New U.S. Regulations Addressing Inversions

Inversion, Anti-Avoidance, Earnings Stripping

On April 4, 2016, the U.S. Government blasted "inversion" transactions - where a U.S. company is acquired by a smaller, foreign corporation based in a lower-tax jurisdiction - with new temporary and proposed regulations that not only make it even more difficult to invert, but eviscerate the tax benefits of inversions. However, Swiss companies could be affected as well.

This update is provided by True Partners Consulting LLC.

During the past several years, "inversion" transactions — where a U.S. company is acquired by a smaller, foreign corporation based in a lower-tax jurisdiction — have been attacked by the U.S. Government. On April 4, 2016, the U.S. Government brought out the heavy artillery and blasted the transactions with new temporary and proposed regulations that not only make it even more difficult to invert, but eviscerate the tax benefits of inversions.

The temporary regulations (T.D. 9761) incorporate the rules described in Notices 2014-52 and 2015-79 that address certain transactions designed to avoid the anti-inversion purposes of Code section 7874 and to reduce the tax benefits of companies that invert. The temporary regulations also clarify certain definitions and exceptions and introduce new rules addressing issues not discussed in either Notice, including (i) identifying a foreign acquiring corporation in multi-step transactions; (ii) disregarding stock of the foreign acquiring corporation that is attributable to previous acquisitions of domestic entities; (iii) requiring CFCs to recognize gain upon certain asset transfers to a related foreign person that is not a CFC; and (iv) defining group income for purposes of the substantial business activities test.

But the truly explosive change is contained in the proposed regulations, which will treat as stock certain related-party interests that otherwise would be treated as debt for federal income tax purposes. The proposed rules are designed to attack “earnings stripping” — whereby a foreign corporation lends money to its US subsidiary, which can then reduce its US taxable income through interest deductions while including in its foreign income the interest payments (presumably at a lower tax rate). The rules, however, apply not only to cross-border transactions, but also to instruments between two related domestic entities.

In the view of the government, related-party indebtedness is suspect because there is typically little economic incentive for a related-party lender to impose discipline and diligence on the behavior of a related party borrower. The proposed rules therefore contain two major elements: a documentation requirement and re-characterization of certain purported debt as equity, in whole or in part, to reflect its substance.

Please download the full article of True Partners Consulting LLC here.

Consequences for Swiss companies?

Even if the regulations are designed to attack "inversion" transaction, the new debt-equity rules could also have significant consequences on debt financing of US subsidiaries of Swiss groups since the regulations aim to limit US interest deduction resulting from newly created debt that is not associated with additional profit in the US (intra-group). The issuer would not be entitled to a deduction of interest payments since they would be re-characterized as dividends for all U.S. tax purposes. On the other hand, the interest income would still be taxable in the hand of the counterparty, e.g. in Switzerland. That would result in double taxation.

These rules will apply to any debt instrument issued on or after April 4, 2016, with certain transition rules. Existing debt from a Swiss company to a US subsidiary would generally not be affected unless it is modified or refinanced after that date.

However, almost every corporate taxpayer will be impacted in some way by these new rules. Taxpayers should review all of their existing intercompany debt arrangements (including open accounts maintained for cash management purposes) to determine their potential exposure if the proposed regulations become final.

Please let us know if you need assistance in this review or if you have any questions.

* Thomas Linder

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