New IRS Guidance on Corporate Inversions Mostly Prospective

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By Alison Bennett

Nov. 19 — The IRS issued new guidance to continue the government's battle against inversion deals that let U.S. companies move their addresses outside the U.S. to reduce taxes—guidance that is for the most part prospective, but signals the government's intense efforts to make these deals tougher and less attractive.

In releasing the guidance Nov. 19, Treasury Secretary Jacob J. Lew said Notice 2015-79 “makes it tougher for companies to invert.”

He stressed to reporters that the administration will continue to use every tactic it has to attack these deals, but can't shut them down completely without help from Congress.

Earnings Stripping Action Likely

Lew said the new notice doesn't address the problem of earnings stripping, but it remains a significant issue on Treasury's radar screen and there is likely to be “action in the coming months.” He told reporters the notice isn't aimed at any specific transaction, even though it comes amid plans for Allergan Plc and Pfizer Inc. to merge, which could create the largest U.S. tax inversion in history if—as expected—New York-based Pfizer were to set the combined company's headquarters in Allergan's home nation of Ireland (217 DTR I-1, 11/10/15).

However, the guidance could impact industries such as drugmakers, technology companies, insurers and manufacturers—many companies with global operations that benefit from inversions.

‘Third Country’ Relocations Tightened

Among other changes, the guidance limits the ability of U.S. companies to combine with foreign entities when the new foreign parent is located in a “third country.” According to an IRS fact sheet, this provision will prevent U.S. firms from essentially cherry-picking a tax-friendly country in which to locate their tax residence.

A senior Treasury official at the news briefing said he expects this provision to have the greatest immediate impact.

In other changes, the notice would also limit the ability of U.S. companies to inflate the new foreign parent corporation's size and avoid rules that would tax the transaction.

Substantial Business Activity Exception Tightened

In addition, it would make a “25 percent exception” for substantial business activities tougher to meet. Under current law, a U.S. company can successfully invert if, after the deal, at least 25 percent of the combined group's business activity is in the country where the new foreign parent is created or organized.

The change would provide that the group can't satisfy the requirement unless the new foreign parent is a tax resident in the foreign country in which it is created or organized, making it tougher for a U.S. multinational to replace its U.S. tax residence with tax residence in a country where it doesn't have substantial business activity.

The notice also aims to prevent inverted companies from transferring foreign operations “out from under” the U.S. tax net without paying U.S. tax, Treasury said.

Mostly Prospective

The senior Treasury official said during the briefing that most parts of the notice are prospective and apply only to transactions after the date the guidance is issued. However, the section dealing with transfers of operations to a new foreign parent is retroactive to the date of Treasury's first wave of guidance on inversions, Notice 2014-52, issued last September (184 DTR GG-1, 9/23/14).

Taken as a whole, “the notice is truly prospective,” the official said.

The guidance follows a Nov. 18 letter to Congress by Treasury's Lew, promising “targeted” guidance but emphasizing at the same time that Treasury doesn't have the authority it needs to completely stop inversions.

Likelihood of Hill Action?

Lew stressed “We look forward to continuing to work with Congress in a bipartisan manner to reform our broken business tax system and to eliminate inversions for good.” The senior official said during the briefing that while solving the problem of inversions as a whole might only be possible as part of broader tax overhaul, it still might be doable for lawmakers to address specific issues in coming months. He stressed that Treasury is willing to work with Congress on any possible action in this area.

Reaction on the Hill was mixed, but all key players agreed changes are needed to head off inversions, with many saying a tax redo is a must.

Sen. Ron Wyden (Ore.), ranking Democrat on the Senate Finance Committee, said action is needed to “end the inversion virus that is plaguing our country,” calling the deals “a red flag on the urgent need for tax reform.” He said this should be a top Hill priority in coming months, and “With leadership in both the House and Senate recognizing the importance of fundamental tax reform, there's no reason we shouldn't be able to get there.”

Hatch Weighs In

Finance Chairman Orrin Hatch (R-Utah) said he fears that “a pure anti-inversion approach may have the unintended consequence of encouraging more acquisitions of United States companies by foreign-owned firms. We need to chart a course that tips the balance away from inversions and foreign takeovers.”

He said the best way to solve the problem is through a comprehensive tax overhaul that lowers the corporate tax rate and shifts the U.S. to a territorial system with base erosion protections. Leadership from the White House is needed to forge bipartisan compromise, he said

Pfizer Seen as Evidence of Need for Action

Rep. Sander Levin (Mich.), ranking Democrat on the House Ways and Means Committee, praised the IRS action, but said he agrees with Lew that only legislation can stop inversions, citing the potential Pfizer inversion deal as evidence that lawmakers need to move quickly.

Rep. Chris Van Hollen (D-Md.) said he applauds the administration “for taking new steps to limit the egregious corporate inversions tax loophole.” He said he's hopeful the guidance will keep companies from renouncing their U.S. citizenship just to dodge taxes, but said it won't work to truly stop inversions without help from lawmakers.

“Until Congress tackles this in a serious way, companies that move forward with inversions still have a green light to take advantage of all the benefits of being located in the United States,” he said.

Input From Practitioners

Practitioners said Nov. 19 that it will take time to sort through the very technical changes proposed in the notice.

John Harrington, a partner at Dentons LLP in Washington, said one aspect that requires a closer look is a new provision dealing with disregarding certain stock transferred in exchange for nonqualified property.

“It is a little frustrating that Treasury and IRS are issuing a second notice before implementing Notice 2014-52 into regulations,” Harrington said.

He noted that Notice 2015-79 has corrections and clarifying changes to Notice 2014-52, “which one would have expected to be addressed through regulations rather than through a second notice on the same subject.” he said.

Consequences Huge

“Even if Treasury and IRS believe that they need to act quickly on a specific issue, the consequences of being treated as an inverted entity are huge and one needs to know clearly how they new rules work, even if only to make sure that one does not inadvertently run afoul of them. The notices seem to be designed to chill rather than to guide,” Harrington said.

Philip West, chairman of Steptoe & Johnson LLP, said it is likely that recently announced deals prompted new urgency for releasing these rules, “but it is equally evident that they have been under consideration for longer than the period since the biggest of those recent deals was announced.”

With assistance from Aaron Lorenzo, Marc Heller and Casey Wooten in Washington.

To contact the reporter on this story: Alison Bennett in Washington at

To contact the editor responsible for this story: Brett Ferguson at

For More Information

Texts of Notice 2015-79 and the fact sheet are in TaxCore.

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