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Oct. 8 — Companies that invert on or after Sept. 22 could be impacted by the government's next round of guidance to put the brakes on these transactions, as the administration actively considers tightening the reins on earnings stripping, IRS and Treasury Department officials cautioned.
Although that coming guidance will apply prospectively, “the mere fact that somebody inverts on or after Sept. 22 isn't going to grandfather them out of any future guidance,” Daniel M. McCall, special counsel in the Internal Revenue Service Office of Associate Chief Counsel (International), said Oct. 8 during a webinar sponsored by Penn State Law .
Sept. 22 is the date the Treasury and the IRS issued Notice 2014-52, the administration's newest effort to slow a wave of offshore restructurings designed to escape U.S. tax.
Comments from both McCall and Brenda Zent, a taxation specialist in Treasury's Office of International Tax Counsel, came in response to a question on the scope of the notice's Section 5, from panelist Brian Davis, a tax partner in the Washington office of Ivins Phillips & Barker .
Section 5 said the government is considering guidance “to address strategies that avoid U.S. tax on U.S. operations by shifting or `stripping' U.S.-source earnings to lower-tax jurisdictions, including through intercompany debt,” as well as other ways to curb inversions.
According to the notice, “Future guidance will apply prospectively; however, the Treasury Department and the IRS expect that, to the extent any tax avoidance guidance applies only to inverted groups, such guidance will apply to groups that completed inversion transactions on or after September 22, 2014.”
Zent cautioned that companies that invert on or after the date of Notice 2014-52, but before that next set of guidance comes out, won't be safe from its impact.
Even though the rules will be prospective, “you will be subject to future guidance that we issue,” Zent said.
She asked for comments “as soon as possible” on the earnings stripping issue, stressing that the project is “very much on our radar. Just because we didn't put particular guidance in this first notice, doesn't mean that we won't.”
Officials are strongly focused on the use of intercompany debt to strip earnings out of the U.S., Zent said. She noted the guidance may focus on limiting other benefits as well.
In answer to a question from Davis, Zent said Notice 2014-52 doesn't provide a preview of what will be in the coming guidance.
Zent and McCall addressed a broad range of technical issues under Notice 2014-52, including one of its most high-profile provisions to stop the use of “hopscotch” loans under tax code Section 956 to access low-tax foreign earnings.
“It was relatively clear to us, just from the type of work we do, that a very large economic benefit of the recent wave of inversions was the ability of newly inverted groups to access foreign cash owned by a U.S. parent tax-free,” McCall said.
The IRS attorney said the government wanted to shut down the ability of controlled foreign corporations to loan cash “around” an inversion, up to the new foreign parent. “That was very troubling to us,” he said.
Penn State Law Professor Samuel C. Thompson Jr., who moderated the panel, raised a question of how the government might treat transactions involving loans to U.S. inverters from the foreign parent in deals that took place before Sept. 22.
McCall said although the notice itself doesn't apply to pre-Sept. 22 inversions, the government potentially could challenge earlier transactions under a long-standing anti-abuse rule.
The two officials also discussed an “anti-cash box” provision intended to address situations where companies “stuff” assets into the foreign acquiring company to make that company larger. The rule would disregard stock of the foreign parent that can be attributed to passive assets if at least 50 percent of the foreign group's assets are passive.
Zent said Treasury believes the 50 percent rule is “very generous” and is intended to catch aggressive deals where the foreign acquiring company “isn't conducting a real transaction.” In answer to a question from Davis, Zent said the 50 percent threshold test is a per se rule and isn't rebuttable.
Another provision in Notice 2014-52 discussed during the webinar was the “anti-slimming rule,” which would increase the value of U.S. corporations for purposes of tax code Section 7874 to the extent of their “non-ordinary course distributions.”
McCall said the government has already received comments about how to measure the amounts in question and how to handle transactions that take place mid-year. The government is likely to address these and other technical issues in regulations that incorporate the notice, he said.
He also said the regulations will include a rule to stop companies from paying non-ordinary course distributions to avoid tax code Section 367. The rule will be similar to the one in the notice aimed at the use of these distributions to avoid Section 7874, McCall said.
The government panelists also discussed a provision in the notice to shut down a strategy used by some companies to “decontrol” controlled foreign corporations after inversions. In this strategy, U.S. multinationals have the new foreign parent buy enough stock to take control of the CFC away from the former U.S. parent. This allows the new foreign parent to get access to the deferred earnings of the CFC without paying U.S. tax.
Under the notice, the new foreign parent would be treated as owning stock in the former U.S. parent, rather than the CFC, to remove the benefits of the “de-controlling” strategy. The CFC would remain a CFC and would continue to be subject to U.S. tax on its profits and deferred earnings.
Zent said this “recast” of the transaction will be for all purposes of the tax code and will continue “forever,” as long as the entities continue to exist. “We don't have a cutoff,” she said. The provision applies to specified transactions that take place over the next 10 years, “but if you are recast, it is forever,” she said. In answer to a question from Davis, she said this would be the case even if a recast happened at the end of Year 9.
McCall said in general, “if one is subject to this recharacterization, it does apply for all purposes.” He noted the regulations will address “various permutations” of the CFC de-controlling strategy.To contact the reporter on this story: Alison Bennett in Washington at email@example.com
To contact the editor responsible for this story: Cheryl Saenz at firstname.lastname@example.org
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