs. and is effectively creating new law thus exercising a power not reserved for the executive.

Effective Date of Regs. 26 U.S. Code § 7805 - Rules and regulations • (b) Retroactivity of regulations • (1) In general • Except as otherwise provided in this subsection, no temporary, proposed, or final regulation relating to the internal revenue laws shall apply to any taxable period ending before the earliest of the following dates: • (C) The date on which any notice substantially describing the expected contents of any temporary, proposed, or final regulation is issued to the public.

Effective Date of Regs. • Two further exceptions for retroactivity are carved out within IRC 7805 • 7805(b) (6) Congressional authorization The limitation of paragraph (1) may be superseded by a legislative grant from Congress authorizing the Secretary to prescribe the effective date with respect to any regulation. • There is no such grant related to Earnings Stripping mentioned in the Notice. • 7805(b) (3) Prevention of abuse The Secretary may provide that any regulation may take effect or apply retroactively to prevent abuse. • While the IRS may issue retroactive regs. to prevent abuse, Congress has neither defined the term nor given anyone else power to do the same.