Daily Tax Update - December 27, 2005

THE DAILY TAX UPDATE WILL BE PUBLISHED ON A PERIODIC BASIS UNTIL CONGRESS RETURNS IN SESSION ON JANUARY 18TH.

IRS and Treasury Issue Temp. Regs Relaxing Inversion Rules:
Today, the IRS and Treasury issued temporary and proposed regulations under the newly enacted anti-inversion statute, section 7874. The new rules focus on the aspect of the statute that would generally disregard affiliate-owned stock for purposes of determining whether a foreign corporation is a "surrogate foreign corporation" (generally the acquiring entity in an inversion transaction) and, therefore, whether the adverse tax consequences prescribed by the statute could apply to the foreign corporation's acquisition of a U.S. business.

The preamble to the temporary regulations takes pains to highlight the authority that exists for the regulation, citing both the legislative intent and the grant of regulatory authority in the statute. Presumably, this was necessary because some government officials had previously expressed concerns about the breadth of the government's authority to address some of the problems with the statute.

The general rule of the regulations is that affiliate-owned stock will be excluded from both the numerator and the denominator of the fraction that determines the stock ownership percentage for purposes of section 7874(a)(2)(B)(ii). One application of this rule excludes certain stock of the foreign acquirer that is owned by its subsidiary (so-called "hook stock"). Counting hook stock would enable the 60% ownership threshold of the statute to be defeated in many cases. (Shareholders of the acquired domestic entity must own at least 60% of the foreign acquiror for section 7874 to apply.)

In the most significant elaboration of the statute, however, the temporary regulations provide a special ameliorative rule which, where applicable, includes affiliate-owned stock (other than hook stock) in the denominator of the fraction that determines the stock ownership percentage for purposes of section 7874(a)(2)(B)(ii) but excludes such affiliate-owned stock from the numerator of that fraction. This provision will allow foreign-owned groups with at least 80%-owned U.S. subs to engage in internal restructurings involving those subs without triggering the penalties of section 7874.

Comments are requested on a host of issues for resolution in future regulations, and a warning shot is fired concerning transactions in which a foreign acquiring entity elects pass-through treatment to avoid being a "foreign acquiring corporation." The regulations state that retroactive rules may apply to such structures.

When issued as final regulations, these regulations will apply retroactively to taxable years ending after March 4, 2003. The text of the temporary regulations also serves as the text of simultaneously released proposed regulations.

For additional information, contact Philip R. West via email, or John J. Giles via email.

The regulations can be accessed here.

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