INSIGHT: Back to the Dry-Erase Board: Redrawing Cross-Border M&A Structures Post-Tax Reform

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By Scott M. Levine and Christopher S. Hanfling

Huddled around dry-erase boards with their newly-minted editions of the Internal Revenue Code, tax practitioners continue to reexamine transactions and structures for cross-border M&A. The legislation informally known as the “Tax Cuts and Jobs Act” signed into law Dec. 22, 2017 (2017 tax law) represents the most comprehensive reform to the U.S. federal tax code in a generation and has upended traditional thinking in this area, particularly with respect to the taxation of controlled foreign corporations (CFCs). These changes present a range of questions, opportunities, and traps for the unwary. As a result, tax practitioners in many cases must start over in analyzing the structures—frequently having to redraw them—which may reflect thinking far removed from the traditional approaches. This article provides a high-level overview of some significant impacts of the new rules on cross-border M&A.

Significant Changes under the 2017 Tax Law

Fundamental Changes to International Taxation

Under prior law, foreign income of a U.S. person was subject to current taxation at full U.S. rates. The foreign income of a foreign subsidiary of a U.S. multinational, however, was divided into two categories that were taxed differently. Subpart F income (generally, income of a type that was determined by Congress to be easily shifted to low-tax jurisdictions) was subject to current tax at full U.S. tax rates unless the income was subject to a sufficiently high foreign tax rate (high-tax kickout income). Once taxed, the shareholder had an account for previously taxed income (PTI) with respect to the CFC (a PTI account), and distributions out of the PTI account were generally not subject to additional U.S. tax. All other foreign income of the foreign subsidiary was not subject to U.S. tax until the profits were repatriated back to the U.S. or the shareholder cashed out of its investment in the CFC. When the shareholder cashed out its investment, gain from the sale was generally treated as a dividend to the extent of the CFC’s untaxed earnings.

Under current law, this income is subdivided into several categories subject to tax at different rates. The income of the U.S. parent is divided into regular income and Foreign-Derived Intangible Income (FDII). Regular income is subject to tax at the normal U.S. rates, but FDII benefits from a reduced rate of 13.125 percent (increasing to approximately 16.4 percent after 2025). FDII is generally income from the sale of property for foreign use to or performance of services for foreign customers.

The income of the foreign subsidiary is also divided. Although the Subpart F rules are generally the same, the other foreign income is generally divided between global low-tax intangible income (GILTI), which generally is subject to current U.S. tax at a rate of 10.5 percent (increasing to approximately 13.125 percent after 2025) and included in the shareholder’s PTI account, and the net deemed tangible return (NDTR), which generally is not subject to U.S. tax. Although taxpayers can generally structure their activities so as to avoid generating Subpart F income, most income of foreign subsidiaries likely will be GILTI going forward and therefore subject to current U.S. taxation. The NDTR is generally 10 percent of the tangible asset basis of the foreign subsidiary and GILTI is generally all income, other than Subpart F income and high-tax kickout income, in excess of the NDTR. Although the NDTR and high-tax kickout income are generally not subject to U.S. tax when earned or when repatriated to the U.S. as a dividend under the new participation exemption, if a CFC with such earnings makes an investment in certain U.S. property, the earnings will be included in the U.S. parent’s income and subject to the full U.S. tax rate. Further, when a CFC is disposed of, the participation exemption can apply to the portion of the gain recharacterized as a dividend.

These changes were accompanied by changes to the foreign tax credit system. In general, only 80 percent of foreign taxes paid with respect to GILTI are creditable, and there are no carryforwards for foreign tax credits associated with GILTI. Credits for foreign taxes paid with respect to the NDTR or high-tax kickout income cannot be claimed if the earnings are distributed as a dividend—because the dividend is exempt from tax under the participation exemption—but can be claimed if the earnings are deemed repatriated because the CFC makes an investment in U.S. property. Finally, the pooling rules for foreign taxes were eliminated, and credits are now attributed to income under an annual tracing approach. Therefore, where a CFC has no income in a given category in a given year, foreign taxes paid with respect to that category in that year may be lost and never creditable against U.S. tax.

In addition, a corporation’s ability to claim foreign tax credits against GILTI may be materially limited due to the rules for allocating certain expenses to foreign source income. Such expenses generally include selling, general, and administrative (SG&A), research and development (R&D), and interest expenses. Between such expense allocation rules and the 20 percent foreign tax credit haircut, a corporation’s effective tax rate on GILTI may be well above the 13.125 percent rate initially thought to be the maximum GILTI effective tax (after taking into account the 20 percent disallowance of foreign tax credits).

The rules described above are materially different in the case of U.S. individuals, partnerships, or S corporations. The reduced tax rates on FDII and GILTI and the new participation exemption for high-tax kickout income and the NDTR are not available to taxpayers other than C corporations. Therefore, all income of a CFC other than the NDTR or high-tax kickout income is subject to current U.S. tax at the individual tax rates on ordinary income. Distributions of high-tax kickout income and the NDTR are taxable dividends and credits cannot be claimed for foreign taxes imposed on CFCs.

Individuals that include GILTI or Subpart F income from CFCs generally are able to make an election to be taxed as though they held their CFC investments through a domestic C corporation for purposes of taxing those inclusions (a “962 election”). Where a 962 election is made, the GILTI or Subpart F inclusion is generally subject to tax at the corporate tax rate and foreign tax credits are generally available for foreign taxes paid by the CFC—subject to the 20 percent haircut in the case of GILTI. When the CFC distributes the income, it is subject to U.S. tax again to the extent the amount of the distribution exceeds the amount of U.S. tax previously imposed. Although historically few 962 elections were made, in light of the reduced corporate tax rates, such elections may be more common.

There are several key issues that remain unclear with respect to the consequences of making a 962 election, however. First, although some commentators have suggested that it may be unclear whether individuals that make 962 elections are permitted to claim the reduced rates on GILTI available to C corporations, we believe—particularly in light of recent guidance—that such reduced rates are likely unavailable (although the reduced rates on the transition tax, described below, are available). In addition, the election is not available in certain circumstances where CFC stock is held through a partnership or S corporation.

Further, the tax rate imposed on distributions by CFCs to individual shareholders that make 962 elections may be higher than would be the case if the CFC stock were held through a domestic C corporation. Dividends paid by domestic C corporations and some foreign corporations to individual shareholders generally qualify for a reduced tax rate (usually 23.8 percent), while distributions paid by other foreign corporations to individual shareholders are subject to ordinary income tax rates (up to 40.8 percent, including the 3.8 percent surtax on passive income). Although the general consequence of a 962 election is to treat the electing individual shareholder as though the CFC stock were held through a domestic C corporation, a section 962 election may not cause distributions by the CFC to the individual shareholder to be treated as distributions by a domestic C corporation for purposes of determining the applicable tax rate.

Changes to CFC Definition

The 2017 tax law modified some of the key definitions related to determining whether a foreign corporation is a CFC. A CFC is generally any foreign corporation if more than 50 percent of its voting power or value is owned by “United States shareholders” (U.S. shareholders) on any day during the foreign corporation’s taxable year. A U.S. shareholder is generally any U.S. person that is a 10 percent shareholder in the foreign corporation, applying certain indirect and constructive ownership rules. Only U.S. shareholders of CFCs are required to take into account Subpart F income and GILTI inclusions—a U.S. person holding stock in a CFC is not required to pay such taxes if it owns less than 10 percent of the CFC’s stock actually or constructively. Unlike the constructive ownership rules that apply in determining whether a U.S. person is a U.S. shareholder, the proportionate share of a CFC’s Subpart F income and GILTI taxed to a U.S. shareholder depends only on the shareholder’s ownership of the stock of the CFC either directly or through a straight downstream chain of entities. As a result of these rules, a person can be a U.S. shareholder of a CFC with respect to which the U.S. shareholder is not required to take into account any Subpart F or GILTI inclusions.

Under prior law, a U.S. person had to own 10 percent or more of the total voting power of the foreign corporation to be a U.S. shareholder. Under the 2017 tax law, the standard for U.S. shareholder status is satisfied by 10 percent or greater ownership of the total voting power or value of the foreign corporation. This change is effective for taxable years of foreign corporations beginning after Dec. 31, 2017.

In addition, the 2017 tax law changed the relevant constructive ownership rules for purposes of determining U.S. shareholder status. Among the constructive ownership rules is a rule providing that if 50 percent or more of the value of the stock of a corporation is owned by any person, the corporation is treated as owning the stock owned by that person. This so-called “downward” attribution causes a corporate subsidiary to be treated as owning stock owned by its 50 percent-or-greater parent or shareholder. Prior to the 2017 tax law, such downward attribution could not be applied to treat a U.S. person as owning stock owned by a foreign person—that is, downward attribution could not apply to treat a U.S. corporate subsidiary as owning stock held by a 50 percent-or-greater foreign shareholder. The 2017 tax law eliminates this limitation, thereby allowing this type of foreign-to-U.S. downward attribution. The result of this is that the presence of a single U.S. corporation in a foreign multinational’s holdings can cause all of the foreign multinational’s foreign subsidiaries to be CFCs. This change is effective for the last taxable year of foreign corporations beginning before Jan. 1, 2018, and so is effective for purposes of calculating the transition tax (discussed below).

The below illustration shows the new reach of the CFC regime for taxable years of foreign corporations beginning after Dec. 31, 2017.

Figure 1 CFC regime
Jones Day

The changes to the constructive ownership rules and the definition of a U.S. shareholder result in many U.S. investors now being U.S. shareholders of CFCs in which they may not have a significant interest and with respect to which they may not have access to the information necessary to properly calculate and report their GILTI and Subpart F income inclusions. A foreign multinational without significant U.S. investors may be unable or unwilling to provide such detailed information to small minority holders. Further, given the broad scope of the constructive ownership rules, U.S. taxpayers may not be able to determine whether they are U.S. shareholders with respect to any CFCs.

The change to the constructive ownership rules results in a significant number of additional CFCs with respect to which no U.S. shareholder will be required to take into account Subpart F or GILTI inclusions. The Internal Revenue Service has provided in notices that this change does not apply for purposes of the rules for determining the source of income from certain communications, space, and ocean activities. The U.S. Treasury and the IRS also intend to provide guidance eliminating the reporting requirements for U.S. shareholders with respect to CFCs where no U.S. shareholder is be required to take into account Subpart F or GILTI inclusions.

Rethinking Traditional Structures

Partnership Structures

Many structures, in particular in the private equity area, involve the use of partnerships or other fiscally transparent entities to own significant stakes in foreign corporations. Where a U.S. partnership such as a private equity fund owns a 10 percent interest in a foreign multinational, as discussed above, the partnership may now be required to take into income Subpart F and GILTI inclusions even though under prior law there would have been no CFCs in the structure. As also discussed above, even where the partnership’s ownership of the foreign corporation was structured to constitute less than 10 percent of the voting power so as to avoid U.S. shareholder status, the change to voting power or value could cause U.S. shareholder status if the partnership owns more than 10 percent of the value of the foreign multinational.

Further, unless the partnership elects to be treated as a C corporation for U.S. tax purposes (and therefore subject to multiple levels of taxation), the reduced rate on GILTI inclusions may be unavailable to its partners, although the reasoning is different for corporate and non-corporate partners. Guidance may be issued providing that the reduced rate is available for corporate partners but not non-corporate partners. Foreign and tax-exempt investors generally will not want to invest through C corporations as they generally are not subject to tax on GILTI and Subpart F income. Therefore, U.S. individual investors in such structures may want to consider whether it is efficient to own the foreign company stock through a U.S. corporate blocker eligible for the reduced rate on GILTI.

In general, the decision whether to own the foreign company stock through a U.S. corporate blocker will depend on the anticipated foreign tax rates and the desirability of current distributions of profits. Where the foreign tax rate is high enough, it may be tax efficient to treat foreign corporations as partnerships for U.S. federal income tax purposes, avoiding the 20 percent haircut on foreign tax credits from GILTI inclusions. Alternatively, where the foreign taxes are low enough and especially if there is less need for current distributions of profits, it may be tax efficient to drop the CFC stock—or interest in the partnership that holds the CFC stock—into a domestic corporation that can qualify for foreign tax credits and potentially the reduced tax rate on GILTI inclusions. This possible structure is illustrated below.

Figure 2 Domestic C Corp Blocker
Jones Day

For example, if a CFC with a non-corporate U.S. shareholder that is subject to a 5 percent foreign tax rate earns $100x of GILTI, the $95x of GILTI is subject to a maximum individual tax rate of 37 percent, resulting in $59.85x of after-tax cash and an aggregate tax rate of 40.15 percent, as no foreign tax credits would be available to such shareholder. If the U.S. shareholder drops the CFC stock into a domestic C corporation that has no other income or expenses (and assuming that the C corporation is not ineligible for the reduced tax rate on GILTI by reason of holding the CFC stock through a partnership), the $95x of GILTI is subject to a 10.5 percent tax rate, reduced by foreign tax credits (equal to $4x, or 80 percent of the $5x of foreign taxes paid), for a corporate tax of $6.5x. When the C corporation distributes its $88.5x of earnings to the individual shareholder, it is subject to a second level of tax, usually at a maximum rate of 23.8 percent (including the 3.8 percent surtax on passive income), resulting in $67.44x of after-tax cash and an aggregate rate of 32.56 percent. Further, the C corporation can retain the $88.5x of earnings for reinvestment, deferring the 23.8 percent tax until the earnings are distributed.

Section 338(g) Elections

Under prior law, when a U.S. acquirer would purchase a foreign target, the U.S. acquirer would usually make an election under tax code Section 338(g). A Section 338(g) election, which is generally available for taxable acquisitions of corporations from unrelated parties, causes the target to be treated for U.S. tax purposes as having sold all of its assets to a new corporation and liquidated. The tax attributes of the target are eliminated and the target receives a step-up in the basis of its assets to fair market value. In the case of a domestic target, this generally results in an undesirable second level of tax. In the case of a foreign target, however, the deemed asset sale frequently was not subject to U.S. taxation under prior law.

Under prior law, the benefits of a Section 338(g) election for a foreign target usually outweighed the costs and so such elections were frequently made as a routine matter. The elimination of tax attributes, in particular earnings and profits (E&P) and foreign taxes paid, would permit the acquirer to determine the character of future distributions and related foreign tax credits more easily. In addition, the step-up in basis would permit additional amortization and depreciation deductions, which would reduce Subpart F income and, subject to significant limitations, possibly permit the parent to utilize more excess foreign tax credits than if the election had not been made. Finally, the election would eliminate the risk that a purchaser would be required to include Subpart F income earned in the pre-acquisition period. However, the PTI accounts and foreign taxes paid would be lost, and any U.S. property of the foreign target subject to the grandfather exception to Section 956 would lose grandfather status for certain assets acquired before the corporation became a CFC (Section 956 generally provides that a CFC is deemed to make a distribution to its U.S. shareholders to the extent of its investments in certain U.S. property). In addition, a U.S. seller could have recognized additional Subpart F income, depending on the nature of the target’s assets, which generally would be offset by reduced gain on the sale, converting capital gain (subject to a reduced rate of tax for individuals) into ordinary income.

Under current law, these benefits and costs are significantly different, and so acquirers will need to reconsider the utility of Section 338(g) elections. The new participation exemption means that distributions out of the foreign earnings of the foreign target will not be subject to tax, and further eliminates the availability of foreign tax credits for those foreign earnings. Therefore, retaining untaxed E&P of a foreign target may be beneficial to the acquirer. Further, foreign tax taxes paid will still be relevant to the extent that the foreign corporation makes an investment in U.S. property. Where the untaxed earnings of a foreign target were subject to sufficiently high foreign taxes, it may be beneficial for an acquirer to cause the target to invest in U.S. property. Finally, foreign subsidiaries of U.S. companies will normally have significant PTI accounts, and the elimination of those accounts may be undesirable. The step-up in asset basis also presents new considerations. The increased depreciation and amortization deductions may reduce the amount of Subpart F income and GILTI generated by the foreign corporation. Further, the increase in asset basis may increase the NDTR. Similarly, the elimination of grandfather status for U.S. property for purposes of Section 956 may be less significant of a cost, given that many CFCs will have limited or no income other than GILTI or Subpart F income.

The consequences of a Section 338(g) election on a U.S. corporate seller of a first-tier CFC are significantly different. All gain recognized by the foreign target in the deemed asset sale generally will be GILTI subject to tax at 50 percent of the normal corporate rate, unless the income would otherwise be Subpart F income or is sheltered by the NDTR. The GILTI inclusion likely will increase the seller’s basis in the target stock, potentially replacing the entire amount of gain on the sale with a lower-taxed GILTI inclusion. However, it may also replace gain that is untaxed by reason of the new participation exemption with a taxable GILTI inclusion. In the case of an individual seller, however, the election may convert low-taxed capital gain into high-taxed ordinary income.

Check-and-Sell Transactions

In addition to Section 338(g) elections, another common acquisition structure was the check-and-sell transaction. Gain recognized by a CFC on the sale of stock generally is Subpart F income but gain on the sale of business assets generally is not. Therefore, sellers would frequently elect to treat the CFC subsidiaries of CFC sellers as disregarded entities immediately prior to the sale to cause the sale to be treated as a sale of business assets not subject to current U.S. tax.

Under current law, although the same check-and-sell transaction would reduce Subpart F income, gain from the sale of business assets would generally be GILTI and subject to current U.S. tax. The reduced U.S. rate may be beneficial for corporate U.S. shareholders of CFC sellers, depending on the relevant foreign tax rate, but the GILTI inclusion may change the desirability of such structures.

Comparison of Check-and-Sell and 338(g) Alternatives

Where a CFC sells a lower-tier CFC to an unrelated buyer, the seller generally can choose between a check-and-sell transaction and requesting the buyer make a 338(g) election. From the buyer’s perspective both alternatives are treated as asset purchases, with generally the same consequences. The seller, however, may not be indifferent between the two alternatives. Although many of these considerations existed under prior law, the implications of these considerations under the current international tax regime may be quite different.

In the check-and-sell alternative, the gain or loss from the asset sale is included in the determination of income—and therefore GILTI and Subpart F income—of the CFC seller, while a 338(g) election causes those amounts to be recognized by the CFC target. The results of these alternatives under the rules for offsetting income and deductions and claiming foreign tax credits may be materially different. For example, if the target or seller has significant deficits in the year of the sale, those deficits could reduce GILTI generated on the sale, which, as discussed above, could result in the U.S. shareholder being unable to claim credits for foreign taxes imposed on the sale. This may not be relevant in cases where the seller is a CFC that benefits from a participation exemption under local law. Conversely, where the sale is at a loss, such loss could offset GILTI otherwise generated in the year, similarly preventing the U.S. shareholder’s ability to credit allocable foreign taxes. Further, different rules apply for using CFC losses to offset Subpart F income depending on whether the losses and income are considered earned by the same CFC. These and other considerations should be reviewed when determining the structure for the disposition of a lower-tier CFC, as illustrated below.

Figure 3 Disposition of lower-tier CFC
Jones Day

Key New Due Diligence Items

Section 965 Liabilities

The 2017 tax law imposed a one-time toll charge (sometimes referred to as a “transition tax”) on the deferred foreign income of foreign subsidiaries of U.S. taxpayers. In general, any U.S. person that owned 10 percent or more of any foreign corporation was required to take into income a one-time inclusion based on the aggregate deferred income of the foreign corporation. This inclusion was subject to a reduced rate of U.S. tax, either 8 percent or 15.5 percent, depending on the cash position of the foreign corporation. This tax can be paid in annual installments over an eight-year period, and the liability to make payments carries over to successors. Given the potentially large transition tax liabilities of companies over the next several years, significant due diligence will be required to ensure that all such liabilities have been paid or appropriately reflected in the purchase price.

The transition tax was imposed on earnings of any “specified foreign corporation,” a term that includes both CFCs and any foreign corporation with respect to which one or more U.S. corporations is a U.S. shareholder. This is broader than just CFCs and may not have been tracked by a target corporation or a seller prior to the 2017 tax law. Further, the change to the constructive ownership rules means that a potentially large number of corporations that had no U.S. shareholders before the 2017 tax law were specified foreign corporations for purposes of the transition tax (although in such case only the 2017 earnings are subject to the tax). Many companies with indirect minority holdings in foreign corporations may not even have access to the information necessary to determine whether such foreign corporations were specified foreign corporations or, if so, the amount of transition tax liability.

Many companies subject to the transition tax elected to pay the tax in eight annual installments. The installment payments are back loaded, with the majority of the tax due in the final years, so material transition tax liabilities will continue to be carried on the books of companies over the next eight years. Although the sale of substantially all of the assets of a target triggers the acceleration of the target’s remaining installment payments, this acceleration can be avoided if the buyer agrees to make the remaining payments. Further, there is some uncertainty whether the relevant taxable year for determining the statute of limitations on assessment of the transition tax is the year of the inclusion (2017 or 2018 in most cases) or the year in which the installment payment is due. If the relevant taxable year is the year in which payment is due, the statute of limitations for the transition tax could potentially be open for more than a decade. Therefore, transition tax liabilities of targets, as well as their prior acquisitions, will need to be carefully reviewed.

CFC Status

As discussed in detail above, the rules for determining CFC status have been significantly revised. These revisions mean that it is more complicated to determine whether a foreign target is or has been a CFC. This can have significant consequences, such as whether the foreign corporation has PTI or untaxed earnings and the ability to make entity classification elections. The historical ownership structures of targets will need to be reviewed carefully to determine whether under the new downward attribution rules there are or were any U.S. shareholders, a task that may prove quite challenging.

Premature Planning

The 2017 tax law was passed quickly and the U.S. Treasury and the IRS have provided limited guidance as to the application of the new rules, so there are significant open questions as to the interpretation and application of the 2017 tax law. For example, the U.S. Treasury and the IRS have broad authority under the transition tax to ignore transactions designed to reduce the amount of liquid assets on hand as of the relevant measurement dates, although it has not provided any guidance as to when or how it will use that authority. Further, it remains unclear whether a number of key calculations are made on a company-by-company or consolidated group basis, and the new system of tracing foreign taxes to income is not fully explained.

In light of the material changes under the 2017 tax law, taxpayers have been forced to plan transactions or restructure without answers to these open questions. Taxpayers have taken a range of reasonable positions on these issues and will likely file tax returns before some of these questions are answered. As guidance is released, taxpayers may find that their transactions did not have the desired results or that the guidance causes their transactions to have unanticipated consequences. Acquirers will need to determine the level of risk associated with the planning engaged in by targets, particularly in light of intervening guidance and the relevant effective dates of such guidance.

Interest Deductibility Limitation

The 2017 tax law significantly restricts the ability of taxpayers to deduct interest expense, which will likely have material effects on the financing and structuring of transactions. Under prior law, a U.S. taxpayer was generally restricted from deducting certain interest paid to related parties in excess of 50 percent of adjusted taxable income if the taxpayer’s debt-to-equity ratio was greater than 1.5 to 1.0. Disallowed interest was carried forward indefinitely.

Under current law, taxpayers are not allowed to deduct net interest expense in excess of 30 percent of an approximation of EBITDA (EBIT after 2021). This limitation applies regardless of the debt-to-equity ratio of the taxpayer and regardless of whether the interest is paid to a related party. Disallowed interest can be carried forward indefinitely. It is anticipated that the U.S. Treasury and the IRS will require this limitation to be applied at the consolidated group level, rather than on a company-by-company level, although no such guidance has been released as of yet. Further, the limitation would still be imposed on a company-by-company basis in the case of foreign corporations.

This limitation on the deductibility of interest may significantly impact the financing of transactions going forward. Leveraged purchases may no longer be efficient if the increased interest expense cannot be deducted. Alternatively, purchasers may try to spread the leverage around to all of the companies in its worldwide group, such that no company has interest expense in excess of the 30 percent limitation. These arrangements will need to take into account any applicable limitations on interest deductibility and other restrictions on leverage in the local jurisdictions. Finally, equity financing, in particular limited and preferred equity, may be more common.

New Opportunities and Incentives

Sales by CFC Subsidiaries of Foreign Multinationals

In general, where a CFC disposes of stock in a foreign corporation in which the CFC is at least a 10 percent shareholder, the gain recognized by the CFC is treated as a dividend to the extent of the untaxed earnings of the foreign corporation accumulated while the CFC held the foreign corporation stock. This deemed dividend likely will not result in U.S. tax to the U.S. shareholders under the new participation exemption. Where there is gain in excess of the amount treated as a dividend, such gain is usually Subpart F income. As discussed above, the foreign subsidiaries of most foreign multinationals are now CFCs. Therefore, dispositions of lower-tier stock by such CFCs may potentially trigger deemed dividends, Subpart F income and GILTI.

Many foreign multinational structures, however, will have a parent corporation that is not a CFC because of the mechanics of the downward attribution rule. Therefore, sales by the parent corporation, rather than its subsidiary, will not generate deemed dividends, Subpart F income or GILTI. Acquisition structures where the foreign multinational parent is the selling corporation may be more efficient. In some cases, this may be achievable by having the top-tier subsidiaries of the foreign multinational elect to be disregarded for U.S. federal income tax purposes. For example if a foreign multinational with a 15 percent U.S. shareholder owns a foreign seller and the foreign seller owns a foreign target, the consequences to the multinational’s U.S. shareholder are significantly different if the seller first elects to be disregarded for U.S. federal income tax purposes. The sale will be treated as made by a foreign corporation that is not a CFC (the foreign multinational) and therefore not generate any deemed dividends, Subpart F income or GILTI. These alternatives are illustrated below.

Figure 4 CFC sub sale by foreign MNC
Jones Day
FDII Deductions for Asset Acquisitions

Certain asset sales by U.S. corporations may benefit from reduced rates of taxation. If a U.S. corporation sells assets to a foreign acquirer for use outside the U.S., gain from the sale generally will constitute FDII eligible for the reduced tax rate. Although this likely will be unavailable for sales of tangible property such as U.S.-located plants and equipment (because such assets would likely remain in the U.S.), the portion of the gain from the sale of intellectual property attributable to ex-U.S. rights may qualify. This may have the effect of providing foreign purchasers with a material advantage over domestic purchasers in acquiring intellectual property-rich targets. Further, this may incentivize U.S. multinationals to effect acquisitions through their CFCs rather than directly. For example, if a U.S. pharmaceutical company desires to sell its rights to a drug, the portion of the purchase price attributable to the foreign rights may qualify for a reduced tax rate, but only if the purchaser is foreign.

The statutory language of the FDII rules also presents the question whether stock sales can qualify for the reduced tax rate. Although stock is generally treated as property under the tax code (with certain exceptions), the statute requires the seller to establish to the satisfaction of the IRS that the property is for a “foreign use.” It is unclear whether or how the “use” of stock can be classified as domestic or foreign, or how this use would be established. Further, the U.S. Treasury and the IRS have broad authority to specify how such use can be established and may issue guidance prohibiting stock sales from qualifying. In the absence of any such guidance, however, here may be an argument that sales of the stock of foreign—and even domestic—subsidiaries to foreign acquirers can qualify for the reduced tax rate on FDII. This could present a material advantage to foreign acquirers over their domestic competitors.


The above discussion is but a summary of the seemingly endless issues raised by the 2017 tax law and its impact on cross-border M&A. The myriad of tax consequences to what just a few months ago were run-of-the-mill transactions will continue to demand careful planning considerations. Tried-and-true M&A structures honed by tax lawyers and their clients over several decades may go the way of the buggy whip and the 8-track tape. Only time will tell which structures will replace them and what further alterations will need to be made as the U.S. Treasury and the IRS provide guidance on the numerous uncertainties surrounding the 2017 tax law.

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