It seems like every day brings news of another possible corporate inversion transaction. The news reports usually describe these transactions as another United States corporation moving or relocating outside of the country. While the management of the U.S. company tries to downplay the tax impact, most of these transactions are largely driven by tax savings – for the corporation. While they may lower taxes for the corporations that are inverting, these transactions generally result in tax bills for many shareholders.
The U.S.-based company does not actually move offshore in an inversion transaction. Instead, the company agrees to acquire a foreign corporation and structures the acquisition so that the U.S. company becomes a subsidiary of the foreign company it is acquiring. The shareholders of the U.S. company exchange their shares for shares of the foreign corporation. Since the U.S. company usually has a larger market capitalization than the foreign corporation, at the completion of the transaction the former shareholders of the U.S. company often end up owning more than 50 percent of the shares of the foreign corporation that was acquired. The foreign corporation must have sufficient market capitalization so that the U.S. shareholders do not end up owning 80 percent or more of the foreign corporation, or it will be treated as a U.S. corporation for income tax purposes and the inversion will not have accomplished anything. (Some of the proposals being discussed in Congress to stop inversions would lower this threshold to 50 percent.)
Transactions involving the exchange of stock for stock of the acquiring company are normally structured in a manner that allows the U.S. shareholders to exchange their stock without having to recognize any tax gain that may be inherent in their shares. A different rule applies, however, where the shares are exchanged for shares of a foreign corporation in which the U.S. shareholders will receive more than 50 percent of the stock. In that case, the exchange is taxable to the U.S. shareholders. The taxes may be significant if a shareholder owns a large block of stock, the shareholder has held it for a very long time and it has a low cost basis.
While the shareholders are given an opportunity to vote on the transaction, many of the outstanding shares may be owned by pension funds and other institutions that are not sensitive to tax considerations. Individual shareholders may be forced into a transaction that will result in a large tax bill. If you are charitably inclined, donating the shares of a corporation that is likely to be inverted may be a smart move. You can give the shares to a charity without recognizing your tax gain and still receive a charitable contribution deduction for the full fair market value of the shares, subject to the applicable percentage limitations.
If you want to consider a charitable contribution of shares of a company likely to invert, you must make the contribution before the transaction has received all necessary approvals and the charity is legally required to exchange the shares for shares of the foreign corporation. If you wait too long, the gift will be treated as one in which you sold the shares and then gave the resulting cash to the charity. The safest course is to donate the shares before the shareholders of the U.S. company have approved the transaction.
Concerned that Congress would not be able to act on inversion transaction in an expeditious manner, the IRS on September 22 issued Notice 2014-52. The Notice provides that regulations will be issued under five different sections of the Internal Revenue Code in order to make inversions more difficult to implement and to reduce the tax benefits of inverting. The regulations will be effective for inversion transactions completed on or after September 22, 2014.
The regulations will make it more difficult for a U.S. corporation to invert by tightening the rule that the former shareholders of the U.S. company cannot own 80 percent or more of the foreign acquirer after the inversion. The bulk of the regulations will make inversions less beneficial by making it more difficult for the new foreign parent to utilize the tax-deferred foreign earnings of the acquired U.S. company. We will continue to monitor this area and keep you apprised of any further developments.