The U.S. Treasury Department issued temporary regulations last week – effective Friday, April 8 – that change the landscape for U.S. companies interested in “inverting,” as we reported here. Corporate inversion is the general term for a number of transactions, including a merger that has the effect of relocating a U.S. corporation’s legal domicile to a country with a lower tax rate. To discourage corporate inversions and preserve U.S. tax revenue, Congress has legislated to impose penalties in the Internal Revenue Code (IRC) (that can operate to nullify some or all of the tax benefits of an inversion) and in the body of government contract law (that render inverted companies ineligible to obtain government contracts and funding). The new regulations will have significant implications on the inversion analysis from a tax perspective; however, they are not expected to impact U.S. government procurement law.

  • Tax Impact of Temporary Inversion Regulations. The temporary regulations target inversion deals by applying a new (and stricter) methodology for determining whether a company meets the statutory control/stock ownership thresholds that apply in considering whether a corporation is inverted. If a transaction is classified as an inversion in which the shareholders of the U.S. company continue to own 80 percent or more of the stock of the foreign parent, the foreign parent is treated as “tax resident” in the U.S. in the same manner as a domestic company – in effect, the transaction is not respected for U.S. tax purposes. If the shareholders of the U.S. company own between 60 and 80 percent, certain tax benefits of the inversion are disallowed, including the ability to use net operating losses or other tax attributes to reduce U.S. tax on the “offshoring” of U.S. assets and the ability to access “trapped cash” in controlled foreign subsidiaries without paying U.S. tax. The new rules provide that in determining whether the 60 and 80 percent ownership tests are met, stock of the foreign company attributable to assets acquired from a U.S. corporation during the past three years is disregarded. In essence, the new rules “slim down” foreign companies that have “fattened up” through multiple inversion transactions in the three-year period before an inversion and make it harder for the shareholders of the domestic corporation to stay below the 60 and 80 percent ownership thresholds.
  • Government Contract Impact of Temporary Inversion Regulations. Inverted domestic corporations (IDC) per the Federal Acquisition Regulations (FAR) are penalized greatly in that the government may not enter into or fund any contract with any such corporation. The FAR provides that a company can avoid being considered an IDC if it can show that the shareholders of the legacy domestic company own less than 80 percent of the former domestic company’s stock by vote or value or if it can show that it has “substantial business activities” in its new country of domicile. The government contracts inversion test does not venture beyond this 80 percent ceiling to apply the stricter 60 percent ceiling (and thus does not create the 60- to 80-percentage span as does the IRC). While the test for determining whether a company is an IDC under the FAR mirrors the 80 percent threshold test used by the IRC, the FAR does not cross-reference the IRC or its regulations. Accordingly, Treasury regulations – such as the temporary ones issued earlier this week – addressing computation of ownership in the context of the inversion thresholds – do not apply in the government contracts context, unless and until they are adopted into the FAR.

Given Treasury’s bold steps as of late, who knows what steps Congress – or the FAR Council – will take to next. Recently, there has been a flurry of proposed legislation on this front. While nothing has passed yet, the key takeaway is that government contractors should stay tuned. For additional information about this topic, please contact the authors of this posting or the Hogan Lovells attorney with whom you work.