office_of_chief_counsel internal_revenue_service memorandum number release date cc intl b04 pref-120527-10 third party communication none date of communication not applicable uilc date date to from associate area_counsel large business international chief branch office of associate chief_counsel international subject application of sec_7874 this chief_counsel_advice responds to your request for assistance in accordance with sec_6110 this advice may not be used or cited as precedent new x old x appraiser taxpayer’s tax counsel taxpayer’s accounting firm lenders subgroup agreement agreement agreement memorandum country country country country --------------------------------------- ---------------------------- ----------------- --------------- --------- ------------------------ ----------------------------------------------------- -------------------------------- -------------------------------------------------------- ---- ------------------------------------ ------------------------------------- -------- --------- ------------------ pref-120527-10 country country state state city city city city region a region b region c date date date year year year year year year year year year b p q c e x dollar_figure a b c d e f ---------- ------------------------ -------------- -------------- ---------- --------------- -------------- ----------------- -------------- ---------------------- ----------------- -------------------- ----------- --------------------------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------------------------------------- ------------------------ -------------------------- ------------------------------------------------------ -------------------------------------------------------- -------------------------------------------------------- ------------------- ---------- ------ ----- -------------------- ------------------------------ -------- ------ pref-120527-10 g ------ issue whether new x is a surrogate_foreign_corporation within the meaning of sec_7874 and if so whether it is treated for purposes of the internal_revenue_code code as a domestic_corporation pursuant to sec_7874 conclusion new x is a surrogate_foreign_corporation within the meaning of sec_7874 and is treated for purposes of the code as a domestic_corporation pursuant to sec_7874 facts i background in year -------------------------------------- -------organized its many separate ------- operations into a subsidiary which was later renamed x corporation x or old x x became an independent publicly traded domestic_corporation in -------year ----------------------- -- after the ----------- x was a ---------------------------- ------ ------------------------------------------- ----------------------------------------------------------------------- in ------------year x ---------------------------------------------------------------------------------------- -------- ------------------------------------------------------------------------------- the initial ------------ ------------- extended ---------------------------------------financing to x pursuant to the --------- ------------------------- and other relevant agreements after being refinanced in ------- the --------------------consisted of -------------------of secured loans ------------------------------------- ----------------------- the --------------- ------ --------------- notes had first liens on significant assets of x the --------------- notes had a second lien on the same assets ------------------ --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------------------ the notes held by the --------------------were traded over time such that the identity of the --------------------varied --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- pref-120527-10 --------------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------- ii --------------- ------------------------and --------------------------- p and q -------------------------------- acquired more than percent of the ------------------------of the ---------------------------------- -------- and varying percentages of the --------------- ------------------------------------------------- -------------------------------------------------------------------------------------------- the amounts of the ---------------------------------notes held by p and q over the period varied however p and q always held more than percent of the ------------------------of the -------------------- ------ --------------- ----------after ---------- ---------- in addition the holders of the ------------- --- ------ --------------- ----------collectively held approximately percent of the --------------- -------- of the --------------- -------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------1 ---------------------------------------------------------------------------------- --------------------------------------------------------------------------x was reorganized --------------- ----------------- iii payments to -------------------- under the agreement the agreement and the other referenced agreements the holders of the --------------- ------ --------------- ---------were entitled to be paid ------------------ -----------------2 -------------------------------------------------------- in addition the holders of the ------------------------were entitled to receive ------------------------------------------------------------- ----------------------------------------------------------------------- iv funding of payments to -------------------- ------------------------------------------------------------------------------------------------------------------------------------------ -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------------------------------------ -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------- pref-120527-10 --------------------------------------------------------------------------------------------------------- first x would sell its --------- ------------ division and ---------------------------------- sites to b in exchange for dollar_figureb ---------- second as described in detail below -------------------------------- a ------------------------------ ---------------------------formed under the laws of ---------------------------- country treated as a -----------------for federal tax purposes new x or taxpayer was formed new x acquired other assets from old x for a stated amount of dollar_figurec ---------- and the assumption of certain old x liabilities ----------------------------------------------------------------- ---------------------- ---------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- -------- v formation of new x on -------------- ---------- new x was formed as a country ------ to acquire old x’s assets the taxpayer intended that new x be treated as a ---------------- for u s tax purposes new x was to issue --------------------------------------------------------------------------- together the equity securities -- contributed dollar_figure------------------of cash to new x in exchange for all the ---------------------------------------------------- the ----------------------------- -------------- were to be issued for a stated purchase_price of dollar_figured ---------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- the -----------------------------------------------------------------represented a ------ ------ and ---- percent interest respectively in new x the holders of the -----------------------------------and-----were committed to purchase dollar_figure------ ---------- of ------------------------------of new x the holders of the --------------------------------- ---------------would also be --------------------------------dollar_figure-------------- ---------------------------------- ---------- new x never issued the ----------------------------- originally a different ------ ------------------------- a state ------ was formed by p q to acquire the x assets and to conduct the x business it was subsequently determined however that a country -------- ----------------should be used so p q caused ---------------------------to assign its rights under the ------------- ---------------------------------contracts to new x these percentages are based on the ---------------------------------------------------------------------------------------- ------------------------------------------------------- under the --------------------------------------------------------------------- --interests represented by the --------------------------------------------equity securities vary based upon the liquidation value of the company pref-120527-10 -- contributed dollar_figure------------------cash to new x in exchange for all of the ------------------------- --------------------------- -- retained the ----------------------------------- and transferred the ----- -----------------------------------to the ---------------------------------------------------- the c in exchange for the c agreeing to waive and release its claims against ---and x and x affiliates the -----------------------------------were issued to the -------------------- including p and q_and_a subgroup of ----------------------------------------------------------------------------------- ------------------------------- for a stated purchase_price of dollar_figured ---------- according to the taxpayer new x established the following initial ----------------------------- ------------------------------------------------------------------------------------------------------------for the -----------------------equity securities following the closing of the ---------------------------------- ------------------------------------------------------------------------------------------------------------------- dollar_figure------------------in the aggregate for the holders of the ----------- equity securities dollar_figure------------------in the aggregate for the holders of the ----------- equity securities dollar_figure----------------in the aggregate for the holders of the ----------- equity securities and according to the taxpayer the ----------- equity securities issued ------------------------------ --------------------------------initially carried a ----------------------of dollar_figure----------------- ----------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------- -- and the other holders of the ----- ----------- equity securities including p and q and the -------------------------- were according to the taxpayer credited with dollar_figure----------------and dollar_figure---------------- respectively of ------------------------- it is not clear on what basis the dollar_figure------------------ ---------------------------------was allocated between the ----------- equity securities dollar_figure---------------- and the ----------- equity securities dollar_figure---------------- however all the holders of ----------- equity securities including p and q the -------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------- vi acquisition of new x equity securities under the agreement the ----- one of the contracts upon which the ------------ was dependent p and q committed to purchase from new x the ----------- equity securities and dollar_figuree ----------of notes under the agreement p and q reserved the right and indeed intended to syndicate all or a portion of their obligation to purchase the ------------ equity securities and notes prior to the --------------------------------- the --------------- ------- -------- were trading at an average of dollar_figure ----------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------5 the average trading value was for the period between --------- ---------- and ------------------ ---------- pref-120527-10 --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- approximately ---- days after ------------------------------------------------------------- p and q offered the --------------------the right to purchase in the aggregate -------percent of the --- ----------- equity securities and -------percent of the notes that they committed to purchase the ------------------- p and q and their related entities were among ------------- ------------- to which the offer was made in order to acquire the ----------- equity securities a ------------------also had to agree to ------------------------------------------------------ ------------------------------------------------------------------- the ---------of ----------- equity securities and notes were allocated to the -------------------------------based upon ------------ --------------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------- the individual ------- ----------------------------------could then subscribe to ---------representing the proportionate amount of ------------------------------------ in addition according to the taxpayer prior to and in anticipation of p and q entering into the agreement whereby p and q committed to purchase all the ----------- equity securities of new x p and q offered ------------------------------------------------------------------- -- ----------------------------------------------------------- the right to purchase a portion of the remaining g percent of the ----------- equity securities which it would not offer in the ----- ------------------7 the ---------------------------were also offered the right to purchase the ------ ----------- equity securities that were to be offered in the ----------------- but not acquired ------ ------------- holding ---- percent of the ------ -------- accepted the offer and purchased ----------- equity securities the -------------------------- other than funds managed by p and q acquired approximately -----percent of the ----------- equity securities in excess of the amount of ----------- equity securities they could have purchased by participating in the ----------------- in executing the transaction the -----------------------------under the ------agreement offset all amounts due to the individual ------ ------------- by the amounts that the individual ------ ------------- owed for the ----------- equity securities and notes the ----------------------------- paid the individual ------ ------------- the net amounts due them ----------------------------------- ------------------------------------------------------------------------------------------- net of the amounts that the individual ------------ owed the -----------------------------for purchase of the it appears that in certain instances --------- related to the -------------------actually purchased the ------------ equity securities so that not every purchaser had actually owned -------------- when this memorandum refers to the --------------------------- depending on the context it may refer to either the entities that were offered the ------------ equity securities or the --------- that actually purchased the securities it appears however that the ---------------------------did not have a right_of_first_refusal with respect to the remaining g percent of the ------------ securities as they appear in fact to have only been able to purchase interests not already syndicated to p and q and other -------------------- pref-120527-10 ------------equity securities the ----------- equity securities were then issued by new x to the individual ------ ------------- vii properties held by old x in connection with the --------------------------------- the properties held by old x were in effect categorized into three classes properties sold to b b properties properties acquired by new x acquired properties and ---------------------------------- ------------------------------------------------------------------- -----------------------properties a b properties as part of the --------------------------------- b agreed to purchase the b properties which consisted of old x’s ---------------------business and -------------------------------------------------- ----------------------------- although the stated amount to be paid for the b properties was dollar_figure-----------------plus the assumption of certain liabilities the amount of cash actually paid for the b properties was reduced to dollar_figureb ---------- notwithstanding the purchase_price of dollar_figureb ---------- b reported the b properties as having a net value of dollar_figure----- ----------on its financial statements as of -------------- ---------- in addition appraiser inc appraiser an outside valuation expert retained by the service determined the value of the b properties at the time of the sale to b to be dollar_figure----- -------------------------------------------------------------------------------------------------------------------- ---------- b acquired properties the acquired properties consisted of all of the properties held by old x including a portion of the proceeds from the sale of the b properties other than the -------------------- --------------- properties although as noted above new x transferred only dollar_figurec ----------of cash to old x and assumed certain old x liabilities for the acquired properties this amount did not reflect the value of the acquired properties for fresh-start accounting purposes and in connection with the --------------------------------- taxpayer’s accounting firm valued the acquired properties other than the portion of the proceeds from the sale of the b the value of the gross assets was reported at dollar_figure-------------- comprised primarily of accounts and notes receivable inventories and property plant and equipment the amount of the liabilities was reported at dollar_figure----- ---------- comprised primarily of accounts_payable accrued expenses short term debt and other liabilities in ----------------------- b sold the b properties to a third party for dollar_figure----- ---------- plus assumed_liabilities b recorded a dollar_figure---- -----------gain on the sale for financial_accounting purposes pref-120527-10 properties the taxpayer’s accounting firm valuation determined that the net assets of new x as a going concern had a value of dollar_figure--------- --------- after adding assumed - ------------ liabilities and various other liabilities to this net asset value the value of new x’s gross assets equaled dollar_figure----------- --------- c -----------------------properties the -----------------------properties primarily consisting of approximately ---- ------------------ ---------------------sites ---------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------- the taxpayer represented that these assets were valued at approximately dollar_figure---- ----------dollar_figure viii business activities of the new x eag a in general the taxpayer throughout its form ---------------------------------------------------------------------- --------------------------------------------------------------- describes new x as the continuation of old x the expanded_affiliated_group within the meaning of sec_7874 that includes new x the new x eag operated its business in ---- countries through approximately ----- sites as of july of year a ----- of the ----- sites -----percent were located in country b historical conduct -- ----------------------------in the united_states in year historically ----------------------------- --------------------------------------------------- old x was formed in year -------------combined its various --------operations into a single subsidiary -------------------------------from which it was formed have ----------------------------------- since --------------------------------- in year ---------------------------------- -- x conducted certain ---------------------activities in country x’s country activities expanded in year as a result of the acquisition of the e business after the --------------------------------- the new x eag operated these country businesses c property located in country appraiser inc an outside valuation expert retained by the service determined a similar enterprise value of dollar_figure------------------ net of liabilities appraiser determined that the -----------------------properties had no value pref-120527-10 according to taxpayer as of date ---------- ---- percent of the new x eag’s total gross assets and -----percent of its total property plant and equipment were located in country dollar_figure the above fraction includes in the denominator approximately dollar_figure------------of cash and cash equivalents which includes dollar_figure------------in cash for which the taxpayer did not have an immediate need in working_capital as of date ---------- however at the time of the --------------------------------- the taxpayer determined that this cash was necessary in order to enable new x to continue as a ---------------------------------------------------------------- -------------- this cash which -- and the ------ ------------- contributed to new x in exchange for equity securities was not held in country according to a valuation study commissioned by x the value of the country operations as of -------------- ---------- was dollar_figure-------- ----------using the market approach that is by using multiples based on the stock prices of comparable publicly traded companies after taking liabilities into account the fair_market_value of the country operating entities was dollar_figure--------- ---------- based on this net valuation approach the net equity value of new x’s country legal entities was ---------percent of its total equity valuedollar_figure d performance of services in country as of date ---------- -----percent of the new x eag employees were located in country in addition the payroll expense of the new x eag attributable to employees located in country constituted -----percent of its worldwide payroll expense as of date ---------- e sales of goods based on financial statements -------percent of x’s net sales were from goods ------------- --------------------in country for the period from -------------- ---------- through -------------- - --------- for the nine-month period ending on date ---------- sales to country customers represented -----percent of worldwide sales f managerial activitie sec_11 the property figure is net of accumulated depreciation using a similar net equity value approach appraiser concluded that the value of x’s country entities was dollar_figure----- -----------as of the ---------------------------------- which represented -------percent of x’s business_enterprise value pref-120527-10 at the time of the --------------------------------- the new x eag’s worldwide headquarters and top management were all located in city ---------- the new x eag maintained regional headquarters in city country city country and city country the divisional offices for x’s ---------------------------------------------- of which the majority of new x’s country assets were a part were located in country only local management overseeing country operations was located in country ------------ of the new x eag’s executives approximately -----percent of its more than ----- executives were located in country as of date ---------- g ownership of new x by investors resident in country after the --------------------------------- the new x equity securities were owned by -- the c and the ------ ------------- including q and p neither -- nor the c was resident in country the ------ ------------- were primarily u s --------------------------------- the ------- ------------------had investors located in various countries taxpayer has not provided information indicating that any holders of the equity securities were resident in country h business activities in country material to the achievement of overall business objectives new x is a supplier of ---------------------------------------------------------------for ------------------- --------------------- its business consists of ------divisions ------------------------------------------ --------------------------------------------------------------------------------------------------------------------- ----------------------------------------- the new x eag ---------------------certain --------------------------------- in country including e and ---------------products in various ---------------------facilities located in ------ different locations taxpayer asserts that the country business provides ----------------- -------------------capability that contributes to new x’s other businesses including its e operations in addition the new x eag’s country operations include ----- ---------------- -------developing ---------------------------------------------- according to its ------------- the new x eag adopted -------------------------model under which ----------------------------are serviced from ---------------countries in order to reduce --- ----------------and increase ---------------------------- as of year ---- percent of its hourly workforce was located in such ------------ countries and ---- percent of this workforce was temporary under this model the region a market generally was served from region b and region c new x stated in its --------------that it expected nearly half of its future growth to be generated from --------------markets particularly country and accordingly has substantially expanded its presence in --------------markets it stated that as of year it has operated in country for nearly ----------years and it employed approximately ------- pref-120527-10 --------- people in country including approximately --------- ------------------------------------- ---------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------- the ------------------------offered ------------------------------------------- for ---------------------------- needs the ----------------------------offered products for --------------------------------------------- --------- including a e product line the -------division provided a wide range of ------------ --------------------------------------------in the following areas ----------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------ -------------------------------------------------------------------------------------------------- --------------------------------------- the ----------- division provided ---------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------- the division provided ---------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- -------------------------- the products that new x produced were sold to the ----------------------------------------------- ---------------------------------------------------------- all over the world in addition to lowering its labor costs and focusing on --------------markets new x’s stated strategic plan was to develop ---------------------------------- focused on --------- industry trends ------------------------------------------- ------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- pref-120527-10 ix aftermath of the ----------------------------------- the taxpayer has stated that the equity securities in new x were readily_tradable on a secondary market or the substantial equivalent thereof within the meaning of sec_7704 on -------------- year new x redeemed the ----------- and ----------- equity securities for approximately dollar_figure-------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------------- x taxpayer’s treatment of the transaction based on a draft tax opinion dated ------------------13 from its outside tax counsel ----------- ------ the taxpayer took the position that new x was not a surrogate_foreign_corporation within the meaning of sec_7874 because the requirements in sec_7874 regarding the acquisition of substantially_all the properties held by old x and a b iii regarding substantial_business_activities of the new x eag were not satisfieddollar_figure xi procedural posture all years at issue are currently under examination law and analysis i overview the draft tax opinion was never finalized the draft opinion concluded that the requirement in sec_7874 regarding ownership was satisfied as a result of stock received by the -------------------------------------------- finding that b ecause the interests in x -------were received for cash under notice 2009-78’s broad exclusion of cash payments for stock interests the overlapping shareholder test appears to be met pref-120527-10 in addition to analyzing the three requirements under sec_7874 that must be satisfied for new x to be treated as a surrogate_foreign_corporation certain other related issues must also be considered thus after first outlining the general rules under sec_7874 in section ii of the law and anlysis section of this memorandum section iii analyzes the effect of new x being a ------------------------------------ because old x was under ------------------------------ -------------------------------------------------------------- ----------------------------------------------------------------------------- section v applies judicial doctrines to the -------------------------------------------and their acquisition of new x equity securities sections vi vii and viii analyze the substantially_all requirement the ownership requirement and the substantial_business_activities requirement respectively that must be satisfied for new x to be treated as a surrogate_foreign_corporation section ix analyzes the treatment of new x as a surrogate_foreign_corporation to which sec_7874 applies ii sec_7874 - in general a statute sec_7874 provides rules for expatriated entities and their surrogate foreign_corporations an expatriated_entity is a domestic_corporation or domestic_partnership with respect to which a foreign_corporation is a surrogate_foreign_corporation and any united_states_person related within the meaning of sec_267 or sec_707 to such domestic_corporation or domestic partnershipdollar_figure sec_7874 provides that a foreign_corporation constitutes a surrogate_foreign_corporation if pursuant to a plan or a series of related transactions three conditions are satisfieddollar_figure first the foreign_corporation completes after date the direct or indirect acquisition of substantially_all_of_the_properties held directly or indirectly by a domestic corporationdollar_figure second after the acquisition at least percent of the stock by vote or value of the foreign_corporation is held by former shareholders of the_domestic_corporation by reason of holding stock in the_domestic_corporation the ownership condition dollar_figure third after the acquisition the expanded_affiliated_group that includes the sec_7874 sec_7874 provides that i f a foreign_corporation acquires directly or indirectly substantially_all_of_the_properties of a domestic_corporation or partnership during the 4-year period beginning on the date which i sec_2 years before the ownership requirements of subsection a b ii are met such actions shall be treated as pursuant to a plan sec_7874 provides that t he transfer of properties or liabilities including by contribution or distribution shall be disregarded if such transfers are part of a plan a principal purpose of which is to avoid the purposes of sec_7874 sec_7874 similar provisions apply if a foreign_corporation acquires substantially_all_of_the_properties constituting a trade_or_business of a domestic_partnership sec_7874 pref-120527-10 foreign_corporation does not have substantial_business_activities in the foreign_country in which or under the law of which the foreign_corporation is created or organized when compared to the total business activities of such expanded affiliated groupdollar_figure sec_7874 defines the term expanded_affiliated_group as an affiliated_group as defined in sec_1504 but without regard to sec_1504 except that sec_1504 is applied by substituting more than percent for at least percent each place it appears under sec_7874 certain stock of the foreign_corporation is not taken into account in determining whether the ownership condition is satisfied stock of the foreign_corporation held by members of the expanded_affiliated_group that includes the foreign_corporation and stock of the foreign_corporation sold in a public offering related to the acquisition described in sec_7874 if the foreign_corporation constitutes a surrogate_foreign_corporation and the percentage described in sec_7874 ownership fraction is at least percent but less than percent the corporation continues to be treated as a foreign_corporation for u s tax purposes but the taxable_income of an expatriated_entity for any taxable_year which includes any portion of the applicable_period in no event is less than the inversion_gain defined in sec_7874 of the entity for the taxable yeardollar_figure if the foreign_corporation constitutes a surrogate_foreign_corporation and the ownership fraction is at least percent then notwithstanding sec_7701 it will be treated as a domestic_corporation for all purposes of the codedollar_figure b legislative_history congress enacted sec_7874 in to remove the incentive for entering into an inversion_transaction that is a transaction in which a u s_corporation may reincorporate in a foreign jurisdiction and thereby replace the u s parent_corporation of a multinational corporate group with a foreign parent_corporation as a result of such transactions u s_corporations were able to remove income from foreign operations from the u s taxing jurisdiction - for example by having the u s_corporation transfer some or all of its foreign subsidiaries directly to the new foreign parent or other related foreign_corporations - and engage in earnings stripping through payment by a u s sec_7874 sec_7874 sec_7874 h_r rep no 108th cong 2nd sess joint_committee on taxation general explanation of tax legislation enacted in the 108th congress jcs-5-05 date pincite pref-120527-10 corporation of deductible amounts such as interest to the new foreign parent or other foreign affiliates congress was concerned that certain inversion_transactions permit corporations and other entities to achieve these results even though the entities would continue to conduct business in the same manner as they did prior to the inversion although under prior_law inversion_transactions may have given rise to immediate u s tax consequences at the shareholder level and or the corporate level such consequences did not provide a sufficient deterrent to inversion transactionsdollar_figure accordingly congress determined that a new regime was needed to address these transactions the applicability and consequences of which depend on the extent of the overlap of the former shareholders of the u s_corporation and those of the new foreign parent congress believed that certain inversion_transactions involving percent or greater identity of stock ownership have little or no non-tax effect or purpose and should be disregarded for u s tax purposes although other inversion_transactions may have sufficient non-tax effect and purpose to be respected - where there is less identity of stock ownership - any applicable corporate-level ‘toll charges’ for establishing the inverted structure should not be offset by tax_attributes such as net operating losses or foreign tax_credits iii ------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------29 ------------------------------------------------------ h_r rep no 108th cong 2nd sess conf_rep h_r rep no pincite s rep no 108th cong 1st sess s rep no pincite general explanation of tax legislation pincite h_r rep no pincite h_r rep no pincite s rep no pincite shareholders may have had little or no gain for example when stock prices declined and the corporate level tax may be reduced or eliminated through the use of net operating losses foreign tax_credits and other tax_attributes h_r rep no pincite h_r rep no pincite s rep no pincite s rep no pincite ----------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------- 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--------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ---------------------------------- v the ------------------------------------------and their acquisition of new x equity securities pursuant to the --------------------------------- the ------ --------------were entitled to receive dollar_figureb ---------- --------------------------------------- however only a portion of the proceeds was actually received by the ------ ------------- the remaining amount was acquired by new x as a result of the ------ ------------- investing in new x equity securities specifically shortly after becoming entitled to the dollar_figureb ---------- and pursuant to various agreements the ------ ------------- acquired all the ----------- equity securities from new x in exchange ------------------------------------- ---- ---- --------------------------------------------- pref-120527-10 for an offset to the dollar_figured ----------of cash they were entitled to receive ----------------------------- ----------36 the issue is whether for tax purposes these two steps - that is being entitled to receive dollar_figured ----------of cash --------------------------------------- and acquiring ----------- equity securities in new x in exchange for an offset to such right to receive cash - should be respected as separate and independent actions or rather should be integrated under judicial doctrines such that the ------ --------------are treated as receiving the ----------- equity securities ------------------------------------------------------- accordingly the proper treatment of these steps is relevant both for purposes of determining whether the requirements in sec_7874 regarding the acquisition of substantially_all the properties and a b ii regarding stock ownership are satisfied as discussed in sections vi and vii respectively of the law and analysis section of this memorandum a in general sec_7874 by its express terms considers all aspects of the entire transaction at issue for purposes of determining whether a foreign_corporation is a surrogate_foreign_corporation sec_7874 considers all actions taken pursuant to a plan or a series of related transactions thus the statute itself first mandates that all aspects of the plan be taken into account in general case law interprets the term plan broadly to encompass all methods of putting into effect an intention proposal or schemedollar_figure the statute at hand however expands the already-broad plan standard by requiring that a series of transactions related to the plan must also be taken into accountdollar_figure thus even if not technically part of the plan broadly defined transactions must be taken into account if they bear any relation to the plan in addition to this statutory directive to consider all actions taken pursuant to a plan - and transactions related to the plan - applicable judicial doctrines must be considered when characterizing transaction steps specifically the substance of a transaction and not its form governs its treatment for tax purposesdollar_figure under the step_transaction_doctrine individual steps in a transaction are consolidated into a single integrated the dollar_figured ----------amount consisted of dollar_figure----- -----------of cash actually transferred with the remaining dollar_figurec ---- ----------representing an offset against ------------------------------------------------------------------- see 229_fsupp_517 d conn notwithstanding th e absence of a formal plan the court must consider whether or not any informal plan did exist as a matter of fact 291_f2d_680 4th cir a plan is a method of putting into effect an intention or proposal quoting 167_f2d_214 6th cir see also sec_7874 which treats all acquisitions of properties during a four-year period as being pursuant to a plan deeming all acquisitions occurring during such a period as being pursuant to a plan further evidences congressional intent underlying sec_7874 is to look to the substance of the entire transaction rather than giving credence to individual steps of the overall transaction see 324_us_331 pref-120527-10 transaction in order to ensure that a transaction is taxed in accordance with its substance rather than its formdollar_figure when applying the step_transaction_doctrine courts must consider all steps in light of the entire transactiondollar_figure courts have applied three alternative tests in deciding whether to invoke the step_transaction_doctrine the end result test under which the transaction will be collapsed if it appears that a series of formally separate steps are really prearranged parts of a single transaction intended from the outset to reach the ultimate result the mutual_interdependence_test which focuses on whether the steps are so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series and the binding_commitment_test under which a series of transactions is collapsed if at the time the first step is entered into there was a binding commitment to undertake the later stepdollar_figure if the step_transaction_doctrine applies to integrate a series of steps courts will disregard those steps that do not reflect the substance of the overall transactiondollar_figure thus for example courts will disregard a circuitous exchange of assets or a circular_flow_of_cash for purposes of determining the tax consequences of a transactiondollar_figure it is also the long-standing ruling position of the service to disregard circular flows of cashdollar_figure 13_f3d_577 2d cir see also 302_us_609 a given result at the end of a straight path is not made a different result because reached by following a devious path 862_f2d_1486 11th cir citing 324_us_331 828_f2d_221 4th cir the step_transaction_doctrine encourages the view of transactions in their entirety 702_f2d_1234 5th cir t axpayers cannot compel a court to characterize the transaction solely upon the basis of a concentration on one facet of it when the totality of circumstances determines its tax status internal quotations omitted see 418_f2d_511 ct_cl see 630_f2d_1169 7th cir 450_us_913 see 391_us_83 see 251_f3d_210 d c cir explaining that under the step_transaction_doctrine the service and the courts may ignore a step in a series of transactions 747_fsupp2d_49 d mass the step_transaction_doctrine is a judicial manifestation of the more general tax law ideal that effect should be given to the substance rather than the form of a transaction by ignoring for tax purposes steps of an integrated transaction quoting 422_f3d_1339 fed cir internal quotations omitted see 76_fedclaims_570 holding that a purchase by a subsidiary of stock of its parent on the open market followed by a transfer several months later of such stock to the parent in exchange for a note was a transaction to which the step transaction pref-120527-10 b application to -------------------- the agreements underlying these two transaction steps by their express terms are interrelated and therefore part of the same plan under the agreement q and p were required to purchase all the ----------- equity securities and related notes and they reserved the right and intended to syndicate all or a portion of their obligation the agreement specifically mentions the --------------that was made by the group led by q and p in fact the agreement and its exhibits which include the agreement and the agreement together are referred to as the ------------------ thus the acquisition of the ----------- equity securities by the ------ ------------- cannot be viewed as a separate transaction from the ----------------------------------- as described above pursuant to the ----------------agreement q and p as majority holders of the ------------------------------------ -------- had the power to ---------------------------- ------------------------------ and thus were able to ------------------------------------------------------- ------------------------------------------------------------------------------------------------------------- the ------ ------------- acquired their ----------- interests in new x via the memorandum also referred to as the -----------------------which commenced on ------------------ ---------- and expired ------------------------ ---------- the limited amount of time during which potential investors could review and evaluate participation in the offering as a practical matter limited the offering to investors already familiar with x’s business and the ------------------- ------------------ that is the ------ ------------- in addition the limited class of eligible investors under the agreement explicitly included the ------ -------------dollar_figure thus p and q specifically arranged to and in fact successfully did syndicate equity interests in new doctrine applied and as a result concluding that the subsidiary’s purchase and ownership of the parent stock must be ignored for tax purposes georgia cedar corp v comm’r 55_tcm_853 applying the step_transaction_doctrine to disregard the circular flow of a note and as a result determining the relevant tax consequences based on the remaining non-disregarded steps see revrul_83_142 1983_2_cb_68 disregarding circular cash flows between parent and subsidiary in connection with spin-off revrul_80_154 1980_1_cb_68 treating cash distribution followed by purchase of stock in distributing_corporation as stock_dividend revrul_78_397 1978_2_cb_150 disregarding circular cash_flow in connection with multi-step acquisition revrul_74_564 1974_2_cb_124 disregarding circular cash_flow in connection with merger transaction memorandum page under the agreement eligible participants in the offering included are described as -------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------- pref-120527-10 x only to the ------ ------------- the ------ ------------- standing as ------------ --- old x is the origin of their opportunity and right to participate in the new x equity offering in fact the quantum of equity_interest for which each holder of the ----------- equity securities could subscribe was determined based on ------------------------------------ thereby making the equity purchase a function of their --------- moreover percent of the new x ---------- --------------------------------------------------------------------------------------------------------------------- equity securities was acquired by ------ ------------- thus under the statute both the entitlement to the cash and the acquisition of the new x equity securities in exchange for an offset to such entitlement are taken into account together for purposes of determining whether new x is a surrogate_foreign_corporation next the treatment of these steps taken together is considered under judicial doctrines - namely the step_transaction_doctrine as described below together these two steps are treated as a single integrated transaction for tax purposes under all three formulations of the step_transaction_doctrine end result test under the end result test purportedly separate transaction steps will be amalgamated into a single transaction when it appears that they were really component parts of a single transaction each intended from the outset to be taken for the purpose of reaching the ultimate result this test focuses on the subjective intent of the parties when they structure the transactiondollar_figure in this case the ultimate result is that all of the holders of the ----------- equity securities in new x were formerly ------ ------------- the agreement governing the mechanics of the issuance of the ----------- equity securities evidences an intention from the outset on the part of the taxpayer -- and p and q for -- ------ ------------- to acquire the ----------- equity securities specifically the agreement required p and q each a ------ ------------ to purchase the entire dollar_figured ----------of ----------- equity securities that was to be issued and to offer to assign its right to purchase such equity securities to the holders of the --------------- ----------------------------------- thus it was the intent and agreement of the parties from the outset that all of the ----------- equity securities would be held by former ------ ------------- and the end result test is satisfied mutual_interdependence_test the mutual_interdependence_test focuses on whether the steps are so interdependent that the legal relationships created by one transaction would have been fruitless without a completion of the seriesdollar_figure this test concentrates on the relationship between the see 137_tc_70 see 88_tc_1415 pref-120527-10 steps rather than on the end resultdollar_figure the inquiry here is whether taking into account the overall --------------------------------- there would have been an offering of the ----------- equity securities in new x absent the ------------------------------------------------------------------ -------------------------------------------------------------------------------------------------------and the commitment from p and q to purchase the ----------- equity securities in new x the agreement the agreement and the agreement were all integrated and as such one would not have been separately and independently executed specifically the ------ --------------------------------------------------------------------------------------------------------------------- --------------could not have been paid had -- and p and q not committed to purchase equity in the new entity in addition since new x was a newly formed entity without capital but for the required investment of p and q and -- it could not have paid old x for the acquired properties a critical component of the --------------------------------- in addition the cash paid_by new x to old x for the acquired properties was then used to ----------------------------------------------------- accordingly without the required investment of p and q and -- the ------ ---------could not pay the ----------------------------------------------- ---------------------------------------------------------------------------------------------------------------the total_amounts that they were due under the --------------------------------- thus the mutual_interdependence_test is satisfied binding_commitment_test the third test the binding_commitment_test provides for the application of the step_transaction_doctrine only where there is a binding commitment to take each step in a multi-step transaction the facts at issue here also satisfy application of the binding_commitment_test p and q themselves ------ ------------- were under a binding commitment to purchase the ----------- equity securities in new x thus while other ----- --------------------------------------------------------------------------------------------------------------------- - ------------- were technically under no legal_obligation to purchase such interests and p and q intended from the outset to and in fact did offer them the opportunity to purchase the equity even without such syndication the ----------- equity securities in new x were required to be purchased by ------ ------------- of old x furthermore as discussed above immediately prior to the --------------------------------- the --------------- ----- --------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------- the excess value attributed by the market to -----------------------------effectively dictated from an economic perspective that nearly all ---------------------would be converted to equity in new x c analysis of taxpayer argument see 927_f2d_1517 10th cir pref-120527-10 the taxpayer asserts that the entitlement of the ------ ------------- to ---------------------------- -----------------------------------------------------------------------------------------------------------------of cash --------------------------------------- and the acquisition of the ----------- equity securities ---------------------------------------------------------- should be treated as separate and independent actions for tax purposes in support of this theory the taxpayer asserts that the ------ ------------- had no legal or contractual right to receive the equity securities --------------------------------------- as a result according to the taxpayer the ----------- equity securities were acquired in exchange for cash rather than ----------------------------- -------------------- specifically the taxpayer argues that ------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------ chose not to subscribe for the --------- -- equity securities in new x the taxpayer states that neither the ----------------------- --- -----------------------------------------------------provided ------ ------------- with the right to receive equity securities ------------------------------------------------- thus the taxpayer asserts that the form of the transaction steps should dictate the treatment of the transaction for tax purposes such that the -------------------------------------------and the acquisition of the equity securities should be treated as separate and independent actionsdollar_figure the ----------------------------------involved myriad complex steps pursuant to various documents and related agreements for tax purposes these steps are characterized based on their overall substance and in light of the entire transaction under the facts and circumstances the overall substance of these integrated steps is that the ------ ------ ------------- received all dollar_figured ----------of ----------- equity securities ---------------------------------- ---------------------------- the facts as analyzed above demonstrate that the acquisition of the ----------- equity securities by the ----- ------------- was pursuant to the overall ------------------------------------- ---------------------------------------------------------------------------------------------------------------- the taxpayer’s assertion that the agreement and agreement - the agreements pursuant to which the ------ ------------- obtained their ----------- equity securities - were not related to the ----------------------------------does not withstand scrutiny under examination as indicated the acquisition of the ----------- equity securities was pursuant to the agreement an agreement related to the ---------------------- and so should be taken into account together with the ---------------------- both in accordance with the specific mandate in sec_7874 as well as long-established case law ----------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- ------------------------------------ pref-120527-10 d conclusion the step_transaction_doctrine applies as long as the criteria of one of the tests are satisfieddollar_figure here however each formulation of the step_transaction_doctrine applies with respect to the ------------------------------------- and the acquisition by the ------ ------------- of the ----------- equity securities in new x in exchange for an offset to that ---------------- because the ------------------------------the acquisition of the ----------- equity securities are integrated under the step_transaction_doctrine these two steps are characterized to reflect the overall substance of the transaction under the case law and long-standing service ruling policy the circular_flow_of_cash - ------------------------------------------------------ --------------------------------------------------------------------------------------------------------------------- -is disregarded once the circular cash is disregarded the remaining steps accurately reflect the substance of the transaction - that is the ------ ------------- receive the ----------- -------------------------------------------------------------------------------------------------------------------- equity securities -------------------------------------- furthermore as discussed above the statute itself makes clear that the entire transaction including all related steps should be analyzed togetherdollar_figure thus the characterization of this single integrated transaction is that the ------ ------------- received the ----------- equity securities ------------------------------ --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- vi the substantially_all requirement a in general the substantially_all requirement under sec_7874 is met if the foreign_corporation completes after date the direct or indirect acquisition of substantially_all_of_the_properties held directly or indirectly by a domestic_corporation thus this requirement will be satisfied if new x directly or indirectly acquired substantially_all_of_the_properties held directly or indirectly by old x the legislative_history to sec_7874 provides that i t is expected that the treasury secretary will issue regulations applying the term ‘substantially all’ in this context and will not be bound in this regard by interpretations of the term in other contexts under the code there are no regulations or other authorities that address the question of what see barnes group inc et al v commissioner tcmemo_2013_109 pincite citing 137_tc_70 and 927_f2d_1517 10th cir see sec_7874 s rep no n date pincite pref-120527-10 constitutes substantially_all_of_the_properties held by the_domestic_corporation for this purpose thus this requirement must be analyzed based on the plain meaning of the statutory language taking into account the policies underlying the provision and congressional intentdollar_figure the analysis should be based on all the relevant facts and circumstances of the particular transaction under a plain reading of the statute the determination is made based on the properties held by the_domestic_corporation at the time of the acquisition after taking into account all transactions that occur prior to and in connection with the acquisitiondollar_figure the properties fraction - that is the percentage of the total properties held by the_domestic_corporation at the time of the acquisition that are acquired by the foreign acquiring_corporation - is an important factor in determining whether the requirement will be satisfied in addition the statute makes no mention of liabilities of the_domestic_corporation nor does it refer to net properties thus a plain reading of the statute indicates that for this purpose the value of the properties held by the_domestic_corporation ordinarily should be determined on a gross basis - that is not net of liabilities in addition as discussed sec_7874 was enacted to prevent expatriations where the putative foreign_corporation continues to conduct business in substantially the same manner as before the inversiondollar_figure as such because the statute was designed with the continuing operation of a business in mind it is appropriate that such business be valued on a going concern rather than on a liquidation value basis see 734_f3d_296 4th cir as in any case of statutory interpretation we begin with an analysis of the statutory language the meaning of a statutory provision is not to be determined in isolation we look not only to the particular statutory language but to the statute as a whole and to its object and policy internal citations and quotations omitted 231_f3d_1207 9th cir in interpreting a statute we look first to the plain language of the statute construing the provisions of the entire law including its object and policy to ascertain the intent of congress internal citations and quotations omitted 110_fsupp2d_1117 n d iowa explaining that if after considering the plain meaning of a provision taking into account the context object and policy of the statute the provision is ambiguous then a court must look to other aids to determine congressional intent including legislative_history and the purpose the subject matter and the condition of affairs which led to its enactment internal citations and quotations omitted as discussed in section v a of the law and analysis section of this memorandum sec_7874 by its express terms considers all aspects of the entire transaction at issue broadly defined compare sec_956 amount of united_states_property taken into account under sec_956 is determined by reference to the property’s adjusted_basis reduced by any liability to which the property is subject sec_1244 the adjusted_basis to the corporation of the property for determining gain reduced by any liability to which the property was subject or which was assumed by the corporation sec_1_312-10 net_basis of the assets transferred and of the assets retained and defining net_basis as the basis of the assets less liabilities assumed or liabilities to which such assets are subject sec_1_514_c_-2 taking into account t he amount of money and the fair_market_value of property contributed by the partner to the partnership net of liabilities assumed_or_taken_subject_to by the partnership s rep no pincite general explanation of tax legislation pincite pref-120527-10 b percentage of properties acquired the denominator of the properties fraction is the gross value of the properties held directly or indirectly by old x at the time of the acquisition after taking into account all transactions prior to and in connection with the acquisition the numerator of the properties fraction is the gross value of the old x properties included in the denominator of the properties fraction that are acquired by new x the taxpayer asserts that the substantially_all requirement is not satisfied based on the treatment of the b properties and the -----------------------properties accordingly the acquired properties the b properties and the -----------------------properties will be separately considered acquired properties the acquired properties were held by old x immediately before the acquisition and were acquired by new x as a result the gross value of the acquired assets is included in both the numerator and the denominator of the properties fraction b properties the b properties were sold in connection with the --------------------------------- in form the dollar_figureb ----------of sales proceeds received from ------------------------------------------------------ ---------------------------------------------------- as explained in section v of the law and analysis section of this memorandum however only dollar_figuree ----------of the dollar_figureb ------------ purchase_price is treated for tax purposes as --------------------------------------------------------- ----------------------------------- the remaining dollar_figured ----------is treated for tax purposes as being acquired by new x in effect as a replacement asset for a portion of the properties sold to bdollar_figure thus the dollar_figured ----------portion of the purchase_price is included in both the numerator and the denominator of the properties fraction in addition the dollar_figuree ----------of proceeds distributed to the ------ ------------- is not held by old x at the time of the acquisition after taking into account all transactions that occur prior to and in connection with the acquisition accordingly the dollar_figuree ----------of cash proceeds is not included in the numerator or the denominator of the properties fraction taxpayer asserts that the value of the b properties or in the alternative the dollar_figureb ---------- received in exchange for the b properties should be included in the denominator but not the numerator of the properties fraction first taxpayer asserts that this result as noted above the dollar_figured -----------amount consisted of dollar_figure----- -----------in cash proceeds and dollar_figurec --------------- ------------------------------------------------------------------------------------------- pref-120527-10 follows from a plain reading of the statute because the b properties were sold to b in connection with the ----------------------------------and therefore were not acquired by new x taxpayer further asserts that the sales proceeds received by old x from b should be taken into account in the denominator but not the numerator of the properties fraction because non-operating replacement assets such as cash proceeds do not constitute historic operating_assets taxpayer believes the legislative_history supports this position because sec_7874 was intended to target transactions in which corporations and other entities continue to conduct business in the same manner as they did prior to the inversion and which have little or no non-tax effect or purpose taxpayer argues that the substantially_all requirement is not satisfied in cases where significant business_assets and operations are sold to a third party prior to or in connection with the acquisition because such transactions cannot be described as having little or no non- tax effect however the statute does not indicate or suggest that properties that are sold prior to or in connection with the acquisition should be included in the denominator but not the numerator of the properties fraction indeed the statute by its terms provides otherwise taking into account all steps pursuant to a plan or a series of related transactions the statute applies with respect to properties held by the_domestic_corporation and as discussed in section v of the law and analysis section of this memorandum for u s tax purposes the dollar_figured ----------of the cash proceeds from the sale of the b properties is treated as held by old x immediately prior to the acquisition in effect taxpayer asserts that there is an unstated requirement in sec_7874 that it does not apply with respect to all properties held by the_domestic_corporation but rather applies only with respect to properties used in a historic_business such a requirement which would be similar to the continuity of business_enterprise requirement for reorganization purposes should not be read into sec_7874 in fact when the provision is read in its entirety it is clear that no such additional requirement is present or intended sec_7874 as applied with respect to domestic partnerships is satisfied if the foreign_corporation acquires substantially_all_of_the_properties constituting a trade_or_business of the partnership emphasis added there is no such trade_or_business requirement in sec_7874 as it applies with respect to properties of a domestic_corporation nevertheless taxpayer’s argument in effect requires that the trade_or_business qualifier in the rule that applies to domestic partnerships also applies to domestic corporations if congress had intended the trade it should be noted here that throughout the taxpayer’s ----- new x is described as a continuation of old x s rep joint_committee on taxation general explanation of tax legislation enacted in the 108th congress pincite see sec_1_368-1 the continuity of business_enterprise rule requires that the issuing_corporation either continue the target corporation’s historic_business or use a significant portion of the target corporation’s historic_business_assets in a business sec_1_368-1 neither this rule nor the reorganization rules in general has any relevance to the application of sec_7874 pref-120527-10 or business requirement to apply to domestic corporations the trade_or_business language would have modified properties in the context of both domestic corporations and domestic partnershipsdollar_figure taxpayer’s formulation is also contrary to the legislative_history and general policies underlying sec_7874 if taxpayer’s position were accepted after any disposition of a significant portion of its historic operating_assets - for example through sale disposition or transfer in satisfaction of liabilities - a domestic_corporation arguably could convert to a foreign_corporation without being subject_to sec_7874 congress could not have intended this result accordingly the dollar_figureb ---------- of cash proceeds received from b should not be given the special treatment suggested by the taxpayer and instead must be taken into account in the properties fraction in the same manner as any other propertydollar_figure taxpayer also asserts that even if the cash proceeds were to be considered as replacement properties none of the cash was acquired by new x but rather --------------- -------------------------------------------------------------------------------------- the taxpayer notes that the phrase substantially_all is not defined in sec_7874 and asserts that the plain meaning of the term does not suggest that any portion of the domestic entity’s assets should be excluded from the denominator of the properties fraction thus according to the taxpayer none of the cash proceeds should be included in the numerator of the properties fraction because they were not acquired by new x but according to taxpayer the cash proceeds should still be treated as property held by old x and therefore included in the denominator of the properties fraction as discussed above dollar_figured ----------of the dollar_figureb ----------sale proceeds as replacement for the properties sold to a is treated for tax purposes as being held by old x immediately before the acquisition and as being acquired by new x as a result dollar_figured ----------of the sale proceeds is included in both the numerator and the denominator of the properties fraction the remaining dollar_figuree ----------of cash proceeds is treated for tax purposes a sec_64 see 133_sct_1886 we have long held that where congress includes particular language in one section of a statute but omits it in another section of the same act it is generally presumed that congress acts intentionally and purposely in the disparate inclusion or exclusion internal quotations omitted 548_us_557 a familiar principle of statutory construction is that a negative inference may be drawn from the exclusion of language from one statutory provision that is included in other provisions of the same statute 138_tc_204 when congress includes particular language in one section of a statute but omits it in another section of the same act it is generally presumed that congress acted intentionally and purposely in so doing internal quotations omitted even if the properties fraction were to be applied only to historic operating_assets as taxpayer asserts it should be applied consistently that is only historic operating_assets should be considered in the numerator and the denominator of the properties fraction the properties fraction simply would not provide a meaningful indication of substantially_all if it only took into account operating_assets in the numerator but took into account operating_assets and all other properties in the denominator as taxpayer suggests pref-120527-10 being distributed from old x ------------------------------------------------------------------------------- ---------------------- the proper treatment of properties distributed to shareholders prior to or in connection with the acquisition turns on the meaning of the word held sec_7874 only applies with respect to properties held by the_domestic_corporation thus the question is whether properties that are distributed by the_domestic_corporation either prior to or in connection with the acquisition should continue to be treated as being held by the_domestic_corporation for purposes of the substantially_all requirement they should not all aspects of the transaction including distributions of property in connection with the --------------------------------- should be taken into account for purposes of this requirement as discussed in section v a of the law and analysis section of this memorandum sec_7874 and judicial doctrines mandate that all aspects of the entire transaction broadly defined be taken into account under this standard distributions ----------------------------------------------------------- --------------------------------------------------------------------------must be taken into account thus because dollar_figuree ----------of the cash proceeds is treated as distributed pursuant to the --------------------------------- the proceeds are not considered held by old x and are not included in the denominator of the properties fraction treating distributed properties as held by the_domestic_corporation and therefore included in the denominator of the properties fraction as taxpayer asserts is also inconsistent with the purpose and policies underlying the substantially_all requirement sec_7874 is intended to prevent inversion_transactions in which corporations and other entities continue to conduct business in the same manner as they did prior to the inversion the requirement is intended to consider the extent to which the properties held by the_domestic_corporation immediately prior to the acquisition are held by the foreign acquiring_corporation as compared to properties that are retained and held by the_domestic_corporation that is it measures the extent to which the foreign_corporation represents a continuation of the_domestic_corporation as opposed to representing only a portion of the properties held by the_domestic_corporation with the_domestic_corporation continuing to hold other properties to the extent the_domestic_corporation continues to hold properties the foreign_corporation represents less of a mere continuation of the_domestic_corporation in addition including distributed properties in the denominator of the properties fraction would have the effect of inappropriately exempting numerous transactions from the application of sec_7874 that is this interpretation would arguably permit domestic corporations that distribute a sufficient amount of their properties - for example as a dividend or a spin-off under sec_355 - to immediately thereafter convert into a foreign_corporation without being subject_to sec_7874 congress did not intend this result s rep joint_committee on taxation general explanation of tax legislation enacted in the 108th congress pincite pref-120527-10 --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------dollar_figure ----------------------properties for the same reasons discussed above with respect to the dollar_figuree ----------of distributed proceeds from the sale of the b properties neither the -----------------------properties nor proceeds from their sale ------------------------------------------------- are included in the denominator of the properties fraction these properties remained in old x only for the purpose of being disposed of ---------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------- although the -----------------------properties differ from the b assets in that they had not been sold as part of the --------------------------------- the intent of old x was to hold the assets for the sole purpose of ---------------------------------------------------------------------------- ------------ thus they should be treated the same way as the portion of the a properties that were used ----------------------------------- that is excluded from both the numerator and denominator of the properties fractiondollar_figure c gross value of properties taxpayer asserts that the gross value of the properties should not be determined based on the independent third-party valuation provided by taxpayer’s accounting firm in ---------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------------------------- we note that given their relatively small value - either dollar_figure---- -----------or dollar_figure-- depending on the valuation study or dollar_figure---- -----------according to taxpayer - the effect of including the -----------------------properties in the denominator of the properties fraction would be immaterial pref-120527-10 connection with the --------------------------------- but rather should be based on an implied valuation derived from ----------------------- trading of the --------------- -------- in the period prior to the --------------------------------- based on that methodology the taxpayer imputes the value of the acquired properties to be approximately dollar_figure--------- --------- rather than the approximately dollar_figure------- ----------value determined by taxpayer’s accounting firm relying on the price from --------------------------------trading of the --------------- ---------------- -------------------------------------------------------------------------------------------------------during periods of time prior to the ----------------------------------is not indicative of the gross values of the assets at the time of the acquisition valued on a going-concern basis the taxpayer’s accounting firm valuation report prepared in contemplation of the ------------ ----------------------------------and used to prepare the opening balance_sheet of new x is more reliable evidence of the value of the properties for purposes of the properties fraction taxpayer relied on this report in preparing its ------------- and its financial statements both of which were released to the public accordingly the gross values of the properties relevant for purposes of determining the properties fraction based on the taxpayer’s accounting firm report are as follows b properties proceeds dollar_figureb ---------- proceeds transferred to new x proceeds -------------------------------- acquired properties -----------------------properties total d conclusion dollar_figured ---------- dollar_figuree ---------- dollar_figure------ --------- dollar_figure---- ---------- dollar_figure---------------- the acquired properties and dollar_figured ----------of the proceeds from the sale of the b properties are included in both the numerator and the denominator of the properties fraction the properties that were sold in connection with the ----------------------------------- ------------------------------------------------------------------------------------------------------------------ or the cash proceeds from such sales used to ------------------- are not held by old x at the time of the acquisition and therefore are not included in the numerator or the denominator of the properties fraction thus the properties fraction is percent and new x acquired substantially_all the properties held by old x within the meaning of sec_7874 when the ----------------------------------is viewed in its entirety as required under sec_7874 a properties fraction of percent is consistent with the overall substance and economic reality of the transaction only one of two things occurred with respect to all the properties held by old x prior to the acquisition they were either acquired by new x acquired properties and dollar_figured ----------of proceeds from the sale of the b properties or pref-120527-10 they were sold ------------------------------------------------------------------------------------------------ of proceeds from the sale of the b properties and all the proceeds from the sale of the -- -----------------------properties other than the cash received from new investors new x’s properties consist only of properties held by old x thus new x is a complete successor to old x as reorganized which is consistent with a properties fraction of percentdollar_figure vii the ownership requirement the ownership requirement under sec_7874 is met if after the acquisition at least percent of the stock by vote or value of the foreign_corporation is held by former shareholders of the_domestic_corporation by reason of holding stock in the domestic corporationdollar_figure in addition for this purpose disqualified_stock is excluded from the denominator of the ownership fractiondollar_figure thus in analyzing the ownership requirement it is necessary to determine i the amount of new x stock held by former shareholders of old x after the acquisition by reason of holding stock in old x and ii the extent to which the new x equity securities constitute disqualified_stock and therefore are excluded from the denominator of the ownership fraction a stock of new x held by reason of holding stock in old x in general sec_1_7874-2t f i provides that for purposes of sec_7874 stock of a foreign_corporation that is held by reason of holding stock in a domestic_corporation includes stock of a foreign_corporation received in exchange for or with respect to stock of a domestic_corporation the broad phrase with respect to contemplates a wide range of potential relationships accordingly stock in the foreign_corporation must be held as a result of some connection between the stock and being a former shareholder of the_domestic_corporation under the regulations the phrase by reason of is construed broadly and includes not only taxable and nontaxable exchanges and distributions but also any other transactions where stock in the foreign_corporation is acquired because the shareholder held stock in the domestic even if as taxpayer asserts the b properties or dollar_figuree -----------of the cash proceeds from the sale of the b properties are treated as held by old x and therefore included in the denominator of the properties fraction the properties fraction would still be over percent dollar_figure----------------- ------------------- and therefore would still constitute substantially_all for purposes of sec_7874 such stock ownership is also relevant for purposes of determining whether sec_7874 applies see section vii b of the law and analysis section of this memorandum sec_1_7874-2t n example pref-120527-10 corporationdollar_figure accordingly where stock of the foreign_corporation is held as a result of being a shareholder of the_domestic_corporation including as a result of being a creditor of an insolvent domestic_corporation the by reason of requirement is satisfied application to stock of new x after the acquisition by new x of substantially_all the properties of old x the equity securities were held by -- the c and former ------------------- in order to determine whether the ownership fraction is satisfied the way in which these shareholders acquired their equity securities must be considered -- contributed dollar_figure--------- ----------in cash to new x in exchange for ------------ ------ ----------- equity securitiesdollar_figure thus the -----------------------------equity securities received by -- were not held by reason of holding stock in old x instead they were received by reason of contributing cash to new x similarly p and q and the ----------------------------- contributed dollar_figure-------and dollar_figure------- ----------in cash respectively to new x in exchange for ---- ------------equity securities therefore the portion of the ----------- equity securities received by the ---------------------------in exchange for cash was not held by reason of holding stock in old x all of the remaining equity securities were acquired by ------ ------------- in form in exchange for -------------------------------------------------------------------------------------------------- ------------------- as discussed in section v of the law and analysis section of this memorandum however the substance of these two integrated steps is that the ------ ---- ------------- received their new x ----------- equity securities --------------------------------------- ------------------- thus the ------------equity securities in new x were acquired in exchange for or with respect to - and therefore by reason of - ------------------------------- ---------------------------------------------------- accordingly the new x ----------- equity securities received by the ------ --------------------------------------------------------------------------- ----------------------------------- are included in the numerator and the denominator of the ownership fraction see td 2009_28_irb_114 section e which explains that the temporary regulations also clarify that the ‘by reason of’ condition may be satisfied other than through exchanges or distributions as noted above in section vi of the facts section of this memorandum the ------------ equity securities were then transferred from----to the c the c received its equity interests in new x at least in part in exchange for its agreement to ----------------------------------------------------------------------------------------- -----------------------------------of old x see ------------------------------------dated ------------------- as a result the ----------- equity securities received by the c also may be viewed as being held by reason of its ------- ---------------------------- thus regardless of whether they are viewed as having been issued to ---in exchange for cash or issued to the c in exchange ---------------------------------- the ------------ equity securities will not reduce the ownership fraction pref-120527-10 b exclusion of new x stock from the denominator of the ownership fraction on date the service and treasury_department issued notice_2009_78 irb notice_2009_78 announced that regulations would be issued under sec_7874 that would identify certain stock of the foreign_corporation that is disregarded for purposes of the ownership test these regulations would address transactions intended to avoid the application of sec_7874 that involved transfers of cash or certain other assets to the foreign_corporation in a transaction related to the acquisition described in sec_7874 --------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------- notice_2009_78 states that regulations will provide that stock of the foreign acquiring_corporation issued in exchange for nonqualified property in a transaction related to the acquisition is not taken into account for purposes of the ownership fraction without regard to whether such stock is publicly traded on the date_of_issuance or otherwise the notice further provides that the term nonqualified property includes cash or cash equivalents finally the notice states that the regulations will apply to acquisitions completed on or after date on date the service and treasury_department issued temporary regulations implementing the rules described in notice 2009-dollar_figure the preamble to the temporary regulations explains that the service and treasury_department are concerned with transactions intended to avoid sec_7874 that involve a transfer of cash or other assets to the foreign_corporation in exchange for additional equity such that the ownership requirement would not be satisfieddollar_figure accordingly the temporary regulations modify the statutory public offering exclusion rule in sec_7874 to take into account a non-public offering of stock for certain property including cash that presents the same opportunity to inappropriately reduce the ownership fraction the preamble notes as an example that a private_placement of the stock of a foreign acquiring_corporation in exchange for cash raises the same policy concern that the ownership fraction will be inappropriately reduced by increasing the net assets of the foreign_corporation sec_1_7874-4t b provides that subject_to a de_minimis exception not relevant here disqualified_stock is treated as stock described in sec_7874 td fr date id id id pref-120527-10 and therefore is not included in the denominator of the ownership fractiondollar_figure disqualified_stock includes stock transferred to a person other than the domestic entity in exchange for nonqualified property sec_1_7874-4t i defines nonqualified property to include cash or cash equivalents consistent with the effective date announced in notice_2009_78 these rules apply to acquisitions completed on or after september dollar_figure the ----------- ------ ----------- equity securities were transferred by new x to -- in exchange for cash which is nonqualified property similarly new x transferred a portion of the ----------- equity securities to p and q and to the ---------------------------------- ---------------------------------------------------------------------------------------------------------- in their capacity as financiers rather than as ------------------- in exchange for cash as a result under sec_1_7874-4t b the -----------------------------equity securities and the portion of the ----------- equity securities transferred to p and q and to the ------------------ ---------------in exchange for cash in their capacity as financiers rather than as ------ ------ ------------- are not included in the denominator of the ownership fractiondollar_figure c analysis of taxpayer argument taxpayer asserts that sec_7874 does not apply because q and p received a portion of their ----------- equity securities in new x not by reason of -------------------------- -------- but rather in their capacity as promoters or investors in exchange for an undertaking to provide financing to new xdollar_figure under the agreement p and q were required to provide dollar_figured ----------in equity financing to new x in exchange for all of its ----------- equity securities in fact as set forth in the summary of ---------------------------------------------------------provided by the taxpayer p sec_1_7874-4t c provides that stock is disqualified_stock only to the extent that the transfer of the stock in the exchange increases the fair_market_value of the assets of the foreign acquiring_corporation or decreases the amount of its liabilities this limitation only applies to acquisitions completed on or after date however and therefore does not apply to the transaction at issue sec_1_7874-4t k iii even if this limitation did apply it would not affect the analysis because the transfer of the new x equity securities in exchange for cash increased the fair_market_value of the assets of new x sec_1_7874-4t k see footnote noting that even if certain equity securities are viewed as not having been received in exchange for cash they should be viewed as having been received by reason of --------------------------------- old x the taxpayer also asserted that the -------------------- acquired the new x equity securities in exchange for cash and not by reason of ------------------------------------ and therefore did not satisfy the ownership requirement this argument is addressed in section v of the law and analysis section of this memorandum pref-120527-10 and q and the ---------------------------provided approximately dollar_figure----- ----------in equity financing and syndicated the remaining portion of their obligation as they were permitted to do under the agreement with approximately dollar_figure----- ----------ultimately being provided by --------- ------------- and approximately dollar_figure---- ----------being provided by other ------------------ ------------- according to the taxpayer in exchange for a cash investment of approximately dollar_figure----- ---------- p and q and the ------------------------------------- ----------------------------------------------------------------------------------------------------received an aggregate ---------------------------------------------------------------------of approximately dollar_figure----- --- ---------- the taxpayer claims that the --------------------------------------------of approximately dollar_figure------ ----------must have been attributable to q and p’s actions as promoters and lead investors in providing a financing commitment to new x the taxpayer argues that the ----------- equity securities received in exchange for this financing commitment should qualify neither as being received in exchange for cash such that they are not disqualified under sec_1_7874-4t nor as received by reason of ---------------------------------------- thus the taxpayer asserts that this stock should be included in the denominator but not the numerator of the ownership fraction the taxpayer’s argument that p and q received additional and disproportionate equity value in new x based on their entrepreneurial involvement is disproven by a straightforward analysis of the -----------------------------------------------on which the taxpayer relies importantly as is illustrated by the taxpayer’s --------------------------- summary all the owners of ----------- equity securities including the ---------------------- ---- ------------- and not just p and q were awarded ----------------------------------------------------- -------------------------------------------------------------------------------------------------------------on exactly the same terms with every investor receiving ----------------------credit of dollar_figuref for each dollar_figure of cash deemed investeddollar_figure the ------------------ ------------- contributed approximately dollar_figure---- ----------in exchange for ----------- equity securities of approximately dollar_figure----- ---------- similarly the ------ -----------------contributed approximately dollar_figure----- ------------ and were awarded an aggregate ---------------------------------------------of approximately dollar_figure--- ------------------- thus the ------------------and the --------- ------------- received dollar_figuref in ----------- --------------------------------------------------------------------------------------------------------------------- new x equity securities for every dollar of cash contributed dollar_figure----- ---------- dollar_figure---- ----------- and dollar_figure--------- ------------------- ---------- respectively which is equal to the dollar_figuref ----------- value that p and q received for each dollar they invested in new x dollar_figure----- ---------- dollar_figure----- - in all dollar_figure----------------------of cash was contributed to new x in exchange for equity the initial value of new x immediately after the ---------------- as indicated by the ----------------------------------------------- was dollar_figure-- --------------------- thus the value of the non-cash property acquired from old x must have been equal to dollar_figure-------------------- this approximately dollar_figure-----------------of property was not contributed by any shareholder of new x but rather simply reflects the value of the old x assets acquired by new x pursuant to the ---------- -------------------------------- for purposes of determining the parties’ ------------------------------------in new x the value attributable to the dollar_figure---------------- in non-cash property was allocated among the classes of new x equity with the ----------------------equity securities purchased by -- being credited with approximately dollar_figure-- ------ -----------and the ------------ equity securities purchased by the --------------------being credited with approximately dollar_figure------------------ pref-120527-10 ---------- therefore it cannot be the case that p and q were awarded additional equity in exchange for services rendered in having secured financing or on any other basis instead they received ----------- equity securities on the same terms as all of the other holders this is also made clear in the memorandum which states ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ----------------------------------------84 there are no agreements documents or other evidence to suggest that p and q or the - ---------------------------------------------------------------received new x equity securities in exchange for a financing commitment or -----------------------------as taxpayer now asserts indeed all of the agreements and documentation reflect the simple fact that the ----------- equity securities were issued on the exact same terms and conditions to all parties and that p and q and the ---------------------------had no rights separate and apart from those ----------------------------------dollar_figure p and q did not enter into any agreement or any other arrangement to provide a financial commitment or deal-making services in exchange for equity securities or any other_property instead p and q simply --------------------------------------------------------------- ------------------ like all the other ------ ------------- and consistent with --------------------- p and q received new x stock ---------------------------------- all rights and value received by p and q derived from ---------------- and only from ---------------- but for -------------- p and q had no rights whatsoever to receive new x stock or any other_property pursuant to the --------------------------------- d calculation of the ownership fraction the shareholders of new x - the former --------------------------------------- acquired their new x stock in only one of two ways by reason of --------------------------------------------- -------------------------------------------------------------------------------------------------------------- and in exchange for cash to the extent the new x stock is held by reason of ------------ - see memorandum page as discussed above the taxpayer has argued that the ---------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------- assuming arguendo that such a characterization is correct it implies that new investors with no prior connection to the ------------- entity could buy dollar_figuref worth of ------------ equity securities for each dollar invested as noted above that dollar_figuref per ------------ equity security is the same price as was paid_by p and q thus even under the taxpayer’s characterization of the transaction there cannot have been any excess value awarded to p and q for their dealmaking services pref-120527-10 ----------------------------------------------------------------------------- it is included in both the numerator and the denominator of the ownership fraction to the extent the stock was acquired in exchange for cash it is not included in either the numerator or the denominator of the ownership fractiondollar_figure thus the ownership fraction is percent an ownership fraction of percent is consistent with the overall substance and the economic reality of the --------------------------------- stated simply after the acquisition new x holds only two categories of properties properties formerly held by old x and cash because the new x stock issued to -- and other investors in exchange for newly invested cash is not included in either the numerator or the denominator of the ownership fraction all the remaining stock of new x reflects the old x properties acquired by new x and therefore is included in both the numerator and the denominator of the ownership fraction which would yield an ownership fraction of percent this result is also consistent with the policies underlying the ownership condition of sec_7874 and the exclusion rule under sec_1_7874-4t b the ownership condition is intended to measure the extent to which the foreign acquiring_corporation new x represents a mere continuation of the_domestic_corporation old x dollar_figure the exclusion rule provides that for this purpose cash and other nonqualified property are not taken into accountdollar_figure thus for example if a newly formed foreign_corporation holding no other_property acquires all the assets held by a domestic_corporation in exchange for stock the ownership fraction is percent a percent ownership fraction reflects the fact that the foreign acquiring_corporation holds no properties other than those held by the_domestic_corporation and therefore represents nothing more than a continuation of the_domestic_corporation the result would be the same as a result of the application of sec_1_7874-4t b if the foreign_corporation also issued stock to an investor in connection with the acquisition of the assets held by the_domestic_corporation in exchange for cash - that is the ownership fraction would still be percent this is the case because the foreign_corporation holds only property held by the_domestic_corporation and cash which is nonqualified property the ownership fraction would potentially be reduced below percent only to the extent the foreign acquiring_corporation held property prior to the acquisition or acquired qualified_property as defined in sec_1_7874-4t i in exchange for stock in a transaction related to the acquisition of the properties of the_domestic_corporation the ownership fraction is reduced in such cases because the foreign acquiring_corporation does not merely reflect a continuation of the domestic the stock is not included in the numerator because it was not held by reason of holding stock in old x it is not included in the denominator as a result of the application of sec_1_7874-4t b s rep no 108th cong 1st sess this result is consistent with the rule in sec_7874 which excludes from the numerator and denominator of the ownership fraction stock sold in a public offering related to the acquisition described in sec_7874 pref-120527-10 corporation but rather represents a combination of the_domestic_corporation and the other properties held by the foreign acquiring_corporation here new x is a newly formed foreign_corporation and therefore did not hold any properties prior to the acquisition of the properties of old x in addition the new x equity securities that were issued in a transaction related to the acquisition of the properties held by old x were issued solely in exchange for cash which is nonqualified property --------------------held all the -------------------------------------------prior to the ---------- ---------------------------------and --------------------- along with -- and the c - held all the new x stock after the --------------------------------- accordingly the only significant change effected by the transaction is that the old x business along with newly invested cash is now conducted in the form of a foreign - rather than a domestic - corporation this is the prototypical transaction that sec_7874 was enacted to preventdollar_figure therefore a percent ownership fraction is not only the proper technical application of the rules but is wholly consistent with the policies underlying the ownership requirement the treatment of all the shareholders of new x and the calculation of the ownership fraction are summarized as follows new x shareholders by reason of of -- --------- -- equity -- of ------------ -------------------------- c of ------------ -------------------------- q p as financiers -------------------------- as financiers cash -- cash from b cash cash -- ------- ----- sec_7874 owner- ship test fraction n a n a n a n a treatment excluded excluded excluded excluded see s rep no pincite in particular these inversion_transactions permit corporations and other entities to continue to conduct business in the same manner as they did prior to the inversion the committee believes that certain inversion_transactions involving percent or greater identity of stock ownership have little or no non-tax effect or purpose and should be disregarded for u s tax purposes pref-120527-10 ------ ------------- including q and p and ---------------------- --------------------------- --------------------------- ------------- ------------ ----------- ------- included in numerator and denominator viii the substantial_business_activities requirement a in general the substantial_business_activities requirement under sec_7874 is met if after the acquisition the expanded_affiliated_group which includes the entity does not have substantial_business_activities in the foreign_country in which or under the law of which the entity is created or organized when compared to the total business activities of such expanded_affiliated_group whether the statutory requirement is satisfied therefore depends on the comparative level of business activities in the foreign_country measured against the level of total business activities of the group worldwide in light of this statutorily-required comparison the requirement may be satisfied that is one may conclude that the necessary substantial level of business activities is not present by a seemingly large level of business activities in the foreign_country which nevertheless is not substantial in the overall context of the worldwide business activities of the group thus this requirement will be satisfied if after the acquisition the new x eag does not have substantial_business_activities in country when compared to the total business activities of the new x eag the legislative_history addresses the substantial_business_activities test in sec_7874 as follows the congress believes that inversion_transactions resulting in a minimal presence in a foreign_country of incorporation are a means of avoiding u s tax and should be curtailed in particular these transactions permit corporations and other entities to continue to conduct business in the same manner as they did prior to the inversion but with the result that the as discussed above the ------------ equity securities ultimately received by the c could alternatively be viewed as having been acquired by reason of the c’s ------------------------- similarly because q and p had the power to control the -------------- the ------------ equity securities they acquired in their capacity as financiers could also be viewed as having been acquired by reason of their standing as ----------------------- furthermore the --------------------------- even in their capacity as financiers were only allowed to participate in the offering as a result of their standing as -------------------- in old x such that even the ------- ----- equity interests they acquired in their capacity as ---------------------------could be viewed as having been acquired by reason of their --------------------- in all cases the ownership fraction would remain percent pref-120527-10 inverted entity avoids u s tax on foreign operations and may engage in earnings-stripping techniques to avoid u s tax on domestic operationsdollar_figure in june of the service and treasury_department issued a first set of temporary regulations regulations that provided guidance on the substantial_business_activities requirementdollar_figure the regulations set forth both a general all-facts-and- circumstances rule93 and a bright-line safe_harbor for purposes of determining whether an expanded_affiliated_group has substantial_business_activities in a given foreign_country under the safe_harbor an expanded_affiliated_group was considered to have substantial_business_activities in a country if each of the following requirements was satisfied employees after the acquisition the group employees based in the foreign_country accounted for at least percent by headcount and compensation of total group employees assets after the acquisition the total value of the group assets located in the foreign_country was at least percent of the total value of all group assets and sales during a one-year period preceding the acquisition the group sales made in the foreign_country accounted for at least percent of total group sales in general the regulations applied to acquisitions completed on or after date and prior to date in june of the service and treasury_department issued new temporary regulations regulations that replaced the regulationsdollar_figure the regulations retained a facts-and-circumstances provision largely similar to that contained in the regulations but did not retain the safe_harbor the preamble to the regulations explained that the safe_harbor was not retained because it may apply to certain transactions that are inconsistent with the purposes of sec_7874 sec_91 s rep no pincite general explanation of tax legislation pincite td 2006_2_cb_252 the general facts-and-circumstances rule under regulations is largely similar to the sole facts- and-circumstances provision contained in the regulations discussed below the one-year period referred to as the testing_period is the 12-month_period ending on the last day of the expanded affiliated group’s monthly or quarterly management accounting_period in which the acquisition is completed sec_1_7874-2t g as amended by td c b pref-120527-10 which is meant to prevent certain transactions that seek to avoid u s tax by merely shifting the place of organization of a domestic_corporation or partnership under the regulations the substantial_business_activities determination is based on all facts and circumstances the determination is not based solely on the absolute amount of business activities in the foreign_country rather the determination is based on a comparison of the amount of business activities in the foreign_country to the total business activities of the expanded affiliated groupdollar_figure the regulations provide that the relevant items to be considered in the facts-and- circumstances determination include the following i the historical conduct of continuous business activities in the foreign_country by the expanded_affiliated_group ii the conduct of continuous business activities in the foreign_country by the expanded_affiliated_group in the ordinary course of one or more active trades_or_businesses involving- a property located in the foreign_country that is owned by members of the expanded_affiliated_group b the performance of services in the foreign_country by employees of the expanded_affiliated_group and c sales of goods to customers iii the performance in the foreign_country of substantial managerial activities by officers and employees of the expanded_affiliated_group who are based in the foreign_country iv a substantial degree of ownership of the expanded_affiliated_group by investors resident in the foreign_country v business activities in the foreign_country that are material to the achievement of the overall business objectives of the expanded affiliated groupdollar_figure td 2009_2_cb_114 sec_1_7874-2t g id pref-120527-10 the regulations require the determination of substantiality to take into account the total business activities of the group including the above relevant items the presence or absence of any item or set of items is not determinative moreover the weight given to any item or set of items depends on the facts and circumstancesdollar_figure in general the regulations apply to acquisitions completed on or after date and before date accordingly the regulations apply for purposes of determining whether the new x eag meets the substantial_business_activities requirement in sec_7874 b applicable foreign_country new x treated as a foreign_corporation created or organized in country for purposes of sec_7874 is an entity described in sec_7874 accordingly in determining whether new x is a surrogate_foreign_corporation within the meaning of sec_7874 it must be determined whether the expanded_affiliated_group that includes new x has substantial_business_activities in country c analysis of taxpayer’s position on substantial_business_activities id sec_1_7874-3t f regulations in june of the service and treasury_department issued new temporary regulations that replaced the facts-and-circumstances determination contained in the regulations with a bright-line_rule under this rule in general the expanded_affiliated_group will have substantial_business_activities only if at least percent of the expanded affiliated group’s total group employees by number and employee compensation group assets and group income is located or derived in the foreign_country td 2012_28_irb_41 the preamble to the regulations states that the all-facts-and-circumstances determination was replaced by a bright-line_rule because the latter will provide more certainty in applying sec_7874 to particular transactions than the temporary regulations and will improve the administrability of this provision ---------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------------------------- pref-120527-10 taxpayer asserts that the substantial_business_activities requirement should be interpreted in a manner such that business activities are substantial if they are more than minimal this assertion largely rests on the legislative_history quoted above that inversion_transactions resulting in a minimal presence in a foreign_country are a means of avoiding u s tax and should be curtailed taxpayer’s interpretation takes the legislative_history reference to minimal presence out of context which points to an example of an abuse targeted by the statute but does not define the scope of the statutory response to the abuse the statute plainly speaks of substantial not minimal business activities and requires a facts and circumstances comparison between the applicable foreign_country and the worldwide group the regulations set forth the item-based determination of the threshold and do not turn on any minimal floor indeed the elimination of the prior safe_harbor belies any minimalistic measure prior to the enactment of sec_7874 a u s -parented multinational group of corporations could become foreign parented for u s federal tax purposes even if it had previously conducted no activities whatsoever in the jurisdiction of the foreign parent these so-called naked inversion_transactions drew the ire of members of congress prior to the enactment of section 7big_number and accordingly it is natural that congress would state in the legislative_history as an example that such transactions were abusive however this statement does not imply that any transaction passes muster because the expanded affiliated group’s business activities in the country were more- than-minimal congress easily could have drafted an anti-abuse statute with such a limited scope if it had wanted to do so for example it could have simply chosen the phrase does not have more than minimal business activities instead of does not have substantial_business_activities in drafting sec_7874 congress made the standard substantial_business_activities and the term should be interpreted in a manner consistent with the plain meaning of the word substantial in this context considerable in amount value or worth taxpayer’s interpretation of substantial to equal more-than-minimal would frustrate the over-arching policy set forth in sec_7874’s legislative_history removing the incentives for transactions that allow formerly u s -parented entities from conducting s rep no pincite general explanation of tax legislation pincite for example in describing a bill that was similar to the enacted version of sec_7874 senators grassley and baucus described inversion_transactions in which these foreign parent corporations are nothing more than a sheet of paper in a filing cabinet grassley and baucus called such an inversion a purely paper transaction with no substantive change in the current business operations of the u s_corporation or its foreign subsidiaries ranking member chuck grassley r-ia and chairman max baucus d-mt reversing the expatriation of profits offshore repo act press briefing memo tax analysts doc no webster’s third new international dictionary of the english language unabridged pref-120527-10 business with a foreign parent in the same manner as they did prior to the inversion_transaction especially where the transaction lacks non-tax effect and purpose finally and consistent with the legislative intent the regulations interpreting substantial_business_activities make clear that the term substantial cannot be interpreted to mean more-than-minimal the preamble to the temporary regulations which contained a similar facts-and-circumstances test to the regulations at issue makes clear that the regulations were not intended to permit inversion_transactions where the expanded affiliated group’s activities were simply more-than-minimal the preamble states that the irs and the treasury_department believe that congress was concerned about transactions where the new foreign parent entity is incorporated in a country in which the expanded_affiliated_group does not have a bona_fide business presence that is meaningful in the context of the group’s overall business emphasis added the subsequent elimination of the percent safe_harbor provides further support that the regulations should not be interpreted based on a more-than-minimal standard the safe_harbor was removed because it was considered to be insufficiently stringent-not because it was too difficult to satisfy accordingly the substantial_business_activities requirement is not interpreted based on the more-than-minimal standard as taxpayer asserts instead the requirement in sec_7874 will not be satisfied only if the new x eag’s country business activities are substantial when compared to its total business activities d application of items enumerated in regulations to the new x eag the new x eag’s country business activities must be evaluated based on all the facts and circumstances including the five items set forth in the regulations the key to the substantiality determination under the statute and the regulations is a comparison of the amount of business activities in country to the total activities of the new x eag worldwide thus while the business activities in country may seem sizeable they will fail to constitute substantial_business_activities within the meaning of the statute and regulations if relatively insubstantial when considered in the overall context of the eag’s total worldwide business activities as discussed below the facts and circumstances including the items enumerated in the regulations do not s rep no pincite td td fr big_number the irs and the treasury_department have concluded that the safe_harbor provided by the temporary regulations may apply to certain transactions that are inconsistent with the purposes of sec_7874 which is meant to prevent certain transactions that seek to avoid u s tax by merely shifting the place of organization of a domestic_corporation or partnership the temporary regulations therefore do not retain the safe_harbor provided by the temporary regulations pref-120527-10 support the position that the new x eag conducted substantial_business_activities in country for purposes of sec_7874 historical conduct of continuous business activities x was formed in year ----------- a historically u s -based --------------- combined its ---- ------- operations into a single subsidiary the --------divisions from which x was formed conducted business activities in the united_states by --------------------- -------since its founding in year and x has conducted business activities in the united_states since its formation thus prior to the ----------------------------------x and the divisions from which it was formed had conducted business activities continuously in the united_states for approximately ----- years x has no similar historical conduct of continuous business activities in country as recently as the years year through year x had only a nominal presence in country x’s country business activities were expanded beyond this nominal presence in year as a result of the acquisition of the e business taxpayer asserts that it historically conducted substantial activities in country because it had conducted operations in country since it first became an independent company in year ------------------------------------ taxpayer further notes in support of this contention the acquisition of e in year the regulations are devoid of any suggestion that the historical conduct of continuous activities in the foreign_country may be supplied by a recent acquisition the contrary suggestion follows from the plain meanings of historical and continuous similarly the regulations do not support the taxpayer’s notion that the historical conduct of continuous business activities begin only when they are operated in an independent company -- as opposed for example to being operated in a subsidiary or division of its predecessor company ---------------------------------------------------------- the regulations require that the substantiality determination including the relevant items in this instance the historical conduct of continuous business activities must take into account the total business activities of the eag thus the relevant period of time in each of these years less than ------ percent of x’s net property at year-end was located in country and country represented slightly over ------ percent of its net sales by comparison over ---- percent of x’s net property and net sales were in country in each of such years we distinguish between historical activities of the predecessor corporations the businesses or stock of which were acquired through mergers or stock for stock exchanges and the historical activities of business entities which were merely purchased the predecessor corporations which were merged or acquired for stock are really just continuing in a different corporate form accordingly their activities are relevant for this factor however the historical activities of the corporations or the corporations’ businesses which were merely purchased for cash are not relevant to the analysis of this factor pref-120527-10 for assessing this item is the ------year history of x the x business activities have been conducted continuously in the united_states - and not country - over x’s entire ------ year history x conducted almost no meaningful business activities in country until the acquisition of d in year thus x has not historically conducted continuous business activities in country the conduct of continuous business activities a property located in country currently new x operates its business in ---- countries through approximately ----- sites ---- of which are located in country -----percent country assets generally were associated with new x’s e business which constitutes a segment of one of its ------------ ---------------------------------------------------------------------------------------------------------core businesses the --------------------------- business country assets generally were not associated with new x’s other ------core business segments based on new x’s financial statements as of date year new x’s country assets constituted ---- percent of x’s total property plant and equipment this amount is based on book_value which approximated the fair_market_value of the assets taxpayer’s tax opinion states that the new x eag’s country assets account for ---- percent of the group’s total book_value as of the same date the taxpayer asserts that the country assets constitute much higher percentages of the new x eag’s total assets taxpayer asserts that the cash in excess of dollar_figure------------ held in country should be excluded from the calculation because cash is passive in nature and therefore not relevant in measuring business activities taxpayer also asserts that including passive_assets in the calculation would be manipulable excluding the cash from the value of the gross assets as taxpayer asserts would result in ------ percent of the assets being located in country taxpayer also asserts that the comparison should be based on the fair_market_value of the assets net of liabilities taking into account the value of assets including cash less liabilities would result in ---------percent of the assets being located in country excluding the cash the historic country presence of d should not be taken into account in this analysis sec_1 c ii contains a special rule that the active trade_or_business test of sec_1 c i a is satisfied when the transferee foreign_corporation acquired at the time of the exchange or any time prior to the exchange a trade_or_business that had been active throughout the entire month period preceding the exchange the sec_7874 regulations do not contain such a rule and as already noted they do not suggest that historical business activities can be acquired taxpayer’s tax counsel opinion page appraiser concluded that the net equity value of x’s country entities represented --------percent of x’s business_enterprise value as of --------------- ---------- pref-120527-10 and taking into account assets reduced by liabilities would result in ---- percent of the assets being located in country however nothing in the regulation suggests that cash should be excluded from the calculation while it is true that passive investment-type assets may not be indicative of active business activities in many cases new x’s cash was not held in this capacity indeed the taxpayer’s own draft tax opinion acknowledges that the approximately ----- --------- in cash provided by -- and the ------------------ was contributed to new x -------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------- in other words without this capital x might not have ------------------------------------------------------------------- accordingly the cash is an important part of the new x eag’s business activities and therefore must be taken into account for this purpose in addition measuring the assets net of liabilities is inconsistent with a plain reading of the regulation and the policy underlying the provision the regulations provide that property located in the foreign_country should be considered this language does not provide that liabilities are relevant or should otherwise be taken into account in addition taking into account liabilities could produce artificial and inappropriate results because an expanded_affiliated_group depending on its financial situation may be able to choose which member of the group will borrow the necessary funds and then to move the cash around through contributions and distributions this relative amount of country assets is not indicative of substantial_business_activities in country when compared to the total business activities of the new x eag b the performance of services in country as of date ---------- country employees represented approximately -----percent of the new x eag’s employees and -----percent of its payroll this relative amount of country services is not indicative of substantial_business_activities in country when compared to the total business activities of the new x eag c the sales of goods in country indeed the preamble to the regulations provides that the statutory phrase ‘business activities’ ordinarily does not include passive investment activities and related_income and assets and that investment activities should not be given any significant weight td 2006_2_cb_252 taxpayer’s tax counsel opinion page for example the regulations could have provided that net properties or properties reduced by the amount of liabilities are considered see supra footnote pref-120527-10 for the nine months ended date ---------- -----percent of the x eag’s total sales were made in country including sales to affiliates and -------percent of x’s net sales were from goods --------------------in country for the period from -------------- ---------- through - -------------- ---------- this relative amount of country sales is not indicative of substantial_business_activities in country when compared to the total business activities of the new x eag substantial managerial activities at the time of the --------------------------------- the new x eag’s headquarters and top management responsible for the eag’s overall business objectives and leadership were located in country not country in addition the regional headquarters of the new x eag were in country country and country not country in fact the divisional offices for x’s ----------------------------business unit of which the majority of new x’s country assets were a part were located in country not country as of date ---------- only -----percent of new x eag’s executives responsible for overseeing local country operations were located in country this relative amount of country local managerial activities is not indicative of substantial_business_activities in country when compared to the total business activities of the new x eag degree of ownership by investors resident in country at the time of the --------------------------------- none of the holders of the new x equity securities was resident in country accordingly investor ownership does not support a finding of substantial_business_activities in country business activities material to overall business objectives new x has asserted that its e business located in country is important to the achievement of its -----------objectives in addition its ---------------------facilities in country produce other ---------------- parts the materiality of the new x eag’s country business activities under the regulations must be measured in the context of the total business activities and the overall business objectives of the eag as of the time of the --------------------------------- the country business operations are not highlighted in the ------------------------------------------------------- business model as described in public filings in its country tax filings new x reported that it was managed and controlled in country rather than country pref-120527-10 --------------------------------------------------------------------------------------------------- ------ -- ----------------------- ----------------------------------------------------------------- --------------- ------------------------------------------------- --------------------------------- ------------------------------------------------------------------------------------------- ------- ------------ --------------------------------------------------------------------- ---------------- ---------- ----- ----------------------- --------------------------------------------------------- ------------------ -------------------------------------------------------------- ----------------- -------------- this discussion makes no mention of country in addition taxpayer does not suggest that its country operations contribute to its ---------------------model such public filings also stated that x intends to focus its business on --------------markets as -------------------- --------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------- ----------- ------------------------------------------------------------------------------------------------------ -------------- ------------------ ----------------------------------------- --118 this is a category of countries that clearly does not include country or for that matter ----------------------- the largest market for its ------------------- further although the new x eag had a small number of executives and members of management in country its headquarters and overall management were located in country at the time of the --------------------------------- accordingly the new x eag’s country business activities were not responsible for the group’s overall leadership at the time of the --------------------------------- finally the new x eag’s country activities are relatively small when compared to its worldwide activities which include ------main businesses ---------------------------------------- --------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------- as noted above country operations were largely focused on e systems which is only one segment of one of these ------businesses in its ---------------- x stated that its -------- ------------- ---------------and -----------------were located in ---- major --------------centers in -- ----- enumerated countries as country was not included in that list the centers located in country were not considered to be major by new x the ----- was later amended to state that new x has ---- major --------------centers in ----------enumerated countries including country only after the lack of any reference to country was noted by the service the country operations do contribute to one stated strategic objective of new x that is to develop -----------------------------------focused on creating -------------that are -------- it ----------------------------------------------------------------------------------------------- id pincite in fact as of year the new x eag employed approximately -----------employees in country which is approximately ----------times greater than its number of country employees as of year pref-120527-10 is not clear how important the e business is to the -------- objective however as x country 5’s --------------made little mention of -------------------in its discussion of this objective further any such contribution is made within one out of ------divisions of the business and to one of several overall business objectives thus while this contribution may be important by itself as noted under the statute and regulations the substantiality determination must take into account the total business activities of the expanded_affiliated_group under all the facts and circumstances country business activities are not material to the achievement of the overall business objectives of the eag e conclusion following is a summary of the foregoing analysis of the items to be considered under the regulations in assessing whether the taxpayer had substantial_business_activities in country when compared to the total business activities of the eag item new x eag - percentage in country historical business activities no property located in country operating sites property services headcount compensation sales managerial activities executive officers ----- ----- ----- ----- ----- -- for example --------------------------------------------------------------------------------------------------------------------- ---section of the business_discussion did not mention ------------------- and the section entitled ----------------- ----------------------- only mentioned it once in a sentence that did not differentiate e and ------------------------- -------------------------------------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------- see ------------------------ -------------- at -------- pref-120527-10 regional management local management country 1-resident owners business activities material to overall business objectives -- ----- none no under the regulations the substantial_business_activities determination is based on all facts and circumstances the determination is not solely based on the absolute amount of business activities in the foreign_country rather the determination is based on a comparison of the amount of business activities in the foreign_country to the total business activities of the expanded_affiliated_group the regulations require the determination of substantiality to take into account the total business activities of the group including the above relevant items the presence or absence of any item or set of items is not determinative moreover the weight given to any item or set of items depends on the facts and circumstances after examining all of the facts and circumstances including the items enumerated in the regulations after the acquisition the new x eag does not have substantial_business_activities in country when compared to its total business activities although its country business activities may be viewed as being more than minimal this is not the relevant standard the country activities of the new x eag must be substantial when compared to its total business activities from both a quantitative and qualitative perspective the new x eag’s country business activities are not substantial when compared to those of the entire new x eag they were insubstantial in size and scope relative to new x’s overall business activities and objectives - historically at the time of the --------------------------------- and under its ----------------------------------------business model therefore after the acquisition the new x eag does not have substantial_business_activities in country when compared to the total business activities of the new x eag and the requirement in sec_7874 is satisfied ix ---------------------------------------------------------------------------------------------------------------- ----------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- pref-120527-10 --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- -----------------120 ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------ sec_1_7874-2t m provides that if a foreign_corporation is treated as a domestic_corporation pursuant to sec_7874 sec_367 does not apply to any transfer of property by a united_states_person to such foreign_corporation as part of the acquisition described in sec_7874 as noted above in section iii of the law and analysis section of this memorandum for purposes of sec_7874 new x is ---------------a foreign_corporation ---------------------- ---------------------------------------- in addition as discussed in sections vi vii and viii of the law and analysis section of this memorandum each of the three requirements in sec_7874 is satisfied and as a result new x is treated as a surrogate_foreign_corporation as discussed in section vii of the law and analysis section of this memorandum the ownership fraction is percent and as a result new x is a surrogate_foreign_corporation to which sec_7874 applies -------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------- finally under sec_1_7874-2t m the transfer of property from old x to new x is not subject_to sec_367 case development hazards and other consideration sec_120 ----------------------------------------- ---- the regulation further provides however that sec_367 does apply to the conversion of the foreign_corporation to a domestic_corporation pref-120527-10 this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views please call if you have any further questions