In September 2014 we reported on the practice of “tax inversions”, cross-border transactions in which the resulting entity may be headquartered in another country for tax purposes. A number of recent transactions between the U.S. and Canada have been seen as inversions by some. On April 4, the U.S. Department of the Treasury and the Internal Revenue Service announced new temporary and proposed regulations that may significantly impact cross-border transactions involving U.S. companies.
As a result of previous action by the Treasury, companies in a cross-border deal can avoid triggering the tax code’s inversion rules when the U.S. company’s value is less than 80% of the combined group value. In calculating the foreign parent’s value, the new temporary regulations will disregard stock of the foreign parent attributable to prior acquisitions of U.S. companies within three years. This means that if the foreign parent has recently engaged in other cross-border transactions, the new rules may classify the transaction as an inversion even if the ownership thresholds are met.
The Treasury also announced proposed regulations to address the issue of earnings stripping, a practice where companies move earnings to a jurisdiction with lower corporate tax rates. The measures taken largely involve reclassifying instruments that would normally be considered debt. Proposed regulations include:
- Limitations on transfers of related-party debt to a low-tax foreign affiliate by treating the transferred instrument as stock;
- Measures to address dividend distributions of debt in which a U.S. subsidiary borrows cash and pays a cash dividend distribution to the foreign parent;
- Treating as stock instruments that might otherwise be considered debt if they are issued in connection with transactions between related corporations that are economically similar to dividend distributions; and
- Rules allowing the IRS to divide a purported debt instrument into part debt and part stock.
The Treasury and the White House also released the The President’s Framework for Business Tax Reform. A key element of this new framework involves strengthening the international tax system to discourage profit shifting. It is clear that the current U.S. administration intends to introduce further and more permanent rules which will affect cross-border M&A deals. Companies considering deals involving U.S. entities will have to consider how to structure their transactions in light of these new considerations.
The author would like to thank Jacqueline Byers, articling student, for her assistance in preparing this legal update.
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