Being on the west coast, much of my work has an international component. Foreign and international tax transactions can be particularly complex. There are many “gotchas” that make these transactions difficult to manage. Non-tax lawyers often deal with foreign tax-sensitive transactions but sometimes the client would be much better served if a tax lawyer is contacted and gets involved in the deal. Here is a snap shot of some of the caveats that make international tax transactions difficult to manage.
Outbound transactions (foreign acquirer and domestic target). In an outbound transaction, a foreign acquirer is engages with a domestic target. This can be done on a tax deferred or tax free basis if there is compliance with numerous requirements. Generally, the acquirer must have been engaged in an active trade or business for at least 36 months and it must be larger than the target so that less than 50% of the acquiror stock is changing hands.
The company’s accountant plays a vital role in these deals and should be heavily involved. Many reporting requirements must be complied with because the failure to comply could result in turning a non-taxable transaction into a taxable one.
Inbound transactions. In a 367(b) inbound transaction, a domestic acquirer acquires a foreign target. Generally, this can be done on a tax-free basis. Nevertheless, it is important to be cautious when the target is a “controlled foreign corporation” (CFC). A transfer of stock of a CFC may trigger an income inclusion (the “1248 Amount”) when the foreign corporation is more than 50% owned by US persons. Section 1248 re-characterizes stock gains as ordinary to the extent of the earnings that are attributable to the US shareholders.
Classic inversion. Years ago, there was a lot of press about U.S. companies exporting jobs, inverting, going offshore and forming Bermuda holding companies and not paying taxes ever again. Whole industries seem to have simply got up and left California for tax reasons via the inversion. An example of a classic inversion is as follows: A US semiconductor company forms a foreign company (maybe in the Cayman Islands). Then the foreign company acquires the US company in a stock for stock exchange. When the deal is done, shareholders of the U.S. company own shares of a Cayman company which owns the U.S. target. Under old law, that inversion would have been taxable because, among other things, the Cayman acquiror had no 36-month active trade or business. The company or its shareholders might have paid a tax on that transaction (based on value, which may have been depressed at the close of the transaction) or possibly no tax being paid because the company was able to offset the gains with its net operating losses (NOLs).
Now, there are a whole set of anti-inversion rules to prevent this transaction. Eventually, Congress caught on and passed new laws to govern outbound stock deals. Now, if the shareholders of the U.S. target own more than 80% of the foreign acquirer, the foreign acquirer is treated as if it were a U.S. corporation. Consequently, it does the company no good to do a tax motivated migration.
If ownership continuity is between 60% to 80% meaning that the shareholders of the U.S. target own more than 60% of the foreign company but less than 80%, the foreign company will not be treated as a U.S. company but the company will not be able to use its NOLs to offset the gain on the transaction. Also, if there is a stock based compensation in an inversion, the IRS will impose an excise tax. These rules have pretty much shut down the whole strategy although there are still ways to accomplish those goals.
When a company is sold, section 1248 taxes the sellers as though the earnings were distributed as a dividend. Section 1248 is important to consider when drafting the acquisition agreements because the 1248 inclusion amount is determined at the end of the year and allocated day by day among the year. Thus, post close events can impact the seller’s tax consequences.
Next, foreign joint ventures…
For more information on mergers and acsuisitions, and the tax aspects of purchases and sales of businesses, see RoyseLaw Mergers and Acquisitions, RoyseLaw Tax, Recent M&A Transactions, and blog posts at Royse University M&A, and Royse University Tax. Additional materials on mergers and acquisitions can be found at our blog posts at Franchise Tax Board Audits Sale of S Corp in 338(h)(10) Transaction, Corporate Reporting of Transactions Affecting Basis, M&A Trends and Qualified Small Business Stock. See M&A slides at SlideShare.