On July 11, 2018, Treasury and the Internal Revenue Service (IRS) published final inversion regulations (TD 9834) which are largely consistent with the temporary (T.D. 9761) and proposed regulations (REG-135734-14) (together, the 2016 regulations) published on April 8, 2016.

  • The final regulations, like the 2016 regulations, target so-called “inversions,” which are transactions that generally involve the acquisition of a US corporation or business by a foreign corporation in exchange for shares when the former shareholders of the US corporation own 60% or more of the acquiring foreign corporation. Congress, Treasury and the IRS have targeted through legislation and regulations the tax benefits that may be obtained by inverted corporations.
  • Section 7874 requires an examination of the shareholder overlap between a domestic corporation and an acquiring foreign corporation before and after a transaction (the Stock Ownership Test) in order to determine whether to treat the foreign acquiring corporation as a domestic corporation going forward or to limit its use of certain tax attributes, unless the resulting group has sufficient activities in the new jurisdiction (the Substantial Business Activities Test).
  • The final regulations largely adopt the changes in the 2016 regulations to these tests, which were tailored to increase the circumstances under which section 7874 applies.
  • The final regulations make some limited modifications and clarifications to the 2016 regulations, including to the rules applying the Stock Ownership Test which can disregard foreign acquiring corporation stock issued in certain prior domestic entity acquisitions (the Serial Acquisitions Rule).
  • A US District Court invalidated the Serial Acquisitions Rule in the 2016 regulations for failure to comply with the notice and comment requirements of the Administrative Procedure Act (APA). Chamber of Commerce v. IRS, 2017 WL 4682049 (W.D. Tex. 2017). The government is expected to withdraw its appeal of the District Court’s decision.
  • The final regulations were reviewed by the Office of Management and Budget (OMB) for at least 124 days, almost triple the period reflected in the Memorandum of Agreement between OMB and Treasury.



Under section 7874, certain US federal income tax attributes are not allowed to be utilized to reduce federal income tax on certain income and gain of “surrogate foreign corporations.” A foreign corporation generally is treated as a foreign surrogate corporation if, pursuant to a plan:

  1. the foreign corporation directly or indirectly acquires substantially all of the properties held directly or indirectly by a domestic corporation,
  2. the Stock Ownership Test is satisfied (i.e., after the acquisition, at least 60% of the stock by vote or value of the foreign acquiring corporation is held by former shareholders of the domestic corporation by reason of having held stock in the domestic corporation), and
  3. the Substantial Business Activities Test is not satisfied (i.e., the resulting expanded affiliated group does not have substantial business activities in the country in which the foreign acquiring corporation is organized).

Alternatively, if the foreign corporation would otherwise be a surrogate foreign corporation and former shareholders of the domestic corporation hold at least 80% of the stock (by vote or value) of the foreign acquiring corporation by reason of having held stock in the domestic corporation, the foreign acquiring corporation is treated as a domestic corporation for all purposes. The rules apply analogously to the acquisition by a foreign corporation of substantially all of the properties constituting a trade or business of a domestic partnership (for simplicity, the discussion below describes the rules in the context of corporations).

Stock Ownership Test

The final regulations focus significantly on the rules for calculating the ownership percentages for purposes of the Stock Ownership Test. Consistent with the 2016 regulations, the final regulations provide special rules with respect to:

  • stock attributable to prior domestic entity acquisitions (i.e., the Serial Acquisitions Rule);
  • stock attributable to passive assets (the Passive Assets Rule);
  • certain inversion transactions involving a change in tax residence of the foreign corporation (the Third-Country Rule); and
  • certain non-ordinary course distributions (the NOCD Rule).

The final regulations also modify the application of certain de minimis exceptions applicable to calculations under the Stock Ownership Test.

Serial Acquisitions Rule

The final regulations retain the Serial Acquisitions Rule from the 2016 regulations, which excludes stock of the foreign acquiring corporation from the denominator of the ownership fraction if attributable to a prior domestic entity acquisition within the 36-month period ending on the signing date of the relevant domestic entity acquisition. The rule was designed as an administrable test to prevent foreign acquiring corporations from increasing in size and allowing for acquisitions of even larger domestic entities without being subject to section 7874. The final regulations clarify that the determination of stock of the foreign acquiring corporation attributable to a prior domestic entity acquisition does not include certain stock deemed received in the prior domestic entity acquisition (due to the NOCD Rule or certain other disregarded transfers). In addition, an exception is provided for previous domestic entity acquisitions within a foreign-parented group. It was determined that such prior transactions should not be viewed as creating a platform for larger domestic entity acquisitions.

The preamble also expressed the IRS’s disagreement with the District Court’s invalidation of the Serial Acquisitions Rule in Chamber of Commerce.

Passive Assets Rule

The Passive Assets Rule excludes from the denominator of the ownership fraction stock of the foreign acquiring corporation attributable to certain passive assets. Under the 2016 regulations, the Passive Assets Rule applied for purposes of determining the ownership percentage by vote and value. Considering the rule excludes an amount of stock and not particular shares of stock, the final regulations only apply the rule for purposes of determining the ownership percentage by value. In the event that classes of stock of the foreign acquiring corporation have different voting power, Treasury and the IRS found it too complex and burdensome to provide for a special rule for an appropriate exclusion allocation for purposes of the vote test. Further, the final regulations provide that stock excluded under any other stock exclusion rule is not taken into account for purposes of calculating the stock exclusion amount under the Passive Assets Rule.

Third-Country Rule

To address a concern that the tax residence of the foreign acquiring corporation may be driven by tax planning, the 2016 regulations provided a rule that excludes stock of the foreign acquiring corporation from the denominator of the ownership fraction when a domestic entity acquisition is a “third-country transaction.” A third-country transaction occurs when a foreign acquiring corporation that would otherwise become a surrogate foreign corporation acquires a foreign corporation in connection with the acquisition of a domestic corporation, and the foreign acquiring corporation is tax resident in a different country than the acquired foreign corporation.

The final regulations adopt the Third-Country Rule with certain exceptions. First, where the expanded affiliated group has substantial business activities in the third country compared to the total business activities of the expanded affiliated group excluding the acquired domestic corporation, the rule does not apply. Second, the rule likewise does not apply if the foreign acquiring corporation and the acquired foreign corporation are both created or organized in, or under the law of, foreign countries that do not impose a corporate income tax and neither is a tax resident of another foreign country. However, Treasury and the IRS declined to provide a requested exception based on a comparison of treaty benefits. The final regulations also provide that a change in the tax residency of the acquiring foreign corporation in connection with the acquisition of a domestic corporation will be treated as the acquisition of a foreign corporation that implicates the Third-Country Rule.

Non-Ordinary Course Distribution Rule

The 2016 regulations provided a NOCD Rule that, for purposes of determining the ownership percentage by value, deems domestic corporation shareholders to receive (by reason of holding stock of the domestic corporation) an amount of stock of the foreign acquiring corporation with a fair market value equal to the aggregate value of NOCDs made by the domestic entity in the 36 months prior to the acquisition.

The final regulations provide for seven clarifications or modifications with respect to the NOCD Rule. For example, the final regulations clarify that a distribution to which section 355 applies, even if it is part of a reorganization described in section 368(a)(1)(D), does not qualify for the asset reorganization exception to the NOCD Rule.

Further, the final regulations modify a special rule that applies to a distribution of stock of a domestic controlled corporation by a domestic distributing corporation in a section 355 transaction. The final regulations make it clear that the rule considers only the fair market value of the stock of the controlled corporation owned by the distributing corporation and any related person in determining whether the fair market value of the controlled corporation represents more than 50% of the fair market value of the stock of the distributing corporation. If so, the controlled corporation is deemed for purposes of the NOCD Rule to have distributed the stock of the distributing corporation.

In addition, the final regulations clarify the interaction of the NOCD Rule and the expanded affiliated group (EAG) rules; confirm that NOCD stock is included in both the numerator and the denominator of the ownership fraction except as provided in the EAG rules; and provide rules for allocating NOCD stock among former domestic corporation shareholders, characterizing NOCD stock when there are multiple foreign acquiring corporations, and applying the NOCD Rule when two or more domestic corporations are treated as a single domestic entity.

De Minimis Exceptions

Certain rules under section 7874 contain a de minimis exception, in recognition of the fact that minimal actual ownership continuity largely resembles a cash purchase of the domestic corporation. For administrative ease, the final regulations provide that only former domestic corporation shareholders that own (taking into account applicable attribution rules) at least 5% of the stock of the domestic corporation need to be identified. If no such former domestic corporation shareholder (taking into account applicable attribution rules) owns 5% of the foreign acquiring corporation or a member of the expanded group, the de minimis exception applies and the relevant rule that would otherwise increase the deemed ownership by shareholders of the domestic corporation is not implicated.

Substantial Business Activities Test

Under the Substantial Business Activities Test, the foreign acquiring corporation must be subject to tax as a resident of the foreign country in which, or under the law of which, the foreign acquiring corporation was created or organized, in addition to demonstrating certain significant levels of activity in that country. Under the final regulations, a tax resident is defined as “a body corporate liable to tax under the laws of the country as a resident.” The preamble provides that such a definition prevents the need for guidance with respect to fiscally transparent entities. In addition, when the relevant foreign country does not impose corporate income tax, the tax residency requirement does not apply, and only the activity levels must be met to satisfy the test.

Post-Inversion Tax Avoidance Transactions

The 2016 regulations also provided rules under sections 304(b)(5)(B), 367, 956(e), and 7701(l) to address certain transactions taxpayers have engaged in with respect to inversions in order to erode the US tax base. The final regulations adopt these rules with minor modifications.

Of note, Treasury and the IRS did not adopt a comment that regulation section 1.956-2T be expanded to apply to all foreign-parented groups, and not only those that are foreign-parented as a result of an inversion transaction. Under regulation section 1.956-2T, United States property can include under certain circumstances an obligation of a foreign person and the stock of a foreign corporation. The preamble indicates that Treasury and the IRS are continuing to study the comment. Additionally, the final regulations made nomenclature changes, addressed “downward attribution” in light of the repeal of section 958(b)(4), and adopted the section 956 short-term obligation exception promulgated through prior Notices.

Effective Date 

The applicability dates of the rules in the final regulations are generally the same as those provided in the 2016 regulations. However, differences between the final regulations and the 2016 regulations generally apply on a prospective basis, with an election for taxpayers to apply the differences retroactively.

Eversheds Sutherland Observation: The 2016 regulations were issued contemporaneously with the section 385 regulations which together were meant to significantly diminish the US federal tax benefits of corporate inversions through earnings-stripping. While it is widely believed that the section 385 documentation requirements will be withdrawn in light of US tax reform changes, Treasury officials have commented that the debt recast rules of regulation section 1.385-3 may remain. See the Legal Alert entitled Rethinking Regulations: Treasury Report Targets Regulations to Reduce Burden, October 12, 2017. The Tax Cuts and Jobs Act (TCJA), Pub. L. No: 115-97, and pending guidance issued thereunder, primarily with respect to the base erosion and anti-abuse tax (i.e., BEAT) and new section 163(j), are likely the primary tools to further curtail the US tax benefits of corporate inversions, rather than additional targeted regulatory actions of Treasury and the IRS specifically addressing such transactions.


Based on the government’s filings in the Fifth Circuit appeal of Chamber of Commerce, it appears that the final regulations were under OMB review on March 9, 2018. The government represented at that time that issuance of the regulations was “imminent.” The final regulations were not issued until July 11, 2018, 124 days later. The April 11, 2018 Memorandum of Agreement between OMB and Treasury provides for an OMB review period of only 45 days.

Eversheds Sutherland Observation: As discussed above, the final regulations are similar in most respects to the 2016 regulations. If OMB required more than four months to review the final regulations, it is not clear how OMB will meet the 10-day target in the Memorandum of Agreement for tax reform regulations.

The government represented it would withdraw its appeal of Chamber of Commerce once the regulations were finalized. Taxpayers may continue to challenge the validity of the 2016 regulations and the final regulations under the APA.