Daily Tax Update - December 27, 2005


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.

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

Steptoe & Johnson LLP has one of the largest and most diverse law firm tax practices in the country. The practice covers the entire spectrum of federal taxation, including representation of businesses before the Congress, Treasury and the national office of the IRS; transactional planning for domestic and multinational corporations; complex audit and controversy work for corporations and other business interests contesting IRS adjustments; litigation before the Tax Court, Court of Federal Claims, district courts, courts of appeals and the Supreme Court. The firm's tax practice also encompasses all aspects of employee benefits (ERISA), executive compensation, tax-exempt organizations and charitable giving.  Steptoe has an extensive state and local tax practice, representing an array of business clients on complex sales and use tax, corporate income tax and property tax matters, both advising those clients and handling audits, administrative appeals, and litigation for them.  Read  more information on Steptoe's tax practice