Source: https://www.fenwick.com/publications/pages/us-companies-leading-ma-surge-despite-treasury-action-to-limit-transactional-options.aspx
Timestamp: 2019-12-14 16:04:16
Document Index: 510377225

Matched Legal Cases: ['§ 351', '§ 351', '§ 351', '§ 351', '§ 351', '§ 351', '§ 1', '§ 381', '§ 381', '§ 7874', '§ 367', '§ 367', '§ 367', '§ 367', '§ 1', '§ 367', '§ 367', '§ 936', '§ 1', '§ 367', '§ 721', '§ 704', '§ 721', '§ 721', '§ 267', '§ 1', '§ 482', '§ 704']

By David L. Forst and James P. Fuller • March 22, 2016
​David Forst and Jim Fuller of Fenwick & West summarise numerous developments in the U.S. M&A tax landscape after a record year for dealmaking – driven by healthcare and technology industries – which puts 2015 on par with 2007 numbers, adjusted for inflation.
Inversion transactions continue in the U.S., despite the U.S. Treasury Department continuing to attempt to prevent them – or at least make them unattractive to the extent that taxpayers are discouraged from pursuing the restructuring option.
Another rule provides that stock of the foreign acquirer is not counted in the denominator of the ownership fraction if it is received in exchange for 'non-qualified property'. Non-qualified property includes property acquired with a principal purpose of avoiding the intent of section 7874, regardless of whether the transaction involves an indirect transfer of other non-qualified property.
S-2 owns foreign subsidiaries X, Y and Z. In the transaction, P transfers the stock of S-1 to S-2 in exchange for additional S-2 voting stock. In a second pre-arranged step, S-1, X, Y and Z transfer their assets to S-2's newly-formed foreign subsidiary, N, in exchange for N common stock. Thereafter, S-1, X, Y and Z liquidate.
Rev. Rul. 78-130 treated the S-1 transaction as a triangular C reorganisation. Rev. Rul. 2015-9 offers a new approach, characterising the transaction as a § 351 transfer by P of the S-1 stock to S-2. The subsequent transactions in which S-1, X, Y and Z transfer their assets to N and then liquidate are treated as D reorganisations.
The ruling states that a transfer of property may be respected as a § 351 exchange, even if it is followed by subsequent transfers of property as part of a pre-arranged, integrated plan. However, the ruling also states that a transfer of property in an exchange otherwise described in § 351 will not qualify as a § 351 exchange if, for example, a different treatment is warranted to reflect the substance of the transaction as a whole.
Under the facts of the ruling, even though P's transfer is part of a pre-arranged, integrated plan involving successive transfers, P's transfer satisfies the formal requirements of § 351. The ruling states that an analysis of the transaction as a whole does not dictate that P's transfer be treated other than in accordance with its form, in order to reflect the substance of the transaction.
The IRS also issued Rev. Rul. 2015-10. In this ruling, P owns a limited liability company (LLC), treated as a corporation, and a first-tier subsidiary (S-1). S-1 owns second-tier sub S-2 which in turn owns third-tier sub S-3. P transfers the ownership interests in LLC to S-1 and on down the chain to S-3. The LLC then becomes disregarded under the check-the-box rules. This transaction is treated as two § 351 transfers with the final step treated as a D reorganisation.
The IRS finalised temporary regulations issued in 2011 that provided 'clarifications' to the nominal share concept in the 2009 final all-cash D reorganisation regulations. The new final regulation 'clarifies' that the nominal-share basis-designation rule only applies if an actual shareholder of the issuing corporation receives the nominal share pursuant to Treasury Regulation § 1.368-2(d).
That shareholder must add the nominal share's basis to a share of the issuing corporation's stock that the particular shareholder actually owns. Thus, share basis can be lost in an all-cash D reorganisation – the basis will disappear completely – unless planning is considered.
There are two new requirements for F reorganisation treatment compared with the proposed regulations. First, that immediately after the F reorganisation, no corporation other than a resulting corporation may hold property that was held by the transferor corporation immediately before the F reorganisation if the other corporation would, as a result, succeed to and take into account the items of the transferor corporation described in § 381. Second, that immediately after the F reorganisation, the resulting corporation may not hold property acquired from a corporation other than a transferor corporation if the resulting corporation would, as a result, succeed to and take into account the items of the other corporation described in § 381(c).
The final regulations reiterated a rule in the proposed regulations that an F reorganisation can have independent significance from related transactions, but the preamble to the regulations states that notwithstanding this rule, in a cross-border context, related events preceding or following an F reorganisation may be related to the tax consequences under certain international provisions that apply to F reorganisations. For example, such events may be relevant for purposes of applying certain rules under § 7874 (inversions) and for purposes of determining whether stock of the resulting corporation should be treated as stock of a controlled foreign corporation for purposes of § 367(b).
Treasury and the IRS released important proposed regulations on the treatment of transfers of intangible property by U.S. persons to foreign corporations subject to § 367(d). The proposed regulations eliminate the so-called foreign goodwill exception from the § 367(d) regulations, and limit the § 367(a) active trade or business exception to certain tangible property and financial assets. The regulations, once finalised, would have a retroactive effective date to apply to transfers occurring on or after September 14 2015, and to transfer occurring before that date, resulting from entity classification elections that are filed on or after that date.
The preamble states that the proposed regulations would eliminate the foreign goodwill exception under Temp. Treas. Reg. § 1.367(d)-1T and limit the scope of property that is eligible for the active foreign trade or business exception generally to certain tangible property and financial assets. Accordingly, under the proposed regulations, when there is an outbound transfer of foreign goodwill or going concern value, the U.S. transferor will be subject to either current gain recognition under § 367(a) or the tax treatment provided under § 367(d).
This would be a major change in the law, and one that is at odds with the clear legislative history, which states that "no gain will be recognised on the transfer of goodwill and going concern value for use in an active trade or business". Note that the Obama Administration has proposed to change the law to include goodwill, going concern value and workforce-in-place in § 936(h)(3)(B). At first, the Administration's description referred to this change as a "clarification". However, in the two most recent Administration Budgets, the assertion that this change would be a 'clarification' was dropped. These proposals were never enacted by Congress.
In addition, the proposed regulations eliminate the existing rule that limits the useful life of intangible property to 20 years. The preamble states that if the useful life of transferred intangible property exceeds 20 years, the limitation might result in less than all of the income attributable to the property being taken into account by the U.S. transferor. Accordingly, proposed Treas. Reg. § 1.367(d)-1(c)(3) provides that the useful life of intangible property is the entire period during which the exploitation of the intangible is reasonably anticipated to occur, as of the time of the transfer.
These rules apply when a U.S. person transfers property to either a domestic or foreign partnership where income or gain derived from property contributed by a U.S. partner could be allocated to a foreign partner. The purpose of these rules, which are linked to the § 367(a) outbound transfer regime, is to impose an 'exit tax' on appreciated tangible property and intangible property (whether appreciated or not) that leaves the U.S. taxing jurisdiction.
The regulations under § 721 would require a U.S. partner contributing built-in gain property to a partnership (whether domestic or foreign) with a related foreign partner either immediately or periodically to take the gain into account. The regulations will do this by forcing a partner to elect the remedial allocation method under § 704(c) with respect to the built-in gain property or otherwise forego the application of 721(a). The new rules apply to both tangible and intangible property with a built-in gain. In the Notice, the IRS states that it has elected to exercise its regulatory authority granted in section 721(c) to override the application of section 721(a) in certain cases where the transfer of property to a partnership (domestic or foreign) would result in built-in gain on the property being includible in the gross income of a foreign person. The Notice states that the IRS has elected not to act on section 367(d)(3) because the transactions at issue are not limited to transfers of intangible property. The Notice states that Treasury and the IRS intend to issue regulations providing that § 721(a) will not apply when a U.S. transferor contributes an item of Section 721(c) property (or portion thereof) to a Section 721(c) partnership, unless the 'gain deferral method' is applied with respect to such property. The portion of the Notice addressing the gain deferral method does not apply to transactions to which § 721(a) otherwise would not apply.
A Section 721(c) Partnership is generally a partnership (domestic or foreign) if a U.S. person contributes Section 721(c) property to the partnership, and, after the contribution and any transactions related to the contribution, (i) a related foreign person is a direct or indirect partner in the partnership, and (ii) the U.S. transferor and one or more related persons own more than fifty percent of the interests in partnership's capital, profits, deductions or losses. Relatedness is defined by reference to § 267(b) or 707(b)(1).
The gain deferral method contains five requirements, the most notable of which is that the Section 721(c) partnership must adopt the remedial allocation method described in Treasury Reg. § 1.704-3(d) for built-in gain with respect to all Section 721(c) property contributed to the partnership. It effectively requires the taxpayer to elect between including its built-in gain in respect of the section 721(c) property immediately (if it does not choose the remedial method and also follow the other requirements below) or including the built-in gain in installments (by choosing the remedial method and following the other requirements of the gain deferral method).
The Notice also states that § 482 and related penalties apply to controlled transactions involving partnerships. For example, when U.S. and foreign persons under common control enter into a partnership, the amounts of their contributions to and distributions from, the partnership are subject to adjustment in order to reflect arm's-length results. Partnership allocations, including allocations under § 704(c), also are subject to adjustment.
Originally published in the International Tax R​eview​ on March 18, 2016.​​​​