Treasury Department Issues New Guidance for Corporations that Transfer Operations Abroad to Reduce Tax Liability

BurgerKingFood.jpg“Corporate inversion,” the process by which a corporation merges with a foreign corporation and relocates its headquarters to the foreign company’s home country, has received a considerable amount of attention in recent months. It is often expressly intended to reduce a corporation’s tax burden by moving the company to a country with lower corporate taxes, while still maintaining physical operations in the U.S. The White House and others have criticized the practice, and corporations are lobbying against laws that would restrict it. The Internal Revenue Code (IRC) already contains “anti-inversion” provisions, and a recent notice from the Department of the Treasury (DOT) states that new Internal Revenue Service (IRS) regulations will enhance the scrutiny of foreign mergers.

Section 7874 of the IRC, 26 U.S.C. § 7874, seeks to regulate corporate inversions. It applies to any U.S. corporation that transfers its headquarters and other assets overseas through a merger with a foreign corporation after March 4, 2003. The merged foreign corporation is subject to the same tax treatment as a domestic corporation if 80 percent of its stock is held by the U.S. company’s former shareholders, and it does not have “substantial business activities” in its home country. Id. at §§ 7874(a)(2), (b). If the merged foreign corporation has 60 percent of its shareholders in common with its domestic predecessor, the IRS designates it as a “surrogate foreign corporation” and applies U.S. tax rates to the amount of its inversion gain. Id. at §§ 7874(a)(1)-(2).

Several U.S. corporations have announced inversion plans in 2014. While some of them decided not to follow through after public opinion turned against them, other deals are still in the works. The U.S. pharmaceutical company Pfizer abandoned a bid to acquire the British company AstraZeneca, and the pharmacy chain Walgreens decided not to reorganize in Switzerland after merging with that country’s Alliance Boots. The fast-food chain Burger King, however, is reportedly still in the process of acquiring Tim Hortons and reorganizing in Canada.

Inversion is, in some ways, similar to the practice of renouncing one’s U.S. citizenship to avoid paying federal taxes. Foreign corporations are not subject to the U.S. corporate income tax rate, just as citizens of other countries are not subject to individual income tax and other taxes. One key difference is that corporations may remain in the U.S. even after moving their headquarters, while a renunciation of citizenship requires leaving the country. Corporate inversion is also rarely available to small businesses, since it requires maintaining physical locations in multiple countries.

The DOT issued Notice 2014-52, which outlines changes to § 7874 regulations, in September 2014. The changes affect any inversion that takes place on or after September 22. They will prevent certain actions aimed at avoiding the 60 percent and 80 percent thresholds, such as shifting money from the domestic corporation to overseas accounts in order to make the foreign corporation appear larger. They will also apply added scrutiny to certain types of transactions that commonly appear in inversions, such as investments by the foreign corporation in U.S. property, described in IRC § 956.

Small business lawyer Samuel C. Berger represents entrepreneurs and businesses in New York City and Northern New Jersey. Our fixed-fee legal-service packages cover a wide range of legal needs, including business formation, mergers and acquisitions, and contracts. To schedule a confidential consultation with an experienced and skilled business law advocate, contact us today online or at (212) 380-8117.

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Photo credit: By Boston at en.wikipedia [Public domain], from Wikimedia Commons.