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Inversion Transactions




This portion of the introduction to the basic principles of United States federal income taxation of corporate acquisitions is part of the Pillsbury Winthrop Shaw Pittman LLP Tax Page, a World Wide Web demonstration project. Comments are welcome on the design or content of this material.

The information presented is only of a general nature, intended simply as background material, is current only as of the latest revision date, October 15, 2007, omits many details and special rules and cannot be regarded as legal or tax advice.


Internal Revenue Code § 7874

An inversion transaction generally involves transforming a corporate group with a U.S. parent into one with a foreign corporate parent. Typically, an inversion was implemented as a reverse triangular merger with Parent being the newly formed foreign parent that in turn forms Acquiring as a transitory U.S. merger subsidiary that merges with and into the existing U.S. parent, Target, with Target surviving as a wholly owned subsidiary of Parent and the Target shareholders becoming Parent shareholders.

Under the § 367 rules Target's U.S. shareholders would recognize gain in the transaction but no gain would be recognized by Parent, Target or any other member of the inverted corporate group. Under other portions of the § 367 rules, Target would recognize gain (but not loss) on its assets were it to merge with and into Parent or otherwise reincorporate in a foreign jurisdiction. Although Target would recognize gain on any post-inversion transfer of assets to Parent (e.g., stock of Target's foreign subsidiaries), corporate groups were permitted to offset that gain with available net operating loss carryovers and could frequently engage in inter-group "earnings stripping" transactions (e.g., intercorporate debt or licenses) to reduce the group's net income subject to U.S. tax.

Under the "anti-inversion" provisions of the American Jobs Creation Act of 2004, Parent becomes a "surrogate foreign corporation" of Target upon Parent's indirect acquisition of substantially all of Target's assets (through the acquisition of Target's stock) if as a result of and after that acquisition the former Target shareholders own at least 60% (by either vote or value) of the outstanding Parent stock. However, Parent does not become a surrogate foreign corporation if, after the acquisition, the Parent corporate group has substantial business activities in the foreign country in which or under the laws of which Parent is created or organized when compared to the overall business activities of the Parent corporate group.

If the former Target shareholders meet the 60% stock ownership test but hold less than 80% of the outstanding Parent stock, for 10 years Target and its more than 50% owned U.S. affiliates cannot use any deductions (including net operating losses and typical earnings stripping deductions) to offset income from transfers of assets to or licenses with foreign affiliates. If, however, the former Target shareholders hold at least 80% (by either vote or value) of the outstanding Parent stock as a result of their holding of Target stock, Parent is treated as a U.S. corporation for U.S. federal income tax purposes.

    Parent is thus subject to U.S. federal income tax on its worldwide income and Parent's more than 50% owned foreign subsidiaries are "controlled foreign corporations." If Parent is treated as a U.S. corporation the former Target shareholders do not need to satisfy the special § 367 requirements to be eligible for nonrecognition treatment on the exchange of their Target stock for Parent stock.

The legislative history provides that for purposes of the 60% and 80% tests an initial public offering of Parent stock, even if contemporaneous with the inversion transaction, is disregarded. The new anti-inversion rules explicitly state that they override any conflicting provisions in U.S. income tax treaties.


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